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The SEC’s Progressive Rulemaking Will Be Its Statutory Undoing
Proposed rules such as enhanced climate disclosures show that the agency is overreaching its congressional mandate in pursuit of a political agenda
By Stone Washington
Over the past two years, the Securities and Exchange Commission (SEC) has radically shifted priorities. It has moved from its mission of protecting investors and maintaining fair, orderly and efficient markets toward the wholly political cause of supporting an environmental, social and governance (ESG) framework.
Some in Congress have tried to call attention to the problem, but SEC Chairman Gary Gensler, appointed by President Biden in 2021, has mostly stonewalled lawmakers. Even Gensler’s five-hour testimony before the House Financial Services Committee on April 18 did not explain the agency’s need to pursue controversial rules like its proposed enhanced climate disclosures, which would compel tens of thousands of public companies to disclose financial metrics and corporate activities that could conceivably foster climate change risks. The SEC’s focus on rules that control activities outside its purview shows that it’s time for Congress to rein in agency overreach.
Aggressive Agency Rulemaking
The new activist bent of the agency appears to come from a centralized, top-down power structure. With Gensler’s tenure of only two years at the SEC, his employees have proposed a record number of federal rules. So far, Gensler has overseen 53 new rules, which is twice as many as those of his two immediate predecessors, Jay Clayton (26) and Mary Jo White (23). In fact, Gensler’s SEC has already proposed the same number of rules that White oversaw during her entire four-year tenure. This increase in rulemaking is acknowledged by the agency itself. According to an inspector general report cited in the SEC’s 2022 Financial Report, “In only the first 8 months of 2022, the SEC proposed 26 new rules, which was more than twice as many new rules as proposed the preceding year.”
The agency now averages more than two rule proposals per month and has finalized many of these rules at the bureaucratic equivalent of a breakneck pace. SEC commissioners have scaled back the average time for members of the public to issue comments on proposed rules. Typically, an individual has 60 days to submit a public comment to a proposed new rule. But the SEC has shortened this period to 45 or even 30 days for many of its rules. The public has been granted 21% less comment time during a period when administrative rulemaking is proceeding 200% faster than normal. In other words, Gensler’s SEC is advancing twice as many regulations as usual on investors and public companies, while giving them less time to react.
Compounding this dilemma are many internal issues plaguing the commission. Under Gensler, workforce attrition at the SEC has leaped to its highest rate in 10 years. The inspector general report reveals that 6.4% of the agency’s workforce—or about 289 positions—were vacated in fiscal year (FY) 2022. Undaunted, the agency is pressing Congress to fund even more positions. The SEC recently requested funding for a total of 5,261 positions. That would be 454 more than the agency was granted in FY 2022, an 8.4% increase. Even if funded, it will be hard for the SEC to fill those jobs. The inspector general reports that the federal government takes on average 98 days longer, or twice as long, to hire new employees than private-sector employers do. This will place more burden on the SEC’s human resources department, its Office of Minority and Women Inclusion and senior management. The agency has taken 100 business days or more to fill positions 50% of the time.
Another problem with the SEC’s aggressive rulemaking is that rule-makers themselves often have insufficient time to weigh the consequences. Many of the agency’s major proposals over the last two years lacked substantive statutory justification and clear assessment of their financial costs. This criticism has been leveled at the agency’s climate disclosure rule, four-part equity market overhaul and its corporate political spending disclosure rule. During the recent hearing, House Financial Services Committee Chair Patrick McHenry charged that Gensler “failed to justify these significant rules with thorough evidence, careful studies, and even cost-benefit analysis.”
Enhanced Climate Disclosures
The SEC’s climate disclosure rule is the centerpiece of Gensler’s agenda. This rule would require publicly traded companies to disclose how their activities might affect the environment via greenhouse gas emissions. A 490-page regulatory behemoth, the rule stands to increase annual disclosure costs on companies by $6.4 billion, marking a 250% increase. The annual internal work burden for employees of affected companies will rise by 5.8 million hours, a 23.6% increase, while companies will be forced to pay $6.3 billion in added fees to hire professionals every year.
To this day, Gensler has yet to provide members of Congress with an internal cost-benefit analysis of its proposed mandate. The rule relies only upon base cost estimates from separate analyses on the registration information and disclosures of 6,000 affected companies. The proposed rule does not reveal a concrete internal economic analysis that properly weighs the potential benefits of the rule with the severe costs imposed on public companies.
Gensler’s April appearance before Congress provided little assurance that such an analysis of the rule would be provided, fueling GOP criticism that the SEC chair is deliberately stonewalling requests to evade proper congressional oversight.
In the “economic analysis” section of the rule, the SEC claims that the perceived benefits—“investor protection, improving market efficiency, and facilitating capital formation”—will thrive from the rule’s passing. Yet the rule itself does little to explain how mandatory climate disclosures will enhance market efficiency or provide investor protection. While some environmentally conscious investors will appreciate the greater corporate transparency such disclosures provide, the rule will simultaneously disadvantage many companies in the process.
Under the rule’s “indirect costs” section, companies will be forced to share valuable internal information that is typically kept from the public eye. This includes information about supply chains, operating locations, production processes and business models. This informational exposé will disadvantage many companies while giving a leg up to their competitors, as the rule itself admits: “To the extent that a registrant’s business model or strategy relies on the confidentiality of such information, the required disclosures may put the registrant at a competitive disadvantage,” it states.
Additionally, the rule’s pro-ESG focus will unofficially blacklist many greenhouse gas-emitting companies. This practice is often referred to as “ESG screening,” where certain factors are assessed by an individual’s decision to invest in a company or product. Fossil fuels, firearms, private prisons and tobacco are among the many industries screened out of consideration by investors with ESG-conscious portfolios. By mandating climate disclosures, the SEC’s rule would empower ESG advocates to more effectively screen out producers of oil, coal, natural gas and other commodities deemed a threat to the climate.
U.S. capital formation is not likely to benefit from the SEC’s climate disclosure rule. In fact, none of Gensler’s 53 rules effectively address the problem of capital formation. In the U.S., the rate of new public companies entering the market by floating their shares or offering initial public offerings (IPOs) has hit a 30-year low. Last year, the capital output from IPOs declined by 94% compared with 2021, while the number of U.S. IPOs dropped by a staggering 78%. That seems like something the SEC might want to address.
Reps. Patrick McHenry (R-NC) and Ann Wagner (R-Mo.) voice these concerns in a letter released prior to Gensler’s April hearing. Instead of addressing the deterioration of public markets, “the Commission has focused on implementing costly regulatory disclosure requirements on topics that go beyond its scope,” the letter reads. “The SEC must shift its priorities towards facilitating capital formation and ensuring that American public markets remain the most attractive in the world.”
Other Regulatory Overreaches
Beyond climate disclosures, the SEC has also proposed a rule to compel companies to disclose political campaign contributions in their annual filings. Where the climate disclosure rule reveals an SEC attempt to regulate greenhouse gas emissions in place of the Environmental Protection Agency, the political campaign disclosure rule is an attempt for the agency to regulate campaign donations in place of the Federal Election Commission. In this, the SEC was again attempting to assume regulatory authority that Congress has not delegated to it, until the rule was barred from implementation by a Republican rider in the FY 2022 congressional budget.
The SEC has more vigorously pursued rules and enforcement actions that target cryptocurrency companies. Under Gensler’s watch, the agency’s Crypto Assets and Cyber Unit has leveled 130 enforcement actions against crypto firms deemed to be noncompliant with securities laws affecting crypto assets, exchanges and stablecoins. Lawmakers have questioned whether these enforcement actions make sense, given that it’s unclear whether a crypto token is a security, a commodity or something else.
During his appearance before the House last month, Gensler was unable to define whether the digital currency Ethereum (Ether) is a security or a commodity. In February, he argued that “everything other than Bitcoin” qualified as a security, contradicting the Commodity Futures Trading Commission Chair Rostin Behnam, who classified Ether as a commodity. If one agency says crypto is a commodity and another argues it’s a security, how can the SEC justify its enforcement against “noncompliant” crypto issuers? This interagency confusion does not provide a conducive environment for regulating crypto exchanges. It also fosters more of an incentive for Congress to step in and provide clarity.
Under Gensler, it has become clear that the SEC is exceeding its congressional mandate. The commission has spent more time promulgating rules that pursue lofty political goals outside its regulatory scope and less time upholding the pillars of its mission. The SEC of today is no longer the agency that Congress envisioned 90 years ago. If enough lawmakers care, that could ultimately prove its undoing.