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ESG policy trembles in our post-Chevron world

 

By Stone Washington, Competitive Enterprise Institute

The US Supreme Court recently rendered one of the most historic decisions in administrative law in the consolidated cases of Loper Bright v. Raimondo and Relentless v. Department of Commerce. The outcome was a welcome one, as federal agencies can no longer rely on their shaky interpretation of statutory authority as a basis for skirting judicial review.

Nor can courts side with agencies simply because of their expert judgment on policy. The Supreme Court has essentially leveled the playing field for private litigants to more fairly challenge federal agency interpretation of their rules and regulations.

Among the many policy areas implicated by Loper Bright, one problematic policyscape stands to suffer a major blow: environmental, social, governance (ESG). Last June, nearly one year before Loper Bright was decided, I warned about activist financial regulators like the Securities and Exchange Commission (SEC) potentially losing their interpretive edge in rulemaking once the Supreme Court overturned the deference doctrine of Chevron v. NRDC (1984). Given that the SEC routinely exceeds the limits of its statutory authority by advancing ESG policies in place of its traditional responsibilities, the loss of judicial deference leaves it particularly vulnerable to rebuke by federal courts.

We are already seeing Chevron’s demise affect multiple ESG-related court cases. The most notable instance of this can be seen with Utah v. Su (formerly known as Utah v. Walsh). Within a month of the Supreme Court’s Loper Bright decision, the Fifth Circuit Court decided to remand the Su case back to a federal district court in Texas.

The Fifth Circuit instructed the Texas court to render a new opinion on the matter without deferring to the expert judgement of the Labor Secretary.

For perspective, the Texas district court originally upheld a widely disputed ESG rule approved by the Department of Labor (DOL) in November 2022. The rule overturned two Trump-era safe harbors for private fund advisors overseeing 401K retirement accounts.

These safe harbors prevented advisors from injecting ESG criteria into their financial stewardship decisions. Instead of considering ESG, the advisor could only pursue financial or pecuniary factors when determining what investments to make on behalf of the retiree.

The overturning of these provisions emboldened the Biden-era DOL to adopt its ESG rule in a manner that is widely incompatible with Employee Retirement Income Security Act of 1974 (ERISA) legal standards. This sparked opposition from a bipartisan coalition in Congress and 29 states attorneys general led by Utah, bringing the case all the way up to the Fifth Circuit.

Now under reconsideration in court, the DOL is at a severe disadvantage. Lacking deference, DOL officials will struggle to justify sidelining the retirement-security protections of ERISA in favor of unspecified ESG goals. Pursuing ESG criteria without the approval or knowledge of the retiree places DOL at odds with a fiduciary’s legal duty of loyalty and prudence.

Beyond DOL’s ESG woes, the SEC faces a major wakeup call from Loper Bright. The full Fifth Circuit Court will soon be revisiting the controversial, SEC-approved Nasdaq board diversity rule. The rule requires all publicly listed companies on the Nasdaq exchange to appoint at least two board directors from marginalized backgrounds or provide an explanation as to why they do not.

This governance mandate has been opposed by many interest groups and businesses, mostly on the grounds that it usurps the privacy of corporate boards to select directors. Many critics also emphasize that policy that creates separate categories based on the race, ethnicity, sex, and sexual orientation of individuals is inappropriate and potentially in opposition to laws like the Civil Rights Act of 1964.

Opposing coalitions argue that it’s not right for Nasdaq to regulate companies to appoint more women or minorities based on diversity quotas. ESG selection criteria and racial quotas for board director candidates run far afield from what Nasdaq is supposed to be focused on. As a self-regulatory organization (SRO), Nasdaq’s ESG edict is akin to market manipulation of corporate governance, exceeding its oversight as a neutral exchange.

This case will face its greatest test under post-Chevron judicial review. The full Fifth Circuit recently reheard oral arguments from both parties and accepted amicus briefs and are expected to render a decision soon.

Nasdaq and the SEC will no longer be able to rely on amorphous provisions in the Securities Exchange Act of 1934, as the Supreme Court has determined that such ambiguity cannot justify the government’s position. Instead, the Fifth Circuit will likely pay close attention to the specifics of the 1934 Act, which says that the NASDAQ rules (or any SRO) “are not designed to …regulate… matters not related to the purposes of [the Act.].”

Lastly, the SEC will face its greatest post-Chevron reckoning in the case of Iowa v. SEC. All eyes in the world of financial regulation are on this case, after a lottery by the Judicial Panel on Multidistrict Litigation consolidated ten separate lawsuits against the SEC’s climate disclosure rule into the Eighth Circuit.

The SEC has sought to vastly expand its disclosure authority by requiring public firms to report their climate change risks across every aspect of their business dealings.

The SEC’s rule represents the boldest federally imposed ESG mandate to date. If implemented, businesses will be hit hard with a $628 million compliance burden and millions of additional work hours just to prepare the requisite paperwork. Many affected businesses will also outsource their greenhouse gas emitting activities to ease reporting burdens, while others may avoid going public just to avoid this draconian mandate.

As I explain in a recent policy report, the SEC’s rule relies on shaky interpretations of broad delegations of authority under the 1934 Act and Securities Act of 1933 that Congress simply did not permit. Such interpretive folly is ripe for denial in a post-Chevron court of law, as the SEC can no longer assume it has plenary authority to regulate environmental policy matters via the companies it oversees.

With Chevron overturned, the Eighth Circuit is perfectly situated to invoke the major questions doctrine on the grounds that the SEC lacks an intelligible principle to promulgate expensive climate disclosures that will disrupt the capital markets.

Financial regulators face a stark new reality following Chevron’s demise. Agencies have made brazen attempts to adopt environmental regulation that binds corporate activity or interferes with investor access to capital. Congress has already taken action to prepare several Congressional Review Act resolutions of disapproval against these regulations that a potential Republican administration may uphold.

In the meantime, courts may act quickly to strike down several of these ESG rulemakings, even those proposed by non-financial agencies like DOL. One thing is certain: financial regulators no longer wield an interpretive edge when attempting to justify their ESG policies in court. Overreliance on Chevron deference may prove to be ESG’s undoing in court.

 


Stone Washington is a Research Fellow with the Competitive Enterprise Institute’s Center for Advancing Capitalism.