After being signed into law in December, the Uyghur Forced Labor Prevention Act (“UFLPA”) took effect this week. The law, which officially went into force on June 21, creates a rebuttable presumption that any goods that were “mined, produced, or manufactured, wholly or in part, in the Xinjiang Uyghur Autonomous Region” were made using forced labor, and bars their importation into the U.S., unless the importer can produce documentation within 30 days that meets the “clear and convincing evidence” standard in order to qualify for an exception.

Direct imports into the U.S. from Xinjiang have fallen significantly in light of enduring reports of detention camps in the Xinjiang region in northwest China where ethnic Uighurs and other Muslim minorities are reportedly forced to “learn Chinese and memorize propaganda songs” and to work as part of a sweeping “re-education” campaign. The UFLPA could, nonetheless, have sweeping consequences for the fashion industry given its breadth, as well as the extent to which apparel manufacturers rely on cotton from the Xinjiang region. After all, the law applies not only to products shipped directly from Xinjiang, but also to shipments that come from other countries but that contain products made from cotton (and other raw materials) and/or labor tied to Xinjiang. 

This stands to make the applicability of the law greater given the fact that “a wide range of raw materials and components from [the Xinjiang region] find their way into factories in China or in other countries, and then to the U.S.,” according to the New York Times.

From a purely-cotton-perspective, the potential impact of law is striking. The U.S. imported about $9 billion worth of cotton goods from in 2020, according to former Executive Assistant Commissioner Office of Trade, U.S. Customs and Border Protection Brenda Smith, as previously reported by the AP. In terms of the Xinjiang region, alone, it is responsible for 85 percent of China’s cotton, and an estimated 20 percent of the global cotton supply by the Worker Rights Consortium. “Virtually the entire [global] apparel industry” – high fashion and luxury names, included – “is tainted by forced Uighur and Turkic Muslim labor,” the labor rights monitoring organization told the Guardian  last summer, due in large part to the difficulty that comes with tracing the origins of garments and their composite parts in multi-national brands’ sweeping supply chains.

Now that the UFLPA is firmly in place, Steptoe & Johnson LLP’s Jeffrey Weiss and Claire Schachter suggest that companies engage in the following initial steps … 

Evaluate the effectiveness of the existing company-wide supply chain due diligence system for assessing and mitigating forced labor risks – including g., all internal and independent third-party risk assessment/auditing systems; supplier code of conduct monitoring and enforcement; engagement with direct and indirect suppliers; forced labor risk training, etc. – and determining whether the individual components and due diligence system as a whole are likely to satisfy the CBP Guidance/UFLPA Strategy guidance and what modifications/additional processes, if any, may be needed;

Develop detailed supply chain maps for products imported into the United States in order to identify and assess the risks of any links to Xinjiang or listed entities/facilities/products and develop mitigation strategies;

Develop an efficient approach for gathering and preparing necessary supply chain documentation for potential submission to CBP in the event any shipment is detained and the company seeks to demonstrate the shipment is outside the scope of the UFLPA or that it qualifies for an exception to the rebuttable presumption; and

Monitor developments on UFLPA implementation, including additional guidance from CBP, likely to be released over the coming months.

Calls to regulate the booming “buy now, pay later” (“BNPL”) industry have not deterred big brands like Apple and Amazon from the idea of offering consumers an interest-free, no-fee way to spread payments for purchases. Apple cited “users’ financial health” when it announced the introduction of this new feature earlier this month, but research shows financially vulnerable people need more protection. It is possible to regulate this sector to safeguard consumers without completely restricting access. By learning from previous efforts to regulate the payday lending sector, for example, the industry and its regulators could take steps to prevent misuse.

The use of BNPL payment platforms almost quadrupled in 2020, with transaction values reaching £2.7 billion ($3.31 billion). In 2021, BNPL transaction value in the United Kingdom grew by as much as 70 percent to £6.4 billion ($7.83 billion) or 5 percent of the total e-commerce market. This form of credit allows people to pay for online purchases in installments, without a credit record check. It tends to attract younger borrowers, with a quarter of users aged 18-24 years old and half aged 25-36 years old, according to data shared by providers with the UK’s financial regulator, the Financial Conduct Authority (“FCA”). 

It has also encouraged some shoppers to spend more than they can afford. Citizens Advice says two in five BNPL users have struggled to repay, and one in four of those that have missed a payment have been contacted by debt collectors. And while BNPL was conceived as a convenient way to purchase big-ticket items such as sofas and TVs, the rising cost of living means people are now using it to pay for essentials, such as food and toiletries. Research has also found that users who are unable to repay their BNPL sometimes use credit cards with typical interest rates of 20 percent to delay repaying their debt.

A rise in overstretched users is not only detrimental to consumers, it could also damage businesses. Retailers have increasingly relied on BNPL to boost sales by allowing people to spread the cost of goods over a series of payments. They pay the provider a fee for the purchased goods and the BNPL business model is reliant on consumers’ repeat use. Retailers have used this to navigate recent challenges like Brexit and COVID-19. Up to 92 percent of merchants surveyed last year had integrated their first BNPL solution since early 2020. But the rising cost of living crisis has changed the economics of this form of credit for all involved. 

Lessons for Regulating BNPL

As a result, regulation looks increasingly likely, and necessary, to provide consumers with greater protection from financial harm. The FCA has already enforced new contractual changes to terms and conditions to help protect consumers using Klarna, Clearpay, Laybuy and Openpay. These new measures include protecting consumers that cancel their goods through BNPL from being charged a late payment fee. 

At the moment, the hope is that other providers will follow suit. This regulation needs to be enforced across the sector in a way that shields consumers without removing access to this form of finance. The regulation of payday lending in 2015 provides valuable lessons for BNPL. My research on the experience of borrowers shows that, while “high-cost, short-term” credit regulation protected users from falling into too much debt, it also excluded many people from accessing this credit at all. Ultimately, this regulation restricted consumer choice by forcing several high-profile lenders into administration. Their business models no longer worked due to the stricter rules on lending and a cap on the cost of credit, combined with an influx of pre-regulation compensation claims.

Protecting Consumers

Financial regulation that aims to protect consumers must support those on the lowest incomes that are shouldering the greatest burden in the cost of living crisis. More generally, an uplift in benefits in line with inflation would be useful. Credit is not always the right solution, but affordable community finance providers such as credit unions and community development finance institutions should also be promoted. For BNPL regulation specifically, regulators can and should design rules that will ensure that consumers are protected but also able to continue to use this increasingly popular form of finance. According to my research, the following measures would help:

– Clarifying that BNPL is a form of credit and the implications of using it so that consumers can make informed decisions; 

– Ensuring providers make sufficient and appropriate checks about whether consumers can afford to repay loans alongside their other financial commitments to reduce overall debt. This would rely on access to real-time data to prevent multiple loans with multiple providers; and

– Adding greater consumer goods protection to match other forms of credit such as credit cards, which offer a refund if goods are lost or damaged.

The BNPL model is unlikely to disappear any time soon. Instead, BNPL companies are already starting to adapt to a more regulated future by changing their business models to some extent. For example, Klarna’s moves to report its data to credit scoring companies certainly indicates it is pre-empting regulation of the sector, as well as an economic slowdown that could curb its growth in the near future. Even with this outlook, however, confidence in the sector remains. Thoughtful regulation will ensure present players and new entrants can build responsible BNPL offerings that online shoppers can continue to add to their baskets.

Lindsey Appleyard is an Assistant Professor at the Research Centre for Business in Society at Coventry University. (This article was initially published by The Conversation.)

The enactment of a French law that prohibits the destruction of unsold goods (namely, non-food products) is forcing brands to look more carefully at the volumes they are producing in order stay within the bounds of the law, while also avoiding the excessive markdowns that they view as a death knell to their luxury positioning. First passed back in early 2020, the “Projet de loi relatif à la lutte contre le gaspillage et à l’économie circulaire” – or Bill on the fight against waste and the circular economy – subjects companies to an array of new sustainability-centric mandates, such as those that require the systematic phasing out of automatic paper receipts and single use plastic in fast food restaurants and a ban on plastic packaging on most fruit and vegetables, followed by the outright ban on all single-use plastics by 2040. 

Of particular relevance for the fashion industry is the prohibition on the destruction of an array of different types of unsold goods, including garments and accessories. To be exact, the law – which was formally approved by the French Sénat in January 2020, and formally put into effect on January 1, 2022 – aims to require producers, importers and distributors to refrain from destroying unsold goods. The fashion industry has been a particular target of the legislation, according to French legislators, who have noted that “apparel retailers, in particular, renew their products more frequently [than other industries] and often have surplus unsold stock.” Mass-market fashion companies and luxury brands, alike, have been tied to the practice of destroying unsold merchandise to avoid selling it at a discount and/or paying to store it, and as a way to avoid cross-border costs in some cases and to benefit from the “drawback” of certain duties in others. 

Leading up to the passage of the unsold goods law, the French government asserted that apparel and accessories companies were among some of the notable culprits in terms of the more than 650 million euro (nearly $740 million) worth of new consumer products that are destroyed or disposed of on an annual basis in France, and the $900 million more worth of unsold items going to landfills.  

(As for applicability, the law governs “producers,” a term that is defined by Article L. 421-1 of French Consumer Code as: “(a) manufacturer of the product (when it is established in the European Union) and any persons who present themselves as manufacturers by affixing their names, trademarks or other distinctive signs on the product, or any repairer of the product, (b) manufacturer’s representative (when the manufacturer is not established in the European Union) or the importer of the product (in the absence of a representative established in the European Union), and (c) any other professionals in the marketing chain, in so far as their activities may affect the safety characteristics of a product.”)

(With applicability in mind and just to play devil’s advocate for a moment, it is worth asking how effective this law will be given that luxury brand’s biggest markets (i.e., the markets where they offer up/sell the most products, and thus, likely manufacture and/or ship the largest quantities of their products to) are the U.S. and China, which maintain no such bans on destruction.)

In terms of how significantly the law is expected to impact brands, it may not necessarily be as striking as it seems. Product destruction has not only fallen out of favor in light of consumer concerns about Environmental, Social, and Governance elements, but for some time, no shortage of brands have adopted other methods for dealing with excess stock that still enables them to still generate revenue from it. As TFL has previously reported, no small number of brands have opted to quietly sell off merchandise to retailers like T.J. Maxx and online equivalents, or have turned a blind eye when their authorized retailers do so in order to generate revenue for unsold products at the end of a season. 

Traditionally, brands have “tolerate[d] grey market activity for the sake of making their short-term results better,” Bernstein analyst Luca Solca stated back in 2018, putting the figure for these out-of-channel sales at “5 to 10 percent” of annual revenue for many fashion brands. However, attitudes towards the sale of branded goods outside of companies’ unauthorized distribution channels have started to change, as they look to regain some of the control that has been ceded with the rise of the global e-commerce market and potentially, the burgeoning luxury resale segment, as well. 

At the same time, brands have pulled way back when it comes to discounting of unsold products, as seen in brands’ practice of touting increases in full-price sell-throughs. Late last year, Ralph Lauren revealed that it had decreased its reliance on off-price sales, and is focusing on its own retail sales – over wholesale and off-price avenues. A rep for the company confirmed, saying that it has “‘significantly reduced’ the amount of inventory it is sending to discount chains.” Other companies like Armani have boosted prices and said they have reduced the volumes of their output. “We have taken out things that traditionally do not sell,” Giorgio Armani said in an interview last spring. In addition to serving as a potential boon from a bottom-line perspective, Mr. Armani emphasized that “this will have a wider impact on the environment.” 

What Now?

Where does the current state of things leave brands that do not want to face off against the French government and the relatively newly-implemented law that bans the destruction of unsold goods? LVMH’s environmental development director Helene Valade told AFP that while “the luxury business model is closely adjusted to demand,” the new law is, nonetheless, pushing luxury brands “to learn more about their clients to better anticipate their purchases and reduce stocks to a minimum.” 

Enduring supply shortages and increased willingness among consumers to shell out following periods of lockdown have likely had a hand in helping to reduce output and supply, respectively. In December, Chanel’s president of fashion Bruno Pavlovsky, for one, said the brand did “not have enough products – especially for handbags.” Meanwhile, Valade – pointing to versions of Loewe bags – said that LVMH brands are seeing more products, namely leather goods, that are out of stock than in excess. 

In the event that there is unsold inventory, AFP has stated that “selling products to staff at lower prices is one option,” particularly for the likes of LVMH, Kering, and other fashion groups that have large workforces. 

Beyond that, two avenues seem like obvious options – and neither one necessarily forces brands to overtly chip away at their (hard-earned and marketing-heavy) luxury positioning. Primarily: Brands might be wise to utilize the resale market in a more strategic way in order to move excess merch. Secondary market efforts could provide brands with an additional point of access to entry-level luxury spenders in much the same way as more accessible, lower-priced products do. Greater activity by brands in this arena would give  them the ability to more closely control the products that are being offered up and the conditions of those sales. And of course, in-house resale efforts and/or partnerships with established resale players could enable brands to somewhat discretely get rid of unsold stock without having to slap slashed price tags on their wares in stores. 

Should brands aim to make bigger moves to own the resale space, they could sell off unsold goods alongside products that they buy-back from retailers (at the end of the season to avoid deep discounts there) and/or from consumers in something of the same way as resale platforms do. Not exactly novel territory, the melding together of pre-owned goods and close-out pieces is already happening in the secondary market. In addition to catering to consumers who wanted to consignment pre-owned products, The RealReal has been working with brands and retailers to off-load unsold apparel and accessories for several years, hence, all of the “new with tags” merch. Seemingly doubling down on this B2B element of its business, a rep for The RealReal previosuly told TFL  that the resale giant had seen “a 30 percent increase in supply from brands in the six weeks to April 14, 2020 compared with the same period a year earlier.” 

More recently, The RealReal President Rati Levesque noted that the vendor side of things is “a driver for high value for us,” namely, by way of “fine jewelry, watches, [and] handbags,” and says that the company expects to “continue to see that trend for the holiday.”

Another option for brands comes in the form of branded subscriptions boxes, a category that has been ramping up, as indicated by the investment by LVMH’s Luxury Ventures in Heat, the mystery box company that acquires unsold inventory from fashion brands – from Off-White to Balenciaga – and offers them up to consumers. 

Finally, donation is an option, as well. As set out by the French law, for unsold basic goods, companies will be required to allow their use, including by donating them to specifically accredited associations that can ensure such products are utilized by an end customer in accordance with their purpose. It is, of course, difficult to imagine that brands will be quick to offload products with their branding on them in this way. 

In light of enduring overproduction issues and budding legislative attempts to stomp out waste, the fashion industry is seeing the enduring rise of start-ups – such as Heat, materials resale platform Nona Source, and Trove, which partners with brands to create online platforms for them to sell used goods – that seek to assist companies with reducing their waste and dealing with unsold inventory. Efforts like these and others will likely continue to proliferate, and not just because of the French law, which may expose companies to financial penalties and the potential for the regulatory body in charge of the protection of competition and consumers to publish any infractions online or in the press at the expense of the company being fined, which could expose the offender to substantial reputational damage, particularly as sustainability initiatives continue to prove important to consumers across the globe. 

Chances are, the French anti-destruction law may be the first of more legislation, as consumers, investors, and regulators, alike, continue to pay attention to companies’ workings when it comes to the environment and demand more transparency and in some cases, action. 

First proposed over two years ago in December 2020, the Digital Services Act (“DSA”) was agreed to late last month. The European Parliament (the European Union’s legislative arm) came to an agreement in principle with the individual EU Member States to move forward with the process of finalizing the DSA, which will set forth new accountability and fairness standards for online platforms, social media platforms, and other internet content providers, depending on the entity’s size, societal role, and impact on individuals’ lives.

Broadly speaking, the DSA will counter the sale of illegal products and services on online marketplaces and aims to combat illegal and harmful content on online platforms, such as social media. At the same time, the Digital Services Act also broadly aims to increase transparency and fairness in online services.

In a similar vein to past comprehensive EU legislation, the Digital Services Act gives individuals control through transparency requirements that entities must abide by, requiring new judicial or alternative dispute mechanisms to be implemented to allow individuals to challenge content moderation decisions and/or seek legal redress for alleged damages caused by an online platform. The DSA will also require a certain amount of transparency into entities’ algorithms that are used to recommend content or products (i.e., target) to individuals.

Background and EU Legislative Process

The DSA is a small piece of a larger package of laws and regulations that have slowly made their way through the EU legislative process. One piece of that package, the Digital Markets Act (“DMA”), which was already agreed to in March 2022, focuses on regulating anti-competitive and monopolistic behavior in the technology and online platform (digital and mobile) industries. The DMA is at the forefront of a global trend that is seeing regulators look to antitrust legislation as a way to regulate technology companies and online services.

With the principal agreement in place, the Digital Services Act will now be taken up in a co-legislative manner, meaning the individual EU Member States (France, Germany, etc.) must take up and pass the DSA for full approval by the EU Council, which is made up of representatives from each EU Member state. In tandem, the European Parliament will take up the DSA for approval. Once the European Parliament and full EU Council approve the DSA, it will be finalized and effective. As proposed, the DSA will take effect on the later of 15 months after it becomes effective, or January 1, 2024.

However, very large online platforms will have a shortened timeline and must comply with the DSA within 4 months of its effective date.

There is a dearth of details of what might end up in the final version of the Digital Services Act, and the final scope and impact of the new law will not be known until the final text is released. However, the EU has provided some insight and general principles that will guide the final text. These insights can help entities that must prepare for the DSA.

Spectrum of Applicability

The DSA applies to “digital services,” which broadly includes online services, including online infrastructure, such as search engines; online platforms, such as social media; and/or online marketplaces and even smaller websites. Additionally, the DSA will apply regardless of where an entity is established. If an entity is an online service that operates in the EU, it must comply with the DSA. However, as mentioned above, the applicability of the specific requirements will depend on the size and impact the service has.

There are four categories of online services according to the DSA: (1) intermediary services; (2) hosting services; (3) online platforms; and (4) very large platforms. Each subsequent category of online service is also considered a sub-category of the preceding type of online service, meaning the requirements placed on intermediary services are also placed on hosting services, etc. Intermediary services include those entities that provide network infrastructure, with some examples being internet service providers and domain registrars. Hosting services include cloud and website hosting services. 

Online Platforms include online marketplaces, app stores, economy platforms, and social media sites. And finally, very large online platforms include those online platforms that serve and reach over 10 percent – or about 45 million – of consumers in the EU.

DSA Requirements

The requirements of the DSA are cumulative and will depend on the size and impact of a given company. In lieu of many specifics and details, entities can, nonetheless, begin preparing for the types of policies and procedures that will be required. The requirements that the EU has outlined for the proposed DSA are broken down below by the specific categories of online services.

Intermediary Services – If an entity is considered an intermediary service, it must implement policies and procedures related to the following areas: (1) transparency reporting; (2) terms of service/terms and conditions that account for defined EU fundamental rights; (3) cooperation with national authorities; and (4) accurate points of contact and contact information, as well as appointed legal representatives, where necessary.

Hosting Services – If an entity is considered a hosting service, the entity must comply with the above intermediary service requirements. Additionally, a hosting service must: (1) report criminal offenses (likely related to the sale of illegal products and services, or the posting of illegal and harmful content); and (2) increase transparency to its consumer base through notice and choice mechanisms that fairly inform the individual consumer.

Online Platforms – If an entity is considered an online platform, it will need to comply with the above intermediary service and hosting service requirements.

Additionally, an online platform must implement policies and procedures that address: (1) complaint and redress mechanism (that includes both judicial and alternative dispute remedies); (2) the use of “trust flaggers;” (3) abusive notices and counter-notices (e.g., dark patterns); (4) the verifications of third party suppliers on online marketplaces (including through the use of random or spot checks; (5) bans on targeted advertising to children and on target advertising based on special characteristics (e.g., race, ethnicity, political affiliation); and (6) transparent information on targeting and recommendation systems.

Specifically, the obligations imposed related to “trust flaggers” will require online platforms to allow trusted flaggers to submit notices related to illegal content or products and services on the given online platform. For an individual to be considered a “trusted flagger” they must meet certain certification requirements. Certification is only granted to those that: (1) have expertise in detecting, identifying, and notifying supervisory authorities of illegal content; (2) is able to exercise its responsibilities independent from the specific online platform; and (3) can submit notices to the proper authorities in a timely, diligent, and objective manner.

Very Large Platforms – Very large platforms are the most regulated sub-category of online services under the DSA. These entities must comply with the requirements set forth for intermediary services, hosting services, and online platforms. Additionally, they must: (1) implement risk management and crisis response policies and procedures; (2) conduct internal audits, and have external audits conducted, of the services; (3) implement opt-out mechanisms so individuals can opt out of targeted advertising or user profiling; (4) share data with public authorities and independent researchers; (5) implement internal and external-facing codes of conduct; and (6) cooperate with authorities in response to a crisis.

The transparency and audit requirements set forth for very large platforms will require annual risk assessments to identify any significant risks to the platform’s systems and services. The risk assessment must include reviews of the following (1) illegal content, products, and/or services; (2) negative effects on defined EU fundamental rights, especially with respect to privacy, freedom of expression and information, anti-discrimination, and the rights of children; and (3) manipulation of the services and systems that could result in negative effects on public health, children, civic discourse, the electoral system, and national security.

In addition to the risk assessment, independent external auditors will need to conduct assessments of the services and systems at least once a year. Such auditors will need to produce a written report and very large platforms will need to implement and maintain policies and procedures to remedy any identified issue.

Penalty For Noncompliance

Individual EU Member States will have the freedom to implement the specific rules and procedures for how penalties will be issued under the DSA. In the most recent draft, the DSA called for penalties that are “effective, proportionate and dissuasive” meaning the penalties imposed could be imposed where no direct damages occurred or be in excessive of any direct damages. As proposed, any entity that violates the DSA can face a penalty up to 6 percent of its annual revenue.

Looking Forward

Once implemented and effective, the DSA will set the standard for requirements related to fairness, transparency, and responsibility that online services must comply with. Entities that fall within any of the DSA’s four categories of in-scope digital services will need to begin investing resources into policies and procedures to address the various topics addressed in the DSA.

The DSA sets out a compliance deadline of January 2024, or 15 months after the DSA’s final effective date. This gives a number of entities time to jump-start their compliance efforts. However, the base compliance deadline is a bit deceptive as a large number of entities will likely fall within the very large platform category. Such entities will only have 4 months post-DSA effective date to come into compliance and cannot afford to final approval of the DSA to jump-start their compliance programs.

Lucas Schaetzel is an associate in Benesch Friedlander Coplan & Aronoff LLP’s Intellectual Property/3iP Practice Group. 

Better information leads to better decisions – this is the idea behind the regulatory device known as “mandated disclosure.” Mandated disclosures are all around you – from calorie counts on fast food restaurant menus to conversations with doctors around informed consent. But the biggest experiment yet in mandated disclosure is the U.S. Securities and Exchange Commission (“SEC”)’s proposal to extend these ideas to climate impacts facing U.S.-listed companies and require uniform climate disclosures.

The SEC’s proposed disclosure rules, which the regulator released in late March, would require publicly traded companies to release information to investors about their emissions and how they are managing risks related to climate change and future climate regulations. Largely in response to investors clamoring for more information about climate risks, as well as pressure from green groups that believe disclosure will drive climate-conscious investing, SEC Chair Gary Gensler announced in 2021 that the commission would use its statutory authority to require climate-related disclosures.

While it is easy to spot risks facing companies like ExxonMobil, which produces and sells fossil fuels that contribute to global warming, more hidden vulnerabilities exist for businesses across the U.S. economy. Here is what you need to know about climate disclosures and some of the challenges the SEC faces in adopting them. 

What investors want to know

Investor pressure for better information about climate impacts comes from two directions. First, some investors want to avoid companies that will be most affected by climate change. A company’s products may be regulated in the future because of their impact on the climate, for instance, or its supply chains may get more expensive over time. Investors want to know which businesses will be able to adapt and preserve profitability. 

Second, many investors are interested in ESG investing, which involves assessing companies’ commitments to environmental, social and governance factors. Today, ESG investing accounts for $17.1 trillion – or 1 in 3 dollars – of the total U.S. assets under professional management. The challenge for the SEC is to ensure that claims being made about the sustainability of a company are based on reality

The trend toward ESG investment has led to an outpouring of voluntary disclosure: About 90 percent of companies in the S&P 500 voluntarily publish reports disclosing statistics on things like carbon emissions and how much renewable energy they use. Meanwhile, some large investors – and certain governments – require disclosure. For example, BlackRock, a multinational asset manager with around $10 trillion under its control, requires companies it invests in to disclose certain climate information. The United Kingdom plans to implement rules requiring climate disclosures starting in April 2022, and the European Union has reporting rules in place. 

But the U.S. has been slow to impose mandatory climate disclosure requirements. Public companies have only been subject to a more general legal standard that they not materially mislead investors. The SEC released guidance in 2010 to encourage climate disclosures, but it has not been enforced and has failed to prompt standardized disclosures.

Rule benders & the effectiveness of climate disclosure

Research on the broader use of mandated disclosure, such as for home mortgage lending and consumer product labeling, shows that crafting effective disclosure regulations is difficult. One reason is that the companies can easily evade disclosing useful information while still complying with the letter of the law, and these “rule benders” can be very creative. Consider the restaurant in New York City that was subject to a health inspection grading regulation and managed to disguise its “B” rating by simply adding “EST” to its display of its grade. Disclosure regulations can also fail when they don’t effectively communicate valuable information. 

study of one type of climate disclosure – emissions labels on consumer products – found mixed evidence as to whether consumers altered their behavior in response. Rule benders can exploit human tendencies to discount or filter out warnings by providing an avalanche of unnecessary information that confuses and overwhelms the intended recipient. 

Expect court challenges

One challenge the SEC has grappled with is whether it has statutory authority to require companies to disclose their “Scope 3” emissions – or emissions that a company does not directly control, such as emissions from the use of its products or emissions that come by way of its supply chain. A company like Amazon, for example, may have extensive upstream Scope 3 emissions in its suppliers’ transportation networks. General Motors would have extensive downstream emissions when people drive its gas-powered vehicles.

The SEC’s three Democratic commissioners, who make up a majority of the commission, have reportedly split on whether certain Scope 3 emissions can be viewed as “material” to investors and therefore subject to disclosure. “Material” is defined as information that a reasonable person would consider important in making an investment decision. 

Some critics of climate disclosures, including several Republican state attorneys general, suggest that the SEC has no authority to require disclosures that are not financially material. Missouri’s attorney general wrote that requiring climate reporting would impose “large costs and administrative burdens” on publicly traded companies. A group of senators suggested greenhouse gas-related assets would shift to private companies. West Virginia’s attorney general threatened to sue the SEC. At the same time, critics note that the costs of disclosure would vary. Some companies already intensely monitor emissions. Others would likely face high costs if Scope 3 emissions were included. An oil company, for one, might have to measure emissions from all the vehicles using its fuel

The Administrative Procedure Act allows courts to vacate SEC rules that are deemed arbitrary or capricious because the agency failed to offer sufficient justification for choosing the proposal over alternatives. The SEC is acutely aware of this risk. A prior oil and gas extraction disclosure rule was invalidated by a court in 2013 as arbitrary and capricious. 

The SEC’s proposed climate risk disclosure rules, the public comment period for which the regulator recently extended by almost a month, will not be the final effort to use information to shape the private sector’s response to climate change. What the SEC does will affect those future moves, which is likely why it took its time and is proceeding cautiously.

Daniel E. Walters is an Assistant Professor of Law at Penn State. William M. Manson is a Law Student at Penn State. (This article was initially published by The Conversation.)