SEC Disclosure Rules Face ‘Sea Change’ Challenge From Business

Business groups’ First Amendment challenge to a Securities and Exchange Commission rule on stock buybacks threatens far-reaching consequences for the regulator’s efforts to require disclosure of corporate information.

Led by the US Chamber of Commerce, the groups have sued to vacate the rule, arguing the requirement that companies disclose their rationale for repurchasing stock shares violates the First Amendment’s protections against compelled speech.

It’s a broadside against SEC rules that require companies to disclose certain information to investors—rules that have for decades operated without rigorous First Amendment scrutiny, legal scholars said. A court ruling subjecting the buyback rule to an elevated level of review would endanger other disclosure rules, including ones surrounding executive compensation and environmental risks.

“For any court to suddenly subject a garden variety disclosure mandate like this to rigorous First Amendment review would be a huge sea change in the way that the courts think about securities disclosure,” Washington and Lee University law professor Sarah Haan said.

The Chamber and other business groups brought the case at the US Court of Appeals for the Fifth Circuit, which has been skeptical of administrative agencies’ power. In May 2022, the court ruled the SEC’s use of in-house judges was unconstitutional.

Other federal agencies could also feel the impact of a ruling against the SEC on First Amendment grounds. Georgetown University law professor David Vladeck said most agencies have informational rules designed to make markets safer and fairer.

“A loss here for the SEC will be a loss for the kind of protective regulation that the United States has enjoyed for decades and decades,” Vladeck said.

‘A Big Deal’

The US Chamber of Commerce, along with the Longview Chamber of Commerce and the Texas Association of Business, brought their case in May, shortly after the SEC adopted its stock buyback rule. A main requirement of the rule is that companies tell investors why they repurchased stocks.

The Chamber argues the rule is invasive and premised on “politician-driven concerns about buybacks” that are contradicted by the SEC’s own 2020 study finding that, on average, repurchases have a positive effect on a company’s value.

Lawyers representing public companies also question how valuable the information is to investors. “The government, it appears, just doesn’t like buyback programs,” said Michael Blankenship, managing partner of Winston & Strawn LLP’s office in Houston.

But arguing the SEC lacks authority under the First Amendment to require the disclosure of information on stock buybacks is “a big deal,” Haan said.

The regulation of securities-related speech hasn’t historically raised First Amendment concerns, legal scholars, including Haan, said in a 2022 letter to the agency. That kind of “speech,” like contracts or tax returns, has traditionally been outside the scope of protected speech, the scholars said.

Better Markets, a Washington-based group that advocates for tougher financial rules, said in an amicus brief last week that the Chamber’s arguments threaten “the foundation of securities regulation in the United States.”

‘Rafts of Litigation’

The Chamber argues the buyback rule is subject to strict scrutiny, the most exacting form of judicial review.

Applying that rigorous standard of First Amendment review to securities regulation would make it difficult for the SEC to have any meaningful rules and could lead to “rafts of litigation for years,” said Amanda Shanor, an assistant professor at the University of Pennsylvania’s Wharton School who focuses on freedom of speech.

“It would make many of the agency’s decisions constitutional questions for the court to decide, as opposed to for the agency to decide under the statute,” Shanor said.

In its response in the case this month, the SEC argued the buyback rule concerns “commercial speech,” and is subject to a less demanding standard of review.

The agency’s approach, likely driven by strategic considerations, sets it on a dangerous slope, some legal scholars cautioned.

While some commercial disclosure requirements can be reviewed under a forgiving standard, others are subject to a higher test from the Supreme Court’s 1980 decision in Central Hudson Gas & Electric Corp. v. Public Service Commission of New York.

Under Central Hudson, the SEC would be required to show the regulation isn’t more extensive than necessary to serve a substantial government interest.

“There is a danger that if suddenly the courts were to decide this is all commercial speech, and it’s all subject to Central Hudson review, every securities disclosure regulation ever written by the Securities and Exchange Commission would have to be reevaluated under that standard,” Haan said.

‘Pandora’s Box’

First Amendment arguments loom over other SEC efforts.

The National Association of Manufacturers has made compelled-speech arguments in a case concerning the SEC’s authority to influence company proxy ballots. That case is also at the Fifth Circuit.

Critics of the SEC’s proposed climate disclosure requirements, including West Virginia’s attorney general and the Cato Institute, a libertarian think tank, have also raised First Amendment concerns about the proposal. The SEC aims to adopt that rule in the coming months, and legal challenges will likely follow.

“You’re starting to see a multi-prong First Amendment attack on the ability of the Securities and Exchange Commission to mandate all kinds of disclosure,” said Haan. It could be “like opening up Pandora’s Box,” she warned.

Some First Amendment experts view the challenges as a continuation of a years-long effort by businesses to change the law around commercial speech, a trend Shanor tracked in a 2015 academic paper. But attorneys said lawsuits may also be responding to the more aggressive rulemaking of its current chair, Gary Gensler.

“While historically the SEC has been largely untouched by First Amendment concerns, that may not be the case in the future,” said Toby Galloway, a former SEC attorney and chair of the securities litigation and enforcement group at Winstead PC in Texas.

Cooley LLP special counsel Reid Hooper said well-established rules requiring disclosures that investors have come to expect, including those around executive compensation, could be more difficult to question.

The buyback rule has “just been adopted, its going into effect, and there are some views from practitioners and companies as to how useful the disclosure will be,” said Hooper, a former SEC attorney.

Several years ago, the SEC lost on First Amendment grounds when the US Court of Appeals for the DC Circuit struck down a requirement from the 2010 Dodd-Frank Act that companies disclose when their products include “conflict minerals.”

While the ruling didn’t spur a series of constitutional challenges to securities disclosure rules, legal scholars have noted the DC Circuit treated the rule as a consumer protection regulation, rather than a standard securities disclosure.

The Supreme Court agreed in June to review the Fifth Circuit’s decision about the constitutionality of the SEC’s use of administrative law judges. Some scholars foresee a similar path for the SEC’s stock buyback rule.

“This case is going to have repercussions,” Vladeck said. “If in fact the Fifth Circuit invalidates the rule on First Amendment grounds, the Supreme Court will have to review the case.”

The stock buyback case is Chamber of Commerce of the United States of Am. v. SEC, 5th Cir., No. 23-60255.