Legal Update
Mar 13, 2024
Final SEC Climate Disclosure Rules Greeted with Mixed Emotions and Lawsuits: What Your Company Needs to Know
On March 6, 2024, the SEC announced its long-awaited adoption of final rules regarding climate-related disclosures by public companies and in public offerings (the “Climate Rules”).[1] The SEC dialed back the more prescriptive nature of the previously proposed climate rules (the “Proposed Rules”)[2] in favor of allowing public issuers to assess the degree and content of disclosure in accordance with the Climate Rules through the SEC’s materiality lens.
Background of the Climate Rules
The Climate Rules become effective sixty days following publication in the Federal Register,[3] bringing a close to this chapter of watching how the SEC will craft its climate-disclosure rules amidst the ESG pendulum swinging from investors’ calls for more transparency to facing challenges by a chorus of anti-ESG voices in a divisive US political environment. Since Commissioner Allison Herren Lee’s March 15, 2021 request for public input on climate disclosures[4] and the SEC’s March 23, 2022 Proposed Rules,[5] the SEC has been outpaced in its rule-making by other US states and international bodies that have been shaping the content of climate focused narrative for companies. Notably, the SEC does not recognize disclosure with other alternative disclosure regimes as being in compliance with the SEC disclosure rules. With such a patchwork of ESG/sustainability disclosure frameworks from standard setters like ISSB and TCFD to states and regulators like California and the European Union, consistency with other jurisdictions’ rules would likely be a welcome evolution to the SEC rules as the story unfolds. Each framework is guided by a desire for “consistent, comparable, decision-useful information”[6] but the patchwork of the frameworks reveals differences on the scope of information needed to have such information.
Much of the immediate reporting on the Climate Rules has focused on the fact that they are less burdensome than the Proposed Rules, with reports characterizing the Climate Rules as “weaker” or “scaled back.”[7] And indeed, the Climate Rules do soften several aspects of the Proposed Rules, perhaps most notably in removing any requirements for “Scope 3” greenhouse gas disclosures, which would have required certain companies to disclose emissions along their “value chain” such as production and transportation of goods purchased from third parties, employee commutes, and the use of the company’s products by third parties.[8] That said, the Climate Rules still set forth an extensive reporting structure, and compliance with the Climate Rules will still be a costly and labor-intensive endeavor, anticipated to encompass 15% of a company’s overall SEC disclosure costs.[9]
SEC Chair Gary Gensler characterized the rule as upholding the “basic bargain” of federal securities laws, which is to provide disclosures that allow investors to decide the risks they take in investing.[10] Chair Gensler referenced the SEC’s long history of updating disclosure requirements, including those relating to environment and the climate making particular note that the SEC does not have a role as to climate risk.[11] Rather, he cited the increased focus on investors using climate as a risk factor in investment decision-making.
The divisiveness of the Climate Rules was on full display in the statements made by Commissioners despite Chair Gensler’s framing of the Climate Rules. Commissioner Crenshaw, who voted in support of the Climate Rules, voiced her view that the Climate Rules do not go far enough, stating “this is not the rule I would have written. While these are important steps forward, they are the bare minimum.”[12] In contrast, the two Republican-appointed Commissioners, Peirce and Uyeda, both issued scathing dissents.[13] Commissioner Peirce, questioning the need to replace “our current principles-based regime with dozens of pages of prescriptive climate-related regulations,” predicted that “[t]he resulting flood of climate-related disclosures will overwhelm investors, not inform them.”[14] Commissioner Uyeda argued that in passing the Climate Rules, “the Commission ventured outside of its lane and set a precedent for using its disclosure regime as a means for driving social change.”[15]
The Climate Rules were also almost immediately subject to legal challenges opening a new and expected chapter in the ESG tug-of-war around the role of climate as a factor in investment decision making. State attorneys general have filed petitions for federal appellate review in both the Fifth and Eleventh Circuits (and civil litigation has also been filed in the Fifth Circuit by companies subject to the Climate Rules), arguing that the adoption of the Climate Rules exceeds the SEC’s statutory authority and was arbitrary and capricious.[16] We are in a wait-and-see mode as to whether the SEC will be challenged on whether the rule did not go far enough. Press releases by the US Chamber of Commerce and the Sierra Club have both signaled they may use litigation to challenge the Climate Rules, with the Chamber of Commerce threatening to sue “to prevent government overreach” and the Sierra Club, conversely, threatening to sue based on the SEC’s scaling back of the final Climate Rules from the Proposed Rules, leaving the SEC in an apparent no-win situation on whether it struck the appropriate balance between the Proposed Rules and Climate Rules.[17]
While it is unknown whether these legal challenges will be successful, companies should in the interim continue to proceed to prepare to meet the Climate Rules as-drafted.
The Climate Rules
Among other things, while the scope of the Climate Rules varied greatly from the Proposed Rules, the Climate Rules still adhere to disclosure requirements around four pillars of governance, strategy, risk management and metrics & targets, just with more materiality judgments to make. The hallmark provisions of the Climate Rules require disclosure of:
Material Climate-Related Risks. The Climate Rules require disclosure of any “material” climate-related risks, meaning any climate-related risk reasonably likely to have a material impact on the company, “including on its business strategy, results of operations, or financial condition.”[18] Climate-related risks include both “acute risks,” such as short-term weather events like hurricanes, floods, tornadoes, and wildfires, and “chronic risks” resulting from “longer term weather patterns, such as sustained higher temperatures, sea level rise, and drought, as well as related effects such as decreased arability of farmland, decreased habitability of land, and decreased availability of fresh water.”[19] It also includes “transition risks,” that is, the risks arising from changes in regulations, technology, or the market to address climate (such as increased costs stemming from climate-related policy changes, reduced sales/consumer behavioral changes with respect to carbon-intensive products, or risk of legal liability and litigation defense costs.[20]
Governance. In addition, the Climate Rules will require a description of how a company’s board of directors oversees climate-related risks, including the identification, if applicable, of any board committee responsible for oversight of these risks and a description of how that committee is informed about the risks.[21] It will also require a description of “management’s role in assessing and managing climate-related risks,” including which management positions (or committees) are responsible for assessing these risks, the relevant expertise of the individuals in these positions or committees, and whether they report to the board.[22]
The discussion around climate disclosure is often heavily focused on verifiable emissions calculations and accompanying efforts to reduce emissions. What is often lost in the discussion is the governance of assessing climate as a financial risk on business strategy, operations, and growth. The scope of governance will necessarily vary depending on industry, but with actors on both sides of the climate disclosure debate ready to litigate in the US as the means to effect any desired change, it bears reminding that officers are recognized as having a Caremark duty of oversight. As public filers ready themselves for disclosure, being able to articulate the role of management and how climate, as a financial risk, is considered and managed is worth assessing through a disclosure lens.
Targets and Goals. The Climate Rules further require companies to disclose any material climate-related target or goal, including how the target is to be measured, the timing by which the target is intended to be achieved, and a qualitative description of how the company intends to meet the goal.[23]
Scope 1 and Scope 2 Greenhouse Gas Emissions (for Certain Large Filers). The Climate Rules require certain large companies (large accelerated filers and accelerated filers[24] that are not otherwise exempted)[25] to make various disclosures relating to greenhouse gas emissions. These include both “Scope 1” emissions (“direct GHG emissions from operations that are owned or controlled by a registrant”) and “Scope 2” emissions (“indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a registrant”).[26] Importantly, however, these Scope 1 and Scope 2 emission disclosures are only required where they are “material,” with materiality not determined “merely by the amount” of emissions, but rather by whether a reasonable investor would consider their disclosure important when making the investment (for example, if the emissions are significant enough to materially impact the company’s business or financial conditions, or are necessary for an investor to understand whether the company has met its stated targets and goals).[27]
Time for Compliance and Safe Harbor
Once the Climate Rules are effective (sixty days after their publication in the Federal Register), companies’ time to comply will be phased in with a compliance date dependent on the status of the registrant, the content of the disclosure, and other accommodations, with the earliest being Large Accelerated Filers having some disclosures required by the Fiscal Year Beginning 2025.[28] Importantly, with respect to Scope 1 and 2 emissions, Large Accelerated Filers will need to make their disclosures beginning in the Fiscal Year Beginning 2026, and Accelerated Filers subject to the rule in the Fiscal Year Beginning 2028.[29]
There will also be a safe harbor by which certain disclosures, such as those pertaining to “transition plans, scenario analysis, the use of an internal carbon price, and targets and goals,” except for historical facts, will be considered a “forward-looking statement” for purposes of the Private Securities Litigation Reform Act,[30] thus providing a layer of protection against securities class action complaints in connection with these disclosures.[31]
Other Regulatory Frameworks
Separate and apart from the Climate Rules, companies must also ensure that they are monitoring and aware of other state and federal regulatory frameworks with respect to climate issues. Of particular note, late last year California enacted an extensive climate disclosure framework impacting both private and public companies (including, for certain large companies, Scope 3 disclosures). [32] Even though California is facing its own set of legal challenges to the law, other states such as Illinois, Colorado, and Minnesota require certain types of companies, such as public pension and retirement investment funds or banks, to make various particular climate disclosures.[33]
Disclosure Readiness
The SEC’s adoption of the Climate Rules reflects the SEC’s continued position that climate is a risk factor that public filers must consider when providing complete disclosures to investors. Despite the longer phase-in period, public filers will need to continue to ready themselves for another disclosure regime. In this regard, steps to take are:
- Use Frameworks as a Check-In: As we note above, most frameworks follow an arc that covers disclosure around four pillars of governance/oversight (at both the board and management level), strategy, risk management and metrics & targets. Sometimes, a couple other items are noted like opportunities and trade-offs per the EU CSRD. Before getting into the weeds of the disclosure rules, take stock of these pillars at a macro-level looking at the industry and then inward to the organization. Current efforts around climate can be used as a check-in on the organization’s focus and assessment of climate risk as well as identify any gaps that may signal areas for opportunity, enhanced risk management, and growth.
- Sustainability Practice vs. Financial Risk: Considering whether climate related efforts are a sustainability practice important for certain stakeholders versus a financial risk can be the start to guiding the materiality analysis for SEC disclosure. In addition, for public filers that are also subject to the EU CSRD, the SEC’s focus is on financial materiality (inbound materiality). The EU CSRD has a double materiality standard for evaluating sustainability impacts. In addition to inbound materiality, reporting companies must also assess outbound materiality – generally speaking, impacts on society and the environment. This major difference is expected to also drive different disclosures. Given this difference, it will be important to evaluate the disclosures for consistency between the disclosures.
- Evaluating Disclosures: Given the nature of the data and the eventual need for assurance there is heightened focus on the verifiability and credibility of data, typically assessed through an auditor's lens. The language and context for the data and manner in which is presented should have an equal level of focus.
- Become Friends with Operations: Regulatory disclosures are driven by legal counsel, who are increasingly having a role in broader sustainability governance and reporting but may not always be connected to those preparing the broader sustainability reporting and/or the operational teams. The SEC’s materiality lens will shape what is disclosed in the SEC reports versus the sustainability report and likely result in a different scope of published information between the reports, much like in the human capital disclosure space. While sustainability reports carry SEC Rule 10b-5 liability for materially misleading statements, there is now a heightened level of need to be vigilant in reviewing the disclosures for consistency, context and accuracy. Ensuring that both internal and external counsel is well partnered with key individuals that are the source of information for any reporting item is critical for achieving truthful and complete disclosure.
If you have questions, please reach out to the authors and the Seyfarth Impact & Sustainability team for assistance.
[1] Press Release, SEC Adopts Rules to Enhance and Standardize Climate-Related Disclosures for Investors (SEC, March 6, 2024). The full text of the Climate Rules can be found here.
[2] The Proposed Rules can be found here. Seyfarth’s analysis of the Proposed Rules can be found here.
[3] Climate Rules, supra n.1 at 1.
[4] See Lee, Allison Herren, Public Input Welcomed on Climate Change Disclosures (SEC, March 15, 2021).
[6] Gensler, Gary, Statement on Final Rules Regarding Mandatory Climate Risk Disclosures (SEC March 6, 2024).
[7] See, e.g., Tabuchi, Hiroko et al, S.E.C. Approves New Climate Rules Far Weaker Than Originally Proposed (New York Times, March 6, 2024); Noor, Dharna, US Regulators Approve Significantly Scaled Back Climate Disclosure Rule (The Guardian, March 6, 2024); Frazin, Rachel et al, SEC Finalizes Weakened Rule To Make Companies Disclose Climate Information (The Hill, March 6, 2024).
[8] For a further definition of what the Proposed Rules considered to fall within “Scope 3” emissions, see Proposed Rules, supra n. 2 at 39-40.
[9] See Peirce, Hester, Green Regs and Spam: Statement on the Enhancement and Standardization of Climate-Related Disclosures for Investors (SEC, March 6, 2024) (“Although the cost estimates for this rule are dramatically lower than the cost estimates for the proposed rule, my understanding is that, based on our estimates, 15 percent of a company’s annual SEC disclosure costs would be attributable to climate disclosures”) (emphasis added).
[12] See Crenshaw, Caroline, A Risk by Any Other Name: Statement on the Enhancement and Standardization of Climate-Related Disclosures (SEC, March 6, 2024).
[13] See Peirce, supra n.9; Uyeda, Mark, A Climate Regulation under the Commission’s Seal: Dissenting Statement on The Enhancement and Standardization of Climate-Related Disclosures for Investors (SEC, March 6, 2024).
[16] See State of West Virginia et al v. SEC, Petition for Review (11th Cir., not yet docketed); Press Release, Louisiana Attorney General Liz Murrill’s Office Files Lawsuit Against Securities And Exchange Commission (Discussing petition to Fifth Circuit by Louisiana, Mississippi, and Texas which has not yet been docketed); Liberty Energy Inc. et al v. SEC, 24-60109 (Fifth Cir.). At the same time, several climate groups such as the Clean Air Task Force, the Sierra Club, and Public Citizen have raised concerns the Climate Rules’ omission of Scope 3 disclosures. See Hirji, Zahra et al, Green Groups Decry SEC’s Climate Disclosure Rule as Too Weak (Bloomberg News, March 7, 2024).
[17] See Press Release, U.S. Chamber Statement on the SEC Climate Disclosure Rule (U.S. Chamber of Commerce, March 6, 2024); Press Release, SEC Climate Disclosure Rule Represents Important Progress, But Falls Short on Key Metrics of Financial Risk (Sierra Club, March 6, 2024).
[18] See Climate Rules, supra n.1 at 89.
[19] Id. at 92. Any disclosure should include both risks that are “reasonably likely to manifest” in twelve months (“short-term”) or beyond twelve months (“long-term”). Id. at 103.
[21] Id. at 168. Note that unlike the Proposed Rules, the Climate Rules will not require companies to identify specific board members responsible for this oversight or the expertise of board members in climate-related risks. Id. at 169.
[24] For the Climate Rules’ discussion of whether a company qualifies as a “large accelerated filer” or “accelerated filer,” see id. at 29, ns. 65-66.
[25] That is, that are not Emerging Growth Companies (“EGCs”) or Smaller Reporting Companies (“SRCs”). Id. at 245. For the Climate Rules’ discussion of whether a company qualifies as an SRC or EGC, see id. at 17, ns. 21-22.
[28] Id. at 35, 588-592. See Fact Sheet, The Enhancement and Standardization of Climate-Related Disclosures: Final Rules at 3 (“Phase-In Periods and Accommodations”).
[29] Climate Rules, supra n.1 at 589.
[31] See 15 U.S. Code § 78u–5 (providing safe harbor for forward-looking statements, with certain exceptions).
[32] See Ferrari, Giovanna et al, New California Laws Mandate Climate Disclosures For Both Private and Public Companies (Seyfarth Shaw LLP, Oct. 19, 2023).