Key Implications of SEC’s Climate-Related Disclosure Rules

Summary

On March 6, 2024, the Securities and Exchange Commission (“SEC”) in a 3-to-2 vote[1] adopted its landmark climate-related disclosure rules (the “Final Rules”), which will significantly expand the climate-related information that U.S. public companies and foreign private issuers (other than Canadian issuers reporting on Form 40-F) will be required to disclose in their periodic reports and registration statements.[2] Our March 7, 2024 publication provided a high level summary of the Final Rules. This memorandum provides additional analysis of the Final Rules and their implications for public companies.

The Final Rules were adopted to provide investors “more complete and decision-useful information about the impacts of climate-related risks on registrants”.[3] After receiving a record 24,000 comment letters on its March 2022 proposed rulemaking (the “Proposed Rules”),[4] the SEC narrowed the Proposed Rules. Notably, the SEC qualified many disclosure requirements by materiality (including disclosures of Scope 1 and 2 greenhouse gas (“GHG”) emissions), eliminated the proposed Scope 3 emissions reporting requirements, and narrowed the proposed financial statement disclosures.

Nevertheless, the Final Rules still prescribe expansive climate-related disclosures that will meaningfully increase the cost, compliance challenges and liability exposure associated with public reporting. Key implications of the Final Rules for public companies include:

1. In light of the relatively short initial compliance timeline, in-scope companies should prepare now.

Companies will need to stand ready to comply with the rules in advance of the applicable initial compliance date. For companies that do not have robust climate reporting processes already in place, it could take substantial effort and resources to build up the infrastructure needed to ensure compliance readiness. Even a company that already publishes TCFD-aligned climate disclosures in its sustainability reports may need to expend significant additional efforts to subject such disclosures to the rigor required for disclosures in SEC filings, including to comply with disclosure controls and procedures and support Sarbanes-Oxley officer certifications. In addition, the new financial statement disclosures will be subject to audit and will be within the scope of internal controls over financial reporting. Therefore, it is crucial for companies to promptly review their data collection and control infrastructure, assess the controls and procedures currently in place to capture, prepare and validate the information required under the Final Rules, and to adopt and implement new controls and procedures prior to initial reporting. For example, for large accelerated filers, a SWE occurring in January 2025 may trigger disclosure under the Final Rules, and such filers will need to ensure that they have established and tested processes (including those discussed below) in advance for identifying a SWE and tracking the related financial impacts.

2. Interpretive challenges under the Final Rules, such as the determination of materiality and disaggregated financial impact of SWEs, will increase reporting complexity.

Key elements of the Final Rules pose interpretive challenges that may require changes to current practices:

Materiality of GHG emissions metrics. Assessing the materiality of GHG emissions metrics could pose particularly significant interpretive challenges. The SEC stated that the materiality of GHG emissions metrics should be assessed under the Supreme Court’s standard in TSC Industries, Inc. v. Northway, Inc., and intimates such an assessment could require companies to conduct qualitative and quantitative assessments with respect to their Scope 1 and 2 emissions.[5] As a result, companies may need to track and monitor their Scope 1 and 2 emissions in order to evaluate materiality, even in situations where a company ultimately determines that the disclosures are not required. The SEC further acknowledged that, for some companies, the cost of making a materiality determination could be significant, especially if the company is not already tracking this information for internal purposes.[6]

Adding to the challenges, a standardized approach to determining materiality in the GHG emissions context has not emerged. Today, many companies use a “comply-or-explain” approach when deciding which GHG emissions metrics they disclose under voluntary frameworks such as TCFD. In the absence of a standardized approach, different stakeholders within a company, as well as its attestation and other external service providers, may need to expend meaningful coordination efforts to align on materiality determinations. While the Adopting Release lists a range of factors that may indicate Scope 1 and/or 2 emissions are material to a company, such factors are non-exhaustive, and stakeholders may take differing views on how to apply such factors. Companies should also be mindful that the SEC may not defer to companies’ materiality determinations with respect to climate-related disclosures, as evidenced by the SEC staff’s comment letters on this topic between 2021 and 2024. Therefore, in making this determination, companies should consider coordinating across their organization, including their board, management and their risk, legal, finance, technology, sustainability and accounting functions.

Other materiality determinations and related implications. The Final Rules call on companies to make materiality determinations in many other contexts, such as in connection with material climate-related risks and their material impacts, which may differ from disclosure determinations made as part of voluntary climate reporting under TCFD or another standard. Any perceived discrepancy between the information contained in an SEC filing and those in other public disclosures (including prior SEC filings and voluntary reports) could invite questions from the SEC, shareholders, potential litigants and other stakeholders. For example, if a company determines that certain climate-related information included in its voluntary sustainability report is immaterial and therefore omits such information from its annual report or registration statement, the SEC could question the company’s materiality determination, as it has done in its recent comment letters. As another example, if a company discloses a material chronic risk under the Final Rules but did not disclose such risk in prior SEC filings, stakeholders may question the omission of such disclosure in prior years.[7]

Companies should also be aware that their materiality determinations can potentially trigger additional disclosure requirements under the Final Rules. For example, once a company identifies a climate-related risk as material, any transition plans adopted to manage the impact of such material risk must also be disclosed. As discussed in “Targets and Goals”, if a company determines that a GHG emissions reduction target or goal is material, the company may also need to report and annually update the underlying Scope 1, 2 and/or 3 emissions metrics to satisfy its disclosure obligations, even if the GHG emissions metrics are not otherwise required to be disclosed. In other words, if a company discloses a net zero goal covering Scope 1 and/or 2 emissions but does not report GHG emissions metrics under Item 1505, such decision could attract questions from the SEC and other stakeholders.

Determining disaggregated financial Impact of SWEs. The Final Rules link financial statement disclosure requirements to “severe weather events” and “other natural conditions” without defining such terms. This will require companies to make their own determinations as to which SWEs trigger disclosure, and they will need to substantiate these determinations as part of the audit process. In addition, companies will need to disaggregate the financial impacts of SWEs, which imposes further interpretive challenges since it can often be difficult to determine whether a financial impact results from a SWE or other surrounding circumstances. Making these interpretations in a principled manner that is consistent with robust internal controls over financial reporting will require significant time and effort from the company and its auditors. Interpretive issues should be addressed well in advance of the initial compliance date and with sufficient time to conduct required testing.

3. In assessing initial compliance readiness, companies must consider the implications of climate-related disclosure requirements in other jurisdictions, such as the EU and California.

For many companies, the Final Rules will constitute only one of several disclosure frameworks under which they must report climate-related information. U.S. public companies and foreign private issuers subject to multiple climate-related disclosure requirements will need to consider the overlap and discrepancies between the information requirements in each relevant jurisdiction, requirements with respect to reporting timelines, formats and attestation, each jurisdiction’s approach to materiality and the standards of liability applicable to disclosures provided. In designing a climate-related disclosure plan that is responsive to all relevant requirements, a threshold question is whether to use a single climate disclosure report that complies with multiple standards, or to prepare separate reports that differ in scope and content.

No substituted compliance or recognition of non-U.S. disclosure rules. The SEC’s rejection[8] of substitute compliance will most immediately affect companies subject to the EU’s Corporate Sustainability Reporting Directive (“CSRD”) and those that report in jurisdictions expected to adopt disclosure requirements aligned with the standards developed by the International Sustainability Standards Board (“ISSB”), such as the United Kingdom, Australia, Canada, China, Japan, New Zealand and Singapore. The SEC noted that it “may consider such accommodations in the future”, depending on how international climate reporting practices develop and the SEC’s experience with disclosures made under its rules[9], but provided no timeline for revisiting the matter.

State-level requirements. In the U.S., state lawmakers have enacted or proposed climate-related disclosure requirements with explicitly extraterritorial coverage. For example, California’s expansive climate-related disclosure laws will require TCFD-aligned disclosure of climate-related financial risk and Scope 1, 2 and 3 emissions reporting for all U.S. companies (both public and private) that “do business” in California and meet a specified total annual revenue threshold. As drafted, the California law requirements are not qualified by materiality. While it is clear that California’s climate-related disclosure laws would intersect with those in the Final Rules, it is not yet clear how they will interoperate. The California laws require implementing regulations that have not yet been developed and are facing pending litigation. Similar laws have also been proposed in other states, including New York and Illinois.

Requirements in other jurisdictions can influence the SEC’s assessment of compliance with the Final Rules. The SEC indicated that it intends to observe developments in climate-related reporting requirements in other jurisdictions.[10] For example, the SEC stated in the Adopting Release that companies should consider whether GHG emission metrics may be material (and therefore required to be disclosed under the Final Rules) if a company discloses a material transition risk that has manifested as a result of a GHG reporting requirement in another jurisdiction that has made such company’s emissions currently or reasonably likely to be subject to additional regulatory burdens through increased taxes or financial penalties.[11]

Companies may produce separate voluntary reports. Because the Final Rules omit or adjust certain elements of the TCFD framework, companies may choose to continue to publish more fulsome voluntary reports in response to expectations of shareholders, proxy advisors, customers, counterparties, sustainability disclosure and ranking organizations (such as CDP) and other key stakeholders, who may prefer climate reporting that more closely aligns with TCFD.[12] As discussed above, the SEC and other stakeholders may focus on perceived discrepancies between SEC filings and voluntary disclosures, and companies must carefully consider their statements made outside SEC filings in evaluating their approach to the Final Rules.

4. The Final Rules will increase companies’ overall exposure to litigation and regulatory risks, but only provide a limited safe harbor.

By increasing the amount of climate-related disclosures required to be filed with the SEC, the Final Rules will increase public companies’ exposure to liability. Given the limited safe harbor provided under the Final Rules and the current polarized environment, legal teams should be integrated early in the reporting process to mitigate potential legal risks.

Liability safe harbor excludes historical facts. Given the inherently uncertain nature of some of the climate-related disclosures that will be required, as well as evolving science, standards, methodologies and industry practices, many commenters requested that the SEC provide robust safe harbors covering both forward-looking and certain historical information provided under the new climate-related disclosure requirements. The SEC opted to specify in Item 1507 that the PSLRA safe harbor covers required disclosures related to transition plans, scenario analysis, internal carbon price and targets and goals,[13] but explicitly stated that the safe harbor will not apply to matters of historical facts. The express exclusion for historical facts significantly limits the protection afforded under the safe harbor, as many of the inputs to these plans, analyses, prices, targets and goals will consist of a complex mix of factual and forward-looking information, making key aspects of the disclosures outside of the safe harbor provision. In addition, there is no liability safe harbor for Scope 1 and 2 GHG emissions or the new financial statement disclosures, where significant interpretive challenges exist as discussed above.

“Filed” not “furnished”. The Final Rules will require the new disclosures to be filed in registration statements and in periodic reports that are automatically incorporated into registration statements. As a result, the climate-related disclosures filed under the Final Rules could be subject to heightened Securities Act liability.

Polarization of climate-related issues. The new disclosures may also increase companies’ exposure to risks associated with action taken by regulators, other government officials, shareholders, customers, employees and other stakeholders, who may have diverging views and interests with respect to climate-related topics. In preparing the disclosures required under the Final Rules, companies should also consider the potential reactions of key stakeholders to such disclosures (including disclosures with respect to climate-related strategy, transition plans and targets and goals), which could have legal, reputational, operation and financial implications.

5. Legal challenges to the Final Rules amplify uncertainty for public companies.

The Final Rules have attracted immediate and intense scrutiny from a variety of stakeholders. Multiple petitions have been filed and more filings are anticipated. A preliminary ruling impacting the effectiveness of the Final Rules could be made in the coming months.

To date, petitions challenging the Final Rules include those filed by:

• 10 state attorneys general on March 6, 2024 in the Eleventh Circuit, arguing that the adoption of the Final Rules exceeded the SEC’s statutory authority and is otherwise “arbitrary, capricious, an abuse of discretion and not in accordance with law”;[14]
• Liberty Energy Inc. and Nomad Proppant Services LLC on March 6, 2024 in the Fifth Circuit along with an emergency stay motion and a request for a ruling on the stay by March 16, 2024;[15]
• a group of three state attorneys’ general on March 7, 2024 in the Fifth Circuit, who described the Final Rules as “regulatory overreach seeking to advance the Biden Administration’s climate-change agenda” in an accompanying statement;[16] and
• the Texas Alliance of Energy Producers and the Domestic Energy Producers Alliance in the Fifth Circuit on March 11, 2024, who issued an accompanying statement that “Congress did not authorize the SEC to demand that companies report environmental or any other controversial issues completely unrelated to finance”.[17]

In addition, on March 6, 2024, the Sierra Club announced that it is “considering challenging the SEC’s arbitrary removal of key provisions [including Scope 3 disclosure requirements] from the final rule, while also taking action to defend the SEC’s authority to implement such a rule”.[18] On the same day, the U.S. Chamber of Commerce issued a statement that it “will continue to use all the tools at [its] disposal, including litigation if necessary, to prevent government overreach and preserve a competitive capital market system”.[19]

The uncertainty surrounding a potential judicial stay or vacatur of the Final Rules imposes additional challenges for companies subject to the Final Rules, including how to prioritize resources and allocate budgets. However, given the potentially significant amount of preparation required to become compliance-ready, companies may not have the luxury of waiting for a final judicial ruling, particularly large accelerated filers that will need to comply with respect to fiscal year 2025 and other companies that will require substantial enhancements to their climate reporting procedures to become compliance-ready.

Endnotes

1SEC Chair Gary Gensler and Commissioners Caroline Crenshaw and Jaime Lizárraga voted in favor of the Final Rules, and Commissioners Hester Peirce and Mark Uyeda voted against.(go back)

2The Final Rules will become effective 60 days following their publication in the Federal Register. (go back)

3See SEC Release Nos. 33-11275; 34-99678; File No. S7-10-22 (March 6, 2024) (the “Adopting Release”) at p. 12, available at https://www.sec.gov/files/rules/final/2024/33-11275.pdf. (go back)

4See the SEC’s press release announcing the adoption of the Final Rules, available at https://www.sec.gov/news/press-release/2024-31.(go back)

5See the Adopting Release at p. 247.(go back)

6See the Adopting Release at pp. 247-8.(go back)

7See note 11 above on the SEC statement in the Adopting Release that many companies do not discuss climate-related risks in response to existing disclosure requirements.(go back)

8See the Adopting Release at p. 568.(go back)

9See the Adopting Release at p. 805.(go back)

10Id.(go back)

11See the Adopting Release at pp. 246-47.(go back)

12For example, Glass Lewis’s latest benchmark policy stated that it will assess whether companies have produced TCFD-aligned disclosures. See Glass Lewis, 2024 Benchmark Policy Guidelines at p. 8, available at https://www.glasslewis.com/wp-content/uploads/2023/11/2024-US-Benchmark-Policy-Guidelines-Glass-Lewis.pdf?hsCtaTracking=104cfc01-f8ff-4508-930b-b6f46137d7ab%7C3a769173-3e04-4693-9107-c57e17cca9f6.(go back)

13Item 1507 of Regulation S-K.(go back)

14See the Petition for Review filed by 10 state attorneys generals in the Eleventh Circuit, available at https://ago.wv.gov/Documents/SEC%20Climate%20Disclosure%20Petition%20for%20Review.pdf;.(go back)

15See the Petition for Review filed by Liberty Energy Inc. and Nomad Proppant Services LLC in the Fifth Circuit, available at https://app.pacerpro.com/cases/18698083.(go back)

16See the Petition for Review and accompanying statement from Louisiana Attorney General Liz Murrill, available at https://www.ag.state.la.us/Article/13199.(go back)

17See the Petition for Review and accompanying statement from the Texas Alliance of Energy Producers and the Domestic Energy Producers Alliance, available at https://pacificlegal.org/wp-content/uploads/2024/03/DEPA-v.-SEC-Petition-for-Review_final.pdf.(go back)

18See Sierra Club’s statement (March 6, 2024), available at https://www.sierraclub.org/press-releases/2024/03/sec-climate-disclosure-rule-represents-important-progress-falls-short-key.(go back)

19See U.S. Chamber of Commerce’s statement (March 6, 2024), available at https://www.uschamber.com/finance/corporate-governance/u-s-chamber-statement-on-the-sec-climate-disclosure-rule.(go back)