SEC’s Climate Disclosure Rule: What directors and officers need to be aware of

Earlier this month (March 2024), the Securities Exchange Commission finally released its Climate Disclosure Rule (“Rule”) which will require certain types of publicly-listed companies to incrementally begin disclosing its climate-related disclosures. Unsurprisingly, legal action against the SEC almost immediately ensued.

Disclosures

The Rule requires that applicable companies disclose the following in accordance with phase-in periods:

• Scopes 1 and 2 GHG emissions (eventually requiring third-party assurances)
• Short-term and long-term risks climate-related risks
• Mitigation and adaptation strategy in relation to climate-related risks
• Board’s oversight of material climate-related risks
• Existing processes for identification, assessment, and management of material climate-related risks
• Climate-related targets or goals have materially impacting the company
• Financial statement disclosures in relation to climate-related risks

It is important to note that materiality was at the forefront when the Commission finalised the Rule. As such, climate-related risks are defined to mean “actual or potential negative impacts of climate-related conditions and events on a registrant’s business, results of operations, or financial conditions” which also includes physical and transition risks as well as chronic and acute risks.

The SEC gives an example of a disclosure relating to financial statement disclosures such as the costs of repairs for damage from severe weather events such as hurricanes or tornadoes. However, certain exemptions may apply in reporting such as expenses less than $100,000 in aggregate. The SEC repeatedly contends that in finalising the Rule, it was mindful of compliance being too costly and burdensome.

In addition, the Rule also provides a safe harbor regarding forward-looking statements which would limit private lawsuits against companies in relation to certain climate-related disclosures. However, companies may still be vulnerable especially if the disclosures are not in alignment with previous statements about a company’s “green” strategy, values, and operations. In other words, it may become easier to accuse companies of greenwashing.

Challenges to the Rule

Within hours of releasing the Rule, legal actions commenced against the SEC with the Rule being temporarily halted by the 5th Circuit then again reinstated upon the 8th Circuit Court of Appeals consolidated hearing to take place given the multidistrict litigation that has taken over. The SEC has already faced opposition and legal action from both sides of the ESG-spectrum which includes environmental interest groups, private companies, several state Attorney Generals, and corporate interest groups.

Given the controversy surrounding the Rule, whatever the decision rendered by the 8th Circuit Court of Appeals, it is highly probable a petition for certiorari will be submitted to Supreme Court. However, the Supreme Court would ultimately have to agree to hear the case. The Rule, in its current state, is also susceptible to a change in Administration and further political opposition.  

Nevertheless, the 886-page report provides justifications as to why it deviated from its proposed rule. The SEC justified its new policy by the comments from its open comment session which was originally extended. The comments were from a diverse range of stakeholders including renowned shareholder activists, the usual accounting and law firms, think tanks, environmental groups, and of course, corporate entities that would be subject to the rules.

Critics of the SEC have stated that the SEC has exceeded its authority beyond the ascertainable standards pursuant to the 1933 and 1934 Acts. However, the SEC reasons that it is authorised pursuant to s 7(a)(1) of the Securities Act to require disclosures “as appropriate in the public interest or for the protection of investors.” The SEC further defends its decision to require the climate risk disclosures as it has, in the past “responded to marketplace developments, investors’ need for information important to their decision-making, and advances in economic, financial, and investment analysis and analytical frameworks, as well of the costs of such disclosures.”

Indeed, some investors expressed a need for more reliable information about the effects of climate-related events on the company they’re invested in. The Commission very clearly stated that it “is agnostic as to whether and how issuers manage climate-related risks so long as they appropriately inform investors.” The materiality standard, as stated by the Supreme Court in TSC Industries v Northway, defines a fact as material if there is a “substantial likelihood that a reasonable shareholder would consider” it important in its investment decisions. Additionally, the Department of Labor under the Biden Administration recently allowed fiduciaries of ERISA funds to take ESG factors into account when making investment decisions.

Environmental interest groups have strongly criticised the SEC for not including Scope 3 of the GHG Emissions which accounts for indirect emissions. Pragmatically, Stanford Law Professor Joseph Grundfest suggested that the SEC along with the EPA should incorporate a harmonised form of GHG emission disclosures that would easily allow investors and companies to access this. While the SEC maintains that it derived its disclosure requirements from the TCFD framework and GHG Protocol, it diverges – the ultimate goal is ensure that the standards adhere to what a reasonable investor would consider.

The Proactive D&O

At this point in time, it may not be unwise for directors and officers to gain an understanding of where their company currently falls in terms of disclosure preparedness and what that process could look like. It should also be noted that your company may also be subject to ESG-related laws in other jurisdictions. As such, it may also be worthwhile to task counsel to keep you afloat of this ever-changing area of disclosures amidst a changing climate – environmentally, politically, and legally.

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