Day of Reckoning: SEC Votes 3-1 to Propose New Climate Disclosure Rules

As a director, do you understand the material risks and opportunities your company faces from climate change? What about greenhouse gas emissions in your company and its supply chain (Scope 1, 2, and 3)? And how is your board equipped and organized to oversee these matters?

On Monday, March 21, with the release of proposed rules on The Enhancement and Standardization of Climate-Related Disclosure for Investors, the Securities and Exchange Commission (SEC) took a decisive step toward requiring all public companies to disclose all such “climate-related” matters in their initial stock-sale prospectuses and their annual reports. Love it or hate it, the new proposal is likely to result in final rules that will have companies and boards scrambling to comply, even as some business groups attempt to challenge the proposal in court.

The newly proposed SEC rules—at 510 pages one of the longest single-topic disclosure rules ever published by the SEC (by comparison, the release describing the conflict minerals rules was only 356 pages)—marks a true turning point for corporate climate disclosures. Although the SEC published guidance in an interpretive release in February 2010, these rules, once final, will be the first of their kind. The 2010 guidance asked companies to disclose risks from legislation and regulation, international agreements, impact of business trends, and physical impacts of climate change. The newly proposed 2022 rules expand this framework considerably: they use the term “climate-related” 1,182 times, making it clear that climate impact is everywhere. If passed in their present form, the rules would be effective as of December 2022, and apply to reports on fiscal years as ending as early as December 2023, with later periods for smaller companies, per page 100 of the release. The proposed rules would require “attestation” (approval by an independent expert such as an audit firm), starting with “limited” attestation at first but eventually requiring “reasonable” attestation—standards explained in the fine print of the rules.

The public now has at least 60 days to comment before the SEC votes on a final rule, either 30 days after publication in the Federal Register, or May 20, 2022, whichever period is longer. (All comments on these newly proposed rules must reference File S7-10-22. Click here to submit a comment.)

Conflicting Commission Views

The three Democrat commissioners supported the proposal, with one dissent from the Commission’s lone Republican. In an SEC press release about the proposed rules, SEC Chair Gary Gensler claimed that the rules were “driven by the needs of investors and issuers,” asserting that it would “provide investors with consistent, comparable, and decision-useful information for making their investment decisions, and it would provide consistent and clear reporting obligations for issuers.” Commissioner Caroline Crenshaw’s statement called the proposed rules “an important and long-awaited step forward.” In her statement supporting the proposed rules, former acting commissioner Allison Herren Lee called the proposal a “watershed moment,” and made several technical points aimed at making the rules as strict as possible, for example, questioning the value of a non-auditor attestor, and questioning the grace period of limited (rather than reasonable) attestation.

When Lee was acting chair of the SEC in early 2021, she issued a February 2021 statement asking the SEC’s Division of Corporation Finance to heighten its scrutiny of climate-related disclosures, as well as a March 2021 statement asking for general comments on climate change disclosure.

In her unique vote of dissent, Commissioner Hester Peirce claimed that the rules favored a consulting sector she called the “climate industrial complex” and argued that, if passed, the sweeping rules would make fundamental changes to the current disclosure regime, “harming investors, the economy, and this agency.” She also warned that the rules could come under constitutional challenge as a violation of corporation free speech.

The Structure of the Proposed Rules

The proposed rules (as described on pages 44–45 of the March 21 release) would require the following disclosures, among others:

• The oversight and governance of climate-related risks by the company’s board and management. NACD has been championing this as the US Host Chapter in the Climate Governance Initiative of the World Economic Forum. (More about this later.)

• How any such risks have had or are likely to have a material impact on its business and consolidated financial statements over the short-, medium-, or long-term, as defined by the company. (The rules release includes a discussion of materiality, emphasizing that any “materiality determination is made with regard to the information that a reasonable investor considers important to an investment or voting decision.”)

• How any such risks have affected or are likely to affect the company’s strategy, business model, and outlook.

• The company’s processes for identifying, assessing, and managing climate-related risks and whether or not these processes are part of an overall risk management system. If the company uses scenario analysis, the proposed rules would “require a description of those analytical tools, including the assumptions and methods used” (p. 358).

• The impact of climate-related events and transition activities on the line items of a registrant’s consolidated financial statements and related expenditures (and disclosures of impacted estimates and assumptions).

• The extent of owned greenhouse gas (GHG) emissions, whether directly from owned assets (Scope 1 GHG), or indirectly from owned assets (Scope 2 GHG). There will be no safe harbor from litigation if these disclosures are challenged as false or misleading by plaintiffs.

• Companies will also be required to disclose emissions from indirect non-owned assets (Scope 3 GHG) emissions if they are material, and/or if the company has set a reduction target. Smaller companies are exempt from this last requirement, and there will be a general safe harbor for Scope 3 disclosures.

Details on Board Oversight

For every area of disclosure, the proposed rules offer detailed requirements. Of most immediate concern to board leaders will be the details on the aforementioned area of “board oversight and governance.” Under this category of disclosure (detailed on page 100 of the release), the rules would require a company to disclose this information:

• Which board members or board committees (if any) are responsible for the oversight of climate-related risks

• Which board members (if any) have expertise in climate-related risks, fully describing the nature of the expertise

• How the board or board committee discusses climate-related risks—and with what frequency

• How the board is informed about climate-related risks, and how frequently the board considers such risks

• Whether and how the board (or board committee) considers climate-related risks as part of its business strategy, risk management, and financial oversight

• Whether and how the board sets climate-related targets or goals and how it oversees progress against those targets or goals, including the establishment of any interim targets or goals

Form of Disclosure

The newly proposed rules build on existing disclosure requirements under the two main regulations for public companies: Regulation SK (Code of Federal Regulation, Part 229, covering all nonfinancial disclosures) and Regulation SX (Code of Federal Regulation, 17 CFR Part 210, covering all financial disclosure). Accordingly, the proposed rules explain how a company should provide the climate-related information in the registration statement or annual report (which may be by reference from other sections mandated by Regulation S-K, such as Management’s Discussion and Analysis) and how to provide financial information as mandated under Regulation S-X, via notes to the financial statements. The proposed rules require companies to electronically tag both kinds of disclosures (narrative and quantitative) in Inline XBRL. The proposed rules specifically require that the disclosures must be “filed rather than furnished.”

Likely Response to the New Proposal

Many organizations will be building on comments they have already conveyed to the Commission over the past year in response to the March 2021 request by then acting chair Lee. While most of the 6,000 responses received were form letters (following one of the SEC’s four model forms), more than 700 were unique. Most of the letters were from climate groups urging greater disclosure. A small percentage of the unique letters were from corporations or their representatives (such as the is 2021 Business Roundtable letter) or similar letters from the US Chamber of Commerce and National Investor Relations Institute (NIRI). All these corporate letters urged safeguards against liability. For example, the NIRI comment made three key recommendations aimed at reducing undue liability for directors: flexibility of approach, a safe harbor similar to the one for forward-looking financial statements, and the status of “furnishing” rather than “filing.”

This last point is particularly important because any time a financial statement is filed with the SEC it is vulnerable to lawsuits under securities laws. Also requesting furnished rather than filed statements was an early comment from the CEO of the nonprofit XBRL, which develops protocols for SEC electronic filings to make them easily searchable and comparable.

An investor perspective no doubt helpful to the SEC staff in writing the rules came from a BlackRock comment last year. BlackRock recommended working with the leading standard setters, citing the Task Force on Climate-Related Financial Disclosures (TCFD) a protocol developed by GRI, VRF, and others. The 2022 proposed rules are based explicitly on this model as well as on the Greenhouse Gas Protocol for measuring GHG.

Likelihood and Timing of Passage

Judging from the supportive comments and votes of the three Democrat appointees on the four-member Commission, majority approval of final rules is likely before the end of the year. The Commission may have felt some pressure from Congress. In a February 9 letter to Chair Gensler, Sen. Elizabeth Warren noted that the late start in proposing climate rules will cause delays, which are “unwarranted and unacceptable.” Commissioner Lee is leaving the Commission in June 2022, and while she is likely to be replaced by someone with similar views, there may be an effort to fast-track the rules before she leaves.

In responding to the proposed rules, many organizations will be building on comments they have already made in response to a previous SEC call for comment, made March 15, 2021, by then acting chair Allison Herren Lee. As of today, more than one year later, nearly 6,000 individuals and institutions have sent in comments on climate change disclosure to the SEC, in response to Commissioner Lee’s 2021 request. While most of these were form letters (following one of the SEC’s four model forms), more than 700 were unique, with most of these urging greater disclosure. Most of these were from environmental advocacy groups (such as the Sierra Club) that are not themselves issuers of financial statements or investors in corporations.

Will the Rules Be Challenged in Court? A Matter of Precedent

The US Chamber of Commerce and the Business Roundtable have both sent early comments in 2021 supportive of the general goal of disclosure, but also asking the SEC to make the standard “furnished” rather than “filed” to lessen potential liability risk under US securities laws. They are likely to challenge the proposed rules on this point, and, if it becomes final, to challenge it in court. There may be a parallel action from the Energy and Environment Legal Institute, a conservative group that challenges climate-related rules (as this past petition for rulemaking shows).

In recent years, the Supreme Court has heard a number of challenges to regulatory power over corporations—that most recent one being now argued in court: West Virginia v. United States, argued February 28, 2022, challenging the government’s authority to compel environmental standards. The original petition in this case was authored by Patrick Morrisey, who has objected to mandatory climate reporting on this same ground, as stated in this letter to the SEC sent in March 2021. Successful challenges to SEC authority include one challenging conflict mineral disclosure as a First Amendment violation (in Nat’l Ass’n of Manufacturers, Et al. v. SEC, et al., 2014, upheld 2015), and another vacating one of two final proxy access rules (Business Roundtable et al. v. SEC, 2011).

Get Ready

Many in the governance community—especially the many in the climate advisory community—will welcome these new rules. Yet others may protest them in comments or even in court. All boards, however, would be wise to anticipate the emergence of a new climate disclosure regime in some form—and to practice good climate governance in the meantime.