Learn what actions corporate counsel need to take to better prepare their compliance with the new SEC climate rules, despite the pending litigation that could upend them
Earlier this month, the U.S. Securities and Exchange Commission (SEC) adopted new rules pertaining to climate disclosures, sparking a wide array of reactions from various stakeholders. The regulations come as part of a broader push towards integrating climate-related risks into companies’ financial reporting framework.
These new rules have noteworthy implications on climate risk, reporting, and corporate transparency. Despite the new rules facing significant litigation from various corporate interests, in-house legal departments should not delay in deploying resources to prepare to meet these regulatory requirements.
The reception to the SEC’s new climate disclosure rules has been varied. Many clients have expressed a sigh of relief that the rules were not as stringent as they could have been, particularly regarding the most burdensome aspects of reporting and compliance, according to Darryl F. Smith, Partner at Eversheds Sutherland. However, the final rules are still comprehensive, necessitating significant effort and resources to comply. This sense of relief is balanced with an acknowledgment that while the most onerous proposals were not adopted, the remaining requirements are far from trivial.
The rules’ impact on reporting and timelines
A key aspect of the SEC’s final rules is the decision to omit mandatory Scope 3 emissions reporting — involving regulatory disclosures around vendors and suppliers downstream in the company’s supply chain. Instead, the SEC required disclosure of Scope 1 and 2 emissions only when they are deemed material. Alison Taylor, a Clinical Professor at NYU’s Stern School of Business, an author, and ethics expert, points out pragmatically that the reporting exercise on emissions is less important than actually using the information to spur action that could reduce their impact on the planet.
While dropping the requirement for Scope 3 reporting is the most controversial aspect of the rule, Smith noted this decision will not affect every company equally, as many will be subject to other mandatory reporting obligations or will voluntarily report Scope 1, 2, and 3 emissions. Excluding Scope 3 emissions considerably alters an organization’s climate risk and reporting disclosure as it limits the completeness of reported data, potentially obscuring the full impact of an organization’s carbon footprint. As such, the market’s reaction to disclosures — or the lack thereof — will serve as an indicator of the significance of greenhouse gas (GHG) reporting data in investment decisions.
In-house legal departments should proactively assess the climate risk information available to them and not delay their preparation for disclosure until the pending litigation is complete.
The final requirements also differ significantly from the previous proposal that focused on the materiality threshold for disclosing Scope 1 and 2 greenhouse gas emissions, as well as for various disclosures related to climate risks and the transition to a lower-carbon economy.
Critics of the rule as written, such as the Sabin Center for Climate Change Law at Columbia University Law School, point out allowing companies and other third parties to conduct their own assessments of materiality enables companies to determine what information is material or immaterial and thereby results in less consistent information for investors. Supporters argue, on the other hand, that the SEC has long relied on companies to determine what information is material.
Another notable change in the final rules is the extension of the deadline for reporting disclosures, which now falls on the second quarterly Form 10-Q filing after each year’s end, allowing up to 225 days from the year’s end before disclosure is required. This extension aims to provide companies with more time to gather and verify their data, which is critical as the infrastructure for reporting is still developing. Accurate GHG reporting is crucial, as rushed or inaccurate reporting could mislead investors and result in legal action. The additional time granted should enable more accurate and complete disclosures.
The regulation also has the option for companies to disclose climate risk information in financial statement footnotes without adhering to a 1% threshold for financial impact. This represents a softer approach compared to the original proposal’s line-by-line analysis. Despite being less stringent, the requirement to disclose expenditures, losses, and capitalized costs resulting from severe weather events and other natural conditions at the 1% level remains a challenging task, according to Smith. It demands careful consideration, especially because such information will be subject to the audit process.
Preparing for disclosure amid pending litigation
Even with ongoing litigation and a stay from the U.S. Court of Appeals for the 5th Circuit, SEC registrants remain subject to existing disclosure obligations regarding material information. (Most recently, a judicial panel for the 8th Circuit Court consolidated at least nine lawsuits challenging the SEC’s climate rules.)
Given this state of flux, Smith advises in-house legal departments to proactively assess the climate risk information available to them and not delay their preparation for disclosure until the litigation is complete.
For some issuers, GHG emissions are required for 2025; and as such, the groundwork for adequate information infrastructure and data collection should begin immediately, regardless of the current legal uncertainties. It is also essential for companies to be prepared to respond to inquiries on climate-related issues from various parties, including corporate board members, investors, lenders, business partners. and consumers.
The reception to the SEC’s new climate disclosure rules has been diverse, with a mix of relief and acknowledgement of the comprehensive requirements. While some corporate leaders may have anticipated more stringent regulations, the final rules have been seen as a balanced approach that requires significant effort and resources to comply.
Many clients have expressed gratitude for the more measured approach, while still recognizing the importance of addressing climate-related risks and opportunities. Overall, the final rules are seen as a step forward in promoting transparency and responsible business practices.
