Lok – Fall 2022

SEC Focus on Climate Change Risk and Disclosure

Kathleen Lok

As environmental concerns continue to rise, investors and companies have continued to contend with how to report the impact of climate related risks on their business. Currently, the SEC does not require any specific environmental risk reporting, and instead bases disclosures on materiality.[1] This lack of a standardized framework gives companies much discretion to decide what environmental and climate-related information they choose to report, which is often done through voluntary sustainability reports.[2] A 2022 survey by Deloitte showed that more than two-thirds of public companies with over $500 million in revenues do not have an environmental, social, and governance (ESG) council or working group.[3] However, on March 21, 2022, the SEC voted to propose new rules that would require public companies to provide audited financial statements containing climate-related expenditure metrics, report their greenhouse gas emissions, and disclose climate-related risks and their material impacts on business.[4] If adopted, this proposal would subject public companies to allocate a significant portion of their budget in order to abide by its terms. It is estimated that compliance with the rule will cost an additional $420,000 a year on average for small public companies and $530,000 a year for larger public companies.[5]

Though some companies voluntarily provide climate-related reporting, many of the companies most responsible for the corporate greenhouse gas emissions refrain from disclosing their financial position would be affected climate-related risks.[6] This proposal would require registrants to disclose how any climate-related risks are likely to have a material impact on business, how these risks would affect the company’s strategy and business model, and the governance of these risks by the company’s board. The required disclosures would also extend to the financial impact of climate-related natural events, and what the company’s processes are for identifying, assessing, and managing climate-related risks in their overall risk management system. Companies would also be required to disclose information about their Scope 1 and 2 emissions metrics, as well as Scope 3 emissions if material or if the company has set a greenhouse gas emissions target that includes Scope 3 emissions.  Scope 1 and 2 metrics cover emissions from sources directly controlled by the company and emissions derived from the activities of a third party, while Scope 3 emissions include all other indirect upstream and downstream emissions in the supply chain.[7] Proponents and opponents of the proposal have submitted varying changes they would like to see to the rule, many centering around the removal of Scope 3 emissions disclosures, the adoption of a principals-based approach to materiality rather than bright-line rules, and an extended phase-in period.[8] Especially with Scope 3 emissions, sustainability experts have expressed concern with the difficulty of pinpointing the source of Scope 3 emissions and the possibility of double counting, given that companies would be tracking both their own and their suppliers’ emissions.[9] Even considering the large amount of public commentary, it remains to be seen whether the SEC will alter the terms of the proposal, especially considering the proposal will still experience pushback even if the strictest rules are rolled back.

The potential financial burden of these compliance costs has only intensified the debate on both sides.[10] Since the public comment period for the proposal started, 14,645 comments have been submitted. Of the comments supplied, 88% of form letters supported its passage and 12% opposed the proposal, while 53% of individualized submissions expressed support and 43% expressed opposition.[11] Around a third of the comments submitted in opposition of the proposal claim that the SEC’s actions were ultra vires, meaning they were acting beyond the scope of the their legal authority.[12] The SEC’s legal authority is defined by the Securities Act of 1933 and the Securities Exchange Act of 1934, which gives the SEC the power to create rules or regulations requiring disclosure of information “necessary or appropriate in the public interest or for the protection of investors.”[13] To determine whether a proposed rule meets these requirements, the SEC must also consider “whether the action will promote efficiency, competition, and capital formation.”[14] Through an examination of statutory context, legislative history, and congressional intent, detractors of the proposal could argue that the SEC lacks clear statutory authority. Congress has previously mandated environmental reporting requirements in other contexts, such as their authorization of the Greenhouse Gas Reporting Program (GHGRP), which allows the EPA to mandate public disclosure of GHG emissions.[15] Those opposing the rule may argue that without clear congressional allowance, the SEC does not have the authority to implement the proposed rule. In addition, Congress has established a pattern of expanding the subject of non-financial mandatory disclosures only through statute (e.g., executive compensation, corporate governance, and conflict minerals).[16] Though Congress introduced the Climate Risk Disclosure Act in the Senate in 2021—a bill that would require companies to disclose information regarding climate change-related risks—it has yet to be passed, further emphasizing the lack of congressional approval.[17]

The SEC’s proposal in response to the growing demand for climate-related information and its impact on other government agencies would have a significant influence on the overall potential of market participants to hold companies accountable for the risks they pose to the environment. The large number of public comments in a short three-month period and the novelty of the SEC imposing a required disclosure in this subject matter means that if adopted, whether with changes or as is, the rule would likely face a bout of litigation and judicial scrutiny.[18] Regardless, it is evident that the SEC’s response is a direct reaction to the absence in the market of climate-related information and the upward trend of demand for this type of data.[19] The SEC will now need to respond to the submitted comments, after which it will draft a final rule that will need a majority approval to pass.

Kathleen Lok is an Associate Editor with MJEAL. Kathleen can be reached at kzlok@umich.edu.

[1] Basic Inc. v. Levinson, 485 U.S. 224 (1988).

[2] Bloomberg Law, Proposed SEC Climate Disclosure Rule (Aug. 12, 2022), https://pro.bloomberglaw.com/brief/proposed-sec-climate-disclosure-rule/.

[3] Press release, Deloitte, US Public Companies Prepare for Increasing Demand for High Quality ESG Disclosures (Mar. 14, 2022), https://www2.deloitte.com/us/en/pages/about-deloitte/articles/press-releases/us-public-companies-prepare-for-increasing-demand-for-high-quality-esg-disclosures.html.

[4] Press Release, U.S. Securities and Exchange Commission, SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors (Mar. 21, 2022), https://www.sec.gov/news/press-release/2022-46.

[5] Suman Naishadham, Companies weigh in on proposed SEC climate disclosure rule, AP News, (June 17, 2022), https://apnews.com/article/climate-government-and-politics-environment-07b736081cf7cd8e46bb40e9834e717e.

[6] Tommy R. Wilkes and Emelia Sithole, Biggest polluting firms failing to disclose climate risks – study, Reuters (Oct. 5, 2022), https://www.reuters.com/business/biggest-polluting-firms-failing-disclose-climate-risks-study-2022-10-05/.

[7] U.S. Securities and Exchange Commission, supra note 4.

[8] Jacob H. Hupart, et. al., What Public Comments on the SEC’s Proposed Climate-Related Rules Reveal—and the Impact They May Have on the Proposed Rules, The Nat’l L. Rev. (July 20, 2022), https://www.natlawreview.com/article/what-public-comments-sec-s-proposed-climate-related-rules-reveal-and-impact-they-may.

[9] Laura Corb, et al., Understanding the SEC’s proposed climate risk disclosure rule, McKinsey & Company (June 3, 2022), https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/understanding-the-secs-proposed-climate-risk-disclosure-rule.

[10] Id.

[11] Id.

[12] Id.

[13] 15 U.S.C. §§ 77, 78.

[14] Id. §§ 77b(b).

[15] Jacqueline M. Vallette and Kathryne M. Gray, US SEC’s Climate Risk Disclosure Proposal Likely to Face Legal Challenges, Mayer Brown (Apr. 21, 2022), https://www.mayerbrown.com/en/perspectives-events/publications/2022/04/us-secs-climate-risk-disclosure-proposal-likely-to-face-legal-challenges.

[16] Id.

[17] Climate Risk Disclosure Act of 2021, H.R. 1187, 117th Cong. § 402(8) (2021).

[18] Vallette and Gray, supra note 15.

[19] Naishadham, supra note 5.

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