How the SEC Shifted Green

In February and March 2021, the SEC hired its first-ever senior policy adviser for climate and ESG, directed the Division of Corporation Finance to enhance its focus on climate-related disclosures in public company filings, created a climate and ESG task force in the Division of Enforcement and solicited public input on climate change disclosures.

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Let’s talk climate change and finance. pic.twitter.com/WkBl7ebLka

— Gary Gensler (@GaryGensler) October 25, 2021

The SEC’s spring 2021 regulatory agenda, published in June, includes proposed rule amendments slated for October 2021 “to enhance registrant disclosures regarding issuers’ climate-related risks and opportunities.” SEC Chairman Gary Gensler has also said that he has requested SEC staff “to develop a mandatory climate risk disclosure rule proposal for the commission’s consideration by the end of the year” but suggested that it may be early 2022 before the rule is released to the public. In the meantime, recent comment letters sent to public companies from the SEC’s Division of Corporation Finance suggest the agency is already taking a more proactive approach to the review of climate disclosures than it has in prior years.

It may be helpful to review the background on the SEC’s actions and statements relating to climate change disclosures, including recent comment letters, and discuss takeaways from the responses to its request for public input on climate change disclosures, as well as identify actions public companies can take now to prepare for potential increased enforcement and disclosure obligations.

SEC’s Existing Climate Disclosure Guidance and Recent Comment Letters

In 2010, the SEC published interpretive guidance for public companies regarding existing disclosure requirements as they apply to climate change. This guidance came after several years of mounting pressure from state attorneys general, environmental groups, institutional investors and others to clarify climate change disclosure requirements under existing SEC rules. The 2010 guidance provides that the direct and indirect consequences of climate-related regulations, legislation, international accords and business trends, as well as the physical effects of climate change, could have a material effect on a registrant’s business and operations. Where that materiality threshold has been met, the SEC stated that companies would be required to make climate change disclosures under Regulation S-K in the description of the business, discussion of legal proceedings, risk factors, and/or management’s discussion and analysis.

The 2010 guidance’s immediate impact on public company climate change disclosure practices was limited. In a 2012 report prepared at the direction of the Senate Committee on Appropriations, SEC staff indicated that they did not find any notable year-to-year changes in the disclosures reviewed from the year before the 2010 guidance to the year after. Further, in an analysis of 10-K annual reports filed by S&P 500 companies between 2009 and 2013, Ceres, a sustainability nonprofit organization, concluded that while the percentage of companies making any climate-related disclosures increased from 45 percent to 59 percent over this period, most of the disclosures “are very brief, provide little discussion of material issues and do not quantify impacts or risks.” Ceres also found in the same study that between 2010 and 2013, only 25 of the more than 45,000 comment letters sent by SEC staff to companies related to climate change disclosures. More recently, Ceres identified only six SEC comment letters that mentioned climate change between 2016 and 2020.

This trend appears likely to be reversing. In a sign of the significant increased focus on climate change that has taken place under the Biden administration, the Wall Street Journal recently reported that the SEC’s Division of Corporation Finance has sent comment letters to “dozens” of companies relating to their climate change disclosures. A sample comment letter posted on the SEC’s website in September 2021 requests information on material climate change transition risks, litigation risks and physical risks with respect to the business; purchases or sales of carbon offsets; and why certain information disclosed in the company’s corporate social responsibility report was not included in its SEC filings.

Climate Science and Policy Advancements and New Investor Pressures

Concerns over the pace and effects of climate change have escalated in the years since the 2010 guidance was issued, with experts and political leaders increasingly calling for bold action. This year, the Intergovernmental Panel on Climate Change found that meeting the Paris Agreement goal of limiting warming to 1.5°C will require “immediate, rapid and large-scale reductions in greenhouse gas emissions.” An International Energy Agency report issued in May concluded that achieving net-zero greenhouse gas emissions by 2050, which scientists say is necessary to achieve the Paris Agreement goal, will require immediately stopping all new oil and gas exploration projects and more than doubling spending on low-carbon technologies. At an April summit on climate change, Biden announced that the U.S. will target a reduction in net greenhouse gas emissions of 50 percent to 52 percent of 2005 levels by 2030. Other countries also set new emissions targets, and further commitments are expected at the UN Climate Change Conference (COP26) in Glasgow, Scotland in November.

As a result of these developments, investor pressure on companies to take climate action and enhance their climate disclosures has increased significantly. For example, Larry Fink, CEO of BlackRock, the world’s largest asset manager, has called on companies “to disclose a plan for how their business model will be compatible with a net zero economy” by 2050. Additionally, 2021 saw an increase in the number of climate-related shareholder proposals as well as record levels of support for such proposals. Some of the proposals requested additional climate action (e.g., successful proposals at ConocoPhillips and Chevron seeking Scope 3 emission reduction targets), while others focused on disclosure (e.g., successful proposals at Phillips 66 and Delta seeking reporting on how the companies’ climate lobbying aligns with the Paris Agreement). At least 12 shareholder proposals relating to climate have passed so far this year, a record number, largely due to support from large asset managers such as BlackRock, firms motivated both by a desire to push companies to address climate-related risks as well as a need for data to help determine what companies to include in energy-transition and climate-themed funds.

Responses to the SEC’s Request for Public Comment on Climate Change Disclosures

In March 2021, then-Acting SEC Chairwoman Allison Herren Lee issued a statement requesting public input on climate change disclosures. The request raised 15 multi-part questions, covering topics such as the potential form and content of the disclosure, the feasibility of quantification and measurement of climate risks (including Scope 1, 2, and 3 greenhouse gas emissions), the benefits of establishing industry specific requirements, and the advantages and disadvantages of drawing on existing voluntary reporting frameworks.

According to Gensler, the SEC received an estimated 550 unique comment letters in response to its request for input, with three out of every four supporting mandatory climate disclosure rules. The majority of the comment letters came from investment, banking/financial organization and corporate entities, as well as trade associations; others came from NGOs (including standard-setting organizations), government officials, academics, and other interested firms and individuals.

Many of the comment letters, including those from BlackRock, Chevron, Walmart and Uber, recommend the SEC rely in some way on the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), a framework for assessing and reporting on climate risks and opportunities that is increasingly endorsed by market participants and governments. Gensler recently remarked that he has asked staff to learn from the TCFD in formulating a proposed rule.

Beyond support for enhanced climate disclosures based on the TCFD recommendations, the comment letters also highlight a number of difficult questions that SEC staff are likely grappling with in drafting a proposed rule. For example, a group of legal scholars noted that the SEC could designate the TCFD or another standard setter as authoritative, but congressional authorization would be needed to provide public funding to the standard setter for ongoing review of and updates to its standards. According to the scholars, such funding would make the standard-setter “more independent, objective and accountable.” Commenters such as United Airlines, the U.S. Chamber of Commerce and Enbridge suggested that any new rules should be flexible and allow for variation depending on the materiality of climate change to a particular industry or company. Many commenters, including Vanguard and the Business Roundtable, supported mandatory disclosure of Scope 1 and 2 greenhouse gas emissions in their letters, but fewer advocated for mandatory disclosure of Scope 3 emissions, given the challenges of data collection and the lack of methodological consensus around accounting. Other points raised in comment letters include whether climate disclosures should be furnished to or filed with the SEC (furnishing results in a lower liability risk), whether they should be included in existing filings or a separate filing, what liability protections should be available around such disclosures, and whether private companies should also be subject to climate disclosure requirements.

A handful of comment letters suggest the SEC lacks authority to enact climate disclosure regulations (e.g., the Western Energy Alliance and US Oil & Gas Association) or that a proposed rule could violate the First Amendment (e.g., the Missouri and West Virginia attorneys general). More common among the critical responses, however, is a concern about straying from the materiality standard that underpins current regulations, a concern echoed by SEC Commissioner Elad Roisman.

In a recent speech discussing the materiality standard, Lee, now a commissioner, addressed the “myth” that SEC disclosure requirements must be strictly limited to material information, noting that the relevant provisions of the Securities and Exchange Acts give the SEC “full rulemaking authority to require disclosures in the public interest and for the protection of investors,” without reference to materiality. According to Lee, the concept of materiality instead arises under the anti-fraud rules, where it functions as a limit on anti-fraud liability.

However, other recent disclosure changes that do not hinge on materiality were congressionally mandated (e.g., the mine safety and health and conflict minerals disclosures required by the Dodd-Frank Act), and the concept of materiality could be relevant under Section 23 of the Exchange Act, which requires the SEC to make a cost-benefit analysis during the rulemaking process to ensure a new rule does not “impose a burden on competition not necessary or appropriate” to advance the purposes of securities law. The agency’s cost-benefit calculus is likely to be intensely scrutinized following issuance of any proposed rule.

Preparing for Potential Increased Disclosure Obligations and Enforcement

Despite the complex considerations involved in crafting a proposed rule, the SEC appears to be moving quickly. On Sept. 14, Gensler reiterated in testimony before the Senate Committee on Banking, Housing and Urban Affairs that SEC staff are preparing a climate change disclosure rule proposal that will be informed by economic analysis and put out to public comment. Although the contours of any potential rule remain uncertain, and any such proposed rule may not be finalized until 2022 (meaning reporting requirements likely would not be affected until 2023), there are steps companies can take now to prepare:

• Take inventory of existing climate disclosures. The SEC’s recent issuance of comment letters to companies regarding climate change disclosures suggests it intends to more carefully police disclosures at the same time that it moves forward with the proposed rulemaking. Companies can work with counsel in connection with the preparation of their upcoming 10-K, 20-F and proxy statement filings to carefully evaluate their disclosures in order to ensure they satisfy the 2010 guidance, address the points set forth in the sample comment letter, and are substantiated and not misleading. It would also be prudent to review any incremental disclosures made in ESG or corporate social responsibility reports or other similar documents and identify any climate-related statements that could raise questions as to whether they should be included in SEC filings as responsive to the 2010 guidance. Evaluating existing disclosures is particularly important since the SEC’s Climate and ESG Task Force has been given the initial task of identifying “material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.”
• Work with counsel to enhance climate governance. Companies will benefit from robust board-level oversight of climate change in order to prepare for potential increased SEC enforcement activity and disclosure requirements. Companies can work with counsel to clearly delineate climate responsibilities within their charters and enhance their disclosure controls and procedures with respect to climate information, including the process for determining what information is included in SEC filings versus voluntary disclosures.
• Analyze climate-related risks and opportunities using the TCFD framework and refine climate strategy. Given the TCFD framework’s widespread adoption, the SEC may rely on it in crafting a proposed rule. Companies can review their climate-related governance, strategy, risk management, and metrics and targets as called for by the TCFD, taking into account both physical and transition risks. With respect to metrics and targets, this would include carefully calculating Scope 1 and 2 annual emissions, and, to the extent Scope 3 emissions data is not currently collected, developing a plan for collecting it. Particularly since Gensler has asked staff to recommend how companies might disclose emissions information, companies may also want to consider engaging a third-party expert or accountant to provide verification or assurance of their calculations. Such verification or assurance can provide confidence to investors and improve internal controls and reporting systems. Companies may also engage their boards to refine their climate goals, strategies and mitigation plans.
• Coordinate with counsel to determine the company’s stance on climate proposed rules. Companies can coordinate with counsel to develop a plan for the review of and response to forthcoming proposed rules, including whether to submit a comment letter to the SEC. Companies may consider submitting comments independently or participating in submissions by industry associations.

Sofia Martos, Bob Hayward, Shaun Mathew and Emilie Jones also contributed to this article.