LawFlash

How Public Companies Can Prepare for the SEC’s Proposed Climate-Related Disclosure Rules

April 20, 2022

In a historical proposed rulemaking, the US Securities and Exchange Commission marked the first time it has indicated that climate-related disclosure is material information that all public companies must provide regardless of industry or size. This LawFlash provides some key takeaways as to what public companies can do now to prepare for possible implementation.

On March 21, 2022, the US Securities and Exchange Commission (SEC) proposed long-awaited rules that would require registrants to provide climate-related disclosure in registration statements and periodic reports (the Proposal).[1] The SEC has signalled to public companies and other stakeholders its position that climate-related disclosure is material disclosure necessary for investors to make an informed investment decision for some time. For example, in guidance published in 2010, the agency outlined how its existing rules may require narrative climate-related disclosure, including through a discussion of business development, risks, litigation, and results of operations.[2]

In 2021, then Acting Chair Allison Herren Lee released a statement soliciting public input on climate change disclosures,[3] and later that year, the SEC’s Division of Corporation Finance, the division with primary oversight of public issuers’ disclosures, published a sample letter to public companies outlining the types of climate-related issues that public company issuers should consider in disclosure.[4]

Furthermore, the agency also underscored its stance on the materiality of climate and environmental, social, and governance (ESG)–related disclosure through the creation of a Climate and ESG Task Force in the Division of Enforcement.[5]

THE PROPOSAL

The proposed rules are extensive and comprehensive, and they represent a significant shift in the perspective of public companies’ disclosure on climate. As noted above, the prior SEC guidance on climate-related disclosure emphasized a materiality analysis that was specifically tailored to each company’s unique position in the marketplace and its respective industry. In this respect, the prior guidance did not go so far as to indicate that every company must provide climate-related disclosure.

Here, the Proposal differs, and explicitly states that “existing disclosures of climate-related risks do not adequately protect investors,” and frames its intent as ensuring that climate-related information is “consistent, comparable, and reliable.”[6] As such, the proposed rules are generally applicable to all public companies, with respect to both their registration statements seeking to raise capital in the public markets (i.e., filings under the Securities Act of 1933) and in their ongoing periodic reporting obligations (i.e., annual report filings under the Securities Exchange Act of 1934).

The proposed disclosure requirements, the majority of which would be provided in a separately captioned “Climate-Related Disclosure” section of the registration statement or annual report, address a variety of climate-related topics relevant to public companies. The proposed rules would require a discussion of the company’s climate-related targets, goals, and transition plans, if any; the oversight and governance of climate-related risks; the process for identifying, assessing, and managing risks; and the short-, medium-, and long-term impact of identified climate-related risks and their effect on a company’s strategy, business model, and outlook.

Additionally, in addressing physical climate-related risks, public companies would need to identify the location of properties, processes, or operations subject to such physical risks. The Proposal also requires that certain financial statement metrics, such as the disaggregated climate-related impacts on existing financial statement line items and related disclosure, be included in the financial statement footnotes, which would subject such disclosure to be within the scope of an audit of the financial statements by an independent public accounting firm.

One of the most controversial aspects of the Proposal relates to disclosure of Scopes 1, 2, and 3 greenhouse gas (GHG) emission data. In this respect, the Proposal would require that all public companies disclose Scope 1 (direct GHG emissions) and Scope 2 (indirect GHG emissions from purchased electricity and other forms of energy) data. Additionally, a public company would also have to disclose its Scope 3 (indirect GHG emissions from upstream and downstream activities in a company’s value chain) data to the extent material or if a public company has set an emissions reduction target or goal that includes Scope 3 GHG emissions; disclosure related to Scope 3 would be subject to a specific safe harbor for liability.[7]

Since Scope 3 GHG emissions data address a public company’s upstream and downstream value chain, such information may also impact private companies in a value chain that may be compelled to provide GHG emissions data to assist a public company in satisfying its SEC disclosure mandates. Finally, an accelerated or large accelerated filer would also need to obtain an attestation report from an independent attestation service provider covering the Scope 1 and Scope 2 GHG emissions disclosure.

The Proposal indicates that the proposed GHG emissions disclosure is based on the GHG Protocol’s concepts of scope and related methodology,[8] and it acknowledges that such disclosure may be broader and more comprehensive than similar disclosure required by other regulatory agencies, such as the US Environmental Protection Agency (EPA).[9] In this respect, the Proposal distinguishes the purpose and nature of SEC-related disclosure and reporting from that of the EPA and stresses the importance of providing disclosure to investors regarding emissions-related risks tailored to an individual company.[10]

WHAT'S NEXT

The Proposal was approved by a vote of 3-1, with the chair and all three commissioners each issuing their own statements regarding the proposed rules.[11] Dissenting Commissioner Hester M. Pierce argued that the Proposal was deficient, went well beyond the SEC’s authority, and may constitute unconstitutional compelled speech.[12] Lawmakers have also made public statements critiquing the Proposal. For example, Senator Joseph Manchin released a public letter addressed to SEC Chair Gary Gensler in early April, which criticized the Proposal as being politicized, unduly targeted against fossil fuel companies, and duplicative of both voluntary disclosures made by public companies and EPA reporting.[13]

The comment period for public input on the Proposal remains open until May 20, 2022, and public comment already has been substantial. Groups of Republican members of both the US House of Representatives and the Senate each submitted public comment objecting to the Proposal, noting that the role of the SEC was not to set environmental policy, but instead the role of elected lawmakers. Additionally, the public comment submitted by the Republican members of the Senate argued that the SEC did not have the appropriate “technical expertise” to review the disclosure being sought.[14]

In addition, a number of commentators have expressed concern regarding the public’s ability to submit thoughtful comment in the 60-day period being provided.[15] Chair Gary Gensler has maintained his stance that the Proposal is necessary to ensure meaningful comparability and assessment for investors and that the disclosure being sought is material, noting in a recent interview that “[m]arkets adapt and adjust to new risks . . . [a]nd so that which is material to investors can shift. . . . [climate risks are] material because when you buy or sell a stock, it’s not just about last year’s earnings—it’s about the future.”[16]

If adopted, litigation surrounding the Proposal is expected and could ultimately delay implementation. In this respect, possible examples of litigation surrounding the Proposal echo the challenges associated with the SEC’s implementation of its Conflict Minerals Rule, which also faced legal obstacles and was ultimately scaled back from the original proposal.[17]

how can public companies prepare now

While it is possible that the SEC may make changes to the Proposal in response to public comment, the agency appears determined to implement significant climate-related disclosure mandates for all public companies.[18] The Proposal included phase-in periods for the rules based on the filer status of a company and provided examples of such compliance dates based on an effective date of the rule in December 2022. Under this proposed timeline and assuming a December 31 fiscal year-end, the earliest that climate-related disclosure would be required would be in 2024 relating to the fiscal year ended 2023 for large accelerated filers.[19] In light of the Proposal’s expansive nature, public companies may want to begin internal preparation in anticipation of implementation. Some key considerations are outlined below.

Consider Corporate Governance Structure

Many public companies have already incorporated ESG factors into their businesses and corporate oversight. While the SEC has waded into ESG matters through prior climate-related guidance and disclosure mandates related to human capital and the CEO pay ratio,[20] much of the movement by public companies to explicitly address ESG matters has been driven by non-regulatory initiatives, such as pressure from institutional investors, proxy advisory firms, or shareholder activist groups.

In preparation for the potential implementation of the SEC’s proposed climate-related disclosure, public companies should review their current corporate governance and oversight structure for ESG-related matters and consider whether modifications should be made to climate-related risk oversight and disclosure controls and processes.

While the Proposal does not mandate a specific corporate governance structure or policy, the proposed disclosure would elicit detailed information about how the public company considers and addresses climate-related issues at the board level. For example, is there a specific board committee with direct oversight of climate-related issues and, if so, what does that oversight entail and how is it implemented, or are climate-related issues addressed by the full board? In addition, how does the board currently manage information and disclosure controls and will those current practices sufficiently address the expansive and complex nature of the proposed disclosure? As the proposed disclosure would be presented in annual reports subject to officer certification under the Sarbanes-Oxley Act of 2002, sufficient management oversight is paramount.[21]

Assess Climate-Related Impact Risk Management

Public companies should also consider how management currently assesses the impact of climate-related factors on its strategy, business model, and outlook. In this respect, management should have a clear understanding of materiality as it relates to climate-related issues tailored to its specific business and industry in which it operates.

Additionally, if management has an established program or policy for the ongoing assessment and evaluation of climate-related issues, how does that program assess the physical risks related to the company’s properties, processes, and operations, applicable transition risks, and their financial impact? Does the company use scenario analysis and, if so, what methodologies and key assumptions are used and are they widely accepted? What tools of risk mitigation does management use in its assessments?

Review Existing Climate-Related Disclosure

As noted above, many public companies have voluntarily provided ESG-related disclosure in recent years, including the publication of environmental or sustainability reports on their websites. In anticipation of the proposed rules, public companies should carefully review their existing climate-related disclosures with particular attention paid to possible statements that could be characterized as climate goals or transition plans. For example, the Proposal would require detailed disclosure regarding the scope, timeframe, and standards used for evaluating its progress towards meeting any established targets. Additionally, Scope 3 GHG emission disclosure would be required in instances wherein a public company has set a GHG emissions reduction target or goal, or if material to the company.[22]

Furthermore, public companies may want to consider engaging third-party experts and legal counsel in the evaluation of their current disclosure. In this respect, the proposed rules would require that certain public companies obtain an attestation report from an independent GHG emissions attestation provider related to their Scope 1 and Scope 2 GHG emissions disclosure. If the Proposal is implemented as currently drafted, third-party attestation providers and/or ESG consulting firms may have limited capacity for new clients, and other external factors could impact a public company’s ability to fully assess its climate-relate disclosures and processes.

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Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Boston
Lance C. Dial
Bryan S. Keighery
Carl A. Valenstein

Hong Kong
June Chan
Yile (Eli) Gao
William Ho
Louise Liu
Edwin Luk
Billy Wong

New York
Thomas P. Giblin, Jr.
Thurston J. Hamlette
Christopher T. Jensen
Howard A. Kenny
David W. Pollak
Kimberly M. Reisler

Philadelphia
G. Jeffrey Boujoukos
Justin W. Chairman
James W. McKenzie
Joanne R. Soslow

Pittsburgh
Celia A. Soehner

Princeton
David C. Schwartz

Shanghai
Matthew H. Lewis

Silicon Valley
Albert Lung

Singapore
Bernard Lui*
Joo Khin Ng*
Vanessa Ng*

Washington, DC
Leland S. Benton
Erin E. Martin
David A. Sirignano
Brian V. Soares
George G. Yearsich

*A director of Morgan Lewis Stamford LLC, a Singapore law corporation affiliated ‎with Morgan, Lewis & Bockius LLP



[1] See The Enhancement and Standardization of Climate-Related Disclosures for Investors, 33-11042 (Mar. 21, 2022).

[2] See Commission Guidance Regarding Disclosure Related to Climate Change, 33-9106 (Feb. 8, 2010).

[3] See Lee, Allison Herren, Acting Chair, SEC, Statement: Public Input Welcome on Climate Change Disclosures (Mar. 15, 2021).

[4] See SEC Division of Corporation Finance, Sample Letter (Sept. 2021).

[5] See Press Release, SEC, SEC Announces Enforcement Task Force Focused on Climate and ESG Issues (Mar. 4, 2021).

[6] Supra n. 1

[7] Smaller reporting companies would not be required to provide Scope 3 GHG emissions data. The Proposal includes a specific safe harbor for Scope 3 GHG emissions disclosure; other disclosure that would be responsive to the Proposal may constitute forward-looking statements that would be eligible for the existing safe harbor provided by the Private Securities Litigation Reform Act, as applicable.

[8]The GHG Protocol is considered the leading accounting and reporting standard for GHG

emissions.

[9] See supra n. 1.

[10] See id.

[11] See, e.g., Lee, Allison Heren, Commissioner, SEC, Statement: Shelter from the Storm: Helping Investors Navigate Climate Change Risk (Mar. 21, 2022), Crenshaw, Caroline A., Commissioner, SEC, Statement: Statement on the Enhancement and Standardization of Climate-Related Disclosures for Investors (Mar. 21, 2022).

[12] See, Peirce, Hester M., Commissioner, SEC, Statement: We are Not the Securities and Environment Commission – At Least Not Yet (Mar. 21, 2022).

[13] See Manchin, Joe, Senator, Letter to SEC Chair Gary Gensler (Apr. 4, 2022).

[16] Livni, Ephrat, “Gary Gensler Reflect on His First Year as SEC Chair,” NY Times (Apr. 16, 2011).

[17] See, e.g., Division of Corporation Finance, SEC, Statement: Updated Statement on the Effect of the Court of Appeals Decision on the Conflict Minerals Rule (Apr. 7, 2017).

[18] See, e.g., Gensler, Gary, Chair, SEC, Statement on Proposed Mandatory Climate Risk Disclosures (Mar. 21, 2022).

[19] Accelerated and non-accelerated filers would begin providing the disclosure in 2025 for the fiscal year ended 2024 and smaller reporting companies in 2026 for the fiscal year ended 2025.

[20] See, e.g., Item 101(c)(2)(ii) and Item 402(u) of Regulation S-K, respectively.

[21] See, e.g., Section 302(a) of the Sarbanes-Oxley Act of 2002 and Exchange Act of 1934 Rule 13a-14 and Rule 15d-14.

[22] The Proposal provides examples of when Scope 3 emissions could be deemed material and notes that “[c]onsistent with the concept of materiality in the securities laws, this determination would ultimately need to take into account the total mix of information available to investors, including an assessment of qualitative factors.” Supra n. 1.