The Heat Is On SEC’s Climate-Related Disclosure Rules

On March 6, 2024, the U.S. Securities and Exchange Commission (the “SEC”) adopted new final rules requiring issuers to include extensive disclosure in registration statements and periodic reports regarding material climate-related risks and impacts on their business strategy, financial condition and results of operations.[1] The release promulgating the final rule, which is 885 pages long, represented one of the most significant and complex reforms to the disclosure regime under the Securities Act of 1933 (“Securities Act”) and the Exchange Act of 1934 (the “Exchange Act”) in recent years. The final rules affect virtually every major registration statement under the Securities Act and periodic report under the Exchange Act. The final rules did omit some of the more controversial and onerous provisions in the proposed rule, such as the removal of disclosure on Scope 3 emissions (which come from indirect sources rather than directly from an issuer’s operations), but also added a small number of requirements not included in the proposed rules.

However, the final rules were immediately challenged in court by a wide range and large number of interested parties, beginning with a petition for review filed by the attorneys general of 10 states with the United States Court of Appeals for the Eleventh Circuit on the same day the SEC voted to approve the rules. Additional challenges were then filed by attorneys general in nine additional states in the Eighth Circuit[2]. The U.S. Chamber of Commerce filed a petition for review in the Fifth Circuit, and the Ohio Bureau of Workers’ Compensation, with the attorneys general of Kentucky and Tennessee, filed a petition for review in the Sixth Circuit. On March 21, 2024, all the challenges were transferred to the Eighth Circuit. Despite initially opposing the stay requests, on April 4, 2024, the SEC issued an order announcing that it was voluntarily (and unusually) staying the effectiveness of the final rules pending judicial review by the Eighth Circuit[3]. As of the date of the SEC order staying effective, additional interested parties including the Texas Association of Business have also filed petitions, as further described in the order.

There are also interested parties who feel the final rules do not go far enough, including the Sierra Club and the Natural Resources Defense Council, who objected to the dilution of many aspects of the proposed rules in a petition for review filed with the D.C. Circuit, saying that the final rule “will yield much less information about companies’ exposure to climate-based risks than the proposed rule would have”[4].

Considering the possibility that the various pending court challenges may materially change the substance and scope of the disclosure and other requirements imposed by the rules, the following is a high-level summary of the principal concepts and revised requirements imposed by the final rules as currently drafted.

Compliance Deadlines

The final rule contemplated a medium-term phase-in period for all affected issuers, so it is possible those dates may not change, especially for smaller issuers, but that depends on the pace at which proceedings advance in the Eighth Circuit. For large accelerated filers (“LAF”), the initial disclosure requirements begin to take effect for fiscal years beginning January 1, 2025; for accelerated filers (“AF”) other than smaller reporting companies (“SRC”) and emerging growth companies (“EGC”), they begin to take effect for fiscal years beginning January 2, 2026; for smaller reporting companies, emerging growth companies and non-accelerated filers, they begin to take effect for fiscal years beginning January 1, 2027. In each case, there are additional requirements that begin to take effect in subsequent years beginning as late as January 1, 2033.

Key Concepts

One of the key definitions in the final rules is of greenhouse gases (“GHG”), which includes the seven greenhouse gases covered by the Kyoto protocol: carbon dioxide, methane, nitrous oxide, nitrogen trifluoride, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride. A second key definition is of GHG emissions, which means direct and indirect emissions of greenhouse gases expressed in metric tons of carbon dioxide equivalent, of which direct emissions are GHG emissions from sources that are owned or controlled by a registrant, and indirect emissions are GHG emissions that result from the activities of the registrant but occur at sources not owned or controlled by the registrant[5]. The final rule also includes definitions of global warming potential (“GWP”), renewable energy credits (“REC”), and carbon offsets. Many of these definitions include circular references within definitions and to lowercase terms, such as “emissions”, or “climate-related risks”. This represents a level of scientific detail previously limited to industry-specific environmentally focused regulatory agencies such as the Environmental Protection Agency or Federal Energy Regulatory Commission, not a financial regulator, and has prompted many interested parties to argue the final rule constitutes environmental regulation beyond the SEC’s authority.

Summary of Disclosure Requirements

Scope 1 and Scope 2 GHG Emissions

LAFs and AFs that are not SRCs or EGCs are required to disclose, if material, their Scope 1 GHG emissions (direct GHG omissions from operations owned or controlled by such issuer) and Scope 2 emissions (indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by such issuer). Any such disclosure must be accompanied by an attestation report from a third-party provider providing limited assurance as to GHG emissions disclosures, which provider would be subject to independence and other requirements comparable to those currently applicable to an issuer’s independent public accountants.

Financial Statement Disclosure

Issuers must disclose the possible impact of climate-related risks on their business, and in a footnote to their consolidated financial statements.

Climate Related Risks

In addition to existing risk factor disclosure, issuers are required to describe any climate-related risks identified by the registrant that have had, or are reasonably likely to have, a material effect on the issuer’s strategy, results of operations or financial condition both in the short term (12 months) and long term (beyond 12 months).

Corporate Governance Disclosure

Issuers must describe the board of directors’ oversight of climate-related risks and, if applicable, identify any board committee or subcommittee responsible for the oversight of climate-related risks and describe the processes by which the board or such committee or subcommittee is informed about such risks.

Climate-Related Targets and Goals and Transition Plans

To the extent that an issuer has climate-related targets and goals, scenario analyses, internal carbon pricing and transition plans, these must be disclosed, if material. To the extent an issuer has adopted a transition plan to manage a material transition risk, it must describe the plan and update such disclosures in subsequent years describing actions taken under the plan, including effects on business, results of operations or financial condition, and disclose quantitative and qualitative material expenditures incurred and material impacts on financial estimates and assumptions as a direct result of the disclosed actions.

Private Securities Litigation Reform Act (“PSLRA”) Safe Harbor

The final rules extend the PSLRA’s safe harbor for forward-looking statements to disclosure of transition plans, scenario analysis, the use of internal carbon pricing, and targets and goals.

Conclusion 

Even if modified and/or curtailed, the final rules are likely to represent a significant reform to the disclosure regime under the U.S. securities laws for all public companies and will likely continue to be the subject of ongoing debate, litigation, and continued legislation and rulemaking for years to come.

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[1] https://www.sec.gov/files/rules/final/2024/33-11275.pdf

[2] Attorneys general for Alabama, Alaska, Georgia, Indiana, New Hampshire, Oklahoma, South Carolina, Virginia, West Virginia, and Wyoming filed a petition for review in the US Court of Appeals for the Eleventh Circuit and attorneys general for Arkansas, Idaho, Iowa, Missouri, Montana, Nebraska, North Dakota, South Dakota, and Utah filed a petition for review in the US Court of Appeals for the Eighth Circuit.

[3] https://www.sec.gov/files/rules/other/2024/33-11280.pdf

[4] https://www.sierraclub.org/press-releases/2024/03/sierra-club-earthjustice-lawsuit-challenges-sec-s-weakened-climate-risk#:~:text=WASHINGTON%2C%20DC%20%E2%80%94%20Today%2C%20the,related%20risks%20to%20their%20businesses

[5] https://www.sec.gov/files/rules/final/2024/33-11275.pdf https://www.sec.gov/files/rules/final/2024/33-11275.pdf , p.850.