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SEC announces proposed controversial new climate disclosure rule

Climate|Financial, Executive and Professional Risks (FINEX)
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By Lawrence Fine | April 1, 2022

Recently, the U.S. Securities and Exchange Commission (SEC) proposed a new rule which could drastically increase the climate-related disclosures required.

On March 21, 2022, after a 3 to 1 vote among its commissioners, the U.S. Securities and Exchange Commission (SEC) proposed a sweeping new rule which would potentially drastically increase the climate-related disclosures which the SEC requires, including Scope 3 disclosures relating to the greenhouse gas emissions of companies throughout an entity’s supply chain. The breadth of the proposed rule is controversial and if adopted, the rule will face difficult legal challenges which would be expected to play out during the years before the first filings would be due in 2024. It seems somewhat unlikely that the proposed rule will go into effect exactly as it is currently written and pursuant to its current proposed timeline, but if and when it does go into effect, then compliance will be difficult and expensive, and could lead to increased climate-related regulatory action and litigation.

Components of the proposed new climate disclosure rule

The proposed new rule has many categories of disclosures to be included in registration statements and periodic reports (such as Form 10-Ks), described by the SEC in an official summary as follows:

  • Climate-related risks and their actual or likely material impacts on the registrant’s business, strategy, and outlook;
  • The registrant’s governance of climate-related risks and relevant risk management processes;
  • The registrant’s greenhouse gas (“GHG”) emissions, which, for accelerated and large accelerated filers and with respect to certain emissions, would be subject to assurance;
  • Certain climate-related financial statement metrics and related disclosures in a note to its audited financial statements; and
  • Information about climate-related targets and goals, and transition plan, if any.

The SEC states that, “The proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.”

Most of the reaction to this proposed new disclosure rule has focused on the requirements relating to GHG emissions. The proposed rule provides timelines differentiating between filer categories in relation to different categories of GHG emissions. All filers would have to eventually make disclosures in relation to Scope 1 GHG emissions (the company’s own direct emissions) and Scope 2 emissions (indirect emissions from purchased electricity or other forms of energy). Smaller Reporting Companies will be exempt from the most controversial proposed requirements, disclosing Scope 3 upstream and downstream GHG emissions “in its value chain” “if material, or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.”

In relation to Scope 1 and Scope 2 GHG emissions, the proposed rule would require accelerated and large accelerated filers to offer attestation reports from an independent service provider “with a phase-in over time, to promote the reliability of GHG emissions disclosures for investors.”

The Scope 3 disclosures are the most controversial element of the proposed rule and were evidently the source of some internal debate among the three Democratic SEC commissioners. Some critics, including dissenter Commissioner Peirce (the lone Republican Commissioner and a Trump appointee), believe that the Scope 3 disclosures will be burdensome and expensive to create and inherently unreliable. However, SEC Chair Gensler and supporters of the new rule have pointed out that Scope 3 GHG emissions account for the greatest percentage of emissions and therefore should be measured and accounted for.

Filing deadlines

Large accelerated filers (public float of more than $700 million):

  • Scope 1 and Scope 2 disclosures to be filed in 2024 (for fiscal year 2023)
  • Scope 1 and Scope 2 disclosures with limited assurance (attestation) to be filed by 2025 (for 2024)
  • Scope 1 and Scope 2 disclosures with reasonable assurance to be filed by 2027 (for 2026)
  • Scope 3 disclosures to be filed by 2025 (for 2024) (no attestations, some safe harbor)

Accelerated filers (public float between $250 million and $700 million and revenue of $100 million or more):

  • Scope 1 and Scope 2 disclosures to be filed in 2025 (for 2024)
  • Scope 1 and Scope 2 disclosures with limited assurance (attestation) to be filed by 2026 (for 2025)
  • Scop e 1 and Scope 2 disclosures with reasonable assurance to be filed by 2028 (for 2027)
  • Scope 3 disclosures to be filed by 2026 (for 2025) (no attestations, some safe harbor)

Smaller Reporting Companies (generally public float of less than $75 million or public float of less than $700 million if revenue is less than $100 million):

  • Scope 1 and Scope 2 disclosures to be filed in 2026 (for 2025) (no assurance required)
  • No Scope 3 disclosures required

Division within the SEC

At the time of release, SEC Chair Gary Gensler stated, “I am pleased to support today’s proposal because, if adopted, it would provide investors with consistent, comparable, and decision-useful information for making their investment decisions, and it would provide consistent and clear reporting obligations for issuers.” SEC Chair Gensler added, “I believe the SEC has a role to play when there’s this level of demand for consistent and comparable information that may affect financial performance.  Today’s proposal thus is driven by the needs of investors and issuers.”

The lone dissenting Commissioner Hester M. Peirce voted against the proposed rule and issued a lengthy statement in opposition to it. Commissioner Peirce, in a statement entitled “We are Not the Securities and Environment Commission – At Least Not Yet” disagreed with all of SEC Chair Gensler’s contentions. Commissioner Peirce divided her statement into sections whose headings clearly summarize her position, “I. Existing rules already cover material climate risks; II. The proposed rule dispenses with materiality in some places and distorts it in others; III. The proposal will not lead to comparable, consistent, and reliable disclosures; IV. The Commission lacks authority to propose this rule; V. The Commission underestimates the costs of the proposal; and VI. The proposed rule would hurt investors, the economy, and this agency.”

Commissioner Peirce’s main contention is that historically the SEC has appropriately left to individual corporations’ decisions as to which risks are material and thus necessary to disclose to investors, and many companies do make climate-related disclosures on that basis; the proposed rule presumes that climate disclosures will virtually always be considered material to every investor in every company. (Chairman Peirce quotes the SEC as having stated that in relation to Scope 3 disclosures materiality doubts should “be resolved in favor of those the statute is designed to protect, namely investors.”) Commissioner Peirce believes that the SEC is inappropriately using purported financial concerns as an excuse for pushing companies to prioritize concern about climate change. One of SEC Chair Gensler’s main concerns is that many companies currently put out climate resiliency statements which are not subject to verification or regulatory scrutiny and so mislead investors.

Opposition and challenges expected

Commissioner Peirce believes that the proposed rule, if approved, will ultimately be found to be an invalid overreach of regulatory authority. The West Virginia attorney general, among others, has threatened to sue the SEC over the proposed rule. Given that the administration is already defending the Environmental Protection Agency’s authority to regulate GHG emissions under the Clean Air Act, there are sure to be challenges to the SEC arguably doing the same indirectly.

Key takeaways

The climate disclosure rule is currently in the proposal stage. The proposal will go through a period of public comment and debate before it can be officially adopted. If the rule takes effect in its current form, there will be litigation to challenge it and the SEC’s authority to have adopted it.

If and to the extent that the rule survives in its current form (perhaps a long shot), it is likely to be difficult and expensive to comply with, especially the Scope 3 disclosures relating to the greenhouse gas emissions of companies throughout an entity’s supply chain. The rule could be a huge “score” for “the climate industrial complex,” as suggested by Commissioner Peirce, since many companies “will have to turn to third-party consultants to help them determine Scope 3 emissions.” Commissioner Peirce also stated that the “attestation mandate could be a new sinecure for the biggest audit firms, reminiscent of the one given them by section 404(b) of the Sarbanes-Oxley Act.”

Similarly, the complexities of the proposed disclosure rule could give rise to allegations by private class action plaintiffs that any reporting deficiencies were caused by an intent to defraud. In particular, any company which finds itself in the regulatory crosshairs as a result of this rule could expect private plaintiffs to pile on, including with corporate derivative suits. On the other hand, SEC Chair Gensler would take a contrary view, expressing a hope that in the long run the new rule would benefit companies and their directors and officers by providing additional clarity and consistency in reporting requirements and reducing the temptations to greenwash by stretching the truth in informal climate resiliency reports.

On the insurance front, companies should consider the adequacy of their D&O policies in light of the possible liabilities that could result from an expanded scope of climate change disclosures. Most of the better options in the D&O liability market today should already provide coverage for the new claims which could arise, but companies should verify with their brokers that there are no likely gaps and also be on the lookout to avoid any new coverage restrictions which carriers might seek to introduce in anticipation of increased climate disclosure regulation.

Disclaimer

Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).

Author

Management Liability Coverage Leader
FINEX North America
Willis Towers Watson

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