Last year in this blog, I wrote an
article on Environmental, Social, and Governance (ESG) programs. As I wrote then, momentum is building for companies to adopt environmental, social, and governance—or ESG—programs. Investors, as well as customers, suppliers, employees, and proxy advisors (among others) have all increased pressure on companies to advance their ESG efforts.
In the July 2021 article, I gave the example of hedge fund Engine No. 1, which successfully elected three directors to ExxonMobil’s board, as a way to drive ExxonMobil toward “net-zero emissions energy sources and clean energy infrastructure.” And Chevron’s shareholders successfully approved a shareholder proposal requiring Chevron to “substantially reduce greenhouse gas (GHG) emissions of their energy products in the medium and long term.”
Since that time, momentum has continued to build toward ESG programs – and especially toward climate-related disclosure. Indeed since then, the Securities and Exchange Commission (SEC)
proposed a rule calling for more disclosure by public companies of their climate-related risks and risk metrics.1
This article discusses the SEC’s proposed rule, including its justification and challenges as well as its potential impact on private companies.
The SEC’s Proposed Rule
In March 2022, the SEC
issued a proposed rule on disclosure of climate risks by public companies with a registered class of securities (public companies). The SEC invited comments on the rule through the extended deadline of June 17, 2022.2
Under the proposed rule, public companies would have to disclose information in their annual reports and registration statements about climate-related risks. Such risks include harm to businesses and their assets arising from wildfires, hurricanes, tornadoes, floods, and heatwaves, as well as harm from chronic risks such as gradual temperature increases, drought, and changes in sea levels. Moreover, a company might face risks associated with operating in a carbon-intensive industry in the face of (1) increasing pressure on countries to transition to cleaner sources of energy, (2) consumer demand for cleaner energy, and (3) shifts in prices of energy, among others.
Under the proposed rule, public companies would have to provide the following categories of information (emphasis added):
oversight and governance of climate-related risks by the company’s
board and management;
how any identified climate-related risks have had or are likely to have a
material impact on the company’s business and consolidated financial statements over the short, medium, or long term;
how any identified climate-related risks have affected or are likely to affect the company’s strategy, business model, and outlook;
the company’s processes for identifying, assessing, and managing climate-related risks and whether any of those processes are integrated into the company’s overall risk management system or processes;
the impact of climate-related events (severe weather events and other natural conditions as well as physical risks identified by the company) and transition activities (which refers to transition to lower carbon products and activities) on the company’s financial statements, and disclosure of financial estimates and assumptions impacted by such climate-related events and transition activities;
Scope 1 and Scope 2 Greenhouse Gas (GHG) emissions metrics, where Scope 1 emissions are
direct GHG emissions that occur from sources owned or controlled by the company (e.g., emissions from company-owned or controlled machinery or vehicles) and Scope 2 GHGs are emissions primarily resulting from the generation of electricity purchased and consumed by the company. Because Scope 2 emissions primarily result from another party’s activities, they are considered indirect;
Scope 3 GHG emissions and intensity, if material (such as the emissions from the production and/or transportation of goods by third parties), or the company’s GHG emissions reduction target or goal that includes its Scope 3 emissions. Scope 3 GHG emissions are all indirect emissions other than Scope 2 emission – in other words, emissions generated by sources not controlled by the company; and
the company’s climate-related targets or goals, and transition plan, if any.
The SEC based this disclosure framework largely on that of the
Task Force on Climate-related Financial Disclosures (TCFD) which many companies are already using. Thus, many companies are already familiar with these categories. Some have even been providing disclosure in line with this framework.
The proposed rule has a phase-in period depending on the company’s filer status (relating to company size). In addition, larger companies would have to include an attestation as to Scope 1 and Scope 2 GHG emissions.
Potential Impact on Corporate Governance
While a detailed discussion of this rule is beyond the scope of this article, I do want to make a few comments about this proposed rule as it impacts corporate governance.
First, with respect to governance disclosure under item 1 above, the company would need to disclose whether anyone on the board has expertise in climate-related risks. The rule would also call for the company to disclose how often the board discusses climate-related risks; how the board is informed of such risks; and how the board considers such risks in setting strategy, making decisions, and overseeing the business. It also calls for disclosure on how the board sets climate-related goals and how it oversees progress toward those goals.
This disclosure obviously presumes an active board role in overseeing climate risk, both when performing its oversight duties as well as when making business decisions. It also presumes active board consideration of climate risk when setting business strategy.
Second, a company would also have to disclose various information about management’s role in managing risk, such as whether a particular position or committee assesses and manages climate risk; any climate-related risk expertise of that position or on that committee; and the reporting structure for that position or committee. It also calls for information about how those individuals obtain information about climate-related risks.
Third, when managements evaluates whether a risk is material under item 2 above, it is directed to consider the risk’s magnitude and probability over the short, medium, and long term. Thus, for example, a wildfire risk in California might be a material risk for a company heavily dependent on physical property for its operations, whereas it might not be to a company that does not depend on physical locations. As always, materiality considers what a reasonable investor would find important in making an investment decision.
Obviously, a company’s evaluation of risk involves the unknown future. Thus, the company could have to make statements about the future, which are considered forward-looking information. While generally a company is protected in making such forward-looking statements under the Private Securities Litigation Reform Act (PSLRA) safe harbor, so long as it meet’s the act’s requirements, that safe harbor contains many exceptions that could subject these statements to the antifraud provisions of the securities laws.
Justification for the Rule
Under the Securities Act of 1933 and the Exchange Act of 1934, the SEC has the authority to regulate through disclosure where “necessary or appropriate in the public interest for the protection of investors.” Moreover, the SEC has authority to regulate in a way that promotes “efficiency, competition, and capital formation.”
The SEC has issued the proposed rule discussed above in furtherance of this authority. Specifically, according to the SEC, it has proposed this new disclosure rule:
because this information [referring to the information about climate risk and risk metrics] can have an impact on public companies’ financial performance or position and may be material to investors in making investment or voting decisions. For this reason, many investors – including shareholders, investment advisers, and investment management companies – currently seek information about climate-related risks from companies to inform their investment decision-making. Furthermore, many companies have begun to provide some of this information in response to investor demand and in recognition of the potential financial effects of climate-related risks on their businesses.
The SEC’s goal is not merely to have public companies
provide such disclosure, but also to
have it be consistent, comparable, and reliable. This will allow investors to make investment and voting decisions across all of their investments, based on their own risk preferences. Importantly, as investors can better price climate risk, they can make better investment decisions.
The SEC believes that existing climate-related disclosures do not adequately protect investors. Much of the climate-related disclosure is provided outside of SEC filings (e.g., often in sustainability reports), and is provided using different disclosure frameworks and through different platforms such that the same information is not available to all investors. That makes it more challenging for all investors to access the information, to compare information among companies, and to analyze the provided information alongside the company’s financial performance. It also makes it difficult for investors to hold companies accountable for their statements made outside of securities law filings. Moreover, the SEC believes companies often do not provide investors with adequate information with which to analyze qualitative disclosure about climate risk.
The proposed SEC rule is designed to address these failings. It would require the same type of information be provided in the same public filings (annual reports and registration statements) for all public companies. That would facilitate the making of cross-company comparisons, make the information more accessible to investors, and give investors a more direct avenue through which to hold companies accountable for their disclosure.
Challenges to the Rule
While there is momentum in favor of the SEC’s passage of the rule (or some variation of it), this is not yet a final rule. As such, it does not have any binding effect. Moreover, the comments to the proposed rule suggest that the SEC faces substantial headwinds in adopting the rule.
While many comment letters suggest specific changes to the proposed rule,3 others challenge the SEC’s authority to regulate climate-related disclosure at all. For example, one comment letter submitted by the attorneys general of 24 states4 argues that the SEC does not have authority to regulate climate change. These attorneys general argue that regulating climate change is extraordinary for the SEC, given that it is environmental regulation outside of the SEC’s expertise and requires specific authority granted by Congress.
Not Only for Public Companies
While there is not yet a final rule on climate-related disclosure, one can easily view the SEC’s position from its proposed rule as calling for, at a minimum, reflection on what a company should be doing differently in terms of climate risk management and disclosure.
Indeed, if the SEC is correct that climate-related risks have a material impact on a company’s financial performance, every company – whether private or public – should consider how to effectively become informed of and manage climate risk.
Moreover, companies should consider whether those risks are material, and if so, how it should disclose those risks to investors. After all, a company’s climate risk does not depend on whether or not it has a registered class of securities.
A company conducting a private placement of its securities might have even more reason to comply with relevant aspects of the TCFC framework. After all, the antifraud provisions of the Securities Act apply even to private offerings.
As such, private companies would be wise to become familiar with the new disclosure framework contained in the SEC’s rule. They should use that framework to understand what climate risks they face and, potentially, seek to quantify those risks to the extent that they could reasonably and materially impact their financials or business performance.
Relatedly, companies should consider getting whatever expertise they deem necessary – on the board and in management – to be able to perform these tasks. They should also consider putting in place governance frameworks to oversee the company’s exposure to climate risk, and plan the company’s response should one of those events materialize. Moreover, business strategy and business decisions should appropriately reflect any such climate risk.
As a lawyer, your clients will likely turn to you to lead the charge on this. You can especially help your clients understand which governance structures and disclosure controls to put in place to ensure there is appropriate visibility, internally and externally, about climate risks that could impact your client’s financial performance.
This article was originally published on the State Bar of Wisconsin’s
Business Law Blog. Visit the State Bar
sections or the
Business Law Section webpages to learn more about the benefits of section membership.
1 In 2021, the SEC called for general input on whether it should issue regulations on climate disclosure, even before proposing a rule. Acting Chair Allison Herren Lee Public Statement,
Public Input Welcomed on Climate Change Disclosures.
2 Securities and Exchange Commission, Proposed Rule, Extension of Comment Period,
The Enhancement and Standardization of Climate-Related Disclosures for Investors, Release Nos. 33-11061; 34-94867, May 9, 2022.
comment letter from CFA Institute, June 30, 2022.
4Comment letter from Attorneys General of the States of West Virginia, Arizona, Alabama, Alaska, Arkansas, Florida, Georgia, Idaho, Indiana, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Utah, Virginia, and Wyoming, July 13, 2022.