On March 21, 2022, the Securities and Exchange Commission (SEC) proposed sweeping new climate-related disclosure requirements for publicly reporting companies.¹ Coming in at 510 pages, the proposed rules are nearly as expansive as the obligations they seek to impose.

At a high level, the proposed rules would require both domestic and foreign registrants to:

• Provide narrative disclosures describing climate-related risks and the actual or likely material impact on the registrant’s business, strategy and outlook;
• Discuss the registrant’s governance and risk management processes with regards to climate-related risks;
• Quantify and disclose the registrant’s direct and indirect greenhouse gas (GHG) emissions which, for some registrants, would be subject to third-party assurance;
• Include certain climate-related metrics and disclosures in a separate note to its audited financial statements; and
• Disclose information about climate-related goals and transition plans, if any.

What does this mean?

The scope and demands of the proposed rules – in both breadth and level of detail – are pervasive. If finalized as proposed, the rules’ disclosure, audit and attestation requirements would necessitate significant time, planning and attention across registrants’ organizations in addition to significant compliance expenses. The impact of the proposed rules will vary substantially on public companies based on several factors, such as business, industry, whether Scope 3 emissions are material, current practices regarding climate change reporting, and existing transition plans.

Registrants who have proactively and voluntarily provided climate-related information based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures, will recognize several aspects of the proposed rule and have a head start evaluating the proposed rules and complying with the final rules once adopted. Registrants who have not viewed climate change risks as material or have not sought to voluntarily comply with climate-related disclosure frameworks, will want to inventory their current information and begin to build out the information infrastructure necessary to address the proposed disclosure requirements.

While the magnitude will vary, the proposed rules would affect every public company. They would also affect many private companies and many individuals and consumers who are part of registered companies’ value chains.

The proposed requirements

The proposed rules represent a significant and demanding expansion of existing disclosure requirements. Some of the most prominent disclosure obligations include:

• Impacts of climate-related risks on a company’s business, financial statements, and business model over the short, medium and long-term.
  • The rules separate climate risks into two categories, physical and transition. Physical risks relate to changes in weather or seasonal patterns, severe weather events or the like. Transition risks relate to the broader trends towards decarbonization and how those trends – whether mandated by governments or driven by consumer preference or other stakeholder pressures – have impacted or are likely to impact a registrant.
• Detailed discussions regarding oversight and governance of climate-related risks by the board and management.
• A registrant’s process for identifying and managing climate-related risks.
• Impact of climate-related events, if greater than 1%, on individual line items of a registrant’s financial statements. As part of the financial statements, this data would be included in the scope of the audit.
• All Scope 1 (direct GHG emissions from sources owned or controlled by the registrant) and Scope 2 (indirect GHG emissions from purchased electricity and other forms of energy used by the registrant) emissions: (i) in absolute terms, (ii) without accounting for offsets, and (iii) in terms of intensity (per unit of economic value and unit of production).
• All Scope 3 emissions, if material to the registrant or if the registrant has set a GHG emissions target that includes Scope 3 emissions measured in absolute terms without offsets and by intensity. Scope 3 emissions are all other indirect GHG emissions and includes upstream and downstream activities in a registrant’s value chain.
• If the registrant has transition plans or publicly stated climate-related targets or goals, information about (i) the targets and time horizon, including interim targets, (ii) how the registrant intends to meet the goals, (iii) relevant data regarding progress towards those goals, and (iv) the role of carbon offsets or renewable energy credits in meeting those goals.
• If the registrant uses scenario analysis to assess its climate-risk business strategy, a description of the scenarios as well as detail regarding parameters, assumptions and projected financial impacts.
• If the registrant uses an internal carbon price (i.e. an estimated cost of carbon emissions), information about the price and how it is determined.
• Addressing certain of the above disclosure mandates in a separate note to the registrant’s audited financial statements.
• If an accelerated or large accelerated filer, obtain and file an attestation report from an independent provider covering at least Scope 1 and Scope 2 emissions disclosures.

Phase-in periods and accommodations

As shown in the table below, the proposed rules provide limited relief to companies by phasing in disclosure obligations based on filer status and exempting smaller companies from Scope 3 disclosures entirely. For those subject to Scope 3 disclosures, there is also an additional phase-in period for the disclosure and assurance requirements.

The SEC recognizes the uncertainty regarding estimates and third-party information and proposed rules provide a safe harbor for disclosure of Scope 3 emissions. Provided that a registrant discloses Scope 3 emissions data using a reasonable basis and in good faith, data that was later found to be inaccurate would not be considered fraudulent.

Additionally, forward-looking statements within climate-related disclosures are subject to safe harbors under the Private Securities Litigation Reform Act.

Going after greenwashing

One significant aspect of the SEC’s agenda is to provide greater transparency and accountability for registrants that have adopted transition plans. As noted above, the proposed rules would require a description of a plan including relevant targets and metrics as well as annual updates as to activities and progress towards the stated objectives. This shifts climate change commitments from the sustainability reports and website, to SEC reports. The focus on tying specific and verifiable disclosure in SEC reports to other public statements and goals demonstrates the SEC’s desire to address and prevent “greenwashing,” i.e., overstating or creating an inaccurate appearance of being green. This is a critical concern for investors as well as other stakeholders.

This is not the first time the SEC has addressed the disconnect between public transition plans and SEC filings. In the sample letter regarding climate change disclosures under the SEC existing disclosure requirements released in September 2021, the first question addressed inconsistencies between a registrant’s corporate social responsibility reports and its SEC filings.

For companies that are considering adopting transition plans or climate change commitments, such plans should be considered in light of the disclosure obligations and liability concerns attached to SEC filings.

Comment (and act) quickly

The SEC appears ready to move quickly on adopting climate change disclosure requirements. Comments on the proposed rules are due the later of May 20, 2022 (60 days after the release of the proposed rule), or 30 days after the proposed rule is published in the Federal Register. The comment period for such expansive and substantial rules is surprisingly short. The brief comment period is likely in part due to the significant response to the SEC’s solicitation of public comments regarding climate change disclosure beginning in March 2021.

Perhaps illustrative and foreshadowing, the proposed rules assume an effective date of December 2022. For that date to be met, it would require a very brief review of what are likely to be substantial comments on the proposed rules. The relatively brief comment period and potentially brief window the SEC assumes to review comments may indicate that there will be little variance between the proposed and final rules.

Climate change-related disclosure as material information

Even without the proposed rules, failure to keep up with broad-based investor demands for climate change-related disclosures could create potential liability exposure under current SEC rules.

One of the overarching rules in US securities law is Rule 10b-5, promulgated by the SEC, pursuant to the Securities Exchange Act or 1934 (the Exchange Act). Under Rule 10b-5, it is illegal, “to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” Materiality is based on whether there is a substantial likelihood that a reasonable investor would consider the information important when determining whether to buy or sell a security or how to vote.

The SEC’s 2010 guidance focused on how climate change considerations and risks fit within the SEC’s existing reporting requirements and the overarching concept of materiality and how such considerations could be material to a registrant’s business.² Several commenters have argued that a significant percentage of the proposed rules are not required given the pre-existing materiality requirements.

However, if a significant percentage of the investment community continues to take a position that certain climate change-related information is material and that climate change-related disclosures are important to an investment analysis, omitting to address such information could raise potential Rule 10b-5 concerns. Part of the debate will focus on where to draw the line of materiality with regards to climate change disclosures. The prescriptive nature of the SEC’s proposed rules takes an exceptionally broad view as to what climate change information may be material for investors.

What are scope 3 emissions?

One of the most controversial aspects of the proposed rule is the inclusion of Scope 3 emissions. This extends the proposed scope of climate-related risks extends to the actual or potential negative impacts of a registrant’s entire “value chain” – including upstream and downstream activities related to that registrant’s operations. Pursuant to the proposed rule, upstream activities include activities by a party other than the registrant that relate to the initial stages of a registrant’s production of a good or service, such as, materials sourcing, materials processing and supplier activities. Downstream activities are defined to include activities by a party other than the registrant that relate to processing materials into a finished product and delivering it or providing a service to the end-user, for example, transportation and distribution, processing of sold products, use of sold products, end-of-life treatment of sold products and investments. One of the examples of Scope 3 emissions the SEC uses is customers’ travel to a registrant’s stores. The difficulty of accurately estimating how a customer got there, where they came from and any other variables to determine related GHG emissions is considerable. And yes, some registrants’ Scope 3 emissions will include estimates of your use of their products.

Even with a safe harbor from certain liability protections, the implications and demands of obtaining Scope 3 information are substantial.

Details, details, details

The proposed disclosure requirements are not only expansive, but also exceptionally detail-oriented. A few examples:

• For each of Scope 1, 2 and 3 GHG emissions, disclose on an aggregated and disaggregated basis: i.e. carbon dioxide, methane, nitrous oxide, nitrogen trifluoride, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride.
• The locational requirements for material physical risks include: providing locational information by zip code, disclosing the percentage of properties in flood plains and locations, and disclosing the amount of assets and percentage of total water use and locations in areas of water scarcity.
• Registrants must classify climate-related risks as either physical or transitional, and, if physical, as chronic or acute.

• For registrants required to disclose an internal carbon price: specific assumptions and disclosure about each internal carbon price used in different climate-related scenarios.
• Provide disaggregated financial statement information – on a line-by-line and event-by-event basis – for climate-related risks unless the aggregated impact of severe weather, other natural conditions, and transition activities does not meet a one percent threshold, which seems quite low to focus registrant and investor attention on material analyses.

The granularity and level of detail in the proposed rule is a significant shift from the increased discretion the SEC afforded management to describe their businesses in the 2020 amendments to Regulation S-K under the Exchange Act.

Other thoughts and considerations

Much has been said, and much more will be said, on the appropriate level of climate change disclosure. Into that chorus, we offer the following thoughts:

• While the proposed disclosure obligations rest with publicly reporting companies, these requirements will impact a large number of small and private companies who do business with public companies as registrants seek to obtain accurate and verifiable information regarding indirect emissions data.
• Even with the proposed phase-in periods, registrants who are not currently tracking these metrics should promptly undertake compliance planning. The task of quantifying GHG emissions across a large organization is a monumental endeavor that will necessitate significant resources. Registrants and securities practitioners will remember the logistical challenges presented in compiling workforce data necessary to comply with the CEO pay ratio rule. These new proposed rules will present a myriad of similar and new logistical challenges, but on steroids.

• There will be unintended consequences of the rules, if finalized as proposed. For example, would registrants that are only subject to Scope 1 and Scope 2 consider to spin-off parts of the supply chain, or subsidiaries, so that Scope 1 and Scope 2 emissions come off the books?
• The SEC states that the objective of the disclosures is not to drive targets, goals, plans or conduct but merely to provide investors with tools to assess implications of such targets, goals, plans, or conduct. Even if readers take that statement at face value, many parties driving the expansion of climate change-related disclosures are actively seeking to influence registrants’ targets, goals, plans and conduct.
• One of the SEC’s stated objectives of the proposed rule is to promote “consistent, comparable, and reliable” disclosure. How effective this will be remains to be seen. Investors actively seek a diverse and broad spectrum of climate change and ESG-related information and metrics from registered companies. Whatever information ends up being provided as a result of the SEC’s final rules, it will likely be but one part of the overall mix of information sought by investors. Registrants may be left complying with expansive SEC rules in addition to the multitude of varied and detailed ESG questionnaires from the investment community.
• The detailed and prescriptive disclosure requirements for all registrants will lead to significant compliance costs, in terms of time, human capital, and expenses. The expansive scope and requirements of the proposed rule illustrate why registrants and service providers have proactively spent considerable effort and expense to bolster their ESG-related capabilities. A fair criticism of the proposed rules is whether some of these resources could be better spent on searching for improvements to actually address a registrant’s climate impact rather than increasing compliance obligations.

Regardless as to the form of the final rules, the trend towards broader climate change disclosure appears likely to continue and the SEC will have plenty of company in demanding this information from registrants.

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^{1 See Proposed rule: The Enhancement and Standardization of Climate-Related Disclosures for Investors (sec.gov)}

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