On March 21, 2022, the Securities and Exchange Commission (SEC) proposed expansive and controversial climate disclosure rules. Two years and 24,000 comment letters later, on March 6, 2024, the SEC voted 3-2 to adopt its highly anticipated final rule, The Enhancement and Standardization of Climate-Related Disclosures for Investors. Since the SEC’s initial proposal, the political and business climates have shifted with regards to environmental, social and governance (ESG) matters, many companies and business interest groups actively commented and worked to narrow the proposed rules, and the US Supreme Court’s decision in West Virginia v. EPA created additional uncertainty regarding the SEC’s authority to adopt the proposed rules. The final rules, while still expansive and controversial, are considerably narrower.

What are key takeaways from the final rules?

• For now, many SEC registrants can breathe a partial sigh of relief. Some of the most controversial aspects of the proposed rules were revised, such as eliminating the requirement to report Scope 3 emissions, implementing additional materiality thresholds, scaling back the new financial statement disclosure requirements, and extending the phase-in periods.
• Climate-related disclosure requirements remain unsettled for many companies. Additional disclosure frameworks, such as those in California and the European Union, include Scope 3 emissions reporting requirements and could impose significantly greater burdens on issuers. Pressure from investors, business partners, and consumers also could compel companies to disclose climate-related information over and above what the SEC’s rules require. These additional frameworks will likely leave the SEC’s goal of consistent and comparable information elusive.
• The debate regarding climate-related disclosure is far from over. Several states are challenging the final rules as climate regulation in disguise, exceeding the SEC’s authority, unconstitutionally compelling speech, and unnecessarily burdening companies. Other states and foreign jurisdictions are considering additional disclosure obligations. Environmental groups are considering challenges to the SEC’s removal of certain provisions from the final rules. While the future of these rules lies in the courts, many companies will face increased pressures or new obligations to disclose information beyond the scope of the final rules.

The Final Rules

Since introducing the proposed rules, the SEC has asserted that additional reporting requirements are necessary to protect investors, maintain fair, orderly, and efficient markets, and promote capital formation because climate related incidents and market responses materially impact registrants’ strategy, operations, and business outcomes. In the adopting release, the SEC stated that the final rules will improve the “consistency, comparability, and reliability of climate-related information for investors.”¹

The final rules require domestic and foreign private issuers to file comprehensive climate-related disclosures in their registration statements and annual reports. The final rules continue to leverage the Task Force on Climate-related Financial Disclosures (TCFD) and Greenhouse Gas Reporting Protocol (GHG Protocol) in an effort to provide a degree of consistency across reporting frameworks. While the full scope of the 886-page release of the final rules is beyond the scope of this legal alert, some of the key items registrants are required to disclose include:

• Climate-related risks that have had or are reasonably likely to have a material impact on the registrant, including on its strategy, results of operations, or financial condition in the short-term (within 12 months) and long-term (beyond 12 months).
  • Climate-related risks include physical risks (both acute and chronic) and transition risks, which include the actual or potential negative impact on a registrant’s business attributable to regulatory, technological, and market changes related to climate change.
• The actual and potential material impacts of any of the identified climate-related risks on the registrant.
• If the registrant has taken activities to mitigate or adapt to a material climate-related risk, a description of material expenditures incurred and material impacts on financial estimates and assumptions directly resulting from such activities.
• If the registrant has adopted a transition plan to manage a material transition risk, a description of the plan and subsequent disclosures regarding progress on the plan and impact on the registrant.
• Information regarding scenario analyses that determine that climate-related risk is reasonably likely to have a material impact on a registrant.
• Information regarding a registrant’s use of an internal carbon price, if it is material to the registrant’s evaluation of a material climate risk.
• Any oversight by the board of directors of climate-related risks and management’s role in assessing and managing material climate risks.
• The registrant’s process for identifying, assessing and managing material climate-related risks, if any.
• Any climate-related goal or target that has or is reasonably likely to materially affect the registrant’s business, results of operations, or financial condition, along with material expenditures and material impacts on estimates and assumptions as a direct result of the goal or target.
• Scope 1 and Scope 2 greenhouse gas (GHG) emissions, if material, for Large Accelerated Filers (LAFs) and Accelerated Filers (AFs).
  • GHG emissions are to be reported in gross terms and must exclude the impact of any purchased or generated offsets.
  • As a reminder, Scope 1 includes the registrant’s direct GHG emissions from operations that are owned or controlled by a registrant, and Scope 2 includes indirect GHG emissions from generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a registrant.
  • Registrants must describe their methodology, significant inputs, and significant assumptions in determining their GHG emissions.
  • Smaller Reporting Companies (SRC), Emerging Growth Companies (EGC), and Non-Accelerated Filers (NAF) are exempt from the GHG emissions reporting requirement.
  • As discussed further below, the final rules do not include registrants’ Scope 3 GHG emissions, which include indirect GHG emissions not otherwise included in Scope 2 that occur in the upstream or downstream activities of a registrant’s value chain.
• For those LAFs required to file GHG emission information with the SEC, attestation from an independent third-party assurance provider at a limited assurance standard by 2029 and a reasonable assurance standard by 2033. For AFs required to file GHG emissions information, attestation at a limited assurance standard by 2031. These attestations apply to both Scope 1 and Scope 2 disclosures.
• In a note to the financial statements, and thus subject to auditor review:
  • The capitalized costs, expenditures, charges and losses incurred as a result of severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise that have a greater than the applicable 1% threshold (if not less than a $100,000 or $500,000 de minimis threshold).
  • The capitalized costs, expenditures, charges, and losses related to carbon offsets and renewable energy credits (RECs) if they constitute a material part of a registrants’ climate goals or targets.
  • A qualitative description of how estimates and assumptions used to produce financial statements were materially impacted by risks posed by severe weather events and other natural conditions.
• Disclosures related to transition plans, scenario analysis, the use of internal carbon price, and targets and goals are subject to a safe-harbor as forward-looking statements under Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act or 1934 (Exchange Act) except when providing historical facts.

Implementation

The Rule, which will become effective 60 days after publication in the Federal Register, will be phased in beginning in 2026 (for the fiscal year beginning in 2025), with full implementation by 2034 (for the fiscal year beginning in 2033).

Notable Changes from the Proposed Rules

Most conspicuously, the final rules omit the requirement for registrants to report Scope 3 GHG emissions, which by some measures account for 70% of many companies’ emissions.² Critics of including the Scope 3 requirement pointed to the methodological complexity, financial burden, lack of direct control, disputed relevancy to investors, and burden on registrants’ business partners, many of which are smaller or agricultural businesses. In addition to removing Scope 3, the SEC also restricted the registrants required to report Scope 1 and 2 GHG emissions from all registrants to only LAF and AFs, if material, and exempted SRCs and EGCs. The decision to limit GHG reporting obligations to only certain registrants will limit the consistency, comparability and reliability of GHG emissions disclosures.

Another closely watched aspect of the rules was the reporting deadlines for disclosure of GHG emissions. In the proposed rules, the deadlines did not line up with mandatory disclosures to the Environmental Protection Agency and California Air Resource Board (which require such information later in the year than annual earnings report filings). The final rules adjust reporting dates and permit disclosure of emissions in a domestic issuer’s second fiscal quarterly Form 10-Q or amendment to Form 10-K. Foreign private issuers, and filers of registration statements may disclose emissions no later than 225 days after the end of the fiscal year related to such disclosures.

One of the more surprising aspects of the final rules was that it retained the unusually low 1% disclosure threshold for financial statement disclosures. In lieu of raising the 1% threshold, the SEC instead removed the requirement to disclose the impact of severe weather events or other natural conditions on each line item of a registrant’s consolidated financial statements.

Other changes included adding additional materiality qualifiers to several disclosures, eliminating the requirement to detail board members’ climate expertise, focusing the required disclosures on financial statements on capitalized costs, removing some of the more detail-focused provisions (such as requiring disaggregated disclosure for each of the seven GHGs and property location disclosures broken down by zip code), adjusting the placement of disclosure of material expenditures from Regulation S-X to Regulation S-K, eliminating the requirement to disclose material changes in a Form 10-Q, extending safe harbor from private liability, removing the requirement of private companies involved in business combinations to provide climate disclosures, and extending certain phase-in periods.

Role of Materiality

One of the overarching rules in US securities law is Rule 10b-5, promulgated by the SEC, pursuant to 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 final rules include several references to materiality when determining applicable disclosure thresholds. In the adopting release, the SEC highlights that materiality with respect to Scope 1 and Scope 2 GHG emissions is not determined merely by the amount of the emissions. Rather, materiality depends on whether a reasonable investor would consider disclosure of the information important when making an investment or voting decision or the reasonable investor would view omission of the disclosure as having significantly altered the total mix of information made available.³ The subjective nature of materiality will increase complexity in complying with the final rules.

A key aspect of complying with the final rules – and securities laws more generally – will be determining where to draw the line of materiality with regards to climate-related disclosures. If a significant percentage of the investment community determines that certain climate change-related information is important with respect to investment or voting decisions – even disclosures that are beyond the scope of the final rules – omitting such information could raise potential liability concerns.

Compared to California’s New Climate Disclosure Laws

In 2023, California passed twin climate disclosure laws putting in place the most comprehensive climate-disclosure laws in the United States. The Climate Corporate Data Accountability Act requires companies with more than $1 billion in annual revenues that do business in California to begin reporting GHG emissions data, including Scope 3 emissions, as early as 2026.⁴ Separately, the Greenhouse Gases: Climate-Related Financial Risk Act will require companies with more than $500 million in annual revenues that do business in California to prepare a report in accordance with TCFD requirements disclosing the company’s climate-related financial risks, as well as measures adopted to reduce and adapt to such risks, on a biennial basis, also beginning in 2026.

While the detailed requirements of the California laws will not be known until the regulations are released and finalized, there are substantial areas of overlap and critical differences. Both the new California laws and the SEC rules build on the TCFD and Greenhouse Gas Protocol and are intended to better standardize disclosures and reference frameworks with which many affected companies are familiar. However, unlike the SEC Rules, the California laws apply to both public and private companies that meet the jurisdictional and revenue thresholds. The California laws also do not limit their purpose to investor protection and instead promote them as part of broader leadership efforts in fighting climate change and seeking to influence a transition to a net-zero economy. Like the SEC rules, the California laws are being challenged in court. One distinction in the legal challenges is that new California mandates are laws passed by the legislature and signed by the governor. The SEC is acting without a specific legislative remit. See our prior legal alert here for additional information regarding the California laws.

What’s next?

Despite the scaled back nature of the final rules, and pending legal challenges, registrants should proactively prepare for compliance. Items to consider include:

• Even with the extended phase-in periods, registrants required to report GHG emissions who are not currently tracking these metrics should promptly undertake compliance planning and consider the information infrastructure necessary to compile this data. 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 rules will present a myriad of similar and new logistical challenges, but on steroids.
• In addition to the final rules, the SEC may focus on enforcement actions under existing securities laws as a means to address climate-related disclosures. In a recent speech, Gurbir Grewal, the SEC’s Director of the Division of Enforcement, highlighted the importance that investors are placing on climate-related disclosures and that such disclosures would be evaluated in accordance with the general anti-fraud and other provisions of federal securities laws.⁵
• 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 at face value, many parties driving the expansion of climate-related disclosures are actively seeking to influence registrants’ targets, goals, plans and conduct.
• One of the SEC’s stated objectives of the rules 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 and ESG-related information and metrics from registered companies. The information provided as a result of the SEC’s final rules 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.
• There may be unintended consequences of the final rules, including potential spinoffs of supply chain or subsidiaries to shift emissions to Scope 3 and avoid reporting Scope 1 and 2 GHG emissions.
• While less-burdensome than the proposed rules, the comprehensive disclosure requirements for registrants will lead to significant compliance costs, in terms of time, human capital, and expenses. The expansive scope and requirements of the rules illustrate why registrants and service providers have proactively spent considerable effort and expense to bolster their ESG-related capabilities. A fair criticism of the final 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.

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1 SEC Release Nos. 33-11275; 34-99678, page 12.
2 https://www.reuters.com/sustainability/climate-energy/republican-led-states-say-they-will-sue-us-securities-regulator-over-climate-2024-03-06/
3 SEC Release, page 246.
4 California’s Governor Newsom has stated a willingness to reassess the initial statutory compliance deadlines.
5 SEC.gov | Remarks at Ohio State Law Journal Symposium 2024: ESG and Enforcement of the Federal Securities Laws

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