As more advisory services, investment companies, and public companies have publicized their Environmental, Social, and Governance (ESG) goals, the U.S. Securities and Exchange Commission (SEC) has proposed a set of new rules intended to create a consistent, comparable, and reliable source of information regarding climate change impacts and sustainability efforts to inform and protect investors while facilitating further innovation in this evolving area.

The SEC’s proposed new rules have, however, been met with significant pushback.  SEC Chairman Gary Gensler recently testified before Congress that the SEC has heard the concerns voiced by various stakeholders and constituents in the public comment process “loud and clear.” The SEC has now signaled that it will finalize the proposed climate disclosure rules in October 2023. Responding to public comments, and no doubt mindful of recent Supreme Court decisions on federal agency rule-making authority, the SEC may pull back on some parts of its original proposal.

Background.

In March 2022, the SEC proposed amendments to Regulations S-X that would both enhance and standardize public companies’ climate-related disclosures (“Climate-Related Disclosures”).  These proposed disclosures would require public companies to report on climate-related risks, climate risk-management practices and processes, and any current or potentials impacts that climate-related events will have on a public company’s strategy, business model, outlook, and finances.

The proposal requires companies to report information related to “Scope 1” direct carbon emissions (think fuel use and greenhouse gases), “Scope 2” indirect carbon emissions (e.g., purchased energy and electricity), and for some companies to report on information related to “Scope 3” carbon emissions (i.e., upstream and downstream emissions not resulting from or produced by company activities, such as global supply chains and any indirect impacts caused by their products or services).

The proposal would add a significant new compliance dimension to disclosures by public companies that have decarbonization goals or adopted climate action plans but may also indirectly affect suppliers to and customers of such public companies to the extent such plans contemplate scope 3 reductions. Many such companies further those goals through transacting for carbon offsets and entering into renewable energy attribute purchase agreements including ‘virtual power purchase agreements’ or VPPAs. The proposal could drive increased demand for such transactions from public companies as well as their suppliers and their customers. Attorneys in Foley Hoag’s Energy and Climate practice group has guided our clients through such transactions and will be working with our public markets attorneys as the regulatory picture becomes clearer.

Additionally, the proposal would require additional footnote disclosures to detail the impact of climate-related events and transition activities on relevant line items in the financial statements (“Footnote Disclosures”).  The Footnote Disclosures would require companies to disclose in their financial statements:

• All positive and negative impacts of climate-related events, such as severe weather events and other natural conditions, including flooding, drought, wildfires, extreme temperatures, and sea-level rise, exceeding 1 percent of the related line item.
• All positive and negative impacts on transitions activities, such efforts to reduce greenhouse gas emissions and progress towards the company’s climate-related goals, exceeding 1 percent of the related line items.
• Expenditures related to mitigating the risk of severe weather events and other natural conditions and transition activities.
• How severe weather events and other natural conditions and transition activities affected estimates and assumptions.

The Footnote Disclosures would not only impose additional responsibilities on public companies. Given the requirement of additional disclosures in the footnotes to audited financial statements, independent auditors would also need to grapple with the new disclosure requirements, adding procedures to their audit program designed to test the new required disclosures.

In May 2022, the SEC also proposed enhanced disclosure requirements for funds and advisers incorporating ESG factors into their investment portfolios and strategies (“Enhanced Funds Disclosure”).  At its core, the proposed Funds Enhanced Disclosure rule creates additional disclosures for certain ESG funds to address “greenwashing,” where entities deceive consumers to believe they are more “environmentally friendly” than the facts support. Essentially, the more funds and advisers hold themselves out as ESG focused, the more transparency and detailed disclosures would be required through the proposed Enhanced Funds Disclosure rules.

These proposed climate disclosure rules have been a long time coming, but there have been recent signals that the end – at least in terms of publishing a final set of rules – is in sight.  In June 2023, the White House’s Office of Management and Budget, Office of Information and Regulatory Actions released its Spring 2023 Unified Agenda of Regulatory and Deregulatory Actions.  Included among the items listed on the Unified Agenda was the SEC’s proposed Climate-Related Disclosure rule and the proposed Enhanced Funds Disclosure rules, indicating we can expect a final rule on both topics to be published in October 2023.

Concerns about the SEC’s focus on ESG.

When finalized in October, the Climate-Related Disclosures will likely have been scaled back to some degree from the original proposal.  First, the SEC has received over 15,000 comments on its proposal, many of which expressed particular concern over the potential expansion of SEC authority in ways that would be unprecedented.

SEC Chairman Gensler recently testified before Congress that the SEC has heard the concerns stated by members of Congress, the agricultural community, and small businesses “loud and clear” about the proposed Climate-Related Disclosures, especially around the Scope 3 emissions disclosures which has been particularly contentious.  Gensler stated that the rule that the SEC is trying to finalize is aimed at “bring[ing] comparability and consistency about the public companies.”  However, he also acknowledged that the SEC received “a lot of comments,” including comments providing “alternatives to ensure that we don’t inadvertently . . .  [reach] nonpublic companies.”[1]  Recent reporting suggests that one of Chairman Gensler’s primary concerns about any final Climate Related Disclosure rule is the backlash the SEC might receive in the form of legal challenges.[2]

Many opponents of Climate-Related Disclosures argue that the SEC went too far in their statutory authority, even beyond Scope 3’s possible reach into nonpublic companies.  The SEC proposed these Climate-Related Disclosures under their well-established authority to require public companies to disclosure information that is “necessary or appropriate in the public interest or for the protection of investors” as provided by them in the Securities Act, 15 U.S.C. 77g, and the Securities and Exchange Act, 15 U.S.C. 78l, 78m, 78o.  However, it is possible that opponents would seek to limit the SEC’s ability to require these Climate-Related Disclosures under the developing “major questions doctrine.”

The major question doctrine, used as reasoning to limit agency decision-making powers in recent United States Supreme Court cases, such as West Virginia v. Environmental Protection Agency, citation, 597 U.S. ­­­____ (2022), National Federation of Independent Business v. Occupational Safety and Health Administration, 595 U.S. _____ (2022), and Biden v. Nebraska, 597 U.S. ­­­____ (2023), looks to the “history and breadth” of the agency’s statutory authority and the “economic and political significance” of the agency’s action to determine whether Congress intended to confer such authority to the agency.

In West Virginia, the Environmental Protection Act (EPA) faced a challenge to their Clean Power Plan rule, which addressed carbon dioxide emissions from existing coal and gas power plants. The EPA promulgated this rule under Section 111(d) of the Clean Air Act, which authorizes the EPA to regulate certain pollutants from existing coal and gas power plants.  The Supreme Court struck down the Clean Power Plan, which the court interpreted as trying to compel power generating capacities from coal and gas to wind and solar.  The Supreme Court reasoned that Congress would not delegate, or intend to delegate, “such a sweeping and consequential authority” to make decisions of political and economic signification in a cryptic or vague manner.  According to the Court, the EPA must point to more than “a merely plausible textual basis for the agency action” to show that they have “clear congressional authority” to promulgate the Clean Power Plan.

Considering these recent decisions, public attention on the SEC’s rulemaking around climate-related and other ESG matters, and the SEC’s decision to scale back other rules facing broad opposition,[3] it seems likely that we will get a modified version of the proposed Climate-Related Disclosures, especially regarding the Scope 3 disclosures.

Looking Ahead – Proposed Rules on “Human Capital”

As we look at the upcoming rules, the SEC has also put an additional focus on human capital disclosures. The SEC believes that human capital is a material resource for companies and an important disclosure for investors, and it emphasized a principles-based approach to the disclosure. We will continue monitoring updates from the SEC and any related news closely and provide additional alerts with the latest developments.

[1] Jessica Corso, SEC’s Gensler Calls CFTC ‘Not As Robust’ on Crypto, Law360 (July 19, 2023).

[2] Declan Harty, SEC’s Gensler weighs scaling back climate rule as lawsuits loom, Politico (Feb. 4, 2023).

[3] See Goldberg et al., SEC Final Share Repurchase Disclosure Rules Less Burdensome Than Expected, Harvard Law School Forum on Corporate Governance.