August 21, 2023

Is California going to set the gold standard on climate disclosure?

Cooley LLP

+ Follow Contact

Send

Embed

Cooley LLP

Are you fretting about when (or if) the SEC is going to take action on its climate disclosure proposal and what exactly the SEC has in store for public companies in its final regulations? Consider this: California might just beat the SEC to the punch. You might remember that, in 2021, a California State Senator introduced the Climate Corporate Accountability Act, which failed last year after sailing through one chamber of the legislature but coming up one vote shy in the second (see this PubCo post). But that bill was re-introduced this year as the Climate Corporate Data Accountability Act (SB 253) and packaged with other bills, notably SB 261, Greenhouse gases: climate-related financial risk, into California’s Climate Accountability Package, a “suite of bills,” according to the press release, “that work together to improve transparency, standardize disclosures, align public investments with climate goals, and raise the bar on corporate action to address the climate crisis. At a time when rising anti-science sentiment is driving strong pushback against responsible business practices like risk disclosure and ESG investing,” the press release continued, “these bills leverage the power of California’s market to continue the state’s long tradition of setting the gold standard on environmental protection for the nation and the world.” (See this PubCo post.) If signed into law this time, SB 253 would mandate disclosure of GHG emissions data—Scopes 1, 2 and 3—by all U.S. business entities with total annual revenues in excess of a billion dollars that “do business in California.” SB 261, with a lower reporting threshold of $500 million, would require subject companies to prepare reports disclosing their climate-related financial risk, in accordance with TCFD framework, and describe their measures adopted to reduce and adapt to that risk. If signed into law, according to Bloomberg, SB 253 would apply to over 5,300 companies and SB 261 would apply to over 10,000 companies. But, given their history, what makes anyone think these bills will be signed into law this time? As Politico observes, “[w]hen do you know a bill might have legs? When there’s a bit of horse-trading going on.” And that’s apparently just what’s been happening recently with these bills.

Bloomberg reports that “[c]orporate support for the legislation has been growing this year. More than a dozen companies have submitted a letter to lawmakers in support of SB 253” and 12 wrote in support of SB 261, including, in both cases, some very familiar names. Both bills have passed in the California Senate and should come up for approval in the Assembly before the end of the legislative session on September 14—less than a month away.

SB 253 would require the California Air Resources Board, referred to as CARB, by January 1, 2025, to develop and adopt regulations requiring “reporting entities” to disclose annually their Scopes 1, 2 and 3 GHG emissions, in conformance with the Greenhouse Gas Protocol, to a nonprofit “emissions reporting organization” engaged by the state to develop a reporting program to receive these disclosures and make them publicly available on a digital platform. A “reporting entity” is a “partnership, corporation, limited liability company, or other business entity formed under the laws of this state, the laws of any other state of the United States or the District of Columbia, or under an act of the Congress of the United States with total annual revenues in excess of [a billion dollars] and that does business in California.” Total revenues would be determined based on the reporting entity’s revenues for the prior fiscal year. The Senate floor analysis explained that, under existing law, “doing business” in California is defined as “engaging in any transaction for the purpose of financial gain within California, being organized or commercially domiciled in California, or having California sales, property or payroll exceed specified amounts: as of 2020 being $610,395, $61,040, and $61,040, respectively.”

The bill would require the state board to contract with the University of California (or another equivalent academic institution) to prepare a report on the public disclosures made by reporting entities and submit the report to the emissions reporting organization to be made publicly available on the new digital platform to be created by the emissions reporting organization that will feature the emissions data of reporting entities.

Under the bill, disclosures would need to be independently verified by a third-party auditor who is expert in GHG emissions because of significant experience in measuring, analyzing, reporting or attesting to the emission of GHG, with “sufficient competence and capabilities necessary to perform engagements in accordance with professional standards and applicable legal and regulatory requirements” and to enable the auditor to issue appropriate, independent reports. The state board would be required to adopt regulations that authorize it to seek administrative penalties for violations of these provisions not to exceed $500,000 per year, taking into account all relevant circumstances, including the violator’s past and present compliance and whether and when the violator took good faith measures to comply with these requirements.

Recent negotiations are reflected in several important changes to the bill. The annual disclosure was originally scheduled to commence for all Scopes in 2026; however, that provision has been amended to require disclosure regarding Scopes 1 and 2 GHG emissions beginning in 2026, now pushing Scope 3 (upstream and downstream emissions in a company’s value chain) out to 2027. The revised bill also adds confirmation that reporting of GHG emissions will not exceed the GHG Protocol standards and guidance. In a change from the bill that failed last year, this bill now explicitly permits the use of guidance under the GHG Protocol “for scope 3 emissions calculations that detail acceptable use of both primary and secondary data sources, including the use of industry average data, proxy data, and other generic data in its scope 3 emissions calculations.” According to the Senate Environmental Quality Committee’s analysis, relative to the prior bill, these changes to the calculation methodology allowing indirect calculation methods will simplify the reporting requirement. In addition, the assurance requirements have been revised to require audits at only a limited assurance level for Scopes 1 and 2 GHG emissions beginning in 2026 and at a reasonable assurance level beginning in 2030. Whether to require assurance for Scope 3 will be subject to state board review and evaluation in 2026, with potential for the state board to establish a Scope 3 assurance requirement that would begin in 2030. The revised bill also makes clear that emissions reporting should be structured to minimize duplication of effort and allow reporting entities to submit “to the emissions reporting organization reports prepared to meet other national and international reporting requirements, including any reports required by the federal government, as long as those reports satisfy all of the requirements” of the bill. Further, with regard to civil penalties, the bill has substantially narrowed the factors for consideration in imposing penalties. A Scope 3 safe harbor was also added: the bill now provides that a reporting entity would not be subject to an administrative penalty for any misstatements in disclosures regarding Scope 3 GHG emissions “made with a reasonable basis and disclosed in good faith.”

The bills go beyond proposed SEC rules in several key respects. (See this PubCo post, this PubCo post and this PubCo post.) In contrast to the SEC’s climate proposal, which would apply only to public companies, this mandate would apply to private entities as well. Nor is there currently any threshold related to the materiality of Scope 3 emissions, while the SEC proposal required reporting only on Scope 3 emissions that were material or where Scope 3 emissions were included within a GHG emissions reduction target or goal. The bill would also require all reporting entities to report Scope 3 emissions; the SEC’s proposal would exempt smaller reporting companies from Scope 3 disclosure and would require Scope 3 reporting by non-SRCs only as noted above. In addition, the California requirements for assurance are more extensive, for example, potentially covering Scope 3 and applying to all reporting entities. (See this PubCo post.) However, the SEC’s proposal was more extensive in at least one respect: it would require disclosure of climate-related financial statement metrics and related disclosures in a note to the audited financial statements, provisions that were subject to substantial criticism in the public commentary.

The Senate Judiciary Committee analysis includes some public commentary in support and in opposition to the bill. A coalition of supporters contended that the climate crisis

“is the direct result of the cumulative and growing emissions of [GHG] into our atmosphere and the private sector continues to play an outsized role in contributing to the crisis. For example, we know that 100 active fossil fuel producers are linked to 71% of global industrial GHG emissions since 1988. But the full picture of corporate climate emissions remains fragmented, complete, and unverified….By requiring reporting of both direct emissions from these corporations, and any emissions produced from their supply chains and other indirect emissions, SB 253 creates the data infrastructure to drive down corporate carbon emissions. This mandate of comprehensive climate pollution transparency would be the first in the nation and would establish a public right to know which companies are polluting our environmental commons, how much they are emitting, and if they are decreasing—or increasing—their climate emissions, offering a transparent and public way of verifying corporate claims of climate leadership.”

Nevertheless, there is strong opposition. The California Chamber of Commerce and other business groups oppose the bill, arguing, among other things, that the bill would hurt small business, that Scope 3 data was not reliable and that California should not regulate out-of-state emissions:

“Requiring reporting and limiting emissions associated with a company’s entire supply chain will necessarily require that large businesses stop doing business with small and medium businesses that will struggle to accurately measure their greenhouse gas emissions let alone meet ambitious carbon emission requirements, leaving these companies without the contracts that enable them to grow and employ more workers….At this juncture, Scope 3 emissions reporting is more of an art than it is a science. Due to the likelihood of double counting, assessing Scope 3 emissions data with any degree of accuracy is not yet possible….Finally, we are not aware of any statutory authority that would provide the [CARB] the authority to regulate foreign and out-of-state companies delivering goods to California. It seems likely that out-of-state or non-California companies would challenge such authority. Because of this uncertainty, the burden will fall on California-based companies, giving out-of-state and foreign companies a market advantage, driving production out-of-state and increasing the cost of goods for California residents.”

SideBar

The analysis of the Senate Judiciary Committee also presents an argument that the bill does not introduce clear dormant Commerce Clause issues, a topic that has been in the spotlight recently as a result of a case that SCOTUS decided this summer. As explained in the analysis, Section 8 of Article I of the U.S. Constitution grants Congress the power to regulate interstate commerce, implying that the “states may not usurp Congress’s express power to regulate interstate commerce.” According to the analysis, this rule prohibiting

“state interference in interstate commerce, sometimes known as the dormant Commerce Clause, serves as an absolute bar to regulations that discriminate against interstate commerce, i.e., by favoring in-state businesses or excluding out-of-state businesses. But when a state passes a law that ‘regulat[es] even-handedly [across all in-state and out-of-state businesses] to effectuate a legitimate local public interest,’ that law ‘will be upheld unless the burden imposed upon such commerce is clearly excessive in relation to the putative local benefits.’ There is no facial dormant Commerce Clause issue here. This bill grants no favoritism for in-state companies—all U.S.-based companies doing business in California with annual gross revenues in excess of $1 billion are subject to the bill’s reporting requirement. That leaves only the questions of whether the bill’s reporting requirement serves a legitimate local interest, and whether the burden imposed by the reporting requirement is clearly excessive in relation to the benefits conferred.”

The analysis concluded that both prongs were satisfied—that requiring companies to report GHG emissions serves a legitimate local interest and that the burden imposed by the reporting requirement is most likely not clearly excessive in relation to the benefit: the “bill does not impose any new restrictions on GHG emissions—covered companies are required only to tabulate and report on what is already there, i.e., their enterprise-wide GHG emissions. Moreover, the bill limits its application to only the most profitable companies in the country and which do business in California, so the added economic cost of tabulating and auditing scope 1, 2, and 3 GHG emissions is unlikely to impose a significant burden on the affected companies.”

The issue of the dormant Commerce Clause came to the fore in June after Justice Gorsuch issued the majority opinion in National Pork Producers v. Ross. I admit I’m definitely on the side of the pigs here, as were 63% of California voters in 2018, when they (we) voted to approve Proposition 12, which prohibits the sale in California of pork from pigs that were born of mothers placed in conditions of extreme confinement, such as gestation crates. As described in this opinion piece in the NYT, the “life of many pigs, never rosy, has become miserable: They are hidden away in sheds with no dirt to root in, no straw for bedding, and no access to the outdoors. Breeding sows spend much of their lives in tiny pens called gestation crates. At 2 by 7 feet, the crates are barely bigger than the sows, leaving them unable to even turn around.” The law requires that, for pork sold in California, “a sow cannot be confined in such a way that it cannot lie down, stand up, fully extend its limbs, or turn around without touching the side of its stall or another animal.” The pork industry sued, contending that the law unfairly applied to many businesses outside of California and unduly burdened interstate commerce, violating the dormant Commerce Clause. The pork industry estimated that the cost of compliance would increase production costs, affecting both California and out-of-state producers, but because California imports almost all the pork it consumes, most of the compliance costs would fall on farms outside of California. The district court held that the complaint failed to state a claim as a matter of law and dismissed the case. The decision was then affirmed by the Ninth Circuit. The industry appealed to SCOTUS.

The pork industry acknowledged that Prop 12 did not did not discriminate against out-of-state producers. That put the industry in a tough spot from the get-go. Instead, the industry invoked a purported “extraterritoriality doctrine,” which, they claimed, prohibits, on an “almost per se” basis, the “enforcement of state laws that have the ‘practical effect of controlling commerce outside the State,’ even when those laws do not purposely discriminate against out-of-state interests.” The Court disagreed, concluding that the “argument falter[ed] out of the gate.” In the Court’s view, the purported “almost per se” extraterritoriality doctrine “would cast a shadow over laws long understood to represent valid exercises of the States’ constitutionally reserved powers.”

Alternatively, the industry asserted, the Court must apply the balancing test enunciated in Pike v. Bruce Church, Inc. The industry contended that, under Pike, “a court must at least assess ‘the burden imposed on interstate commerce’ by a state law and prevent its enforcement if the law’s burdens are ‘clearly excessive in relation to the putative local benefits.’” However, on the issue of the viability of the Pike balancing test in this instance (where no discrimination or transportation is involved), the opinions were fractured: a minority (Justices Gorsuch, Thomas and Barrett) concluded that the Pike balancing test created “a task no court is equipped to undertake,” particularly where, as here, the “competing goods are incommensurable.“ To reach a decision as to which set of concerns should win out, “[y]our guess is as good as ours. More accurately,” Gorsuch said. “your guess is better than ours. In a functioning democracy, policy choices like these usually belong to the people and their elected representatives.”

The majority, however, disagreed, endorsing the continued viability of the Pike balancing test. As Justice Sotomayor (joined by Justice Kagan) wrote in her partially concurring opinion, a majority of the Court did not support the view that “judges are not up to the task that Pike prescribes.” Applying that test, however, the Justices splintered again. In the end, a plurality of four Justices (as counted by Justice Kavanaugh in his dissent) declined to find that the industry had met the threshold requirement of plausibly alleging a substantial burden on interstate commerce, a requirement that Sotomayor asserted “plaintiffs must satisfy before courts need even engage in Pike’s balancing and tailoring analyses.” As Gorsuch phrased it, the substantial harm to interstate commerce alleged by the industry “remains nothing more than a speculative possibility” and insufficient to state a claim. Dissenting, Chief Justice Roberts, joined by Justices Alito, Kavanaugh and Jackson, would have found that the industry had “plausibly alleged a substantial burden against interstate commerce, and would therefore vacate the judgment and remand the case for the court below to decide whether petitioners have stated a claim under Pike.” Accordingly, the Court affirmed the judgment of the Ninth Circuit.

A pet pig (check out the harness) in my local dog park. The dogs’ reactions: nothing unusual here.

SB 261 would require that, by the end of 2024, and annually thereafter, a “covered entity” must prepare a report disclosing both its “climate-related financial risk,” in accordance with the TCFD framework (see this PubCo post)—which also guided much of the SEC’s climate disclosure proposal—and the measures the covered entity has adopted to reduce and adapt to the disclosed climate-related financial risk. A “covered entity” would be a corporation, partnership, limited liability company, or other business entity formed under the laws of any other state or D.C. (or under an act of the Congress) with total annual revenues in excess of $500 million and that does business in California (excluding insurance companies, which report under their own rules). The Senate floor analysis observes that, of the over 10,000 companies that do business in California and exceed the $500 million revenue threshold, only 20% of them are publicly traded and would be covered by any climate reporting adopted by the SEC. As defined in the bill, “climate-related financial risk” means “material risk of harm to immediate and long-term financial outcomes due to physical and transition risks, including, but not limited to, risks to corporate operations, provision of goods and services, supply chains, employee health and safety, capital and financial investments, institutional investments, financial standing of loan recipients and borrowers, shareholder value, consumer demand, and financial markets and economic health.” The covered entity would then be required, before the end of 2024, to make the report publicly available on its own internet website, and submit to the Secretary of State a statement “affirming, not under penalty of perjury,” that the report discloses climate-related financial risk in accordance with requirements of the bill.

An important change was recently added to the bill to avoid imposing a double reporting requirement that might have unreasonably burdened companies or resulted in conflicts with federal requirements. As amended, in the event that the SEC adopts rules (or other rules or federal laws are adopted) that require a covered entity to prepare an annual report disclosing information materially similar to the information required by the bill, the bill would allow the report by the covered entity under that federal requirement to satisfy the requirements of the California climate-related financial risk report and the covered entity would be able to attest to the Secretary of State that it has “publicly disclosed the climate-risk disclosures” to satisfy the requirements of the bill.

Under the bill, the CARB would contract with a climate reporting organization to prepare an annual public report on the climate-risk disclosures required by the bill and ensure the climate-risk disclosures keep up with changes in the TCFD guidance. The organization would collect and review climate-related financial risk reports, and prepare annually public reports that review subsets of publicly available climate-related financial risk reports by industry, analyze systemic and sector-wide climate-related financial risks facing the state (including potential impact on economically vulnerable communities) and identify inadequate or insufficient reports. The organization would also regularly convene groups of industry representatives, state agencies, academics and other stakeholders to offer input on current best practices, and monitor federal actions.

Under a recent modification of the bill, the state board would be required to adopt regulations authorizing it to seek administrative penalties, up to $500,000 per year, from a covered entity that “fails to make the report required by this section publicly available on its internet website or publishes an inadequate or insufficient report,” taking into consideration all relevant circumstances, including the violator’s past and present compliance and whether “the violator took good faith measures to comply with this section and when those measures were taken.”

[View source.]

Send Print Report

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.