New SEC Climate Rules: Progress or Pandering?

On March 6, 2024, the Securities and Exchange Commissions released its long-awaited final rules on climate disclosure. The rules, which the SEC has dubbed the “Enhancement and Standardization of Climate Disclosure,” have been the subject of intense public debate since they were first proposed in 2022, generating over 24,000 public comments, including 4,500 unique comment letters (one of which was penned by Ever.green) and this controversy did not stop with their adoption. The regulations have been criticized as being unnecessary and overreaching on one hand, and as having been watered down on the other. In fact, on Friday, enforcement of the rules was put on pause by the Fifth Circuit as it hears litigation against the regulation brought by a fracking company.

The key to understanding the new regulations is that the SEC is not requiring companies to act on climate; it is instead requiring the companies to talk about the way they act in a clear and informative manner, in particular when that is relevant to investors. When looked at in this light, the rules more clearly fall within the SEC’s traditional mission, and manage to accomplish two important things that together should increase transparency around private company climate action. First, they will require substantially more disclosure about climate action, of higher quality and reliability, from companies with the biggest carbon footprints. Second, they set general standards for disclosure even among companies not subject to the rule.

What the Rules Say

In brief, the final rules will require:

• All public companies, starting in 2025 for the largest filers, to make annual disclosures of climate-related material risks their businesses face, as well as their climate mitigation strategies, targets and goals;
• Companies meeting the “large accelerated filer” and “accelerated filer” thresholds (1)(other than smaller reporting companies and emerging growth companies) to disclose their direct emissions (Scope 1 emissions), and indirect emissions through energy use (Scope 2 emissions) if those emissions are material, and make certain additional disclosures in their financial statements. 

With respect to the qualification that emissions must be “material” to be disclosed, the SEC states in the release of the final rule that “a matter is material if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote or such a reasonable investor would view omission of the disclosure as having significantly altered the total mix of information made available,” and notes this definition is consistent with both their prior guidance and Supreme Court precedent. This means that whether or not emissions are material doesn’t depend solely on their amount, but rather on their potential impact on a company’s business.

Our partners at Watershed have put together a helpful summary of the final regulation, and the release adopting the final rules, including their full text, can be found here. 

Critics Abound

Shortly after the final rules were announced, ten states filed suit in the 11th Circuit to have the rules struck down as exceeding the SEC’s mandate. Litigation has been brought in three other circuits by parties seeking to invalidate the regulation, including in the Fifth Circuit as noted above, and a temporary stay has been issued against enforcement of the rules while the merits of the case in that circuit are decided. On the other hand, certain changes to the rules from their proposed form have prompted criticism that they do not go far enough. Senator Elizabeth Warren, for example, indicated she was disappointed in the SEC’s decision to “significantly weaken the rule in response to an onslaught of corporate lobbying,” and litigation has been filed in the Second Circuit and District of Columbia to that effect.

Criticism of the rules from those concerned about climate change have focused on changes that weaken emissions disclosure requirements. In the form in which they were proposed in 2022, the rules required all companies to make Scope 1 and Scope 2 emissions disclosures, whether or not material, and required some companies to make Scope 3 emissions disclosures (disclosures about emissions from a company’s value chain) as well. 

Navigating the Courts

It should be noted (and be apparent by now) that in making these changes, the SEC was facing real concerns as to whether the regulations could survive a challenge before the Supreme Court. While beyond the scope of this blog post, the current Supreme Court is widely considered to be skeptical of providing deferential treatment to regulators, and as noted above, the final rules are already under legal challenge.  

Based on comments from key figures at the SEC, these concerns may have prompted both the introduction of a materiality standard for Scope 1 and Scope 2 disclosures and the elimination of Scope 3 disclosures entirely. As Chloe Field and Cynthia Hanawalt of the Sabin Center for Climate Change Law at Columbia Law School write, the day after the rule’s release, Lynn Turner, a key figure in drafting the SEC’s existing materiality guidance, “stated that he believes the materiality threshold is crucial to the rule’s legal durability…[h]e indicated that a reviewing court’s deference to the Agency’s interpretation underpinning the rule may be increased by tying the climate disclosures to materiality for investors.” And in comments made last year while the proposed rules were still under review, Commissioner Gary Gensler noted concerns that Scope 3 disclosures might effectively constitute regulation of nonpublic companies included in the supply chain of public companies, which would be beyond the agency’s mandate. 

Advancement Despite Drawbacks

Despite these changes, the regulations still represent a major step forward in disclosures around emissions, at least with respect to Scope 1 and Scope 2. Some have argued that the final regulations are severely undermined by only requiring disclosure of Scope 1 and Scope 2 emissions when “material”, especially since companies are already effectively required to disclose material information to investors in their public filings.  

However, this overstates the case. As the SEC has made clear in its guidance, and the Supreme Court has confirmed in Basic v. Levison, 485 U.S. 224 (1988) and TSC Indus. V. Northway, Inc., 426 U.S. 438 (1976), whether something is “material” for the purposes of securities law is not defined by a bright-line or numerical test, but rather a “facts and circumstances” analysis of what a reasonable investor would want to know prior to making an investment. While that lack of precise definition could conceivably make it easier for companies to evade disclosure requirements, we think the effect is actually likely to be the opposite: without clear guidance telling them when they do not have to disclose, companies will err on the side of disclosure. Doing so may frequently require less effort than performing a costly materiality analysis to justify non-disclosure. (2)

Further, as WilmerHale stated in a post analyzing the regulations, “the adopting release includes some language that may be intended to drive companies toward a conclusion that such emissions are material in many instances” by indicating, for example, that “emissions can be material if their calculation and disclosure are necessary to enable investors to understand whether the company has made progress toward achieving a target or goal or a transition plan.” 

In addition, while emissions disclosures are no longer required of smaller reporting companies, emerging growth companies, and non-accelerated filers, this still leaves roughly 40% of public companies subject to the regulations, including the largest and most significant companies who are likely to have the largest emissions footprints. Emerging growth company status is also temporary, so as many of these excluded companies mature, they will be required to start disclosing emissions. 

And the disclosures these companies will make are still significant. Review of the final release shows that the requirements around Scope 1 and Scope 2 emissions, when they are triggered and applicable, still require substantial disclosure regarding the methodology, significant inputs (including emissions factors), and significant assumptions used to calculate a company’s greenhouse gas emissions, as well as disclosure of gross amounts of emissions before taking into account purchased or generated offsets. Although some grace was given in extended transition periods to some filers and requirements were relaxed in some areas, the contemplated emissions disclosures remain robust (3). Furthermore, they must still be backed by an attestation report by a third party, an unusual step to require for figures outside of a financial statement. 

Staying the Course, With the Private Sector Leading the Way

Although some details (e.g.,  how the attestation will work in practice) need to be ironed out, the original intent of the proposed regulations to make climate disclosures both more standardized and more rigorous appears intact in the final rules. This seems to be in-line with the SEC’s publicly stated intent. Commissioner Gensler, in his public statement on the new rules, emphasized that the rules will “enhance the consistency, comparability, and reliability of disclosures.” 

Ultimately, whether the new SEC regulations survive litigation challenges or not, climate disclosures are here to stay. Not only are other jurisdictions and regimes also taking action to require disclosures, both internationally and at the state level (including recent regulations by the EU and International Sustainability Standards Board, as well as the climate-related bills passed last year by the State of California) the movement towards corporate accountability for emissions is largely one private actors have taken on themselves. According to the Science Based Targets initiative, “over 4,000 businesses across regions and industries have set emissions reduction targets grounded in climate science” through SBTi, and as Gensler notes in his statement, 90 percent of the Russell 1000 issuers are publicly providing climate-related information,” with nearly 60 percent also disclosing emissions (and largely doing this outside of public filings). 

However, the SEC’s rules should have an influence on the information environment that goes beyond those companies directly subject to them. The disclosure required by the SEC will serve as a model which other disclosures will be measured against. The infrastructure around attestations, if developed properly, may help create best practices around climate disclosure for all companies. Especially in the larger exempt or non-public companies and in higher-stakes situations, there will likely be an attempt to replicate the model set by the SEC, due both to public pressure and a desire to protect against the risk of failing to disclose information to investors that the SEC has strongly suggested is material.  

In Summary: Two Steps Forward, One Back

With all the activity and rapid developments in the climate sector, gaining an understanding of what different organizations are doing– and whether those actions are actually having a positive impact on climate – can be extremely complicated. If the final regulations stand, they can help play an important role in making disclosure easier to understand and transparent at all levels of the industry. 

Ultimately, by standardizing the way companies talk about climate to the public, the SEC’s rules can help create an environment where transparency and impact are rewarded, which is an environment in which progress on climate change will accelerate. 

Disclaimer: Ever.green and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.

1. Accelerated filers are generally companies with over $75 million in publicly-held equity (or $700 million for large accelerated filers), that have been public companies for over one year and are current in their reporting requirements.  There are some exceptions to the definition (and the heightened reporting obligations it implies) for companies with revenues below $100 million.
2. We are not alone in this assessment; see, for example, Professor George Georgiev of the Emory University School of Law, described by Field and Hanawalt here.  Field and Hanawalt do bring up a longer-term concern with the SEC’s potential reliance on materiality - namely that it may be in future used to erode the SEC’s ability to require disclosure of non-material information, which to date has been well established.
3. For example, companies are no longer required to report disaggregated emissions by each particular greenhouse gas, and instead of explaining their calculation methodologies in detail, they can describe whether they are following a methodology employed by the Greenhouse Gas Protocol, the EPA, an applicable ISO standard, or some other methodology.