The Securities and Exchange Commission (SEC) announced in recent weeks multiple efforts to highlight climate change in corporate disclosures and to increase scrutiny and, potentially, enforcement focus on company disclosure efforts on climate and other environmental, social, and governance (ESG) matters. While the topic of ESG disclosures is not new, the increased attention to the topic, and climate change in particular, is noteworthy and expected to remain an area of focus at the SEC and under the Biden Administration more broadly.
Existing Frameworks
The question of whether and what companies should disclose to investors and the public about the risks and opportunities presented by global climate change (and the government policies to confront it) is not novel. The SEC issued guidance on this issue over a decade ago.1 Various stakeholders are also increasingly interested in climate-related disclosures, regardless of what the SEC requires.
Climate Change Disclosures Under Regulation S-K and the 2010 Guidance
For companies subject to SEC reporting requirements, Regulation S-K sets forth the non-financial statement disclosure requirements applicable to SEC filings, such as annual reports on Form 10-K and quarterly reports on Form 10-Q, including some brief references to environmental matters. For example, Regulation S-K Item 101, which applies to Form 10-K, requires disclosure of any material effects of complying with environmental laws, and Item 103, which applies to Form 10-K and Form 10-Q, requires disclosure of material legal proceedings, with separate guidance on disclosing environmental legal proceedings.
The SEC’s 2010 Commission Guidance Regarding Disclosure Related to Climate Change (2010 Guidance) clarifies that existing disclosure requirements set out in Regulation S-K may require companies to make climate change-related disclosures.2 The 2010 Guidance describes the intersection between climate change and the SEC’s disclosure requirements by identifying four potential triggers for disclosure: (1) developments in federal and state legislation and regulations regarding climate change, (2) treaties and other international accords, (3) the indirect consequences and business trends brought on by climate change, and (4) the physical effects of climate change. Those specific triggers are subject to the general caveat that companies need only disclose those matters that are material under the securities laws (as defined by the U.S. Supreme Court).
Investor Driven Climate Change Reporting
For a variety of reasons, including investor and other stakeholder requests, many companies voluntarily report on climate change risks and opportunities and related metrics, as well as on broader matters of sustainability and ESG concerns. Voluntary disclosures often take the form of sustainability or resiliency reports posted on company websites, but voluntary disclosures also include company responses to questionnaires put out by third party organizations that collect and publish the information across companies and industries. The rise of firms providing ESG ratings and investment funds explicitly focused on “ESG investing” further spur companies to voluntarily make ESG information public.
The SEC’s recent statements suggest that those multiple modes of disclosure might pose risks for companies. For example, in carrying out the Acting Chair’s direction, discussed below, to review filings in light of the 2010 Guidance, the SEC staff may decide to issue comments on SEC filings noting differences between the filings and voluntary disclosures, or the SEC staff may undertake enforcement investigations where a review of voluntary reports suggests required filings are materially misleading or are missing material information.
Point of Increased Emphasis
Scrutinizing Disclosures and Updating Guidance
On February 24, SEC Acting Chair Lee issued a statement directing the Division of Corporation Finance “to enhance its focus on climate-related disclosure in public company filings.”3 In that Statement, the Acting Chair called for SEC staff to study existing disclosures on the topics addressed in the 2010 Guidance. Such study, Lee suggested, could feed into updates to the Guidance to meet the needs of the current market and environment. About one week later, on March 4, the SEC announced the formation of a Task Force in the Division of Enforcement focused on climate and other ESG issues.4
President Biden’s nominee for Chair of the SEC is also focused on climate risk disclosures. In a March 2 confirmation hearing before the Senate Banking Committee, Gary Gensler stated that, under his leadership, the SEC would issue new guidance for climate risk disclosures.5 During the hearing, Mr. Gensler indicated that disclosure requirements should be grounded in traditional concepts of materiality. He also repeatedly emphasized that investors want to see climate risk disclosures and suggested that investor demands are relevant to understanding what is material. However, Mr. Gensler’s statements were not explicit, and it is not entirely clear how he would approach materiality in the ESG space. For example, he noted that strong support from shareholders in favor of topics presented in shareholder proposals at annual meetings could indicate that a matter is material to shareholders.
On March 11, Acting Director of the SEC Division of Corporation Finance, John Coates, published a statement in connection with remarks he delivered at the 33rd Annual Tulane Corporate Law Institute, noting how important ESG issues have become to investors, public companies and capital markets, while at the same time acknowledging that “substantial debate” remains over the appropriate contents and details of ESG disclosures.6 In light of the rapid changes in the ESG landscape and the lack of a uniform set of metrics to cover all ESG issues for all companies, Mr. Coates expressed a belief that “SEC policy on ESG disclosures will need to be both adaptive and innovative.” To develop such standards, Mr. Coates offered a list of significant questions that “the SEC should be a key part of answering,” which likely will be featured in future SEC efforts to update its approach to climate and other ESG disclosures:
- What disclosures are most useful?
- What is the right balance between principles and metrics?
- How much standardization can be achieved across industries?
- How and when should standards evolve?
- What is the best way to verify or provide assurance about disclosures?
- Where and how should disclosures be globally comparable?
- Where and how can disclosures be aligned with information companies already use to make decisions?
In framing a path forward, Mr. Coates also addressed some guiding considerations: (1) stay mindful of the costs of providing ESG disclosures, balanced against the costs from the absence of a consensus on ESG disclosures, (2) recognize that the SEC disclosure regime around “mandatory” disclosures is not a binary system and that there are opportunities for flexibility in constructing disclosure requirements, and (3) remember the potential benefits of a “coordinated global disclosure system” and the careful attention to institutional design that is required to achieve it.
Finally, the SEC Division of Examinations recently highlighted climate change and other ESG considerations in the announcement of its 2021 examination priorities.7 The Division will focus on the increasing number of registered investment advisors and funds offering ESG investing vehicles and advice, and will scrutinize their disclosures and advertising for false or misleading statements.
New Rules?
Historically, the SEC has taken the position that it does not need to mandate specific ESG disclosures by rule because the SEC’s principles-based disclosure regime already requires disclosures on those topics to the extent material. However, the two Democrats already on the Commission have publicly stated that principles-based disclosure has proven to be inadequate, and they favor specific disclosure requirements.8 A Democratic majority on the Commission will increase the likelihood of rulemaking to require specific climate disclosures, potentially including metrics.9
Congress may also choose to act in this area. The House of Representatives’ Committee on Energy & Commerce recently proposed the CLEAN Future Act.10 If passed into law, the proposed legislation would amend the Securities Exchange Act of 1934 to require that the SEC promulgate rules requiring public companies to disclose information relating to, among other things, direct and indirect greenhouse gas emissions of the issuer and its affiliates, fossil fuel-related assets owned or managed by the issuer, and climate-related risk disclosures by industry or sector. Congress may also use committee hearings to push the Commission or representatives of industries associated with climate change on questions of corporate disclosure.
Some states are also working on (or have in place already) legislation on this topic. For example, California’s Climate Corporate Accountability Act, introduced January 26, 2021, would require companies doing business in the state with annual revenues in excess of $1,000,000,000 to disclose their greenhouse gas emissions from the prior calendar year to the California Air Resources Board beginning in January 2024.11 Thus, even in the absence of federal action, states may proceed with requiring more robust disclosures, including of specific climate metrics.
Enforcement and Litigation Potential
The SEC also made clear that it is prepared to initiate enforcement action on the basis of companies’ inadequate climate risk disclosures. As noted, on March 4, the SEC issued a press release announcing the deployment of a 22-member task force to examine “misconduct” in the ESG disclosure area, “[c]onsistent with increasing investor focus and reliance on climate and ESG-related disclosure and investment.”12 The Climate and ESG Task Force will begin by analyzing material gaps or misstatements in public companies’ climate change statements under existing disclosure rules and will pursue tips, referrals, and whistleblower complaints on ESG-related issues. Companies should be prepared to defend their climate-related disclosures and differences between those filed disclosures and the company’s voluntary climate statements.
Beyond the potential for more robust SEC enforcement in this area, companies should be cognizant of the risk of enforcement by state attorneys general and class action litigation. Attorneys general in New York and other places have filed suits against fossil fuel companies alleging that the companies have misled investors and the public by failing to disclose climate change impacts in assessing investment opportunities and business operations. In addition, securities fraud class actions advancing similar allegations have been gaining steam in recent years. The trend makes clear that investors are taking a harder look at how climate change can impact their investments—and they are demanding that companies do the same.
Minority SEC View
The efforts by the Acting Chair have been met with some skepticism by the two Republican members of the Commission, who released a public statement, also on March 4, in response. Their pushback puts down a marker that the announced shifts in priorities cannot themselves create new reporting obligations and suggests that, in fact, the announcements amount to little more than “continuing ongoing efforts with a little extra fanfare.”13 The statement details long-running efforts by the Commission on climate change (including the 2010 Guidance) and posits “that the new initiative is simply a continuation of the work the staff has been doing for more than a decade and not a program to assess public filers’ disclosure against any new standards or expectations.”14 And it seeks to contextualize calls for new guidance, making clear the Republican Commissioners’ view that such guidance cannot “elicit more specific line items or otherwise convert the Commission’s general principles-based approach to a prescriptive one.”15
Conclusion & Implications
There is surely much more to come on ESG disclosures. A new Commission release refreshing the existing climate change disclosure guidance is highly likely, and new rulemaking efforts aimed at requiring more specific disclosures in that area are also likely. Although climate change is the current focus, investors and the Commission could soon turn to disclosures about other ESG concepts, such as racial equity, environmental justice, human capital, and political contributions.
Public companies and investment funds should prepare for the SEC’s heightened scrutiny on climate-related issues by thoughtfully reviewing and potentially refining company statements—both mandated and voluntary disclosures—on climate change. It is absolutely not the case that all information regarding climate matters included in company sustainability and similar voluntary reports needs to be included in SEC filings. That said, it is advisable to review disclosures in SEC filings in light of those separate, voluntary disclosures to ensure that the overall picture is consistent. For example, if voluntary statements indicate that major capital expenditures or changes in business plans are expected in order to achieve greenhouse gas emissions goals, then the disclosures in SEC filings about expected capital expenditures and business plans likely would need to reflect those same expectations.
With regard to federal and state mandated disclosures, companies should have controls around their data and supporting materials underlying their public statements. Companies should also look to assess whether there are any inconsistencies between the public and internal information. For instance, companies should be consistent when providing to different audiences climate disclosures that are based on the same underlying reporting requirements. When the reporting requirements are different, companies should consider the nature of those differences and if there may be opportunities for consistency, such as in the raw data set used to generate the disclosures to be made. Companies should also examine the transparency around their voluntary disclosures and whether those disclosures could be viewed as misleading or inconsistent with similar mandatory disclosures. Each of these actions should help better position companies in the event that the SEC, state attorneys general, or other interested regulators come knocking.
