On 21 March, the U.S. Securities and Exchange Commission (“SEC”) held an open meeting to consider proposed rules which would require public companies to disclose additional climate-related information. The agency voted to officially propose the rules in a 3-1 party line vote. The text of the proposed rules is available here.
Comments on the proposed rules must be submitted within 60 days, or by 20 May 2022. This is an unusually short comment period for proposed rules of this magnitude.
- The proposed rules would require public filers to provide climate-related information in registration statements and annual reports such as the Form 10-K. The proposed rules draw from existing disclosure frameworks including the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.
- Companies would be required to disclose Scope 1 and 2 greenhouse gas (“GHG”) emissions, including data on carbon offsets.
- Companies would be required to disclose Scope 3 GHG emission “if material” or if the company has publicly set climate goals.
- In addition to GHG emissions data, the proposal would require companies to provide forward-looking statements about how climate risks are likely to affect their business, and information about the company’s governance around climate risks.
- The proposed rules contain a “safe harbor” for liability for Scope 3 emissions disclosure. Commissioner Peirce raised concerns about the efficacy of this safe harbor language.
- Chair Gensler, along with Commissioners Lee and Crenshaw, defended the materiality of the proposed rules as important information to investors that is related to financial performance. Commissioner Peirce forcefully disagreed.
- SEC officials did not discuss how the proposed rules would be enforced.
- Gensler: “Statement on Proposed Mandatory Climate Risk Disclosures”
- Peirce: “We are Not the Securities and Environment Commission – At Least Not Yet”
- Lee: “Shelter from the Storm: Helping Investors Navigate Climate Change Risk”
- Crenshaw: “Statement on the Enhancement and Standardization of Climate-Related Disclosures for Investors”
Scope 1 and 2 Disclosure Requirements
The proposal would require disclosure of direct GHG emissions (Scope 1) and indirect GHG emissions created through the purchase of electricity and other types of energy (Scope 2). Accelerated or large accelerated filers would be required to obtain an attestation report from an independent GHG emissions attestation provider.
Filers would be required to disclose absolute emissions data (both by disaggregated constituent greenhouse gases and in the aggregate in absolute and intensity terms) as well as data on purchases of carbon offsets.
While Scope 3 reporting requirements have drawn more attention, Scope 1 and 2 reporting requirements will present a number of definitional and practical reporting issues for companies. Commissioner Peirce explained in her statement, “[A]lthough the proposal is based in part on popular voluntary frameworks, those frameworks are neither universally used nor precisely followed.”
Scope 1 and 2 Disclosure Liability
The proposed disclosures would be treated as filed (rather than furnished) and thus subject to potential liability. The SEC indicated that this increased liability would result in information that is more carefully prepared than in voluntary public reporting.
The GHG emissions attestation provider would also be subject to liability for the attestation conclusion or opinion provided.
The SEC then noted three perspectives from commenters regarding liability:
- “[C]ommenters indicated that the treatment of climate-related disclosures as filed would help ensure that investors have confidence in the accuracy and completeness of such disclosures because of the liability associated with filed documents.”
- “Some of these commenters stated that the Commission’s treatment of such disclosures as filed could act as a disincentive to providing “broader” disclosure and would incentivize some issuers “to disclose in the manner most limited to meet the specific requirement and avoid more robust explanation.”
- “[C]ommenters stated that the treatment of climate-related disclosures as furnished would be appropriate because, in their view, much of that disclosure is based on projections and aspirational statements ill-suited to the application of a stricter liability standard.”
The extensive citations to comments in response to Commissioner Lee’s “request for information” of 15 March 2021 leave no doubt that the proposal is heavily influenced by that unorthodox request and resulting feedback.
Scope 3 Disclosure Requirements
The proposed rules would require Scope 3 emissions disclosure, defined as “indirect emissions from upstream and downstream activities in a registrant’s value chain.” The disclosures would be required:
- “If material,” or
- “If the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.”
The SEC explained how registrants would determine what is material under the proposed rules: “The materiality determination that a registrant would be required to make regarding climate-related risks under the proposed rules is similar to what is required when preparing the MD&A section in a registration statement or annual report. The Commission’s rules require a registrant to disclose material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.”
Commissioner Peirce pointed out the broad range of potential interpretations for this materiality standard, stating that “similarity is in the eye of the beholder.”
Firms would not be required to calculate GHG emissions according to the methodology prescribed by the GHG Protocol. Firms would be required to disclose absolute emissions data (both by disaggregated constituent greenhouse gases and in the aggregate in absolute and intensity terms). Small reporting companies would be exempt from Scope 3 disclosure.
Scope 3 Disclosure Liability and Commissioner Peirce’s Concerns
As with Scope 1 and 2 disclosures, Scope 3 disclosures would be filed (rather than furnished) and thus subject to potential liability. The proposed rules included a safe harbor for Scope 3 emissions disclosure “to alleviate concerns that registrants may have about liability for information that would be derived largely from third parties in a registrant’s value chain.”
Under the Scope 3 safe harbor, a statement made by or on behalf of a registrant is deemed not to be a fraudulent statement, unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith. In other words, a filer would only be liable for Scope 3 emissions disclosure “if it was made without a reasonable basis or was disclosed other than in good faith.”
Commissioner Peirce objected to the standards of reasonable basis and good faith in the context of the Scope 3 disclosure safe harbor. Peirce asked, “How is a company to determine which particular climate model or set of estimates constitutes a “reasonable basis” when different models and estimations lead to substantially different results?” She added, “Is it bad faith if a company that gets wildly different numbers from two suppliers that appear to use similar processes for producing and transporting raw materials chooses to use the numbers that produce the lowest Scope 3 emissions?” The safe harbor provision opens a door for companies to have to defend using the lower reported statistics against subjective standards of reasonability and good faith.
The problem that potentially eviscerates the safe harbor is the private right of action under the securities laws, which of course attaches to disclosures on Form 10-K. How will courts and juries interpret “reasonable basis” and good faith? Inconsistent decisions will likely result. Most companies will choose to settle, rather than fight the inevitable suits.
Governance and Operational Climate Risk Disclosures
In addition to GHG emissions information, the proposed rules would require disclosure regarding a filer’s governance around climate risk and the effects of climate risk on a company’s business. Specifically, it would require disclosures of:
- Governance of the managers and board regarding climate risks;
- Short-, medium-, and long-term predictions of the material impact of identified climate risks;
- Current or expected changes to strategy, business model, or outlook based on climate risks;
- The methodology to identify, assess, and manage climate-related risks and that method’s relation to overall risk management system or processes;
- A description of the transition plan if one has been adopted, including the relevant metrics and targets used to identify and manage any physical and transition risks;
- Whether the registrant uses scenario analysis regarding climate-related risks, a description of the scenarios used, as well as the parameters, assumptions, analytical choices, and projected principal financial impacts;
- A registrant’s use of an internal carbon price, information about the price and how it is set; and
- Impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items in the registrant’s consolidated financial statements along with the financial estimates and assumptions used.
While some of this information such as information on a company’s internal carbon pricing and future climate risks could constitute forward looking statements, the proposed rules extend Private Securities Litigation Reform Act safe harbors for forward-looking statements to this climate-related information. 
The SEC’s fact sheet includes an overview of reporting timelines for the proposed disclosures, under the assumption that proposed rules will be adopted with an effective date in December 2022 and that the filer has a December 31st fiscal year-end. Scope 1 and 2 disclosure filing will begin in 2024, with Scope 3 emissions disclosure following in 2025.
Chair Gensler framed the proposed rules as an extension of SEC environmental-related disclosures, which began in the 1970s. He also argued that investors see climate-related information as important. He stated, “As the Supreme Court has explained, information is material if “there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment or voting decision, or if it would have “significantly altered the total mix of information made available.”
The proposed rules used more forceful language: “Investors need information about climate-related risks — and it is squarely within the Commission’s authority to require such disclosure in the public interest and for the protection of investors — because climate-related risks have present financial consequences that investors in public companies consider in making investment and voting decisions. Investors have noted that climate-related inputs have many uses in the capital allocation decision-making process including, but not limited to, insight into governance and risks management practices, integration into various valuation models, and credit research and assessments.” The proposed rules also claimed, “Even if the probability of an adverse consequence is relatively low, if the magnitude of loss or liability is high, then the information in question may still be material.”
Commissioner Peirce delivered an extensive rebuttal to the claim that the proposed disclosures would be material. Voluntary reporting is usually limited to what the company itself deems material, which would change fundamentally under the proposed rules. Peirce argued, “The Commission proposes today to require companies to pull into Commission filings much of this non-investor-oriented information that is either immaterial or keyed to a distended notion of materiality that seems to turn on an embellished guess at how the company affects the environment.” She defined materiality by its importance to an investor and as unrelated to environmental objectives. The vague standards of materiality are answered with the introduction of independent third-party climate consulting firms, to which she responds, “Score one for the climate industrial complex!” Scope 3 is even further outside the bounds of materiality for Peirce. The fact that the Commission is requiring immaterial disclosures beyond simple fact-based information constitutes a Constitutional violation, according to Peirce. When the SEC departs from only requiring reporting of material information, relevant to investors, they veer into the realm of “compelled speech,” violating the First Amendment.
Peirce’s Dissent – Additional Notable Items
Peirce opened her dissent with the line: “Many people have awaited this day with eager anticipation. I am not one of them,” and questioned the lack of a materiality limit on the disclosure requirements and the immateriality of many of the required disclosures. She pointed out that physical risks are often already reported under Regulation S-K and many businesses publish “Sustainability Reports” on their websites to inform the non-investor public.
She also questioned how realistic the SEC’s compliance and transition cost estimates are. She pointed out that getting assurance from an independent GHG emissions attestation provider will likely be expensive and firms will have to outsource much of the work of complying with the new disclosure requirements. Accelerated filers and large accelerated filers must have their attestation report prepared and signed by a GHG emissions attestation provider who meets specified levels of expertise and independence. Scope 3 statistics will be especially difficult to obtain, as the suppliers and consumers may not have the data available and even if they do, it may not be reliable enough for the company to trust. The proposing release points out that many commenters suggested limiting disclosures to Scopes 1 and 2, pointing to the difficulty of acquiring data on Scope 3 emissions from third parties and the related methodological uncertainties. The release notes, “It may also be necessary to rely heavily on estimates and assumptions to generate Scope 3 emissions data.”
Industry and Congressional Response
- “The SEC is finally heeding the calls from institutional investors, companies, regulators, and the public.”
- “The Chamber is concerned that the prescriptive approach taken by the SEC will limit companies’ ability to provide information that shareholders and stakeholders find meaningful while at the same time requiring that companies provide information in securities filings that are not material to investors. “
- “We are concerned that the Commission’s sweeping proposal could require non-material disclosures and create confusion for investors and capital markets.”
- “The Biden Administration is pushing its climate agenda through financial regulators because they don’t have the votes to pass it in Congress.”
- “Today’s action hijacks the democratic process and disrespects the limited scope of authority that Congress gave to the SEC. This is a thinly-veiled effort to have unelected financial regulators set climate and energy policy for America. Forcing publicly-traded companies to gather and report global warming data—almost none of which is material to the business’s finances—extends far beyond the SEC’s mission and expertise.”
- “To protect Americans and our economy from climate change, we have to understand how climate risk affects our businesses, workers, and communities. The SEC’s proposal is a step forward and would establish for the first time consistent data frameworks, balancing the need to accurately evaluate market risks while ensuring small businesses aren’t overburdened.”
- “Today’s vote by the SEC is a needed next step towards ensuring that market participants properly disclose critical information on climate risks so that investors and the financial markets are better protected and can accurately integrate and reflect risks posed by climate change.”
- “The SEC took a crucial first step to protect investors from material risks related to climate change.”
- “[T]oday’s proposal completely omits climate-related corporate political influence activities. Investors deserve disclosure of climate-related lobbying activity or support for outside groups that engage in climate-related influence activities.”
- “The same high-ranking SEC officials that authored these rules will inevitably be hired by these firms on the back end to reap the vast compliance fees required by the regulations they just wrote.”
- Senator Hagerty also sent a letter to SEC Chair Gensler stating that the proposed rules are subject to Congressional review
Commissioner Lee raised several questions regarding the details of the proposed rule, largely revolving around the regulatory framework of the rule and the Scope 3 disclosures. During the open meeting, she first asked if the proposed rules should stay under Regulation S-K or if it should be placed under Regulation S-X so that internal controls are included in the reporting requirements. The alternative would be to introduce internal controls under Regulation S-K.
Lee also drew a distinction between limited and reasonable assurance and asked commenters to advise on which is a realistic expectation for filers. Regarding Scope 3 disclosure, Commissioner Lee asked if the rule gives companies enough explanation to determine materiality or if it should require companies to disclose the basis for their determination of materiality. She also proposed that the safe harbor provision be conditioned on a company’s method of calculating Scope 3 disclosures.
The SEC did not provide detail on how it would enforce the proposed rules. Keith Higgins, former Director of the Division of Corporate Finance, told the Washington Post, “When you get into a lot of detail about greenhouse gas emissions and what types of disclosures are material to investors, I’m not convinced the SEC is the place where that expertise resides.”
In addition, although much commentary will no doubt be focused on Scope 3 disclosures, Scopes 1 and 2 raise serious questions about their relation to financial risks and returns.
How Patomak Can Help
The SEC is accepting comments on the proposed rules for 60 days after issuance (20 May 2022) or 30 days after publication in the Federal Register, whichever is later. After the comment period closes, the SEC review comments received and begin to develop a final rule.
Patomak’s professionals have extensive experience helping firms navigate and respond to SEC proposals. If you would like to hear more about how Patomak can help, contact Paul Atkins (firstname.lastname@example.org), Adam Glazer (email@example.com), Paul Ray (firstname.lastname@example.org), or Ted Serafini (email@example.com).
 The proposal to separate the disclosure of carbon offsets comes after environmental organizations including Sierra Club and Public Citizen sent a letter to the SEC on 10 February 2022 calling for separate offset disclosure. Letter Available at: https://www.sierraclub.org/sites/www.sierraclub.org/files/blog/Offsets%20Disclosures%20in%20Climate%20Risk%20Disclosure%20Rule.pdf.
 “Information filed as part of a registrant’s Form 10-K carries certain additional potential liability, which itself can cause registrants to prepare and review information filed in the Form 10-K more carefully than information presented outside SEC filings.” U.S. Securities and Exchange Commission proposed rule RIN 3235-AM87, “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” [Release Nos. 33-11042; 34-94478; File No. S7-10-22], (20 March, 2022) at 23. https://www.sec.gov/rules/proposed/2022/33-11042.pdf.
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 U.S. Securities and Exchange Commission proposed rule RIN 3235-AM87, “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” [Release Nos. 33-11042; 34-94478; File No. S7-10-22], (21 March, 2022) at 87. https://www.sec.gov/rules/proposed/2022/33-11042.pdf
 SEC Chair Gary Gensler, “Statement on Proposed Mandatory Climate Risk Disclosures,” U.S. Securities and Exchange Commission (21 March, 2022). https://www.sec.gov/news/statement/gensler-climate-disclosure-20220321
  U.S. Securities and Exchange Commission proposed rule RIN 3235-AM87, “The Enhancement and Standardization of Climate-Related Disclosures for Investors,” [Release Nos. 33-11042; 34-94478; File No. S7-10-22], (21 March 2022) at 9. https://www.sec.gov/rules/proposed/2022/33-11042.pdf
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 Maxine Joselow and Douglas MacMillan, “The SEC proposed a landmark climate disclosure rule. Here’s what to know,” Washington Post, (21 March 2022). https://www.washingtonpost.com/business/2022/03/21/sec-climate-change-rule/.