The SEC’s Climate Disclosure Rules Go to Court

On March 6, 2024, the U.S. Securities and Exchange Commission adopted its long-awaited final rules requiring publicly traded companies to disclose certain climate-related information in their SEC registration statements and annual reports.

Years in the making, the disclosures are intended to provide public information on how companies are being financially impacted by climate-related risks and how they are addressing the risks, according to the SEC. The rules were scheduled to take effect on May 28.

Within a few hours of their release, 10 state attorneys general filed the first challenge to the final rules in the U.S. Court of Appeals for the 11th Circuit. They asked that court to vacate those rules, asserting that the SEC had exceeded its statutory authority and that the requirements are arbitrary and capricious.

Various SEC registrants and their trade associations filed eight additional challenges to the rules in other federal appellate courts in the ensuing days. On March 15, the 5th Circuit stayed implementation of the rules pending resolution of an appeal from Liberty Energy. On March 21, the Judicial Panel on Multidistrict Litigation consolidated the nine cases into a single case that was awarded through a lottery process to the 8th Circuit. The 5th Circuit then vacated its stay.

Liberty Energy then filed a new stay motion in the 8th Circuit. On April 4, however, the SEC unilaterally issued its own stay order pending completion of the litigation, which could take a year or longer even before factoring in a potential Supreme Court appeal.

The Fight to Come

In issuing its stay order, the SEC emphasized that it was “not departing from its view that the final rules are consistent with applicable law and within the commission’s long-standing authority to require the disclosure of information important to investors in making investment and voting decisions” and stated that “the Commission will continue vigorously defending the Final Rules’ validity in court and looks forward to expeditious resolution of the litigation.”

Because the final rules look significantly different from those initially proposed in March 2022, predicting the outcome of those challenges is much more difficult than it would have been two years ago. That is because the SEC eliminated the most controversial proposed requirements that, arguably, more clearly exceeded the commission’s authority. In addition, many of the remaining requirements are now tied to the commission’s general “materiality” disclosure thresholds that have been relied upon more generally for triggering requisite disclosures for decades.

Republicans have staunchly opposed the rules. The two Republicans on the five-member commission both not surprisingly voted against issuing the final rules. House of Representatives committee chairs already have begun holding hearings. If Republicans retake the White House before the litigation concludes, a GOP-dominated SEC would almost definitely concede the litigation and vacate the final rules.

The Rules

The 886-page final rules can generally be divided into three sets of disclosure obligations, each of which is discussed below. Several of those obligations also would require reporting entities to satisfy attestation and assurance requirements designed to ensure that the reported information is validated.

1. Greenhouse Gas (GHG) Emissions

The final rules mandate that larger registrants report certain “material” GHG emissions, with the process phased in over time.

Generally, GHG emissions disclosures fall into three buckets:

In many respects, the GHG emissions disclosures were the most controversial component of the proposed rules because they are perceived as being the most unrelated to a company’s financial performance, which many argue should be the sole focus of mandated securities disclosures. The SEC attempted to blunt criticisms by making three primary changes.

First, the final rules eliminate any Scope 3 emissions reporting obligations. For the insurance industry, this eliminates all uncertainty around the extent to which publicly traded insurers and brokerage firms would have been required to report on their policyholders’ emissions. Any such reporting obligations would have been exceedingly difficult if not impossible to effectuate.

Second, the final rules generally apply the Scope 1 and 2 emissions reporting obligations to larger publicly traded companies—SEC “large accelerated filers” and “accelerated filers”—and not to smaller reporting companies or emerging growth companies.

 Third, even larger entities generally must disclose their GHG emissions only to the extent that they are “material.” The commission noted that the traditional federal securities laws “materiality” construct applies to this assessment: whether a reasonable investor would consider the disclosure important when making an investment or voting decision or such reasonable investor would view the omission of the disclosure as having significantly altered the total mix of information made available.

Notably, the commission suggested that Scope 1 and 2 emissions may be material if the registrant is exposed to a material transition risk—a need to make changes to reduce its emissions—that has resulted from its required GHG emissions metrics reporting under foreign or state law. It specifically cited California’s GHG emissions disclosure laws and the International Sustainability Standards Board (ISSB) standards being adopted globally.

2. TCFD Reporting (Sort Of)

The final rules require all registrants to make disclosures that are based on, but are not identical to, the reporting framework from the international Task Force on Climate-related Financial Disclosures, including:

• Climate-related risks that have had or are reasonably likely to have a material impact on the registrant’s business strategy, results of operations, or financial condition
• The actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook
• Any oversight done by the board of directors for climate-related risks and the role of management in assessing and managing such risks
• Any climate-related targets or
  goals that materially affect the registrant’s business, operation results, or financial condition.

3. Financial Statement Impacts

The final rules also require financial statement footnote disclosure of:

• The net aggregate amount of expenses and losses incurred during the fiscal year as a result of severe weather events and other natural conditions
• The net aggregate amount of capitalized costs and charges recognized during the fiscal year as a result of severe weather events and other natural conditions.

These disclosures are subject to a 1% financial impact disclosure threshold. The final rules significantly reduced this obligation, however, by applying that threshold to pre-tax income or total shareholders’ equity and not to each line item of a registrant’s consolidated financials as initially proposed.

For now, though, the courts will decide the immediate future of the SEC’s “final” (at the moment) climate disclosure rules.