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03.29.2024 | Legal Advisory

Update: SEC Suspends New Climate Disclosure Rules

The U.S. Securities and Exchange Commission (SEC) on April 4, 2024 issued an administrative order to “stay” (i.e., suspend) the climate-related disclosure rules which the SEC adopted on March 6, 2024 (Final Rules). The order states the stay will remain in effect until “the completion of judicial review” of the eight petitions challenging the Final Rules. As we discussed in our March 29, 2024 advisory (below), the judicial review of those petitions has been consolidated in the U.S. Court of Appeals for the Eighth Circuit. According to the order, SEC’s rationale in issuing the stay is to “facilitate the orderly judicial resolution of those challenges and allow the court of appeals to focus on deciding the merits” and to avoid “potential regulatory uncertainty if registrants were to become subject to the Final Rules’ requirements during the pendency of the challenges to their validity.” The order also states “[i]n issuing a stay, the [SEC] is not departing from its view that the Final Rules are consistent with applicable law and within the [SEC]’s long-standing authority to require the disclosure of information important to investors in making investment and voting decisions[, and therefore], the [SEC] will continue vigorously defending the Final Rules’ validity in court and looks forward to expeditious resolution of the litigation.” We anticipate that the judicial review of the pending challenges will not be complete – and therefore the stay will remain in effect – until the Supreme Court definitively addresses the legality of the Final Rules, which we believe will likely not occur before 2025.

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Overview

On March 6, 2024, in a 3-2 vote along party lines, the Securities and Exchange Commission (SEC) issued a controversial 886-page final climate-related disclosure rule (Final Rules) that will require companies to include certain climate-related information in annual reports on Form 10-K (or Form 20-F for foreign private issuers) and in most registration statements. For large accelerated filers in the U.S. with calendar fiscal years, the first disclosures will be required in 10-Ks for the fiscal year ending December 31, 2025, which must be filed by Monday, March 2, 2026. Additional disclosures by large accelerated filers, and initial disclosures by accelerated filers, will be required one year later. The SEC initially proposed the climate disclosure rules in March 2022. (For ease of reference, the term “registrant” used below refers to an SEC reporting company filing annual reports or a company filing a registration statement with the SEC. Large accelerated filers and accelerated filers are sometimes referred to as LAFs and AFs, respectively.)

The Final Rules follow the convention used in the proposed rules and adopt the terminology for greenhouse gas (GHG) emissions (e.g., “Scope 1”, “Scope 2”, and “Scope 3” emissions) used in the GHG Protocol, [1] which dates back to the late 1990s. The Final Rules define “Scope 1 emissions” as direct GHG emissions from operations that are owned or controlled by a registrant and “Scope 2 emissions” as indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a registrant.

Complying with the Final Rules will require a substantial commitment of time and resources by registrants, but the regulatory burden will be much less than it would have been under the reporting scheme originally proposed by the SEC. Proposed disclosure requirements that were modified or eliminated in the Final Rules include various prescribed narrative disclosures, disclosures in the notes to audited financial statements, and a requirement to disclose material Scope 3 GHG emissions and provide an attestation report covering the Scope 3 disclosures. In the proposed rule, Scope 3 GHG emissions were defined to mean all indirect GHG emissions not otherwise included in a registrant’s Scope 2 emissions that occur in the upstream and downstream activities of a registrant’s “value chain.” Upstream emissions include emissions attributable to goods and services that the registrant acquires, the transportation of goods (for example, to the registrant), and employee business travel and commuting. Downstream emissions include the use of the registrant’s products, transportation of products (for example, to the registrant’s customers), end of life treatment of sold products, and investments made by the registrant.

Lawsuits Challenging Final Rules

The public policy rationale underlying the Final Rules, at least from the perspective of a majority of the SEC commissioners, is that the Final Rules are necessary for and desired by investors to provide more complete and “decision-useful information” about the impacts of strategies and risks that a registrant has determined will likely materially impact its business, results of operations, or financial condition, thereby improving consistency, comparability, and reliability of information about climate-related risks and protecting investors, promoting market efficiency, and facilitating capital formation. In the Final Rules, the SEC stated that it “remains agnostic about whether or how registrants consider or manage climate-related risks.”

Critics of the Final Rules argue that the SEC is seeking to inject the SEC into the world of climate politics by compelling publicly traded companies to disclose GHG emissions and “climate-related” risks. At least 24 Republican-led states, including Louisiana, Ohio, Texas, and West Virginia, and major business groups like the U.S. Chamber of Commerce are challenging the Final Rules in court, arguing that the SEC lacks clear authority to adopt the Final Rules and therefore the Final Rules violate the “major-questions doctrine” and asserting the Final Rules will only create more confusion and undermine investor confidence. Conversely, the Sierra Club, one of the largest environmental advocacy groups in the U.S., has filed a lawsuit arguing that the Final Rules do not go far enough to protect investors. All of the cases have been consolidated in the United States Court of Appeals for the Eighth Circuit (Court of Appeals Docket No: 24-1522).

Climate-Related Disclosures Required by Final Rules

The Final Rules address climate-related risks in three respects primarily through the addition of Article 14 of Regulation S-X (financial statements) and Items 1500 through 1508 of Regulation S-K (disclosures outside of financial statements).

The SEC adopting release for the Final Rules includes a table summarizing the phased-in compliance dates of the Final Rules, both for Article 14 of Regulation S-X and subpart 1500 of Regulation S-K.

Financial Statement Disclosures

In financial statement footnotes, registrants must provide information about:

1. capitalized costs, expenses, charges, and losses incurred “as a result of” severe weather events and other natural conditions, subject to one percent thresholds and de minimis exceptions described below,

2. certain carbon offsets and renewable energy certificates (RECs), and

3. material impacts on financial estimates and assumptions that are due to severe weather events and other natural conditions or disclosed climate-related targets or transition plans.

For the disclosure of financial statement effects of severe weather events and other natural conditions, the Final Rules have separate one percent threshold calculations and de minimis levels for income statement and balance sheet reporting:

Income Statement

Registrants must disclose, in notes to the financial statement, expenses and losses incurred if the aggregate amount of such expenses and losses equals or exceeds one percent of the absolute value of the registrant’s pre-tax income (or loss) for the relevant fiscal year.

But no such disclosure is required if the aggregate amount of expenses and losses reflected in the income statement is less than $100,000 for the relevant fiscal year.

Balance Sheet

Registrants must also disclose in the financial statement notes capitalized costs and charges recognized if the aggregate amount of the absolute value of such costs and charges equals or exceeds one percent of the absolute value of the registrant’s stockholders’ equity (or deficit) at the end of the relevant fiscal year.

But no such disclosure is required if the aggregate amount of capitalized costs and charges reflected in the balance sheet is less than $500,000 for the relevant fiscal year. [2]

On a related note, if the estimates and assumptions a registrant uses to produce its financial statements were materially impacted by risks and uncertainties associated with severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise, or any disclosed climate-related targets or transition plans, the registrant must provide quantitative and qualitative disclosures about how the development of such estimates and assumptions was impacted. These disclosures are subject to a separate delayed phase-in until the fiscal year immediately following the fiscal year of the registrant’s initial compliance date for subpart 1500 disclosures under Regulation S-K.

These disclosures will be subject to existing audit requirements for financial statements and will also trigger the registrants to review internal control over financial reporting (ICFR) and disclosure control and procedures (DCP) in preparation to comply with the Final Rules and audit procedures. Audit committees will need to oversee these processes, of course, and therefore registrants will need to begin implementing policies and procedures in advance of their respective phase-in dates that will allow registrants to comply with the relevant disclosure deadlines.

Non-Financial Statement Disclosures

The Final Rules amend Regulation S-K to require disclosure outside of the financial statements of material “climate-related risks”[3] to which the registrant is exposed and any governance and processes used to manage climate-related risks, including, in addition to the disclosure of material Scope 1 and Scope 2 GHG emissions discussed below, the following:

• The material impact of climate risks on the company’s strategy, business model, and outlook.
• Governance and oversight of material climate-related risks.
• Risk management processes for material climate-related risks.
• Climate targets and goals if such target or goal has materially affected or is reasonably likely to materially affect the registrant’s business, results of operations, or financial condition.

The Final Rules emphasize registrant-specific materiality determinations. For example, Item 1502(a) of Regulation S-K provides that in describing any climate-related risk that has materially impacted or is reasonably likely to have a material impact, a registrant should describe whether such risks are reasonably likely to manifest in the short-term (i.e., the next 12 months) and separately in the long-term (i.e., beyond the next 12 months), and Item 1502(b) of Regulation S-K – which requires disclosure of actual and potential material impacts of any climate-related risks on the registrant’s strategy, business model, and outlook – specifies that a registrant is required to disclose only material impacts of climate-related risks that it has identified in response to Item 1502(a). More specifically, the Final Rules provide a non-exclusive list of potential material impacts of climate-related risks:

• Business operations, including the types and locations of its operations;
• Products or services;
• Suppliers, purchasers, or counterparties to material contracts, to the extent known or reasonably available;
• Activities to mitigate or adapt to climate-related risks, including adoption of new technologies or processes; and
• Expenditures for research and development.

If none of the listed types of impacts or any other impacts are material to a registrant, the registrant need not disclose them.

If the registrant’s Board of Directors exercises oversight over climate-related risks, the Final Rules require disclosure of the Board committee or subcommittee responsible for that oversight, and the process adopted that apprises them of climate-related risks. If the registrant has disclosed a climate-related target or goal or transition plan, the registrant must describe whether and how the Board oversees progress against the target or goal or transition plan. If a registrant’s management oversees climate-related risk, the Final Rules require disclosure of which positions or committees are responsible and the relevant expertise of those positions’ holders or committee members, the process used to manage and assess climate-related risk, and whether the information is reported to the Board or a Board committee. In addition, the registrant will be required to disclose any transition plans, scenario analysis, or internal carbon prices to manage a material climate-related risk, if any.

Scope 1 and Scope 2 Greenhouse Gas Emissions

The Final Rules do not mandate Scope 1 and/or Scope 2 GHG emissions disclosures from all registrants. Subject to delayed phase-in discussed below, LAFs and AFs must disclose direct emissions (Scope 1) and indirect emissions typically associated with energy produced offsite or consumed by the registrant (Scope 2), but in each case only if those GHG emissions are material to the registrant for its most recently completed fiscal year. [4] [5]

The Final Rules state that the SEC expects registrants will apply traditional notions of materiality under the federal securities laws when evaluating whether its Scope 1 and/or Scope 2 emissions are material. Thus, materiality is not determined merely by the amount of these GHG emissions. The question is whether a reasonable investor would consider the disclosure the registrant’s Scope 1 emissions and/or its Scope 2 emissions important when making an investment or voting decision or such a reasonable investor would view omission of the disclosure as having significantly altered the total mix of information made available.

The Final Rules state that a registrant’s Scope 1 and/or Scope 2 emissions may be material because their calculation and disclosure are necessary to allow investors to understand whether those emissions are significant enough to subject the registrant to a transition risk that will or is reasonably likely to materially impact its business, results of operations, or financial condition in the short- or long-term. For example, where a registrant faces a material transition risk that has manifested as a result of a requirement to report its GHG emissions metrics under foreign or state law because such emissions are currently or are reasonably likely to be subject to increased costs, due to regulatory, technological, or market changes, the registrant should consider whether such emissions metrics are material under the final rules. The SEC further notes that a registrant’s GHG emissions may also be material if its calculation and disclosure are necessary to enable investors to understand whether the registrant has made progress toward achieving a target or goal or a transition plan that the registrant is required to disclose under the Final Rules. Conversely, the fact that a registrant is exposed to a material transition risk does not necessarily result in its Scope 1 and Scope 2 emissions being de facto material to the registrant. For example, a registrant could reasonably determine that it is exposed to a material transition risk for reasons other than its GHG emissions, such as a new law or regulation that restricts the sale of its products based on the technology it uses, not directly based on its emissions.

There is no requirement for smaller reporting companies (SRCs), emerging growth companies (ECGs), and non-accelerated filers to disclose Scope 1 and Scope 2 emissions.

As noted above, no registrant is required to disclose Scope 3 emissions.

For LAFs with calendar fiscal years, Scope 1 and Scope 2 emissions, if material, must first be reported for the year beginning January 1, 2026. (For AFs with calendar fiscal years, Scope 1 and Scope 2 emissions, if material, must first be reported for the year beginning January 1, 2027.)

The Final Rules provide that any GHG emissions metrics required to be disclosed pursuant to Item 1505 in an annual report filed with the SEC on Form 10-K may delayed by approximately one quarter by incorporating such metrics by reference from the registrant’s Form 10-Q for the second fiscal quarter in the fiscal year immediately following the year to which the GHG emissions metrics disclosure relates.

Attestation reports will eventually be required when disclosing Scope 1 and Scope 2 emissions, at a limited assurance level starting in filings for fiscal years 2029 for LAFs and 2031 for AFs, and at a reasonable assurance level for LAFs starting in filings for fiscal year 2033.

Effective Date of New Rules

The final rule will become effective on May 28, 2024 (i.e., 60 days after the date of publication of the Final Rules in the Federal Register on March 28, 2024), unless the Final Rules are stayed by the Eighth Circuit (or the Supreme Court). 

Nutter Notes:  Litigation over the legality of the Final Rules will no doubt be a hard-fought, protracted battle. It’s more likely than not that the Eighth Circuit (or the Supreme Court) will stay the effectiveness of the Final Rules pending resolution of the litigation. (On March 26, 2024, Liberty Energy, the party that successfully obtained a stay from the Fifth Circuit before all cases were transferred to the Eighth Circuit, requested the Eighth Circuit to reinstate that stay. As of the publication of this advisory, the Eighth Circuit has not issued a decision.) The legal challenge to the Final Rules will likely end up before the Supreme Court ultimately, unless a Republican is elected president in 2024, in which case the SEC led by a Republican-appointed chair may rescind the Final Rules.

The conundrum now confronting registrants – especially large accelerated filers – is what action should they be taking in 2024. We anticipate that, absent a long-term stay, most large accelerated filers will assume for planning purposes that the SEC’s phase-in timetable will hold and therefore will likely begin to develop a work plan for how the registrant will eventually assess the materiality of climate-related risks and gather data necessary to track the financial statement effects of severe weather events and other natural conditions, subject to the one percent thresholds and de minimis exceptions noted above ($100,000 income statement; $500,000 balance sheet). Although for community and regional banking companies in many regions, expenses, charges, and losses incurred “as a result of” severe weather events and other natural conditions may not exceed the one percent thresholds – or possibly the de minimis cut-off amounts, these banking companies nevertheless will need to design and implement processes and procedures to track such amounts for the periods beginning on and after January 1, 2025 for large accelerated filers, which will be less than a year from the adoption of the Final Rules. (For other accelerated filers, the phase-in date is for the periods beginning on and after January 1, 2026.)

Similarly, even for the community and regional banking companies that can reasonably expect to have immaterial Scope 1 or Scope 2 GHG emissions, those banking companies nevertheless will need to design and implement processes and procedures to track Scope 1 and Scope 2 emissions for the periods beginning on and after January 1, 2026 for large accelerated filers. (For accelerated filers, the phase-in date for possible Scope 1 and Scope 2 reporting is for the periods beginning on and after January 1, 2027.)

Lastly, the Final Rules add new safe harbor from private liability for all climate-related disclosure required by the specified sections (other than historical facts) related to transition plans, scenario analysis, internal carbon pricing and climate-related targets and goals, all of which are considered forward-looking statements for purposes of the Private Securities Litigation Reform Act. Additionally, providers of attestation reports for Scope 1 and Scope 2 emissions will not be considered “experts” for purposes of liability under Section 11 of the Securities Act of 1933, as amended.

[1] The GHG Protocol was created through a partnership between the World Resources Institute and the World Business Council for Sustainable Development, which agreed in 1997 to collaborate with businesses and NGOs to create a standardized GHG accounting methodology.

[2] The Final Rules use the phrase “for the relevant fiscal year” which is odd in the context of balance sheet items. The accompanying commentary, however, can be read to mean that the SEC intends that the test is whether the cumulative aggregate amount of capitalized costs and charges exceeds $500,000.

[3] The Final Rules define “climate-related risks” to mean the actual or potential negative impacts of climate-related conditions and events on a registrant’s business, results of operations, or financial condition. The definition of climate-related risks includes both physical risks and transition risks. “Physical risks” are defined to include both acute and chronic risks to a registrant’s business operations. “Acute risks” mean event-driven risks and may relate to shorter-term severe weather events, such as hurricanes, floods, tornadoes, and wildfires. “Chronic risks” are defined as those risks that the business may face as a result of longer-term weather patterns, such as sustained higher temperatures, sea level rise, and drought, as well as related effects such as decreased arability of farmland, decreased habitability of land, and decreased availability of fresh water. “Transition risks” mean the actual or potential negative impacts on a registrant’s business, results of operations, or financial condition attributable to regulatory, technological, and market changes to address the mitigation of, or adaptation to, climate-related risks, including increased costs attributable to climate-related changes in law or policy, reduced market demand for carbon-intensive products leading to decreased sales, prices, or profits for such products, the devaluation or abandonment of assets, risk of legal liability and litigation defense costs, competitive pressures associated with the adoption of new technologies, reputational impacts (including those stemming from a registrant’s customers or business counterparties) that might trigger changes to market behavior, changes in consumer preferences or behavior, or changes in a registrant’s behavior. However, the Final Rules do not require the registrant to disclose acute, chronic, or transition risks to the operations of those with whom a registrant does business, except where such risk has materially impacted or is reasonably likely to materially impact the registrant’s business, results of operations, or financial condition.

[4] If a registrant is an LAF or an AF other than an SRC or EGC and its Scope 1 emissions are material but its Scope 2 emissions are not material, then, under the Final Rules, the registrant must disclose its Scope 1emissions but would not be required to disclose its Scope 2 emissions (and vice versa if its Scope 2 emissions are material but its Scope 1 emissions are not). If a registrant’s Scope 1 and Scope 2 emissions both are material, then it must disclose both categories of emissions.

[5] The Final Rules state that the SEC expects a registrant to also disclose whether it calculated its Scope 2 emissions using a particular method (which may differ from the method used to calculate Scope 1 emissions, to the extent both Scope 1 and 2 emissions are required to be disclosed under the final rules), such as the location-based method, market-based method, or both. Similarly, a registrant should disclose the identity of any calculation tools used, such as those provided by the GHG Protocol or pursuant to GHG emissions calculation under the ISO standards.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the Rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.