The SEC finalized its climate-risk disclosure rule earlier today, two years after first proposing the rule. The final rule significantly pares back disclosure requirements for greenhouse gas emissions but otherwise adheres to the basic structure of the proposed rule. This post summarizes the process followed to get to this point, potential legal challenges to the final rule, and key differences between the final rule and the March 2022 proposal.
The Origins of the Climate-Risk Disclosure Rule
The rule’s origins date to March 2021, when then-acting SEC chair Allison Herren Lee released 15 questions for consideration “with an eye toward facilitating the disclosure of consistent, comparable, and reliable information on climate change.” The initial request sought feedback on several issues that would come to haunt the rulemaking process, including: whether registrants “should report (such as, for example, scopes 1, 2, and 3 greenhouse gas emissions, and greenhouse gas reduction goals),” whether disclosures should be incorporated “into existing rules such as Regulation S-K or Regulation S-X,” and “the advantages and disadvantages of making disclosures subject to audit or another form of assurance.”
Mario Olczykowski and I reviewed a representative sample of these initial comment letters and identified several key themes. We found many of the corporate commenters already disclose climate-risk information and support efforts to ensure investors have access to the information they need to make informed decisions. However, most companies wanted “climate-related disclosures to be furnished—as opposed to filed—in order to protect registrants from the strict liability that comes with including disclosures in documents filed with the SEC.” We noted that many of these commenters expressed concerns over “the insufficient science and methodologies behind quantitative climate-related disclosures, including scope 3 emissions.” Environmental NGOs and consumer advocacy groups disagreed; they argued that Scope 1,2, and 3 emissions should be filed in audited financial statements without any legal safe harbors.
Most of the initial commenters recommended that mandatory climate-risk disclosure be guided by Task Force on Climate-Related Financial Disclosures (TCFD) and the final rule does incorporate TCFD recommendations on governance, strategy, and risk management. While most commenters on the initial request for information supported – in the abstract – mandatory climate-risk disclosure, there were several dissenting voices that foreshadowed future legal challenges. For instance, West Virginia Attorney General Patrick Morrisey argued that the SEC does not have a “compelling government interest” in requiring climate-related corporate disclosures that he believes are immaterial to a reasonable investor. According to Morrisey, any SEC rule requiring climate-risk disclosure would be compelled speech in violation of the First Amendment, an argument recently deployed by the Chamber of Commerce in their lawsuit against the state of California over its new corporate climate disclosure laws.
Critiques of the Proposed Rule
On March 21, 2022, the SEC released a proposed climate-risk disclosure rule that “would require registrants to provide certain climate-related information in their registration statements and annual reports.” The comment period for the 490-page release was originally set to end on May 20, 2022, but was pushed to June 17, 2022 after the Commission received numerous requests for an extension. The Commission received over 15,000 comments, the most ever received for a single proposal.
The proposed rule leaned heavily on the TCFD framework, largely because TCFD recommendations have become “widely accepted by both registrants and investors.” This included a requirement that all registrants disclose Scope 1 and 2 emissions. Chair Gensler was under tremendous pressure from progressive groups and environmental NGOs – groups that championed his initial appointment as chair – to mandate Scope 3 disclosure. These groups argued that Scope 3 accounts for sixty to ninety percent of most companies’ carbon emissions and is therefore critical information for investors to better understand a given company’s transition risk (business-related risks that follow societal and economic shifts toward a low-carbon and more climate-friendly future). Recognizing the “relative difficulty in data collection and measurement” for Scope 3, the SEC attempted to compromise by requiring “disclosure of Scope 3 emissions only if those emissions are material, or if the registrant has set a GHG emissions reduction target or goal that includes its Scope 3 emissions.” The Commission provided additional accommodation by exempting smaller reporting companies from Scope 3 disclosure, as well as by providing a legal safe harbor for Scope 3 disclosure and a longer phase-in period.
After the comment period closed, Morgan Smith and I reviewed a sample of over 500 comment letters to better understand the main points of disagreement by commenter type (asset managers, fossil fuel companies, environment NGOs, etc.) Our main finding was that an overwhelming majority of commenters opposed the proposal’s approach to Scope 3 disclosure. Environmental and consumer advocacy groups expressed concern that issuers would avoid making public emissions reductions commitments to avoid having to disclose Scope 3 emissions. Private sector commenters, and Republican politicians, were overwhelmingly opposed to any kind of Scope 3 disclosure requirement. Their concerns centered around the lack of methodological rigor around Scope 3 calculation and the potential for non-SEC reporting companies to face significant cost increases when the public companies they service start to demand their emissions data to satisfy Scope 3 disclosure requirements. The latter concern came to center around the impact to small farmers, a sacred cow in American politics. Dozens of comment letters were submitted by state farm bureaus and agricultural producers, many of them family owned. Donald Stehle, of Stehle Cattle Company, warned that mandating Scope 3 disclosures “will indirectly place a burden on every farmer or rancher whose goods are sent to publicly traded processing companies, restaurants, or retailers.” And at a recent House Financial Services Committee hearing focused on the proposed climate-risk disclosure rule, one of the witnesses was a third-generation Michigan fruit farmer who argued that farmers like him would see their costs go up if the SEC mandates Scope 3 disclosure. These concerns even persuaded some Democratic politicians to oppose Scope 3 disclosure. Senator Jon Tester (D-Mont.), himself a farmer, wrote to chair Gensler to express concerns about “the negative effects” the proposal “may have on agricultural producers covered by a public company’s indirect Scope 3 disclosure requirements.”
Our review of the comment file also identified significant concerns over the proposed rule’s requirement that registrants disclose in a note to their “financial statements certain disaggregated climate-related financial statement metrics that are mainly derived from existing financial statement line item.” Many private-sector commenters and trade associations argued that the requirement to disclose the financial impacts of climate-related events for each financial statement line item, provided it meets a 1% reporting threshold, is unworkable and could significantly increase costs (in large part due to auditing requirements).
The Omnipresent Threat of Legal Challenge
The proposed rule’s comment file made clear that the SEC was going to be sued no matter what was in the final rule. Thus, the question for Chair Gensler became: How do you draft a final rule capable of withstanding legal challenge while still providing investors with consistent, comparable, and reliable climate-risk information? Many supporters of mandatory climate-risk disclosure pushed the SEC to adopt an expansive rule precisely because the rule would be challenged in court. Better to go big and roll the dice in court, so the thinking went. But this logic was never going to fly with Chair Gensler, as evidenced by his begrudging approval of eleven bitcoin spot bitcoin exchange-traded products after the “U.S. Court of Appeals for the District of Columbia held that the Commission failed to adequately explain its reasoning in disapproving the listing and trading of Grayscale’s proposed ETP.” The Commission could have come up with a new reason to disapprove the Grayscale listing, but Chair Gensler assumed this decision would also be overturned, thus a begrudging approval.
Over the past two years, the climate-risk disclosure rule’s prospects for legal durability have only grown bleaker. In June 2022, the Supreme Court struck down the EPA’s Clean Power Plan in West Virginia v. EPA. The Majority relied on the major questions doctrine, which holds that “a clear statement is necessary for a court to conclude that Congress intended to delegate authority ‘of this breadth to regulate a fundamental sector of the economy.”” Opponents of mandatory climate-risk disclosure subsequently argued that Congress never assigned the SEC with the task “of deciding major questions of climate policy” and that the proposed climate-risk disclosure rule would unconstitutionally “impose changes on massive swathes of the American economy.” The Commission, and supporters of the proposed rule, argued that the SEC is simply fulfilling its statutory mandate to provide investors with the information they need to make informed investment decisions.
Further threatening the final rule’s survival is the likely demise, or at least weakening, of Chevron deference. In Chevron v. Natural Resources Defense Council, the Supreme Court indicated that courts should defer to an agency’s reasonable interpretation of an ambiguous statute. But this past January, the Court heard oral arguments in two separate cases challenging a rule by the National Marine Fisheries Service. Both plaintiffs asked the Court to overrule Chevron and the conservative majority appears inclined to do so. Such a ruling would weaken the SEC’s hand in court.
There is also a potential administrative law challenge to the proposed rule based on inadequate, or shoddy, cost-benefit analysis. In December 2023, the U.S. Fifth Circuit Court of Appeals struck down the SEC’s share buyback rule for failing “to conduct a proper cost-benefit analysis.” Many commenters on the proposed climate-risk disclosure rule criticized the SEC’s cost-benefit analysis, which takes up over 100 pages of the release, for downplaying the cost of compliance. The SEC relied, in part, on a survey I conducted for the Climate Risk Disclosure Lab in estimating that ongoing compliance costs for large companies would be $530,000 per year and $420,000 for smaller companies. Registrants, trade associations, and some asset managers argued that these costs would be much higher due to legal and assurance costs.
California Establishes a New Baseline
The SEC’s legal authority – when it comes to challenges based on cost-benefit analysis – was strengthened last October when California passed two related laws that would require most publicly traded companies to report Scope 1,2, and 3 emissions as well as climate-related financial risk in accordance with TCFD recommendations. SB 253 requires all business entities with total annual revenues over $1 billion that do business in California to disclose scope 1, 2, and 3 emissions annually (starting in 2026 for scopes 1 & 2, and 2027 for scope 3). SB 261 requires all companies with over $500 million in annual revenue and conducting any business in California to prepare a biannual climate-related financial risk report starting in 2026. These two laws will cover roughly 5,300 and 10,000 companies respectively.
If these laws survive the Chamber of Commerce’s lawsuit, it would raise the baseline for the SEC’s climate disclosure rule, meaning, as Chair Gensler noted, it would be less costly for companies to report climate-risk information to the SEC because they’d already be producing that information in accordance with California law. The same is true for US companies with EU operations who must disclose specific information on key sustainability issues under the EU’s Corporate Sustainability Reporting Directive (CSRD).
Key Changes to the Final Rule
Ultimately, the California laws did not persuade the SEC to keep, or strengthen, the proposed rule’s GHG emissions disclosure requirements. Instead, the Commission moved in the opposite direction. While the proposed rule required all public companies to disclose Scope 1 and Scope 2 emissions, subject to assurance requirements, the final rule requires Scope 1 and Scope 2 disclosures for larger registrants only when those emissions are material. Given that public companies are already required to disclose all material information, the final rule essentially preserves the status quo when it comes to emissions disclosures (very few companies include emissions data in SEC filings). The Commission also bowed to commenter pressure and dropped all requirements pertaining to Scope 3 disclosure.
The final rule also expands the safe harbor for private liability, which only covered Scope 3 under the proposed rule, to cover disclosures “pertaining to transition plans, scenario analysis, the use of an internal carbon price, and targets and goals.” This change was surely made to address concerns about the potential costs of legal liability, although much of this information would be covered by the existing safe harbor for forward-looking statements.
The final rule is also notable for what did not change. Requirements to disclose climate-related information relating to governance, strategy, and risk management are largely the same. The Commission also kept the requirement to disclose the “financial statement effects of severe weather events and other natural conditions” in a note to the financial statements subject to the same 1% threshold. However, the final rule excludes the proposal’s requirement that registrants provide line-item disclosures on expenditures tied to transition activities.
While disclosure around transition-related expenditures is no longer required, the final rule does keep a requirement that registrants have to disclose, in a note to the financial statements, the “capitalized costs, expenditures expensed, and losses related to carbon offsets and renewable energy credits or certificates” if they constitute a “material component of a registrant’s plans to achieve its disclosed climate-related targets or goals.” This information is needed to address greenwashing concerns over corporate net-zero commitments.
Conclusion
Every SEC chair is appointed for a reason – to help execute the President’s economic agenda within the confines of the law. But the law is malleable, and heads of regulatory agencies have historically been willing to push legal boundaries to advance certain priorities. Indeed, it is hard to know where the boundaries are if you never push.
In May 2021, President Biden issued an Executive Order on Climate-Related Financial Risk, stating the policy of his Administration is to “advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk.” It then fell on Chair Gensler to turn this policy into a legal reality. It has not been easy.
Many environmental groups are understandably upset with changes to the final rule. Incredibly, some are even threatening to sue the SEC for “dropping major provisions from the proposal, including Scope 3.” These groups all purport to represent the interests of investors, despite rarely – or ever – weighing in on prior SEC rulemakings. The views of actual investors from the comment file tell a different story. They are supportive of mandatory climate-risk disclosure but have doubts about the usefulness of Scope 3 data and financial statement footnotes.
Chair Gensler has consistently said that the purpose of mandatory climate-risk disclosure is to provide investors with “consistent, comparable, and decision-useful” information. This is the standard by which the final rule should be judged. While it does not have everything that environmental and consumer advocate groups want, and it includes more than public companies want, there is no doubt that the final rule – should it survive – will provide investors with more accurate information about climate-related risks at public companies. That is meaningful progress.
Lee Reiners is a lecturing fellow at the Duke Financial Economics Center and directs the center’s Climate Risk Disclosure Lab.
