Investing in Transparency: Unpacking the SEC’s Climate Disclosure Overhaul—Part 2

Note: Enforcement of the SEC’s climate disclosure rule was issued an administrative stay by the Fifth Circuit Court of Appeals, temporarily halting implementation of the disclosure regulation until further court rulings. The lawsuits have now been consolidated and, per lottery, are being heard in the Eighth Circuit Court of Appeals. The Fifth Circuit has dissolved its temporary stay; it remains to be seen if the Eighth Circuit will pause the regulations again.

On March 6, 2024 the SEC voted with a 3-2 approval on the Enhancement and Standardization of Climate-Related Disclosures for Investors. The initial proposed rule was first introduced in 2022 and ignited a highly contentious debate from the market, resulting in over 24,000 comments from a wide array of people and perspectives. The final rule mandates climate risk disclosure in regulatory filings by thousands of public companies and in public offerings. The SEC believes that investors should have an understanding of, or at the very least access to information on, the impacts of climate change on financial performance and risks that affect their investments. According to a recent survey, 90% of investors agree that reporting regulations enable them to make more informed investment decisions.

This is the second piece in a 3-part article series exploring the key elements of the final rule, implementation timelines, legal challenges already facing the rule, and much more. In part 1, we explored the major components of the rule and important disclosure dates for affected parties to be aware of. In this piece, we will share our 4 major takeaways on the elements that did (and didn’t) make the final rule, as well as look at the legal challenges it is already facing in the courts. 

4 Major Takeaways From the Final Rule

1 – Materiality Ambiguity:

Materiality is perhaps the most important topic in the final climate disclosure rule. Throughout the rule certain information is required to be disclosed only if it’s determined by the reporting company to be material. The SEC uses the Supreme Court’s definition of materiality which means that a fact is material if there is “a substantial likelihood that the … fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” Simply put, materiality refers to information that would affect investor decisions.

Since the release of the final SEC rule, many companies and legal teams have been expressing how vague and ambiguous the rule is on assessing materiality and how further clarification or guidance from the SEC is needed. 

Materiality assessments can involve various factors beyond financial or GHG emissions metrics, such as regulatory compliance, customer demands, industry trends, and more. However, the SEC’s final rule does not provide a prescriptive approach for materiality assessments which means it will be assessed differently for each company. Not having a prescriptive approach leaves room for many climate risks being deemed immaterial and therefore not disclosed, as well as making a regulated company vulnerable to liability.

2 – Scope 3 Exclusion:

Scope 3 emissions disclosure was the most contested feature of the original proposal; however, the final rule dropped the scope 3 requirement after significant lobbying and litigation pressure. Challengers claimed that scope 3 is too difficult to measure and would subject private companies to the rule. 

Despite exclusion of scope 3 emissions, that does not mean compliance will necessarily be easy. The final rule still has an extensive reporting structure, leaves many questions to be answered, and will be labor and time intensive, especially for organizations that have not previously considered climate risks.

Reporting on scope 3 emissions is becoming the baseline for other global climate-related regulations and voluntary standards. That means companies are still going to be faced with pressure to focus on calculating scope 3 emissions and engaging with their supply chain.

This makes the SEC’s exclusion of scope 3 a complicated matter for companies from a compliance perspective as some companies subject to the SEC rule may also be subject to other climate disclosure laws with scope 3 requirements. Most notably, California’s SB 253, also known as the Climate Corporate Data Accountability Act (CCDA), recently became the first law in the United States to mandate scope 3 disclosures, covering both public and private companies. 

Companies are going to need a roadmap of how to comply with these more stringent requirements–what to report, where to report, and who to report what to. For example, information that is considered material for the EU’s Corporate Sustainability Reporting Directive (via its double materiality requirement), may not need to be disclosed under the SEC final rule.

3 – Offsets Disclosure May Offer Advantages:

If implemented properly, investments into actions beyond a company’s value chain can mitigate future risks. For example, companies with high emissions in hard-to-abate sectors can invest in emerging carbon dioxide removal (CDR) technologies now so that they can scale and be available to durably neutralize residual emissions at accessible price points. Additionally, beyond value chain mitigation investments can enhance brand differentiation, enable price premiums linked to climate leadership and social responsibility, and subsequently contribute to talent retention and customer brand loyalty.

Having visibility into the amount of money a company is spending on climate action may help accelerate the flow of private capital into climate solutions. The SEC requirement for offset procurement disclosure in financial statements may be a demand driver.

It plays into the “polluter pays” principle where those who produce more pollution should bear more of the costs of its management.  This added transparency: holds emitters more accountable for paying for their contribution to climate change, should allow for peer/competitor comparison of private climate finance contributions, and could ultimately reward companies who are voluntarily doing more.

If offsets procurement disclosure does result in fostering more private climate finance, it will be imperative for buyers to procure only the highest-quality and impactful solutions. Additional, verifiable, durable, and scalable projects will be of higher demand and value.

Limited Safe Harbor:

The final rule created a safe harbor from private liability for climate-related disclosures pertaining to transition plans, scenario analysis, the use of internal carbon pricing, and targets and goals as these are forward-looking statements. This liability protection does not extend to historical facts.

Legal Battles

There has been a wide spectrum of reactions to the final rule, but central to the spectrum are legal challenges. Legal challenges were not unexpected, as previously mentioned the SEC received over 24,000 comments on the rule.

Business groups are arguing that the requirements represent a regulatory overreach, raise compliance costs, create unnecessary burdens, and introduce new liabilities. Thus far, at least 25 states have opposed the SEC’s rule in court; including a lawsuit filed only hours after the rule was approved. Enforcement of the SEC’s climate disclosure rule was issued an administrative stay by the US Fifth Circuit Court of Appeals, temporarily halting implementation of the disclosure regulation until further court rulings, which has since been dissolved. There were lawsuits also pending in at least six other courts, but these have since been consolidated and, per lottery, are being heard in the Eighth Circuit Court of Appeals. It remains to be seen if the Eighth Circuit will pause the regulations again.

On the opposite end of the spectrum, environmental group Sierra Club sued the SEC and claimed that the final rule doesn’t provide investors with enough information regarding the climate-related risks a company is potentially exposed to. The Sierra Club believes the SEC weakened the rule by dropping critical disclosure requirements, like scope 3 emissions reporting, and allowing the selective reporting of scope 1 and 2 emissions by only having to disclose what is deemed material, rather than mandating the disclosure. 

Some of these legal challenges are occurring at the same time as the lawsuit filed against California over its recently released climate legislation–it will be important to monitor these developments.

Now that you have an understanding of the key elements of the rule, who it impacts and when, read the final article in this 3-part series as we share actionable tips to help your organization begin preparing for implementation of the SEC’s new disclosure rule.

Prepare for reporting and get ready for SEC disclosure with Climate Vault. Learn how you can measure, manage, report, and take direct action on your organization’s carbon footprint with the Climate Solutions Platform. 

Note: Climate Vault is not offering legal advice. While the information in this article pertains to legal issues, it is not intended as legal advice or as a substitute for the particularized advice of your own counsel.