SEC Adopts Final Climate-Related Disclosure Rules

On March 6, 2024, the Securities and Exchange Commission (SEC) adopted its final rules mandating climate-related disclosures by publicly traded US companies and foreign private issuers in their periodic reports (e.g., annual 10-K filings, Form 20-F) and registration statements (for new issuers) filed with the SEC.¹

In his statement regarding the final rules, SEC Chair Gary Gensler commented that these regulations "...would provide investors with consistent, comparable, decision-useful information, and issuers with clear reporting requirements."²

Gensler continued that the final rules are "grounded in materiality," which is a "fundamental building block" of disclosure requirements under the federal securities laws."²

Taking a helicopter view of the lay of the land, the final rules require disclosure of:

• Material climate-related risks and the impact of such risks on the company's business, results of operations and financial condition
• Oversight and governance of material climate-related risks by the board of directors and management
• Information pertaining to climate-related targets or goals
• Material greenhouse gas (GHG) emissions data
• Financial statement footnote disclosures on expenditures resulting from severe weather events and other natural conditions³

Caveats to the final rules

• Smaller reporting companies (SRCs) and emerging growth companies (EGCs) are exempt from reporting Scope 1 GHG emissions (direct emissions from operations that the public company owns or controls) and Scope 2 GHG emissions (indirect emissions from purchased or acquired electricity, steam, heat and cooling that the public company consumes).
• Only larger public companies — large accelerated filers (LAFs] and accelerated filers (AFs) that aren't SRCs and EGCs (non-exempt AFs) — must disclose Scope 1 and Scope 2 GHG emissions, and only if they are material to their business or financial condition.
• LAFs and non-exempt AFs must provide limited assurance from an independent third party as to their Scope 1 and Scope 2 GHG emissions, and LAFs will later be required to provide reasonable assurance.
• Disclosure of Scope 3 GHG emissions has been eliminated for all companies.
• There's no requirement to describe climate-related expertise of board members.
• The final rules extend Private Securities Litigation Reform Act (PSLRA) safe harbor from private liability for climate-related disclosures (excluding historical facts), providing protection for forward-looking statements pertaining to transition plans, scenario analysis, the use of an internal carbon price, and targets and goals.³

The SEC is using a phased-in approach for compliance with the final rules, as further detailed in the SEC's compliance chart and timeline:³

Critical highlights of the final rules

The cornerstones of the final rules are risk management, corporate governance, business strategy and metrics/targets. These essential features are included in the newly added subpart 1500 Climate-Related Disclosures to SEC Regulation S-K and new Article 14 of Regulation S-X, among others. In addition to the Scope 1 and Scope 2 GHG emissions disclosures explained above, we highlight other key required disclosures.³

A description of climate-related risks that had or are reasonably likely to have a material impact on the company's strategy, results of operations and financial condition (in the short term of less than 12 months and in the long term beyond the next 12 months), plus any actual or material impacts of any identified climate-related risks on the company's strategy, business model and outlook.

• Materiality in securities law is determined based on the substantial likelihood that a reasonable investor would consider it important when determining how to vote or making an investment decision, or its omission as having significantly altered the total mix of information available.²
• Disclosure of activities undertaken to mitigate or adapt to a material climate-related risk, including a description of material expenditures incurred and the material impacts on financial estimates and assumptions that directly result from these activities, which include the use of transition plans, scenario analysis or internal carbon prices.

Information pertaining to the oversight of climate-related risks by the board of directors and any role that management has in assessing and managing material climate-related risks.

• Include identification of any board committees or subcommittees responsible for the oversight of climate- related risks, as well as the processes by which the board or its committees are informed of these risks.
• Companies must also disclose whether and which management positions or committees are responsible for assessing these risks, the relevant expertise of these persons in detail (e.g., prior work experience, degrees or certifications, or other background in climate-related matters), and whether such positions report to the board of directors.

Description of risk management processes companies use to identify, assess and manage material climate-related risks, including whether and how any of the processes it has disclosed has been integrated into the company's overall risk management system.

Information about the effect of climate-related targets or goals, including whether and how any climate-related targets or goals have materially affected or are reasonably likely to materially affect their business, results of operations or financial condition.

• This disclosure includes material expenditures and material impacts on financial estimates and assumptions directly resulting from the target, goal, or actions taken to make progress toward achieving such targets or goals.
• Details need to be provided if carbon offsets or renewable energy credits or certificates are used as a material component of the company's plan to achieve its climate- related targets or goals.

Financial impacts and related disclosures must be included in a note to audited financial statements, but only if those impacts meet certain thresholds relative to capitalized costs, expenditures, charges, and losses pertaining to severe weather events, natural conditions, or carbon offsets/renewable energy credits.³

Cross-pollination and liability

These climate-related disclosure requirements may present several areas of particular concern for board directors and C-suite officers. Consider the following:

Materiality

The bedrock of many disclosures rests in whether the information is material to reasonable investors, but materiality is subject to various interpretations. Public companies must recognize that materiality determinations must take both quantitative and qualitative considerations into account.

A standard approach to determining materiality in the context of climate-related disclosures has not yet surfaced. Consequently, determinations of materiality may open a Pandora's box by triggering other disclosure requirements such as attestation, transition plans, and targets and goals.

Further, a heightened level of scrutiny must be employed in evaluating disclosures for consistency and accuracy. Some believe the SEC and other stakeholders will seize the opportunity to question materiality determinations, if they identify any variations between the information included in SEC filings and those in other public disclosures, including information in prior filings or voluntary reports.⁴

Financial reporting

The disclosure of the financial impact of severe weather events and natural conditions may be particularly problematic for chief financial officers (CFOs) engaging in this exercise for the first time with no clear definition of what constitutes a severe weather event nor guidance for describing the costs associated with such events. Liability may arise from both under-reporting and over-reporting these risks. The distinction between useful and non-useful information is ambiguous, which opens the door for increased liability for CFOs, controllers, chief accounting officers and companies.⁵

Cross-pollination

On the US front, in October 2023, California enacted three bills (SB 253, SB 261, AB 1305) collectively referred to as the Climate Corporate Data Accountability Act. Both large public and private companies with annual revenues over $1 billion doing business in California are required to disclose GHG emissions for Scope 1 (direct emissions from operations), Scope 2 (indirect emissions from energy used), and Scope 3 (indirect emissions from the supply chain).

The required reporting begins in 2026 for Scopes 1 and 2, and in 2027 for Scope 3.⁶ California's law is broader and more stringent than the final rules. While it is being challenged in courts, California was first in the nation to pass its climate bills,⁷ and other states (New York, Illinois) are following its lead.

At the moment, it's unclear whether the final rules will preempt such laws.

Similar in breadth to California's law, in July 2023, the European Union (EU) adopted the Corporate Sustainability Reporting Directive (CSRD), which may apply to EU subsidiaries of many US companies and non-EU companies with significant activities in the EU that may also be subject to the final rules. The CSRD is much broader than the final rules, because it covers several sustainability topics of which climate is only one. CSRD requires reporting on biodiversity, land use, water pollution, community impact and even fair labor practices, among others, depending on a double materiality assessment that takes into account financial materiality (similar to the final rules) and impact materiality, such as effects on clients, local communities and the environment, among others.⁸

The natural inclination of companies required to make disclosures under these different frameworks is to streamline the process and take a holistic approach to ensure consistent regulatory reporting and alignment. Yet, given different requirements, it's more likely that companies will need a custom approach. Cross-pollination or substituted compliance of disclosure responses doesn't appear to be an option at this time.⁴ However, this may all change in the future as different jurisdictions work towards aligning their approach to these disclosures.

Liability

Board directors and C-suite officers understand that the requirements of the final rules are diverse and cast a wide net, with some touching closer to the boardroom than others. Significantly, the climate-related disclosure demands may pose substantial risks to a public company's budget, performance, reputation and liability risk profile.⁹ Consider the following examples, all of which present liability within the context of climate-related disclosures.

• Failure to have effective disclosure controls and procedures, including internal control over financial reporting and climate-related information. These compliance violations are frequently the subject of enforcement actions and may be considered a strict liability violation.
• Providing inconsistent, inaccurate or incomplete information, or omitting critical information, with respect to climate-related governance, risk management, risks and opportunities, which may lead to allegations of fraud.¹⁰

Plaintiffs' law firms are also expected to bring demands for the inspection of books and records, shareholder derivative litigation, securities class actions and other similar activity, as a result of what they may consider inaccurate climate-related disclosures.

It's also incumbent upon companies to recognize that the polarization of climate-related issues is a liability within itself, given that reactions from government and key stakeholders can carry significant ramifications from various perspectives, such as reputational and regulatory risks, among others.

The SEC is postponing implementation of the final rules as it addresses the current challenges against them filed by various groups to be decided by the Eighth Circuit; however, companies are expected to continue working towards compliance and assessing potential liability risks.¹¹

Risk management strategies

To close the loop for board directors, C-suite officers and companies with respect to the final rules, we provide the following suggestions.

• Review the SEC compliance timetable to determine when and how the new rules apply to your company.
• Take inventory of and assess your prior climate-related disclosures.
• Ascertain how the final rules will affect future disclosures in SEC.
• Evaluate the current processes and internal controls in place for financial reporting and disclosures to ensure accurate qualitative and quantitative information.
• Pinpoint existing climate-related goals and targets.
• Identify and remediate gaps in disclosure and controls, both in and outside of financial statements, as they relate to GHG emissions and other required disclosures.
• Analyze how the final rules will impact your company's operations and identify disclosure obligations that will be challenging for your company to meet.
• Educate the board of directors, management, and employees about the final rules, and evaluate your company's internal team and resources.
• Examine board oversight of climate matters and consider implementing new roles, responsibilities, or committees to refine oversight and corporate governance.
• Plan for advisers to discuss materiality determinations and attestation, if applicable.
• Align reporting with disclosure requirements of other states and foreign regulators.
• Stay apprised of global greenwashing litigation and the legal challenges to the final rules.

Reporting companies will also fare better with a timeline and checklist of responsibilities for new disclosures required by the final rules.

Board directors and C-suite officers must also preemptively prepare for litigation that may be brought by the plaintiffs' bar or potential regulatory actions in connection with climate-related disclosures. Part of this preparation is reviewing your Directors and Officers (D&O) Liability insurance to ensure that protection from liability is in place. Due to the complexity surrounding the final rules, a first-in-class risk management program built by industry and coverage specialists is paramount. Part of your business strategy should be engaging Gallagher's Executive and Financial Risk practice specialists, who always stand ready to assist.