On March 21, 2022, the U.S. Securities and Exchange Commission (SEC) released its long-awaited proposed rule relating to environmental disclosure. The Enhancement and Standardization of Climate-Related Disclosures for Investors (Proposed Rule), if adopted, would require public domestic and foreign SEC-registrant companies to report on various climate-related quantitative and qualitative information. It is anticipated that the Proposed Rule will be adopted in the coming months and will undoubtedly be a watershed moment for corporations, regulators, attorneys, accountants, and the economy as whole.
Though greatly simplified, much of the corporate and securities law and regulation in the United States developed and revolves around two core principles: 1. corporations exist to drive investor (shareholder) profit and 2. information upon which a potential or actual investor reasonably relies in weighing investment decisions (material information) should be reported by companies and should have a base level of consistency, accuracy, and transparency across the market, allowing investors to compare like information in their investment decisions.
However, in recent decades, and in the past few years in particular, the rise of environmental, social, and (corporate) governance (ESG) concerns has had significant impacts on the above principles. While no definite set of ESG principles exists, various entities, such as UNPRI and the CFA Institute, provide illustrative lists. These impacts culminate in the SEC's Proposed Rule, which will be summarized below. The rest of this article will attempt to contextualize the Proposed Rule for various practitioners by introducing its ESG basis, providing an overview of the SEC's reporting framework, summarizing the Proposed Rule, and noting criticisms and the likely path forward.
Incorporating ESG factors in corporate law and securities regulation in many ways strengthens the aforementioned principles and is not merely a passion project for corporate management. As to the first principle, long-term investment viability and value is created by a corporation remaining commercially viable and healthy in the market, which many ESG commitments support. Additionally, approximately 40 states (including the District of Columbia) have enacted benefit corporation legislation, which is a legal entity form distinct from the traditional corporation (though still largely similar). While management in a traditional corporation have fiduciary duties that exclusively support the first principle above, management in a benefit corporation is allowed or mandated to have a co-equal fiduciary duty to ESG considerations, though not supplanting the presently existing fiduciary duties of management. There is now estimated to be over 3,000 benefit corporations in the United States.
As to the second principle, many corporations, traditional and benefit, have voluntarily reported on ESG factors for some time, particularly on environmental issues such as greenhouse gas emissions and primarily in corporate sustainability reports (CSRs). However, there is little consistency, accuracy, or transparency in these voluntary reports. The result is a set of information that institutional investors find to be of poor quality and retail investors find to be incomparable across companies. The scale of reporting also continues to proliferate, with the SEC seeing a third of all filings include information as to climate impacts on business and 92 percent of the S&P 500 companies issuing corporate sustainability reports. Increased reporting is largely desired by the market, but inconsistency across this many reporting entities further complicates matters for institutional and retail investors alike.
Further complicating matters is the prevalence of greenwashing, a general term that encompasses overzealous, mischaracterized, or fraudulent ESG claims, often contained in CSRs. CSRs often contain more robust, though mostly qualitative, ESG information relative to disclosures made to the SEC. For instance, companies typically announce their net-zero carbon intentions in their CSRs, underpinned by extensive tree-planting schemes to sequester carbon and offset their emissions on their path to net-zero. Problematically, the land area required to plant a distributed global forest capable of sequestering all of the carbon committed to in tree-planting based carbon offsets contained in these CSRs is 1.6 billion hectares. That is roughly five times the size of India and currently equal to global agriculturally productive land. Thus, there is simply not enough land to accommodate these net-zero tree planting claims in CSRs, making them ineffectual from a practical perspective and potentially misleading from a legal perspective. Prior to the Proposed Rule, the SEC began taking a serious look into this pervasive greenwashing.
Still further complicating matters, the underlying climatic situation continues to degrade. In summary of the United Nations' Intergovernmental Panel on Climate Change's (IPCC) Sixth Assessment Report, released in February of 2022, IPCC representative Hans-Otto Pörtner stated the following in the press release accompanying the report: “The scientific evidence is unequivocal: climate change is a threat to human wellbeing and the health of the planet. Any further delay in concerted global action will miss a brief and rapidly closing window to secure a liveable future.” The practical delineation between climate, economy, and law continues to meld together and the SEC has acknowledged that the current reporting framework may be contributing to potentially misleading climate-related disclosures.
Under the current disclosure regime, issuers are required to file disclosures when registering securities, as well as on a periodic basis thereafter. The Securities Act of 1933 requires domestic issuers to file Form S-1 (and foreign issuers Form F-1) with the SEC when registering its securities. The Exchange Act of 1934 requires public companies to file periodic reports with the SEC. The reports are either annual (Form 10-K), quarterly (Form 10-Q), or on a current basis when a number of specified events occur (Form 8-K). Regulation S-X and Regulation S-K outline the forms most often used when a registrant is required to file a disclosure with the SEC. Regulation S-X defines the form, content, and requirements for financial disclosures. Regulation S-K provides instructions for filing forms.
Although these filings do not expressly require climate-related disclosures, the SEC requires, for both registration and reporting, that, in addition to information expressly required by regulation, the disclosure of “such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.”
To provide guidance to public companies regarding the SEC’s existing disclosure requirements as they apply to climate change matters, the SEC, in 2010, published an interpretive release identifying the “most pertinent non-financial statement disclosure rules” that could require disclosure related to climate change. This includes, within Regulation S-K, Item 101–Description of Business, Item 103–Legal Proceedings, current Item 105 (then Item 503(c))–Risk Factors, and Item 303–Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A).
Despite this guidance, the SEC largely remained silent on climate change until the start of the Biden administration, when it began to take several notable actions related to climate change disclosures. These actions include:
