II. The History of Environmental Disclosure in American Capital Markets
The stock crash in October 1929 marks the point in time when investor confidence in American capital markets was at its lowest. With the help of Congress and close aides, Franklin D. Roosevelt signed into law the Securities Act of 1933 (1933 Act) and the Securities Exchange Act of 1934 (1934 Act). The 1934 Act created the Securities and Exchange Commission, an arm of the executive branch charged with policing public and private offerings of securities, including the disclosure of information about securities. Once learning of the dishonest dealing market participants were engaging in to make a buck, the SEC “was designed to restore investor confidence in our capital markets by providing investors and the markets with more reliable information and clear rules of honest dealing.” The Commission’s role is trifold: (1) protect investors, (2) maintain fair, orderly, and efficient capital markets, and (3) facilitate capital formation. Availing itself to strict adherence of its purpose, the SEC has reacted to market movement through the rulemaking process and investors have increased their number of risky investments, demonstrating renewed confidence in American markets.
The recently finalized climate-related rules echo existing mandatory disclosures that the SEC introduced fifty years ago. Four decades after its formation, the Commission issued its first interpretive release advising registrants to consider disclosing financial information impacted by compliance with environmental laws. In 1971, the SEC reminded registrants that the 1934 Act requires disclosure of capital outlays for environmental and pollution compliance. The 1971 release reminded registrants of the requirement for disclosure when environmental impacts materially affect “the earning power of the business, or cause material changes in [how the] registrant’s business [is] done or intended to be done.” During the same period, large public corporations committed to addressing climate-related issues. For example, General Motors pledged to create “pollution free cars by 1980.” Other advertisements similarly declared: “It can be the beginning of the end of pollution. Or the beginning of the end.” Environmentalism inundated corporate governance policy across the US and continues to be a subject for discourse among the public today.
In 2010, American capital markets underwent another shift. In response to investor demand, registrants began to increase their voluntary climate-related disclosures. These voluntary disclosures expanded upon what the 1971 release exacted and were not required in any of the SEC’s mandatory filings. Review of these voluntary disclosures raised many red flags. The Commission identified discrepancies in the climate-related information that registrants shared with investors, reminiscent of the dishonest dealing the SEC was created to abolish.
Over a decade after firms increased voluntary disclosure of climate-related information, the SEC requested suggestions from the public regarding how it should police the information. The Commission witnessed drastic variations in the information provided to investors for making informed decisions. The SEC also identified that investors had little guidance on interpreting climate-related risks and their effects on registrants’ business and financial statements. In the absence of rules from the SEC, the voluntary disclosures created inconsistent, confusing, and unreliable methods for investors to assess risk to their portfolios. The Commission learned that eighty-five percent of investors think that “more standardization of sustainability reporting” would allow them to manage their capital more efficiently. Similarly, eighty-three percent of investors believe standardization would enhance risk management. To compound the confusion, registrants have included the voluntary climate-related disclosures in SEC-required filings. Between 2019 and 2020, thirty-one percent of Form 10-K registrants, seventy-three percent of Form 40-F registrants, and thirty-nine percent of Form 20-F registrants mentioned climate-related keywords in their filings. For illustrative purposes, maritime transportation mentions climate in ninety-four percent of its disclosures; electric services mentions climate ninety percent of the time; oil and gas mentions climate eighty-four percent of the time; and steel manufacturing, eighty-two percent. Despite the prevalence of voluntary environmental disclosures, no regulatory authority had been fact-checking the statements registrants were making to investors. Even with the final rules, the SEC’s exclusion of Scope 3 disclosure means that some climate-related statements will continue to go unchecked. While lack of review over information provided to investors affects investment, it unwittingly impacts contractual obligations to investors as well. For example, sustainability-linked bonds allow firms to commit to specific ESG goals in exchange for favorable interest rates from investors. Because registrants were able to communicate ESG adherence to their investors without adequate review, investors fail to receive reliable information they believe is material to their investment strategies.
III. The SEC’s Climate-Related Disclosure Framework
The SEC’s final climate-related disclosure framework requires domestic and foreign registrants to disclose specific climate-related information in registration statements and periodic filings for the purpose of enhancing and standardizing disclosures for investors. The scope of information affected applies to climate-related risks that could “reasonably likely” have a material impact on business, operations, or financial status. The disclosure requirements can be broken down into three general categories: (1) governance and risk-related disclosures; (2) accounting-related disclosures; and (3) greenhouse gas disclosures. These three categories are accompanied by additional guidelines for registrants who have developed transition plans, utilized scenario analyses, or those registrants with climate-related targets. Transition plans are strategies to “manage a material transition risk,” such as metrics or goals that the firm has used to identify and manage risks. Registrants that utilize scenario analyses and determine that a climate-related risk may have a material impact on business must disclose such scenario(s) along with any assumptions. The description must include the considerations and projections of the material financial impacts discovered. For example, if a carbon price is used for a registrant’s evaluation of climate-related risks, the internal price, including information on how it is established, must be disclosed. Because transition plans, scenario analyses, carbon prices, and targets or goals require predictions, a safe harbor exists. Specifically, the statements required by these disclosures are considered “forward-looking statements” as defined by the Private Securities Litigation Reform Act (PSLRA) and the 1933 and 1934 Acts. Under the PSLRA, courts have interpreted forward-looking statements, regardless of the presence of historical fact, as statements accompanied by cautionary language and lacking actual knowledge to the contrary. Interestingly however, the final rule explicitly excludes “historical fact” from the forward-looking statement safe harbor.
The final rule applies to most 1934 Act registration statements and periodic filings, including those of foreign registrants. The compliance date for the final rule is reliant upon the registrant’s filer status, but phase-in periods apply to all registrants. Private parties in business transactions and asset-backed security issuers are not subject to the rule. Smaller reporting companies (SRC) and emerging growth companies (EGC) are exempt from disclosure of GHGs. Because the final rule applies to a large number of firms, it is important for SEC registrants and their attorneys to understand the final rule’s three general categories of disclosures.
A. Governance and Risk-related Disclosures
The first category of disclosure relates to governance and risk. Modern corporate governance has evolved into ESG governance, and the final rule captures this shift. Under the rule, registrants must disclose governance of climate-related risks and the applicable risk management processes undertaken by management and the board of directors. Governance disclosure requires a description of registrants’ standing processes for identifying and managing climate-related risks so that investors can understand actions that registrants are taking. Think of questions like: “what is the board of director’s involvement?” and “what is management’s role?” For example, investors must know if a registrant’s risk management protocol is integrated into its general risk management system or if it comprises a separate oversight process. Additionally, the final rule does not proscribe procedures for oversight and leaves registrants free to determine how to manage their businesses. For example, the final rule requires disclosure of which management positions oversee climate-related risks rather than imposing rules regarding those management positions. This allows registrants to freely make business determinations.
In addition to governance, registrants must disclose information about the risks that exist to its business. Business models are relevant to investment decisions and are affected by various climate-related events. A definition of climate-related events include hurricanes, floods, tornadoes, wildfires, and other natural occurrences. These events become material to investment decisions because they present issues which affect registrants’ positions in the market. Under the final rule, registrants must disclose the material impacts of climate-related risks on strategy, business model, and outlook that have, or are likely to occur. The historical and assumptive nature of identifying past and future risks allows investors to assess registrants’ sustainability and growth opportunities. The governance and risk-related disclosures avoid imposing a “one-size-fits-all” model and instead allows registrants to tailor disclosures to their particular circumstances. Similar in their construction to the management discussion and analysis disclosures promulgated in 1989, the governance and risk-related disclosures fit squarely within the statutory authority of the SEC.
B. Accounting-related Disclosures and Information About Risk
The second category of disclosure relates to accounting. Disclosing the effects of risk on the financial performance of registrants’ businesses is essential for reducing the information asymmetry gap between investors and registrants. Under the final rule, financial statement disclosure focuses on the costs, expenditures, charges, and losses resulting from climate-related events, carbon offsets, and renewable energy certificates (RECs). Notwithstanding these parameters, the disclosure of carbon offsets and RECs is only required when used as a “material component” in registrants’ plans to achieve targets or goals. The materiality threshold for the accounting-related disclosure is unique and subject to a pre-determined percentage. Specifically, accounting disclosures are only required if the aggregate amount exceeds specific percentage thresholds set forth in the final rule. This artificial materiality threshold may struggle in the Eighth Circuit, especially in consideration of the SEC’s Accounting Bulletin No. 99, which professes that percentage thresholds “cannot be appropriately used as a substitute for a full analysis of all the relevant considerations [regarding materiality].” Rather, “a matter is ‘material’ if there is a substantial likelihood that a reasonable person would consider it important.”
C. Greenhouse Gas Disclosures
The third category of disclosure relates to greenhouse gases (GHG). Climate-related risks that are material to investment decisions include GHGs. Because investors have identified GHG emissions as an indicator of registrants’ risk, the final rule outlines specific guidelines for emissions reporting. In contrast to the final rule, the Commission’s original proposal identified three categories of emissions to be disclosed: Scope 1, Scope 2, and Scope 3. All three of these emission categories are based upon other widely adopted disclosure frameworks, such as the Task Force on Climate Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol. The EU, Canada, Australia, France, and the United Kingdom are some of the many countries with developed economies that have adopted policies using the Scope 1, 2, and 3 categories. But the final rule excludes any Scope 3 disclosure requirement. Scope 3 describes emissions that occur throughout a registrant’s value chain, which includes upstream and downstream activities. Upstream emissions come from goods and services that a registrant receives. For example, a freightliner’s emissions during transport of packaging tape from its country of origin to a mail carrier’s port of arrival would be part of the mail carrier’s Scope 3 emissions. In contrast, downstream emissions are created from use, transportation, and treatment of a firm’s products and investments. For example, emissions resulting from waste disposal of packaging tape would be part of a mail carrier’s Scope 3 emissions. Since the SEC dropped Scope 3, the final rule only requires Scope 1 and 2 disclosure and does not mandate GHG reporting from all registrants. Registrants exempt from disclosure include SRCs and EGCs, which is consistent with other securities policies pertaining to these registrants.
Scope 1 describes direct GHG emissions. Direct GHG emissions occur from sources under the registrant’s ownership or control. For example, the direct emissions of a mail carrier would include the emissions from its facility. Scope 2 describes indirect GHG emissions. The difference between Scope 1 and 2 emissions is that Scope 2 occurs at sources not under the registrant’s ownership or control. Specifically, Scope 2 emissions arise through registrants’ activities, such as when electricity and other forms of energy are purchased. For example, a mail carrier could determine its Scope 2 emissions by calling its utility company. Scope 1 and 2 emissions must be disclosed in gross terms, which excludes carbon offsets and RECs. To allow flexibility for registrants, the final rule provides that Scope 1 and 2 emissions may be based on organizational boundaries drawn by the registrant rather than requiring distinctions to align with those in financial statements. For example, registrants may choose to adopt a “control” approach by only providing GHG emissions under its control. Given the complexity of emissions data, registrants are permitted to use “reasonable estimates” for disclosure purposes as long as a description exists for the reasons behind the estimates. Because of the significance that climate-related impacts can have on registrants’ financial statements and business models, it is essential that investors are informed of foreseeable risks.
The disclosure of impacts like GHG emissions permits investors to assess the commitments made to them by registrants, such as targets or goals. The final rule requires disclosure of climate-related targets or goals reasonably likely to have a material effect on registrants’ businesses, operations, or financial position. For example, targets that require expenditures or new operations are likely subject to disclosure. All targets or goals—whether known to the public or not—are subject to the final rule. Because of this, board approval is not a condition for disclosure of targets. Also notable is the requirement that registrants disclose the time period in which the goal is set to be achieved and whether it is based on a treaty. GHG disclosure alleviates the information asymmetry gap and allows investors to anticipate the risks involved in registrants achieving their targets and goals. Additionally, because GHGs guide registrants’ climate-related targets, understanding firms’ Scope 1 and 2 emissions increases investors’ comprehension of other disclosures within the final rule, such as impacts on financial statements and business model. With respect to Scope 3, it is prudent for registrants and their attorneys to consider how they will comply with Scope 3 disclosure in the future, especially because investors point to climate risks as material to their investment decisions.
IV. The EU’s Sustainability Disclosure Framework
The European Union’s Corporate Sustainability Reporting Directive (CSRD) serves as the EU’s rough equivalent to the SEC’s climate-related disclosures. Like the US, climate-related disclosures are not novel to the EU’s regulatory scheme; they have been present for at least the last ten years since adopting the Non-Financial Reporting Directive (NFRD). The CSRD is considered an addition to the NFRD, which requires disclosure of some ESG information. The NFRD requires large public-interest firms to disclose information pertaining to ESG-related concerns such as the environment, social matters, human rights, anti-corruption, bribery, and diversity on company boards. Large public-interest firms are defined as listed firms, banks, insurance companies, and others designated by national authorities with over five-hundred employees. In 2023, all EU member states were given eighteen months to implement the CSRD into national law. Implementation into national law may be more, but not less, strict than the directive. Under the CSRD, the compliance date for large firms began in the 2024 fiscal year. Smaller listed firms benefit from a period similar to that of a “phase-in period” with compliance beginning in 2025.
Like the public comment period in the US administrative process, the EU utilizes a “public consultation” period once a directive has been adopted. From 2017 to 2020, the EU released guidelines advising firms on climate-related information reporting. Some of these guidelines contained additional supplements or reporting requirements under the NFRD. It was only in 2021 when the European Parliament and Council proposed the Corporate Sustainability Reporting Directive. The CSRD amends the NFRD and enhances climate-related disclosures throughout the EU, to assist “investors, civil society organisations, consumers and other stakeholders to evaluate the sustainability performance of companies.” Both domestic and foreign companies are subject to the directive and must disclose information specific to sustainability matters. Under the EU’s framework, domestic and foreign companies are charged with identifying how ESG matters have and will affect the company’s development, performance, and position. There are three categories of firms subject to the CSRD: (1) companies listed on EU-regulated markets; (2) large domestic incorporated companies; and (3) foreign parent companies. Firms subject to the CSRD are often referred to as “undertakings.” The second category of firms subject to the CSRD, “large domestic incorporated companies,” includes those with: (a) 250 employees during the fiscal year; (b) a balance sheet total or total assets of at least $20 million euros; or (c) a net revenue greater than $40 million euros. The third category of firms subject to the CSRD, “foreign parent companies,” are subject to additional criteria. Specifically, the CSRD applies to foreign parents with a net revenue equivalent or greater than $150 million euros (approximately $165 million dollars) for the past two fiscal years with either: (a) one or more subsidiaries or branches in the EU fulfilling the aforementioned criteria for EU companies (listed on an EU market or containing the criteria of a large company), or (b) those with a branch in the EU generating more than $40 million euros. Generally, the compliance date for foreign firms begins in 2028. The EU’s disclosure framework has many similarities to the SEC’s final rule. But the most notable difference is that foreign parent companies who meet the above criteria, even those headquartered in the US, are required to disclose value chain, Scope 3 emissions.
The EU’s sustainability disclosures may be broken into seven categories: (1) impacts on business model; (2) targets or goals; (3) business expertise; (4) ESG policies; (5) incentives for sustainability matters; (6) impacts on operations; and (7) climate-related risks. These disclosures must appear in undertakings’ management reports. Similar to the US, these categories of disclosures are jointly accompanied by additional requirements for disclosure of ESG matters considered material to the organization or its shareholders. Referred to as the “double materiality test,” firms must evaluate CSRD disclosure from two distinct perspectives: the “inside-out” perspective and the “outside-in” perspective. The inside-out perspective focuses on the impact of ESG matters on undertakings, including the impacts of its value chain, an example of which would be Scope 3 reporting. The outside-in perspective focuses on the impact of ESG matters on undertakings as a whole. For example, the outside-in perspective may recognize the cost of compliance for present or upcoming environmental policies.
Like the SEC’s forward-looking statement safe harbor, the CSRD includes language that is seemingly liability-limiting. The CSRD states, “sustainability reporting standards shall take account of difficulties undertakings may encounter in gathering information from actors throughout their value chain, especially from those which are not subject to the sustainability reporting requirements . . . and from suppliers in emerging markets and economies.” Similar language under the US legal system would likely cause a fact dispute during the motion stage of litigation. But still, the CSRD does implement a “tiered” framework for one of its rules that the SEC could adapt to address the concerns of Scope 3 disclosure in a future rendition of its final rule.
Focusing on three reporting requirements similar to the SEC’s—(a) business expertise, (b) impacts on business model, and (c) greenhouse gases—and a fourth rule structured as a (d) “tiered” approach to assurances—it is possible for the SEC to adapt to concerns regarding value chain disclosure. With the likely implementation of Scope 3 disclosure in the US, the CSRD provides an example of Scope 3 parameters. Because the EU experiences a dichotomy like the federal and state structure in the US, the EU offers a test case that can guide the SEC’s climate-related rule.
A. The EU’s Business Expertise Disclosure
The CSRD requires undertakings to report information about business expertise and policy regarding sustainability matters, much like the SEC’s governance and risk-related disclosures. Under the CSRD, undertakings must disclose policies regarding the skills of administration, management, and supervisory bodies concerning sustainability issues. This includes disclosure of sustainability incentive schemes offered to individuals within administration, management, and supervision. Particularly, and similarly to the SEC’s rule, undertakings must disclose information regarding their risk management processes or systems. But unlike the SEC’s rule, the EU’s sustainability disclosure framework goes further, requiring additional disclosure of ESG-related activities such as those exerting political influence (like lobbying).
B. The EU’s Impacts On Business Model Disclosure
The CSRD also requires undertakings to disclose the impacts of climate-related matters on business models, like the SEC’s rule about risk disclosure. Under the CSRD, undertakings must describe business models in terms of sustainability principles. Under both disclosure frameworks in the EU and US, firms must disclose the impacts of climate-related risks on the business in the short-, medium-, and long-terms. In addition to factual statements and predictions about climate-related impacts on business models under the CSRD, undertakings must disclose financial and investment plans to ensure compatibility with the Paris Agreement. This differs from the SEC’s final rule, which only requires disclosure of treaty compliance if the time horizons to achieve targets are based on a treaty.
C. The EU’s Greenhouse Gas Disclosure
Like the US, the EU also requires undertakings to disclose GHG emissions because firms’ climate-related targets and goals impact investors’ decisions. Based on the standardized framework of the TCFD, the CSRD categorizes GHG emissions into the same Scope 1, 2, and 3 categories used in the SEC’s original proposal. Undertakings’ disclosures of targets must include a description of progress made towards them and, unlike the SEC’s rule, a statement declaring whether the targets are based on “conclusive scientific evidence.” This requirement illustrates how the EU’s reporting standards require information in excess of the SEC’s rules. Further, under the CSRD undertakings must disclose climate change mitigation efforts.
D. The EU’s “Tiered” Approach to Assurance Disclosure
The CSRD requires assurances and restricts firms’ liability through use of a tiered approach that the SEC could use as a model to address liability concerns. Under the CSRD, the first tier requires undertakings to be subject to “limited” assurances during their first year of reporting. Under a limited assurance review, auditors perform fewer inquiries than under a reasonable assurance review. The second tier comes after the first year of reporting when the EU will assess whether moving from a “limited” to a “reasonable” assurance review would be feasible for undertakings and their auditors. The tiered approach serves as a method of ensuring the sustainability information disclosed by firms is credible, meeting the needs of investors while giving firms time to adapt. Additionally, the tiered approach mitigates costs imposed under the directive by allowing undertakings to develop their reporting practices over time. Because limited assurances are less costly than reasonable assurances, the imposition of costs can be controlled and phased in.
E. Takeaways From The EU’s Framework
The EU’s framework possesses strong similarities to the SEC’s. Both regulatory regimes require disclosures to a similar degree: oversight and governance, impacts on financial statements and business model, GHG emissions, and targets or goals. Unlike the SEC’s final rules, the EU’s sustainability disclosures require Scope 3 emissions reporting. By comparing the CSRD and the SEC’s final rule, registrants and their attorneys can anticipate how the SEC may implement Scope 3 disclosure in the future. Specifically, the SEC could craft a safe harbor for Scope 3 emissions disclosure to protect registrants from liability. The Commission could glean the tiered approach used by the CSRD for the creation of a safe harbor that protects registrants and investors. A tiered safe harbor is a realistic solution for the SEC to ensure climate-related information disclosed by registrants is credible and meets the needs of investors while simultaneously allowing mitigation of costs and giving firms time to adapt.
V. Critiques of the SEC’s Climate-Related Framework
Those supporting the SEC’s final rule make arguments for investor choice and protection, standardization among other international disclosure frameworks, and enhanced transparency from registrants. The responses in support of the Commission’s original proposal and final rule have come from seasoned market participants with trillions of dollars of assets under management. Comments conveying disapproval of the SEC’s final rule argue claims like First Amendment violations and climate science skepticism, but majorly reflect two primary categories of arguments against the original proposal: ultra vires and compliance cost arguments. Ultra vires arguments represent the largest category of opposition towards the final rules.
A. Ultra Vires Arguments
A basic ultra vires argument in the administrative law context is predicated on government action beyond the scope of power granted by Congress. The principle question of an ultra vires argument being: “whether framed as an incorrect application of agency authority or an assertion of authority not conferred—is always whether the agency has gone beyond what Congress has permitted it to do.” This means that whether an issue has been framed as (1) “an incorrect application of agency authority,” or (2) “an assertion of authority not conferred,” an ultra vires argument asserts that an agency has gone beyond its statutory authority. Many of the ultra vires arguments opposing the Commission’s final rule cite the major questions doctrine, Chevron, and the Administrative Procedure Act (APA).
Critics attempt to dispel the final rules under the major questions doctrine, likening the SEC’s final rules to the similarities of the climate-related disclosures in West Virginia v. EPA. In this decision, the US Supreme Court held that the EPA lacks authority under the Clean Air Act to regulate power plant emissions using a tactic known as “generation shifting.” The EPA’s tactic legislatively shifted the nation’s electrical mix from hydrocarbons to renewable sources, effectively regulating constituents’ ability to make business determinations. The majority explained that “generation shifting” represents a “major question” of which administrative agencies lack scope unless there exists a clear conference of power from Congress. The major questions doctrine, as rhetorically described by Justice O’Connor, depends on its underlying principle: “Congress could not have intended to delegate a decision of such economic and political significance to an agency in so cryptic a fashion.” Those relying on West Virginia to dissuade support of the SEC’s final rule fail to point out the narrow scope of the holding. In West Virginia, the Court clarified the major questions doctrine only applies to “extraordinary cases” requiring a departure from “routine statutory interpretation.” West Virginia does not support the proposition that climate-related disclosures are “extraordinary” since the case regards regulations. Turning to the SEC’s final rule, mandating the disclosure of information that is material to investors is not the same as regulating GHGs or regulating registrants’ ability to make business determinations. Even so, West Virginia is believed to represent an “approval” of the major questions doctrine, signaling a disposition towards “a partial shift away from the traditional deference [that was] afforded to government agencies” under Chevron.
Critics of the SEC’s final rule also cite the now defunct Chevron doctrine. In 1984, the US Supreme Court held, in Chevron v. Natural Resources Defense Council, that courts should defer to an agency’s interpretation of ambiguous statutes. While apolitical in nature, the doctrine had been used as partisan ammunition before being overturned. The demise of Chevron reflects the Court’s disposition to restrict agencies. Now when there is a question of statutory authority, courts must turn to the APA which requires use of “independent judgement in determining the meaning of statuary provisions.” For agencies, this creates uncertainty. The interest in revival of the major questions doctrine, death of the Chevron doctrine, and underscore of the APA has rocked the enforcement action of administrative agencies. It is likely for these reasons the SEC eliminated Scope 3 disclosure from its final rule.
If the Commission adopts Scope 3 in a future rendition of its final rule, it must address ultra vires arguments that value chain GHG disclosure is beyond the purview of the SEC. These arguments fall flat. Courts have recognized that Congress gave the SEC “very broad discretion to promulgate rules governing corporate disclosure. The degree of discretion accorded the Commission is evident from the language in the various statutory grants of rulemaking authority.” Because investors consider climate-related information material to their investment decisions, they look to registrants for accurate data. For example, in 2021, Glass Lewis, one of the world’s largest proxy advisory services companies, announced it would consider unclear disclosure of board oversight regarding environmental issues as a cause for concern. Beginning in 2022, Glass Lewis adopted a policy of actively recommending against board-level committee chairs for failure to disclose environmental oversight shortcomings. Although Scope 3 disclosure effectuates no more authority than Scope 1 or 2, the nature of value chain data collection demands a safe harbor for registrants.
B. Compliance Cost Arguments
Compliance costs reflect another primary argument for undermining the final rule. The basis of the argument is that the final rule imposes unreasonable costs on registrants. Specifically, compliance costs are both indirect and direct. Examples of indirect costs include litigation risk and potential “disclosure of . . . proprietary information.” To mitigate indirect costs, the SEC adopted two mechanisms in its final rule: (1) existing and proposed safe harbors, and (2) phase-in periods. Direct costs consider the administrative costs for compliance. To the extent registrants are not already situated, gathering data for the disclosures may require firms to re-allocate staff or independent services. To anticipate compliance costs, the SEC identifies specific factors affecting direct costs in the final rule. For example, registrants that already collect information pertinent to the disclosures will experience less cost. Costs may also be mitigated for those registrants currently subject to climate disclosures abroad and domestically. Another factor considers whether registrants are already subject to other federal or state regulations which share parameters similar to the final rule. For example, state law policing the insurance industry already requires disclosure of climate-related risks. An additional factor mitigating filing cost is whether registrants subject to the final rule are subject to other Inline XBRL requirements. Further, small firms may experience larger incremental costs because of their nature but may experience lower costs to the extent that they are generally “less complex.” Ultimately, compliance costs are dependent on the extent to which registrants have complied with regulations that share parameters with the final rule. Because of the prevalence of climate reporting, it is likely most registrants already comply with state and federal regulations that are similar. For example, the EPA mandates GHG reporting from large suppliers and direct emitters of hydrocarbons. This includes current SEC registrants. Utilizing life-cycle analyses, the EPA’s reporting requirements also extend to firms that may contribute to emissions “in the future.” Gathering life-cycle data for compliance with the EPA requirement—at some level—requires a Scope 3 assessment. Additionally, at least seventeen states have statutory GHG reporting requirements. For example, New York requires firms to report direct, Scope 1 emissions. Scope 1 disclosure is the most common emissions reporting requirement among states, easing the transition for registrants when it is their time to comply with the Commission’s rules. State requirements of Scope 3 disclosure also exist and are likely to grow. The concern related to compliance costs suffers as a weak argument that can be made about any government action. All forms of regulation or new disclosures will cost a registrant some compliance cost, and the Commission’s final rule adopts mechanisms to curtail expenditures. For these reasons, an argument relying on the imposition of costs is feeble.
VI. The Implementation of Scope 3 and Balancing Investor Protection with Capital Formation
The increasing likelihood that the SEC will adopt Scope 3 disclosure is based on several considerations, and when it does, the Commission must balance investor protection with capital formation. Today, eighty-five percent of investors think “more standardization of sustainability reporting” would allow them to value and manage their capital more efficiently. And sixty-eight percent of investors believe standardization would enhance risk management. Given the quantitative data, investors rely on the climate-related information communicated in registrants’ annual reports, websites, and marketing materials. Because investors rely on climate-related information to make decisions, the SEC must protect investors through oversight of climate information, which necessarily includes Scope 3.
For capital formation, the SEC must ameliorate the liability concerns of registrants. At the root of concerns represents a historical tension between the free enterprise economy and the democratic system, and jurisprudence’s current disposition towards restricting agencies lends support to critics. Nevertheless, this support renders moot since disclosures, whether or not climate-related, do not extend beyond the Commission’s authority. In an amicus brief supporting the final rule, the Institute for Policy Integrity at New York University School of Law points out that critics misinterpret the final rules as “unheard of,” but realistically, “the SEC is playing catchup: Much of corporate America already provides or will soon provide climate-related disclosures, either voluntarily or to comply with mandatory disclosure laws in other jurisdictions.”
As it applies today, the final rule ineffectively balances investor protection and capital formation. While it is true that the absence of Scope 3 in the final rule abrogates the liability concerns registrants share for misstatements or omissions, the SEC has the ability to protect registrants while providing investors with the information oversight needed for an efficient capital market. One way of doing so would be through the implementation of Scope 3 disclosure coupled with a safe harbor. Because value chain emissions are relevant to registrants’ disclosure of targets and goals, the absence of Scope 3 in the final rule leaves investors with an information gap. One of the greatest issues in abating Scope 3 disclosure is the “leg-up” it presupposes on investors. Under wealth maximization theory, a corporation’s purpose is to maximize shareholder value. In pursuit of particular goals, this purpose is prohibitive unless management reasonably believes the goals will maximize shareholder value. Therefore, if management wants to pursue a particular goal, it is incentivized to depict it as increasing shareholder value, even if it doesn’t. In other words, policy incentivizes registrants to frame information to investors as increasing shareholder value even if this is false, highlighting the importance for a complete climate-related disclosure framework inclusive of Scope 3. Because the EU experiences a dichotomy similar to the federal and state structure in the US, it provides a test case that can guide the SEC’s framework. To effectively balance the concerns of investors and registrants alike, the implementation of Scope 3 must coincide with a safe harbor. The safe harbor could mirror the CSRD’s tiered approach by imposing an initial tier consisting of full protection from liability, restricted through temporal parameters. Once the temporal limit ends, the second tier could reduce the liability protection and look similar to forward-looking statement treatment. Such a safe harbor would protect registrants and those in their value chains as they adapt to gathering emissions data. Temporal limits paired with a step-down in liability protection keep investors at the forefront of the rule without burdening registrants. This kind of safe harbor would reflect other regulations promulgated by the SEC and refine the imbalance between investor protection and capital formation.
VII. Conclusion
Investors consider climate-related information material to their investment decisions, and registrants have responded through voluntary disclosure of climate information. The voluntary disclosures have plagued investors with confusion, and the discrepancies among the disclosures have made it difficult to understand how climate-related risks affect registrants’ business and financial statements. In the absence of rules from the SEC, the market’s demand for climate-related disclosures has created inconsistent, confusing, and unreliable methods for investors to assess risk to their portfolios. The Commission’s final rule did not come without discourse, but critics conflate disclosures with regulations and rely on the red herring argument that climate-related information is not within the SEC’s authority. This is misleading, because the issue at bar is whether investors find the information material to their investment decisions. Some studies identify climate-related risks as the most significant investor engagement priority, and investors readily point to climate risks as material to their investment decisions. Consideration of climate-related information for assessing risk has been so widely adopted that proxy advisory firms issue recommendations based on climate data.
The SEC’s final rule signifies the agency’s continued efforts to mitigate dishonest dealing, but since capital markets are at the mercy of available information, the absence of Scope 3 in the final rules leaves an information asymmetry gap. If the SEC adopts Scope 3 in a future rendition of its final rule, it must implement a safe harbor to effectively balance investor protection and capital formation. The CSRD represents a more complete framework the SEC can adapt to fit American capital markets. In the end, the crux of the agency’s climate-related disclosures is simple: investors should be provided with information considered material to their decisions, and registrants should be able to support their climate-related communications to investors.
