Seeking Compromise, the SEC Finalizes Controversial Climate Rules

Background

On March 6, 2024, the U.S. Securities and Exchange Commission (the “SEC”) adopted long-awaited final rules requiring climate-related disclosure[1] for both domestic and foreign private issuers (other than Canadian issuers utilizing the Multijurisdictional Disclosure System) that are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  The rules amend Regulations S-K and S-X to require new climate-related information in registration statements and annual reports.  Although the final rules will require significant new disclosures regarding climate-related risks and greenhouse gas emissions, they provide a narrower scope of disclosure and longer phase-in periods than the rules initially proposed by the SEC in March 2022. The new disclosure requirements phase in over time, with the earliest for large accelerated filers in 2026.   

Key Provisions of the Final Rules

1. Climate-Related Governance and Risk Management

The final rules require companies to identify and discuss climate-related risks and their impact on the company, as well as the company’s governance and risk management efforts regarding such risks. The disclosure must include:

• climate-related risks that have materially impacted or are reasonably likely to have a material impact on the company, including on its strategy, results of operations, or financial condition, whether such risks are likely to manifest in the short-term or long-term;
• actual and potential material impacts of identified climate-related risks on the company’s strategy, business model and outlook, and whether and how the company considers such impacts as part of its strategy, financial planning, and capital allocation;
• activities to mitigate or adapt to a material climate-related risk, including any transition plans, scenario analysis or internal carbon prices;
• if activities have been undertaken to mitigate or adapt to a material climate-related risk, a quantitative and qualitative description of material expenditures incurred and material impacts on financial estimates and assumptions resulting from such activities;
• processes for identifying, assessing, and addressing material climate-related risks; and
• board oversight of climate-related risks and management’s role in assessing and managing the company’s material climate-related risks.

2. Climate-Related Targets and Goals

The final rules also require registrants to disclose any climate-related target or goal if such target or goal has materially affected (or is reasonably likely to do so) the company’s business, results of operations or financial condition. Companies must provide annual disclosure of progress made towards meeting any such target or goal, and whether and how that progress has been achieved. Additionally, the final rules require disclosure of the impact of carbon offsets and renewable energy credits or certificates (“RECs”) and the nature and source of the offsets or RECs, if carbon offsets or RECs are a material component of a company’s plans to achieve its climate-related targets or goals.

3. Greenhouse Gas Emissions Disclosure

Large accelerated filers (“LAFs”) [2] and accelerated filers (“AFs”) [3] will be required to report their Scope 1 and Scope 2 emissions, which relate to the greenhouse gases (“GHG”) emitted from companies’ operations and energy use, respectively, to the extent such emissions are material.  For domestic filers, such disclosure must be included in the annual report on Form 10-K (or at the election of the issuer, in the issuer’s quarterly report on Form 10-Q filed for the second quarter following the fiscal year to which the GHG emission disclosure relates). For foreign private issuers, the disclosure must be included in an amended Form 20-F due at the same time such disclosure is due for domestic filers. An attestation report from an independent assurance provider covering Scope 1 and Scope 2 emissions disclosures will be required at a limited assurance level starting in filings for fiscal years 2029 for LAFs and 2031 for AFs, and at a reasonable assurance level for LAFs starting in filings for fiscal year 2033. No filers other than LAFs are required to provide attestation reports at a reasonable assurance level.

In a departure from the rules initially proposed by the SEC, smaller reporting companies (“SRCs”) [4] and emerging growth companies (“EGCs”) [5] are exempt from the Scope 1 and Scope 2 emissions disclosure requirements, and no filers will be required to disclose Scope 3 emissions, which are the GHG emissions resulting from activities or assets not directly controlled or owned by the reporting company but released as part of its value chain.

4. Financial Statement Footnote Disclosure

The final rules amend Regulation S-X to require disclosure in a footnote to the financial statements of capitalized costs, expenditures, losses, charges, and losses incurred as a result of “severe weather events and other natural conditions” such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures and sea level rise, subject to one percent and de minimis thresholds.  If carbon offsets or RECs are a material component of the company’s plan to achieve its disclosed climate-related targets or goals, the company must also disclose the aggregate amount of capitalized costs, expenses and losses related to such carbon offsets and/or RECs. Issuers are required to provide these new disclosures in any annual report or registration statement that is required to include any of the new climate disclosures and audited financial statements.

5. Liability Protection

The final rules add a new safe harbor from private liability for climate-related disclosures related to transition plans, scenario analysis, internal carbon pricing and climate-related targets and goals. The Private Securities Litigation Reform Act safe harbors for forward-looking statements will extend to these disclosures.  Additionally, providers of attestation reports for Scope 1 and Scope 2 emissions will not be considered “experts” for purposes of liability under Section 11 of the Securities Act of 1933, as amended (the “Securities Act”).  

Reporting Requirements

1. Disclosures to be Filed with the SEC

Although many companies have been voluntarily issuing standalone environmental, social and governance reports containing climate-related disclosures (often posting this information on their websites), the climate-related disclosures required under the final rules must be included in companies’ registration statements filed under the Securities Act and annual reports filed under the Exchange Act. Other than forward-looking disclosures explicitly protected by the safe harbor provision under the final rules, this subjects climate-related disclosures to potential liability under Sections 11 and 12 of the Securities Act as well as Sections 10(b) and 18 under the Exchange Act. The SEC has taken the position that treatment of the disclosure as filed rather than furnished, thereby subjecting such disclosures to the same potential liability as other business or financial information in a registrants’ SEC filings, will promote accuracy of and consistency across such disclosures.

Reporting issuers may integrate disclosures into existing sections of their SEC filings such as Risk Factors, Description of Business, or Management’s Discussion and Analysis, provide the disclosure in one or more standalone sections of their SEC filings, or incorporate the disclosure by reference from other SEC filings.  

2. Filer Status to Dictate Compliance Deadlines and Scope of Reporting

The final rule will impact reporting issuers differently depending on their filer status. The compliance schedule under the final rules provides for phase-in periods over the next several years. Foreign private issuers (“FPIs”) will be required to include these disclosures in their Forms 20-F in the same way that domestic filers will be required to include the disclosures in their annual reports on Form 10-K (or, in the case of Scope 1 and Scope 2 GHG emissions disclosures, their quarterly reports on Form 10-Q).

Large Accelerated Filers will be required to:

• Comply with the applicable disclosure requirements (other than those given longer phase-in periods as noted below) beginning with their annual reports and registration statements containing financial information for any fiscal year beginning in 2025 (filed in 2026).
• Provide the following disclosures and/or comply with the following requirements beginning with their annual reports and registration statements containing financial information for any fiscal year beginning in 2026 (filed in 2027):
  • quantitative and qualitative disclosure regarding material expenditures incurred and material impacts on financial estimates as a result of activities undertaken to mitigate or adapt to climate-related risks, including any transition plans or as a direct result of targets or goals or actions taken to make progress toward meeting such targets or goals; and
  • inline XBRL tagging.
• Provide Scope 1 and Scope 2 GHG emissions disclosures beginning with their annual reports on Form 10-K for fiscal year 2026 (filed in 2027) or, if they elect, their quarterly reports on Form 10-Q for the second quarter of 2027 (or in the case of FPIs, amendments to their annual reports on Form 20-F filed within 225 days after the end of the fiscal year beginning in 2026).
• Provide the attestation report at a limited assurance level beginning with their annual reports and registration statements containing financial information for any fiscal year beginning in 2029 (filed in 2030).
• Provide the attestation report at a reasonable assurance level beginning with their annual reports and registration statements containing financial information for any fiscal year beginning in 2033 (filed in 2034). Note that no filers other than LAFs are required to provide attestation reports at a reasonable assurance level.

Accelerated Filers (other than Smaller Reporting Companies and Emerging Growth Companies) will be required to:

• Comply with the applicable disclosure requirements (other than those given longer phase-in periods as noted below) and inline XBRL tagging requirements beginning with their annual reports and registration statements containing financial information for any fiscal year beginning in 2026 (filed in 2027).
• Provide and/or comply with the following disclosures and requirements beginning with their annual reports and registration statements containing financial information for any fiscal year beginning in 2027 (filed in 2028):
  • quantitative and qualitative disclosure regarding material expenditures incurred and material impacts on financial estimates as a result of activities undertaken to mitigate or adapt to climate-related risks, including any transition plans or as a direct result of targets or goals or actions taken to make progress toward meeting such targets or goals.
• Provide Scope 1 and Scope 2 GHG emissions disclosures beginning with their annual reports on Form 10-K for fiscal year 2028 (filed in 2029) or, if they elect, their quarterly reports on Form 10-Q for the second quarter of 2029 (or in the case of FPIs, amendments to their annual reports on Form 20-F filed within 225 days after the end of the fiscal year beginning in 2028).
• Provide the attestation report at a limited assurance level beginning with their annual reports and registration statements containing financial information for any fiscal year beginning in 2031 (filed in 2032).

Non-Accelerated Filers, [6] Smaller Reporting Companies and Emerging Growth Companies will be required to:

• Comply with the applicable disclosure requirements (other than those given longer phase-in periods as noted below) and inline XBRL tagging requirements beginning with their annual reports and registration statements containing financial information for any fiscal year beginning in 2027 (filed in 2028).
• Provide and/or comply with the following disclosures and requirements beginning with their annual reports and registration statements containing financial information for any fiscal year beginning in 2028 (filed in 2029):
  • quantitative and qualitative disclosure regarding material expenditures incurred and material impacts on financial estimates as a result of activities undertaken to mitigate or adapt to climate-related risks, including any transition plansor as a direct result of targets or goals or actions taken to make progress toward meeting such targets or goals.

Note that non-accelerated filers, SRCs and EGCs, will not be required to provide Scope 1 or Scope 2 GHG emissions disclosures or attestation reports.

Impact of the Final Rules 

1. Comparability and Consistency?

In many provisions of the rule, the SEC removed prescriptive detail included in its rule proposal and added materiality qualifiers.[7]  These changes were made in response to commenters that complained of the reporting burden of the rules as proposed, and the possibility that some of the information may not be relevant to their business or investors.  However, by giving registrants greater leeway and flexibility determining whether disclosure is required and, when provided, how such disclosures are structured, the SEC may have diluted one of its primary goals of providing consistent and comparable data across disclosures made by reporting issuers subject to SEC rules.

It is also worth noting that a number of disclosure requirements are triggered only if the registrant is already engaged in certain conduct.  For example, a registrant is required to provide details about transition plans, internal carbon costs and scenario analyses if they already have transition plans, internal carbon costs and scenario analyses.  This raises the question of whether, counter to the larger goal to elicit additional disclosure and foster transparency on the part of issuers, the disclosure requirement could discourage some registrants from engaging in conduct that will consequently require additional disclosure on these points. Alternatively, some registrants may be motivated to create such transition plans if they currently lag behind industry peers.

2. Compliance Burden on Reporting Companies

Additionally, the SEC readily acknowledges that other jurisdictions, such as California and the European Union, have climate disclosure regimes.  Moreover, the SEC modeled its requirements on the Taskforce on Climate-Related Disclosure framework and the GHG Protocol in order to build on existing voluntary practice and foster some level of consistency and comparability.  But to shore up its legal authority argument, the SEC stresses that its rules are designed to provide disclosure for investors in SEC registrants and not for the purpose of climate regulation.  The final rule therefore does not closely coordinate or blend its disclosure requirements with those of other jurisdictions, for example by substituted compliance or express preemption.  Therefore, SEC registrants may be subject to multiple, overlapping but nonidentical disclosure requirements relating to these matters, increasing their compliance costs.

Of particular note, many registrants subject to the SEC rule are also subject to climate disclosures required by California and/or the European Union (“EU”).  Last October, Covington provided an overview of how companies should be approaching compliance with California’s SB 253 and SB 261, which require public and private companies meeting certain revenue thresholds to report climate risk and GHG emissions (including Scope 3) on a slightly more accelerated timeline than the SEC rule.  In another client alert, we explored how companies should be approaching compliance with the EU’s Corporate Sustainability Reporting Directive (CSRD) and its European Sustainability Reporting Standards (“ESRS”). The ESRS mandate disclosures across Scope 1, Scope 2, and Scope 3 (though subject to a so-called double materiality assessment), require limited assurance, and will apply to many U.S. multinationals with a presence in Europe.  Many companies will need to prepare for compliance with the SEC, California, and the EU rules in parallel.

The burden also includes adopting or modifying a company’s control environment.  The SEC made changes to both Regulation S-K with respect to business disclosure and Regulation S-X with respect to financial statement disclosure.  Although the phase-in periods appear to give reporting issuers time to comply with the disclosure requirements (the first updates to the SEC filings not due for another year at the earliest), companies will need to take near-term steps by examining their disclosure controls and procedures to determine whether they will be able to provide timely and accurate disclosure of this information.  The changes to the financial statements will also trigger the application of internal accounting controls and be subject to audit procedures.  Audit committees will need to oversee these processes, which means that companies will need to begin implementing policies and procedures that will allow them to comply with the disclosure deadlines relating to their financial information.

Conclusion   

Many commenters said they would consider legal challenges to the SEC’s final rules, including on First Amendment and “Major Questions” grounds.  Indeed, attorneys general from 10 states have already filed a petition in the 11^th Circuit challenging the rules; more challenges may be in the offing. On the other hand, environmentalists and climate activists have criticized the SEC for not requiring more disclosure. It is impossible to predict the outcome at this stage, and boards and management should not be complacent. 

If you have any questions concerning the material discussed in this client alert, please contact the members of our Securities and Capital Markets and Environmental, Social, and Governance (ESG) practices.