SEC ESG Changes: What Companies Can Do To Prepare
On March 21, 2022, the Securities and Exchange Commission (SEC) voted to advance a set of proposed rules for climate-related disclosure statements for all SEC-registered companies. Details on the SEC ESG changes were the subject of one of our prior articles. The SEC decision on greenhouse gases will dramatically change how companies conduct business practices and disclose information to shareholders and the public. The changes also underscore the incredible importance of taking a measured approach to all types of advertising, marketing, ESG statements, or other information disclosures that touch on Environmental (“E”) factors, including greenhouse gas emissions (GHG). There are several steps that companies can take now to prepare for the likely eventual passage of SEC rules related to greenhouse gases, which we detail below.
SEC ESG Changes
The SEC proposed rule requires SEC-registered companies to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements. The required information about climate-related risks also would include disclosure of a registrant’s greenhouse gas emissions.
More specifically, the proposed rules would require the following information disclosures:
Oversight and governance practices by the company’s board and management related to climate risks;
Which climate-related risks identified by the company have had or will have a “material impact” on the business, whether short-, medium-, or long-term;
How climate-related risks have or will affect the company’s strategy, business model, or outlook forecast;
Identification of the company’s processes for identifying, assessing and managing climate-related risks and whether the processes are integrated into the company’s overall risk management system or processes;
The impact of climate-related events and climate-transition activities on the company’s financial statements and related expenditures, as well as an estimate of the financial impact of these events or activities;
Scope 1 and Scope 2 GHG emissions metrics expressed in the aggregate and also disaggregated;
Scope 3 GHG emissions metrics, or whether the company has set a GHG emissions reduction target or goal that incudes its Scope 3 emissions. The proposed rule also creates a safe harbor for liability from Scope 3 emissions disclosures and an exemption from the Scope 3 emissions disclosure for smaller companies; and
The company’s climate-related targets or goals and transition plan, if any.
The SEC ESG changes would include a phase-in period for all companies, with the compliance date dependent on the company’s filer status, and an additional phase-in period for Scope 3 emissions disclosure.
Preparations Companies Can Make Now
There are several steps companies can take now in order to prepare for the likely SEC ESG changes that are to come.
First, companies should review statements or disclosures that may already exist related to climate. Some companies voluntarily report metrics related to greenhouse gases and other climate-influencing factors, but these metrics may not comply with the information that the SEC will require in the future. Understanding prior disclosures and the ways that such information was determined from within the company will provide a key starting point for identifying ways that internal processes and procedures can be adapted for more stringent reporting. These steps are often referred to as a climate audit, and are key components to understanding changes in corporate practices that will need to be made to comply with SEC requirements.
Second, examine the scope of your company’s Scope 3 emissions now. A starting point for this is to determine which Scope 3 emissions that the SEC would look at are, in fact, “material”, since only material Scope 3 emissions would need to be reported under the SEC’s proposed rule unless the company chose to set its own target Scope 3 emissions goals. Many companies who choose to undertake the carbon accounting process must rely on their supply chain to provide critical information for these determinations, which is not always easy. However, due diligence is still the best course of action, if for no other reason than to potentially take advantage of the proposed rule’s safe harbor provision. This provision holds that only disclosures made without a reasonable basis or in bad faith will be deemed fraudulent by the SEC. This will be a critical defense tool for companies who find themselves under SEC scrutiny.
Third, companies should ensure that their C-suite or Boards have the proper tools to oversee the company’s decisions with respect to climate impacts. Companies should determine whether special committees need to be established in order to provide clear delineations of governance on this important topic. It will also be critical to determine whether the committee members, or any other executives charged with ESG related decision-making, have the background necessary to enable them to make sound decisions for the company’s future. Determine ways to provide executives with education on critical ESG topics or consider hiring outside consultants or advisors as a resource for the executives.
The proposed disclosure requirements will add an increased level of scrutiny on companies that are not as far along in climate-control measures and data gathering as other companies. This will in turn increase scrutiny and accountability of board members for failure to deliver measured results as compared to competitors. It could also turn the SEC into the driving agency for climate disclosure enforcement actions.
While it is possible that any final SEC rule on GHG disclosures will be challenged in court, companies must nonetheless prepare now for changes that are, at least as of now, likely in the next several months. Failure to do so would not only have impact on SEC enforcement targeting, but also may lead to governance disruption by disgruntled shareholders over board or management inaction.