Long-Awaited SEC Climate Disclosure Rule Draws Legal Challenges Across the Ideological Spectrum

On March 6, 2024, the U.S. Securities and Exchange Commission (the “SEC”) took a monumental step toward integrating climate risk into the fabric of public company reporting with the adoption of the “Enhancement and Standardization of Climate-Related Disclosures for Investors” final rule (the “Final Rule”). This represents a pivotal shift in how climate-related risks are perceived and reported within the financial landscape, addressing growing investor demand for transparent, reliable, and comparable climate-related information.

Importantly, the Final Rule significantly departs, in many respects, from the rules the SEC originally proposed in March 2022 (the “Proposed Rule”) following the SEC’s receipt of more than 24,000 comment letters. As further described below, key changes from the Proposed Rule include eliminating Scope 3 greenhouse gas (“GHG”) emissions disclosure requirements, exempting certain smaller companies from Scope 1 and 2 GHG emissions disclosures, and eliminating climate-related board of directors expertise disclosure requirements.

The Final Rule has already amassed at least a dozen legal challenges filed by a variety of parties, including environmental advocacy groups, state attorneys general, and private industry. On March 21, 2024, nine of those challenges were consolidated for review by the St. Louis-based U.S. Court of Appeals for the Eighth Circuit, following a seldom-used lottery process.

Summary of the Final Rule

The Final Rule aims to provide investors with consistent, comparable, and reliable information about the financial impacts of climate-related risks on reporting companies’ operations and how these risks are managed. SEC Chair Gary Gensler emphasized that the Final Rule builds upon the SEC’s long-standing requirement for material risk disclosures by public companies, adapting it to include climate-related risks in line with investor demands.

The Final Rule includes annual disclosure requirements with regard primarily, but not limited to, the following:

• how climate-related goals and material risks have had or are reasonably likely to have a material impact on a reporting company’s business strategy, results of operations, or financial condition;
• activities to mitigate or adapt to material climate-related risks, including quantitative and qualitative information about material expenditures and impacts on financial estimates that are the direct result of mitigation of (or adaptation to) climate-related risks, transition plans, or disclosed targets or goals (or actions taken to achieve or progress toward those targets or goals);
• the effects of severe weather events and other natural conditions on financial statements, including, for example, the costs and losses resulting from severe weather events, subject to a threshold of the greater of 1% of the absolute value of pretax income, or $100,000;
• any processes for the assessment and management of material climate-related risks, as well as whether and how any such processes are integrated into the company’s overall risk management systems; and
• Board-level oversight of climate-related risks including a description of the board of directors’ oversight of climate-related risks, whether any board committee or subcommittee is responsible for the oversight of such risks, and a description of the process by which the board (or the committee or subcommittee, if applicable) is informed about such risks.
  

Differences from the Proposed Rule

The Final Rule does not require the levels of disclosures contemplated by the Proposed Rule. The SEC made significant adjustments from the Proposed Rule to the Final Rule, making the latter less stringent in some respects while providing more clarity and flexibility in reporting.

Key changes include:

• Scope of GHG Emissions Reporting: The Final Rule offers flexibility in determining the organizational boundary for Scope 1 and Scope 2 GHG emissions and eliminates the requirement for Scope 3 emissions disclosure.
• Materiality and Disclosures: The Final Rule modifies the approach to determining materiality for GHG emissions disclosures and revises the financial statement impacts evaluation to require disclosure only when aggregate amounts exceed certain thresholds relative to pretax income or total shareholders’ equity.
• Extended Compliance Timelines: The adoption timeline has been lengthened providing large accelerated filers until fiscal year 2025 (for applicable filings due in 2026) to comply with most disclosures and GHG emissions information.
• Exemptions for Certain Issuers: Smaller reporting companies, emerging growth companies, and nonaccelerated filers are exempt from the GHG emission disclosures and related attestation requirements.
• Expanded Safe Harbor: The safe harbor for forward-looking climate-related disclosures was expanded to encompass certain protections with regard to non-factual disclosures relating to transition plans, scenario analysis, internal carbon pricing, and targets and goals.
  

Litigation Landscape

The legal challenges to the Final Rule are extraordinary in their origin and scope and in the legal mechanism for resolution. The Final Rule drew challenges both from across the country and the ideological spectrum, with parties scrambling to file in jurisdictions they viewed as favorable. These diverse challenges culminated in a lottery-based venue consolidation process supervised by the Judicial Panel on Multidistrict Litigation. Each federal appeals court in which a challenge was filed (the U.S. appeals courts for the Second, Fifth, Sixth, Eighth, Eleventh, and District of Columbia circuits) received a single entry in the lottery, and on March 21, the Eighth Circuit was randomly selected to preside over nine of the consolidated cases.

Although the Fifth Circuit had originally stayed implementation of the Final Rule, the court lifted the stay on March 22, 2024. Shortly thereafter, on March 26, 2024, certain plaintiffs in the consolidated case sought an administrative stay of the Final Rule from the Eighth Circuit. Although that request is still technically pending, on April 4, 2024, the SEC exercised its discretion to voluntarily stay the Final Rule pending the completion of judicial review of the consolidated petitions by the Eighth Circuit.

The approach used to select venue for the consolidated cases is exceptionally unusual and underscores the Final Rule’s national significance and controversial nature. Further, the challenges to the Final Rule run the ideological gamut, including claims that the SEC's disclosure requirements are both overreaching and do not go far enough. Such developments reflect the complex interplay between regulatory efforts to address climate risks and the diverse perspectives on the scope and authority of such regulations.

Critics argue that the Final Rule exceeds the SEC's authority, venturing into environmental regulation rather than sticking to its core mandate of ensuring fair, orderly, and efficient markets. Proponents, however, see the Final Rule as a necessary evolution of disclosure standards in the face of mounting climate risks. The outcome of this litigation could have far-reaching implications for future regulatory efforts aimed at integrating environmental, social and governance (“ESG”) factors into financial reporting and corporate governance practices. The litigation surrounding the Final Rule not only tests the bounds of the SEC's authority to mandate climate-related disclosures but also sets a significant precedent for the role of federal agencies in addressing ESG issues.

Implications

The Final Rule represents a significant shift toward integrating climate risk into financial reporting, aimed at enhancing investor access to material information. Yet, the ongoing legal challenges underscore the complexities and controversies surrounding climate disclosure standards and regulatory authority. Resolution of these issues will not only impact the enforcement of the Final Rule but also shape the broader landscape of climate-related financial regulation.

The significant revisions from the Proposed Rule to the Final Rule reflect the SEC's responsiveness to public commentary and its commitment to balancing investor needs with the practicalities faced by reporting companies. Notably, the Final Rule introduces significant flexibility in reporting GHG emissions, recognizing the varying capabilities and contexts of different companies. This adaptability is evident in the decision to forgo mandatory Scope 3 emissions reporting, a contentious aspect of the Proposed Rule that many argued would impose undue burdens on companies. Moreover, the Final Rule’s phased implementation timeline and safe harbors for certain disclosures are designed to mitigate the potential costs and challenges of compliance. These modifications reflect the SEC's effort to refine the Final Rule and balance the need for more robust climate-related disclosures without overburdening the entities it seeks to regulate.

Although the litigation is likely to extend for years, public companies should take steps to prepare for the possibility that the Final Rule will become effective. If the Final Rule is upheld, reporting could be required as early as 2025. However, the process to gather required information necessary for disclosure is likely to take some time, particularly as to Scope 1 and Scope 2 emissions, so companies should begin planning now.

First, companies should assess which particular requirements of the Final Rule will apply to them and whether their reporting status qualifies them for later-required disclosures. For example, accelerated filers and large accelerated filers will be subject to the Final Rule’s attestation requirements and thus should evaluate any changes to financial statement and internal control practices in light of the Final Rule’s requirement of an independent registered public accounting firm’s audit of internal control over financial reporting. Second, companies should evaluate their ability to make materiality determinations for disclosure items under the traditional materiality analysis as required by the Final Rule. Finally, boards should consider whether to delegate any or all of the board oversight requirements of the Final Rule to a board committee or subcommittee.

A complete copy of the SEC release regarding the Final Rules can be found here. The SEC press release announcing the Final Rule can be found here.

We will continue to monitor material developments in the consolidated case. If you have questions, feel free to contact Michele Kloeppel, Sara Chamberlain or Nabil Al-Khaled.