By Mark S. Nelson, J.D.
SEC Chair Gary Gensler and Renee Jones, Director of the SEC’s Division of Corporation Finance, began the process of promoting the Commission’s climate risk disclosure proposal before an online audience with Ceres, a nonprofit organization focused on sustainability. The event, styled by Ceres as a “Briefing on the SEC Climate Disclosure Rule, with SEC Chair Gary Gensler,” saw Gensler and Jones offer some background on why the proposal was drafted as it was. The Commission issued its proposal to update and standardize its rules for climate risk disclosure on March 21, 2022, and public comments on the proposal are due by May 20, 2022.
The grand bargain. Gensler’s prepared remarks reiterated his statement from the day the Commission proposed its climate risk rule that investors get to decide what risks to take in the marketplace so long as companies are held to a standard of full, fair, and truthful disclosures. Gensler’s focus on the “long tradition” of SEC risk disclosure requirements may presage the SEC’s legal defense of a climate risk rule, if and when, a final rule is adopted, with the SEC likely arguing that the rule fits within its existing authorities and some industry groups arguing that the SEC would have exceeded its authorities.
Gensler emphasized that disclosure requirements have evolved from the first requirements for financial disclosures to encompass other topics, including risk, the Management’s Discussion and Analysis, environmental issues and, as of 2010, guidance on climate risk. For Gensler, the roll-out of the climate proposal is based on a need for standardization, albeit within the SEC’s tripartite mission while also being tempered by the omnipresent materiality standard.
“I believe the proposed rule would build on that long tradition,” said Gensler. “It would provide investors with consistent, comparable, and decision-useful information for their investment decisions and would provide consistent and clear reporting obligations for issuers.”
Gensler also spoke at times on the specifics of the climate proposal, but also on the SEC’s more generalized concerns that influenced the drafting of the proposal. For example, Gensler said that the climate risk disclosure will go in a company’s Form 10-K instead of elsewhere because this is the place where investors go to find information about a company. According to Gensler, the SEC was concerned that investors be able to go to a singular location to obtain climate risk information from a company. Gensler further noted that this approach brings into play certain disclosure controls (e.g., Sarbanes-Oxley Act Section 302) and is similar to the approach being taken by the International Sustainability Standards Board’s placement of climate disclosure in the general purpose financial reports.
Gensler also observed that the SEC is a disclosure-based regulator, not a merit-based regulator. In a brief Q&A with Ceres President and CEO Mindy S. Lubber following his prepared remarks, Gensler elaborated that the SEC’s role is standardization. In a separate Q&A between the Rev. Kirsten Snow Spalding, Senior Program Director, Investor Network at Ceres, and Jones, Jones echoed Gensler in her response to a question about how the proposal requires disclosure only if relevant tools exist. Jones noted that the proposal sought to balance the need for climate risk information against cost and that the focus is on disclosure because the SEC does not mandate conduct.
Jones also addressed a number of issues around how the proposal would handle Scope 3 disclosures. For example, Jones noted that the safe harbor for Scope 3 emissions disclosures is not a blank check from liability but went on to observe that the proposal recognizes the need for companies to rely on third parties, the fact that Scope 3 standards are less developed, and the need to balance disclosure against potential costs.
Also, in reply to a question about why the proposal would require assurance for Scopes 1 and 2 disclosures but not Scope 3 disclosures, Jones suggested that investor confidence is higher if there is assurance.
The debate over assurance in the climate risk proposal is similar to the questions that can arise in other areas of federal securities laws, such as whether an emerging growth company should take advantage of the opportunity to opt out of certain disclosures for a period of time or instead opt in to presumably make the company more desirable to investors.
Both Gensler and Jones said the SEC seeks public comments on the entirety of the climate risk proposal and not just key issues. Said Gensler: “I know some aspects of the proposal might interest certain commenters more than others, but I’ll be clear: We are seeking feedback on every line item, and we benefit from all of those comments.”
Preview of Ceres comment. Lubber had opened the program with some comments on the urgency with which she believes regulators and companies should address the issue of climate change. According to Lubber the risk from climate change is bigger than the subprime meltdown, a reference to the collapse of subprime mortgage markets at the onset of the Great Recession in 2008. She also suggested that there is still time for companies to address climate issues before the problem become insurmountable but that the SEC’s proposal is needed to ensure that when companies do make climate disclosures that the information disclosed is of a higher quality than is currently available.
Steven M. Rothstein, Managing Director for Ceres Accelerator for Sustainable Capital Markets, along with several other speakers on behalf of Ceres, previewed the likely contents of its forthcoming public comment on the SEC’s climate risk proposal. Overall, Rothstein suggested that Ceres could urge the SEC to accelerate compliance with certain aspects of the proposal. As drafted, the proposal contains multiple phase-ins that can last up to several years; in the case of certain disclosures requiring third-party assurances, the standard for assurance will change over time with the applicable standard increasing as the rules are phased in.
Isabel Munilla, Director of U.S. Financial Regulation at Ceres, suggested some “accommodations” the SEC had made to address companies’ concerns voiced during the pre-comment phase before the Commission formally issued its proposal. The accommodations include: (1) the use of phase-ins; (2) adherence to the materiality standard; (3) a combination of new and existing safe harbors, including one for Scope 3 disclosures; (4) the absence of a mandate for certain items such as targets, transition plans, and scenario analyses; (5) limits on who must provide assurance of GHG reporting coupled with the allowance of estimates for some disclosures; and (6) exemptions for small reporting companies.