The U.S. Securities & Exchange Commission (SEC) issued its final climate risk disclosure rule on March 6, 2024. The rule, as adopted, requires registrants to provide detailed climate-related disclosures in their annual reports and registration statements. According to the agency’s press release, the rule is designed “to enhance and standardize climate-related disclosures by public companies and in public offerings … to respond to investors’ demand for more consistent, comparable, and reliable information about the financial effects of climate-related risks on a registrant’s operations …”
The agency first proposed its climate disclosure rule in March 2022. At that time, we wrote about the proposed rule and key takeaways from a D&O perspective. See, SEC announces proposed controversial new climate disclosure rule (April 1, 2022). Specifically, we addressed controversial elements of the proposed rule, notably the requirement for disclosure of upstream and downstream greenhouse gas emissions (“GHG”) “in the value chain,” the so-called “Scope 3” disclosure requirement.
As we predicted then, the final rule faced vigilant opposition, with registrants raising concerns among a record level of submitted comments, more than 24,000 comment letters, including over 4,500 unique letters. Ultimately, the SEC acceded to many of the concerns by rolling back some of the proposed rule’s more aggressive requirements, including, but not exclusively:
The addition of materiality thresholds, in particular, substantially weakens the rule’s impact as the federal securities laws have long imposed obligations on public companies to disclose material risks. One of the principle criticisms of the 2022 proposed rule was that it created an overreaching presumption that climate risk would be material to every public company. While that may not be the case, it’s noteworthy that large multinational corporations already have obligations to comply with more burdensome EU rules, as well as rules imposed in other jurisdictions, such as California (which rules themselves are currently being challenged).
For a more comprehensive assessment of the rule’s disclosure provisions, as well as key differences between the proposed rule and final rule, see our climate and executive compensation teams’ analysis in SEC issues final rule on climate-related disclosures (March 13, 2024).
In an effort “to enhance investors’ ability to evaluate a registrant’s overall management of climate-related risks,” the final rule also includes disclosure provisions specific to board oversight. In particular, the rule will require:
These disclosures are not required for registrants that do not exercise board oversight of climate-related risks.
In the wake of its adoption, the rule is predictably facing legal challenges by the attorneys general of ten states, as well as organizations with opposing interests – filings across jurisdictions among “the rule’s too strong” and “the rule’s too weak” contingencies.
In one case, on March 15, the Fifth Circuit Court of Appeals granted the motion for an administrative stay of petitioners, Liberty Energy Inc. and Nomad Proppant Services LLC, thus temporarily putting the rule on hold as the petitioners’ challenge moves forward. The petitioners had argued a stay was necessary to prevent “irreparable injury in the form of unrecoverable compliance costs and constitutional injuries” from the rules. In responding to the SEC’s contention that no stay was necessary as the rules do not require disclosure in the immediate future, the petitioners successfully argued that they would need to incur nonrecoverable compliance costs “now” to create “elaborate internal control systems and disclosure control procedures…”
In contrast, on March 13, the Sierra Club and Sierra Club Foundation filed litigation in the Court of Appeals for the District of Columbia Circuit alleging the rule inadequately delivers on the agency’s statutory mandate “to protect investors, maintain fair, orderly, and efficient markets, and promote capital formation.”
As of this writing, these cases represent two of nine cases filed in six separate circuits challenging the rule.
All of the challenges arise on the heels of the U.S. Supreme Court’s imposition of limitations in 2022 on the authority of the Environmental Protection Agency to regulate greenhouse gas emissions, thus calling into question the SEC’s very authority to adopt rules relating to climate change. Also of note: Republican members of the U.S. House Financial Services Committee unveiled 13 draft bills ahead of its March 20, 2024, hearing titled "SEC Overreach: Examining the Need for Reform." The draft bills purportedly seek to slow down the agency’s rulemaking activity, among several other measures.
Update – March 22, 2024: By law, when an agency rule is challenged in multiple federal courts, one appellate circuit court is selected to hear the challenges on a consolidated basis. In this instance, the SEC rule challenges will be heard by the Eighth Circuit Court of Appeals in St. Louis.
Should legal challenges fail to result in extensions of the rule’s implementation, requirements will phase in over time, but much will depend on a company’s filing category. Disclosures (other than those pertaining to GHG emissions) and financial statement notes will phase in beginning in the company’s Fiscal Year Beginning (FYB) 2025. The first Scope 1 and 2 emissions disclosures will phase in beginning in FYB 2026. Additional disclosure requirements are scheduled to phase in at later dates.
The exposure to public companies and their directors and officers often lies in the adequacy and accuracy of an issuer’s public filings and other statements, compliance with regulatory mandates, and fulfillment of director duties.
The risk of a securities class action may arise where there are shareholder losses brought on by a precipitous drop in share value. In such a case, private class action plaintiffs might allege that reporting deficiencies resulting in the drop were false and misleading, coupled with an intent to defraud. In the context of the SEC’s climate rule, shareholders might focus on disclosed emissions targets and plans to achieve targets.
Although the safe harbor for forward looking statements could provide some measure of relief for corporations, it would not likely shield them from liability for alleged statements of current fact, such as statements relating to the organization’s progress in attaining targeted objectives.
Directors and officers also face the risk of derivative litigation alleging breaches of fiduciary duty, including the duty of oversight. While the business judgment rule may serve as a broad defense to fiduciary duty claims, questions as to the effectiveness of the rule have recently surfaced. See, for example, failed motions to dismiss oversight claims in the Marchland and Boeing derivative actions. A broader discussion of this issue can be found here.
Heightened liability also may be seen in the extension of the duty of oversight to corporate officers under Delaware law in the McDonalds litigation. We further note that 2022 changes to Delaware law expanding exculpation protections to corporate officers [DGCL § 102(b)(7)(v)] expressly does not apply “in any action by or in the right of the corporation,” i.e., derivative lawsuits.
SEC investigations and follow-on proceedings are additional foreseeable risks.
Historically, most climate-related disclosures have been voluntary. Going forward, however, the rule’s disclosure mandates and similar requirements in an increasing number of jurisdictions globally will likely create exposures for companies that previously had made very few, if any, public comments relative to their climate impact, practices, and risks.
The types of claims that may foreseeably emerge from the new rule would appear to fall within the scope of most of the better policy offerings in today’s D&O liability insurance market. As with most other D&O claims, there may be limitations in the form of conduct-based exclusions and other restrictions. Entity investigation coverage, for example, is not customarily provided (but is increasingly worth considering as an add-on). Nevertheless, there presently are no common limitations specific to climate-related disclosures.
Regardless, companies should work closely with their brokers to ensure there are no likely coverage gaps and also to determine the availability of enhancements to coverage wordings. Should insurers attempt to impose limitations specific to climate risk claims, insureds and their brokers should identify and push back on any such efforts.
Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
