March 22, 2022Client Alert

Courts, Congress Present Obstacles for SEC’s New Environmental, Social, and Governance Disclosure Standards

Publicly-traded companies and other stakeholders have until May 20 to submit feedback for the U.S. Securities and Exchange Commission’s (SEC) proposed environmental, social, and governance (ESG) disclosure standards published on March 21. The proposed rules do not ask companies to reduce their climate impact, but could shape companies’ futures by compelling them to share concrete data about how climate impacts business. The proposed rule floats uniform ESG disclosure and accounting standards designed to equip investors to compare company performance. The proposal also follows hundreds of large companies who are already disclosing ESG and climate data, as well as similar rules coming online in major financial centers like the United Kingdom, the European Union, Hong Kong, and Singapore. The SEC modeled its work on the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol among other sources, noting that many financial institutions and companies already back these.

The proposal requires publicly-traded companies to disclose in regular corporate filings the financial risks of climate change, such as rising sea levels, severe weather, and the costs of shifting to renewable energy. Covered companies must also disclose their “Scope 1” direct combustion emissions, and “Scope 2” emissions from purchased power or heat emissions. Large companies may also need to disclose “Scope 3” indirect emissions from suppliers and products if companies tout their emission reduction standards and/or these emissions impact the company’s revenues or profits (“material”). About 1,500 U.S. firms already disclose their Scope 3 emissions according to the non-profit CDP. The proposal includes a safe harbor provision, sought by business, to shield companies who may misreport their Scope 3 emissions due to inaccurate or incomplete information from vendors. Finally, the SEC’s proposal would require companies to account for their use of offsets, such as carbon capture and sequestration (CCUS), to bring down emission totals.

On timeline, companies would phase in their climate disclosure reporting that would vary based on factors like their size and whether they are disclosing Scope 3 emissions. If the rule is finalized by the end of 2022, a large covered company would need to be ready to file required information with the SEC in 2024.

With the proposed rules published, expect a fight as regulators, environmentalists, and companies jostle to shape the final rule through the comment period and beyond. The SEC has already fielded hundreds of comments on a potential new ESG rule, and will hear even more during this comment period. Michael Best Strategies expects the final version of this ESG rule could be much different than this week’s proposal. Environmentalists, for example, are pushing the SEC to get tougher: last week, Sen. Sheldon Whitehouse (D-RI) and progressive allies argued the SEC should also require companies to disclose their climate-related lobbying activities in shareholder reports. Environmentalists will also likely object to the SEC proposal’s safe harbor provisions for mistakes in reporting Scope 3 emissions.

The fight over the rule's future could end up in court: West Virginia Attorney General Patrick Morrisey plus 15 other state AGs argued last year the SEC would overstep its authority with new ESG rules, threatening a lawsuit. Business groups like the U.S. Chamber of Commerce and the American Petroleum Institute could throw their support behind this legal battle.

Even without court action, a Republican-controlled Congress could also eventually overturn the rule. Depending on when the Administration finalizes the rule and whether Republicans win a veto-proof majority in this year's mid-term election, a Republican congressional majority could in early 2023 roll back the rule under the Congressional Review Act, which allows a new Congress to consider CRA resolutions on rules issued in the last 60 session days of the previous Congress.

We expect a new iteration of the draft ESG rule later this summer. For the latest, reach out to your client servicing team. 

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