Is it Easy Being Green? Demystifying SEC Climate Disclosure Rules

In the midst of the growing trend to invest in climate-forward and environmental, social, and governance (ESG) companies, the U.S. Securities and Exchange Commission (SEC) is once again taking steps to stay current. The SEC is considering passing climate-related disclosure requirements for all public companies, as well as naming rules and enhanced disclosures for investment funds and investment companies. 

Today, we’ll go over background information about the new SEC rules, highlight aspects of these rules, and talk about how they might apply to a reporting company. 

Why Is the SEC Proposing the New Rules?

With the growing trend to invest in environmentally friendly funds, an increasing number of investors are looking to add ESG funds to their portfolios. In turn, investment funds are scrambling to incorporate climate-related or ESG factors into their portfolios. As it stands, there’s no standardized definition of ESG factors. This may result in disgruntled and misled investors who have misconceptions about a company’s strategies and focus on ESG factors and climate-related risk. 

Proponents of the proposed rules praise their potential to increase transparency, limit “greenwashing,” and provide actionable information on climate and ESG-conscious investors. 

Opponents of the rules (such as Commissioner Hester M. Pierce) criticize the proposed rules on several grounds. They focus on the tenuous relationship between climate-related regulation and ESG-related disclosures — the focus of the SEC — and pose fundamental questions as to whether the SEC is stepping too far outside its mission. Further, the sheer scope of the rules may invite challenges on the basis that the SEC is exceeding its authority. 

What Are the Three Proposed Rules?

Three broad rules are in the pipeline at the SEC.  On March 21, 2022, the SEC proposed new rules that would require domestic and foreign private issuers to provide climate-related disclosures.¹ In May 2022 the SEC also proposed two new rules that would affect investment funds and investment companies.^{2 3}  

Proposed Rules for Domestic and Foreign Private Issuers

Representing probably the most controversial of the SEC’s proposed rules, the new climate-related disclosure regime would require registrants to provide information regarding climate-related decisions and risks.  All domestic registrants and most foreign private issuers would be subject to the proposed rules.⁴   Some of the information that registrants may have to provide includes:

• Oversight of and actions regarding climate-related risks, including climate-related governance, risk management, and information regarding any climate-related targets or goals; 
• How identified climate-related risks might impact the registrant’s financial or business strategy; 
• The specific measures and processes that the registrant uses to address the impact of climate-related risks on its business and vice versa; 
• The past or present impact of climate-related risks or events on the registrant’s business and financial statements; 
• Measure and disclose greenhouse  gas emissions (“GHG”) that are directly attributable to the registrant’s operations (“Scope 1”); 
• Larger registrants will have to provide data regarding emissions from indirect sources, such as electricity (Scope 2). In addition, some larger registrants would also be required to disclose data that includes emissions attributable to their suppliers and customers (Scope 3);
• Larger registrants would be required to provide an independent attestation for Scope 1 and Scope 2 emissions; 
• Add a new note to the registrant’s audit financial statements that address the climate-related impact on financial statement line items.

To learn more about the proposed enhancements to the SEC rules on climate disclosure, you can read the SEC’s proposal or Fact Sheet.

Proposed Rules for Investment Funds

Fund Naming Rules

Under the current SEC Names Rules, if a fund’s name suggests that it specializes or focuses in a particular area, the fund needs to show that at least 80% of the fund’s investments go towards that focus. For example, let’s say a fund’s name is Small-Cap Investment Fund. Then in most cases, generally at least 80% of the fund’s investments should go toward companies that meet the “small cap” definition. (As always, exceptions apply). 

In an effort to modernize the existing Names Rules, the SEC’s proposal extends the “80% requirement” to those firms whose name implies that they:

• Invest in companies with particular characteristics; or 
• Use ESG or climate-related factors when making investment decisions.

In its fact sheet, the SEC specifically uses the words “growth” and “value” as examples of words denoting that a firm invests in companies with particular characteristics. 

To learn more about the new Naming Rules, you can read the SEC’s proposal or Fact Sheet. 

Additional Disclosures for Environmental, Social, and Governance (ESG) Investment Funds and Investment Companies

The SEC’s newly proposed  rule would  require that certain ESG investment advisers and investment companies provide additional disclosures in three categories:

1. Strategy, 
2. Impact, and
3. GHG Emissions. 

These guidelines apply to disclosures in a firm’s SEC registration documents, prospectus, or adviser brochure. The breadth and depth of the disclosure for a fund depends on how heavily the fund incorporates ESG factors into its investment decisions. 

To learn more about the ESG funds’ and investment companies’ disclosure rules, you read the SEC’s proposal or Fact Sheet. 

What These Changes Might Mean for Reporting Companies

The SEC may choose to make additional changes to the rules based upon comments and other factors before adopting a finalized version. If implemented, the SEC proposes a phase-in plan to gradually implement the program between now and 2028. 

We have a few general suggestions for our publicly traded clients, as well as clients undertaking private offerings.  While final rules have yet to be adopted, and any final rule could be subject to a court challenge, given the breadth of the proposed rules, companies should be proactively reviewing current climate-related policies and procedures. Further, as the rules are currently drafted, actions taken by an issuer could trigger heightened disclosure. For example, if a smaller reporting company has a “publicly set” climate-related targets, that company would most likely be required to provide much more information regarding its emissions. Also,  under the proposed rules, climate-related disclosures will be considered “filed” and rather than “furnished.” As a result, issuers could face additional liability under Section 18 of the Exchange Act.  Issuers should evaluate their policies governing corporate disclosures to ensure that any climate-related disclosure (including on the company website or social media) has robust underlying support.

 Avoid characterizing your company or its operations as “green” or making general statements about being environmentally friendly unless you have solid support for these statements and are prepared to provide that support in a reasonably detailed format.  This includes statements in press releases, Twitter and social media generally.   

¹SEC Proposed Rule Release No. 33-11042, The Enhancement and Standardization of Climate-Related Disclosures for Investors

²SEC Proposed Rule Release No. 33-11067, Investment Company Names

³SEC Proposed Rule Release No. 33-11068, Environmental, Social, and Governance Disclosures for Investment Advisers and Investment Companies

⁴The proposed rules do not amend Form 40-F (the form used by Canadian issuers who report in the US under the MultiJurisdictional Disclosure System. The SEC has explicitly invited comments on this issue