SEC Unveils Controversial ESG Disclosure Rule Proposal

On March 21, 2022, the Securities and Exchange Commission (“SEC”) issued a rule proposal addressing Environmental, Social, and Governance (“ESG”) disclosure regulation, a concern of many investors. (SEC Press Release). The rule proposal targets disclosure of environmental issues by public companies in their required financial statements. Id. Republicans and many industry groups strongly opposed the rule, arguing that the rule would cause an unwarranted spike in compliance costs. (Paul Kiernan, The Wall Street Journal). Further, critics contend that the rule goes beyond the SEC’s mandate to protect investors by requiring disclosure of information relevant to companies’ financial performance. Id.

The Administrative Procedure Act (“APA”) governs the SEC’s rulemaking process. (SEC Rulemaking Process). The APA requires that federal agencies publish a notice of proposed rulemaking in the Federal Register, which explains the proposed rule and its rational, as well as the opportunity for public participation through the submission of written comments. Id. Additionally, the APA requires publication of a final rule and an accompanying statement of basis and purpose not less than 30 days before the rule's effective date. Id.

The proposed rule divides companies’ emissions into three categories for reporting purposes: Scope One emissions are the direct greenhouse gas (GHG) emissions from operations that are owned or controlled by the company; Scope Two emissions are the indirect GHG emissions from the generation of energy that the company acquires. (SEC Proposed Rule). All public companies would be required to disclose their Scope One and Two emissions—the data for which should be reasonably available, according to the SEC. Id at 159. The SEC does not see disclosure of Scope One and Scope Two emissions as too burdensome because the EPA already requires disclosure of many companies’ Scope One emissions, and the EPA provides detailed guidance for calculating Scope Two emissions. Id.

Scope Three emission includes all indirect GHG emissions, which occur in the upstream and downstream activities of the companies supply chain. (SEC Proposed Rule). Under the proposed rule, public companies with less than a $250 million market capitalization would be exempt from reporting Scope Three emissions. (Kristen Broughton & Mark Maurer,  The Wall Street Journal). A company would only be required to disclose Scope Three emissions if it determines that the emissions are material or if it has set a GHG emissions reduction target that includes its Scope Three emissions. (SEC Proposed Rule, at 162.) Thus, a company will only need to disclose its Scope Three emissions if it finds a substantial likelihood that a reasonable investor would consider those Scope Three emissions important when making an investment or voting decision, granting firm managers broad discretion. Id.

The SEC commissioners voted 3-1 along party lines, with all three Democrats voting to issue the proposal. (Paul Kiernan, The Wall Street Journal). The SEC extended the required public comment period to ninety days following complaints that the initial sixty-day window did not provide interest groups adequate time for analysis. (Mark Maurer, The Wall Street Journal). The SEC received over five thousand comments on the proposed rule during the public comment period which closed in June 2022. (Cynthia A Williams & Robert G. Eccles, Harvard Law Forum).

Companies from numerous industries submitted comments requesting that the SEC scale back many of the proposed rules, particularly the Scope Three emissions requirement. (Andrew Ramonas & Amanda Lacone, Bloomberg Law). Tom Quaadman, Executive Vice President of the U.S. Chamber of Commerce, a business lobbying group, said the group “will advocate against provisions of this proposal that [force disclosure of immaterial risks] or are unnecessarily broad,”. (Matthew Goldstein & Peter Eavis, The New York Times). Similarly, “the measurement, target-setting, and management of Scope Three is a mess,” said Anant Sundaram, a finance professor at Dartmouth College’s Tuck School of Business. “There is a wide range of uncertainty in Scope Three emissions measurement . . . to the point that numbers can be absurdly off.” (Jean Eaglesham, The Wall Street Journal). Additionally, Senator Pat Toomey (R., Pa.) criticized the rule as a “thinly veiled effort to have unelected financial regulators set climate and energy policy for America,” while arguing that the SEC has exceeded its grant of authority from Congress. (Paul Kiernan, The Wall Street Journal).

However, SEC Chairman Gary Gensler argues that investors and asset managers representing tens of trillions of dollars have called for companies’ climate-related disclosures to be more standardized. Id. While hundreds of firms have already begun reporting data about their carbon emissions and other climate-related metrics, SEC officials say current disclosures are inconsistent and hard for investors to compare. Id. The proposal has supporters in the private industry, as well; Rachel Glaser, CFO at Etsy, sees the rule as a step toward creating unified and organized policies and guidance for corporate climate disclosures. (Kristen Broughton & Mark Maurer The Wall Street Journal). Additionally, Mike Zechmeister, CFO of C.H. Robinson, an environmentally friendly freight and logistics company, thinks the SEC rule could drive many companies to work with more environmentally friendly companies. Id.

While crafting the final rule on the matter, the Commission released two more ESG-related rule proposals. (Roger E. Barton, Reuters). The first is an amendment to existing regulation under the Investment Advisor’s Act of 1940 that would update the disclosures for funds and investment advisors who claim to consider ESG when investing. (SEC Proposed Rule, Federal Register). The second would require funds with ESG terminology in their names to “invest at least 80% of their assets in accordance with the investment focus that the fund’s name suggests.” (SEC Proposed Rule). Furthermore, the SEC created a Division of Enforcement Climate and ESG Task Force, which uses the current securities laws—primarily the anti-fraud provisions—to monitor ESG related misconduct. (SEC Press Release). In the later part of 2022 alone, the SEC launched investigations into the ESG investment funds of Goldman Sachs, Deutsche Bank, and New York Mellon, the last of which ended up settling for about one million U.S. dollars. (Lananh Nguyen & Matthew Goldstein The New York Times).

The SEC has now passed its self-imposed October 2022 deal line for the issuance of the final rule on the matter. (Andrew Ramonas & Amanda Lacone,  Bloomberg Law). Based on the rule proposals and recent enforcement actions discussed above, the SEC appears to be determined to implement an environmental disclosure regime that provides investors crucial information for investment decisions, which could also have the added benefit of reduction in GHG emissions. Since the rule is almost certain to be challenged, the SEC must carefully consider and address all comments received because the APA limits the evidence in such trials to the comments received during the comment period and the agencies responses. (William J. Grimaldi et al., Federal Circuit Bar Journal). Additionally, if the rule is litigated the SEC may face an uphill battle enacting such expansive regulation under the current Supreme Court, which Supreme Court Justice Elana Kegan has described as having an “anti-administrative state” agenda. (Charlie Savage The New York Times). Regardless of the agency’s response to the public comments, the SEC’s final rule will seriously affect investors, public companies, and the environment.