Lawrence A. Cunningham & Bill Hayes

The  SEC’s climate disclosure rule will have obvious and enormous impacts on company disclosure teams, including lawyers, accountants, and compliance personnel. What about boards of directors?  The Editor of Directors & Boards magazine, Bill Hayes, recently opened that topic with Mayer Brown’s Lawrence Cunningham, who has been closely involved in the SEC’s rulemaking. Their Q&A follows and also appears on the Directors & Boards website.

Hayes/D&B: How do you think the SEC’s new climate change disclosure rules will most significantly impact public company boards?

Cunningham: The impact on boards from the rules as originally proposed would have been direct, and from the rules as finalized will be indirect–both of which could be significant for many boards and directors. The SEC withdrew or eased its most intrusive proposals, such as requiring disclosure of director climate expertise and board climate discussions, and went for more open-ended disclosure of oversight roles instead.

That said, the SEC’s approach of proposing and withdrawing or restating the mandates equips climate advocates with tools to pressure companies to provide that information. Some boards will thus be significantly impacted through this indirect route. 

The rules impose substantial costs on companies in money and time, which will stretch disclosure budgets and staff. This will entail additional reporting to the management disclosure committee, board audit committee and ultimately to the board. Boards will therefore receive far more information on this topic and be compelled to oversee it, whether directly mandated or not.  

The board audit committee will be required to supervise new disclosures mandated by Regulation S-X or in a company’s financial statements. Audit committees of NYSE-listed companies must meet with management and the auditor to review and discuss the annual audited and quarterly financial statements.  

Boards should review whether their committee charters need or warrant any revisions. A company with a board committee on climate-related matters may consider adding to its charter the duty to review climate-related disclosures in the company’s SEC filings.

Hayes/D&B: The final rules require disclosure of a range of climate-related matters. Would you say that some of these different aspects vary as far as how they will impact boards? If so, what disclosures will be easier for boards vs. ones that might prove more difficult to meet?

Cunningham: Yes, requirements are vast and varied, some touching closer to the boardroom than others. But all pose significant risks to a company’s budgeting, performance, reputation, and liability risk profile.  All require careful attention and disclosure to comply with the rules and avoid related risks and liabilities.  You can think of the disclosures in a few clusters:

 Policy and Process

  • board oversight for companies that have board oversight or targets or goals related to climate change;
  • material impacts and management of climate-related risks on their business, results of operations, or financial condition, as well as any transition plans, scenario analysis, or internal carbon pricing they use;
  • processes for identifying, assessing, and managing material climate-related risks and how they are integrated into their overall risk management system or processes; and
  • any climate-related targets or goals that have materially affected or are reasonably likely to materially affect their business, results of operations, or financial condition, and their progress toward meeting them, as well as the role of carbon offsets in their strategy.

The rules amend Regulation S-X to mandate that companies disclose certain climate-related financial statement metrics and related disclosures in a note to their audited financial statements, such as costs and losses from severe weather events and other natural phenomena, carbon offsets, and financial estimates and assumptions affected by climate-related risks or transition plans, as well as relevant information to clarify the financial statement impacts.

Larger companies must disclose their Scope 1 and/or Scope 2 emissions metrics, if they are material, on a phased-in basis, and obtain attestation reports from qualified providers. These disclosures must be accompanied by an attestation report from an independent and expert provider who meets certain criteria and standards, and must also include additional disclosures about the attestation engagement and provider.

Hayes/D&B:  In what way do these final rules differ from those that were originally proposed by the SEC?

Cunningham: Federal agencies sometimes follow the “anchor-and-adjust” strategy, a negotiating ploy of exaggerating one’s opening position in order to make a subsequent move look more reasonable.  That happened here, as the final rules are less severe than those proposed, but remain bold to say the least.  

The headline change is not mandating disclosure of the emissions of one’s customers (so-called Scope 3), which a company not only cannot control but can scarcely measure, and clearly exceeding the SEC’s authority.  Another serious problem with the proposed rules was the absence of materiality qualifiers, which the final rules partially correct by applying materiality qualifiers to emissions data as well as to a number of other items.  On the governance front, as noted, the final rules correct some of the overreach into the boardroom contained in the proposed rules. 

Hayes/D&B:  Do you expect that there will be legal challenges to these new rules and if so what do you think the chances for success will be?

Cunningham: Yes, legal challenges are being made to these new rules and the plaintiffs have strong arguments, some of which I laid out in several comment letters on the proposed rules. 

Many state attorneys general and industrial companies have already sued the SEC, arguing that it overstepped its authority, disregarded feedback, and failed to properly evaluate the rule’s economic impact.  More lawsuits are likely to follow from trade groups arguing that the rules raise significant policy issues that only Congress can authorize and that they violate free speech rights by compelling companies to express a particular perspective on climate issues.

I believe one or more of these arguments will prevail.

On the other hand, I doubt that climate activists who want the SEC to impose more and mandate more reporting of emissions from sources outside their control will have much luck in court. The SEC’s role is to ensure investor protection, not promote social agendas, and the climate activists may lack the legal right to sue.  Also, it is easier to challenge what the SEC did than what it did not do.