The Securities and Exchange Commission will vote Wednesday on a raft of climate-disclosure rules that have been in the works for years and, as has become customary, the rules will almost certainly face a legal challenge.
“A lawsuit is, sadly, almost guaranteed, regardless of its merit,” said Harvard professor of law and economics John Coates.
The rules are likely to be adopted, but companies and their lawyers are watching the action closely to gauge the prospect that a potential lawsuit could mean companies don’t have to work on figuring out the rules in the meantime. In recent years, the SEC has implemented relatively shorter timelines for compliance that have left executives in finance, legal, and accounting functions scrambling for purchase. For instance, the SEC adopted final rules related to executive compensation disclosures that took effect in October 2022 for fiscal years ending in December 2022.
The rules on climate are also coming at a time when it seems some large asset managers are distancing themselves from the topic. Since February, J.P. Morgan Asset Management, State Street, and Pacific Investment Management Co. (Pimco) have exited the Climate Action 100+ investor coalition. Similarly, BlackRock shifted its participation to BlackRock International. Those departures follow the exits of nine large insurance companies and Vanguard leaving the Net Zero Asset Managers initiative in recent years, bringing the total assets under management that have left these groups upwards of $19 trillion. Those departures could have a chilling effect on investor support for a rule intended to address investors’ needs.
As proposed, the rule would require companies to provide some new and a few modified disclosures in annual reports on climate-related financial risks and metrics. Reuters last week reported that the commission, since it initially proposed the rule in 2022, has walked back some of the aspects that had ginned up significant opposition from companies and observers. Initially, the SEC had moved to require companies to disclose what are known as Scope 3 greenhouse gas emissions, which are value chain emissions that stem from a company’s operations. In the final draft, the SEC has since backed down from Scope 3, Reuters reported. In addition, the commission has softened its stance on Scope 1 and 2 emissions disclosures, and companies will have to offer related disclosures only if they determine such emissions have a material impact on their businesses. The proposal included some governance requirements for corporate boards that are also on the chopping block.
The regulations would also require companies to file their disclosures in Form 10-Ks, rather than requiring investors to gather data from a hodgepodge of places including sustainability reports, corporate websites, and third-party disclosures. Including the information in a 10-K filing also increases the potential liability a company faces in providing the disclosures, which might prompt them to compile the information more carefully, said the SEC in its proposing release.
According to Coates, many large companies are already providing information likely to be included in the rule, given demands from investors and European law. The content of the final rule will determine whether companies will comply while a legal challenge works its way through the courts.
Yet in the weeks leading up to the vote, there were plenty of warning shots about the potential areas for legal challenge. There were ripples following a late February comment letter from a group of 20 professors of law and finance that called upon the SEC to reexamine the rationale for the rule proposal in the first place in light of large asset managers leaving climate coalitions in recent months.
“Such withdrawals call into further question much of the SEC’s stated rationale for the Proposal, including its characterization that such alliances evidence a ‘consensus’ view favoring the Proposal,” the letter stated.
Reducing the requirements related to Scope 3 disclosures would go a long way to reducing the risk of litigation, said Lawrence Cunningham, special counsel at Mayer Brown and a director on the boards of Constellation Software and Markel Group. Cunningham was one of the signatories on the letter. Yet the commission would have had to cut the rule back significantly to avoid all the legal risk.
Plus, the SEC might still have some exposure on the process they undertook in formulating the rule, said Cunningham. In a recent case concerning share buybacks, the Fifth Circuit vacated the rule in December 2023 after the SEC didn’t respond to comments and didn’t show that opportunistic stock buybacks were a genuine problem that needed to be solved by the commission. Any version of a climate rule to be voted on this week will have to meet that test, said Cunningham.
The other open issue is that the initial rule proposal stated the SEC was moving to adopt rules on climate disclosures as a result of investor demand, said Cunningham. “They made that statement—investor demand—dozens of times in the proposal,” he noted. Now that the climate coalitions have lost significant investors, it might be a more narrow group of interests that are asserting this demand, he said.
Whatever they come out with, if they haven’t done “additional homework” to figure out the investor protection rationale and which investors are demanding this rule beyond the climate coalitions, the SEC is likely to face legal challenges even if the rule is scaled back substantially, said Cunningham.
“I’d welcome it—I would love to see them have done that homework,” said Cunningham. “That’s an important part of what I’ll be looking for and what I think independent observers will look for: Have they taken seriously the genuine gaps that were pointed out.”
