SEC Turning Up the Heat on Climate Change and ESG Disclosures

Public companies take note: The Securities and Exchange Commission is getting serious about the quality of both climate-related and ESG disclosures in public company filings. Now is the time to take a hard look at what you are reporting.

The Opening Salvo

In February 2021, the Securities and Exchange Commissions’ then-acting chair, Allison Herren Lee, directed the Division of Corporate Finance to enhance its focus on climate-related disclosures in public company filings.

This was a short release that read mostly as a reminder that the SEC issued guidance on climate-related disclosures in 2010 and that it expects companies to follow it, given investors’ increasing interest on the topic.

The statement closed with the reminder that:

Ensuring compliance with the rules on the books and updating existing guidance are immediate steps the agency can take on the path to developing a more comprehensive framework that produces consistent, comparable, and reliable climate-related disclosures.

Then, the SEC’s Climate and ESG Task Force

Less than a month later, however, the agency went from the mode of issuing a gentle reminder to the announcement of a much more aggressive posture. Specifically, in March 2021, the SEC announced the formation of a new task force for climate disclosures and ESG in the Division of Enforcement.

Make no mistake: They are looking to make examples out of misbehaving issuers. The statement included a reminder that whistleblower tips are welcome.

In the statement, the SEC noted that the initial focus of its Climate and ESG Task Force will be to “identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.” (This is referring to its 2010 guidance found here.) As a reminder, climate-related disclosures report a company’s financial or operational risks related to climate change.

As law firm Davis Polk points out, “Use of the term “material” is significant because of the current debate about whether climate change poses a material risk to all public companies. The question of materiality is likely to be a key issue in any novel enforcement investigations regarding climate change disclosures.”

This task force’s mandate goes beyond climate disclosures, however, and specifically includes the broader topic of ESG, which is to say it is adding social and governance disclosures into the mix. “ESG” in this context refers to a set of non-financial corporate performance indicators being used to measure metrics associated with the environment, social issues, and governance. I’ve written about this topic at length here on an ESG primer for boards.

In addition to looking at gaps or misstatements in disclosures, the new task force will also “analyze disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.” The SEC is building on recent efforts in this area as well, and recently issued a bulletin on ESG funds to educate investors on this type of investing.

The agency reported its task force will use data analytics to “mine and assess information across registrants, to identify potential violations.” This is not the first time the agency has used analytics to find violators, including accounting fraud and earnings per share violations.

Voluntary or Mandatory Disclosures?

Climate and ESG disclosures have been largely voluntary to date, though there are some mandatory disclosures required by the SEC. These include, for example, the climate disclosures outlined in the SEC’s 2010 guidance and disclosure requirements concerning board diversity.

The pressure on companies to provide disclosures on ESG topics goes well beyond SEC requirements, however. Of the three categories within ESG, investor requests for environmental or climate-related disclosures are among the most robust.

Institutional investors like BlackRock and others have made it very clear that climate risk is an investment risk and sustainable investing is their primary focus moving forward. (You can read more about this in an article I wrote on climate disclosures.)

Blackrock, in fact, is a founding member of The Task Force on Climate-Related Financial Disclosure (TFCD). According to the Task Force on Climate-Related Financial Disclosures 2020 Status Report:

Nearly 60% of the world’s 100 largest public companies support the TCFD, report in line with the TCFD recommendations, or both. In addition, nearly 700 organizations have become TCFD supporters since the Task Force issued its 2019 status report, an increase of over 85%.

In addition, social unrest has prompted many companies to make commitments and disclosures with respect to the “S” or “social” part of ESG. As I’ve written in the past, companies need to be very careful with these types of disclosures or they might face public scrutiny and legal action.

Now with the SEC’s new task force, the pressure is mounting on issuers to ensure compliance with the SEC’s 2010 climate guidance and other disclosure rules. The SEC has also announced plans to update its guidance.

So, what is the future of climate and ESG disclosures – voluntary or mandatory?

In a March 2021 speech, SEC’s then-acting chair, Allison Herren Lee, argued that the COVID pandemic has clarified that historical distinction between social value and market value makes little sense, and as a consequence suggested that mandatory ESG disclosures for all public companies might be on the horizon:

”Not all companies do or will disclose without a mandatory framework, raising the cost, or resulting in the misallocation, of capital. Investors also aren’t getting the benefits of comparability that would come with standardization. And there are real questions about reliability and level of assurance for the disclosures that do exist.”

Lee’s comments also made note of the tremendous pressure felt by issuers being “assailed from all sides by competing and potentially conflicting demands for information.”

Thus, Lee concluded, the SEC needs to create a comprehensive ESG disclosure framework. She specifically called for comments on climate disclosures to further inform the agency’s policymaking.

“There are important questions to be answered here,” said Lee. “What data and metrics are most useful and cut across industries, to what extent should we have an industry-specific approach, what can we learn from existing voluntary frameworks, how do we devise a climate disclosure regime that is sufficiently flexible to keep up with the latest market and scientific developments?”

Moving beyond climate and to the other elements of ESG, Lee suggested that the SEC needs to encourage disclosure on topics ranging from human capital topics like diversity to political spending.

Lee specifically tied political spending back to climate by noting that some companies have made carbon neutral pledges while simultaneously making political donations that would suggest such pledges are less than completely sincere.

Next Steps

The SEC comment period on climate change disclosures has begun and will continue until mid-May 2021. Some corporations may choose to provide the SEC with comments. All corporations will want to review their climate and ESG disclosure practices given the attention these topics are getting.

Indeed, according to the 2021 Examination Priorities Report issued by the SEC’s Division of Examinations, climate and ESG disclosures are specific areas of focus this year. Particularly for systemically important issuers, “The Division will shift its focus to whether such plans…account for the growing physical and other relevant risks associated with climate change.”

In the past, some companies may have declined to do much in the way of ESG or climate-related disclosures, the feeling being that these sorts of issues were not “real” business issues. This position will be increasingly difficult to sustain in a world with investors and now the SEC is continuing to turn up the heat.

Having said that, it’s worth repeating that disclosures must be accurate, not aspirational. With this in mind, consider the following steps I’ve outlined previously:

1. Determine what disclosures your company is already making about climate change. You want to get the lay of the land here, including in your SEC filings, website, or any reports that have been put out. Also ensure you know what internal teams have disclosed to the public about ESG issues.
2. Understand what kinds of voluntary climate-related disclosures might be appropriate for your company. Review your competitors’ disclosures as well as any guidelines established by organizations like TCFD.
3. Initiate discussion in the boardroom. ESG discussions may fall within a board’s fiduciary duty obligations, so determine what level (if any) of commitment the company should have to ESG.
4. Think about measurement. Maybe you’re not yet ready to disclose metrics, but you want to get an idea of things like the company’s carbon footprint. Consider forming an internal group or hiring an outside vendor to help.
5. Work with experts on disclosures. Being diligent with your ESG disclosures means working with attorneys, accountants, and experts in their fields to make sure those disclosures are accompanied by appropriate caveats and specific information about methodologies.
6. Consider incorporating climate-related information into risk factors. On this last point, remember that one of the primary duties of a board is the oversight of risk. Boards with relevant climate issues will want to discuss the issues with management. Further, if the board has identified climate as an issue of concern for the business, that concern should be reflected in a company’s risk factors.

Finally, keep an eye on the SEC. The reputation of the newly confirmed chairman of the SEC, Gary Gensler, as well as his comments at his confirmation hearing suggest that he is likely to continue the SEC’s push towards creating a mandatory disclosure framework for climate issues specifically and ESG more broadly.