Changing Expectations for Financial Disclosure of Climate-Related Information

In early 2020, State Street Global Advisors, BlackRock, and other investment firms announced their plans for persuading companies to address financially-material environmental, social, and governance (ESG) issues. The high-profile announcements followed moves in recent years by Wellington Management, CalPERS, and other institutional investors to integrate climate-related data into their processes and increase the pressure on companies to more deeply consider climate change risks and disclose how they are accounting for those risks in their operations. Companies have responded with a steady stream of climate-related goals, commitments to disclose in line with the Financial Stability Board’s Task-Force on Climate-Related Financial Disclosures (TCFD) recommendations, and climate reports in addition to sustainability and annual reports.

Why does this matter for the law?

It indicates that a key component of materiality – who is a “reasonable investor” – is evolving as it relates to climate-related information. Securities law requires companies to disclose certain material information to investors and imposes liability for omissions and untrue or misleading statements. The reasonable investor’s evolving view of climate-related information means companies can no longer make materiality determinations as they always have.

Material information has a particular, if nebulous, definition in domestic securities law. The Supreme Court defined it in TSC Industries, Inc. v. Northway, Inc. as information substantially likely to significantly alter the total mix of information available to a reasonable investor. As investors take concrete actions to incorporate climate-related information into their processes and as they make specific decisions dependent on that information, the information can become material for the purposes of disclosure. The challenge is determining what specific information is material for a particular company and when it becomes so. Recognizing the increasing importance of information does not necessarily mean it is material to a particular investment decision or a particular company in light of the total mix of information available.

The Securities and Exchange Commission (SEC) has not adequately addressed the rapidly changing climate discussion, the rise of its importance to investors, or the certainty of climate-related impacts. Non-governmental organizations have stepped into the void, with SASB providing the most developed industry-specific guidance on when ESG issues may become material under U.S. securities law. The TCFD’s framework has also heavily influenced the conversation, providing heft to the effort and solidifying buy-in from industry players that were involved in the development of its recommendations. Other organizations like CDP, GRI, IIRC, and WBSCD continue to contribute by providing disclosure platforms or guidance on specific metrics.

As investor treatment of climate change information becomes more sophisticated and investors are more comfortable using that information to inform their decisions, we are entering a new stage that will soon have a significant impact on legal outcomes by affecting what climate-related information courts consider material.

When, how, and even whether certain topics become material are case specific. A court considers all of the information about a company an investor reviews and how the information  fits in context. There is no bright-line rule, and courts are understandably wary of setting the threshold too low.

How the spike in investor focus on climate concerns will shape courts’ understanding of the reasonable investor’s expectations remains to be seen. In prior cases involving environmental information, materiality findings generally coincided with acute events, such as spills or accidents. Courts have also found substantial noncompliance with environmental regulations material. Very few cases have raised questions of materiality specific to climate change-related information. Two cases directly addressing climate disclosures have resulted in opinions, both involving the same basic facts. The courts in these cases acknowledged the potential materiality of climate-related information but did not find the particular information questioned in those cases materially misleading.

Four trends indicate that today’s reasonable investor considers more and more climate-related information material: (1) the growing, consistent interest by mainstream investors in climate-related information; (2) recent indications that investors use the climate information they get from companies and are seeking out and incorporating additional information; (3) companies’ response to investor demands for more information; and (4) the increasing importance of the Big Three firms’ (BlackRock, State Street, and Vanguard) views on climate information due to the consolidation of investment decision-making in their hands and incentives for them to place a high importance on portfolio-level climate impacts.

As investors find new ways to incorporate climate-related information into their portfolio management practices, evidence grows to support a court finding that such information is material. Corporate disclosures around the physical risks of climate change may cross the materiality threshold even sooner than disclosure related to transition risk once investors better understand the current and near-term physical impacts of our changing climate.

These trends highlight the importance of companies clearly explaining how they evaluate and consider climate-related information in a straightforward manner that does not risk misleading investors. There remain no bright lines between the important and the material, but there is growing consensus around what climate-related information may be material in particular industries.

As the increased focus on climate-related information leads to sophisticated efforts to incorporate such information into investor decisionmaking, the small drip of cases questioning the adequacy of corporate disclosures may become a torrent if companies don’t more effectively address questions of climate impacts on their business.

This post comes to us from Hana V. Vizcarra, staff attorney at Harvard Law School’s Environmental & Energy Law Program. It is based on her recent piece, “THE REASONABLE INVESTOR AND CLIMATE-RELATED INFORMATION: CHANGING EXPECTATIONS FOR FINANCIAL DISCLOSURES,” available here.