The concept of materiality has been called the “bedrock” or the “cornerstone” of the corporate disclosure system established by Congress in the federal securities laws.[1] But, despite its importance, determining how to use or apply the concept can be difficult.

The climate-risk disclosure rule (“the Rule”) [2] adopted by the U.S. Securities and Exchange Commission on March 6, 2024 incorporates traditional notions of materiality as a basis for most elements of the required disclosures.  Registrants will now need to determine the materiality of matters that they may not have considered previously.  In this post, we examine considerations that we believe are relevant to that materiality assessment.[3]

Most significant is the overwhelming support for the proposed rule expressed by asset management and asset owner entities that submitted comments on the proposal (which were more far-reaching, prescriptive, and potentially burdensome than the final rule).   And these were not hollow or unsupported investor demands. Many investors provided detailed descriptions about how climate-risk information is vitally important to them in making their investment and voting decisions.

Also, although climate risk may be uncertain and long term in nature, that does not mean it is immaterial for today’s investors – the Rule and the Adopting Release (that is, the portion of the SEC’s March 6^th  release that explains the background and rationale for the Rule) makes that clear.  Moreover, as to a concern about liability, many companies have long been making climate-related disclosures outside of SEC filings, thereby missing out on the scrutiny and rigor intrinsic to SEC filings, as well as the safe harbor protection that the SEC’s Rule will provide for certain climate disclosures. Given this situation, it appears that many issuers may be better off from a liability standpoint with disclosures made pursuant to the Rule.

Rule Text and Adopting Release

Emissions Disclosures as Discussed in the SEC’s Adopting Release

Item 1505 of the Rule requires that large accelerated, filers (issuers with public floats of $700 million or more) and accelerated filers (issuers with public floats between $75 and $700 million)[4] disclose their Scopes 1 and 2 greenhouse gas emissions “if material.”[5]  Materiality had not been a requirement for emissions disclosures in the rule as it was proposed in 2022; it was included in the final Rule in response to concerns expressed by commenters.  Materiality was also added to elements of the Rule other than emissions disclosure (as discussed further below).[6]

The Adopting Release explains that “we intend that a registrant apply traditional notions of materiality under the Federal securities laws when evaluating whether its Scopes 1 and/or 2 emissions are material.”[7]  By “traditional notions,” the Adopting Release refers to other SEC regulations and relevant Supreme Court case law (in particular, TSC Industries v. Northway[8]) which define information as being material where “there is a substantial likelihood that a reasonable investor would consider the information important in deciding how to vote or make an investment decision” or, put another way, where there is “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”[9]

The Adopting Release gives some examples of factors that are relevant, although it also states that these factors are “non-exhaustive” and, as one law firm has written, “stakeholders may take differing views on how to apply such factors.”[10]  The factors given as examples are:

• whether the calculation and disclosure of the emissions is necessary “to allow investors to understand whether those emissions are significant enough to subject the registrant to a transition risk that will or is reasonably likely to materially impact its business, results of operations, or financial condition in the short or long term; for example, where emissions “are reasonably likely to be subject to additional regulatory burdens through increased taxes or financial penalties”; and
• whether the calculation and disclosure “are necessary to enable investors to understand whether the registrant has made progress toward achieving a target or goal or a transition plan that the registrant is required to disclose under the final rules.”

The emphasis on a target, goal, or transition plan in the materiality determination makes much sense; these are the circumstances in which the relevant information seems likely to be material.  For example, Ceres has issued reports focused on transition plans and has said that such plans are likely to require expenditures on, among other things, “capital investments; investments in new staff and expertise; process efficiencies; research, development, and deployment of new technologies and designs; and collaboration.”[11] These expenditures may be substantial.

The Adopting Release cautions that materiality “is not determined merely by the amount of these emissions.”[12]  This view is consistent with the Commission’s long-held view that materiality requires an assessment of both quantitative and qualitative factors.[13]   Thus, there is no specific threshold where emissions in excess of the threshold are material and those below are immaterial.  But, while the quantity of emissions by itself may not be determinative, it is clearly a significant, and likely most important, element of the materiality assessment relevant to emissions.  Studies have shown that high-emitting companies are likely to trade at a discount on the stock market and/or need to offer higher returns to attract investors.[14]

The Adopting Release also explains that the presence of a material transition risk does not necessarily mean that the emissions information is material if, for example, the transition risk – that is, the risk associated with an organization’s efforts to reduce greenhouse gas emissions and use renewable energy — is caused by something other than emissions, such as “a new law or regulation that restricts the sale of its products based on the technology it uses.”[15]  The Commission also said that “the fact that a registrant is exposed to a material transition risk does not necessarily result in its … emissions being de facto material to the registrant.”[16]

The absence of further guidance from the SEC perhaps underlines how difficult this issue is and how it is very much dependent on the facts and circumstances of individual issuers.  It seems necessary, therefore, for the registrant to take into consideration other aspects of the rulemaking to obtain a better insight into what a reasonable investor might consider important in making an investment or voting decision.  What follows is a discussion of some of these factors.

The Term “Reasonably Likely”

In Items 1501 through 1504 (“Governance,”, “Strategy”, “Risk Management”, and “Targets and Goals”), the Rule sets forth a number of disclosure requirements that are modeled on those of the Task Force on Climate-related Financial Disclosure.  Certain of these items also use the word “material”, such as the disclosure requirement of “management’s role in assessing and managing the registrant’s material climate-related risk” (Item 1501(b)) and “any processes the registrant has for identifying, assessing and managing material climate-related risks” (Item 1503(a)). But elsewhere, in Item 1502 (“Strategy”) and Item 1504 (“Targets and Goals”), the Rule adds language — it uses the phrase (or a close variant thereof) “materially affected or is reasonably likely to materially affect the registrant’s business, results of operations, or financial condition (emphasis added).”

The phrase “reasonably likely to be material” is used in Item 303 of Regulation S-K (Management Disclosure and Analysis, or MD&A).  Item 303 was amended in 2020,[17] and the Adopting Release on the 2024 Rule states that readers should refer back to the adopting release for the 2020 amendments in order to better understand the climate rule requirements.[18]  In the 2020 adopting release, the SEC explained that “reasonably likely to cause” is not the same as “will cause.”[19]  In other words, there need not be certainty either about whether climate change will come to fruition or that it will have a material financial impact – the threshold of “reasonably likely” applies.

Long-Term Risks

An important element of the Final Rule is the requirement that an issuer disclose information that is material in both the short and the long term.  Item 1502(a) (“Strategy”) states: “In describing these material risks, a registrant must describe whether such risks are reasonably likely to manifest in the short-term (i.e., the next 12 months) and separately in the long-term (i.e., beyond the next 12 months).”  This disclosure was modeled on the temporal standard used for MD&A disclosures under Item 303 of Regulation S-K.[20]  The Commission noted support for this approach from numerous commenters and explained:

[C]limate risk information can be informative about financial performance in a way that goes beyond current account numbers. As stock prices reflect profits potentially years in the future, even long-term climate-related risks can affect profitability, though not all climate risks are necessarily long term.  In any case, risks to cash flows, even those that are far in the future, can still be important for investors today.[21]

The Adopting Release also cites a letter from Vanguard describing climate risks as “material and fundamental risks for investors and the management of those risks is important for price discovery and long-term shareholder returns”.[22]  Thus, the SEC rejected the sometimes-stated view that climate risk is too long term to be material to investors today.

“Tipping the Scales”

One leading law firm has stated that, at least with respect to disclosure of Scopes 1 and 2, the SEC’s Adopting Release seems to favor disclosure over non-disclosure.  The firm’s client memo states:

Although the adopting release makes repeated reference to traditional standards of materiality, it suggests in certain places that the SEC has tipped the scales of materiality determinations toward disclosure.[23]

The law firm notes, as have many other commenters, that “[m]any companies will not be making climate-related disclosure decisions in a vacuum. Climate reporting is already widespread, particularly among larger companies.”  A past practice of voluntary disclosure may support a conclusion in favor of materiality under the Rule.

A “tip the scales” reading of the Adopting Release seems logical for other reasons.  Perhaps most importantly, when the Supreme Court first articulated the standard for materiality in TSC v. Northway it said that doubts as to materiality of information would be commonplace but, particularly in view of the “prophylactic” investor-protection purpose of the securities laws and the fact that disclosure is within management’s control, “it is appropriate that these doubts be resolved in favor of those the statute is designed to protect”[24]  — that is, investors.[25]

It also makes sense given the background to the rulemaking.  As noted above, the proposed rule did not include a materiality threshold for many of the disclosures, including the emissions disclosures; based on adverse comments from many industry groups, the materiality requirement was inserted.  But the SEC’s comment file includes letters describing how the federal securities laws do not require materiality as an element of a disclosure rule.   For example, a letter signed by 30 leading securities law scholars stated that “nothing in the federal securities statutes or in judicial precedent, including Supreme Court precedent, imposes a materiality constraint on Commission rulemaking, or requires the Commission to incorporate materiality qualifiers in the language of specific disclosure rules.”[26]

While not statutorily required, the SEC opted to include materiality, explaining in the Adopting Release that it was doing so in order “to mitigate the compliance burden and related concerns” and to avoid the disclosure of “immaterial” items.[27]  Thus, it was for practical, not legal, reasons that the SEC made the change.  Corporate leadership such as the Business Roundtable have long acknowledged “an obligation to publicly disclose [material] information to prospective investors and shareholders so that they may make informed investment and proxy voting decisions”.[28]   That longstanding legal obligation may lend support to a finding in favor of disclosure.

Climate Reporting Under Other Disclosure Regimes

As the SEC noted many times in its Adopting Release, numerous companies are already reporting many of the items that are required under the Rule pursuant to standards developed by the Sustainability Accounting Standards Board. [29]  This is significant for purposes of the materiality analysis under the Rule, since SASB sets forth a materiality threshold consistent with the SEC’s traditional standard.[30]

Also discussed in the Adopting Release is the fact that many issuers will be required to make disclosures under other reporting regimes, such as the European Union’s Corporate Sustainability Reporting Directive (“CSRD”) or California’s new laws, SB 253, the Climate Corporate Data Accountability Act, and SB 261, the Climate-Related Financial Risk Act.[31]  This may be another factor relevant to the materiality analysis.  For example, the Adopting Release suggests that the fact that a company must comply with other emissions reporting regimes could mean such emissions metrics are material under the Rule due to the threat of additional regulatory burdens.

Moreover, because the SEC inserted the materiality element into most components of the Rule largely to avoid overburdening companies, it may strike investors and others as odd for a company to disclose various aspects of climate risks pursuant to other reporting regimes and not make the same or similar disclosure in an SEC filing – there is no “overburdening” concern where information has already been disclosed.

In this regard, it should be noted that the CSRD and the California laws impose reporting requirements that are not included in the SEC rule, as result of the “double materiality” element of the CSRD (that is, the company’s material impacts on society) and the Scope 3 disclosure requirement in both the CSRD and California law.  Accordingly, companies will make some disclosures under these other reporting regimes that will not be relevant to obligations under the Rule.

Investor Demand

Investors’ Demand for and Use of Climate Information

It is important to keep in mind that the determination of materiality is made from the investor’s standpoint – the issuermust figure out what the investor wants or needs.  Whether information is material (or “reasonably likely” to be material) can be gleaned from the comment letters on the SEC’s proposed climate rule.  Ceres analyzed the letters of over 300 institutional investors, including both asset owners and asset managers, who collectively own or manage more than $50 trillion in assets. Ceres looked at their positions on key provisions in the SEC’s proposed rule and foundoverwhelming support for those provisions — ranging from 95% to 100%.[32]

Moreover, the four largest institutional investors, with combined assets of $20 trillion, stated support for the rule when it was proposed (while, at the same time, urging modifications, many or most of which were made).  Blackrock said “we use GHG emissions estimates to size an issuer’s climate-related exposure.”[33]  Vanguard said the emissions disclosure “will help investors better understand a company’s exposure to, and management of, climate without imposing undue burden on companies.”[34]

State Street said: “We strongly welcome the Commission taking initiative in this area and leveraging global frameworks such as the Taskforce on Climate-related Financial Disclosures (“TCFD”).[35] Improved climate disclosure will benefit investors that are increasingly integrating climate-related financial risks and opportunities into their investment decisions. Increased standardization will also benefit U.S. companies that are currently navigating a myriad of requirements and expectations from a broad range of stakeholders.”  And Fidelity said it “supports requiring companies to disclose in the Form 10-K (on both an aggregated and disaggregated basis) Scope 1 and 2 emissions … We believe that Scope 1 and 2 emissions data are now table stakes and part of investors’ fundamental expectations of companies.”[36]  Many other investors, large and small, expressed similar views.[37]

Given this administrative record, it can hardly be gainsaid that climate-information – both the emissions data and other disclosures – is being sought by investors.  This is important because of the focus, under the TSC Industries v. Northway test for materiality, on the interests of the “reasonable investor.”  Oftentimes, as former Commissioner Lee has written, corporate managers and their lawyers and auditors “are asked to apply the ‘reasonable investor’ test without necessarily having sufficient understanding of what investors want or expect.”[38]  That cannot be said here – we know what the overwhelming majority of investors want and expect.

There is no legal test for how much investor demand is necessary for information to be material, and every company’s situation will be different; the analysis will always revolve around the registrant’s particular facts and circumstances.  As former Commissioner Lee said on a webcast, “There will be a fair amount of leeway and management discretion around how to make materiality determination”.[39]  But legal scholarship suggests a “tipping of the scales” where the demand is so high.  Consider the views of Professor John C. Coffee, the Adolf A. Berle Professor of Law and director of the Center on Corporate Governance at Columbia Law School and one of the nation’s top securities law scholars.  He wrote that, given the level of investor support demonstrated during the rule’s comment period, there is a “presumption” in favor of materiality:

Because a substantial majority of the stock in public corporations is now held by institutional investors (most of which are vocal in their desire for more climate-related disclosures), it would be myopic for a court to ignore their strong preferences. If the majority of the market wants the information, it presumptively should be material.[40]

Although Prof. Coffee referred to a “majority” of supportive investors as providing the go-ahead for SEC rulemaking, the appropriate quantitative threshold could be much lower.  There does not appear to be any generally accepted or SEC-approved level of needed support in this context, but when materiality began being focused on in the 1970s some of the most prominent securities law scholars suggested a lower level would be fine.  SEC Commissioner Bevis Longstreth referred to a “significant number of investors” as being sufficient for a finding of materiality.  Federal Judge Jack Weinstein wrote in the landmark case Feit v. Leasco Data Processing Equipment Corp.,332 F. Supp. 544, 571 (E.D.N.Y. 1971), “A fair summary of the rule stated in terms of probability is that a fact is proved to be material when it is more probable than not that a significant number of traders would have wanted to know it before deciding to deal in the security at the time and price in question. What is statistically significant will vary with the legal situation. . . Anything in the order of 10% of either the number of potential traders or those potentially making 10% of the volume of sales would more than suffice. [41]

Given the level of investor support for the Rule expressed during the comment process, any of these various thresholds – a majority, a “significant number,” or 10 percent — would appear to be satisfied.

Examples of How Investors Use Climate Risk Information

Evidence of investor demand is sometimes dismissed with the assertion that “investors always ask for more disclosures.”  But that doesn’t hold up when investors, as here, offer concrete examples showing precisely how they use the requested information.  According to statements made at the SEC’s open meeting on the final rule, the administrative record now includes approximately 24,000 letters including over 4,500 unique letters.  Mixed within that voluminous pile of correspondence are numerous letters that make powerful arguments on how the commenters use climate-related information and why, therefore, such information is material.

A particularly good description of how climate information is important was provided by Wellington Management in its comment letter:[42]

Our investors and analysts have found several instances where climate-related information was integral to making an investment recommendation.

For example, we:

• • increased holdings in a real estate investment trust (“REIT”) that, among other positive steps, expanded its investments in certified green office buildings, which command a premium compared to non-green buildings;
  • reduced position in bonds issued by a utility company with significant coal fired electricity generation due to ongoing coal-ash clean-up costs and a shrinking buyer base, resulting in a higher cost of capital and higher risk of default;
  • limited exposure to US oil major that is not investing sufficiently in renewable energy relative to global peers, based on the view that the forthcoming oil demand plateau caused by electrification will continue to challenge the existing business model, increase risk of stranded assets, and shrink the base of capital providers;
  • improved outlook for a variety of mining companies considering both the structural demand from the energy transition (transport, renewables) and companies’ allocation of capex to decarbonization of the metals supply chain to improve the industry’s long-term positioning, which may be underappreciated by the market;
  • sold a position in an energy company where the portfolio manager determined that its capital investment plans did not include adequate considerations of the flooding risk associated with the construction of a new plant;
  • identified a semi-conductor manufacturer as a more attractive investment when we learned it was diversifying its manufacturing locations to diversify its water sourcing, which is critical to the manufacturing of semi-conductors;
  • avoided debt of certain utility companies where we determined the debt is not correctly priced to reflect certain weather and wildfire risks; and
  • formed a negative assessment of a utility generating electricity from hydro-electric power based on our assessment of drought risk.

Wellington further explained that it could make these decisions “only after extensive research and analysis,” including “estimates,” and for “a significant number of issuers” they were simply unable to obtain enough data “to support equivalent analysis.[43]  The inference from Wellington’s letter is that, because climate risk information can be material in investment decision-making, issuers should lean heavily towards disclosing it (much like the “presumption” noted by Prof. Coffee).  The letter makes clear how wildfires, flooding, droughts, decarbonization, stranded assets and many other risks may be essential to investment analysis.

Voting Interests

It is sometimes forgotten that the materiality determination relates not only to the reasonable person’s investmentdecision but also to his/her voting decision.  Indeed, the seminal Supreme Court decision on the definition of materiality, TSC Industries v. Northway, Inc., involved a voting decision, not an investment decision.  The Northway decision describes materiality as a requirement that “the defect have a significant propensity to affect the voting process,” not that it actually change the investor’s vote.[44]

On a webinar, former SEC Commissioner Robert Jackson, who teaches at the New York University School of Law, emphasized the importance of voting decision-making to the materiality analysis.  He said (based on our transcription of the recording):[45]

It doesn’t make sense to think of materiality as only buying or selling securities. Consider index funds—they buy or sell securities as necessary to match the index. If you limit materiality only to buying and selling materials, then nothing is material. That can’t be—and indeed is not—the law. The Supreme Court of the United States (SCOTUS) has been very clear about that. There’s been an effort in Washington to move away from this definition to so-called “financial materiality,” but information can absolutely be material if it drives voting decisions.

Indeed, the increasing frequency of climate-related shareholder resolutions is an indication of investor interest in climate risk and its relevance to shareholder suffrage.  A report by the organization As You Sow states that climate proposals in 2024 “remain firmly focused on GHG emissions goals, reporting on them and explaining how companies plan to adjust to a much lower carbon economy in the future.” Certainly, the administrative record establishes that, at least for many companies, climate risk establishes a “propensity” to impact a voting decision.

Universal Materiality

One discussion of materiality that has not received much attention is “universal materiality.”  It was raised by SEC Commissioner Hester Peirce in her dissenting statement on the proposed rule.  She referred to “types of universally material climate information that are not being disclosed under [the] existing rules.” [46]  If by “universal materiality” Commissioner Peirce was suggesting that certain information must be material for all public companies, then that is not supportable under the statute or any case law.  As Prof. George Georgiev has written, this would be “an incredibly high bar that few, if any, of the SEC’s existing disclosure rules would meet” and it “cannot be the proper standard for evaluating new disclosure rules.” [47]

Other Relevant Legal Considerations

The “Probability/Magnitude” Test

In addition to the TSC v. Northway test for determining materiality, the SEC and the courts have used another test, mostly in the context of preliminary merger transactions, known as the “probability/magnitude test,” adopted by the Supreme Court (at the SEC’s urging) in Basic v. Levinson.[48]  Under Basic, materiality depends on the probability that a transaction will be consummated, and also on the significance of the transaction to the issuer of the securities – that is,the materiality of a future event depends “at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.”

The probability/magnitude formula is not limited to circumstances involving preliminary merger negotiations.  Indeed, the Supreme Court noted the adoption of that formula in another leading securities law case, Texas Gulf Sulphur,[49]which involved a misleading press release regarding the results of exploratory drilling for mineral deposits.

Applying the Basic v. Levinson test in the context of climate change risk inexorably leads to a strong argument in favor of a broad approach to the materiality assessment.  The probability of climate risk is difficult to measure but the magnitude of the impact could in many circumstances be great, although as one commentator stated “this will likely be a highly contextual and fact-driven inquiry.”[50]  Climate change is already having a significant financial impact on many companies; as just one example, California utilities spent tens of billions of dollars to cover the costs of wildfire mitigation and damages.[51]  As another example, studies have shown that because of climate change the number of major hurricanes has increased.  And the costs associated with the transition to a less carbon-intensive economy will also be great.  The “probability” may include many uncertainties and much speculation, but the “magnitude” could be great.

The Safe Harbor and Legal Risks Generally

The SEC issued climate guidance in 2010 [52]  and said that Item 303 (MD&A) required issuers in some situations to make climate-related disclosures.  But the legal risk under the federal securities laws for not making such disclosures was likely minimal.[53]  The SEC has historically brought few MD&A non-disclosure enforcement cases, and the Supreme Court recently limited the availability of private lawsuits for such non-disclosures. [54]  Private lawsuits in this context have largely been unsuccessful.

The Rule provides safe harbor protection from liability for forward-looking disclosures (other than historical facts) regarding transition plans, scenario analysis, internal carbon pricing, and targets and goals, but it goes no further than that.  Thus, the safe harbor protects companies from liability for false or misleading statements relating to these categories of disclosure, but it does not protect companies where they fail to disclose or omit information that is found to be material (although, to recover damages in private securities litigation, plaintiffs are required to surmount many hurdles in addition to proof of material omissions).  Companies should keep this liability risk in mind when considering what to disclose.

Another liability-related issue is that many public companies have for years been issuing stand-alone sustainability reports where they discuss climate-related risk.  These reports have often been criticized for “greenwashing,” and they do not typically go through the kind of scrutiny from lawyers, accountants, and others that is the case for disclosures made in SEC filings.  And yet, companies can be liable for securities fraud for false statements made in these reports.  Importantly, the Rule’s safe harbor protection would not extend to statements outside of the SEC filing.

Since the new climate disclosure rule was issued on March 6, some commentators have also said that any perceived discrepancy between the information contained in an SEC filing and those in other public disclosures (including prior SEC filings and voluntary reports) could invite questions from the SEC, shareholders, potential litigants, and other stakeholders. For example, if a company determines that certain climate-related information included in its voluntary sustainability report is immaterial and therefore omits such information from SEC filings, the regulator might question the company’s materiality determination.  Indeed, the SEC’s Division of Corporation Finance did this in recent comment letters.[55]

A disclosure made in an SEC filing is much more carefully prepared than other types of disclosures, such as those made in sustainability reports.  An SEC filing gets scrutiny from lawyers, accountants, and a range of persons in senior management, and is also subject to CEO and CFO certification.  Thus, the combination of the safe harbor and the likelihood of more reliable 10-K disclosures suggest that companies might be better off, not worse off, making the disclosures set forth by the Rule.

Prior Conclusions on Materiality of Climate Risk Information

Some companies may be concerned that if they were to reach a conclusion in favor of materiality under the new Rule they may be subject to criticism for not having reached the same conclusion in prior years, when they were required to comply with longstanding SEC disclosure rules as explained in the SEC’s 2010 guidance.[56]  They may believe that this situation will give rise to criticism from investors or possible legal claims being asserted either by the SEC or private litigants.

We appreciate these concerns but do not believe they are well-founded.  As the Adopting Release makes clear, recognition of the financial impact of climate change and the need for better disclosure has grown enormously just over the last few years.  The Adopting Release states, “there has been an increased recognition of the current and potential effects, both positive and negative, of these events and associated physical risks on a registrant’s business as well as its financial performance and position.” [57] The Business Roundtable made a similar point in 2015, stating that materiality “naturally evolves over time to address new issues and developments and takes into account the facts and circumstances that are relevant to each company.”[58]

Much has happened in the last few years. According to S&P Global, the percentage of US companies disclosing Scopes 1 and 2 GHG disclosure has been rising steadily in the US, from 24% and 23% in 2018 to 47% and 45% respectively in 2022.  During this same period the International Sustainability Standards Board was established by the International Financial Reporting Standards Foundation, and the European Union moved forward with the Non-Financial Reporting Directive and, then, the Corporate Sustainability Reporting Directive.  Also, during this time period, the impact and cost of extreme weather events exacerbated by climate change – wildfires, floods, etc. – was increasingly acknowledged.  Another relevant fact is the extraordinary increase in the number of companies using the disclosure standards issued by the SASB – from 13 companies in 2017 to 2499 companies in 2023.[59]

Thus, relevant materiality factors in this context have changed dramatically within the past four or five years.  There should be no meaningful concern about Monday-morning quarterbacking.  Nothing in anything the SEC has said supports a conclusion that it will take such an aggressive enforcement approach based on a company’s new disclosures, and no precedent exists for it in connection with prior SEC disclosure rulemakings.

Scope 3 Disclosures

The proposed rule’s Scope 3 disclosure requirement elicited wide-ranging views and was ultimately dropped from the final rule.  The Rule makes Scope 3 disclosure voluntary because of “the potential burdens such a requirement could impose on registrants and other parties as well as questions about the current reliability and robustness of the data associated with Scope 3 emissions.”[60]  The Adopting Release acknowledges that Scope 3 could be material to some investors, as it “may allow investors to develop a fuller picture of the registrant’s transition risk exposure and evaluate and compare investment risks across registrants more thoroughly”.[61]

In practice, Scope 3 is important to many investors,[62] and nothing will prevent companies from voluntarily making Scope 3 disclosures.  Some experts have already said as much.  Former Commissioner Robert Jackson said on a webinar[63]: “I feel very comfortable and confident that Scopes 1, 2 and 3 are going to continue to be in many, many U.S.-based issuer disclosures for the foreseeable future. . . not because of anything that happened in Washington, but because of what investors have been asking for and of course, because international standards have embraced that approach as well.”  Former Commissioner Allison Lee said on a different webinar[64]: “People with the capital still want Scope 3. It’s hard to understand Scopes 1 and 2 without 3. . .You might get a competitive advantage doing that [i.e., voluntarily disclosing scope 3].”

It has been said by some commentators that, although an explicit Scope 3 disclosure requirement has been dropped, other items in the Final Rule may be viewed as requiring such disclosure.  For example, one law firm has written, “Scope 3 GHG emissions disclosure may be required to describe the progress the registrant makes towards the target or because achieving the target involves material costs for the registrant.”[65]  But the SEC has gone out of its way, in no uncertain terms, to make clear that the required disclosure targets or goals is not a “backdoor” means of requiring Scope 3 disclosure. On a Ceres webinar held in early April, Eric Gerding, Director of SEC Division of Corporation Finance, reiterated several times that nothing in the final rule mandates Scope 3 emission disclosure.[66]   And, importantly, the SEC has emphasized that registrants should not impose informational burdens on third-party non-registrants; if a company opts to make Scope 3 disclosures it can rely on estimates. The Adopting Release states[67]:

We have revised one of the types of potential material impacts listed in the proposal that referenced “suppliers and other parties in [a registrant’s] value chain,” by replacing this phrase with “[s]uppliers, purchasers, or counterparties to material contracts, to the extent known or reasonably available.” This revision is intended to address the concern of some commenters that requiring a registrant to include material impacts to a registrant’s value chain would be overly burdensome to both the registrant and to entities in the registrant’s value chain. The adopted provision is consistent with the Commission’s general rules regarding the disclosure of information that is difficult to obtain, which will apply to the final rules if their conditions are met.  Accordingly, as modified, this provision will help limit the compliance burden of the final rules by eliminating any potential need for registrants to undertake unreasonable searches or requests for information from their value chains.

Registrants are likely to take the SEC’s admonition seriously and avoid imposing Scope 3 burdens on non-registrants.  The SEC wants such burdens to be avoided, and registrants want (or should want) to stay in the good graces of their regulator.

*                        *                                 *

It is possible that the Commission or its staff might provide further insights into this matter through the issuance of guidance, FAQs, or speeches and other public statements.  SEC enforcement actions, if such are brought, will also furnish guidance, as will comment letters from the Division of Corporation Finance.  Other relevant sources of information may be shareholder resolutions and policy positions taken by Institutional Shareholder Services and Glass Lewis.  And, as is the case for any disclosures, issuers will examine what their peers are doing, and many will take measures to stay in step with best practices.

ENDNOTES

[1] David A. Katz and Laura A. McIntosh, Wachtell, Lipton, Rosen & Katz, Corporate Governance Update: ‘Materiality’ in America and Abroad, Harv. L.S. Forum on Corp. Gov. (May 1, 2021), https://corpgov.law.harvard.edu/2021/05/01/corporate-governance-update-materiality-in-america-and-abroad/ ; Advisory Committee on Corporate Disclosure, Report to the Securities and Exchange Commission (November 1977).

[2] The Enhancement and Standardization of Climate-Related Disclosures for Investors, 89 Fed. Reg. 21668 (March 28, 2024,) Final rule: The Enhancement and Standardization of Climate-Related Disclosures for Investors (sec.gov) (hereinafter “Adopting Release” and “Rule” or “Final Rule”).  The citations to the Rule in this article refer to the SEC-issued version, https://www.sec.gov/files/rules/final/2024/33-11275.pdf

[3] The Rule has been challenged in court and a stay entered.   State of Iowa, et al. v. United States Securities and Exchange Commission, No. 24-01522 (8^th Cir Mar. 12, 2024).

[4] U.S. Securities and Exchange Commission, Accelerator Filer and Large Accelerated Filer Definitions (April 23, 2020), SEC.gov | Accelerated Filer and Large Accelerated Filer Definitions.

[5] See Adopting Release at 222.

[6]  Not all Rule requirements include a materiality threshold.  Materiality is not an element of the financial statement footnote disclosure requirement (Article 14 of Regulation S-X) or the governance disclosure requirement (Item 1501(a)).

[7] See Adopting Release at 246.

[8] TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438, 449 (1977).

[9] See Adopting Release at fn. 381, citing 17 CFR 230.405; 17 CFR 240.12b-2; Basic Inc. v. Levinson, 485 U.S. 224 at 231, 232, and 240 (1988); TSC Industries, Inc. v. Northway, Inc., 426 U. S. at 449.

[10] Sullivan & Cromwell, Key implications of SEC’s climate-related disclosure rules for public companies (March 12, 2024), https://www.sullcrom.com/SullivanCromwell/_Assets/PDFs/Memos/Key-Implications-SEC-Climate-Related-Disclosure-Rules.pdf.

[11] We Mean Business et al., Climate transition action plans: activate your journey to climate leadership (October2022). available athttps://www.ceres.org/sites/default/files/reports/2022-11/WMBC-Climate-Transition-Action-Plans.pdf

[12] See Adopting Release at 245.

[13] See generally, Staff Accounting Bulletin 99, https://www.sec.gov/interps/account/sab99.htm.  SAB 99 is heavily relied upon by companies making materiality assessments but, other than making clear that materiality has both quantitative and qualitative aspects, its usefulness is limited in the context of sustainability assessments.

[14] See, e.g., World Economic Forum, How much do investors care about carbon emissions? A new study sheds light (March 20, 2023).

[15] See Adopting Release at 247.

[16] Id. at 246.

[17] SEC Rel. 10890, Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information,

[18] See Adopting Release at 106.

[19] SEC Rel. 10890 at 43.

[20] See Adopting Release at 111.

[21] Id. at 643.

[22] Id. at fn.2787

[23] Davis Polk, “Amid storm of controversy, SEC adopts final climate disclosure rules” (2024), available at: https://www.davispolk.com/insights/client-update/amid-storm-controversy-sec-adopts-final-climate-disclosure-rules

[24] TSC v. Northway at 448.

[25] The U.S. Supreme Court also explained in United States v O’Hagan, 521 U.S. 642, 672 (1997) that “[a] prophylactic measure, because its mission is to protect, typically encompasses more than the core activities prohibited.”

[26] Prof. Jill Fisch, et al, Comment Letter (June 6, 2022),  https://www.sec.gov/comments/s7-10-22/s71022-20130354-297375.pdf

[27] Id. at 124, 146.  See also, Commissioner Allison Herren Lee, Living in a material world: myths and misconceptions about materiality” (May 24 2021), SEC.gov | Living in a Material World: Myths and Misconceptions about “Materiality”

[28] Business Roundtable, The Materiality Standard for Public Company Disclosure: Maintain What Works,  https://www.businessroundtable.org/archive/resources/the-materiality-standard-public-company-disclosure-maintain-what-works

[29] See Adopting Release at 631.

[30] See generally, Janine Guillot, Materiality: The Word that Launched a Thousand Debates (May 13, 2021), https://sasb.ifrs.org/blog/materiality-the-word-that-launched-a-thousand-debates/

[31] See Adopting Release at 52.

[32] Ceres, Analysis shows that investors strongly support the SEC’s proposed climate disclosure rule (Oct. 11, 2022), https://www.ceres.org/news-center/blog/analysis-shows-investors-strongly-support-secs-proposed-climate-disclosure-rule

[33] BlackRock, Comment Letter (June 17, 2022), s71022-20132288-302820.pdf (sec.gov)

[34] Vanguard, Comment Letter (June 17, 2022),  s71022-20132302-302834.pdf (sec.gov)

[35] State Street, Comment Letter  (June 17,2022), Covington & Burling Letter Template (statestreet.com)

[36] Fidelity, Comment Letter (June 17, 2022),  s71022-20132177-302674.pdf (sec.gov)

[37]  For example, Federated Hermes said: “We consider the requirement to disclose scopes 1 and 2 emissions, and material upstream and downstream scope 3 emissions, to be the foundational component of the suggested rule that creates significant positive impacts… We are confident this disclosure will contribute to informed capital allocation and business decisions, resulting in improved value creation and risk mitigation for investors.” Wellington Management commented: “With clear and comparable Scope 1 and Scope 2 GHG Emissions, as would be required under the Proposal, investors can better assess current operational efficiency, particularly within peer groups, to identify issuers who are more insulated from (or more exposed to) transition risks. With this information, investors can identify which companies within carbon-intensive industries would be most resilient in terms of margin impact to the introduction of a carbon price, other transition-oriented policy, or structural shifts from carbon-based energy production.” Available at: SEC.gov | Comments on Proposed rule S7-10-22

[38] Allison H. Lee, Living in a material world: myths and misconceptions about materiality, supra n. 29.

[39] Allison H. Lee (March 12, 2024). Expert Perspective: SEC’s Final Climate Rule Unveiled [Webinar]. Persefoni, [On-Demand] Expert Perspectives: SEC’s Final Climate Rule Unveiled – Persefoni

[40] John Coffee, Unpacking the SEC’s Climate-Related Disclosures: A Quick Tour of the Issues (March 29, 2022), https://clsbluesky.law.columbia.edu/2022/03/29/unpacking-the-secs-climate-related-disclosures-a-quick-tour-of-the-issues/

[41] See A.A. Sommer, Jr., The Slippery Slope of Materiality (Dec. 8, 1975), https://www.sec.gov/news/speech/1975/120875sommer.pdf

[42] Wellington Management, Comment Letter (June 17, 2022),https://www.sec.gov/comments/s7-10-22/s71022-20131856-302305.pdf

[43] Other investors also gave examples of how climate-related information impacted their decision making.  Here for example is what Manulife Investment Management said in its comment letter:  s71022-20131967-302426.pdf (sec.gov)

“…when considering a potential investment in a steel company, with strong financial statements and a robust outlook for growth, we may go through a due diligence appraisal that will look at the issuer’s scope 1 and scope 2 emissions and evaluate against peers with similarly available data. This evaluation may show that the issuer is producing significantly higher emissions than peers. When considered against a likely future price on carbon in the issuer’s market, our modelling may then demonstrate that the issuer’s projected profit margins will shrink significantly. The issuer will no longer have the upside we first considered, and we may adjust our position.”

[44] TSC v. Northway at 449, quoting Mills v. Electric Auto-Lite, 396 U.S. 375, 384 (1970).

[45] Robert Jackson, SEC’s new climate rule [Webinar]. Watershed (March 13, 2024), available at:  Rob Jackson, former commissioner, on the SEC’s new climate rule on Vimeo

[46] Hester Peirce, Comm’r, U.S. Sec. & Exch. Comm’n, We are NOT the Securities and Environment Commission – At Least Not Yet (Mar. 21, 2022), https://bit.ly/3viMw7r

[47] George Georgiev, The SEC’s Climate Disclosure Rule: Critiquing the Critics, 50 Rutgers L. Rec, 101, 126 (2022).

[48] Basic v. Levinson, 485 U.S. 224 (1988)

[49] Texas Gulf Sulphur, 401 F.2d at p. 864

[50] Wasim, Note, Corporate Non-Disclosure of Climate Information,119 Columbia Law Rev. 5 https://columbialawreview.org/wp-content/uploads/2019/06/Wasim-CORPORATE_NONDISCLOSURE_OF_CLIMATE_CHANGE_INFORMATION.pdf   CITE

[51] Mark Specht, “Both Utilities and Fossil Fuel Companies are to blame for western wildfires” May 16 (2023), available at: Both Utilities and Fossil Fuel Companies Are to Blame for Western Wildfires – Union of Concerned Scientists (ucsusa.org)

[52] Release No. 33-9106, Commission Guidance Regarding Disclosure Related to Climate Change (February 2, 2010).

[53] See generally, K&L Gates, Some Liability Considerations Relating to ESG Disclosures (May 1, 2017),

https://www.klgates.com/Some-Liability-Considerations-Relating-to-ESG-Disclosures-05-01-2017.

[54] Macquarie Infrastructure Corp. v. Moab Partners, L.P., Sup. Ct. Docket 22-1165 (April 12, 2024).  CITE

[55] Sullivan & Cromwell, supra note 13.

[56] Commission Guidance Regarding Disclosure Related to Climate Change, Release No. 33-9106 (Feb. 2, 2010) [75 FR 6290 (Feb. 8, 2010).

[57] Adopting Release at 415.

[58] Business Roundtable, The Materiality Standard for Public Company Disclosure: Maintain What Works (October, 2015), https://s3.amazonaws.com/brt.org/archive/reports/Materiality%20White%20Paper%20FINAL%2009-29-15.pdf.

[59] http://sasb.ifrs.org/company-use/sasb-reporters/

[60] See Adopting Release at 256.

[61]Id.

[62] See, e.g., comment letters from Brown Advisory’s Sustainable Investing Business, Minnesota State Board of Investment, California Public Employee’s Retirement System, Veris Wealth Partners, Illinois State Treasurer, Kepos Capital, southside Bancshares.  SEC.gov | Comments on Proposed rule S7-10-22

[63] Rob Jackson, SEC’s new climate rule [Webinar]. Watershed. (March 13, 2024), Rob Jackson, former commissioner, on the SEC’s new climate rule on Vimeo

[64] Allison H. Lee (March 12, 2024). Expert Perspective: SEC’s Final Climate Rule Unveiled [Webinar]. Persefoni.[On-Demand] Expert Perspectives: SEC’s Final Climate Rule Unveiled – Persefoni

[65] Debevoise & Plimpton, “An in-depth analysis of the SEC’s climate-related disclosure rules” March 15, (2024), available at: an-in-depth-analysis-of-the-secs-climate-related.pdf (debevoise.com)

[66] Eric Gerding, The New Era of Transparency: A Briefing on the SEC’s Climate Disclosure Rule (April 8,2024), available at: The New Era of Transparency: A Briefing on the SEC’s Climate Disclosure Rule (youtube.com)

[67] Adopting Release at p. 117 (footnotes omitted)

This post comes to us from Tom Riesenberg, senior regulatory advisor to Ceres, a sustainability advocacy nonprofit that works on financial regulatory matters relating to climate change.