FILE – The seal of the U.S. Securities and Exchange Commission at SEC headquarters, June 19, 2015, … [+]
When the U.S. Securities and Exchange Commission adopted the highly anticipated Climate-Related Disclosure Rule in March, it was met with fanfare from the financial industry. It was also met with a series of legal challenges, from both supporters and opponents, questioning the validity of the new rule. As a result, the SEC quickly delayed the implementation of the rule indefinitely while the courts settled the question. However, the financial industry largely ignored the stay, continuing to push the narrative that the rule was in place and companies needed to move forward with compliance.
As international focus on climate change increased in the wake of the Paris Agreement, there has been a simultaneous increase in pressure on businesses to be more accountable for their climate and environmental policies. This translated into a rise in environmental, social, and governance reports and sustainability reports created by companies to attempt to showcase their green initiatives.
Around 2020, the production of these reports became standard practice by both publicly traded and privately held companies. However, there was no standardization of content. Companies could include what they wanted, from environmental policies to LGBTQ+ initiatives. This lack of standardization was problematic, especially as ESG was becoming a factor in financial reporting and investment strategy.
Regulators scrambled to create sustainability reporting standards. In 2021, the International Sustainability Standards Board drafted the International Financial Reporting Standards Foundation’s Sustainability Disclosure Standards. IFRS is an independent, nonprofit organization that develops financial reporting standards, including international accounting standards. IFRS is not used in the U.S., who uses generally accepted accounting principles, also known as GAAP, but is used in 132 jurisdictions. The IFRS Standards were adopted in June 2023 as the global standard for sustainability and climate change reporting, including greenhouse gas emissions.
In March 2022, the SEC proposed the development of a climate-related reporting standards. The final rule, adopted on March 6, 2024, required large publicly traded companies to disclose climate action, GHG emissions, and the financial impacts of severe weather events. The rule was initially set to go into effect in 2026.
According to the SEC’s estimates, the required reporting costs will be high. For S-K amendments, compliance is estimated to be $327,000 for the first year and $183,000 for the following years. For GHG Scope 1 and Scope 2 emissions, the cost is estimated to be $151,000 for the first year and $67,000 annually. For amendments to Regulation S-X, the first-year cost is estimated to be $500,000 and $375,000 annually. Assurance of emissions disclosures is estimated to run between $50,000 and $150,000.
In other words, a lot of money is going to be spent to comply with the SEC rule. That also means there is a lot of money to be made. That is why consulting, advisory, and tech companies in this area are continuing to push for compliance. Workovia’s annual conference in September has a significant focus on climate-related disclosures and ESG. They are not alone. EY is encouraging clients to move forward with compliance.
What happens next with the SEC climate-related disclosure rule is still in question. Legal minds may disagree, but, in my opinion, the SEC’s rule will never go into effect. At least not the current version.
Five notable cases were filed against the SEC in the wake of the rule: Iowa v. SEC, Petition for Rev., Energy Company Litigation, West Virginia v. SEC, and Sierra Club v. SEC. Conservative states argue the rule is an overstep of authority. The Sierra Club argues it did not go far enough. Eventually, the various legal challenges will be combined to be heard before the Supreme Court of the United States as one case.
Typically, a court will consider pausing the enactment of a rule while they review it. Rather than waiting on the court, and risking an on-again off-again scenario, the SEC took the initiative and voluntarily paused the enactment of the rule until the courts issue a final opinion. That will take time.
For a comparative timeline, consider West Virginia v. Environmental Protection Agency. That case was initially filed June 2019 in the D.C. Circuit Court. Oral arguments were not heard until October 2020. The Court issued its opinion in January 2021. In October 2021, West Virginia, along with 18 other states, filed a challenge of the D.C. Court ruling. Oral arguments were held before SCOTUS in February 2022. The final opinion that struck down the EPA’s rule was issued on June 30, 2022, three years after the initial legal challenge.
West Virginia v. EPA also gives insight into how this court may rule on the SEC Climate-Related Disclosure Rule. In that case, the Court was asked if the EPA had the authority to devise certain GHG caps under the authority granted to them by Congress in the Clean Air Act. The Court found 6-3 that the EPA had exceeded its authority and invalidated the rule.
The case wasn’t about climate change or the need to take action. It was about who has the authority to create the regulation. Congress creates laws. However, Congress isn’t great with the details. Congress is just too cumbersome, so they pass broad legislation then delegate the drafting of the details to administrative agencies, like the EPA and the SEC. Those agencies are only allowed to act within the limits of the authority delegated to them by Congress.
Interpretation of that authority varies and sometimes the law isn’t well written. The current SCOTUS has taken a narrow approach in interpreting the delegation of authority. Repeatedly, they have found that an administrative agency has exceeded its authority in the passing of a rule. Simply, if you want a new law, go talk to Congress.
In my opinion, it is highly likely that this Court will find the SEC overstepped its authority. However, it could be 2026 before the case gets before SCOTUS. In the meantime, the rule will be paused.
There is also a presidential election to consider. If Donald Trump defeats Joe Biden, then the Trump administration could roll back the rule, possibly making the argument moot. If Biden wins reelection, there is a possibility the SEC will create an alternative rule with different standards.
ESG, sustainability, and climate change will continue to be a major factor in business. However, in my opinion, preparing for a rule that may never go into effect is the wrong focus. Alternatively, there are two areas where U.S. companies to be placing their focus: greenwashing and the European Union.
Over the past year, there has been a notable increase in litigation and regulatory action relating to greenwashing, or the exaggeration of climate-friendly and other environmental actions by a company in marketing materials. Historically, this hasn’t mattered. A company highlighting minor environmentally friendly actions to make themselves look better was standard practice.
However, with the global focus on climate change, regulators and climate activists have started to challenge those claims. Companies are being investigated under consumer protection laws and being sued for statements made in marketing materials and sustainability reports. This is happening in jurisdictions around the world, even those without regulations directly aimed at greenwashing. Notably, the EU is currently drafting strict greenwashing legislation that could become the global standard.
The EU, through the European Green Deal, is leading in all areas of climate-change related regulation. Their new policies will have an impact on U.S. companies. The Corporate Sustainability Reporting Directive, a reporting standard similar to the SEC rule, will apply to U.S. companies that operate in the EU and will require companies that do businesses with EU companies to supply information for the EU company’s reports. The Corporate Sustainability Due Diligence Directive, that created a new legal liability for climate change and human rights, will hold EU companies accountable for the actions of their suppliers. The greenwashing directives will most likely impact any business that markets to EU residents. Depending on the final language, that has the potential to have a long reach. The Nature Restoration Directive will impact supply chains in the U.S.
Admittedly, I have positioned my legal practice to make money on climate-related disclosures, sustainability, and other ESG regulations. I don’t read 200-page regulations or write for Forbes just for fun. However, I have an obligation to my clients to advise them honestly, even if that means I make less money. It would be unethical for me to encourage clients to spend hundreds of thousands of dollars to comply with a rule that may never go into effect.
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