The staff of the Division of Corporation Finance (“Staff”) of the U.S. Securities and Exchange Commission (“SEC”) published a sample comment letter on climate change disclosures on September 22, 2021. A brief statement that precedes the sample comment letter reiterates the view expressed in the SEC’s 2010 interpretive guidance that a variety of existing SEC disclosure rules may require companies to disclose the current and potential future material impacts of climate change on the company’s business and financial condition and performance. The Staff has been conducting an extensive review of climate change disclosure and compliance in Form 10-K reports. When the Staff has questions about a company’s climate change disclosures it has sent a comment letter to the company, and the sample comments reflect the Staff’s experience during this review, which is ongoing. The sample comment letter highlights the importance of a thorough review of company disclosures about climate change and related issues, both in SEC filings and in materials such as Corporate Social Responsibility (“CSR”) reports that companies prepare and post to their websites.
What Companies Should Do Now
The sample comment letter highlights three areas of a company’s climate change disclosures that they should focus on: disclosures in SEC filings; disclosures in CSR reports and other non-filed materials; and how a company’s disclosure controls and procedures apply to climate change disclosures. We suggest that companies review the sample comments in the next section of this alert and consider the following points:
Disclosure Compliance in SEC Filings. How does the disclosure about climate change impact the company’s compliance in SEC filings with existing disclosure rules, especially considered in light of the specific interpretations provided by the SEC in the 2010 interpretive guidance? As the 2010 guidance discussed in detail, many existing SEC disclosure rules may require disclosure about the impacts of climate change on the company, if material. These include the following parts of a Form 10-K report:
- Item 1, Business: the material impacts of climate change, which could include (for example) impacts on the company’s products or services, its geographical markets, competitive conditions in the company’s industry and the material impact of governmental regulation on the company;
- Item 1A, Risk Factors: the material risks that the company faces from climate change impacts;
- Item 3, Legal Proceedings: the impact of material pending legal proceedings; and
- Item 7, Management’s Discussion and Analysis: the material impacts of climate change on the company’s financial condition and performance, as well as disclosure of potentially material impacts of known trends, events and uncertainties related to climate change.
We recommend that companies evaluate existing climate change impacts, including known trends and uncertainties, and review their recent disclosures in light of current SEC rules and the 2010 interpretive guidance. Companies with September 30 and December 31 fiscal year ends should begin this process as soon as possible, so that the upcoming Form 10-K report can reflect the results of the company’s review. Our client alert on the 2010 interpretive guidance may be helpful.
Disclosures in Other Company Materials. Are the statements about climate change in other company materials accurate? What internal procedures apply to preparation and review of these materials? Do these materials get legal and/or financial review, when appropriate? Are the statements about climate change in these materials consistent with the statements in the company’s SEC filings? What disclaimers and/or cautionary statements are appropriate for materials that are not filed with the SEC? Has the company reviewed the statements in its CSR report and other website materials with an understanding that the anti-fraud provisions in Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 apply to such statements? It is becoming increasingly common for companies to make statements about their efforts and plans to deal with climate change, as well as other environmental, social and governance (“ESG”) matters in various publications and other public materials. In many cases, these materials are the responsibility of investor relations or marketing groups, rather than the finance, accounting and legal groups that prepare and review SEC filings, and may not be subject to the company’s disclosure controls and procedures. Companies should consider the answers to the questions at the beginning of this paragraph and respond as appropriate.
Third Party Service Providers. Does the company have procedures that govern who will provide information on climate change and other CSR matters to third parties? In addition to an increasing volume of materials prepared by companies for various uses other than SEC filings, companies are becoming involved with an increasing number of third party service providers who prepare reports on the company’s ESG/CSR status and achievements. For example, many companies have issued “green bonds,” which are debt securities issued by the company with an undertaking to use the proceeds of the offering to fund projects that meet specific standards, some of which are directly related to climate change. These offerings typically include an affirmation by the company that it will engage a third party (often the company’s independent auditor) to attest that the company used the proceeds in the manner described in the offering documents. Another example is reports prepared by third parties that provide ESG scores or ratings used by institutional investors. These present risks that are similar to the risks summarized in the preceding paragraph.
The Sample SEC Comments
The full text of the sample comments published by the SEC is reproduced below. The sample letter expressly refers to “compliance with the topics addressed” in the 2010 SEC interpretive guidance. The sample comment letter requests that the company respond in writing to the comments. If the company receives one of these comment letters, the company should address the applicable specific 2010 guidance in its response letter, taking into account the amendments to several of the sections of Regulation S-K that have been made since 2010. This includes the Business, Risk Factors, Legal Proceedings and MD&A sections of the company’s Form 10-K report. The company should also remember that the staff comment letter and the company’s responses will become public. Company letters responding to Staff comments should be prepared with future online public access in mind.
1. We note that you provided more expansive disclosure in your corporate social responsibility report (CSR report) than you provided in your SEC filings. Please advise us what consideration you gave to providing the same type of climate-related disclosure in your SEC filings as you provided in your CSR report.
2. Disclose the material effects of transition risks related to climate change that may affect your business, financial condition, and results of operations, such as policy and regulatory changes that could impose operational and compliance burdens, market trends that may alter business opportunities, credit risks, or technological changes.
3. Disclose any material litigation risks related to climate change and explain the potential impact to the company.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
4. There have been significant developments in federal and state legislation and regulation and international accords regarding climate change that you have not discussed in your filing. Please revise your disclosure to identify material pending or existing climate change-related legislation, regulations, and international accords and describe any material effect on your business, financial condition, and results of operations.
5. Revise your disclosure to identify any material past and/or future capital expenditures for climate-related projects. If material, please quantify these expenditures.
6. To the extent material, discuss the indirect consequences of climate-related regulation or business trends, such as the following:
- decreased demand for goods or services that produce significant greenhouse gas emissions or are related to carbon-based energy sources;
- increased demand for goods that result in lower emissions than competing products;
- increased competition to develop innovative new products that result in lower emissions;
- increased demand for generation and transmission of energy from alternative energy sources; and
- any anticipated reputational risks resulting from operations or products that produce material greenhouse gas emissions.
7. If material, discuss the physical effects of climate change on your operations and results. This disclosure may include the following:
- severity of weather, such as floods, hurricanes, sea levels, arability of farmland, extreme fires, and water availability and quality;
- quantification of material weather-related damages to your property or operations;
- potential for indirect weather-related impacts that have affected or may affect your major customers or suppliers;
- decreased agricultural production capacity in areas affected by drought or other weather-related changes; and
- any weather-related impacts on the cost or availability of insurance.
8. Quantify any material increased compliance costs related to climate change.
9. If material, provide disclosure about your purchase or sale of carbon credits or offsets and any material effects on your business, financial condition, and results of operations.
On the Horizon
It is very likely that the SEC will propose new, specific disclosure requirements related to climate change matters before the end of 2021. ESG disclosures, and particularly climate change, human capital, and diversity disclosure, are among the most prominent and most sensitive disclosures that companies make today. In many cases, the broad range of company groups that are involved in various types of ESG and climate change disclosure present a greater challenge than many other types of company disclosure for content generators. At the same time, the number of content consumers, and the importance of ESG and climate change disclosure to these content consumers, requires companies to manage these disclosures well.
In late July 2021, SEC Chair Gary Gensler outlined some rulemaking considerations in a public statement. Among others, these included requirements related to the location of the new climate change disclosure; new qualitative disclosure requirements; new quantitative disclosure requirements, especially in light of the desire that company disclosures should be comparable among different companies; industry-specific disclosure requirements; and scenario analysis that could show how companies might respond to a range of potential changes, including risks related to climate change.
In March 2021, the SEC announced the formation of an Enforcement Division task force focused on climate change and other ESG issues. While to date the SEC has not announced an enforcement action initiated by the task force, the 22 member task force will likely initiate an enforcement action in the near-term.
The current review of climate change disclosure across a broad spectrum of public companies is one result of the SEC’s focus on climate change issues and disclosures. The proposed disclosure rules that are anticipated before the end of this year are another result. As noted above, ESG matters, and especially climate change, are a very significant focus for many investors, consumers, suppliers and regulators in the U.S. and the rest of the world. Change is clearly coming to disclosures about these topics, and companies should be prepared so they are ready for these changes.