In this episode Partner  Bridget Moore and host  Megan Berge discuss President Biden's May 20 Executive Order on Climate-Related Financial Risks and what companies subject to disclosure requirements need to know now. For more information or assistance with these issues, please contact  Bridget Moore or host  Megan Berge.

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SEC Response

  • Within weeks of her January 21, 2021 appointment as SEC Acting Chair, Allison Herren Lee  created a new ESG-focused position within the Office of the Acting Chair.  Satyam Khanna, the first Senior Policy Advisor for Climate and ESG, will advise on ESG matters and advance related initiatives across the SEC. 
  • On February 24, 2021, Lee  directed the staff of the Division of Corporation Finance to "enhance its focus on climate-related disclosure in public company filings."  Aiming to update the  SEC's 2010 interpretive guidance regarding climate change, Lee instructed staff to review the extent to which public companies have addressed the topics mentioned in the guidance and to "assess compliance with disclosure obligations under the federal securities laws, engage with public companies on these issues, and absorb critical lessons on how the market is currently managing climate-related risks."
  • Acting Chair Lee's focus on ESG is not new.   Criticizing the SEC's failure to address ESG in its 2020 amendments to Regulation S-K, then-Commissioner Lee remarked in August 2020: "It has never been more clear that investors need information regarding, for example, how companies treat and value their workers, how they prioritize diversity in the face of profound racial injustice, and how their assets and business models are exposed to climate risk as the frequency and intensity of climate events increase."  In a November 2020 speech, entitled " Playing the Long Game," Lee reiterated that "regulatory involvement is needed to achieve standardized, comparable, and reliable disclosure in this critical area."
  • On March 4, 2021, Acting Chair Lee launched a  new Climate and ESG Task Force within the SEC's Division of Enforcement. This Task Force is charged with "develop[ing] initiatives to proactively identify ESG-related misconduct" and coordinate Division resources to "mine and assess information across registrants to identify potential violations."  Led by Acting Deputy Director of Enforcement Kelly L. Gibson, the Task Force will initially focus on identifying "material" gaps or misstatements in issuer disclosures of climate risks under existing rules, while also analyzing "disclosure and compliance issues relating to investment advisers' and funds' ESG strategies."  A Division-wide effort composed of 22 SEC staff, the Task Force is expected to work closely with the Divisions of Corporation Finance, Investment Management, and Examinations.
  • On March 15, 2021, Acting Chair Lee  requested public input on the Commission's disclosure rules and guidance as they apply to climate change disclosures, whether and how they should be modified, and how the Commission can best regulate climate change disclosures.  Most recently, Acting Chair Lee called for changes to shareholder proxy voting disclosures that would incorporate "soaring demand" for ESG investment strategies and revamp an "unwieldy, difficult to understand" system in a  speech to the Investment Company Institute on March 17, 2021.
  • Acting Chair Lee's interest in enhanced ESG disclosure also follows on the heels of a  recommendation by a subcommittee of the SEC's Investor Advisory Committee in May 2020, which urged the SEC to earnestly consider "an effort to update the reporting requirements of [SEC registered] Issuers to include material, decision-useful ESG factors." The subcommittee's recommendation maintained that the time has come to address this issue now, after close to 50 years of contemplation in one form or another.
  • On March 22, 2021, the SEC launched an (ESG) investing resource page on its website. According to the Commission's announcement, the new  resource page will pull together agency actions, along with the latest information about ESG investing. "Our all-of-SEC approach looks at how climate and ESG intersect with our broader regulatory framework to get investors the information they need to plan for their financial future," SEC Acting Chair Allison Herren Lee said in a statement announcing the new resource page. 
  • On April 9, 2021, the SEC's Division of Examinations issued a Risk Alert regarding the Division's review of ESG investing. The Risk Alert provides insight into the SEC's perspective on the "potential violations" referred to in the SEC's announcement of the Task Force on March 4, 2021. The Division's Risk Alert focuses on the accuracy and consistency of disclosures, marketing claims, and other public statements; the application of ESG approaches throughout firms; the adequacy of ESG policies and procedures; compliance oversight; and the sufficiency of ESG-related documentation. The Risk Alert describes a number of problematic practices the Division has observed in recent examinations of investment advisers, registered investment companies, and private funds offering ESG products and services. The document also lays out several effective practices that these firms should consider.  https://www.sec.gov/files/esg-risk-alert.pdf
  • Gary Gensler, the newly appointed Chair of SEC, will support the initiatives put in place by Lee.
  • While the SEC's ESG initiatives reach beyond climate change, it will be the "E" in ESG that will be the focus of rulemaking and enforcement, at least in the short term. This is because the groundwork related to the potential materiality related to climate change has been laid.    Specifically, in its 2010 guidance on climate change disclosures, the SEC noted that climate change can be relevant under a variety of existing rules and regulations, such as Regulation S-K itemized requirements for business narrative, legal proceedings, risk factors, and management discussion and analysis. Contemporary legislative and regulatory developments regarding climate change led to the SEC reiterating the need to disclose potential corresponding risks under Regulation S-K.
  • Many commentators have suggested that carbon emissions are an appropriate measurement of an entity's contribution to climate change and therefore are likely to drive asset pricing.  Notably, the 2010 guidance indicated that political developments regarding climate change can create opportunities and risks that might require disclosure in an issuer discussion of risk factors or MD&A.  Here, the SEC guidance observed that political trends, among other things, may create indirect consequences or business opportunities stemming from changes in consumer demand for goods that reduce greenhouse gas emissions.  Political or social trends may also generate reputational damage, the SEC said, based on "the public's perception of any publicly available data relating to its greenhouse gas emissions." Under the 2010 guidance, such reputational risks should be considered for risk factor disclosure.

SEC Disclosure Review

  • The Division of Corporation Finance has issued relatively few comment letters relating to climate disclosures since the 2010 guidance was promulgated. Those comment letters have generally focused on the sufficiency of risk factor disclosure related to climate change and materiality assessments for MD&A disclosure.  As to risk factor disclosure, comment letters have ranged from more general requests to add a climate change risk factor—or explain why one is unnecessary—to more detailed requests regarding potential compliance obligations under proposed regulations. For MD&A disclosure, some comment letters have highlighted inconsistencies between the discussion of climate risks in proxy statements and third-party environmental reports.  For example,  one comment letter addressed the adequacy of MD&A disclosures related to climate risks by pointing to the company's Carbon Disclosure Project (CDP) report that emphasized potential regulatory risks.  That report, according to the comment letter, was largely inconsistent with an earlier proxy statement which minimized those risks.  The comment letter therefore requested an explanation of the materiality assessment for the failure to address this discrepancy in the company's MD&A disclosures in its Form 10-K.
  • Regarding ESG more broadly, the Division of Investment Management has engaged with registrants through the comment letter process for registration statements relating to mutual funds and ETFs that discuss the role of ESG-related data in their investment decisions.  Demands for funds to consider ESG-related data have risen among private equity investors, and some funds have sought to explain the role of such data in their registration statements.  SEC comment letters in 2020 revealed an emerging trend toward demanding more detailed information regarding the role of ESG-related data in investment decisions as well as the sources of that data.
  • Recent comment letters have focused on whether and how funds rely on third-party providers to generate their ESG-related data. Letters have asked registrants, among other questions, whether investments are selected by reference to ESG indices, third-party rating organizations, or proprietary ESG-related screens.  Reflecting a focus on the use of third-party ESG data, the SEC has asked funds to identify those third-party providers, to summarize their criteria or methodology in generating ESG data, and to identify potential related risks.  Other areas of focus in comment letters have centered on how funds define ESG, specific ESG areas of focus, and whether ESG plays a predominant role in decision making.
  • The ESG filing correspondence from Investment Management provides insight into the areas that Corporation Finance might inquire in carrying out its recent directive to enhance its focus on climate-related disclosure and ESG more broadly.  In conducting its heightened review of ESG disclosure, the Division of Corporation Finance might use a framework previously used by its Office of Global Security Risk ("OGSR"), which has been folded into its general filing review team.  OGSR reviewed undisclosed business activities in U.S.-sanctioned countries.  For years, the OGSR engaged with companies based on publicly available information—including news articles and their own websites—which implied ongoing or past business activities in sanctioned countries.  When those activities were not disclosed in public filings, Corporation Finance used comment letters to gather more information.  More specifically, those letters asked for: (1) a description of the "past, present, and anticipated contacts" with sanctioned countries; and (2) a discussion of the materiality assessment for those undisclosed business activities in "quantitative terms" and "qualitative factors" that a reasonable investor would deem important.
  • The SEC Staff can be expected to raise questions in comment letters about ESG-related factors when comparing disclosures in filings, particularly MD&A and Risk Factor disclosures, to Issuers' marketing materials, social media, website and news articles.  If an issuer has self-published ESG reports, Division staff may seek enhanced information regarding how that data was compiled and the underlying methodologies employed using third-party reporting standards, including materiality assessments.  Indeed, failure to disclose the underlying methodologies may lead to Corporation Finance asking about materiality assessments in both quantitative and qualitative terms.
  • Also, based on a recent speech by Acting Chair Lee, the Division of Corporation Finance may inquire about political spending.  Speaking before the Center for American Progress  on March 15, 2021, Acting Chair Lee asserted that political spending disclosure is linked to ESG issues based on research suggesting that some companies made climate pledges while contributing to the campaigns of political candidates with contradictory voting records.  While acknowledging that the SEC "is currently prevented from finalizing a rule in this area," she emphasized the need to consider whether investors can "adequately test" ESG commitment claims "without political spending disclosure requirements."

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