On March 21, 2022, the SEC proposed rules that would require publicly reporting companies to include certain climate-related disclosures in their registration statements and periodic reports. Among other information, the new disclosures would require information about greenhouse gas emissions (GHG), climate-related risks that are reasonably likely to have a material impact on a company’s business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to its audited financial statements.
The proposed rules are enormous in scope, complexity, and ramifications with a polarizing comment response largely along party lines. The comment period ended June 17, 2022, after a relatively short, but necessary extension by the SEC. Despite the controversy, there is no doubt that the rules, even if somewhat modified, will be passed and public companies need to start preparing now. The recently published Reg Flex Agenda indicates we should see final rules in October 2022. The rules will require compliance with extraordinarily granular complex disclosures that are beyond the expertise of attorneys and accountants. Companies will need to engage third-party experts and/or staff up in-house to not only comply with the disclosure requirements but also to carry out and monitor the necessary risk management and transition plans that accompany the new disclosures.
In the first blog in this series, I provided some background and an introduction to the rules (see HERE). The second provided a high-level summary of the proposed rules including the phase in compliance schedule (see HERE). The third blog in the series discussed the disclosures of climate-related risks (see HERE). The fourth moved on to disclosures regarding climate-related impacts on strategy, business model and outlook (see HERE). The fifth blog in the series delved into risk management and transition plan disclosures (see HERE.)
The sixth blog provided an overview of the extremely complex financial statement metrics requirements (see HERE.) This seventh blog in the series will cover GHG emissions disclosures and Scope 1 and 2 attestations.
Scope 3 emission disclosures are a huge point of contention. In a comment letter written by the National Federation of Independent Business, small businesses are pleading with the SEC to eliminate the Scope 3 provisions. These businesses, such as family-owned farmers, restaurants, small manufacturers, distributors, logistics companies, health care, gas stations, convenience stores, home builders, etc… would be disqualified from doing business with larger companies as they simply could not afford the legal, third-party consultant and accounting compliance costs. Small and medium-sized companies that would never consider going public but that provide the lifeblood of American family-owned businesses and jobs, could be forced out of business completely.
The comment letter, among more than 3,400 received by the SEC, was signed by a who’s-who roster of business associations including the National Association of Egg Farmers, the National Restaurant Association, the National Association of Convenience Stores, the National Association of Home Builders, and the National Association of Manufacturers, among others. The very real concern is economic devastation.
GHG Emissions Disclosures
Proposed new Subpart 1500 to Regulation S-K will require the following GHG disclosures for the company’s most recently completed fiscal year: (i) Scopes 1 and 2 GHG emissions metrics, separately disclosed: (a) both by disaggregated constituent greenhouse gas emissions and in the aggregate, and (b) in absolute and intensity terms; and (ii) Scope 3 GHG emissions and intensity, if material, or if the company has set a GHG emissions reduction target or goal that includes its Scope 3 emissions.
Under the rules, “greenhouse gases” include carbon dioxide (“CO2”); methane (“CH4”); nitrous oxide (“N2O”); nitrogen trifluoride (“NF3”); hydrofluorocarbons (“HFCs”); perfluorocarbons (“PFCs”); and sulfur hexafluoride (“SF6”). GHG emissions categories are defined as:
Scope 1 – Direct GHG emissions from operations that are owned or controlled by a company.
Scope 2 – Indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a company.
Scope 3 – All indirect GHG emissions not otherwise included in a company’s Scope 2 emissions, which occur in the upstream and downstream activities of a company’s value chain.
The proposed rules would require a company to disclose information about its direct greenhouse gas (GHG) emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). In addition, a company would be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3), if material or if the company has set a GHG emissions target or goal that includes Scope 3 emissions.
For Scope 3 emissions, the rule release includes a list of certain upstream and downstream activities. Upstream activities include: (i) purchased goods and services; (ii) capital goods; (iii) fuel and energy related activities not included in Scope 1 and 2 emissions; (iv) transportation and distribution of purchased goods, raw materials, or other inputs; (v) waste generated; (vi) business travel by employees; (vii) commuting by employees; and (viii) leased assets related to purchased or acquired goods or services.
Examples of downstream activities include: (i) transportation and distribution of a sold product, good or other output; (ii) third-p arty activities related to processing products that were sold, using products that are sold or end of life treatment of sold products; (iii) leased assets related to sale or disposition of goods or services; (iv) franchises; and (v) investments.
Obviously, it will be difficult to obtain Scope 3 information since the company would not own or control such third party. The SEC rule release suggests a company can influence the receipt of information by choosing to work with suppliers that gather and provide the necessary information. Also, since the information is from a third party, the proposed rules would provide a safe harbor for liability from Scope 3 emissions disclosure.
As mentioned, Scope 3 emissions disclosures are only required if material (not prescriptive) or if the company has set a GHG emissions reduction target or goal that includes such Scope 3 emissions. Materiality, as always, is determined by whether there is a substantial likelihood that a reasonable investor would consider it important when making an investment or voting decision. The SEC rule release makes it clear that it believes Scope 3 emissions will be material more often than not and provides specific examples, such as for the auto industry and agricultural sectors.
Scope 3 GHG emission disclosures would be subject to securities law safe harbor provisions, and they would not be considered fraudulent under such law unless there was no reasonable basis to make or reaffirm them or they were provided other than in good faith. Smaller reporting companies are exempt from the Scope 3 emissions disclosure requirement.
For each emission Scope, a company would be required to disclose gross emissions (before consideration of any purchased or generated offsets) (i) disaggregated by each GHG (carbon dioxide, methane, nitrous oxide, nitrogen trifluoride, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride) and (ii) on an aggregated basis by using carbon dioxide equivalents (“CO2e”). A company would also be required to disclose GHG intensity in terms of tons of CO2e per unit of revenue and per unit produced for the total of Scope 1 and Scope 2 GHG emissions and separately for Scope 3 GHG emissions. If a company does not have revenue or production, the company would be required to disclose another measure of GHG intensity.
Further, a company may disclose additional measures of GHG intensity if it discloses that such metric was used and why it is useful to investors. The proposed rule would permit a “reasonable estimate” for fourth-quarter GHG emission disclosures in the absence of current available data as long as the company discloses any material differences between the actual versus estimated GHG emission data in its next filing. Within its annual report, a company would be required to disclose any material changes between the method or significant assumptions used in the calculations in the current period and those used in historical periods. Information about GHG emissions would be required for the most recently completed fiscal year and, if reasonably available, would need to be provided for the historical periods presented within a company’s financial statements.
For each Scope emissions disclosure, a company will need to include its significant inputs and assumptions as well as the method it used to perform the corresponding calculations. While the proposed rule does not prescribe a specific method for GHG emission calculations, a company would have to disclose the approach it used, including the use of any material, third-party data, calculation tools, and organizational and operational boundaries. It would also need to disclose any data gaps and whether proxy data or another method has been used to address such gaps. Any year-over-year changes in methods or assumptions would also need to be disclosed.
GHG emissions disclosed under the proposed rule must reflect all emissions for consolidated subsidiaries and the company’s share of GHG emissions for investments for which the company applies either proportional consolidation or the equity method of accounting. Any entities not consolidated, proportionally consolidated, or accounted for under the equity method would be reflected in the Scope 3 GHG emission disclosures.
The SEC believes the proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol (i.e., GHG Protocol). However, several commenters have noted that while many aspects of the proposed rule are consistent with the GHG Protocol, the treatment of subsidiaries and affiliates is not. Currently the GHG Protocol allows a company to define control as either an economic interest or operational control, whereas the proposed SEC rules do not include operational control. Accordingly, companies that currently report under the GHG Protocol for operationally controlled subsidiaries would need to amend their approach such that Scope 1 and 2 would only include those subsidiaries for which financial statements are consolidated and operationally controlled affiliations would become Scope 3.
If a company discloses Scope 3 GHG emissions, it would be required to describe the categories of upstream and downstream activities included in the calculation and provide separate Scope 3 GHG emission disclosures for each significant category. Further, the proposed rule explicitly states that a company would be required to consider outsourced activities that it previously conducted as part of its own operations when measuring Scope 3 GHG emissions. A company can also provide a range for its Scope 3 GHG emissions “as long as it discloses its reasons for using the range and the underlying assumptions.”
A company would be required to disclose the data it used to calculate its Scope 3 GHG emissions, including any of the following:
- Emissions reported by parties in the company’s value chain, and whether such reports were verified by the company or a third party, or unverified.
- Data concerning specific activities, as reported by parties in the company’s value chain.
- Data derived from economic studies, published databases, government statistics, industry associations, or other third-party sources outside of a company’s value chain, including industry averages of emissions, activities, or economic data.
Attestation of Scope 1 and Scope 2 Emissions Disclosures
Under the proposed rule changes, accelerated filers and large accelerated filers would be required to include an attestation report from an independent attestation service provider covering Scopes 1 and 2 emissions disclosures. Initially the attestation would require limited assurance with a phase-in over time to require reasonable assurance. In particular, in fiscal years 2 and 3 after the Scope 1 and 2 compliance date, limited assurance may be provided and in fiscal years 4 and beyond, reasonable assurance must be provided.
A company’s financial statement footnote disclosures would be subject to existing audit requirements with an added level of attestations for the Scope 1 and Scope 2 emissions. Also, any voluntary Scope 3 assurance would be subject to the same requirements and the same attestation standards as Scope 1 and Scope 2. While the proposed rule does not prescribe specific attestation standards, it imposes certain minimum requirements for those standards, including that they be publicly available, established with appropriate due process, and subject to public comment.
Under the proposed rule, a GHG emissions attestation provider would have to be: (i) an expert in GHG emissions that performs engagements in accordance with professional standards; (ii) has significant experience in measuring, analyzing, reporting and attesting to GHG emissions; and (iii) independent from the company. The GHG attestation report must include specific information such as the attestation standard used, management’s responsibility for the information, and the attestation provider’s responsibility. The company would also be required to provide additional disclosures, including those related to the attestation provider’s (i) licensing or accrediting information and (ii) record-keeping obligations, as well as whether the attestation engagement is subject to an oversight inspection program. In essence, the attestation provider will be subject to standards consistent with those issued by the AICPA and PCAOB.
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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