Above Board: How Will the SEC Approach a New Framework for Climate Disclosures?

MoFo Perspectives Podcast

27 Apr 2021

In this episode of the Above Board podcast, Morrison & Foerster partner and host Dave Lynn speaks with Alfredo (“Fredo”) Silva, San Francisco partner and co-chair of the firm’s Social Enterprise and Impact Investing Group, on the SEC’s possible future implementation of a global framework for climate disclosures and the potential ESG disclosure implications for public companies. Fredo and Dave touch on why the SEC has recently sought input on implementing a framework for climate change disclosures and formed a Climate and ESG Task Force, the guidance and rules already in effect, and what public companies and their boards of directors should be thinking about with respect to climate and ESG disclosure.


Speaker: Welcome to MoFo Perspectives, a podcast by Morrison & Foerster, where we share the perspectives of our clients, colleagues, subject matter experts, and lawyers.

Dave Lynn: Hello, this is David Lynn. I’m a partner in the Washington, D.C. office of Morrison & Foerster, and I’m very pleased to be joined by my partner Fredo Silva who is based in the San Francisco office of Morrison & Foerster. Today, we’re going to talk about a topic that is really front and center for public companies and their boards of directors. And that is the area of climate change disclosure. With the shift in the political winds in Washington, the SEC now appears to be focused on climate change disclosure, as well as environmental and social disclosure, more broadly, really seeing that as a top priority. And over the past few months, we’ve seen what I think are just the first steps of a process that the SEC is undertaking to reconsider the disclosure framework. Fredo, why has the SEC sought input on implementing a global framework for climate change disclosures and gone to the effort of creating a climate ESG task force?

Alfredo Silva: Yeah, there are a lot of reasons for that, Dave. I’ll start by saying that Allison Herren Lee, who was, up until recently, the agency’s acting chair, has stated a desire to standardize disclosures across industries and even acknowledge that there may be advantages to developing a single set of global standards applicable to companies around the world. And this is sort of the baseline for implementing this request for feedback. Some of the background for this is shareholder pressure. As Lee noted, investors are saying that the information on these issues is quite material to them and their decision making, but they’re simply not getting what they need. Part of this is from inconsistency of practice among companies where there’s a lack of standardized and precise definitions for climate measurements and other ESG definitions. And that can create its own risks where investors may be thinking that a measure for one company is comparable to measure for another.

Alfredo Silva: I think, for example, adjusted EBIDA could mean one thing for one company and one thing for another and not create an apples-to-apples comparison. There’s also inadequate disclosure. So the Brookings Institution, for example, noted that between 2009 and 2010, while there was a 78% increase in climate change-related references in 10Ks for companies on the Russell 3000, the largest volume of that info is skewed towards select industries, mostly in oil, utilities, gas, mining, those kinds of industries. And the disclosure is focusing on a narrow set of risks rather than the broader set of climate‑related and even ESG information that investors are looking to get. This also presents the potential for what we would call greenwashing, where companies that don’t necessarily have the best climate or ESG impact or results, nevertheless, have more resources, and so are able to put out disclosures and sort of win the race simply by having more data that they can churn out, even if the data is not necessarily the best. So the sum of this all is that the current voluntary disclosure approach is not providing the market the actionable data that it needs. And the commission is looking to find a way to solve that issue.

Dave Lynn: Yeah. A couple of the initiatives that have been announced by the Commission over the past few months have included directing the Division of Corporation Finance to look at climate change disclosures in public company filings and having an enforcement-oriented task force look for potential violations that arise from climate or environmental disclosures, which raises, I think, the inevitable question is, what guidance or rules are really out there to apply in this context and what should companies be thinking about when they’re drafting their disclosures?

Alfredo Silva: Yeah, so right now, there are some rules, but there’s not a lot. And I think that’s the driver for this task force and for implementing a potential framework. But what companies need to be focusing on now is of course the guidance that’s in place right now. So the basic idea is the general longstanding principle of materiality and disclosure. You know 10b-5, right? Making sure that if an issuer is disclosing information, that that disclosure is accurate and not misleading. So in this voluntary disclosure framework that we have right now, if you are going to disclose issues around climate and ESG, that you are making sure that you are treating that disclosure with the same level of scrutiny as you would any other information that appears in your 10K or proxy, making sure it’s gone through the same procedures to verify the accuracy and that you’re not omitting any information that would make it misleading.

Alfredo Silva: There is a little guidance out there that is specific to climate disclosure. There was an interpretive release in February of 2010 that talks about disclosure as relates to climate focused mostly on risk factors and climate risk, as well as how you might describe what the board is considering and what’s material to the company in the business section, but this isn’t setting forth a mandatory framework regarding data, which is, I think, more, what folks are looking at is coming down on the horizon. That’s just not there right now. And that interpretive release really does follow mostly these materiality and accuracy and not misleading principles under 10b-5 anyway. So there have been recent rules changes to Reg S-K and as part of the S-K modernization efforts that do note that the SEC considered climate change issues when making those S-K changes. But there haven’t actually been any direct climate-related changes to form—Reg S-K. What we do have are some changes relevant to ESG, however, so for example, the human capital management disclosures that are now required, but nothing just yet on climate.

Dave Lynn: Yeah. When you think about the task that the SEC has in front of it on this topic, there are really a range of options that they might consider going from the sort of status quo, a current voluntary reporting approach that we generally have, to some sort of mandatory reporting under single standard for the types of disclosure that should be provided. How do you think the SEC’s likely to approach this issue and what frameworks or tools or standards might they consider adopting?

Alfredo Silva: So if I were them and thinking like a securities lawyer and what I would want to do, I think that the first thing is you’re going to want to have whatever new framework you implement, have it expand on or really clarify regs under the existing framework. Obviously, you want to have it be consistent. In fact, I think Kelly Gibson, who’s the head of the SEC’s Climate and ESG Task Force they recently formed, last week indicated that while they’re going to base their priorities on the evolution of investor demands in addressing these changes, they will be working off of existing rules and guidance. So I’m not expecting that there’s going to be anything earth shattering in terms of shifting the way that the SEC deals with disclosure issues generally. Part of that, I think, is because the SEC is not going to want to be seen as having knee-jerk reactions or being responsive to the hot topic of the day, given that they’re trying to promulgate rules that have general applicability over the long term to a lot of issues.

Alfredo Silva: So for example, if they were to have rules that talked about global warming, those who quickly become stale given now we talked about climate change. If they were to promulgate rules talking about CSR, corporate responsibility, that would be the wrong acronym because now, while we still have that, people are very focused right now on ESG, environmental, social, and governance issues. So making sure that the rules have general applicability and are talking about general principles, I think, is going to be very important so that they can be mindful and thoughtful about standards changing over time and updating. Even accounting standards do and the rules accommodate that. With respect to standards, in speaking of accounting standards, the SEC tends not to actually mandate standards. They do tend to leave that up to third parties like the securities exchanges or the PCAOB.

Alfredo Silva: So it seems unlikely to me that they will actually mandate specific standards, even as they’re reaching out, to think about a global framework. I’m guessing that they may be more likely to require disclosure around standards that a company has adopted. So, for example, if a company decides that they’re going to measure themselves against the TCFD or SASB, that they will then provide disclosure about that, not to say that they’re doing it, but actually show how, or they may adopt a comply-or-explain framework, where they’re not going to mandate that you follow particular standards at an organization, but provide that if you don’t, then you have to explain why you haven’t and sort of shame companies into adopting a framework and then disclosing. That said, the SEC could always decide to promote a specific framework. And there are several out there that are in the running that it has mentioned in the past.

Alfredo Silva: So there’s the Task Force on Climate-Related Financial Disclosures, or TCFD; there’s a Sustainability Accounting Standards Board, which I mentioned earlier, SASB; there’s the Climate Disclosure Standards Board, CDSB; and then there are others like the Global Reporting Initiative, or GDI, and the Carbon Disclosure Project, or CDP. This is really an alphabet soup of acronyms. And it really begs a question of which one would they adopt if they were going to promote a specific framework. It’s not a clear answer. TCFD seems to be getting the most support among investors and global financial regulators. New Zealand, for example, has introduced legislation to try to adopt that as a reporting standard for its public companies. The U.K. and Switzerland have also made noises about supporting that one. But as the name suggests, it’s the Task Force on Climate-Related Financial Disclosures. It’s climate focused, right? And so it may not be the best framework for promoting ESG generally. Perhaps the Sustainability Accounting Standards Board, SASB, might be more appropriate for ESG. And so the very fact that these standards really have different focuses begs the question of why the SEC or whether the SEC should decide that climate is of unique importance compared to ESG more broadly. And whether one or more of these particular frameworks is one that they should mandate adoption as opposed to a different kind of framework.

Dave Lynn: Yeah. I believe one gating issue that really needs to be considered and some of the comments we’ve heard from members of the commission and from the staff definitely highlights the fact that it is being considered is, do you go the approach of looking towards a global framework for climate reporting by public companies, or would the SEC sort of do a “go it alone” strategy where they think that they can do it better than others and create their own standards or adopt standards that aren’t a global standard? I guess that raises the question, should there be a global framework for climate reporting by public companies?

Alfredo Silva: Yeah, I think that’s a similar question to should there be a global framework for accounting reporting, right? The U.S. uses GAAP, and the rest of the world seems to be moving to IFRS, and that’s already its own issue. So going it alone is something we’ve done in the past, and Americans and American agencies don’t have a huge problem doing that depending on the context, but as far as climate reporting, I really think that this depends who you ask. I think ideally if we were going to implement a global standard, that consistency could enable better comparisons between companies and therefore create competitive dynamics around managing climate and other ESG risks where investors can go ahead and invest in the companies that they feel are better managing these issues based on those apples-to-apples comparisons. On the other hand, that kind of framework may not be appropriate or relevant to all issuers. For some issuers, just climate may not be particularly meaningful, or maybe they have other focuses that are more meaningful compared to other ESG risks for example.

Alfredo Silva: This kind of reporting also adds a lot of costs that some companies may not be able to afford, especially the smaller public companies. And it may well be that there needs to be either a phase in or scale disclosures depending on size, whether you’re a smaller reporting company or versus <inaudible>, for example. I do think that the alternative approach about providing guidance indicating that if you do adopt a standard, whether TCFD or some future implemented global standard, or maybe it will be TCFD that becomes a global standard, just being more transparent about it. So if you say that you adhere to a framework, address how you perform against it standards and being more internally consistent from a report to report, instead of—we do see a lot of issuers out there right now that sometimes will use one standard one year and then kind of have a different approach or talk about it in a different way the next year, just, I think, ensuring more consistency and applying robust internal controls to ensure the disclosure accurate is something that the SEC is probably going to focus more on in the near term and might achieve more bang for the buck than trying to spend a lot of time coming up, either with our own framework or coming up with this global framework. Focusing more on what issues we’re doing right now might be a better use of the SEC’s resources. Again, it really depends on who you’d ask.

Dave Lynn: Where do you think this leaves us for ESG disclosure and ESG considerations for public companies generally, and what should directors be thinking about now as a result of all this?

Alfredo Silva: So climate is really just one area of ESG. It’s a really important area. And for many people for a lot of reasons is the most important area, but it is quite conceivable that the SEC may promulgate guidance that covers or could be applied to ESG more generally, rather than just climate in particular. So we’ll see how that plays out, but that’s my guess as to how this may end up. I would note that ESG is somewhat covered already. Again, you’re required to make environmental disclosure in your business section or risk factors, to the extent relevant. HCM disclosures, the Human Capital Management disclosures, are now required as part of the AP modernization. That could fall into the social element of the “S” in ESG. And corporate governance disclosure requirements tend to fall under the “G,” the governance standard of ESG. So there already are some required disclosures under the ESG framework, but whatever standards or guidelines the SEC may adopt with respect to climate reporting, I do hope will be drafted in a way that it will apply to other ESG elements as well, and not just focus solely on climate.

Alfredo Silva: I would say that as far as directors should be thinking about this, most companies, I think, have already started providing ESG disclosures in their 10K and in their proxy and proxy season is drawing to an end right now. So what I would say is for right now, if you are voluntarily disclosing any aspect of ESG factors beyond what the current rules really require, just be sure that you are doing so with thoughtfulness around materiality, around accuracy, and consistency in that if you are going to be disclosing this voluntarily under the current voluntary regime, that it’s information that investors can rely on, there aren’t material emissions, and you’re applying the same standards to that information that you are to anything else that goes in your proxy or 10K.

Dave Lynn: Great, thank you, Fredo, for all those insights. And thank you for joining me today.

Alfredo Silva: Thanks, Dave.

Speaker: Please make sure to subscribe to the MoFo Perspectives podcast so you don’t miss an episode. If you have any questions about what you heard today, or would like more information on this topic, please visit mofo.com/podcasts. Again, that’s, MoFo, M-O-F-O.com/podcasts.



Unsolicited e-mails and information sent to Morrison & Foerster will not be considered confidential, may be disclosed to others pursuant to our Privacy Policy, may not receive a response, and do not create an attorney-client relationship with Morrison & Foerster. If you are not already a client of Morrison & Foerster, do not include any confidential information in this message. Also, please note that our attorneys do not seek to practice law in any jurisdiction in which they are not properly authorized to do so.