Ever since March 2022, when the SEC released its proposed climate change disclosure guidelines, observers and commentators have watching and waiting to see when the agency would release its final disclosure rules. But in the meantime, important developments elsewhere may mean that many companies may face climate change-related disclosure requirements regardless of the shape the SEC’s final guidelines take. As I noted (here), in July, the European Union adopted its first set of sustainability reporting standards, which will have extensive impact both within and outside the EU. Now, the California legislature has adopted two far-reaching climate-related disclosure bills, which could affect thousands of companies – both public and private, and both within and outside California – and that together could, as the Wall Street Journal put it, represent “among the biggest changes in corporate disclosure in decades.”
The first of the two California bills is Senate Bill 253, the Climate Corporate Data Accountability Act, which would require greenhouse gas (GHG) emissions data disclosures, inclusive of Scopes 1, 2, and 3 emissions, by all business entities (public or private) doing business in California and with annual total revenues in excess of $1 billion. The companion bill, Senate Bill 261, captioned Greenhouse gases: climate-change related financial risk, which would apply to companies doing business in California and with annual revenues of $500 million, would require companies to prepare reports disclosing their climate related financial risk. The two bills together have been referred to as California’s Climate Accountability Package.
According to a press release issued earlier this year by the legislators who introduced the proposed legislation, the goal of the two bills is to “improve transparency, standardize disclosures, align public investments with climate goals, and raise the bar on corporate action to address the climate crisis. At a time when anti-science sentiment is riving strong pushback against responsible business practices like risk disclosure and ESG investing, these bills leverage the power of California’s market to continue the state’s long tradition of setting the gold standard on environmental protection for the nation and the world.”
The two bills will not become law unless and until signed by California Governor Gavin Newsome; however, Newsome has publicly stated that he will sign the bills. According to data cited by Cydney Posner in a post on the Cooley law firm’s PubCo blog, it is estimated that SB 253 will apply to about 5,300 companies, and that SB 261, with its lower annual revenue reporting threshold, will apply to apply to over 10,000 companies.
SB 253 would require the California Air Resources Board to develop and adopt regulations requiring “reporting companies” to publicly disclose the Scopes 1, 2 and 3 GHG emissions to an “emissions reporting organization” engaged by the state to receive the disclosures and make them publicly available on a reporting platform. A “reporting entity” business organization organized under the laws of any U.S. state that does business in California and has revenues over $1 billion. The annual GHG disclosures are to commence in 2026 with respect to Scopes 1 and 2; disclosures with respect to Scope 3 emissions (that is, emissions both upstream and downstream in a company’s value chain) commence in 2027. Under the bill, a reporting entity would be required to obtain assurance, performed by an independent third-party assurance provider, of the entity’s public disclosure and provide a copy of the assurance report to the emissions reporting organization. The state board is required under the bill to adopt regulations that authorize it to seek administrative penalties for violations of the bill’s provisions in an amount not to exceed $500,000 per year.
SB 253 goes beyond the SEC’s proposed rules in several ways. Perhaps most significantly, SB 253 would apply to both public and private companies, whereas the SEC’s proposed rules would apply only to public companies. In addition, while the SEC’s proposed Scope 3 emissions reporting requirements are subject to materiality test, there is no materiality element to SB 253’s Scope 3 emissions requirement. The SEC’s rule also exempts smaller reporting companies from Scope 3 emissions disclosure requirements, whereas SB 253 would require all reporting entities to report Scope 3 emissions.
SB 261 requires that on or before January 1, 2026, and every two years after that, a “covered entity” must prepare a report disclosing both its “climate-related financial risk” and the measures the entity has adopted to reduce and adapt to the disclosed climate-related financial risk. A covered entity is a business entity organized under the laws of any U.S. state with revenues in excess of $500 million and that does business in California. A climate-related financial risk is “material risk of harm to immediate and long-term financial outcomes due to physical and transition risks, including, but not limited to, risks to corporate operations, provision of goods and services, supply chains, employee health and safety, capital and financial investments, institutional investments, financial standing of loan recipients and borrowers, shareholder value, consumer demand, and financial markets and economic health.”
A variety of business groups actively opposed the California legislation, and, as according to the Wall Street Journal article to which I linked above, the legislation could be challenged in court or even by a referendum that opponents could put before voters. However, while legal challenges seem likely, the cumulative effect of the EU guidelines, the California legislation, and the pending SEC guidelines does seem to suggest, as one commentator quoted in the Wall Street Journal article put it, “In one shape or another, these disclosure requirements are coming.”
Even assuming for the sake of conversation that the bills go into effect consistently with the legislation’s own timeline, there will be many questions. Undoubtedly, questions will arise whether or not a given firm is or is not “doing business” in California – in fact, neither of the laws define “doing business in California.” In addition, companies reporting pursuant to the laws’ requirements may struggle to obtain data necessary to comply with reporting requirements, particularly with respect to Scope 3 emissions requirements. Indeed, the need for various entities to supply data to allow reporting companies to comply with disclosure requirements will create strains up and down the “value chain.”
While there are many things to worry about for companies required to make disclosure pursuant to these new requirements, one particular concern I have with respect to the new requirements is that the company disclosures (or omissions) could create heightened litigation risks. For starters, any disclosure requirement creates a context within which disclosure or omissions can be alleged to be misleading or deceptive. The obligation for companies to disclose their financial risk associated with climate change also creates a context within which companies experiencing setbacks owing to, for example, extreme weather events, could be subject to hindsight claims that prior disclosures failed adequately to disclose the risks the company faced.
Another risk arises from the fact that companies may face a natural tendency to want to try to put the best face on companies’ GHG status and progress. The possibility for litigation arises out of these kinds of circumstances is not just theoretical; as noted here, this past summer Delta Airlines was sued a securities lawsuit by a shareholder in a class action lawsuit alleging that the company’s claims of “carbon neutrality” were false and misleading.
All of that said, the one thing California’s adoption of these new disclosure requirements does for sure is to reinforce the conclusion that ESG is a broad, challenging, complex topic that will continue to challenge for companies and their insurers – and it is about to get even more challenging and complex.