ESG Administrative Actions in the United States Under the Biden Administration

On March 21, 2022, the SEC proposed a rule that would enhance and standardize public company climate disclosures. The proposed rule would require issuers to disclose information regarding: (1) the company’s governance of climate-related risks and risk management process; (2) any material impact that climate-related risks are likely to have on the company’s business and financial statements; (3) how climate-related risks are likely to affect the company’s strategy, business model, and outlook; (4) the impact of climate-related events and transition activities on the company; and (5) the company’s greenhouse gas (GHG) emissions. With regards to GHG, the rule would require disclosure of direct emissions (Scope 1) and indirect emissions related to electricity or other energy purchased by the company (Scope 2). Additionally, companies “would be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3), if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.” Certain companies (accelerated and large accelerated filers) would be required to include an independent attestation report addressing their Scope 1 and 2 disclosures. According to the SEC, “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.”

The proposed Climate Disclosure Rule has received thousands of public comments. While many commentators have supported much of the rule, others have been vocal in raising concerns. Key criticisms have included concerns that:

•The proposed rule does not address the increased liability risk created by the new disclosure requirements.

•The Scope 3 disclosure requirements are unduly burdensome.

•The requirement that companies disaggregate and disclose the financial impacts of climate-related impacts and expenditures if they exceed 1% of any financial statement line item is unduly burdensome and based on vague terms and definitions.

•Certain of the disclosure requirements are not tied to materiality.

•The attestation requirement is overly burdensome (given concerns about the supply, quality, and costs of such attestations).

On March 4 2024, the SEC (in a 3-2 vote) approved new climate disclosure rules that are less stringent than the initial proposal, focusing on how public companies should report climate risks and greenhouse gas emissions. The revised rules require large companies to disclose emissions from their operations if deemed "material," but have eliminated the requirement to report Scope 3 emissions across their value chain. Smaller businesses are largely exempt from GHG reporting, a change from the original proposal that sought disclosures from all publicly traded companies. You can find the SEC’s fact sheet summarizing the rule’s key provisions here. Additionally, numerous law firms, consulting firms, and Fintechs have put out their own guides to the new rules as well.

The SEC Disclosure rule requires registrants to disclose board and management oversight and material climate related impacts and risks. Larger registrants will also be required to report Scope 1 and 2 GHG emissions if they are deemed by the company to be material, which eventually will be subject to certain assurance requirements. Also, if registrants have undertaken risk mitigation/transition activities, set climate-related targets/goals, used scenario analysis to determine climate risks are likely to be material, or used internal carbon prices in a material way, they will be required to disclose details regarding these issues as well. The rules further require certain financial statement disclosures related to the costs of severe weather events, subject to de minimis thresholds. A number of aspects of the final rule are built on the TCFD reporting framework and the GHG protocol.

Some key differences between the final SEC rule and the Commission’s original proposal include: (1) eliminating a Scope 3 reporting requirement; (2) tying Scope 1 and 2 reporting to a company’s determination that the information is material; (3) eliminating a requirement to report on board members’ climate experience; (4) softening the disclosure of the impact of severe weather, transition activities, and natural conditions so that it does not need to appear in each line item of the company’s financial statement; (5) allowing companies to report climate information later in the year (at the time of their second quarter reports); (6) elimination of a quarterly update requirement; and (7) additional phase-in flexibility.

Despite the SEC's compromises when adopting the final climate disclosure rule, a coalition of 10 republican led states have sued the Commission to overturn the rule -- filing a petition in the 11th Circuit Court of Appeals in Atlanta. When the Commission’s staff was asked whether the SEC rule would preempt the recent California climate disclosure legislation, they responded that the rule does not expressly preempt state climate rules -- but whether implied preemption could apply would be determined by the courts on a case-by-case basis.

On May 25, 2022, the SEC proposed a rule that would (if adopted) require funds with particular characteristics to invest 80% of its assets in investments suggested by their name. This would impact not only “ESG” funds, but other funds who describe asset classes in their names (e.g., “value” and “growth”). Commentators supporting the rule have stated that the rule promotes investor protection by clarifying information about an investment company’s investments and risks. Critics have expressed concerns that the definition of a “characteristic” is ambiguous as this terminology describes investment strategies and philosophies rather than specific investments and that continual compliance with the 80% rule poses additional challenges with market volatility. The final rule was adopted by the SEC in September of 2023.

On May 25, 2022, the SEC proposed a rule that (if adopted) would require ESG-Focused Funds, Impact Funds, and Integration Funds (that integrate ESG and non-ESG factors in making investment decisions) to make a variety of disclosures supporting their strategies. The greater a fund’s ESG focus, the greater the reporting requirement would be. For example, under this proposal, ESG-Focused funds would need to provide a table that: (1) provides an overview of the fund’s ESG strategy, (2) explains how the fund incorporates ESG factors in its investment decisions, and (3) describes how the fund votes proxies and/or engages with companies about ESG issues. Additionally, ESG-Focused Funds that consider environmental factors in their strategies would be required to disclose both their carbon footprint and the weighted average carbon intensity (WACI) of their portfolio. Environmentally focused funds would also be required to disclose the financed Scope 3 emissions of its portfolio companies (to the extent that the portfolio companies report such information).

According to the SEC, final action for the Fund Disclosure Rule was anticipated for October 2023, though the agency is now targetting April 2024. By requiring companies to provide additional information regarding ESG investment practices, sraised concernsupporters of the rule say it will create an ESG regulatory framework that will help inform and protect investors. Critics, however, have raised concerns that a failure to comply with this rule could place a fund under SEC scrutiny even if undisclosed information was not material to the investment strategy.

The SEC is considering other potential rules and regulations addressing social and governance issues, – including rules relating to board diversity, human capital management, and executive pay versus performance.

The Division of Examinations listed ESG as one of its key priorities in both 2021 and 2022.  In its 2022 Examination Priorities, the Division stated that it would continue focusing on ESG-related advisory services and investment products and whether they are: (1) accurately disclosing their ESG investment approaches and implementing policies and procedures designed to prevent ESG disclosure violations, (2) abiding by their proxy voting policies and voting in line with their ESG-related disclosures/mandates, and (3) engaging in green washing by overstating or misrepresenting the ESG factors incorporated into portfolio selection. In its 2023 Examination Priorities, the Division reaffirmed its focus on ESG-related advisory services and fund offerings, and the need to ensure that ESG products are appropriately labeled and that advisors’ recommendations of such products to retail investors are made in the investors’ best interest.

These priorities followed up on an April 2021 Report issued by the Division where the examination staff raised concerns about:

•Portfolio management practices that “were inconsistent with disclosures about ESG approaches;”

•Controls that “were inadequate to maintain, monitor, and update clients’ ESG-related investing guidelines, mandates, and restrictions;”

•Proxy voting that “may have been inconsistent with advisers’ stated approaches;”

•Claims regarding ESG approaches that were “[u]nsubstantiated or otherwise potentially misleading;”

•Controls that were inadequate “to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices;”

•Compliance programs that “did not adequately address relevant ESG issues,” and compliance personnel who “had limited knowledge of relevant ESG-investment analyses or oversight over ESG-related disclosures and marketing decisions;” and

•“[W]eaknesses in compliance controls regarding performance metrics included in marketing materials,” and a lack of compliance review of the underlying data.

In March 2021, the SEC’s Department of Enforcement created a 20+ person Task Force on Climate and ESG issues. The Task Force was charged with developing “initiatives to proactively identify ESG-related misconduct,” focusing first on “material gaps or misstatements in issuers’ disclosure of climate risks” and “disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.”

In October 2021, the Department of Labor published a proposal to reverse the Trump Administration’s rules restricting the use of ESG factors by ERISA fiduciaries when selecting investments and engaging in proxy voting (and instead explicitly permit the consideration of these factors).

On December 1, 2022, DOL published its final rule titled: “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.” The rule allows retirement plan fiduciaries “to consider climate change and other environmental, social and governance factors when they select retirement investments and exercise shareholder rights, such as proxy voting.” According to the Secretary of Labor: “Today’s rule clarifies that retirement plan fiduciaries can take into account the potential financial benefits of investing in companies committed to positive environmental, social and governance actions as they help plan participants make the most of their retirement benefits . . . .”

Among other things, the new rule specifically:

1) Clarifies “that a fiduciary's duty of prudence must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis,” which “may include the economic effects of climate change and other ESG considerations on the particular investment or investment course of action.”

2) Makes it easier for fiduciaries to apply the “tiebreaker test,” which permits the consideration of collateral benefits other than investment returns (such as ESG factors) in situations where competing investments equally serve the financial interests of the plan.

3) Adds a “provision clarifying that fiduciaries do not violate their duty of loyalty solely because they take participants' non-financial preferences into account when constructing a menu of prudent investment options for participant-directed individual account plans.”

4) Revises proxy voting rules by removing provisions that made it easier for advisors not to vote on shareholder proposals.29

5) Removes special rules for Qualified Default Investment Alternative Provisions (QDIAs), so that they now are treated like other investments.

The rule’s provisions were meant to be effective on January 30, 2023 (except for certain proxy voting provisions that will go into effect in December 2023 to allow investment managers more time to review proxy voting policies and guidelines).

In March 2023, Congress passed legislation to overturn the DOL rule, which President Biden vetoed. Additionally, the DOL rule has faced a number of lawsuits, specifically Utah v. Walsh (filed in Texas by 25 Red State Attorneys General and three private plaintiffs) and Braun v. Walsh (filed in Wisconsin by two private plaintiffs). In September 2023, a Trump-appointed district court judge dismissed the state AG’s lawsuit and upheld the DOL rule. This decision has been appealed to the Fifth Circuit.