US Securities Litigation Perspective
Enhanced Focus by SEC and Investors on Climate-Related Disclosures
As part of President Biden’s whole-of-government approach to confronting climate change, the U.S. Securities and Exchange Commission (“SEC”) has prioritized ESG -related matters. SEC Chair Gary Gensler recently remarked that investors increasingly want to understand the climate risks and workforces of the companies in which they invest. Gensler has asked the SEC staff to propose new disclosure rules related to climate risk and human capital, including workforce and corporate board diversity, by the end of 2021. A prescriptive disclosure framework will likely lead to increased litigation and enforcement.
Existing Principles-Based Disclosure Framework
Any examination of the SEC’s forthcoming ESG disclosure rules must start with existing regulations that affect US issuers.
Item 303 of Regulation S-K requires that registrants disclose known trends and other material information in securities filings. In doing so, it follows the principles-based “materiality” disclosure regime that generally governs disclosure matters for US issuers.
In February 2010, the SEC published interpretative guidance to Regulation S-K to advise when a registrant might be required to disclose the impact of climate change (the “2010 Guidance”). The SEC noted that climate change disclosures could factor into, among other areas, the registrant’s description of its business, legal proceedings, risk factors, and management’s discussion and analysis sections of securities filings. The SEC also provided the following specific examples of climate change-related topics that a registrant should consider disclosing: (1) the impact of legislation and regulation regarding climate change; (2) the impact of treaties or international accords relating to climate change on its business; (3) the indirect consequences of regulation or business trends, including legal, technological, political and scientific developments regarding climate change that may create new opportunities or risks for registrants; and (4) the significant physical effects of climate change that may have the potential to affect a registrant’s operations and results.
On February 24, 2021, then-Acting SEC Chair Allison Herren Lee requested that the SEC’s Division of Corporation Finance scrutinize companies’ climate disclosures for adherence to the 2010 Guidance.6 To that end, on September 22, 2021, the SEC’s Division of Corporation Finance published an “illustrative” Sample Letter containing questions for companies to consider regarding the 2010 Guidance. In releasing the Sample Letter, the SEC reminded companies that the 2010 Guidance may require disclosure related to climate change and stated it might send the Sample Letter to companies regarding their climate-related disclosure or the absence of such disclosure.
The Sample Letter is broken down into three topical sections with respect to climate-related matters:
The SEC asks for explanations as to why expansive disclosures in the company’s corporate social responsibility report are not included in the company’s SEC filings.
The SEC first asks the company to disclose the material effects of transition risks related to climate change that may affect its business, financial condition, and results of operations, such as policy and regulatory changes that could impose operational and compliance burdens, market trends that may alter business opportunities, credit risks, or technological changes. The SEC then requests the company to disclose any material litigation risks related to climate change and explain the potential impact to the company.
Management’s discussion and analysis of financial condition and results of operations
The SEC outlines several topic areas that may require further disclosure, including, if material:
- Pending or existing climate change-related legislation, regulations, and international accords, with a description of any material effect on the company’s business, financial condition, and results of operations;
- Past and/or future capital expenditures for climate-related projects and a quantification of those expenditures;
- A discussion of the indirect consequences of climate-related regulation or business trends, such as:
- decreased demand for goods or services that produce significant greenhouse gas emissions or are related to carbon-based energy sources;
- increased demand for goods that result in lower emissions than competing products;
- increased competition to develop innovative new products that result in lower emissions;
- increased demand for generation and transmission of energy from alternative energy sources; and
- any anticipated reputational risks resulting from operations or products that produce material greenhouse gas emissions.
- The physical effects of climate change on operations and results, which may include the severity of weather, quantification of weather-related damages, the impacts on major customers or suppliers, decreased agricultural production capacity due to drought or other weather-related changes, and weather-related impacts on the cost or availability of insurance;
- Quantification of any increased compliance costs related to climate change; and
- The purchase or sale of carbon credits or offsets and effects therefrom.
The SEC’s Sample Letter serves as yet another reminder that climate change is a priority for the SEC. Companies can expect continued scrutiny and questions from the SEC concerning their existing disclosures while awaiting the SEC’s forthcoming ESG disclosure rules.
The Evolving Regulatory Landscape
In March 2021, the SEC invited public comments on prescriptive climate disclosures. The request for comments set out 15 multipart questions on climate and ESG disclosures, including the following areas that would require additional disclosure:
- How should companies consider disclosing internal governance of climate issues and the impact of climate risk or impact and executive compensation?
- Should climate disclosures be subject to an audit or assessment process or attestation requirement comparable to assurance requirements for financial disclosures?
- Should climate disclosures be subject to specific executive officer certifications?
- Should there be a management sustainability analysis section that is similar to the management discussion and analysis or compensation discussion and analysis?
- How should the SEC address disclosure by private companies in exempt offerings?
The period for public comment closed in June 2021 and the SEC received more than 550 comment letters, three-fourths of which support prescriptive disclosures. Three emerging themes addressed in comments supporting mandatory disclosures include (1) what specific disclosures the SEC should require, such as whether the SEC should require disclosure of Scope 1, 2, and 3 greenhouse gas emissions; (2) where and how issuers should make disclosures, including whether the SEC should require disclosures in a Form 8-K or other SEC report, or in the 10-K annual report; and (3) to what extent the SEC should leverage existing frameworks and standards concerning ESG disclosures, such as those issued by the Task Force on Climate-related Financial Disclosures (“TCFD”) or Sustainability Accounting Standards Board (“SASB”).
In July 2021, the SEC’s Asset Management Advisory Committee (“AMAC”) recommended that the SEC encourage registrants to adopt a disclosure framework for material ESG matters or provide an explanation as to why they have not. The AMAC advised that disclosure frameworks could include (1) those developed by third-party standard setting organizations (like the TCFD); or (2) those developed by an industry group dedicated to ensuring consistent, comparable disclosure of material ESG matters.
It is clear the SEC is determined to develop a comprehensive climate disclosure framework, though it remains unclear exactly what form that framework might take. Companies can expect the disclosure framework to include qualitative and possibly quantitative components. Qualitative components could require companies to explain how they manage climate-related risks and opportunities and how those factors feed into the company’s strategy. Quantitative components could include metrics related to greenhouse gas emissions, financial impacts of climate change, and progress towards climate-related goals.
Litigation and Regulatory Risks
Companies should be aware of their legal and regulatory risks for climate-related disclosures. For one, statements in offering documents are subject to Sections 11 and 12(a)(2) of the Securities Act of 1933, which impose civil liability for material misstatements and omissions in certain offering documents. In addition, Section 10(b) of the Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 prohibit material misstatements and omissions in securities filings and other public statements, including less formal statements like press releases, investor calls and websites. Section 14(a) of the Exchange Act and Rule 14a-9 prohibit material misstatements and omissions in connection with proxy solicitations, under which courts and the SEC have generally applied a negligence standard. Climate-related disclosures may also give rise to liability under state laws, including consumer protection laws.
To date, although litigation relating to climate disclosures is sparse, it is likely to increase given the increasing prevalence and focus on climate disclosures. Companies might find themselves subject to suit for alleged failures to disclose material risks stemming from climate change, such as environmental risks to key assets or supply chain disruptions caused by flooding or wildfires. Or, companies might face allegations of “greenwashing” their disclosures, meaning the company is alleged to have represented its business practices as environmentally friendly when they were not.
Companies might also be subject to enhanced enforcement, as indicated by the September 2021 Sample Letter. Relatedly, in March 2021, the SEC formed a 22-member task force in its Division of Enforcement (the Climate and ESG Task Force) charged with identifying ESG-related misconduct. And in April 2021, the Division of Examinations announced that its 2021 examination priorities would enhance focus on climate-related risks, issuing a Risk Alert noting that “[d]uring examinations of investment advisers, registered investment companies, and private funds engaged in ESG investing, the staff observed some instances of potentially misleading statements regarding ESG investing processes and representations regarding the adherence to global ESG frameworks.”
Best Practices to Reduce Litigation and Enforcement Risks
Companies should consider the following best practices to reduce their litigation and enforcement risks:
Develop internal controls for climate-related disclosures. Companies should develop internal controls, similar to controls over financial reporting, to ensure that climate-related statements are supported by facts and data. Companies should also disclose the basis of projections and explain assumptions with reasonable detail, and utilize estimates, ranges, and aspirational statements when appropriate, that are accompanied by meaningful cautionary language. Further, companies should compare their ESG disclosures made in sustainability or other reports, with those made in SEC filings, and if different, investigate the reason.
Specifically tailor disclaimers to climate-related risks. Companies should consider the specific climate-related risks applicable to their particular circumstances and prepare individualized and detailed cautionary statements tailored to those risks. Cautionary language should be reviewed and updated regularly, warn of specific risks and discuss actual developments relevant to those risks.
Disclose all known material information in voluntary disclosures. Safe harbors for forward looking statements do not protect against false or misleading statements made with actual knowledge that the statement was false or misleading. In April 2021, John Coates, then-Acting Director of the SEC’s Division of Corporation Finance, stated in another context that “[a] company in possession of multiple sets of projections that are based on reasonable assumptions, reflecting different scenarios of how the company’s future may unfold, would be on shaky ground if it only disclosed favorable projections and omitted disclosure of equally reliable but unfavorable projections, regardless of the liability framework later used by courts to assess the disclosures.” Thus, if a company speaks on climate-related issues voluntarily, it must ensure that its statements are neither materially false nor misleading and that such statements do not omit material information.
Canadian Securities Litigation Perspective
Expectations of Canadian Securities Regulators
Increasingly, since 2010 Canadian securities regulators have been focusing attention on the sufficiency of climate-related disclosures by Canadian listed companies.
In October 2010 the Canadian Securities Administrators (CSA), a council of the securities regulators from all of the Canadian provinces and territories, released CSA Staff Notice 51-333 Environmental Reporting Guidance (NI 51-333), providing detailed guidance to reporting issuers on existing continuous disclosure requirements relating to environmental matters under securities legislation. Examples of potential environmental impacts were provided, including interrupted operations, material unplanned costs, licensing and reputational impacts, access to and cost of capital, and the availability and affordability of insurance.
In particular, the guidance advised audit committees, boards, and officers responsible for certifying disclosures to consider the following in fulfilling their oversight functions relating to environmental disclosure:
- Environmental matters that are reasonably likely to impact the issuer’s business and operations in the foreseeable future
- The magnitude, sources and nature of the issuer’s current and anticipated environmental risks and liabilities
- What has been and is likely to be the impact of environmental matters on revenues, expenditures and cash flows
- The impact that environmental matters could have on the company’s financial condition and liquidity
- What assessment has been made by management regarding the materiality to investors about information on environmental matters, and whether the disclosures in the financial statements, MD&A and Annual Information Form (AIF) are consistent with it
In March 2017, as a result of both increased investor interest and domestic and global developments, the CSA announced a project to gather information on the state of climate change disclosure by examining disclosures made by TSX-listed companies regarding risks and financial impacts associated with climate change.10
The results of its review published in August 2019 revealed that despite the guidance provided in NI 51-333, 22% of the issuers sampled made no disclosure whatsoever of any climate-related risks, and 22% provided only boilerplate disclosure. The Staff Notice reporting on the results characterized climate change-related risks as “a mainstream business issue” and reminded issuers that under existing law, they are expected to consider such risks as part of their ongoing risk management and disclose any that are material to their business.11 The Notice provided additional guidance to issuers, their boards and management, to assist them in identifying and determining the materiality of climate change-related risks. This includes undertaking an analysis of the issuer’s exposure to both short and long term risks of climate change, and as part of determining materiality, consideration of how to effectively measure and quantify those risks, whether acute, chronic or transitional.
Current Disclosure Framework
In Canada, all securities law is provincial, and substantially the same across Canada. This discussion will focus on Ontario.
A prospectus is required to be filed with the Ontario Securities Commission (OSC) and a receipt for it issued if a company’s securities are going to be distributed to the public.12 A prospectus is required to provide “full, true and plain disclosure of all material facts relating to the securities issued”. 13 A material fact is one what would reasonably be expected to have a significant effect on the market price or value of the issuer’s securities.14 The prospectus must also include a description of risk factors relating to the issuer and its business, including “general risks inherent in the business carried on by the issuer, environmental and health risks” and “any risk factors material to the issuer that a reasonable investor would consider relevant to an investment in the securities being distributed”.15
If there is a material change in the business, operations or capital of a publicly traded company (or reporting issuer), it must promptly disclose that information in a news release and in a material change report filed with the OSC.16 A change is material if it would reasonably be expected to have a significant effect on the market price or value of the issuer’s securities.17
National Instrument 51-102 Continuous Disclosure Obligations (NI 51-102) also requires reporting issuers to make periodic disclosures of material information in its Annual Information Form (AIF) and Management Disclosure and Analysis (MD&A). The AIF must include risk factors relating to the issuer and its business that would be most likely to influence an investor’s decision to purchase the issuer’s securities.18 The annual MD&A must include risks or uncertainties that the issuer reasonably believes will materially affect its future performance.19
If an issuer includes forward-looking information in its disclosures, it must identify the information as forward-looking, provide cautionary language, state the material factors or assumptions used to develop it, and update any previously disclosed forward-looking information and describe the issuer’s policy for updating it.20
It is an offence to make a statement in any release, report, prospectus or other document required to be filed or furnished under Ontario securities law that is misleading or untrue or does not state a fact that is required to be stated.21
At least in Ontario, recent developments suggest that climate change reporting requirements are expected to become more prescriptive.
In January 2021, the Ontario Capital Markets Modernization Task Force released its final report containing proposals for modernizing securities regulation in Ontario and making Ontario a more attractive capital market destination. Its recommendations include mandating disclosure of material ESG information, “specifically climate-change-related disclosure that is compliant with the TCFD recommendations for issuers through regulator filing requirements of the OSC”. The requirements would apply to all reporting issuers except investment funds and include disclosure of Scope 1, Scope 2 and, if appropriate, Scope 3 greenhouse gas emissions on a “comply or explain’ basis. There would be a transitional phase for issuers to comply with the new requirements.22
In May 2021, draft legislation23 was introduced into the Ontario Legislature which, if enacted, would amend the Act to require issuers and reporting issuers to conduct climate-related risk assessments (involving an analysis of the risks stemming from the impact of climate change as they relate to the issuer in the context of specified scenarios) in order to identify material facts and material changes.24
Litigation and Regulatory Risks
Failure by an issuer to comply with its disclosure obligations either by failing to make a required disclosure, or by making a statement in any release, report, prospectus or other document required to be filed or furnished under Ontario securities law that is misleading or untrue or does not state a fact that is required to be stated is a breach of the Act.25 A breach can provide the basis for proceedings by the Commission under s. 127 of the Act that could lead to sanctions including a fine of up to $1 million per breach and a an order cease trading its securities. Directors and officers also can be sanctioned if they authorized, permitting or acquiescing in a breach by the issuer.26 If found to have breached the Act or to have acted contrary to the public interest, the director or officer may be subject to a prohibition on acting as an officer or director of any issuer or reporting issuer permanently or for a specified period of time, in addition to being ordered to pay monetary penalties.
The OSC has taken enforcement action against officers and directors in connection with breaches of disclosure requirements including as it relates to risks.27 Given the CSA’s focus on climate-related disclosures by TSX listed companies and increased pressure from institutional investors on Canadian issuers for more robust climate change disclosures,28 it is highly likely that enforcement action will be taken against some companies, their directors and senior officers in respect of deficient disclosures.
In addition to the regulatory risk, reporting issuers and their officers and directors also face exposure to shareholder class action litigation in relation to alleged misrepresentations concerning climate change-related risks and impacts in prospectuses, continuous disclosure documents, and oral statements. The Act creates a statutory cause of action for prospectus misrepresentation in section 130 of the Act, and for misrepresentation in continuous disclosure documents and oral statements in Part XXIII.1. Neither cause of action requires proof that anyone relied upon the misrepresentation. While to date there have been no securities class actions alleging misrepresentations in relation to climate change risks, the likelihood of such actions appears to be high. Issuers and their officers and directors are increasingly the target of securities class actions in Canada arising out of risk disclosures.29
Best Practices to Reduce Regulatory and Enforcement Risk
If they have not already done so, senior management and boards of directors of Canadian publicly traded companies should educate themselves about climate change and its expected impacts, understand the company’s disclosure obligations relating to climate change-related risks, and familiarize themselves with available guidance, seeking assistance from external advisors as appropriate.
In addition to the CSA Staff Notices referenced above, a helpful resource includes, for example, the January 12, 2021 Corporate Finance Session of the Alberta Securities Commission (ASC)30. In it, Corporate Finance staff of the ASC provide examples of both good and deficient climate change disclosures, summarize regulatory requirements related to forward looking information, and offer the following tips for good climate-change related risk disclosure:
- Implement a process to identify material climate-change related risks
- Consider risks over the short, medium and long-term
- Consider both physical and transition risks
- Avoid vague or boilerplate language
- Disclose how the issuer’s business is specifically affected
- Where practicable, quantify and disclose the impact of the risk (financial and other), including magnitude and timing
- For voluntary disclosures:
- Prepare with the same rigour as required filings
- Ensure consistency with information included in continuous disclosure filings, when material
- Consider if the disclosure is forward-looking in nature
- Ensure the voluntary disclosure does not obscure material information
- Implement a robust process for reviewing voluntary disclosure to ensure information is reliable and accurate
In addition, as recommended in “A US Perspective – Securities Litigation and Climate Change and Sustainability Risks”, companies should develop robust internal controls for climate-related disclosures, and review and update those disclosures on a regular basis.
Finally, the company’s insurance policies providing coverage for the company and the directors and officers as it relates to securities regulatory investigations, securities class actions and climate change impacts should be reviewed on an annual basis.
Australian Securities Litigation Perspective
Australian businesses increasingly face litigation and regulatory risks associated with disclosure of climate-related risks. This article considers what those disclosure risks are, recent developments and best practice for reducing disclosure risk. If you are interested in reading about other climate-related litigation and regulatory risks, please see our articles on the obligations of directors and boards to consider climate change and our 2021 climate change litigation update.
Disclosure of climate risks expected in Australia
All public companies, large proprietary companies and certain other entities are required to prepare and lodge annual financial reports and annual directors’ reports under Australia’s corporations legislation. Annual directors’ reports must include details of circumstances that may significantly affect the company’s operations and state of affairs in future years and directors must certify that annual financial statements give a true and fair view of the financial position and performance of the company.
There is a growing expectation from regulators and other interest groups that the compliance with these obligations includes disclosure of climate-related risks, in particular:
- Regulatory Guides 228 and 247 issued by the Australian Securities and Investments Commission (ASIC) require climate change risks to be disclosed by listed entities in their annual operating and financial reviews.
- Policy guidance issued by the Australian Securities Exchange (known as the ASX) and the Australian Prudential Regulation Authority (APRA) has emphasised the need for listed and APRA-regulated entities respectively to ensure the same level of disclosure in annual financial reporting.
- The Australian Account Standards Board and the Auditing and Assurance Standards Board have issued joint guidance (reflecting guidance issued by the International Accounting Standards Board) that climate risks may be material to financial statements, especially with respect to valuation and impairments of assets.
- ASIC, APRA and the ASX Corporate Governance Council have each recommended entities adopt the framework developed by the G20 Taskforce for Climate Related Financial Disclosures (TCFD) as the standard for considering and disclosing material climate risks.
Recent regulatory developments
In 2021, there were a number of significant regulatory developments.
- In June, ASIC announced it would engage in targeted surveillance examining the practice of “greenwashing”, where companies disclose only positive aspects of their environmental credentials to the market.
- In June, The Investor Agenda (a collaboration of seven major investor bodies) called for a standardised TCFD-aligned reporting framework to be made mandatory for all ASX listed companies by 2024.
- In October, ASIC Commissioner Sean Hughes declared climate change risk reporting to be one of ASIC’s key priorities for 2022, in particular improving the quality and reliability of disclosures to enable investors to make fully informed decisions.
Litigation and regulatory enforcement risks
Failing to properly disclose climate related risks or making poor quality disclosures may expose companies (and their officers) to regulatory enforcement, civil and criminal penalties. Poor disclosure also increases the risk of private litigation, including for claims for damages caused by statutory misleading or deceptive conduct. Australian businesses also face the risk of significant reputational damage for wrongdoing (whether intentional or not) and inaction.
There have been a number of high-profile examples of litigation in Australia related to climate risk disclosure:
- Mark McVeigh v Retail Employees Superannuation Pty Ltd (REST)
In July 2018, Mr McVeigh commenced proceedings against REST, one of Australia’s largest superannuation funds with total assets over A$50 billion and around 2 million members. Mr McVeigh claims included that REST failed to adequately disclose its strategy to manage climate change risks, which allegedly prevented Mr McVeigh from making informed judgments about the fund’s performance and management, and also breached REST’s disclosure requirements under the corporations legislation. The case was settled in November 2020 with REST undertaking to adopt TCFD reporting recommendations and implement an objective for the fund to achieve a net-zero carbon footprint by 2050.
- Kathleen O’Donnell v Commonwealth of Australia
In July 2020, Ms O’Donnell commenced proceedings against the Australian Government and two of its officers alleging contravention of the statutory prohibition of engaging in misleading and deceptive conduct in relation to financial products. Ms O’Donnell claims that the Australian Government failed to properly disclose climate change related risks in the disclosure documents for Australian Government Bonds. While the case is brought against government entities, it is a salutary warning to companies about the risks of failing to disclose climate change related risks which may have material impact on the price of financial products and, in the case of listed companies, the price of the companies’ own securities.
- Australian Centre for Corporate Responsibility v Santos Ltd
In August 2021, the Australian Centre for Corporate Responsibility (ACCR) (a shareholder advocacy group) commenced proceedings in the Federal Court against Santos Ltd (Santos) alleging contravention of the statutory prohibition of engaging in misleading and deceptive conduct in respect of its 2020 annual report.ACCR alleges a statement by Santos that natural gas is a “clean fuel” misrepresents the effect of burning natural gas on the climate. ACCR also alleges a statement by Santos that it has a plan to achieve net zero emissions by 2040 is misleading because, among other reasons, it rests on undisclosed assumptions about how Santos will use carbon capture and storage.
Best practices to reduce litigation and enforcement risks
- Companies that have not yet adopted the TCFD reporting framework should consider doing so. Any standardised mandatory reporting scheme implemented in the near future is (on current trends) likely to be based on the TCFD framework.
- All large proprietary and listed companies should take steps to monitor developments in disclosure standards for climate-related risk, including guidance published by regulators and the ASX. Companies should continue to invest in the quality of their climate-related risk reporting, periodically testing for accuracy and completeness.
- Companies should be guarded against the possibility of “greenwashing”. Companies should be open and frank about all of their climate-related risks, the policies and procedures in place to address them, and areas for improvement.
- Companies should take care when making disclosures about the future, especially emissions targets, ensuring those statements are made on a reasonable basis. Companies should disclose underlying modelling, assumptions and risks to achieving future targets and plans. If circumstances change so that fulfilment of future plans are affected, threatened or no longer achievable, that change should be disclosed promptly to comply with continuous disclosure obligations.
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