What’s in the Final SEC Climate Disclosure Rule?, with James Cox

Notable quotes

• Information about the risks that climate change poses for business: “A paramount concern, if you read the tone, content, rationalization, and approach that the SEC [US Securities and Exchange Commission] embraces in its final release here, is to enable … two of the key missions of the SEC: facilitating investment behavior … [and] enabling intelligent, informed voting decisions for those who oversee corporations.” (3:55)
• Updates to the proposal from two years ago: “What’s impressed me with the 800-plus pages of the final adopting release is what I would describe as the conciliatory, sensible tone throughout.” (6:33)
• Climate-related disclosure enables company leadership to prepare for the future: “One thing we can’t lose sight of … is that we need information … It would be an error to say that everything that happened in this final release [is] just about enabling investors to buy and sell stocks. It also is an important governance tool. You need information about how [firms are] greeting the risk of our time—climate change—to be able to figure out who should be the stewards of the firm.” (21:54)

Top of the Stack

• Special Series: The SEC Climate Disclosure Rule from the Common Resources blog

The Full Transcript

Kristin Hayes: Hello, and welcome to Resources Radio, a weekly podcast from Resources for the Future. I'm your host, Kristin Hayes. Just a few days ago, on March 6, 2024, the US Securities and Exchange Commission (the SEC) released its final rule related to mandatory disclosure of climate-related risks faced by publicly traded companies. The SEC proposed an initial version of this rule in March 2022, over two years ago and, at long last, voted on the final version, which did offer some important changes from the original proposal.

This rule is one that we've been keeping an eye on here at Resources for the Future (RFF), given its relevance for climate action across the economy. We wanted to spend a little time here on Resources Radio parsing out its content and its import. Joining me to do that is Jim Cox, the Brainerd Currie Distinguished Professor of Law at Duke University and an expert in corporate and securities law. Stay with us.

Hi, Jim. It is a pleasure to talk with you today, and I'm really glad you could join us here on Resources Radio.

James Cox: Great to be talking with you, and I'm excited about participating.

Kristin Hayes: Let me thank you again for joining me just days after the 886-page final SEC rule came out. I know that's a lot to digest. But quickly, before we actually get into the meat of the rule, I wondered if you could tell our listeners a little bit more about your background and your areas of expertise.

James Cox: I've been writing and teaching in corporate securities law subjects for over 50 years. I've been at Duke for 45 years, and I was at four other schools before that, before I came to Duke and could finally get a steady job. I came to Duke with tenure out of California. I write a lot about not just the content of regulation, but the enforcement of regulation. I blend a mix of empirical work with theory, and I have a number of books out there that keep me busy and keep me engaged in subjects such as this.

Kristin Hayes: Great. It sounds like you're a deeply informed candidate to talk to us about this complicated rule. Let me dive right in and ask you a foundational question first. Could you just take us back to why the SEC has an interest in climate-related risks and the greenhouse gas footprints of these publicly traded companies in the first place? Why is that something they care about?

James Cox: I've always seen the SEC, particularly in its regulatory initiatives, being a mirror of society—what's happening in capital markets, particularly. I think that's what was happening here. We knew for a long period of time that not only was there a growing interest in what we now call environmental, social, and governance issues, or ESG, but particularly an emphasis on the e issue. As we're all aware, climate change is real. It's taking place. It's moving much more rapidly than anybody had ever predicted even five years ago. Quite frankly, the horse has left the barn.

There's lots and lots of voluntary disclosure engaged in by industry about the environment, because this is a major risk that has to be addressed. It's a change that's taking place throughout the economies around the world, and we're all linked together with this one threat, which is climate change. So, it's natural for the SEC to start reflecting these concerns.

If I can go on just a little bit more … a paramount concern, if you read the tone and content and rationalization and then the approach that the SEC embraces in its final release here, is to enable investors and voting shareholders—those are two buckets, and we can come back and talk about those buckets being two of the key missions of the SEC: facilitating investment behavior, but more importantly, enabling intelligent, informed voting decisions for those who oversee corporations. There were just wide variances and practices.

One of the mantras of the SEC, from its very initial beginning in the dark days of the Depression, is facilitating comparability across the issuers. We didn't have truly standardized practices. For example, you have some companies that make environmental disclosures—a big cohort did make environmental disclosures, but they didn't follow the same format. They didn't use the same terminology, they didn't speak the same language, and they didn't give the same emphases. There just needed to be, for comparability purposes, the SEC to step forward, and it did do that with this final release.

Kristin Hayes: Interesting. Well, you've already touched a little bit on my next question, which was about what was really driving the creation of the proposed and final rule. Beyond the mandate, it sounds like the SEC itself has a mandate to provide best information or encourage best information related to good corporate decisionmaking for investors. Was it investor demand for this information? You've hinted at that. Did it actually come from the Biden administration or from others in the policymaking space? What were some other drivers?

James Cox: I think the credit really should go to the market. The market needed this information. We know there's been not only an explosion of indexed investing that was going on, but part of that indexed investing was driven by environmental concerns. You have a substantial section of money that's flowing into funds that were going to be environmental, social, and governance funds (or mainly environmentally sane funds), and investors were allocating billions of dollars to these funds, and then the question was just comparability. I think the key feature here is standardization of disclosure where disclosure is taking place.

If I could just go further, what's impressed me with the 800-plus pages of the final adopting release is what I would describe as the conciliatory, sensible tone throughout. Standardization could happen in lots of different places. One, we can think that, for all reporting companies—those thousands of companies that are required to be subject to filing 10-Ks and 10-Qs and in the reporting system of the SEC—you could have one standardization of saying, "For those companies, this is what has to be disclosed and how it's going to be disclosed," and that facilitates comparability across investors.

But the other standardization that occurred is part of the conciliatory tone. The SEC said, "Look, we're not going to say you have to disclose this. We're not mandating disclosure, but if you step forward"—and this is classic Chicago School, freedom-of-the-market thinking—"then we want to make sure it's comparable. When you do start talking about these matters, then this is the format, and this is the content that you need to be doing this with.” That facilitates comparability.

What I just got through saying is there's many instances in the final rules where the SEC said, "We decided not to make this mandatory. We decided not to be prescriptive here, but, if you're going to talk about this specific subject, then here are the metrics that you should be using so we're all talking the same language."

How that relates to what we call basically “signaling theory” that we associate with the freedom-of-the-marketplace thinking in the Chicago school of economics and, certainly, law, is the idea of letting companies start signaling to the marketplace through their disclosures that we've got a good handle on the risks that are being posed to us by climate change. Here, we're signaling that we're on top of it and got a great management team—a better management team than those who aren't signaling. You let the forces of the marketplace sort things out by facilitating, saying, "If you want to start talking about this subject, do it in a way that's comparable, and that's going to enhance the quality of the signal that you're sending."

Kristin Hayes: Really interesting. You just indicated that they've perhaps stepped away. I don't know if that's fair. You should correct me if I'm wrong, but my understanding is that the initial rule actually did have more mandatory nature to it, and it required firms to report a couple of different types of emissions: what we refer to as “Scope 1” emissions, which are direct emissions; their indirect emissions from using electricity, which are also referred to as “Scope 2” emissions; and then, the emissions associated with everything along the supply chain—upstream emissions produced by suppliers, downstream emissions produced by consumers—are referred to as “Scope 3.”

That's a huge bucket of emissions that can be very challenging to measure. Again, please correct me if I'm wrong, but my understanding is that, in the proposed rule, which came out nearly two years ago, those were mandatory. It sounds like that's different in this final rule.

James Cox: It is. The tone of the final rules is vastly different from what we saw two years ago. Two years is a short period of time, but it's also a long period of time in regulation. If you think about it, two years ago, we barely had the Gensler administration in place. We're talking about division heads, etc. The staff are starting to learn how to work together, but the comment period was incredible, and there's a lot of thoughtful comments that were advanced.

The reason this report is almost 900 pages—we keep saying over 800, but it's almost 900 pages long—is the thoughtfulness in which they collated remarks that were coming in from quite a range of comments on almost everything and dealt with the questions and then synthesized them. This was truly, I think, the classic illustration of the wonders of the administrative process with these agencies to be able to do something like this. You could never see Congress being able to handle anything like this. It's set up that way. I think the SEC staff really did a great job here.

Kristin Hayes: I believe it was 16,000 comments that were received on this. So, yeah, a lot of work went into digesting that feedback. Can you say a little bit more about, as they were digesting that feedback, how this final rule actually differs in terms of emissions reporting, and how that reflects what your understanding was from some of those comments?

James Cox: Let's take the one that's getting all the press right now: the so-called “backing off” on Scope 3. I don't want to go into that, because I would be the first to admit that that suddenly drags me out of my depth, because I don't consider myself a scientist. I don't consider myself an environmentalist in the sense of knowing all the nuances that go into measuring, assessing, and evaluating greenhouse gases. But I think that that was a sensible approach. It was a sensible approach not only that you're going to be challenged if you had this, but I also think it's a sensible disclosure approach to not having Scope 3.

If I could just elaborate upon that just a little bit. Of all the areas that were identified in the proposal almost two years ago, that was the most problematic in terms of the quality—and I want to emphasize the quality of the information that was going to be mandated in Scope 3. It was the most vulnerable, not just because of the quality information, but because of the gigantic expense related to even getting close to having something that resembled the trustworthy release of information. That's because you're being asked to disclose information that’s not about something in your shop, in your business that you have control over, in which you have an accounting system that management depends upon to figure out how the ship is being steered through the troubled waters that the company has to pass through to make money for their shareholders, but you're talking about disclosing something that's outside of the area you control. Immediately, the expense of gathering that information, the problematic question about whether you could even get that information … the trustworthiness of that information, I think, goes way, way down.

You add that together, and it's not clear to me that Scope 3 was going to be worth the candle that you had the light to create that amount of information. That's one point.

Then, I'm going to stand back from that blunderbuss statement and make an equally broad one. We are entering into a new terrain, here, about disclosure to be sure that about 20 percent of the reporting companies do make environmental disclosures, and to be sure, there is an industry-led group that's laid out a template for how these disclosures ought to occur. All that sounds like, Wow, it's all there. No, we don't have the rich experience yet.

Quite frankly, before you can run, you have to walk. Before you can walk, you have to be able to crawl. I think that's where we are. This is a learning curve. As somebody who's been in this field for over a half a century and has followed closely the mandatory disclosure rules and the evolution of disclosure rules, I remember when there was no Management's Discussion and Analysis (MD&A). That went back 40 years ago. I remember the brickbats that were being thrown at the SEC about the Management's Discussion and Analysis disclosures.

Anybody who's followed that over the 40 years has seen that even the MD&A disclosures have been a learning curve. It's been a lot of jousting back and forth between what registrants are disclosing and the staff and the SEC issuing several releases scolding companies about not owning up consistently about the MD&A. That was evidence of a learning curve. We're not going to fix this right away, but we're going to gain a lot of experience along the road.

I think the tone of the release and the contours of the rules and the texture of the rules that were adopted in the final report lay a fertile ground for us to have things growing out of these over many years that's going to enable us as we move forward to tweak them from time to time. Wherever we wind up, it's going to be very different from where we are right now. But you had to start someplace and you had to start near terra firma, and I think we're pretty darn close on terra firma here.

Kristin Hayes: That's great. I have so many follow-up questions for you, but actually before that, I want to start and admit, as an SEC newbie, I don't actually know what “MD&A” stands for. Could you just mention what that is?

James Cox: Yes. A complaint that was being lodged in the '70s—again, a lot of it for the free-market thinking—is that mandatory disclosure just tells you where you've been and what investors want to buy is where you're going to be going. Sales management, now … If you see something that's in the current quarter or in a series of quarters in the financial reports, and it looks like past is not going to be prologue, then you need to flag that. That enables investors, but it's also very good for management to think about these things.

Kristin Hayes: Right. This is really interesting. A couple of additional follow-up questions for you.

You mentioned the term “terra firma.” I'd like to parse that out with you in two different senses. I will say I feel like much of the rapid-fire reporting that's come out about this final rule has really described it—the changes in emissions reporting and perhaps some other changes, too—as "weakening." They've made the rule softer, or it has less teeth to it. I wanted to ask you—do you feel like it's actually weakening, or do you feel like some of the changes have actually, let's say, strengthened the rule and put it on a different kind of platform?

That gets us into some of the legal questions, too, which is an area of real expertise for you. We asked you, I think earlier, back in 2022, about the legal basis for the rule and what legal challenges it would face. Now that this final rule has been released, I'd love to go back to that question, too. What legal challenges to this final rule do you anticipate, and is that part of your thinking when you say “terra firma,” as well? Do you feel like this is on better legal footing in the way that the SEC has revised the rule to ensure that it will survive those legal challenges?

James Cox: I've been using “terra firma” in the sense of more concrete, specific, quantifiable information. I compare and contrast that with what I said earlier about Scope 3, which I think was more problematic in terms of whether it could be verified in any meaningful way. The expectations you're going to have are created about your knowledge of what your suppliers are providing you in terms of their own experiences with greenhouse gasses. To be sure, this is noticeable in almost every section that's covered in this nearly 900-page release, where the SEC said, "Well, we decided not to do that from our proposal stage, and we backed up here," and these seem to be that you're stepping back, stepping back, stepping back. My own feeling is they were stepping back to areas that could be verifiable.

I think verifiable, or more trustworthy, information than the alternative would've been the terra firma I'm talking about. I think that that's a wise position. We may ultimately be able to have a system in which we can have something that resembles trustworthy information regarding Scope 3 greenhouse gases. But my sense is that the industry group is not there quite yet. Quite frankly, I think we have to pat the SEC on the back for moving forward and being more concrete than what was going on. Repeatedly, when you read the final adopting release here, there's references saying, "The template that we were using here was the industry-led task force"—the Task Force on Climate-Related Financial Disclosures. That was an industry group.

What they did is they took that which was widely used by the industry group on the ground—these are people trying to regulate themselves, deciding what best practices are, etc. The SEC said, "We're tweaking that. We're starting with that, but then we're filling it in." In many instances, you'll find a report that says, "Look, we're going beyond that. We're making it more concrete." I think that's all for the better.

There's always been this symbiotic relationship between the regulated and the regulator, particularly in the disclosure metrics that get applied. I think that that's really important. Each learns from the other, and at the end, I think they're going to be facilitating wiser, more trustworthy investment decisions that are being made.

It was a tendency to talk more about investors, because we're more aware of that. You get up in the morning, and my Wall Street Journal got delivered this morning, and you see what certain stocks did yesterday. You were reading about firms, what have you. But what's really important, as well, and it's another big button, is how these proxies get voted. They get voted. The nerve center of a corporation is the board of directors, and the owners of the firm elect those directors.

One thing we can't lose sight of the fact of is that we need information. Those decisions are informed, and so it would be an error to say that everything that happened in this final release of the environment—it's just about enabling investors to buy and sell stocks. It also is an important governance tool. You need information about how they're greeting the risk of our time—climate change—to be able to figure out who should be the stewards of the firm.

Kristin Hayes: Let me ask you to just dive into that legal question just a little bit more, as well, in terms of the challenges that this rule is likely to face. From some of the commentary I've read, I do believe that this final rule is, in fact, still likely to face challenges. In your view, what has the SEC done in its revisions to put that rule on firm legal ground? Or has it done enough in its revisions?

James Cox: I think that the SEC, by backing off some of the imponderable questions, for example … This is one of the things I think was really easy to take care of. In the proposal, there was a proposal that companies should engage in scenario analysis, and that's a modern-day word for something else. We all learned in our statistics class about trying to evaluate the future. Scenario analysis means that, if we thought about growing corn, we could think about three states of the environment: a lot of rain, a drought, or just the right amount of rain. Then, you can think about it, any time of the year, what it could look like; it's going to be a rainy year or a dry year, etc. That's scenario analysis. You look at what the outcomes are, and you measure what the expected outcome is. If there's a lot of rain, you assign a probability to it, because that's pretty basic first-year finance, quite frankly.

There's going to be mandating that firms should be thinking about scenario analysis looking into the future and disclose that. Disclose the fruits of that mandated way of thinking about the future in your reports. To me, that's pretty straight-jacketing. Maybe it's my conservative Kansas upbringing, but it certainly makes me think that you're telling people how to think about a problem. I thought the real reason that the markets disciplined managers who didn't think very well or didn't think about the problems at all … The best thing to do is shine a light on, How you think about climate change? But not mandate how they're going to think about it. See my point? There can be lots of reasons why we don't want that to happen.

When you start making scenarios, there's a lot of private information about your firm that goes into thinking about, "Well, what are going to be the three or five or seven states of our business a few years down the road?" If you had to disclose those, then you're going to be disclosing how you're allocating resources within the firm to come out with a new product, a new marketing scheme, what have you. I think that that has a high degree of sensitivity. The SEC backed off on scenario analysis and said, "Look, if you engage in scenario analysis, then disclose it. If that scenario analysis indicated that the plant you had on Miami Beach is going to be underwater in five years, and that's a material event, you've got to disclose that, too," which takes you right back pretty much to what we talked about earlier with Management's Discussion and Analysis.

That's an existing condition that you're going to lose this plant, and it probably ought to be disclosed. There's a lot of things that the SEC did that I think complement current practices, but nevertheless are introducing a certain amount of rigor in the consistency that facilitates comparability. What you'd like to have in facilitating comparability is more people step forward and start doing it and realizing that this can be a benefit signaling to the market that you're on top of the problem.

Companies always have to worry that they'll be embarrassed by their lack of disclosure. I'm going to presume that, as we move in this world and we see expectations for more robust disclosure, which is certainly what we see in the final rule that's adopted here, and as we get more and more aware of the cost of climate change, cutting corners on climate change disclosures can likely result in a very embarrassing story being in the front pages of your local newspaper.

Kristin Hayes: Right. Jim, thank you so much.

James Cox: All right. Thank you for having me.

Kristin Hayes: All right. Take care.

James Cox: Bye-bye.

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