Following up on our previous alerts looking at the Securities and Exchange Commission’s proposed rule for the “Enhancement and Standardization of Climate-Related Disclosures for Investors” (the Proposed Rule) and its GHG reporting requirements, we will now take a deeper dive into the rule’s governance disclosure obligations.

The Securities Exchange Act of 1934 (the Securities Exchange Act) requires reporting companies to maintain disclosure controls and procedures to ensure that information related to all required disclosure items is communicated to management, officers and board members and properly reported in Securities Exchange Act filings. Under the Proposed Rule, companies would need to also disclose: (i) the board’s governance and oversight processes of climate-related risks, and (ii) management’s role in assessing and managing those risks.

The Proposed Rule is more prescriptive than the existing disclosure framework under the Securities Exchange Act’s Regulation S-K and aims to provide investors with relevant information about whether a company’s board, management and principal committees have adequately implemented processes to identify, assess and manage climate-related risks. Disclosures related to corporate governance may be an area where companies are not well prepared to meet the obligations under the Proposed Rule. According to the annual report of the Task Force on Climate-related Financial Disclosures (the TCFD) issued in October 2021, although the TCFD recommends disclosure of the corporate governance related to climate risk, the corporate governance recommendation remains the least disclosed recommendation. According to the TCFD, in 2020, of the companies included in their analysis, only 25% were reporting on corporate governance at the board level and only 18% were reporting on management’s role.

Summary of Board Oversight Disclosure Items

The Proposed Rule would require a company to disclose the following items related to board governance:

• The board members or board committees, if any, responsible for the oversight of climate-related risks. For example, governance of climate-related risks could fall under an existing committee, such as the audit or risk committee, or a company could create a separate committee to focus on climate-related risk.
• The board members who have expertise in climate-related risks, if any, and a description of that member’s experience in such detail as necessary to fully describe the nature of their expertise.
• The frequency by which the board or board committee discusses climate-related risks, including how the board is informed about the risks and how frequently they consider these risks.
• A discussion about whether and how the board or board committee considers climate-related risks as part of its business strategy, risk management and financial oversight. For example, whether the board considers climate-related risks as they relate to major plans of action, setting and monitoring risk management policies, performance objectives, annual budgets, major expenditures, acquisitions and divestitures and its overall level of preparation to maintain shareholder value.
• A discussion on whether and how the board sets climate-related targets or goals and how it oversees progress against those targets or goals, including the establishment of any interim targets or goals.

A company can elect to voluntarily discuss the board’s and management’s oversight of climate-related opportunities. As proposed, this type of disclosure is optional in order to address concerns that such disclosure could involve competitively sensitive information.

Summary of Management Oversight Disclosure Items

Similar to the disclosure requirements proposed for board oversight, the Proposed Rule would require a company to disclose the following items about management’s role in assessing and managing climate-related risks:

• Whether there are management positions or committees responsible for assessing and managing climate-related risks and the identities of the individuals in those management positions or committees.
• A discussion about the relevant expertise of the individuals holding such management positions or serving on such committees in such detail as necessary to fully describe the nature of their expertise.
• The processes by which the responsible management positions or committees are informed about and monitor climate-related risks. For example, whether there are specific positions responsible for monitoring and assessing specific risks, and the extent to which management relies on in-house staff or third-party climate consultants with the relevant expertise to evaluate climate-related risks and implement plans of action.
• Whether the responsible management positions or committees report to the board or board committee on climate related risks and how frequently this occurs.
• A company may also elect to describe management’s role in assessing and managing climate-related opportunities.

Case Law Supporting Adequate Systems and Processes

The Proposed Rule will significantly expand the scope of risks that a board must monitor and govern. Recent case law supports the idea that a “one size fits all” approach to establishing and monitoring systems and processes for collecting information on climate risks and appropriately addressing those risks wont work. In particular, if climate risk is “mission critical” to a company’s operations, management and the board will have a heightened obligation to develop and implement appropriate systems to monitor climate-related risks and to be vigilant for “red flags.” The seminal case on a board’s oversight duties is In re Caremark International Inc. Derivative Litigation 698 A.2d 959 (Del. Ch. 1996) which established two contexts in which director liability may arise: (1) where a board fails to implement a board-level system to monitor the company’s compliance with law or company commitments or (2) where the board has systems in place but ignores red flags. Recent cases indicate that Delaware courts are getting more aggressive in allowing cases to proceed against boards if the board has not adequately monitored “mission critical” compliance issues. It remains to be seen if climate risks may be considered “mission critical,” and under what circumstances.

In Marchand v. Barnhill, 212 A. 3d 805 (Del. 2019), the Delaware Supreme Court allowed an action to proceed against the board of an ice cream company that found that the board had not undertaken sufficient efforts to make sure it was informed of the mission critical compliance issue — food safety. The board had not established a committee to oversee food safety, there was no board level process to address food safety issues and no protocol had been developed by which the board was expected to be advised of food safety reports and developments. The decision reinforces the obligation that boards must implement a reporting and monitoring system for compliance risks that is reasonable under the circumstances and must take steps to monitor and oversee the system.

The court in In re Clovis Oncology, Inc. 2019 WL4850188 (Del. Ch. 2019) also allowed a claim of breach of the board’s fiduciary duty to move forward. The court acknowledged that the board had monitoring and reporting systems in place for the company’s mission critical compliance area — drug safety and efficacy — but found that board ignored “red flags.” While the court noted that the board’s oversight of business risks is afforded discretion, it distinguished compliance risk from business risk. It found that when a company operates in an environment where externally imposed regulations govern its "mission critical" operations, the board's oversight function must be more rigorously exercised. The critical issue in the case was whether the board should have recognized that management was inaccurately reporting the efficacy of a key drug in violation of clinical trial protocols and associated FDA regulations.

Management likewise has a responsibility to implement systems for compiling, reporting, and monitoring climate risks. In addition, there may be increased focus on how management’s compensation is tied to their management of climate-related risks. The Proposed Rule indicates that the SEC did not include a compensation-related disclosure requirement because the agency believes that its existing rules requiring disclosure of all material elements of the company’s executive compensation already provide a framework for disclosure of any connection between executive remuneration and achieving progress in addressing climate-related risks.

The comment period on the Proposed Rules ended June 17, 2022, with the SEC receiving comments from thousands of parties. What, if any, changes the SEC makes to the Proposed Rules remains to be seen. It also is unclear when the final rules might be issued. In any event, it would be wise for boards and management of publicly traded companies to start assessing their systems and processes for managing climate-related risks.

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