As the summer heat fades and leaves begin to fall, so, too, does the Securities and Exchange Commission’s regulatory momentum—at least for now. With the presidential election on the horizon, the fate of several key rulemaking efforts remains in limbo. In this Snapshot, we explore the current state of several SEC initiatives, including its hotly-contested climate disclosure rules, human capital management rules, and corporate board diversity requirements. We also review the ongoing legal challenge to Nasdaq’s director diversity rules. Finally, this Snapshot delves into the SEC’s growing scrutiny around companies’ use and disclosures of artificial intelligence (“AI”) and provides a reminder about new accelerated filing deadlines for Schedule 13G.
Proposed SEC Climate Rules
In last quarter’s Securities Snapshot, we discussed the SEC’s adoption of new rules that require public companies to make certain climate-related disclosures in their annual reports and registration statements (the “Climate Rules”).
The Climate Rules were immediately met with legal challenges, and a series of cases filed across the country were consolidated in early March of this year into a single proceeding before the Eighth Circuit Court of Appeals. Opponents of the Climate Rules have argued the regulations “mandat[e] disclosures not financially material to investors” and also contend that the Commission lacks authority to impose the disclosure regime. In April, the SEC voluntarily stayed the Climate Rules and indicated its intention to defend their validity in court.
There has been little movement in the case—Iowa v. SEC[1]—since last quarter. However, on August 5, 2024, the SEC filed its brief in support of the proposed measure, maintaining it has statutory authority to issue the Climate Rules because they (i) regulate the securities market and not the environment; (ii) require registrants to disclose financial performance; and (iii) apply a materiality standard—only requiring disclosure of information important to investors’ investment and voting decisions. The Eighth Circuit has not yet scheduled oral arguments in the case, making it unlikely the Court will issue a ruling this year.
Given the Supreme Court’s decision in Loper Bright v. Raimondo,[2] which overturned the prevailing Chevron deference standard, the fate of the Climate Rules is somewhat tenuous. Under Chevron, if a statute was silent or ambiguous as to a matter, a reviewing court was to defer to the agency’s reasonable interpretation of its authority. Now, under Loper, it is the courts’ responsibility to determine the meaning of ambiguous statutes, and relatedly, the extent of an agency’s authority. In addition, the Supreme Court in West Virginia v. EPA,[3] concluded that agencies cannot resolve questions of “vast economic and political significance,” such as climate-related matters, without clear statutory authorization. Under these precedents, whether the Eighth Circuit will determine that the SEC has the power to enact the Climate Rules under the Securities Act or the Exchange Act remains unclear.
What Should Companies Do Now?
While the litigation in the Eighth Circuit proceeds, companies should prepare themselves for the possibility that the Climate Rules, either in whole or in part, will become effective. To that end, companies should begin to develop and implement robust processes to identify and assess material climate-related risks, given the SEC’s indications that it may closely review how companies make materiality determinations for purposes of these disclosures. It may also be beneficial to engage with advisors to better understand their environmental and climate-related impacts that may need to be disclosed.
As we have highlighted previously, large accelerated filers would be required to comply beginning with their 2025 annual reports. Accordingly, these companies should continue developing compliance programs by the beginning of 2025 to ensure they can make the required disclosures at the end of the 2025 fiscal year.
Finally, companies can utilize this time to review and revise their current climate-related disclosures, as well as familiarize themselves with public disclosures made by peer organizations to benchmark effective and compliant climate-related filings.
Proposed SEC Human Capital Management Rules
On July 8, 2024, SEC Chair Gary Gensler announced the release of the SEC’s spring 2024 Regulatory Agenda, which identifies rules that the agency may consider adopting within the next twelve months. Among the thirty-four rules included in the Agenda is a proposed Human Capital Management (“HCM”) disclosure. The proposal aims to standardize and increase visibility into public companies’ workforce policies and practices, as part of a broader effort to increase environmental, social, and governance (“ESG”) reporting.
To be sure, the HCM disclosure proposal is nothing new. Not only was the proposal part of the SEC’s fall 2023 Agenda, Gensler even included the HCM initiative in his inaugural agenda shortly after becoming Chair in April 2021. The current timeline for the HCM disclosure is notable, however, because it was initially slated for release in April 2024. Now, the SEC expects to issue its proposed HCM rule in October. The delay, which has aggravated ESG proponents, is underscored by uncertainty surrounding the upcoming presidential election.
Historically, Democrats have favored ESG disclosures like the HCM proposal. Indeed, under Gensler’s leadership, the SEC has adopted new climate change and cybersecurity disclosure rules, both of which reflect priorities of the Biden Administration. While former President Trump has not specifically addressed the HCM proposal, his former SEC Chair, Jay Clayton, oversaw the development of the HCM rules in August 2020. Still, the SEC at the time voted to leave the HCM proposal rooted in the concept of materiality, which meant companies would only be required to disclose “material” information—something a reasonable person would consider important to make a voting or investment decision. Consequently, some investors characterized the proposed rule as somewhat toothless, as it left companies with discretion to decide what is—and is not—material. Vice President Harris has also not directly opined on the HCM proposal, although one could fairly reason she would encourage its adoption given her policy similarities to President Biden.
Moreover, even if the SEC releases the HCM proposal in October as it anticipates, the time to finalize and adopt rules is quickly waning. As former SEC chief accountant Lynn Turner recently noted, “almost all new rules subsequently proposed this year cannot be finished before the election.” As a result, Turner continued, any proposed rules “will be subject to the CRA by the new Congress” and likely be overturned if former President Trump defeats Vice President Harris in November. The CRA—the Congressional Review Act—allows lawmakers to reverse certain federal agency actions, including those of the SEC, with a simple majority.
With just about a month to go before the country elects the next President, the SEC’s current regulatory priorities largely remain in political limbo. And whomever is sworn in next January will likely decide the fate of the SEC’s proposed HCM disclosure rule.
Proposed SEC Corporate Board Diversity Rules
In addition to the HCM proposal, the Commission’s spring 2024 Regulatory Agenda included a proposed corporate board diversity rule, with an anticipated release date of April 2025.
According to prior rulemaking agendas, the SEC has aimed at bolstering board diversity reporting since at least 2016. In fact, the SEC has adopted board diversity disclosure requirements before. In 2009, the Commission adopted Item 407(c)(2)(vi) of Regulation S-K, which requires companies to disclose in their proxy statements the extent to which the company considers diversity in identifying nominees for its board of directors.
SEC officials have provided few details about what the latest board diversity rule would require. The spring 2024 Regulatory Agenda states merely that the Commission is considering “amendments to enhance registrant disclosures about the diversity of board members and nominees.” Although the precise requirements of the proposed rule are unclear, some have suggested they will mirror Nasdaq’s board diversity disclosure requirements—approved by the SEC approved in August 2021—which we previously covered here. Nasdaq’s rules require companies listed on the stock exchange (1) to have at least two directors from underrepresented backgrounds or (2) explain why they do not. Nasdaq-listed companies must also disclose a “Board Diversity Matrix” each year, either in their proxy statement or on their website, detailing demographic information about their board members, including race, gender, and sexual orientation characteristics.
However, just as the SEC’s human capital management proposal remains in flux pending the outcome of the presidential election, so, too, does the Commission’s board diversity proposal. While Gensler’s term as Chair expires in June 2026, if former President Trump is elected in November, it is probable that Gensler would step down soon thereafter, especially given Trump’s pledge to appoint a new chairman “on day one.” Further, a victory by Vice President Harris would not automatically guarantee the implementation of the board diversity proposal, as she may wish to name someone else to lead the agency.
NASDAQ Diversity Matrix Litigation
As discussed in last quarter’s Securities Snapshot, the status of the Nasdaq board diversity disclosure requirements remains uncertain after the Fifth Circuit Court of Appeals held oral argument en banc on May 14, 2024. On July 18, 2024, the Fifth Circuit requested supplemental briefing, which both parties filed on July 25, 2024.
For background, after two advocacy groups—Alliance for Fair Board Recruitment and National Center for Public Policy Research—argued the SEC overstepped its regulatory authority, a panel of three Fifth Circuit judges upheld the Nasdaq rule in October 2023. The challengers’ petitioned for a rehearing by the full Fifth Circuit, which the Court granted in February of this year.
During oral arguments in May, several judges pressed lawyers for the SEC and Nasdaq about the breadth of the Commission’s power under the Securities Exchange Act of 1934 (the “Act”) to impose disclosure requirements. Moreover, Nasdaq’s rule faces an even tougher test in the wake of the Supreme Court’s decision this summer in Loper Bright. No longer can either Nasdaq or the SEC rely on the Act’s general grant of authority to mandate disclosures “important to shareholders’ investment decisions.” Instead, the Fifth Circuit will likely hone in on whether visibility into board diversity is related to the purposes of the Act.
While the Fifth Circuit has yet to issue an opinion, a decision is expected soon. We will continue to monitor the case and provide updates as they occur.
AI Disclosures
Artificial intelligence (“AI”) has revolutionized the way many businesses operate, providing unprecedented innovation and solutions to companies across industries. However, AI also brings with it new risks and problems, and the SEC is taking note.
Because public companies are required to disclose information deemed to be material to their investors, the SEC is beginning to scrutinize what companies are saying about AI—specifically, the risk it poses to their business. On June 24, 2024, Eric Gerding, the director of the SEC’s Division of Corporation Finance, noted that the Commission has “observed a significant increase in the number of companies that mention artificial intelligence in their annual reports.” In addition, securities regulators are warning companies to avoid “AI-washing,” or making exaggerated or misleading claims about their use of AI to investors.
Recent data suggests public companies have begun to respond to the agency’s focus.[4] Over 40% of S&P 500 companies included AI-related risk disclosures in their 2023 Forms 10-K.[5] Likewise, nearly 50% of Fortune 100 companies disclosed AI-related risks in their 2023 annual reports, with those risk factors falling primarily into five areas: (1) cybersecurity risk, (2) regulatory risk, (3) ethical and reputational risk, (4) operational risk, and (5) competition risk.[6]
While AI-related disclosures have become a new target for enforcement and litigation by the SEC, companies can proactively protect themselves from liability going forward. In particular, companies should remain familiar with continuing SEC guidance about crafting AI-related disclosures. In addition, companies should consider whether their board’s audit or risk committees should be responsible for understanding the company’s use of AI and the associated risks and benefits. Finally, companies should seek to create and maintain well-documented risk disclosures that are tailored to the company’s specific use.
Reminder: New Schedule 13G Accelerated Filing Deadline
On October 10, 2023, the SEC adopted amendments to the rules regarding beneficial ownership reporting under Section 13(d) and 13(g) of the Exchange Act. As noted in our prior publication, the revised filing deadlines for Schedule 13G became effective on September 30, 2024. The revised deadlines are based on the exemption used by an investor permitting it to file a Schedule 13G instead of a Schedule 13D.
[1] State of Iowa, et al v. SEC, No. 24-1522 (8th Cir. filed March 3, 2024).
[2] Loper Bright Enters. v. Raimondo, 144 S. Ct. 2244 (2024).
[3] West Virginia v. EPA, 597 U.S. 697 (2022).
[4] Over half of Fortune 500 companies consider AI a risk to business (yahoo.com)
[5] AI Disclosures to SEC Jump as Agency Warns of Misleading Claims (bloomberglaw.com)
[6] Securities Law / Securities Litigation Advisory | Navigating AI-Related Disclosure Challenges: Securities Filing, SEC Enforcement, and Shareholder Litigation Trends | News & Insights | Alston & Bird
