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The SEC’s Proposed Climate-Related Disclosures – First in a New Series

With its March 21, 2022, proposal for extensive climate-related disclosures, the SEC intensified an already active discussion about how companies should provide climate-related information.  The Proposed Rule, as described in this Fact Sheet, is far reaching and complex.  It would bring SEC reporting into entirely new realms.

In this series of blog posts, we are going to first explore the overall objectives and “big picture” of the proposal.  After this “40,000-foot flyover” we will deep-dive into the details of each major area addressed by the proposed disclosures.  We will break each provision into its component parts and explore implications for reporting.

This series of blog posts will also accompany several SEC Institute One-Hour Briefings about the proposed rule.  You can find information and links to each briefing in this blog post.

This first post provides an overview of the proposal and previews subsequent posts.

To begin, the proposed disclosures would be required in annual reports on Form 10-K and 20-F with updates in Forms 10-Q and 6-K.  They would also be required in registration statements under the 1933 Act, in particular Form S-1.  The disclosures would be required for all reporting companies, including smaller reporting companies and emerging growth companies.  Smaller reporting companies are excepted from the Scope 3 disclosure requirements and non-accelerated filers are excepted from the greenhouse gas attestation report requirements.  (Asset-backed issuers would not be required to make these disclosures.)

The proposed disclosures fall into three broad areas:

  • Governance, strategy, risk and related disclosures outside the financial statements
  • Greenhouse gas emission disclosures and attestation requirements
  • Financial statement disclosures

Governance, Strategy, Risk and Related Disclosures

These non-financial statement disclosures would start with this Form 10-K instruction, solving the mystery of what Item 6 has been reserved for:

  • Item 6. Climate-Related Disclosure
    • Provide the disclosure required by Subpart 1500 of Regulation S-K (17 CFR 229.1500 through 229.1507) in a part of the annual report that is separately captioned as Climate-Related Disclosure.

The proposed new Subpart 1500 to regulation S-K would include these Items:

  • Regulation S-K Subpart 1500—Climate-Related Disclosure
    • Item 1500 Definitions
    • Item 1501 Governance
    • Item 1502 Strategy, business model, and outlook
    • Item 1503 Risk management
    • Item 1504 GHG emissions metrics
    • Item 1505 Attestation of Scope 1 and Scope 2 emissions disclosure
    • Item 1506 Targets and goals
    • Item 1507 Interactive data requirement

(Items 1504 and 1505 related to greenhouse gas emissions are discussed in a separate section below.)

The first part of the proposed addition to regulation S-K Subpart 1500 would define many terms, including:

  • Climate-related risks
  • Climate-related opportunities
  • Carbon offsets
  • Transition risks
  • Scenario analysis
  • Scope 1, 2 and 3 emissions
  • Value chain

Proposed disclosures include:

  • Climate-related risks
  • Board oversight of climate issues
  • Board climate-related expertise
  • Management of climate issues
  • Climate-related risk management disclosures
  • Climate-related targets and goals

These new non-financial statement disclosures would be subject to disclosure controls and procedures.  In addition, these new disclosures would be subject to Inline XBRL tagging.

 We will explore each of these areas in subsequent posts.

Greenhouse Gas Emission Disclosures and Related Attestation Requirements

  • These new disclosures are included in Regulation S-K Items:
    • 1504 GHG emissions metrics
    • 1505 Attestation of Scope 1 and Scope 2 emissions disclosure

The proposal would define greenhouse gases and Scope 1, 2 and 3 emissions in S-K Item 1500.  These definitions are essentially consistent with those in the Greenhouse Gas Protocol.

(p) Scope 1 emissions are direct GHG emissions from operations that are owned or controlled by a registrant.

(q) Scope 2 emissions are indirect GHG emissions from the generation of purchased or acquired electricity, steam, heat, or cooling that is consumed by operations owned or controlled by a registrant.

(r) Scope 3 emissions are all indirect GHG emissions not otherwise included in a registrant’s Scope 2 emissions, which occur in the upstream and downstream activities of a registrant’s value chain.

(1) Upstream activities in which Scope 3 emissions might occur include:

(i) A registrant’s purchased goods and services;

(ii) A registrant’s capital goods;

(iii) A registrant’s fuel and energy related activities not included in Scope 1 or Scope 2 emissions;

(iv) Transportation and distribution of purchased goods, raw materials, and other inputs;

(v) Waste generated in a registrant’s operations;

(vi) Business travel by a registrant’s employees;

(vii) Employee commuting by a registrant’s employees; and

(viii) A registrant’s leased assets related principally to purchased or acquired goods or services.

(2) Downstream activities in which Scope 3 emissions might occur include:

(i) Transportation and distribution of a registrant’s sold products, goods or other outputs;

(ii) Processing by a third party of a registrant’s sold products;

(iii) Use by a third party of a registrant’s sold products;

(iv) End-of-life treatment by a third party of a registrant’s sold products;

(v) A registrant’s leased assets related principally to the sale or disposition of goods or services;

(vi) A registrant’s franchises; and

(vii) Investments by a registrant

Measuring Scope 1, 2 and 3 emissions will clearly involve complex estimation and engineering challenges.  The proposed rule does not specify measurement methodologies but does require disclosure about measurement processes.

Companies would be required to report Scope 1 and Scope 2 emissions.  In addition, companies, except for smaller reporting companies, would be required to report Scope 3 emissions if material or if the company has published a target for such emissions.

Accelerated and large-accelerated filers would also be required to provide an attestation report about their Scope 1 and 2 emissions.  The proposed rule provides requirements for the attestation report and for the entity providing the attestation report.

The attestation report would be phased in the first two years providing limited assurance and reasonable assurance after the initial period.

We will explore each of these areas in subsequent posts.

Financial Statement Disclosures

Climate-related financial statement disclosure requirements would be provided by a new Article 14 in Regulation S-X.  This new Article would include:

  • Rule 14-01 Climate-related disclosure instructions
  • Rule 14-02 Climate-related metrics

Included in these disclosures would be information about:

  • Financial impacts of severe weather events and other natural conditions
  • Financial impacts related to transition activities
  • Financial estimates and assumptions impacted by severe weather events and other natural conditions
  • Expenditures to mitigate risks of severe weather events and other natural conditions

Generally, disclosure would be required when the absolute value of any of the provided climate metrics is over 1% of the related financial statement line-item.

These disclosures would be included in a company’s internal control over financial reporting

They would also be included in a company’s annual audit.

We will explore each of these areas in subsequent posts.

Proposed Transition Provisions

The transition provisions are complex.  The proposed rule includes this schedule, which assumes a company has a calendar year-end:

 Climate Transition One

 Climate Transition Two

If you have any specific questions or issues you would like future posts to address, please put them in the comments section.

CorpFin Staff to Respond in Writing to Shareholder Proposal Requests

On December 13, 2021, in this brief Announcement, the CorpFin staff stated they will return to the policy of issuing written responses to all shareholder no-action letter requests.  The Division’s response letters will be posted on their website.  In 2019, the Division implemented a policy of responding in writing only in limited instances and instead provided information in a chart on their webpage.  The Division expects to publish a similar chart at the end of the proxy season.

The policy change to respond to all written no-action requests in writing is effective from December 13, 2021, the publication date of the notice.

As always, your thoughts and comments are welcome!

Where to Place the Performance Graph? A Filed Versus Furnished Example

A frequent question in our SEC Reporting Skills Workshop is “What the heck is going on with the performance graph required by S-K Item 201(e)?”  This question stems from a bit of history about the performance graph, an obscure instruction, and the distinction between furnished and filed documents.

(Spoiler alert:  The graph is not required in Form 10-K and can be furnished in the annual report to shareholders.)

S-K 201(e) requires a five-year line graph comparing the annual percentage change in the registrant’s cumulative total shareholder return on a class of common stock with the cumulative total return of a broad equity market index and a published industry, line-of-business or peer index.  You can read all the details of the requirement here.

Here is an example of the graph from Coca Cola’s 2019 Form 10-K.

Picture1

 

Where to place the graph turns out to be a murky question.  Originally, this graph was a required proxy disclosure.  Several years ago, when the SEC expanded the proxy executive compensation disclosures, they proposed to remove the graph.  Several commenters on the proposal asked the SEC to retain the requirement, stating that it provided valuable information.  The SEC did not want to include the graph in the proxy for a variety of reasons.  As a compromise, the Final Rule added the graph to S-K Item 201.  What the Final Rule did not do was require the graph in Form 10-K.

This is where the filed versus furnished question arises.  Historically, the graph was not filed information.  It was simply furnished in the proxy.  If the SEC had required the graph in Form 10-K it would have become filed information and subject to the 1934 Act’s liability provisions for filed information.  To keep this from happening, the SEC added the following instruction to S-K Item 201(e):

  1. The information required by paragraph (e) of this Item need not be provided in any filings other than an annual report to security holders required by Exchange Act Rule 14a-3 (17 CFR 240.14a-3) or Exchange Act Rule 14c-3 (17 CFR 240.14c-3) that precedes or accompanies a registrant’s proxy or information statement relating to an annual meeting of security holders at which directors are to be elected (or special meeting or written consents in lieu of such meeting). Such information will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

Unfortunately, this instruction was kind of hidden after an instruction for smaller reporting companies.

The bottom line is that the graph does not have to be in Form 10-K and does not have to be filed information.  It can be included in the annual report to shareholders, which is furnished, not filed. Companies that put the graph in the part of the annual report to shareholders that is not included in Form 10-K do not subject the disclosure to the 1934 Act’s liability provisions.

This annual report from Cracker Barrel Old Country Store provides an example of how the graph can be placed in the “wrap” pages of a “10-K wrap” annual report to shareholders.  This means the graph is not included in the filed Form 10-K.  You will find the graph on the back cover of the Cracker Barrel Old Country Store annual report to shareholders.

Lastly, to further illustrate the confusion about this graph, here is an SEC comment letter and company response about the placement of the graph.

The SEC Comment Letter

Re: Monro Muffler Brake, Inc.

Form 10-K for the Fiscal Year Ended March 28, 2015

Dear Ms. D’Amico:

We have limited our review of your filing to the financial statements and related disclosures and have the following comments. In some of our comments, we may ask you to provide us with information so we may better understand your disclosure.

Please respond to these comments within ten business days by providing the requested information or advise us as soon as possible when you will respond. If you do not believe our comments apply to your facts and circumstances, please tell us why in your response.

After reviewing your response to these comments, we may have additional comments.

Form 10-K for the Fiscal Year Ended March 28, 2015

Item 5. Market for the Company’s Common Equity and Related Stockholder Matters, page 16

  1. Please tell us your consideration for including the performance graph as required by Item 201(e) of Regulation S-K.

 

The Company’s Response

Item 5. Market for the Company’s Common Equity and Related Stockholder Matters

  1. Please tell us your consideration for including the performance graph as required by Item 201(e) of Regulation S-K.

Response: It is our understanding that the performance graph is required to be included in the Company’s annual report to stockholders, but not in its Form 10-K. This understanding is based on Instruction 7 to Item 201(e) of Regulation S-K, which states that “the information required by paragraph (e) of Item 201 need not be provided in any filings other than an annual report to security holders required by Exchange Act Rule 14a-3 or Exchange Act Rule 14c-3 that precedes or accompanies a registrant’s proxy or information statement relating to an annual meeting of security holders at which directors are to be elected (or special meeting or written consents in lieu of such meeting).” Further the staff of the Division of Corporation Finance has indicated in Regulation S-K Compliance and Disclosure Interpretations Question 106.10 that the performance graph is not required to be included under Item 5 of Form 10-K and need only be provided in the issuer’s annual report to stockholders.

The performance graph as required by Item 201(e) of Regulation S-K is included in the Company’s 2015 Annual Report under the Financial Highlights section on page 5.

 

SEC Response

Dear Ms. D’Amico

We have completed our review of your filing. We remind you that our comments or changes to disclosure in response to our comments do not foreclose the Commission from taking any action with respect to the company or the filing and the company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. We urge all persons who are responsible for the accuracy and adequacy of the disclosure in the filing to be certain that the filing includes the information the Securities Exchange Act of 1934 and all applicable rules require.

As always, your thoughts and comments are welcome!

Get the S-K Item 201(d) Table Right!

A frequent question in our SEC Reporting Skills Workshop is “What the heck is going on with the table required by S-K Item 201(d)?”  This question results from an actual “mistake” in the Form 10-K Instructions which was later “fixed” by a letter from the SEC to the American Bar Association (ABA) and a Compliance and Disclosure Interpretation.  Despite the “fixes,” this table is still frequently in the wrong place in Form 10-K.

(Spoiler alert:  The table should be in Item 12, not Item 5!)

(As another note, if an equity compensation plan is being submitted to shareholders for action, Schedule 14A requires the S-K Item 201(d) table in the proxy statement.  It will then be incorporated by reference into Item 12 of Form 10-K.)

The uncertainty about the placement of this table dates back to 2001 when the SEC adopted a Final Rule to provide more robust disclosure about equity compensation plans.  This Final Rule required the equity compensation plan table in S-K item 201(d) but was not clear about where to include it in Form 10-K.

This situation begins with the instructions to Item 5 in Form 10-K:

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

(a)  Furnish the information required by Item 201 of Regulation S-K (17 CFR 229.201) and Item 701 of Regulation S-K (17 CFR 229.701) as to all equity securities of the registrant sold by the registrant during the period covered by the report that were not registered under the Securities Act. If the Item 701 information previously has been included in a Quarterly Report on Form 10-Q or in a Current Report on Form 8-K (17 CFR 249.308), it need not be furnished.

(Note:  (b) and (c) omitted)

This instruction seems to require that all the information required by S-K Item 201 should be included in Item 5.  That information includes S-K Item 201(d):

(d) Securities authorized for issuance under equity compensation plans. (1) In the following tabular format, provide the information specified in paragraph (d)(2) of this Item as of the end of the most recently completed fiscal year with respect to compensation plans (including individual compensation arrangements) under which equity securities of the registrant are authorized for issuance, aggregated as follows:

(i) All compensation plans previously approved by security holders; and

(ii) All compensation plans not previously approved by security holders.

Equity Compensation Plan Information 

Plan category  Number of securities to be issued upon exercise of outstanding options, warrants and rights  Weighted-average exercise price of outstanding options, warrants and rights  Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) 
  (a) (b) (c)
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
Total

(2) The table shall include the following information as of the end of the most recently completed fiscal year for each category of equity compensation plan described in paragraph (d)(1) of this Item:

(i) The number of securities to be issued upon the exercise of outstanding options, warrants and rights (column (a));

(ii) The weighted-average exercise price of the outstanding options, warrants and rights disclosed pursuant to paragraph (d)(2)(i) of this Item (column (b)); and

(iii) Other than securities to be issued upon the exercise of the outstanding options, warrants and rights disclosed in paragraph (d)(2)(i) of this Item, the number of securities remaining available for future issuance under the plan (column (c)).

(3) For each compensation plan under which equity securities of the registrant are authorized for issuance that was adopted without the approval of security holders, describe briefly, in narrative form, the material features of the plan.

(Note:  Instructions omitted)

A close reading of the instructions would indicate that this table should be in Item 5 of Form 10-K.  However, the instructions to Item 12 call this conclusion into question:

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 Furnish the information required by Item 201(d) of Regulation S-K (§ 229.201(d) of this chapter) and Item 403 of Regulation S-K (§ 229.403 of this chapter).

These two instructions raise the question of whether the S-K Item 201(d) table should be in Item 5, Item 12 or both?  This situation created enough confusion that the ABA wrote a letter to the SEC asking for clarification.  The SEC sent this response to the ABA which included this section:

  1. Placement of Item 201(d) Disclosure in Forms 10-K and 10-KSB

The Item 201(d) disclosure should be included in Part III, Item 12 of a Form 10-K, and Part III, Item 11 of a Form 10-KSB, as applicable.

The Item 201(d) disclosure should not be included in Part II, Item 5 of a Form 10-K or Part II, Item 5 of a Form10-KSB. Item 5 should include only the disclosure required by Items 201(a), (b) and (c) of Regulation S-K or S-B, as applicable.

An issuer may rely on General Instruction G.3 to Form 10-K or General Instruction E.3 to Form 10-KSB to incorporate by reference the Item 201(d) disclosure from its proxy or information statement, even if the issuer does not submit a compensation plan for security holder action at its annual meeting of security holders.

The SEC then followed their letter to the ABA with this Compliance and Disclosure Interpretation:

Question 106.01

Question: Is the Item 201(d) disclosure required in Part II of Form 10-K, given that Item 5 of Form 10-K indicates that the registrant is required to furnish the information required under Item 201, or should the Item 201(d) disclosure be included (or incorporated by reference) in Part III of Form 10-K given that Item 12 indicates that the registrant is required to furnish the information required under Item 201(d)?

Answer: The Item 201(d) disclosure should be included in Part III, Item 12 of Form 10-K. An issuer may rely on General Instruction G.3 to Form 10-K to incorporate by reference the Item 201(d) disclosure from its proxy statement or information statement, even if the issuer did not submit a compensation plan for security holder action at its annual meeting of security holders. See American (Jan. 30, 2004). [Mar. 13, 2007]

So, despite the ambiguity in the instructions the S-K Item 201(d) table should be in Item 12 in Form 10-K.

As always, your thoughts and comments are welcome!

And the Beat Goes On – The Whistleblower Song

As we have blogged on many occasions, the SEC’s Whistleblower Program has become an important part of the Enforcement Division’s activities.  On September 17, 2020, the SEC announced payments to joint whistleblowers who had raised concerns internally before blowing the whistle to the SEC.  And this September 14, 2020 Press Release announced a $10,000,000 (yes, million!) payment to a whistleblower “whose information and assistance were of crucial importance to a successful SEC enforcement action.”

To date the program has paid out approximately $521 million to 96 individuals.

If you want more background and detail, check out episode six of PLI’s inSecurities podcast, which features a review of how the whistleblower process works and a discussion of how the explosion of tips created by the program has affected the enforcement process.

As always, your thoughts and comments are welcome!

 

PLI’s inSecurities Podcast

If you are looking for a wonderfully informative and entertaining podcast to listen to while you work out at home, run or walk outside, or are just relaxing anywhere, check out PLI’s inSecurities podcast.

The hosts of the podcast, Chris Ekimoff, a forensic accountant, and Kurt Wolfe, a securities regulatory attorney, provide insightful practitioner perspectives in their  biweekly podcast.  Podcast episodes have addressed  topics such as insider trading, developments in the SEC’s whistleblower program, the perspectives the SEC Historical Society brings to securities regulation and business development challenges in the COVID-19 environment.  Chris and Kurt have interviewed prominent securities industry professionals including former SEC Commissioner Robert Jackson, NASAA General Counsel Vince Martinez and whistleblower attorney Matt Stock.

The most recent podcast episode focuses on current developments from the SEC, FASB and PCAOB, which were highlighted in the SEC Institute’s Quarterly Newsletter.  SEC Institute Director George Wilson joined Chris and Kurt for this timely discussion which you can listen to here.  You can also find PLI’s podcast at all the usual podcast sources, including Apple, Google and Spotify.

 

 

As always, your thoughts and comments are welcome!

Welcome to Fall and Our Disclosure Modernization Summary!

Welcome to the start of the fall reporting season as we gear up for the third-quarter and begin preparations for year-end.  We have summarized all of our posts going into the details of the SEC’s March 2019 Disclosure Modernization Final Rule in a single document that you can find here.  

We hope it helps as you think about ways to implement these changes in your next Form 10-K.

Also, we will be exploring the implications of the principles-based concepts in the August 2019 Proposed Rule to modernize business, legal proceedings and risk factor disclosures in  upcoming weeks to help get a head start on those possible changes.

As always, your thoughts and comments are welcome!