The SEC has proposed rules which would require those registered with the SEC to disclose specific information regarding their climate-related financial risks and climate-related financial metrics. [2] This information would be disclosed to the SEC through an entity’s typical registration statements or annual reports, which already contain many other required disclosures. [2]

Importantly, the draft rules require companies registered with the SEC to disclose both their direct and indirect greenhouse gas emissions. These emissions include three discrete categories – Scope 1, Scope 2, and Scope 3. [3] Scope 1 greenhouse gas emissions are those emitted directly by the company through its operations, while Scope 2 emissions are the “indirect” emissions stemming from a company’s energy usage, such as through electricity generation. [4]

Of greater controversy, however, the proposed rules also require disclosure of any Scope 3 emissions a company deems “material” or that are included in a company’s self-appointed emissions targets. [3] Scope 3 emissions are those emitted not directly or even indirectly by a company itself, but rather by the company’s upstream or downstream suppliers and partners. [1]

Though the emissions of a supplier or partner may appear attenuated from a company’s own operations, the breadth of today’s globally connected supply chains seems to necessitate some consideration of these emissions, particularly in the limited cases for which the SEC proposes to mandate their disclosure. In particular, the SEC has carved out a legal safe harbor to guard small companies from the potentially prohibitive costs involved in Scope 3 emissions reporting. [1]

Beyond disclosure of climate-related risks and greenhouse gas emissions, the SEC’s new draft rule also require registrants to disclose any “actual or likely material impacts” that the climate-related risks they face might have on their “business, strategy, and outlook.” [3] These “climate-related risks” can be of any kind, meaning companies will likely need to take stock of both physical threats to their business from climate change – like risks stemming from coastal flooding or other extreme weather events – as well as financial threats – like the ways in which future climate change legislation or a potential carbon tax might impact the company’s bottom line.[3]

While conservative critics argue that the new rules on climate are an overstep of the SEC’s regulatory authority, SEC Chair Gary Gensler and many activist investors disagree. [3] Citing the rapid expansion in investor interest in environmental, social, and governance (ESG) focused funds, Gensler has noted that these rules carry out the SEC’s core mission in ensuring investors have access to “decision-useful” information about the funds in which they invest. The SEC notes that the proposed disclosure requirements are indeed “decision useful” in that they will provide investors with “consistent, comparable, and reliable” information from which investors may make informed decisions about the ways in which climate-related risks might impact their portfolios. [1]

As of today, these climate-related disclosures are still only proposed rules – meaning their next step is public comment, followed by the issuance of a final rule, like within the next year. [3] Critics, including the U.S. Chamber of Commerce, are sure to legally challenge these rules should they be formally adopted. Yet the clear investor demand and the value of data passed on to investors relating to the climate change-causing GHG emissions and the attendant risks a company faces should not be understated.

If you have questions on how the SEC’s new climate-related disclosure rules might impact you, your investments, or your business, the attorneys at Savage Villoch Law are available for consult.

Sources: [1] https://www.sec.gov/news/press-release/2022-46 [2] https://www.sec.gov/rules/proposed/2022/33-11042.pdf [3] https://www.reuters.com/legal/litigation/us-sec-set-unveil-landmark-climate-change-disclosure-rule-2022-03-21/ [4] https://www.compareyourfootprint.com/difference-scope-1-2-3-emissions/

At the heart of the civil and criminal complaints against Nikola are allegations that as its CEO, Trevor Milton, regularly spread false and misleading information about the progress of Nikola’s EV products and technologies. Nikola’s focus is on manufacturing low- and zero-emissions trucks, and the complaints allege in part that under Milton, Nikola published a promotional video of a prototype truck which did not actually work, but appeared to only because the truck was set in neutral and rolled down a hill. [1]

Promotional videos like that one, along with Milton’s enthusiastic social media posts and numerous podcast and television appearances, all painted a picture of exciting and impressive forward progress at Nikola, which Federal prosecutors and SEC regulators allege was nothing more than an illusion. [2]

This illusion allegedly created by Milton came at a steep cost – and was seemingly targeted retail investors in particular. Nikola went public via a Special Purpose Acquisition Company (“SPAC”) in June 2020, and once it began trading publicly, the value of its shares increased by $7 billion. However, Nikola’s value dropped steeply once the public learned of ongoing federal investigations into the company and its operations, leading to huge losses borne by retail investors who had been misled. [1]

Of course, EV companies and their executives are in a unique position given the bounding public interest in, and relative infancy of, the EV market. When attempting to evaluate a new or existing EV company, projections into the future must be made, and no fool-proof roadmap for this technology currently exists.

However, these uncertainties pose a particularly risky situation for prospective retail investors who can be easily misled by companies making false claims about their highly complex products or technologies – especially when, as here, these claims are being shared rapidly over social media.

Here, Nikola’s non-traditional IPO process put unsuspecting retail investors at even greater risk. When a company goes public via a SPAC, the traditional “quiet period” after a company is publicly listed is not required. This allowed Milton to continue amplifying false claims about Nikola on social media just after going public, thereby attracting additional retail investors, and driving the stock price up further. [3]

In pursuing these securities fraud charges against Nikola, the SEC continues to signal its sharp focus on SPAC regulation in the interest of protecting investors. As we all navigate the rapid influx of SPACs along with the continued push for broad adoption of EVs, retail investors should continue to carefully research prospective investments by identifying concrete achievements such as milestones hit and actual sales or delivery figures to date, while steering clear of “bandwagon effect” investing. These careful considerations, along with continued scrutiny by regulators, are some of the best ways to protect your assets in the market.

Sources:

[1] https://www.marketwatch.com/story/nikola-electric-truck-prototypes-were-powered-by-hidden-wall-sockets-towed-into-position-and-rolled-down-hills-prosecutors-say-11627572394

[2] https://www.sec.gov/news/press-release/2021-141

[3] https://www.nytimes.com/2021/07/29/business/nikola-trevor-milton-fraud.html

As defined by SEC Commissioner Allison Lee during her keynote speech at the PLI’s Annual Institute on Securities Regulation in November 2020, a systemic risk is “characterized by the following features: (1) ‘shock amplification’ or the notion that a given shock to the financial system may be magnified by certain forces and propagate widely throughout; (2) that propagation causes an impairment to all or major parts of the financial system; and (3) that impairment in turn causes spillover affects to the real economy.” [1]

Put more simply, a systemic risk is one with the potential to result in the downturn, or even collapse, of an entire market system. The ongoing COVID-19 pandemic is one recent example of such a risk, as we continue to see its economic impacts across every sector of the market. During her speech, Lee noted that although the SEC is not in a position to regulate and slow the actual drivers of climate change, it can – and should – address climate risks through standardization of the environmental, social, and governance (ESG) disclosures that financial institutions make.

The SEC’s interest in managing climate risk seems to be gaining momentum, as John Coates, the SEC’s acting Director of the Division of Corporation Finance, recently echoed Lee’s sentiments by recommending that the SEC take a leadership role in creating a standardized disclosure system for ESGs. [2] Coates commented that ESG disclosures are becoming “less voluntary” than they historically have been, as investor interest in this information has risen significantly. Investors are beginning to expect sustainability reports, and in turn, some form of standardization by the SEC will help protect and inform investors moving forward.

From an outside perspective, a June 2020 report by Ceres, titled “Addressing Climate as a Systemic Risk: a call to action for U.S. financial regulators” offers additional insight into the economic impacts of climate change, along with recommended actions for a slew of financial institutions like the SEC. [3]

The report states that some of the most significant risks inherent in climate change include economic losses and health risks stemming from extreme weather events, as well as the ripple of economic impacts from the eventual transition toward a low or zero-carbon economy.

As seen from this week’s tragic winter storm in Texas, the economic impacts of severe weather events are staggering, and these events are only getting more extreme and more common. Experts are expecting insurance claims from the storm to top $19 billion, the previous record for Texas’ most expensive storm set by Hurricane Harvey in 2017. [4] Not to mention the extensive costs borne by disrupted supply chains, among other market sectors.

Further, as our economy necessarily transitions toward net-zero carbon in order to reduce greenhouse gases that accelerate climate change, there is the potential for widespread disruption of critical industries like transportation and energy. When these multi-trillion-dollar industries suffer, the entire market does too.

While regulatory bodies like the SEC may not lead the charge in slowing climate change itself, they have the unique opportunity to prepare and stabilize the market as climate risks loom. Their recent prioritization of formalized ESG disclosures is a promising sign, but only time will tell whether measures like these will effectively protect the market from the extreme risks posed by climate change.

Sources:

[1] https://www.sec.gov/news/speech/lee-playing-long-game-110520

[2] https://www.reuters.com/article/us-climate-change-disclosures/secs-coates-says-agency-should-help-create-esg-disclosure-system-idUSKBN2AI2CG

[3] https://www.ceres.org/sites/default/files/2020-05/Financial%20Regulator%20Executive%20Summary%20FINAL.pdf

[4] https://www.dallasnews.com/business/2021/02/18/this-years-winter-storm-could-become-the-costliest-weather-event-in-texas-history/