How will the SEC’s new climate regulations affect D&O strategies?

How will the SEC’s new climate regulations affect D&O strategies? | Insurance Business America

Evolving disclosure landscape will necessitate an extra level of readiness

Professional Risks

Kenneth Araullo

The recent adoption of new climate disclosure rules by the Securities and Exchange Commission (SEC) introduces a crucial paradigm shift for public companies, necessitating stringent compliance measures. With the potential for these rules to significantly heighten liability risks for corporate disclosures, directors and officers (D&O) insurance emerges as a critical safeguard.

As companies navigate this evolving regulatory landscape, the role of D&O insurance becomes even more pivotal in protecting against the financial repercussions of disclosure violations and ensuring organizational resilience.

Andrea Lieberman (pictured above), US financial services claims leader at Lockton, advises companies to begin preparations immediately, as while these regulations are currently stayed by the SEC during ongoing legal challenges and may not be enforced until possibly next year, they are poised to significantly impact public companies once implemented.

“Directors and officers liability insurance coverage purchased by public companies is intended to provide coverage for regulatory and private actions seeking damages for disclosure violations and should protect organizations from liability arising from these new rules,” she said. “D&O buyers, however, should work with insurance advisors to carefully review the language in their individual policies to ensure they respond as intended in the event of litigation or regulatory action.”

A shift in climate regulations

On March 6, the SEC finalized climate disclosure rules for public companies, initially proposed in 2022. According to SEC Chair Gary Gensler, these rules are designed to “provide investors with consistent, comparable, and decision-useful information, and issuers with clear reporting requirements.”

“Under the new rules, public companies will be required to disclose a broad range of information, including: material climate-related risks and their potential impact on their business, operations and financial condition; any climate-related targets or goals they have identified that have or may reasonably affect their business, operations and financial condition; and internal processes to identify, assess and manage material climate-related risks, including the roles of management and any board oversight,” Lieberman explained.

Although the SEC’s 2022 proposal included reporting Scope 3 emissions from indirect activities such as those from suppliers, this requirement was removed from the final rules following significant opposition on the grounds of measurement and reporting challenges.

The establishment of the rules follows a trend in other regions, such as the UK, where climate-related disclosures have been mandatory for publicly traded companies since early 2021.

“Disclosure laws across other jurisdictions vary significantly, but the IFRS Sustainability Disclosure Standards (IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures) are increasingly becoming the standard,” Lieberman said. “Within the US, California adopted its own climate emission disclosure rules in October 2023. These rules, set to take effect in 2026, apply to both public and private companies that operate in California and meet certain revenue thresholds.”

Legal challenges for new disclosures

Despite the intent to standardize climate-related disclosures, the new rules have sparked legal challenges, with lawsuits filed by trade groups and attorneys general in several states.

“Litigants and other opponents of the rules have argued that, in implementing the rules, the SEC: overstepped its statutory rulemaking authority, failed to adequately incorporate or analyze the significant public commentary it received following its initial proposal of the rules, and did not conduct an appropriate cost benefit analysis,” Lieberman explained.

As the litigation against the new rules has been consolidated in the 8th U.S Circuit Court of Appeals, and with the SEC delaying their implementation pending the court’s decision, public companies are urged not to delay their compliance preparations.

“While the new rules include a safe harbor provision for climate-related disclosures (considered forward looking statements), they will also likely increase public companies’ exposure to securities and derivative claims as shareholders and plaintiff law firms review climate disclosures for adequacy and materiality,” Lieberman said.

Furthermore, these rules could heighten the risk of securities and derivative claims as stakeholders scrutinize the adequacy and materiality of climate disclosures. The SEC also retains the power to enforce securities law disclosure violations.

“Given the potential exposures created by the new rules, insurers are likely to ask insureds specific questions about their plans to comply with them,” she said. “Public companies with upcoming D&O insurance renewals should work with their insurance advisors and counsel to prepare for this greater underwriting scrutiny.”

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