SEC's evolving stance on climate disclosures has implications for auditors
By Mark Friedlich
October 16, 2024
The Securities and Exchange Commission has been constantly revising its stance on how public companies should report their climate impact.
These ongoing changes are keeping auditors, companies and investors confused. After proposing ambitious rules in 2022, the SEC adopted a scaled-back version in 2024. The new rules are set forth in Release No. 33-11275. However, this new regulatory environment has faced legal challenges, creating uncertainty for companies and auditors. The agency took the unexpected step of voluntarily pausing the implementation of the rules while legal proceedings were ongoing.
Both progress and setbacks have marked the SEC's journey toward finalizing climate disclosure rules. While the initial proposal aimed to require extensive climate-related disclosures, the final rules ultimately focused on critical areas like Scope 1 and 2 emissions, financial statement disclosures, and board oversight. However, even these revised rules have faced significant opposition.
How are the 2022 proposed rules different from the final rules?
One of the most contentious areas was the treatment of Scope 3 emissions. The 2022 proposal would have required public companies to disclose Scope 3 emissions, representing indirect emissions from upstream and downstream activities. This included emissions associated with a company's supply chain, transportation and other value chain activities.
In a significant departure from the original proposal, the SEC eliminated the Scope 3 emissions disclosure requirement in the final rules. This decision was met with praise and criticism, with opponents arguing that Scope 3 emissions are critical to a company's overall carbon footprint.
Other significant changes include the following:
Scope 1 and 2 emissions: While the requirement for Scope 1 and 2 emissions (direct and indirect emissions from purchased electricity) remained, it was limited to larger companies (accelerated and large accelerated filers) and only if the emissions were deemed "material."
Financial statement disclosures: The proposed requirement to disclose the impact of climate-related risks on financial statements was removed from the final rules.
Board oversight: The SEC also eliminated requirements for disclosing board members' climate-related experience and specific climate responsibilities.
Flexibility: The final rules provide more flexibility regarding where and how companies present their climate-related disclosures.
Why did the SEC make the changes?
The SEC's decision to scale back the initial proposal was likely influenced by a combination of factors, including:
Complexity: Scope 3 emissions can be complex to measure and report, and some companies may have faced challenges in collecting and analyzing this data.
Legal challenges: The SEC may have anticipated legal challenges to the Scope 3 emissions requirement and removed it to avoid potential regulatory uncertainty.
Economic impacts: Some critics argued that requiring Scope 3 emissions disclosure could impose significant costs on businesses, particularly smaller companies.
While the final rules represent a compromise between the SEC's initial ambitions and the concerns of various stakeholders, the issue of climate-related disclosures remains a complex and controversial topic. Ongoing legal challenges and continued uncertainty persist.
Legal battles and regulatory uncertainty
Almost immediately after the final rules were adopted, various groups, including businesses, conservative organizations and environmental activists, challenged them in court. In response, the SEC unexpectedly voluntarily paused the implementation of the rules while legal proceedings were ongoing. This decision has created a period of uncertainty for auditors and their clients.
On April 4, 2024, the SEC voluntarily issued a stay on its climate disclosure rules, originally adopted on March 6, 2024. This decision came in response to multiple lawsuits challenging the regulations across several federal circuits. The agency said it issued the stay for several reasons, including to avoid potential regulatory uncertainty. At the same time, litigation is ongoing to allow the court to focus on reviewing the merits of the challenges and to facilitate an orderly judicial resolution of the numerous petitions filed against the rules.
Legal challenges
Multiple lawsuits have been filed challenging the SEC's final climate rules. Business interests and conservative groups have filed challenges in various federal appellate courts. Republican attorneys general have also filed legal challenges. Environmental groups like the Sierra Club have sued, arguing the rules are too weak. These cases have been consolidated and are now pending review in the U.S. Court of Appeals for the Eighth Circuit.
SEC's current position
Despite issuing the stay, the SEC maintains that the climate rules are consistent with applicable law and within its authority. The agency has stated that it will "continue vigorously defending" the validity of the rules in court and reiterated that its existing 2010 climate disclosure guidance remains in effect.
Where we are today
While the stay is in effect, companies subject to SEC regulations will not be required to comply with the new climate disclosure rules. However, many experts advise companies to continue their preparatory efforts, albeit on a less accelerated timeline, given the ongoing investor interest in climate-related disclosures and the potential for the rules to be upheld in court.
What does this all mean for auditors and their clients?
The evolving regulatory landscape has several implications for auditors and the companies they serve:
Increased scrutiny of ESG claims: Even without mandatory disclosures, the SEC remains vigilant against false or misleading ESG claims. Auditors must be diligent in reviewing sustainability reports and other ESG-related communications.
Focus on internal controls: Companies should have strong internal controls to support their ESG disclosures. Auditors may need to assess these controls for their overall audit planning.
Preparation for potential implementation: While the SEC rules are currently on hold, companies should continue to prepare for their potential implementation. Auditors can play a valuable role in helping clients through this period of uncertainty.
The road ahead
The future of climate-related disclosures remains uncertain, but this issue will remain a significant focus for regulators, investors, the courts and the public. Auditors must stay prepared to adapt their practices to meet the needs of their clients during this period of uncertainty and beyond.
[Author: Mark Friedlich
Vice president, U.S. government affairs, Wolters Kluwer Tax & Accounting North America]
[Accounting Today]
