ESG, the SEC, and a successful climate-related proxy proposal
Audit firms play Switzerland with clients on ESG, just like they did with SOX 404. The Big 4 floats above unwanted SEC mandates and a bonanza of new revenue from fulfilling attestation requirements.
The SEC has been plodding along with a behemoth climate disclosure proposal, announced back on March 21. The Big 4 audit firms are fine with this. It gives them more time to lobby for what they want out of it.
The proposed amendments to the Commission’s rules would require that public companies include extensive quantitative and qualitative information about climate change in their annual reports and registration statements. The earliest that these disclosures would be required if adopted is in 2024 for the largest public companies. The rule proposals are wide ranging and would require that companies add new sections to their annual reports and registration statements that would provide details about climate change matters that are today often disclosed in separate communications outside of the SEC reporting system.
Most significantly, the SEC would require specific disclosure of a public company’s direct GHG emissions (Scope 1) and indirect GHG emissions (Scope 2), as well as indirect emissions form upstream and downstream activities (Scope 3), but in the case of Scope 3 emissions only if material or if the company has set a goal that includes Scope 3 emissions. Disclosures about Scope 3 emissions would be subject to a safe harbor for liability under the federal securities laws and would not be required from smaller reporting companies.
For disclosures concerning Scope 1 and Scope 2 emission, companies would be required to file an attestation report covering the disclosures and to provide certain related information about the service provider that prepared the attestation report, which need not be an independent auditor but must meet certain requirements.
The SEC did a test run before issuing its proposal by sending out comment letters to tons of issuers. The SEC asked companies to explain the differences between climate-related disclosures in their Corporate Sustainability Report (CSR) and disclosures made on websites, in conference calls, earnings reports, or in their 10-K annual report.
Kris Benatti’s Bedrock AI newsletter wrote on March 4:
15 climate-related SEC letters have been made public since February 14th, in an unprecedented move by the SEC.
The recent SEC issuer correspondence raises questions about how materiality is assessed in the context of climate disclosure and the future of ESG reporting.
The newly public SEC comment letters are not a surprise. In September 2021, the SEC published this form letter but up until now, we had never seen the letter in action. Since February 14th, an explosion of such SEC comment letters have been made public.
Benatti also raises a key issue that is briefly mentioned by the Big 4 in their comment letters in the proposal to the SEC: materiality.
When and why do climate risks become important to investors and stakeholders? Lawyers, accountants and investment professionals have been grappling with the concept of materiality and climate risks for many years.
The issuer responses to the SEC letters provide a unique view into how issuers are thinking about this topic.
TLDR: Companies believe most climate disclosure is not material in the context of U.S. securities law.
Multiple issuers argued that while the information in their CSR report was material under the Global Reporting Initiative (GRI), it is not material in the context of U.S. securities law. Materiality and the current disclosure requirements related to climate are discussed in more detail in the SEC’s 2010 “Commission Guidance Regarding Disclosure Related to Climate Change”.
The SEC notes that “information is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision….”
Given the increased interest in sustainability/climate on the part of investors, it may become increasingly difficult to argue that climate concerns don’t impact how investors vote and make decisions.
To tee it all up with hard evidence, the SEC established the Climate and ESG Task Force within its Division of Enforcement in March 2021, to specifically seek enforcement actions when there are material gaps or misstatements in issuers’ existing ESG disclosures.
That makes companies’ ESG data, and any audits that develop and validate such data, a securities law risk.
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