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SEC Democrats Worry Climate Reporting Plan Falls Short on Audits

June 13, 2022, 9:30 AM

Democratic SEC Commissioners Allison Lee and Caroline Crenshaw are raising more questions about whether the agency’s climate disclosure proposal would do enough to elicit reliable greenhouse gas emissions data from companies.

The proposal released in March would require companies to report on their carbon footprints and obtain outside reviews of some of the information. The Securities and Exchange Commission would be flexible with the assessments in the beginning and add more checks over time.

The two commissioners told Bloomberg Law in recent interviews they’re interested in requiring companies to obtain independent reviews for all parts of their carbon footprints—going beyond the current SEC draft that would let companies skip third-party assessments of disclosures about their Scope 3 greenhouse emissions.

“Scope 3 is the bulk of many, many companies’ emissions,” Lee said. “And so, it’s important.”

Scope 3 includes emissions from materials and services companies acquire, the investments they make and employee travel, as well as the transportation, disposal, and use of their products, according to the SEC. Because such emissions aren’t directly controlled by businesses, they can be very difficult to calculate.

Crenshaw and Lee joined Democratic SEC Chair Gary Gensler to approve the release of the proposal requiring companies to report greenhouse gas emissions—along with disclosures about how climate change affects them and related issues.

But Lee and Crenshaw also said they wanted to hear more about proposed safeguards against inaccurate emissions reporting.

Getting Assurance

The current proposal only would mandate independent assessments for disclosures about Scope 1 and 2 emissions, which cover companies’ direct operations and power usage.

“We need to get to the place where there’s the kind of reliability and assurance around Scope 3 that we’ll have for Scopes 1 and 2,” Lee said.

Under the current plan, large companies would need to get an auditor or another third party to assess their Scopes 1 and 2 emissions data. The degree of rigor would ramp up over the years.

The proposal would give companies two years after the adoption of any rules to get an independent reviewer to provide “limited assurance” that the information is trustworthy. The reviewer would just have to show they’re unaware of anything that needs fixing under the standard.

The assessments would get more rigorous four years after the adoption of any rules. Companies would need to secure a higher level of outside review called “reasonable assurance” to ensure their reporting is reliable. Hired third-party assessors can make that claim only if they affirm the data is presented fairly in all ways that are important for an average investor, a concept known as materiality.

But companies wouldn’t need any of these assurances for Scope 3 emissions disclosures, which are required only under certain conditions in the proposal—namely, only if Scope 3 information is material to their business or part of a climate goal.

Companies could face fraud cases from the SEC and others over Scope 3 disclosures. But a commission-proposed safe harbor would limit litigation to Scope 3 reporting made without a reasonable basis or done in bad faith.

“While rigorous liability in many contexts can provide incentives that promote reliable disclosures, an accommodation may be warranted for Scope 3 emissions due to the challenges associated with their measurement and disclosure,” the SEC said in its proposal.

SEC Debate

Crenshaw said she isn’t sure the SEC’s current proposal adequately calibrated the checks on Scope 3 emissions disclosures and is open to considering changes.

“Scope 3 emissions involve data that may be more difficult to collect and then calculate compared to Scopes 1 and 2,” Crenshaw said. “So bringing rigor and accuracy to this space is important, and I am interested in hearing how we can best achieve that.”

Disclosures about Scope 3 emissions don’t lend themselves well to traditional checks on corporate reporting, said J.W. Verret, a George Mason University Antonin Scalia Law School associate professor, who studies securities law and accounting.

Auditors routinely test whether a company’s financial reporting can be trusted. But an auditor or other outside verifier, for example, is unlikely to get sufficient responses calling a cellphone maker’s customers to adequately evaluate any Scope 3 emissions data about its customers’ use of electricity to power its devices, Verret said.

“The tools of auditors aren’t designed for something as nebulous as Scope 3 is,” Verret said.

Nestle, HSBC

Any challenges with calculating and checking Scope 3 emissions data haven’t stopped some companies from already getting the information audited and published.

Nestle S.A. and HSBC Holdings PLC, among other companies, have released Scope 3 data that auditors reviewed.

Shareholders want reliable corporate climate information in all its forms, including Scope 3 emissions, said Steven Rothstein, managing director of the Accelerator for Sustainable Capital Markets at Ceres, a nonprofit organization founded by investors and environmentalists.

“It’s important to have third-party review of significant financial factors and climate is one of those,” Rothstein said.

SEC Debate

Lee and Crenshaw were instrumental in including Scope 3 reporting in the SEC proposal, Bloomberg News reported. Gensler had argued Scope 3 reporting would help fuel court cases to kill any climate disclosure rules. Republicans and business groups already are laying the groundwork for litigation.

A spokeswoman for Gensler declined to comment for this story.

Lee is planning to step down in the coming months, likely before the SEC votes to finalize any climate disclosure rules. Jaime Lizarraga, a senior adviser to House Speaker Nancy Pelosi (D-Calif.), is awaiting Senate confirmation to succeed her.

Lizarraga hasn’t publicly weighed in on third-party reviews for Scope 3 emissions reporting. He declined to comment through a representative.

Hester Peirce, a Republican SEC commissioner who voted against the proposal, told Bloomberg Law she wasn’t sure the agency has the authority to mandate climate disclosures, let alone require independent reviews of Scope 3 emissions information.

“Scope 3 is in itself quite an ambiguous metric,” Peirce said. “This is the difficulty that we get in when we ask companies to start disclosing things that are not easy to pin down.”

To contact the reporter on this story: Andrew Ramonas in Washington at aramonas@bloomberglaw.com

To contact the editor responsible for this story: Michael Ferullo at mferullo@bloomberglaw.com, Melissa B. Robinson at mrobinson@bloomberglaw.com