By Soyoung Ho
The Democratic administration under President Joseph Biden next year will likely bring priority changes at the SEC.
“I wouldn’t be surprised if the next chairperson were to take a hard look at some of the issues that are on your minds; for example, the commission’s approach to ESG disclosures, and especially those focused on climate risks,” Democratic SEC Commissioner Caroline Crenshaw said at the 33rd Annual Virtual Financial Services Conference hosted by the Consumer Federation of America on December 10, 2020. ESG is short for environmental, social, and governance.
Under the outgoing Donald Trump administration, the SEC headed up by Chairman Jay Clayton—who sets the regulatory agenda—has largely focused on cutting back rules advocated by businesses. Trump has also put in top officials in his administration who do not believe in climate change, but Biden is expected to make climate risks a priority.
Clayton believes that disclosures should be principles-based rooted in the concept of materiality. This means companies should disclose information that a reasonable person would find important in the total mix of information in making a decision to buy or sell a particular company’s stock.
Clayton has been skeptical about writing a prescriptive disclosure rule on ESG. In his view, a universal metric on ESG will not work because companies have different sets of circumstances. Moreover, critics of standardized reporting believe that sustainability matters mean different things to different people.
But many investor advocates believe that disclosure rules should have a proper mix of prescriptive and principles-based requirements.
On ESG, investors have been pressing the SEC to work on standardized disclosure requirements so companies will provide comparable and useful ESG information. Currently, third-party organizations set ESG standards that companies can voluntarily use. This means that it is difficult for analysts to compare the information. Moreover, investors said the SEC’s 2010 disclosure guidance on climate change has not been effective as many companies have been providing boilerplate disclosures that convey little meaningful information.
“I share your concerns about the inadequacies of voluntary sustainability disclosure framework,” Crenshaw said. “It does not produce reliable and consistent and comparable information. So, given the consensus that climate change will indeed have a significant impact on our financial system, I wouldn’t be surprised to see renewed focus on our modern disclosure system, and what improvements are needed to satisfy investor demands for this reliable and comparable and standardized set of disclosures.”
She added that she also wants to see a specific human capital disclosure requirement. The SEC adopted the rule in August but left it principles-based. (See SEC Adopts Disclosure Rule on Human Capital Management in the August 27, 2020, edition of Accounting & Compliance Alert.)
The priority change is likely to happen at the SEC. For example, the other Democrat on the commission, Allison Herren Lee, has been probably the most vocal advocate of better climate change risk disclosures. She has been giving speeches and voted down rules that do not have stronger prescriptive disclosure requirements.
“I assume there will be some behind the scenes working getting done on climate change/sustainability issues to prepare for the new chair,” said Dave Brown, a partner with Alston & Bird LLP in Washington.
Climate Change Risk CAMs?
In the meantime, PCAOB member Jay Brown has also been talking up the importance of climate change related critical audit matters (CAMs) included in auditor’s reports.
CAMs are issues that have been communicated to the audit committee, are related to accounts or disclosures that are material to the financial statements, and involved especially difficult judgment from the auditor.
Auditors of large public companies have been reporting CAMs since last year. Under a phased-in approach, for smaller companies, the CAM requirement is effective for fiscal years ending on or after December 15, 2020.
“When we talk about CAMs, there is a tendency to talk about them in the aggregate,” PCAOB’s Brown said at the AICPA’s Conference on Current SEC and PCAOB Developments on December 7. “But as you start to drill down, you find some really interesting disclosures.”
According to an interim analysis by the board, there were 2,420 audit reports that had CAMs, as of October 8, for companies with fiscal year-ends ranging between June 30, 2019, and June 29, 2020. The average number of CAMs was 1.7 per report. Of those CAMs, Brown said he has seen three that addressed the impact of climate change on various estimates in the financial statements.
“Do investors think climate change CAMs have value? I think so. Will they be looking for them next year? I think so. Will they be asking audit committees and audit firms about this topic particularly at comparable companies where there was no similar climate change CAM? I am predicting that they will,” board member Brown said. “This disclosure will, I predict, only increase in value and increasingly become integrated into the decision-making process of investors.”
This article originally appeared in the December 14, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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