Under Control: SEC's Climate Disclosure Rules and the Accounting Function's Evolving Role in EHS Management

As was widely anticipated, the SEC has approved the set of final rules entitled The Enhancement and Standardization of Climate-Related Disclosures for Investors (referred to herein as the "Climate Disclosure Rule" or simply, the "Rule"). Among other things, the Climate Disclosure Rule will require certain publicly traded companies to disclose their greenhouse gas (GHG) emissions in registration statements and annual reports. Interestingly, companies to which the Rule potentially applies seem to have dodged two rather significant bullets. The proposed Climate Disclosure Rule would have required certain publicly traded companies to disclose all GHG emissions falling within Scope 1 (direct emissions) and Scope 2 (emissions resulting from consumption of power provided by public utilities). In addition, disclosures of GHG emissions falling within Scope 3 (GHG emissions throughout the value chain) would have been required if such emissions were considered as material. Under the softened final Rules, disclosures of Scope 1 and Scope 2 emissions will only be required if they are material. The requirement to disclose Scope 3 emissions rule has been entirely stricken.

These near misses notwithstanding, the final Climate Disclosure Rule is likely to have a significant impact on the accounting function's role in a company's EHS management activities. The reason for this can be summed up in a simple two-word phrase that strikes fear into the heart of every director, CEO, CFO, general counsel, and corporate accounting professional - material weakness. EHS professionals lose countless hours of sleep over what seems to be the near limitless authority of environmental regulatory agencies to assess penalties in the tens of thousands of dollars range per violation, per day. However, most reasonably foreseeable scenarios of the financial impact of violations of environmental regulatory requirements (at least within the civil enforcement realm) pale in comparison to the consequences of findings of material weaknesses in a publicly traded company's internal financial reporting controls. Such findings can hammer stock prices, bring about abrupt changes in leadership, result in expensive litigation, and invite further scrutiny from government regulators.

The fear of such consequences and the desire to avoid them are why corporate accounting functions may be compelled to assume direct responsibility for the process of measuring, estimating, calculating, and reporting on their respective companies' GHG emissions. As a result, EHS professionals already accustomed to working within the confines of the operational and management controls in place to ensure the completeness and accuracy of environmental reports and permit applications may now find themselves operating within the documentation and reporting procedures dictated by internal auditors, outside auditors, and corporate accounting and financial reporting guidelines.

This may be so regardless of whether a company's Scope 1 and Scope 2 emissions are material. According to the Climate Disclosure Rule, the materiality of a company's GHG emissions is dependent upon a multitude of factors, one of which is the magnitude of the emissions. Many companies already measure and estimate their GHG emissions for other reasons (i.e., to comply with investor demands or certain EPA regulations). If these measurements and estimates are inaccurate or incomplete, incorrect conclusions regarding the materiality of such emissions may be reached. Any determination that these inaccuracies were the result of poor management practices could lead to a finding of one or more material weaknesses in the company's internal financial reporting controls.

EHS professionals in publicly traded companies are accustomed to working closely with the accounting function on estimates of anticipated capital expenditures related to pollution control, contingent environmental liabilities, and liabilities associated with material environmental enforcement actions. For these activities, the accounting function typically defers to the methods and practices developed and implemented by EHS management. However, working directly within the operating procedures and guidelines that have been established to ensure the effective control over financial reporting would be new for most EHS professionals. Nonetheless, at least when it comes to measuring and estimating GHG emissions, this is a mode of operation for which EHS professionals in publicly traded companies may need to be prepared.