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. 

Ernst & Young is leveraging its $1 billion investment in talent and technology to expand the use of artificial intelligence and machine learning over the next four years. 

EY began using older technology over a decade ago for online detection analytics, but new forms of AI are enabling it to spot unusual outliers in audit data. “We started with Excel and went into business intelligence solutions, but we were dependent on our auditors basically spotting the outliers based on tables and charts,” said Marc Jeschonneck, EY’s global assurance digital leader. “The next frontier that we are now embarking on is really to use AI to detect anomalies.”

EY has been using a general ledger anomaly detector and is now embedding AI capabilities in its GL analyzer. “The one that is most used around the audit, with more than 800 billion line items of general ledger data analyzed per year, is actually the general ledger analyzer that we use in most of our audits,” said Jeschonneck. “In that tool, we’re now embedding online detection with time series regression to really go to the next step.”  

Online detection analytics is just one of the ways the Big Four firm is employing AI technology. It’s also using AI for workflow recommendations. “All the firms have their own platforms, and so do we with EY Canvas, with more than 500,000 users in total clients as well as EY professionals,” said Jeschonneck. “We really embed with Canvas AI a recommendation engine into this platform.” It can help when identifying risks, harvesting news alerts and looking into ratios and KPIs of various sectors. 

AI in the EY Canvas recommendation engine shows auditors which risks other audit teams have seen with clients in similar sectors with similar profiles. “It really focuses their attention on what we think matters most,” said Jeschonneck. “Instead of starting from scratch based on the broader knowledge of the team just by themselves, it’s really harvesting from all of the other engagements here to spot those risks that matter most to the engagement.”

Another area where AI and machine learning are leveraged is document intelligence. AI is still limited in its mathematical ability, however, so the technology is mostly using older forms of machine learning for right now. “There is research in our pipeline to move the document intelligence to the next level, even using generative AI capabilities,” said Jeschonneck. “But to be fair, currently we don’t do that.”

Instead EY is using machine learning to craft models to identify any deviations from expectations in tables and disclosure notes. “The first thing that we are planning to use generative AI is when we help our people to improve their experience in summarizing comprehensive documents about accounting and auditing and to improve search results,” said Jeschonneck. “We are very much conscious that the quality of the respective results is highly 

dependent on the quality of the underlying data.”

Search and summarization capabilities will bring knowledge from the broader accounting and auditing teams to EY’s people in a more digestible format. 

EY is careful to balance the risk that comes with applying new technology compared to using more mature tools. 

“Exploring the benefits of the new technology, and making sure that you know about the respective risks, the guardrails that need to be put in place here, is essential for us, and you can expect that regulators and stakeholders around the world carefully observe how auditors explore these new technologies,” said Jeschonneck. 

Firms have to be careful about potentially exposing the data received from clients. “That’s one key consideration when using AI, that we not expose anything beyond the respective data privacy agreements with our clients,” said Jeschonneck.

The firm is careful when certifying solutions and working with regulators, making sure it does robust testing and has the documentation at hand, especially with new technology like generative AI. 

“We always distinguish between what our teams use to really generate audit evidence and what they use as technology to support the broader process,” said Jeschonneck. 

Auditors still have to do many routine administrative tasks, he noted, and they are able to use AI technology like Microsoft Copilot to boost their productivity.

EY works closely with Microsoft, using technology such as Power BI for business intelligence, as well as Microsoft Azure. 

The firm can also use AI technology to uncover fraudulent documents. “When we see falsified documents that were manipulated by people, AI is tremendously helpful for us,” said Jeschonneck. “As it gets easier for generative AI technology to potentially manipulate documents, the response here must be more comprehensive than just how these documents were altered.”

Machine learning and AI tools can help spot such anomalies in some cases more easily than a human being. “Even if you go for a monthly or daily time series, and you’ll have people spotting anomalies by comparing it to their expectation in simple line charts, we’re still dependent on things like the resolution of the screen, or people spotting the outlier by manually going and drilling down into tables,” said Jeschonneck. “But when the algorithms help you to detect those, at least your attention is focused on these first. Then we rely on the talent of our professionals here to really deep dive into those and further investigate.”

EY firms across the globe are leveraging such technology. “Many of the innovations that we have are actually harvested from our member firms from around the world,” said Jeschonneck. “Yes, we have a central team developing it, but we always rely on innovation coming also from the ground, from the people that work directly with our clients.”

The general ledger analyzer, for example, came from the U.S. firm, while time series regression analysis comes from a collaboration of people in Europe and the U.S. The general ledger anomaly detector started in Japan.

EY also provides training in AI to its people. “What we have here is the technology enabling our people, in the hands of professionals who are skilled and have access to the right training making the best use of the technology that we have,” said Jeschonneck. “Technology really gives new opportunities to the people.”

“Timing is everything.” We’ve heard this turn of phrase often in all sorts of scenarios. And if you have clients who are starting a new business or transitioning from a sole proprietorship or partnership to an LLC or corporation, it’s absolutely relevant!

Whether someone incorporates their business now as the year comes to a close or waits until the new year can affect their company in various ways. In this article, I’ll discuss those impacts and explain why some clients might find the option to do a delayed filing attractive. 

Business formation timing considerations

First things first, let’s discuss the three timing options business owners have when forming an LLC or corporation — midyear, end of year or January 1 (a.k.a., the start of the new year). 

Midyear

Registering a business entity with a midyear effective date means the company will be subject to all the tax and reporting requirements associated with their LLC or corporation for that year. And existing businesses that switch to an LLC or corporation mid-year must submit two sets of income tax returns: one for the business structure it operated as during the months before its incorporation date and another set for the remainder of the year when it operated as an LLC or corporation. 

End of year

December is an extremely hectic month for Secretary of State offices across the country, which can create a backlog of filings and potentially result in an effective date a month or more into the new year. Typically, states must receive and process an entity’s registration form before it’s considered effective. So, even if someone requests an effective date in December or on  January 1, the actual effective date might be later if the state is unable to process the registration before the requested effective date. In other words, states generally do not make effective dates retroactive. 

January 1

A January 1 effective date has some perks. It gives the LLC or corporation a clean start — e.g., existing businesses only have one set of tax forms for the tax year vs. the two required if switching entity types midyear. Also, in states that levy LLC franchise taxes, an LLC that files with an effective date of January 1 would not have to pay those fees for the previous year. For example, if a business files its LLC formation paperwork in November 2024 but requests an effective date in January 2025, the LLC won’t have to pay a state franchise tax for 2024. Likewise, the LLC or corporation’s other corporate formalities kick in for that year rather than for the year before.

How to ensure a January 1 effective date

Typically, a business registration filing will be effective on the date the state processes the forms. The processing time may vary between just a few days to several weeks, with expedited filings completed in five to ten business days. 

A delayed filing, however, gives business owners some control over when their corporation or  LLC goes into effect. In states that allow delayed effective dates, business owners can submit their formation paperwork in advance and set a future date for when they want their entity to be officially registered. Different states have different rules for when they’ll accept a delayed filing.

For example, here are several states’ requirements for how far in advance business owners may request a delayed effective date: 

• Alabama – Up to 90 days before the requested effective date;
• California – Up to 90 days before the requested effective date (note that in California, LLCs and corporations that submit their formation paperwork after December 18 will be considered to be in business effective January 1 the next year, provided they do not conduct business between December 18 and December 31 of the current year);
• Florida – Up to 90 days before the requested effective date;
• Illinois – Up to 60 days before the requested effective date;
• Pennsylvania – Up to 90 days before the requested effective date;
• Rhode Island – Up to 90 days before the requested effective date;
• Texas – Up to 90 days before the requested effective date;
• Virginia – Up to 15 days before the requested effective date.

The below states do NOT allow delayed effective dates:

• Alaska
• Connecticut
• Delaware
• Hawaii
• Idaho
• Louisiana
• Maryland
• Minnesota
• Nevada
• New Jersey

How can your clients request a delayed filing?

As your client or their representative completes the forms to establish their LLC or corporation, they should consider their desired effective date and make sure they submit their delayed filing within the state’s acceptable time frame. For instance, if someone wants to form an LLC in Rhode Island with an effective date of January 1, 2025, they can submit their delayed filing as early as Oct. 2, 2024. The company’s Articles of Organization (LLC) or Articles of Incorporation (corporation) should reflect the desired effective date. If the state doesn’t have a designated field on its form to request an effective date, your client can add a provision to request a specific date (if the state will allow it).

Is a delayed filing for everyone?

Whether a delayed filing makes sense for a client depends on their situation. As we discussed, submitting business formation paperwork before the end of this year to request a January 1 effective date next year can make tax filing time less cumbersome and potentially avoid some extra compliance fees. But sometimes, a delayed filing won’t be the way to go. For example, some consultants or other professionals may not want to wait that far in the future to get their entity up and running because they need an earlier effective date to secure a significant client. 

Final thoughts

Delayed filings provide business owners with control over the official registration date of their business entities. By filing business formation ahead of time and requesting a delayed effective date of January 1, business owners may avoid potential paperwork processing backlogs at the state and eliminate extra paperwork at tax filing time. Moreover, it enables entrepreneurs to file their registration forms before the end of the current year for the following year without being on the hook to pay certain fees (like an LLC franchise tax) and submit certain reports (like annual reports) for the year when the registration forms were filed because the entity was not yet effective then. 

As with all business concerns with legal and financial ramifications, your clients should seek expert professional guidance when considering whether a delayed filing will be advantageous for them. That’s where your expertise can make a tremendous difference! And for any questions beyond the scope of the matters you’re licensed to address, please direct your clients to the appropriate resources.