As described in a previous alert, the Securities and Exchange Commission ("SEC") voted on Wednesday, January 27, 2010 to adopt an interpretive release to provide guidance on existing public company disclosure requirements as they apply to business or legal developments relating to climate change. The SEC has now distributed the interpretive release itself, which can be found here. The interpretive release indicates that its purpose is to provide guidance on how to interpret existing SEC disclosure rules and requirements as applied to business and legal developments associated with climate change. The interpretive release does not create new legal requirements or modify existing requirements but is intended to provide clarity and enhance consistency for public companies and investors as they prepare disclosures related to the impacts of climate change and analyze such disclosures.
After briefly describing the public discussion regarding climate change, recent regulatory and legislative developments, and the historical background of SEC environmental disclosure, the interpretive release summarizes the current SEC rules and regulations, primarily found in Regulation S-K, under which reporting public companies may be required to provide climate change disclosure.
Description of Business. The release notes that under Item 101 of Regulation S-K, a reporting public company is required to describe its business and, in particular, to provide disclosure regarding the material effects that compliance with federal, state and local environmental statutes or regulations will have on the company's capital expenditures, earnings and competitive position.
Legal Proceedings. The release then discusses a reporting public company's obligations to disclose certain legal proceedings. Under Item 103 of Regulation S-K, a reporting public company is required to describe any material pending legal proceedings to which it is a party. In addition, pending actions by governmental authorities must be disclosed. The interpretive release notes that an exception to such disclosure requirements exists if the litigation is "ordinary routine litigation incidental to the business." However, proceedings under environmental statutes cannot be considered "ordinary routine litigation incidental to the business" and must be described if they (a) are material to the business or financial condition of the reporting public company; (b) involve primarily a claim for damages or involve capital expenditures or charges to income that, exclusive of interests and costs, exceed 10 percent of the current assets of the reporting public company; or (c) involve a governmental authority and potential monetary sanctions unless the reporting public company reasonably believes that the monetary sanctions will be less than $100,000.
Risk Factors. Item 503(c) of Regulation S-K requires a reporting public company to discuss the most significant factors that make investment in that business speculative or risky. The interpretive release notes that the risk factor disclosure should specify how the risk impacts the reporting public company, as opposed to presenting risks that could apply to any company.
Management's Discussion and Analysis of Financial Condition and Results of Operations. The interpretive release focuses on the disclosures currently required under Item 303 of Regulation S-K, commonly known as "MD&A." It notes that MD&A disclosure is intended to satisfy three objectives: (1) providing a narrative explanation of the reporting public company's financial statements that will allow the reader to view the company "through the eyes of management"; (2) providing a discussion of the context in which the reporting public company's financial information should be analyzed; and (3) providing information about the potential variability of a reporting public company's earnings and cash flow. In pursuit of these objectives, Item 303 calls on a reporting public company's management team to identify and disclose known trends and uncertainties that are reasonably likely to have a material impact on the financial condition or operating performance of the enterprise.
The interpretive release then discusses four areas where climate change may trigger disclosure required by the existing rules: Legislation and Regulation; International Treaties and Accords; the Indirect Consequences of Regulation or Business Trends; and Physical Impacts of Climate Change.
Legislation and Regulation. In addition to considering the impact and materiality of existing laws and regulations regarding climate change, the interpretive release indicates that reporting public companies should evaluate the potential impact of pending legislation and regulation related to climate change. The release notes that a certain development in legislation or regulation may trigger required disclosures under any of the Regulation S-K items discussed above. In particular, in determining whether disclosure is required in MD&A, the release indicates that a reporting public company must evaluate whether the pending legislation is reasonably likely to be enacted and must proceed on the assumption that the legislation will be enacted unless it determines that the legislation is not reasonably likely to be enacted. Based on that analysis, the reporting public company must then determine whether the legislation, if enacted, is reasonably likely to materially impact the reporting public company's business, financial condition or results of operations.
In addition, the release urges reporting public companies not to focus only on negative consequences of pending legislation. As an example, the release indicates that if a "cap and trade" system is adopted, a reporting public company may be able to profit from the sale of allowances if its emission levels are less than its emissions allotment.
International Treaties and Accords. The interpretive release also indicates that reporting public companies should consider disclosure related to the impacts on their businesses of international treaties or accords relating to climate change and provide such disclosure when such impacts are material. The analysis in this area is substantially similar to the analysis of pending legislation.
Indirect Consequences of Regulation or Business Trends. The release also discusses the indirect consequences of climate change developments. It notes that such developments may create new opportunities or risks for companies. Of particular interest, the release indicates that reporting public companies should consider disclosure related to the actual or potential indirect consequences that their businesses may face due to climate change trends. Under the interpretive release, examples of such indirect consequences include potential decreased demand for goods that produce significant greenhouse emissions or potential increased demand for goods that result in lower emissions than competing products. While such developments may be expected to trigger disclosure obligations under the risk factor and MD&A provisions discussed above, the release notes that some developments may be significant enough to cause a reporting public company to change its business in ways that trigger the need to disclose significant shifts in operations in the business description required under Item 101 of Regulation S-K .
Physical Impacts of Climate Change. The final category discussed in the release relates to the direct physical effects of climate change. Public reporting companies will be asked to evaluate the actual and material impacts of environmental matters on their businesses. Such disclosures could include information related to the impact on a business of changes in the severity of weather, sea levels, the arability of farmland and water availability and quality. The release focuses on the physical impacts associated with severe weather, noting the possible impacts of disruption of business operations due to floods, hurricanes or decreased agricultural production capacity in areas affected by drought.
As noted in our previous alert on this topic, the interpretive release was approved by a three-to-two vote of the Commissioners. The two Commissioners who voted against adoption of the release, Commissioner Troy A. Paredes and Commissioner Kathleen L. Casey, released statements describing the reasons for their opposition. Commissioner Paredes expressed concern that the interpretive release's emphasis on potential reputational damage and potential physical impacts associated with climate change may create confusion and uncertainty because of the speculative nature of such impacts. The dissenting Commissioners were also concerned that the interpretive release will not result in public company disclosure of material information that is of significant use to investors as they make investment decisions.