At an open meeting yesterday, the Securities and Exchange Commission (SEC) voted 3-2 to issue an interpretive release regarding disclosures related to climate change issues in annual reports, registration statements and information statements of issuers. The SEC took this action in response to petitions from environmental and investor groups.1
The full text of the climate change interpretive release is not yet available, so the description of interpretive release provided in this special alert is based on the SEC’s press release and statements made by the Commissioners and the Staff at the open meeting.
Separately, on January 26, 2010, the SEC proposed amendments to Rule 10b-18.2 Rule 10b-18 provides issuers with a “safe harbor” from liability for market manipulation when they repurchase their common stock in the market in accordance with the Rule’s manner, timing, price and volume conditions. The amendments, which are largely technical in nature, would clarify and modify the Rule to reflect the continued evolution of trading technologies, platforms and strategies subsequent to Rule 10b-18’s inception by modifying the price condition and limiting the general disqualification provision.
Interpretive Guidance for Climate Change-Related Disclosure
The interpretive guidance related to climate change disclosure discusses in detail the requirements under existing SEC disclosure rules, including:
- Reg. S-K Item 101 (Business: disclose material effects of environmental compliance “on capital expenditures, earnings and competitive position of the registrant and its subsidiaries”);
- Reg. S-K Item 103 (Legal Proceedings: disclose material pending legal proceedings related to environmental matters);
- Reg. S-K Item 303 (MD&A: disclose known trends or uncertainties that the registrant “expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations”);
- Reg. S-K Item 503 (Risk Factors: disclose material risks faced by the registrant); and
- Rule 10b-5 (duty not to make material misstatements or omissions).
From time to time the SEC will issue interpretive releases in order to focus registrants’ attention on existing disclosure requirements that the SEC believes issuers may not be giving enough attention. The SEC issued similar guidance in the past on such varied topics as the effects of inflation, political risks in foreign operations and Y2K.
What Disclosures Does the Interpretive Guidance Require?
Whether or not a company is currently required to disclose the potential impact of climate change on its business depends on whether, taking into account all relevant facts and circumstances, such disclosure would be material to investors. The interpretive guidance clarifies the responsibility of companies to discuss:
- the direct effects of existing and pending environmental regulation, legislation and international treaties;
- the indirect effects of such legislation and regulation on a company’s business; and
- the effect on a company’s business and operations related to the physical changes to our planet caused by climate change.
In describing the disclosure obligations related to indirect effects of climate change issues, the guidance will explain that indirect effects include the costs, risks and opportunities, if material, that a registrant may face in “reputational pressures” arising from climate change issues—the risk, depending on the nature of a registrant’s business and its sensitivity to public opinion, that the public’s perception of any publicly available data relating to its greenhouse gas emissions might expose it to adverse consequence in its business operations or financial condition. Disclosure related to the potential physical effects on a company’s business and operations due to climate change issues requires a consideration of the costs, risks and opportunities, if material, of such issues as the severity of weather (for example, floods or hurricanes), sea levels, the arability of farmland, water availability, changes in the availability of natural resources on which a registrant relies and how these changes to the environment could have material effects on the registrant, such as impairing the distribution and production of goods and damaging property, plant and equipment.
Are These New Disclosure Requirements?
The Commissioners and the Staff noted that they did not believe that the interpretive release imposed any new disclosure requirements. Companies should assume that they will need to take the interpretive release into account for their upcoming Form 10-K filings for calendar year 2009. Meredith Cross, the Director of the Division of Corporation Finance, made clear that the Staff will focus on the disclosure in their filing reviews.
Although the interpretive release does not include any new rules, as a result of the SEC’s action, issuers will have to place new emphasis on their consideration of environmental issues when preparing disclosures. It is worth noting that the universe of existing and potential future climate change-related regulations and legislation continues to grow and implicates large swaths of the U.S. economy. These regulations and legislation may implicate the indirect effects mentioned in the SEC’s guidance.
For example, the Clean Air Act will require a certain portion of the nation’s fuel supply to meet more stringent carbon content requirements. Additionally, the U.S. Environmental Protection Agency is poised to issue regulations to limit greenhouse gas emissions from vehicles. These vehicle rules will trigger other Clean Air Act requirements for stationary sources such as power plants, chemical facilities and other industrial operations. Additionally, numerous pieces of climate change legislation are circulating through Congress, and in his 2010 State of the Union Address, President Obama re-emphasized that energy and climate change legislation is near the top of his priority list.
Also, real climate change regulatory programs are currently being implemented in California, other western states through the Western Climate Initiative and New England through the Regional Greenhouse Gas Initiative. All of which may indicate that the point at which the actual and potential effects of climate regulations and legislation will become “material” for any particular company may be nearer than previously thought. In addition, regardless of viewpoints with respect to the science of climate change, the impact of popular viewpoints and potential legislation and regulations present real risks that must be considered.
What Should Companies Do Now?
- Revise disclosure controls to expressly address climate change.
- Educate members of the disclosure committee or other members of management responsible for disclosure about requirements and the interpretive release.
- Undertake a specific review of any existing internal assessments of the possible impact of climate change on the company’s operations or prospects, including any reputational effects.
- Revisit existing disclosures regarding the company’s business, including MD&A and risk factors, to determine whether additional or revised disclosures are necessary.
Proposed Revisions to Rule 10b-18
What Is Rule 10b-18?
Rule 10b-18 provides a “safe harbor” exemption from allegations of market manipulation to issuers who repurchase their stock, provided repurchases are made in accordance with the Rule. Repurchases of stock in the open market under Rule 10b-18 are limited in terms of the manner in which repurchases are effected, the time of purchase, the price at which shares may be repurchased and the volume of shares that can be repurchased. Rule 10b-18’s safe harbor conditions are designed to minimize the market impact of the issuer’s repurchases, thereby allowing the market to establish a security’s price based on independent market forces without undue influence by the issuer.
What Is the SEC Proposing?
The proposed amendments are intended to clarify and modernize the safe harbor provisions. In proposing the amendments, the SEC acknowledged that the increased speed of today’s market activity, as evidenced by flickering quotes, has made it increasingly difficult for issuers to ensure that every purchase by it of its common stock during the day will meet the Rule’s current price condition.
In particular, the SEC proposes to:
- modify the timing condition to preclude Rule 10b-18 purchases as the opening purchase in the principal market for the security and in the market where the purchase is effected (in addition to the current prohibition against effecting Rule 10b-18 purchases as the opening purchase reported in the consolidated system);
- relax the price condition for certain VWAP transactions;
- limit the “disqualification provision” (i.e., the current provision that failure to meet any one of the four conditions with respect to any of the issuer’s repurchases during the day will disqualify all of the issuer’s Rule 10b-18 purchases from the safe harbor for that day) in fast moving markets under certain specific conditions;
- modify the “merger exclusion” provision to extend the time in which the safe harbor is unavailable in connection with an acquisition by a special purpose acquisition company, or “SPAC”; and
- update certain definitions in the Rule.
The SEC’s proposal to modify the price condition would provide issuers with greater flexibility to conduct their issuer repurchase programs within the safe harbor under conditions designed to reduce the potential for abuse. The proposal would also limit the general disqualification provision, which should provide issuers with additional flexibility to conduct their share repurchase programs in fast moving markets.
The SEC’s proposals to modify the timing condition and the “merger exclusion” provision under the Rule are intended to maintain reasonable limits on the safe harbor, so as to minimize the market impact of the issuer’s repurchases on the market. This is intended to allow the market to establish a security’s price based on independent market forces without undue influence by the issuer, and to promote safe harbor availability only during normal market conditions for an issuer. The proposal is intended to modernize Rule 10b-18, which has not been significantly modified since it was adopted in 1982 to address the changes in the way people trade. The proposed amendments to Rule 10b-18 are available and are subject to a 30-day comment period, beginning with their publication in the Federal Register, which should occur in the next several weeks.