On January 27, 2010, by a vote of three to two, the SEC adopted new interpretive guidance on how public companies should evaluate the impacts of climate change in their communications with shareholders. Such guidance had long been sought by certain pension funds, shareholder advocacy groups and states, who were unsatisfied with the varied nature of corporate disclosure concerning climate change. On February 2, the SEC issued the written interpretive release, which reviews existing environmental disclosure guidance and specifically addresses climate change. The guidance will be effective upon publication in the Federal Register (likely to be in February).

The SEC identified four topics to be evaluated and, as appropriate, discussed in disclosures:

The impact of existing as well as pending climate-change legislation and regulation.

The impact of international accords and treaties on climate change or greenhouse gas emissions.

The actual and potential indirect consequences of climate change regulation or business trends (e.g., reduced demand for carbon-intensive products).

The actual and potential impacts of the physical effects of climate change.

The guidance does not make climate change risk per-se material, and it does not mandate universal disclosure of specific items, such as carbon footprint, carbon intensity or actions being taken to reduce greenhouse gas emissions. Such requirements would have required the SEC to undergo formal rulemaking. The guidance also does not alter the principal tenets of existing disclosure law. Climate disclosure still requires a case-by-case evaluation of materiality by the company in light of reasonable shareholder expectations.

The structure and perspective of the guidance suggest that the SEC expects to see greater attention being given to the evaluation and disclosure of risks and opportunities arising from climate change. The guidance expressly notes that generic disclosure in Risk Factors may not be sufficient. With respect to disclosure under Management's Discussion and Analysis (Item 7 - MD&A), the interpretive release states that, unless a company can determine that climate change legislation or regulation is not reasonably likely, the company must assume that the legislation or regulation will be enacted and must then evaluate the potential materiality of the resulting effects – based on a specific understanding of the company's greenhouse gas emissions and "other operational matters."

The pre-publication copy of the interpretive release is available at http://www.sec.gov/rules/interp/2010/33-9106.pdf.

Impetus for Action

The SEC’s decision to issue interpretive guidance follows years of outspoken criticisms, formal petitions, and advocacy concerning the sufficiency of corporate climate disclosure. Before and during this period, as the science of climate change evolved and was more widely understood, ever more companies across many business sectors had begun to acknowledge the potential relevance and impact of climate change and associated regulation. Many have for years reported their carbon footprint and other parameters to shareholders in sustainability reports and to non-governmental aggregators of climate disclosures, like the Carbon Disclosure Project. Nevertheless, the perception persisted that climate disclosure practices varied widely in quality and transparency, although in practice the SEC and its staff rarely voiced concern. In fact, in her dissent, Commissioner Casey specifically noted that the SEC has never made a particular finding that climate change disclosures to date have been materially inadequate. Moreover, the SEC's interpretive guidance acknowledges that only some of the information that is already provided to the marketplace voluntarily is required under the SEC's disclosure rules.

Effect on Companies

In the absence of clear legal direction from Congress or the Executive Branch as to a carbon price or a mandatory system for reducing greenhouse gas emissions, many companies could offer shareholders little certainty as to the anticipated financial impact of any future federal requirements intended to address global warming. Commissioners Walter and Aguilar emphasized that companies should err on the side of more disclosure when uncertain about the materiality of an issue to the company.

The full effects of the new guidance remain to be seen. For the moment it is apparent that the SEC has become sensitized to the potential importance of climate change to reporting companies and has signaled its expectation that companies focus with renewed vigor on the traditional disclosure analysis, predicated on materiality and likelihood. While purporting not to modify the existing tenets of disclosure practice, the SEC's action will clearly affect the practical application of these principles.

Companies preparing their Form 10-K annual reports will wish to review the SEC’s new interpretive guidance with care and in light of prior disclosures to shareholders concerning climate change, keeping in mind the basic tenets of SEC disclosure and recognizing that the guidance does not represent a checklist of required disclosures.

Other Recent SEC Actions

Last October, the SEC modified its position with respect to the ability of companies to reject shareholder proposals (concerning climate change or other matters) on the basis of the ordinary-business exclusion codified at Rule 14a-8(i)(7). In doing so, the SEC also noted “that there is widespread recognition that the board's role in the oversight of a company's management of risk is a significant policy matter regarding the governance of the corporation.” Therefore, “a proposal that focuses on the board's role in the oversight of a company's management of risk may transcend the day-to-day business matters of a company and raise policy issues so significant that it would be appropriate for a shareholder vote.”