On February 8, 2010, the Securities and Exchange Commission published guidance regarding public companies' disclosure obligations related to climate change (Commission Guidance Regarding Disclosure Related to Climate Change, Release Nos. 33-9106; 34-61469; FR-82 ["Interpretive Release"]). The Interpretive Release is effective immediately, and while many companies already mention the effect of climate change in their filings, most might not provide sufficient detail to meet the new interpretation. Accordingly, calendar year-end companies with upcoming annual reports on Form 10-K should evaluate whether their disclosures concerning climate change are consistent with the new guidance.
It's important to note that the Interpretive Release does not create new legal requirements nor modify existing ones. Moreover, it does not alter the standard under which public companies assess materiality with respect to what information must be disclosed under the federal securities laws, particularly in the MD&A section. Rather, the Interpretive Release reaffirms that existing rules require disclosure of climate change information when material to a public company, and highlights certain areas as examples of situations where climate disclosure may be required. According to the SEC, "This guidance is intended to assist companies in satisfying their disclosure obligations under the federal securities laws and regulations."
Existing Disclosure Items
The Interpretive Release discusses four line-item requirements of Regulation S-K that potentially cover the disclosure of the effect of climate change on public companies:
- Item 101 of Regulation S-K relates to the description of a company's business. With respect to environmental laws, disclosure is required regarding certain costs of compliance, specifically the material effect environmental compliance may have upon the company's capital expenditures, earnings and competitive position, as well as disclosure of any material estimated capital expenditures for environmental control facilities for the remainder of its current and succeeding fiscal years and any other further periods deemed material.
- Item 103 of Regulation S-K requires a public company to disclose material pending legal proceedings to which it or a subsidiary is a party, or to which a property of the company is subject, but typically exempts from such disclosure requirement ordinary routine litigation incidental to a company's business or other proceedings below certain thresholds. With respect to environmental litigation or proceedings, however, the ordinary routine litigation exception does not apply, and disclosure is required if the proceedings relating to environmental laws (i) are material to the company's business or financial condition; (ii) involve damages or monetary sanctions, capital expenditures, deferred charges or charges to income of greater than 10% of the current assets of the company; or (iii) include a governmental authority as a party to the proceeding unless the company reasonably believes any resulting monetary sanctions will be less than $100,000.
- Item 503(c) of Regulation S-K requires a public company to provide, where appropriate, a discussion of the most significant risk factors facing the company, which may include material risks associated with climate change. The risks must be clearly stated, and the disclosure should specify how a particular risk affects the particular company.
- Item 303 of Regulation S-K relates to management's discussion and analysis of the company's financial condition and results of operations ("MD&A"). MD&A includes disclosing any known trends, events, demands, commitments and uncertainties that are reasonably likely to have a material adverse effect on the financial condition or operating performance of the company.
In addition, the SEC identified certain physical consequences of severe weather that may require disclosure, including (1) effects on companies with business operations concentrated on coastlines, (2) disruptions to the operations of major customers or suppliers due to severe weather, (3) increased insurance claims and liabilities, (4) decreased production in areas affected by drought, or (5) increased insurance premiums or a decrease in the availability of coverage.
Climate Change Items
The Interpretive Release also describes several climate change topics that may trigger either positive or negative disclosure by public companies under one of the foregoing four items of Regulation S-K, such as the following:
Impact of Climate Change Legislation and Regulation. The business and financial impact of newly enacted or pending climate change legislation, if material, may be required to be disclosed under one or more of the referenced items of Regulation S-K. In this regard, Item 101 requires disclosure of any material estimated capital expenditure for environmental control facilities to be incurred during the current and the next succeeding fiscal year. Passage of new "cap and trade" or other climate change legislation could impose significant compliance costs on some public companies that would be required to be disclosed under this item. Moreover, a public company may find it necessary to include disclosure in its MD&A with respect to pending legislation or regulations if they would have a material impact on its financial results, prospects, liquidity or capital resources, unless management concludes that the legislation or regulation is not reasonably likely to be implemented. The Interpretive Release notes that two industries likely to be impacted - energy and transportation - face significantly different risks. In addition, certain companies that have positive consequences from legislation or regulation should explain the opportunities that are available to them. For example, certain companies would profit from a cap-and-trade system if one is put in place through the sale of excess allowances for emissions.
Treaties or International Accords. In view of the global nature of climate change initiatives, public companies whose businesses are reasonably likely to be impacted by such international initiatives could necessitate disclosure in the same manner as existing or pending climate change legislation or regulation.
Indirect Consequences of Regulation. Indirect consequences or opportunities from regulation or business trends should be examined. Depending upon the facts and circumstances, public companies may be required to disclose the indirect risks and opportunities created by legal, technological, political and scientific developments in the area of climate change. According to the SEC, such risks or opportunities include:
- Decreased demand for goods that produce significant greenhouse gas emissions;
- Increased demand for goods that result in lower emissions than do competing products;
- Increased competition to develop innovative products;
- Increased demand for generation and transmission of energy from alternative energy sources; and
- Decreased demand for services related to carbon-based energy sources, such as drilling services or equipment maintenance services.
The Interpretive Release notes that another example of a potential indirect risk from climate change that would need to be considered for risk factor disclosure is the impact on a public company's reputation. Depending on the nature of a company's business and its sensitivity to public opinion, a company may have to consider whether the public's perception of any publicly available data relating to its greenhouse gas emissions could expose it to potential adverse consequences for its business operations or financial condition resulting from reputational damage.
Physical Impacts of Climate Change. Significant physical effects of climate change, such as effects on the severity of weather (for example, floods or hurricanes), sea levels, the arability of farmland, and water availability and quality, have the potential to affect a public company's operations and results. For example, severe weather can cause catastrophic harm to physical plants and facilities and can disrupt manufacturing and distribution processes. According to the SEC, possible consequences of severe weather could include:
- For public companies with operations concentrated on coastlines, property damage and disruptions to operations, including manufacturing operations or the transport of manufactured products;
- Indirect financial and operational impacts from disruptions to the operations of major customers or suppliers from severe weather, such as hurricanes or floods;
- Increased insurance claims and liabilities for insurance and reinsurance companies;
- Decreased agricultural production capacity in areas affected by drought or other weather-related changes; and
- Increased insurance premiums and deductibles, or a decrease in the availability of coverage, for registrants with plants or operations in areas subject to severe weather.
Public companies whose businesses may be vulnerable to severe weather or climate-related events should consider disclosing material risks of, or consequences from, such events in their publicly filed disclosure documents.
Immediate Action Required
As noted above, the Interpretive Release is now effective. Therefore, calendar year-end companies should consider whether climate change disclosure should be included and, if so, which items of Regulation S-K should be addressed. Companies that are not calendar year-end companies should examine these issues in connection with their upcoming quarterly reports on Form 10-Q. The Interpretive Release indicated that the SEC staff will be specifically reviewing filings made by companies to determine their compliance with the guidelines and that the SEC will continue to consider the issues presented by climate change in deciding whether to issue further guidance or engage in rulemaking with respect to this matter.