The United States Securities Exchange Commission (“SEC’) has recently taken several actions which clarify its stance on environmental disclosures by reporting companies. In its most detailed pronouncements on the subject to date, the SEC issued interpretive guidance regarding climate change disclosures. This interpretive guidance was preceded by a litany of other regulatory guidance released during the past several years relating to environmental disclosures. These guidance include new standards regarding company exclusion of shareholders’ environmental proposals and several enforcement actions relating to the manipulation of company environmental reserves. Additionally, the Financial Accounting Standards Board (“FASB”) has promulgated several directives which modify the manner in which environmental disclosures are made.
All of these actions should remind reporting companies that environmental disclosures are an area that the SEC has focused on with increasing intensity in recent years, and that reporting companies should take steps to remain informed of the latest requirements and guidance.
SEC Interpretive Guidance Regarding Environmental Disclosures
Early in 2010, the SEC voted 3-2 to provide interpretive guidance to public companies regarding SEC disclosure requirements for climate change. Securities Act Release 9106 and Exchange Act Release 61469 were issued on February 8, 2010, and impose no new reporting requirements on public companies. They do, however, provide interpretive guidance how public companies should integrate climate change issues into their disclosures. The Release begins by outlining the evolving state and federal legislative and regulatory environment for climate change, which includes descriptions of California laws regulating greenhouse gas emissions (“GHG”), the cap-and-trade legislation passed in 2009 by the House of Representatives but not enacted into law, and the Environmental Protection Agency’s requirement that certain sources of GHG keep data measuring such emissions. The Release also describes current and past international accords regarding climate change, including the Kyoto Protocol, which has not been ratified by the United States.
The Release identifies the existing SEC rules which may require climate change disclosure. These include:
- Item 101 of Regulation S-K (Description of Business) which expressly requires a description of the costs incurred by a company in complying with environmental laws;
- Item 103 of Regulation S-K (Legal Proceedings) which expressly requires a description of litigation relating to environmental issues;
- Item 503 of Regulation S-K (as it pertains to Risk Factors); and
- Item 303 of Regulation S-K (as it relates to MD&A).
The Release then turns to four topics, which are not meant to be exhaustive, which illustrate how environmental issues may impact the disclosure requirements.
Impact of Legislation and Regulation
The first topic relates to legislation and regulations and how these items will impact disclosure requirements. For current legislation or regulations, companies are required to disclose material estimated capital expenditures for environmental controls for the remainder of the current and the succeeding fiscal year. Using the cap-and-trade legislation passed by the House of Representatives in 2009 as a concrete example of pending legislation, the Release points out that the regime enacted by this legislation would require companies to disclose the costs to purchase, or profits from sales of, allowances or carbon credits. It would also require the disclosure of facility or technological costs incurred in complying with certain regulatory limits set forth in this legislation or other environmental laws. Also, any changes in profits and losses resulting directly or indirectly from any new environmental laws should be disclosed.
The Release provides less clear guidance as to whether cap-and-trade legislation should be taken into account now. Citing Item 303 to Regulation S-K (MD&A), the Release instructs a company’s management first to determine whether the legislation is “reasonably likely to be enacted.” If the answer to this determination is affirmative, then management must make the determination as to whether or not the legislation will have a material effect on the company’s operations. Unless this material effect is not reasonably likely, then the impact of the legislation must be disclosed. Given the restructuring of Congress after the November, 2010 elections, most commentators conclude that cap and trade is dead in the new Congress.
The Release points out that a similar analysis should be made regarding the impact of international treaties related to climate change. If a company’s business is reasonably likely to be affected by such treaties or agreements, then the MD&A analysis described above should be undertaken. There has been no report that the new Senate will take up ratification of the Kyoto Protocol.
Indirect Consequences of Regulation or Business Trends
The Release then focuses on the more practical effects of climate change itself and how these may affect a company’s disclosure requirements. These “indirect consequences or opportunities” include:
- decreased demand for goods that produce significant GHG emissions;
- increased demand for goods that result in lower GHG emissions than competing products;
- increased competition to develop innovative new 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.
Disclosure of these trends or risks may be required in the MD&A, or, if the impact is significant enough, in Item 101 (Description of Business) disclosures. A company should also consider whether disclosure in its Risk Factors is warranted and the impact that these trends or risks may have on its reputation.
Physical Impacts of Climate Change
The final topic discussed at length in the Release is the weather-related physical impact of climate change resulting from severe weather, rising sea levels, arability of farmland and water availability and quality. The Release points out that these factors could:
- cause property damage to companies with coastal operations;
- disrupt operations or cash flow if major customers and suppliers are directly affected;
- increase insurance claims and liabilities for companies in the insurance industry;
- decrease agricultural production in previously highly productive areas
- and increase insurance premiums and deductibles for companies who are likely to be directly impacted by these factors.
The SEC plans to monitor the impact of this Release on filings made in the coming months as part of its ongoing review process.
SEC Staff Legal Bulletin Regarding Shareholder Environmental Proposals
On October 27, 2009, the staff of the SEC released Staff Legal Bulletin No. 14E (CF) (“SLB 14E”), which reversed the previous staff position that generally permitted companies to exclude shareholder proposals relating to environmental, financial or health risks. The Staff had previously categorized such proposals as engaging in an internal evaluation of risk, which is considered a part of a company’s ordinary business operations. SLB 14E articulates a new standard by which the Staff will evaluate such proposals and the accompanying supporting statements. The Staff will now consider such proposals by inquiring whether they go beyond the ordinary day-to-day business of a company and whether they raise “policy issues so significant that it would be appropriate for a shareholder vote.” There must nevertheless be a “sufficient nexus” between the nature of the proposal and a company’s business for inclusion of a proposal in shareholder materials to be appropriate. While an analysis of whether a proposal primarily involves engaging in an internal evaluation of risk will remain relevant, it will not be dispositive, as was the case under the previous staff position.
SLB 14E reversed several years of SEC policy and may have significant impacts on reporting companies which have operations in industries which affect the environment, such as oil and gas, power-generation, and those that involve hazardous waste.
Recent SEC Enforcement Actions Involving Environmentally Related Financial Disclosure
On June 29, 2007, the SEC settled civil actions against several ConAgra executives, including the Chief Financial Officer, relating to the manipulation of reserves for legal and environmental contingencies. The executives directed that funds from the company’s legal and environmental reserves be used to offset unrelated and unplanned losses for fiscal years 2000 and 2001, resulting in the SEC charging them with materially misstating the financial performance of the company under Exchange Act Rule 13b2-1, and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and Rules 12b-20, 13a-1 and 13a-13. The Chief Financial Officer agreed to disgorge $425,531 plus $174,151 in interest and also to the divestment of 17,648 unexercised stock options and a civil monetary penalty of $100,000.
Recent FASB Releases which Impact Environmental Issues
The FASB has recently promulgated staff positions and interpretations that will affect the way in which companies disclose environmental contingencies.
FASB Interpretation 47, released in March 2005 (“FIN 47”), which deals generally with asset retirement, uses environmental examples prominently and affects certain environmental disclosures. Pursuant to FIN 47, certain contingencies must be recognized immediately, rather than recognized conditionally at a later date. FIN 47 uses a building containing asbestos as an example. If regulations requiring the removal of the asbestos from the building upon its sale are enacted, the owner of the building must recognize the fair value of this removal when the regulations are enacted, not when the building is sold, even though the sale is not a certainty.
FAS 141R and FAS 141R-1, which are FAS Staff Positions issued in December 2007 and April 2009, respectively, expound on the principles of FIN 47 to require immediate recognition of the fair value of certain environmental contractual obligations assumed in business combinations.