With climate change policy now at the forefront of Congress, pressures have been mounting for public companies to reveal their climate change postures, profiles and initiatives to shareholders, regulators and the public. While the current disclosure requirements of the Securities and Exchange Commission do not address climate change issues specifically, climate change disclosures may be implicated by at least three Items of Regulation S-K (Item 101 Description of Business, Item 103 Legal Proceedings and Item 303 Management's Discussion and Analysis of Financial Condition and Results of Operations) and the Sarbanes-Oxley Act of 2002, each of which are described in more detail below.
Businesses routinely fail to disclose climate change-related information that is vital for investors in SEC filings, according to two reports released on June 3, which were commissioned by the Ceres investor group, the Environmental Defense Fund, and the Center for Energy and Environmental Security. The reports, Climate Risk Disclosures in SEC Filings and Reclaiming Transparency in a Changing Climate, analyzed thousands of SEC disclosure forms from energy and transportation companies as well as from firms in the Standard & Poor's 500 index. When addressing whether the SEC would issue formal guidance instructing companies to disclose how the climate change issue could increase their risks related to physical damage, financial loss and legal liability, one of the five commissioners at the SEC stated as recently as this July that 'the staff [of the SEC] is going to be working on it this year," adding that it would be too speculative to predict when, or if, the SEC would formally adopt new disclosure standards. Petitions have already been filed with the SEC to require specific climate change disclosure rules, and pressures to do so will surely continue.
The purpose of this client alert is to outline the primary SEC disclosure issues associated with climate change. Our goal is to provide some general answers that may be useful in connection with your disclosures in periodic reports and offering documents. However, you should consult counsel about facts specific to your circumstances.
Item 101 Description of Business. Item 101 may entail disclosures if, as is expected, the costs of complying with the growing web of climate change laws and regulations become material. Under that Item, corporations must reveal the "effect of existing or probable governmental regulations" on their operations. The breadth of this inquiry is extraordinary -- sweeping within its scope not only the impact of complying with current laws, but also those that are likely to become effective. The disclosures are not limited to impacts and anticipated issues within the current year. Instead, they extend into the future if failures to disclose will result in misleading investors. The mass of global, federal, state and local initiatives bearing down on industry -- as well as those that already apply, such as regional and state greenhouse gas initiatives -- raises complex issues under Item 101 that cannot easily be ignored.
Item 103 Legal Proceedings. Item 103 comes into play when pending or anticipated legal proceedings are material to a corporation, its subsidiaries, or its property. Although massive climate change litigation has been filed and prosecuted against electrical power companies and other industries, the litigation has been unsuccessful -- so far. Most of the cases fail because the courts refuse to entertain them in the absence of standards established by the political branches of government. If, however, the Environmental Protection Agency or Congress specify those standards, or if they are set by global agreements or treaties, the validity of this rationale might be re-examined. Suits that survive dismissal and reach the merits might motivate disclosures, depending on the facts and issues involved.
Item 103 may also encompass citizen suit opportunities available under present law or that may be created by federal climate change legislation currently being considered in Congress. The "American Clean Energy and Security Act of 2009" presently includes an expansive provision allowing suits by "any person who has suffered, or reasonably expects to suffer, a harm attributable, in whole or in part" to climate change. Citizens can recover up to $75,000 per violation, and violations include "any effect" that is "currently occurring or at risk of occurring" and any "incremental exacerbation" associated with a "small incremental emission." Some commentators have argued that the bill "will trigger a lawsuit landslide." This potential threat should be monitored and evaluated carefully.
Item 303 Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A). Item 303 requires a discussion of trends that are currently known, as well as uncertainties or events that the company reasonably expects to have material effect on capital resources, revenues, net income or liquidity. If there is a substantial likelihood that a reasonable investor would deem the information important when making a decision or purchase or sale of securities, the effect meets the materiality standard. Although MD&A disclosures are restricted to information that is "without undue effort or expense," and companies are not required to provide "forward-looking information," these limitations provide little practical guidance. Distinguishing "forward-looking information" from "known trends and uncertainties" can be extremely difficult. Moreover, this item's importance is enhanced because it specifically addresses the mindset of investors -- and because it specifically requires companies to assess whether "reasonably expected" developments are sufficiently important to ensure informed investment decisions.
A few years ago, a fair reading of Item 303 might have justified silence regarding climate change on the part of most public companies. But today, the Kyoto Protocol is a reality for corporations operating in countries that ratified the treaty and carbon trading markets have been established. Moreover, here in the United States, consensus is growing to institute a market-based regulatory program to address greenhouse gas emissions, and some states are actively pursuing their own regulatory mandates to regulate greenhouse gas emissions. Thus, companies operating in countries that have ratified the Kyoto Protocol may already be required to disclose in their MD&A any material costs of compliance with the protocol. Additionally, in the near future it may be possible that two power companies with plants in adjacent states (or even adjacent counties) may have vastly different disclosure obligations, depending on factors as simple as fuel feed stock or as complex as long-range corporate planning for capital improvements.
Sarbanes-Oxley Act of 2002
Perhaps even more important in today's reality, the Sarbanes-Oxley Act of 2002 has dramatically expanded the scope and the timeliness of company information that must be disclosed. Although Sarbanes-Oxley does not alter environmental disclosure requirements, Section 302 of the Act now requires that responsible corporate officers personally certify the accuracy of quarterly and annual financial statements and disclosures -- making them ultimately liable for the accuracy of disclosure of environmental-related liabilities in company financial filings, including climate change. Under this analysis, senior executives may be pressed to be more "forward-looking" in their company's disclosures because they must meet an all-embracing "fair presentation" standard that is more exacting than "clinical" materiality. Hence, management may choose to disclose plans that involve material expenditures in response to climate change concerns. In this vein, some auditors are altering their approach to ensure that they have "properly evaluated the off-balance sheet risks" related to climate change.
In summary, we recommend that you carefully consider the climate change disclosure issues in connection with your periodic reports and offering documents. There are a number of important issues to consider and advance planning will help to avoid unexpected consequences