United States: Certain Climate Change Disclosures May Be Required Under SEC Regulations

Last Updated: February 17 2015
Article by Charles T. Wehland and Jennifer M. Hayes

In the shadow of the Environmental Protection Agency's ("EPA") proposed rule for emission reductions for existing power plants, maintaining the appropriate scope and detail of environmental disclosures as related to climate change is under a spotlight for companies subject to the Security and Exchange Commission's ("SEC") disclosure regulations. While there are currently no mandatory medium- or long-term greenhouse gas emission reduction and limited regulations related to greenhouse gases in the United States, public companies with an international footprint are already subject to emissions reduction targets and climate change regulations that affect capital expenditures, earnings, and the competitive position of their business. Thus, an understanding of the SEC's disclosure requirements in the context of climate change is certainly necessary for some public companies and increasingly necessary for the rest.

As Regulation S-K provides the basic instructions and minimum requirements for various SEC filings, it is the starting point for evaluating a public company's disclosure obligations as related to climate change. Beginning with Item 101, Description of Business, a public company must evaluate the implications of climate change and associated regulation of greenhouse gases on disclosures. Item 101 requires a narrative description of the company's current and intended business. This description includes the "material effects" of environmental compliance on capital expenditures, earnings, and competitive position. The rule specifically states that the company must "disclose material estimated capital expenditures" for the current fiscal year and the next fiscal year. In 2010, a 3–2 split by the vote of five SEC commissioners emphasized that the requirements in Item 101 and other portions of Regulation S-K can require a company to delineate climate change considerations. The capital expenditures associated with the installation of emission control equipment, such as the carbon capture and sequestration equipment contemplated under EPA's emission reduction rule for power plants, are just one example of disclosures required under Item 101.

Under Item 103, Legal Proceedings, climate change implications and regulation of greenhouse gases may also be required to be disclosed. Item 103 requires disclosure of administrative or judicial proceedings under environmental laws if: (i) those proceedings are material, (ii) the claims exceed 10 percent of current assets, or (iii) the government is a party (unless the company has reasonable belief that monetary sanctions will be under $100,000). Involvement in climate change litigation brought under the citizen suit provisions of environmental laws could create a disclosure obligation for a public company.

Regulation S-K includes Item 503(c), Risk Factors, which requires certain SEC filings to include a discussion of the most significant factors that make an investment in the regulated company speculative or risky. The SEC requires risk factor disclosure to clearly state the risk and specify how the particular risk affects the particular registrant. In the context of climate change, risk factors vary from the impact of legislation and regulation to the actual physical impacts of climate change from catastrophic weather events and pervasive climate conditions that may affect asset value or business operations. When they are significant to a registrant, these risk factors should be disclosed to meet the disclosure requirements of Item 503(3).

In addition to the climate change-related matters identified for possible disclosure under Item 101, Item 103, and Item 503(c), Item 303, Management Discussion and Analysis ("MD&A"), requires the disclosure of other information necessary to understand the company's financial condition, including known trends or uncertainties likely to change liquidity in any material way. The extent of the disclosures required under MD&A have not been tested in the context of climate change. However, two key SEC interpretations in the context of disclosing potentially responsible party status ("PRP") in Superfund matters offer clarity. First, the Thomas A. Cole, SEC No-Action Letter (Jan, 17 1989), explains that a known uncertainty exists "where it is reasonably likely that these [clean-up] costs will be material." Second, the MD&A Interpretive Release dated May 18, 1989 explains that there is a duty to disclose where uncertainty is known and reasonably likely to be material. In the example context of PRPs, the guidance explains that MD&A disclosure is required where "management is unable to determine that a material effect ... is not reasonably likely to occur" considering the company's aggregate potential share of cleanup costs and the availability of insurance coverage.

This MD&A guidance language suggests that a public company grappling with making a disclosure related to climate change should default on the side of disclosure. In making its determination about the necessity of climate change disclosure, the company should consider the aggregate costs posed by the various risks associated with climate change and regulation of greenhouse gas emissions. Even as a company considers the aggregate costs, it should also consider mitigating factors such as insurance. Similarly, a public company may want to consider discussing any competitive advantage offered by climate change or regulation of greenhouse gases.

Companies that make the required disclosures are not necessarily insulated from shareholder activism. In recent years, shareholders have proposed resolutions for companies to develop reports on greenhouse gas emissions and consider establishing targets for future reductions. In some cases, companies have successfully resisted including these shareholder resolutions in proxy materials when the companies can point to existing measures that accomplish the same functional objectives as the proposed resolution would. In other cases, the SEC has taken action that leads to inclusion of the shareholder resolution in proxy materials.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Charles T. Wehland
Jennifer M. Hayes
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