Perhaps spurred on by the increases in climate change litigations, the United States Securities and Exchange Commission ("SEC"), on February 2, 2010, published an interpretive release (the "Release") to provide guidance to reporting companies on the impact that climate change issues have on existing SEC disclosure requirements. The Release is effective immediately and does not create new reporting requirements or modify existing ones, but rather seeks to clarify when a reporting company should consider disclosing the material impacts that climate change developments have on its business.
The Release cites evolving climate change legislation and regulation, shareholder demands for greater climate change disclosure, the increasing amount of information that reporting companies disclose outside of their SEC filings and historical SEC disclosure requirements concerning environmental matters as reasons why climate change disclosure guidance is warranted for reporting companies. Activists shareholder groups such as Ceres and some institutional investors, including CalPERS, have long called for such guidance and heralded the Release as an important step towards expanding investor knowledge. The Release was also applauded by New York Attorney General Andrew Cuomo, who had not only filed a petition with the SEC calling for such disclosure guidance, but also had investigated power companies under state law to determine whether they had properly disclosed to investors the financial risks posed by climate change. Attorney General Cuomo's investigations led to settlements with Xcel Energy, Dynegy and AES Corp, requiring that each company disclose risks associated with their greenhouse gas emissions.
The Release seeks to resolve some of the uncertainty on the part of reporting companies regarding what, exactly, should be disclosed. Specifically, the Release focuses on four existing disclosure requirements and four climate change issues that may need to be discussed within the framework of those existing disclosure requirements. The following is a summary of the four existing disclosure requirements where the Release suggests that climate change issues may need to be discussed.
- Item 101 (Description of Business): Item 101 requires a description of the general development of a reporting company's business, including the business of its subsidiaries. This Item specifically requires disclosure as to the "material effects that compliance with Federal, State and local provisions...may have upon capital expenditures, earnings and competitive position of the registrant and its subsidiaries." Material estimated capital expenditures for "environmental control facilities" are also required to be disclosed for the current and succeeding fiscal year "and for such further periods as the registrant may deem material."
- Item 103 (Legal Proceedings): Item 103 requires a brief description of any material legal proceeding to which a reporting company or any of its subsidiaries is a party. Instruction 5 to Item 103 specifically requires disclosure with respect to legal or regulatory environmental proceedings if: (A) such proceeding is material to the business or financial condition of the registrant; (B) such proceeding involves primarily a claim for damages, or involves potential monetary sanctions, capital expenditures, deferred charges or charges to income and the amount involved, exclusive of interest and costs, exceeds 10 percent of the current assets of the registrant and its subsidiaries on a consolidated basis; or (C) a governmental authority is a party to such proceeding and such proceeding involves potential monetary sanctions, unless the registrant reasonably believes that such proceeding will result in no monetary sanctions, or in monetary sanctions, exclusive of interest and costs, of less than $100,000; provided, however, that such proceedings which are similar in nature may be grouped and described generically.
- Item 303 (Management's Discussion & Analysis of Financial Condition and Results of Operations): Item 303 (normally referred to as the MD&A) requires a reporting company to discuss its financial condition, changes in financial condition and results of operations and is intended to provide a narrative explanation of the registrant's financial statements and an assessment of variables that may impact future results. Although there is no specific line item addressing environmental issues, Item 303 and the corresponding MD&A interpreting releases issued by the SEC are broad enough to require disclosure of any environmental matter that management believes may have a material effect on financial condition or operating performance.
- Item 503 (Risk Factors): Item 503 requires a separate section that discusses "the most significant factors that make an investment in the registrant speculative or risky."
The Release also noted the following four examples as ones that may trigger climate change disclosures under the above discussed disclosure rules and regulations.
- Impact of Legislation and Regulation: The impact of current and proposed climate change laws and regulations may require disclosure under several of the Items listed above. For example, the Release states that laws or regulations capping greenhouse gas emissions could require disclosure of material estimated capital expenditures for environmental control facilities under Item 101. In addition, risk factor disclosure relating to the negative impact such laws or regulations may pose on a registrant's business may be required. MD&A disclosure may also be required if legislation or regulation is reasonably likely to have a material adverse effect on the registrant's financial condition or operating performance. The Release additionally pointed out that discussion should not be limited to negative consequences and that appropriate disclosure should be given in the MD&A, for example, if changes in law were to provide new opportunities for reporting companies.
- Impact of International Accords: Similar to US law and regulation, companies should assess the impact that existing international accords (such as the Kyoto protocol and the European Union Emissions Trading System) and future ones may have on its disclosure obligations. The same analysis given to domestic laws and regulations should therefore be given to international accords and disclosure may be required for several of the Items listed above.
- Indirect Consequences of Regulation or Business Trends: Companies should assess the actual or potential indirect consequences it may face as a result of climate change related regulation or business trends. For example, disclosure may be required where a product is linked to the emission of significant greenhouse gas emissions, which could make the product subject to additional regulation or decreased market demand. That said, discussion of business trends should not be limited to those that result in negative consequences – trends resulting in positive consequences such as new business opportunities and markets should also be disclosed.
- Physical Impacts of Climate Change: Companies should assess the actual and potential material impacts of environmental matters on its business. For example, the Release points to risks posed by adverse weather to businesses with operations or properties on coastlines, disruptions to supply chains, increased insurance claims and liabilities for insurance and reinsurance companies as well as increased premiums and deductibles for those seeking insurance and negative agricultural impacts. As with the other climate change issues discussed above, disclosure concerning the physical impacts of climate change may be required under more than one Item.
In determining whether climate change issues should be disclosed within the existing regulatory requirements, the Staff of the SEC confirmed that reporting companies should continue to assess materiality using the standards previously announced by the Supreme Court, which defines something as material if ì[there is a] substantial likelihood an investor . . . would consider [it] important in making an investment decision, or if the information would alter the total mix of information . . . ." As climate change issues continue to evolve, reporting companies must assess the adequacy of their disclosure in light of materiality standards and the guidance given in the Release in order to ensure compliance with federal securities laws and regulations.
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.
