On February 2, 2010, the Securities Exchange Commission published an interpretive release to provide guidance to public companies regarding how existing SEC disclosure requirements apply to climate change. SEC Release No. 33-9106. The interpretive guidance does not create new legal requirements or modify existing ones, but is intended to provide clarity and enhance consistency with respect to existing requirements. The interpretive release became effective upon publication.
The SEC has required disclosure of material environmental issues since the early 1970s, especially the financial impact of compliance with environmental laws. Information is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision, or, put another way, if the information would affect the total mix of available information.
The SEC guidance details how, in recent years, climate change has received increased attention. In addition to the pending climate change legislation in Congress, the Environmental Protection Agency has released a Reporting Rule for large emitters of greenhouse gases and an “endangerment and cause or contribute finding” for greenhouse gases under the Clean Air Act. On an international level, the Kyoto Protocol is currently in effect, the European Union Emissions Trading System is active, and the United Nations Climate Conference in Copenhagen received a great deal of attention. The National Association of Insurance Commissioners has also promulgated a uniform standard for mandatory disclosure by insurance companies to state regulators of financial risks due to climate change and actions taken to mitigate them.
This E-Update first provides a brief description of existing disclosure requirements that may apply to climate change issues, and then summarizes the list of examples put forward by the SEC on the ways that climate change issues could require disclosure that need to be carefully considered when filing SEC reports.
The current status of climate change regulatory developments is a maelstrom of federal and state legislative proposals, multi-state carbon control planning efforts, energy law and policy developments, and developing state and federal regulations. In addition, the Copenhagen Accord potentially sets a new direction for implementing climate change reductions on the international level. Finally, federal appellate court rulings have found climate change nuisance actions justiciable and returned dismissed cases to the district courts. SEC disclosures must be continually updated to reflect these ever-changing developments, and require thoughtful evaluation of potential impacts. This evaluation is made more challenging by the current lack of national legislation that could set a clear course for carbon control requirements in the United States.
The SEC’s guidance catalogs existing requirements that may call for disclosure of climate change issues:
- Business Description. Item 101 of Regulation S-K requires a reporting company to describe its business, including certain costs of complying with environmental laws.
- Legal Proceedings. Item 103 of Regulation S-K requires a reporting company to briefly describe any material pending legal proceeding to which it, any of its subsidiaries, or any of its property is involved. Instruction 5 pertains specifically to environmental litigation.
- Risk Factors. Item 503(c) of Regulation S-K requires a reporting company to provide a discussion of the most significant factors that make an investment in the reporting company speculative or risky.
- Management’s Discussion and Analysis. Under Item 303 of Regulation S-K, the MD&A should provide material historical and prospective textual disclosure that allows investors to assess the financial condition and results of operations of the reporting company, with particular emphasis on its prospects for the future.
- Foreign Private Issuers. Several of the provisions in Form 20-F are parallel to Regulation S-K requirements which may require information concerning climate change matters.
The heart of the interpretive guidance focuses on the following four areas which the SEC believes represent some of the ways climate change may trigger disclosures under the existing disclosure rules and regulations:
- Impact of Legislation and Regulation. There have been significant developments in federal and state legislation and regulation regarding climate change that may need to be addressed in response to Items 101,103, 503(c) or 303 of Regulation S-K. The disclosure could range from disclosing material estimated capital expenditures for environmental control facilities to the specific risks a company may face as a result of climate change litigation. This is particularly true for industries sensitive to greenhouse gas legislation, such as reporting companies in the energy sector. For the MD&A, management must evaluate whether pending legislation or regulation is reasonably likely to be enacted and determine whether the legislation or regulation, if enacted, would have a material effect on its financial condition or results of operations. This expectation that reporting companies determine the likelihood of enactment of pending legislation and regulations has drawn criticism from industry representatives and the securities bar.
- International Accords. Another potential disclosure area is the impact on business by treaties or international accords. Reporting companies who are reasonably likely to be impacted by agreements such as the Kyoto Protocol or European Union Emissions Trading System should consider whether disclosure is required.
- Indirect Consequences of Regulation or Business Trends. Legal, technological, political and scientific developments regarding climate change may create new opportunities or risks for reporting companies that may be material to investors. A few examples include the potential for decreased demand for goods that produce significant greenhouse gas, increased demand for goods that result in lower emissions than competing products, and increased competition to develop innovative new products. These business risks and opportunities may need to be disclosed in the MD&A. Additionally, reporting companies need to consider whether there is a potential impact on their reputation. A company that emits large amounts of greenhouse gas could experience adverse impacts on its business operations or financial condition due to reputational damage.
- Physical Impacts of Climate Change. Significant physical effects of climate change, such as effects on the severity of weather, sea levels, the arability of farmland, and water availability and quality also have a potential to affect the operations and financial condition of reporting companies. Businesses that are vulnerable to severe weather and climate related events should consider the need to disclose the potential risks of, or consequences from, such events.
The SEC issued this interpretive release to remind companies of their existing disclosure obligations and to explain how the SEC believes such obligations may relate to climate change. The SEC intends to monitor the impact of the interpretive release on company filings as part of its ongoing disclosure review program. The SEC also announced that it will hold a public roundtable on climate change disclosure matters in the spring of 2010 as part of its effort to determine whether further guidance or rulemaking in this area is necessary.