The Securities and Exchange Commission (“SEC”) issued an interpretive release on February 2, 2010, entitled Commission Guidance Regarding Disclosure Related to Climate Change. The release does not create any new rules or change any of the SEC’s disclosure requirements. Instead, its purpose is to provide guidance to public companies regarding the SEC’s existing disclosure requirements as they apply to climate change matters.
The SEC states that the four principal areas, which are discussed in more detail below, in which its rules may require disclosure relating to climate change are:• The impact of existing or pending legislation or regulations that relate to climate change;
• The effect of treaties or other international accords;
• The consequences, both positive and negative, including reputational harm, of regulations or business trends; and
• The physical impacts of climate change.
OVERVIEW OF EXISTING DISCLOSURE REQUIREMENTS
The rules that the SEC believes will be most likely to require disclosure in companies’ SEC filings are the following items of Regulation S-K:• Item 101 (Business), which specifically requires, among other things, disclosure about the material effects that compliance with environmental laws may have on the company’s capital expenditures, earnings, or competitive position;
• Item 103 (Legal Proceedings), which establishes thresholds for disclosure of legal proceedings brought under environmental laws that are lower than the disclosure thresholds for most other litigation;• Item 303 (Management’s Discussion and Analysis of Financial Condition and Results of Operations, or “MD&A”), which requires, among other things, disclosure about known trends or uncertainties that have had or may reasonably be expected to have a material favorable or unfavorable impact on the revenues or income from the operations of the company or any of its reportable business segments; and
• Item 503(c) (Risk Factors), which requires disclosure about the most significant risks facing the company.
In deciding what to disclose under any of the SEC’s rules, a public company must decide what information is material to investors and shareholders. The U.S. Supreme Court has said that information is considered 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 if the information would alter the total mix of available information. In the release, the SEC points out that, under the relevant Supreme Court cases, a public company should resolve any doubts about materiality in favor of disclosure.
In the release, the SEC also reviews the requirements, initiatives, and other sources of information available regarding climate change and greenhouse gas emissions, in which many public companies have participated over the last several years, and listed the following disclosure programs:
• The New York Attorney General’s recent settlement agreements with three energy companies regarding their disclosures about their greenhouse gas emissions and potential liabilities resulting from climate change and related regulation;
• Greenhouse gas monitoring and reporting regulations issued by some states and now the U.S. Environmental Protection Agency (the “EPA”);
• The Climate Registry, a non-profit collaboration among North American states and provinces to calculate, verify, and publicly report greenhouse gas emissions for voluntary and state-mandated greenhouse gas emissions reporting;
• The Carbon Disclosure Project, which collects and distributes climate change information relating to emissions, risks, and opportunities faced by participating companies; and
• The Global Reporting Initiative, a sustainability reporting framework for companies regarding reporting of economic, environmental, and social performance, including issues involving climate change and greenhouse gases.\
The SEC points out that, while disclosures or reporting under many of these existing programs is voluntary and may include information that is not relevant to reporting under SEC regulations, registrants should be aware that some of the information that may be reported through these voluntary mechanisms also may be required to be disclosed in filings made to the SEC.
CLIMATE CHANGE-RELATED TOPICS THAT MAY REQUIRE DISCLOSURE
A. Impact of Legislation and Regulation
The release analyzes how the SEC’s existing rules may require disclosure related to the impact of existing or pending legislation or regulatory initiatives, as follows:
• Item 101 of Regulation S-K may require disclosure of capital costs incurred and to be incurred relating to any regulation or legislation governing climate change or greenhouse gas emissions.
• Item 503(c) may require risk factor disclosure of existing or pending legislation or regulation. The guidance states that registrants should consider “specific risks” and avoid “generic risk factor disclosure that could apply to any company.” The SEC notes, for example, that an energy company that may be particularly sensitive to climate change regulation may be subject to significantly different risks compared to companies that are reliant on products that may emit greenhouse gases, such as those in the transportation sector.
• Item 303 requires analysis of whether climate legislation is reasonably likely to have a material effect on the registrant’s financial condition or results of operations. For pending legislation, which is a known uncertainty, a two-step analysis applies:
1. First, management must evaluate whether the pending legislation or regulation is reasonably likely to be enacted. Unless management determines that it is not reasonably likely to be enacted, it must proceed on the assumption that it will be enacted.
2. Second, management must determine whether, if enacted, the legislation or regulation is reasonably likely to have a material effect on the registrant, its financial condition, or results of operation. Unless management can determine that such a material effect is not reasonably likely, disclosure is required. If material, management must also disclose the difficulties involved in assessing the timing and effect of the pending legislation or regulation.
One of the key issues raised in the interpretive release is found in the footnotes. In note 71, the guidance states that “Management should ensure that it has sufficient information regarding the registrant’s greenhouse gas emissions and other operational matters to evaluate the likelihood of a material effect arising from the subject legislation or regulation.” This note refers back to footnote 62, which refers to Exchange Act Rules 13a-15 and 15d-15, which require that the principal executive and financial officers must make certifications regarding the maintenance and effectiveness of a public company’s disclosure controls and procedures. Thus, it appears that the gathering of greenhouse gas emissions data falls within the scope of these rules for purposes of evaluating the need to make disclosures relating to climate change and the effectiveness of disclosure controls and procedures to ensure that the information is collected, evaluated and disclosed on a timely basis.
Another significant point made by the guidance is that a registrant should not limit its disclosure to negative consequences, but must make disclosures about material new opportunities as well. For example, the guidance states that if a cap-and-trade type system is put in place, a registrant may be able to profit from the sale of allowances if its emissions levels are below its emissions allotment. Those that are not covered by statutory emissions caps may be able to profit by selling offset credits for which they may qualify under climate change legislation or regulation.
In order to illustrate these issues, the guidance lists examples of possible consequences of pending legislation and regulation related to climate change:
• Costs to purchase, or profits from sales of, allowances or credits under a cap-and-trade system;
• Costs required to improve facilities and equipment to reduce emissions in order to comply with regulatory limits or to mitigate the financial consequences of a cap-and-trade regime; and
• Changes to profit or loss arising from increased or decreased demand for goods and services produced by the registrant arising directly from legislation or regulation, and indirectly from changes in costs of goods sold.
B. International Accords
The guidance also directs registrants to consider and disclose, if material, the impact on their businesses of international accords on climate change or greenhouse gas regulation, such as the Kyoto Protocol.
C. Indirect Consequences of Regulation or Business Trends
The guidance states that indirect consequences, such as new opportunities or risks, may result from legal, technological, and scientific developments regarding climate change. Such developments may result in increased or decreased demand for products or services of particular companies. Examples provided are as follows:
• Decreased demand for goods that produce significant greenhouse gas emissions;
• Increased demand for goods that result in lower 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.
The release states that disclosure about these business trends or risks may be required in MD&A under Item 303, or in the business description under Item 101 of Regulation S-K. As an example, a company that plans to make changes in its product line or to take advantage of opportunities through material acquisitions of plants or equipment may be required to disclose these changes in its plan of operation under Item 101(a)(1).
Another example offered is the potential impact of reputational damage where, because of a registrant’s sensitivity to public opinion, the public’s perception of any available data relating to its greenhouse gas emissions could adversely affect its business operations or financial condition.
D. Physical Impacts of Climate Change
The release states that any physical impacts of climate change must be reported if material to the registrant. Climate change may have an effect on a registrant’s business, facilities, and operations through severe weather, sea-level rises, melting of permafrost, and temperature extremes. Examples of potential physical impacts to companies were identified as follows:
• For registrants with operations concentrated on coastlines, property damage and disruptions to operations, including manufacturing operations or the transport of manufactured products;
• Indirect financial and operational impacts from disruptions to the operations of major customers or suppliers from severe weather, such as hurricanes or floods;
• Increased insurance claims and liabilities for insurance and reinsurance companies;
• Decreased agricultural production capacity in areas affected by drought or other weather-related changes, which would affect agricultural companies directly, and other companies that rely on them as suppliers, indirectly;
• Increased insurance premiums and deductibles, or a decrease in the availability of coverage, for registrants with plants or operations in areas subject to severe weather;
• Changes in the availability or quality of water or other natural resources, damages to facilities or decreased efficiency of equipment, or decreases in consumer demand for products or services, such as heating fuels if temperatures increase; and
• Financial risks for some registrants, such as for banks whose borrowers’ assets are in at-risk areas.
CONCLUSION
Although the interpretive release does not purport to establish any new disclosure requirements, public companies should evaluate whether they have sufficiently detailed knowledge about their operations, including the level of greenhouse gas emissions, to satisfy existing disclosure requirements as interpreted by the SEC. Public companies should evaluate their current disclosure practices, including their disclosure controls and procedures, to ensure that information about environmental compliance and risks, the impact of new and proposed climate change laws and regulations and similar matters is collected and brought to the attention of the appropriate personnel in a timely manner, and that such information results in accurate, company-specific disclosure of all material information. Public companies should also monitor the disclosures they make about climate risk matters through other means to ensure consistency with their SEC filings.
This interpretive release may not be the last word from the SEC on disclosure requirements related to climate change matters. The release states that the SEC will monitor the impact of the guidance on company filings as part of its ongoing disclosure review program. In addition, the SEC’s Investor Advisory Committee is considering climate change disclosure issues as part of its overall mandate to provide advice and recommendations to the SEC, and the SEC is planning to hold a public roundtable on climate change disclosure in the spring of 2010. The release states that the SEC will use its experience with the disclosure review program together with any advice or recommendations made by the Investor Advisory Committee and information gained through the planned roundtable to determine whether further guidance or rulemaking relating to climate change disclosure is necessary or appropriate.
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