SEC Issues Interpretive Release Related to Climate Disclosure
On February 2, 2010, the Securities and Exchange Commission (SEC) published an interpretive release (Release), approved by a 3 to 2 vote, providing guidance regarding how current SEC disclosure requirements might be applicable to developments relating to climate change. In presenting the Release, SEC Chairman Mary Schapiro stated that the SEC is not “opining on whether the world’s climate is changing, at what pace it might be changing, or due to what causes,” but is issuing the guidance to help ensure that existing disclosure rules are consistently applied, “regardless of the political sensitivity of the issues at hand.” The SEC noted in the Release that, although many companies are voluntarily providing information with respect to the effects of climate change and related legislation through reporting mechanisms other than SEC filings, public companies should be aware that some of the information they may be reporting also may be required to be included in SEC filings pursuant to existing disclosure requirements.
The Release reviews the various existing disclosure rules and guidance under which public companies might be required to disclose the impact of climate change, as well as the general requirement that public companies disclose any further material information that is necessary to make their disclosures not misleading, reiterating that the disclosure may be 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. The Release reviews the history of the SEC’s rulemaking and guidance with respect to environmental disclosures, as well as recent rulemaking petitions in the climate change disclosure arena, with the clear implication being that investors as a class consider climate change information to be material.
In particular, the Release notes that Items 101 (Description of Business), 103 (Legal Proceedings), 503(c) (Risk Factors) and 303 (MD&A) of Regulation S-K may require disclosure related to the impacts of climate change.
- Item 101(c)(1)(xii) requires disclosure of the impacts of environmental laws and regulations on a registrant’s capital expenditures, earnings and competitive position, as well as material estimated capital expenditures for environmental control facilities.
- Item 103 requires disclosures of legal proceedings relating to environmental laws and regulations if, among other things, a governmental authority is a party, unless the company reasonably expects monetary sanctions relating to the matter to be less than $100,000.
- Item 503(c) may require risk factor disclosure regarding the potential effects of climate change and related existing or pending legislation that may make an investment in the registrant risky or speculative.
- Item 303, which requires that registrants discuss known trends and uncertainties that are reasonably likely to have a material effect on their financial condition or operating performance, may require registrants to assess whether climate change or related existing or potential legislation or regulation is reasonably likely to have such an effect.
The Release notes that with respect to disclosing contingent events such as the potential likelihood and timing of the enactment of climate change legislation, registrants should engage in a “probability/magnitude” analysis, and unless management can conclude that the climate change effect or legislation is not reasonably likely to occur, the registrant must assume that it will come to fruition, and must thus disclose the potential material effects on the registrant.
The Release also provides amplification of the items that may trigger climate disclosure required by these rules through four illustrative topics:
Impact of Legislation and Regulation
Developments in federal and state legislation and regulation regarding climate change may trigger disclosure obligations of both potential negative impacts of such regulations and of new opportunities for registrants. Possible consequences include:
- 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.
The Release notes that registrants should consider specific risks they face as a result of climate change legislation or regulation and avoid generic risk factor disclosure that could apply to any company.
Impact of International Accords
Registrants also should consider, and disclose when material, the impact on their business of treaties or international accords relating to climate change.
Indirect Consequences of Regulation or Business Trends
The Release states that indirect results of climate change developments, such as risks and new business opportunities, may be required to be disclosed as risk factors or in MD&A, and by way of example cited:
- 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;
- Decreased demand for services related to carbon based energy sources, such as drilling services or equipment maintenance services; and
- Effects on a registrant’s reputation based on public perception of its position or actions with respect to climate change.
In some cases, these developments could have a significant enough impact on a registrant’s business that disclosure may be required in its business description under Item 101.
Physical Impacts of Climate Change
What may be the most controversial of the SEC’s examples of items to be considered with respect to climate change is the suggestion that disclosure of potential physical effects of climate change on a registrant’s operations and results is required. The Release cites physical effects of climate change such as effects on the severity of weather, sea levels, the arability of farmland, and water availability and quality, and states that registrants whose businesses may be vulnerable to severe weather or climate related events should consider disclosing material risks of, or consequences from, such events in their publicly filed disclosure documents. While most companies that are particularly vulnerable to particular weather risks, such as hurricanes in the Gulf of Mexico, already include disclosures about such weather-related risks to their businesses, the Release takes this a step further by implicitly linking weather and other physical risks to climate change.
In summary:
The Release strongly suggests a bias toward more disclosure regarding climate change, reminding companies that “particularly in view of the prophylactic purpose of the securities laws and the fact that disclosure is within management’s control, ‘it is appropriate that these [doubts about materiality] be resolved in favor of those the statute is designed to protect’” (i.e., investors). However, as articulated by Commissioner Parades’ dissenting statement, the bias toward additional disclosure may result in “an avalanche of trivial information - a result that is hardly conclusive to informed decision-making.” In addition, although the SEC may not intend to base its staff comment process and enforcement program on the conclusions of registrants about the facts of climate change, the bias toward disclosure could embolden private litigants to file more nondisclosure cases.
In light of the continuing political and scientific debate regarding climate change generally, registrants can expect to see disclosures in the area continue to evolve. Baker Botts represented clients in connection with previous New York Attorney General enforcement actions regarding climate change disclosure. Our experience in this matter, as well as statements by the New York Attorney General praising the SEC action as aiding his own enforcement efforts, leads us to believe that state attorneys general will be active in policing these disclosures. The SEC stated that it plans to monitor the impact of the Release on company filings and to hold a public roundtable on disclosure regarding climate change matters later this year.
A copy of the Release is available here.
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