What You Can't See...

The Deepwater Horizon sinking and subsequent Gulf oil leak. A terrible tragedy, resulting in the loss of 11 lives. British Petroleum estimates that 5,000 gallons of oil is leaking into the Gulf of Mexico daily. However, independent scientists, viewing video and remote sensing data of the leak, estimate there could be nearly 20 times that leaking out each day. No matter what value is believed, most agree it is in dire need of being stopped.

So who is at fault? Transocean, owner of the Deepwater Horizon rig? BP, manager of the operation? Or could it be Halliburton, the company overseeing a cement-laying process just prior to the explosion?

Blame will be decided after armies of attorneys have their days, weeks, months and most likely, years in the court. Meanwhile, people are angry and frustrated: Miles of sludge on the coastal water, satellite images of huge brown areas of the Gulf, tarballs on the beaches, fishing fleets stuck in port, and those indelible images of marine life covered in the blackish brown ooze. The combination of economic, environmental, and social impacts cause a widespread concern by otherwise complacent people.

It’s images like these that fuel some of the latest “bursts” of environmental activism. Back in the 1960’s, highly public environmental disasters such as the Cayuhoga River fire in 1969 (actually the sixth on the river, caused by combustion of dissolved chemical loads) and daily smog in major cities, drove the populace to demand change, eventually producing historic legislation still in use today, including the Clean Air and Clean Water Acts and the National Environmental Policy Act (NEPA).

Oil leaks and the immediate damage they cause are easy to see, and most of us do not care who is at fault, just clean it up and make it go away. Billions will eventually be paid out by the above companies (and perhaps others as yet unnamed) in efforts to clean up, mediate, and compensate damages incurred. Thousands, perhaps, even hundreds of thousands of individuals, people like you and me, will be involved in actions in attempts to restore this body of water and all of its natural treasures.

Today, all eyes are on the Gulf, but what about the issues of Climate Change? Certainly, whether the public believes humans are contributing to climate change or not, most understand that greenhouse gases have the potential to cause damage on a planetary scale. Whole populations of both people and animal life can (and are) lose their lands and drinking water. Invasive pests, normally killed off by cold winters, are living through now milder climates and wreaking environmental and economic damage on huge areas of virgin forests. Coral reefs, the rain forests of the sea, are in a serious state of decline. So why is there little public outcry about this?

Imagery and emotion. There’s no sinister blackish sludge, and the now-overused photos of a polar bear on a small ice flow, or villagers in some faraway country pointing to a dry lake bed carry little feeling. Climate change is caused by a build-up of invisible gases, primarily CO2. You can’t see the threat: no immediate business interruption, no oil covered birds, nor can most people understand why CO2 would even be a problem. After all, we were all taught in school, that people exhale CO2, and trees utilize that CO2 to create Oxygen (O2). Plus, it’s a completely natural gas. Of course, this is not to mention society’s confusion. Our company performed an unofficial study amongst a sample group and over 40% stated that greenhouse gases were causing the breakdown of the earth’s ozone layer. So education is another hurdle.

We should all be angry about the situation in the Gulf and should press our political leaders to take actions, not only to ensure the rehabilitation of affected areas and compensate those directly impacted, but also to take steps to minimize the risk of this ever occurring again. Simultaneously, with the global eye, can a national (and international) focus on our planet’s health, similar to the environmental push and resultant legislation of the 1970’s, again be brought to the forefront, igniting change and introducing solutions to a system bogged down in political and economic quagmires?

History has taught us that, unlike the expression, what we can’t see CAN hurt us. Perhaps, in the vein of events from the 1960’s, this terrible tragedy will leave a legacy of positive change for our planet.

Joseph Winn is the President of GreenProfit Solutions, Inc. a sustainability consulting, certifying and contracting firm. For more information, please contact Joseph at 1-800-358-2901 or email jwinn@greenprofitsolutions.com.

New SEC Guidance on Climate Change Risk Disclosure – Part 2

In our last article, we spent some time on the steps and actions leading up to the new SEC Climate Change Risk Disclosure guidance (hereinafter, the “Guidance”). In this article, we will examine the details and requirements of the new SEC guidance. In a following article we will discuss the potential benefits of a certification program, and also measure the relevance this action has on non-public companies.

What the Climate Change Guidance Really Means

The most important thing to realize about the Guidance is that it is not law, it is merely guidance. The requirements of public company disclosures, as set out in the Securities and Exchange Act of 1934 (the “1934 Act”) and Regulation S-K have not changed. The Guidance merely provides some gloss on how the SEC might interpret a disclosure issue if one arose. In addition, to the extent SEC staff provides comments on a public issuer’s financial report discloses, SEC staff are likely to refer to the Guidance when commenting.

The 1934 Act requires quarterly and annual financial reports (with quarterly reports on Form 10-Q and annual reports on Form 10-K) for companies with registered securities (defined in the regulations as “registrants”). The public disclosure requirements of the 1934 Act apply to all publicly-traded companies (i.e., those whose shares are traded on public exchanges like the NYSE and the NASDAQ) and those few companies who have so many shareholders that the public reporting requirements apply to them.

Attorneys, accountants and business people accustomed to working on financial reports under the 1934 Act are familiar with the touchstone of disclosure in those reports: the company must disclose those material elements of its business that a reasonable investor would consider to be material. Nearly all of the other regulations and guidance concerning financial reports spring from this basic principle. Information is considered “material” for disclosure purposes if there is a substantial likelihood that a reasonable investor would consider it relevant in deciding how to vote or make an investment decision.

Item 101 of Regulation S-K requires that the registrant disclose the material effects of compliance with any laws that might apply to the registrant. The Guidance states what should be obvious, that Item 101 “requires disclosure of the material effects that compliance with environmental laws may have on capital expenditures, earnings or the competitive position of a company”.

So, by way of example, if a registrant operates facilities with significant air or water emissions, the registrant should disclose in its financial reports its cost of complying with the Clean Air Act, the Clean Water Act and other environmental laws and the potential financial impacts of non-compliance. In contrast, a public company with no material air or water emissions would not have a duty to disclose its hypothetical liability where there is not reasonable likelihood of that liability coming to pass.

With respect to climate change, the general rule of disclosure under Item 101 means that the registrant must also disclose its actual costs of legal compliance and the potential costs of non-compliance. For example, if legislation imposed a system of emissions cap and trade, companies whose emissions exceed the stated caps, will be forced to buy “credits” and perhaps pay fines. Conversely, companies with emissions under a stated level, will be able to “sell” their credits and potentially improve their financial position. In addition, countries around the globe have and are continuing to assess fines to companies they believe are inflicting environmental damage to their nations.

Importantly, a registrant is not required (and is, in fact, prohibited) from making disclosures that are speculative. Unless and until emissions cap and trade legislation becomes law, a disclosure about the potential benefits of a cap and trade system would generally be ill-advised. In the same way that the benefits of prospective legislation are too speculative to disclose, the cost and expense of potential future legislation would also be too speculative to disclose.
Public reporting companies disclose in their quarterly reports on Form 10-Q and their annual reports on Form 10-K pending legal proceedings. Item 103 of Regulation S-K contains specific requirements about the extent to which particular items of litigation must be disclosed. Again, in general, materiality is the touchstone of disclosure.

The Guidance states that litigation disclosures under Item 103 must include any environmental enforcement actions and orders material to the registrant. As the Guidance notes, there already have been enforcement actions (notably in the State of New York) with respect to the accuracy of environmental disclosures in financial reports. There are also several lawsuits pending in which private litigants have sued companies over alleged climate change resulting from the emissions of those companies. Public companies who are defendants to such suits would be required to disclose them, applying the same materiality standards applied to any other kind of litigation.

If national climate change legislation, including a cap and trade system, became law, disclosures of potential or hypothetical litigation might be appropriate under Item 103. Until such potential legislation becomes law, however, disclosures of hypothetical or potential contingencies under Item 103 are premature. Disclosures must include “such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.” See 17 CFR 230.408 and 17 CFR 240.12b-20.

In quarterly and annual reports, public issuers provide a discussion of the issuer’s financial results and future prospects called “Management’s Discussion and Analysis” (or “MD&A”). Item 303 of Regulation S-K requires an issuer “to disclose known trends, events, obligations or uncertainties that will, or are reasonably likely to, materially affect the company’s liquidity, capital, resources or operations”. In addition, companies are also required to disclose any other information the company believes is necessary to an understanding of its financial conditions, changes in financial condition and results of operations.

Discussing “known trends, events, obligations or uncertainties” is a potential bottomless pit. While management will be aware of immediate and obvious trends (such as increasing or decreasing sales, or increasing or decreasing costs of goods sold) there is an infinite list of potential contingencies that might impact the issuer’s financial performance. In the MD&A, however, the issuer is not required to identify every possible contingency, but rather only those “known trends, events, obligations or uncertainties” that are “material” to a reasonable investor’s decision to invest or vote securities.

Item 503(c) of Regulation S-K helps issuers draw the line between “known trends” and mere speculation by providing that the issuer must disclose "the most significant factors that make the offering speculative or risky" (emphasis added).

By way of example, an actual lawsuit that is pending is more significant than a threatened lawsuit that has not been filed. A threatened lawsuit is more significant than the risk of a possible future lawsuit that has not yet been threatened.

Put into this context, the disclosure of climate change impacts should be ranked against the issuers other known trends and contingencies. If the issuer reasonably believes that certain environmental or climate change impacts are more significant than other contingencies, that belief should guide its disclosure.

By way of example, if an issuer had facilities in low-lying coastal areas that might be threatened by an increase in sea level brought about by an increase in global temperatures, that might be a contingency with the potential to impact the issuer’s financial statements. Whether that risk is one that should be disclosed in a financial report, however, will depend on the relative immediacy and potential impact of that risk in comparison to other risks that the issuer faces. Ultimately, while the Guidance discusses these types of disclosures and provides some color on how issuers should consider them the Guidance does not change the law regarding disclosures and does not necessarily require issuers to disclose new or different kinds of risks.

The practical impact of the Guidance, however, is to raise the awareness of public issuers regarding environmental and climate change risks and costs. In light of the Guidance, public issuers should not reasonably be able to claim surprise if future enforcement actions challenge the adequacy of disclosures of these kinds of risks.
Because the disclosure of contingencies, however, requires a weighing of immediacy and impact against other potential risks, a well-advised issuer will adopt a consistent theoretical construct for considering and weighing the immediacy and impact of risks for disclosure purposes. Part of that theoretical construct, many issuers may conclude, is a process for assessing and measuring the potential impact of environmental and climate change risk. It is to this end that we will address some practical steps issuers may take to perhaps mitigate their environmental and climate change risks in Part 3 of this article series.

About the authors:
Keith Winn is vice president of marketing and chief operating officer of GreenProfit Solutions Inc., a Ft. Lauderdale based sustainability consulting, certification and contracting firm. You may contact him at 800-358-2901 or kwinn@greenprofitsolutions.com.

Jonathan B. Wilson is a corporate and securities attorney at the Atlanta law firm of Taylor English Duma LLP. Mr. Wilson is also the founding chair of the Renewable Energy Committee of the American Bar Association’s Public Utility Section. You may contact him at 678-336-7185 or jwilson@taylorenglish.com.