Has the Climate Changed for SEC Disclosures Regarding Environmental Matters?

Presented by:Jane Whitt Sellers, PartnerJulianna Lowe, Associate

July 31, 2008www.mcguirewoods.com

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Scope of presentation

• Focus will be on current SEC disclosure requirements applicable to public companies

• Not about mandatory GHG reporting that EPA is working on under FY2008 appropriations bill or California mandatory reporting

• Not about currently active voluntary registries or sustainability reports

• Not about climate change itself (no offense to non-believers intended!)

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What might prompt a company to make SEC disclosures to investors regarding climate change or GHG emissions? • Voluntary, Informal – Responding to requests by investors,

investment bankers and other constituents• Shareholder proposals regarding sustainability reports

generally in form of recommendation to board of directors• Formal – Companies must evaluate whether disclosure

regarding these matters is required, or prudent, under existing general and environmental disclosure requirements

• Currently no specific SEC guidance regarding appropriate climate change or GHG disclosure analysis

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What SEC rules might require disclosure regarding climate change or GHG issues?

• Two primary contexts for SEC disclosure – securities offerings and periodic reports

• Securities Act governs disclosure in offering context; Exchange Act governs periodic reporting

• Both Acts link to a common set of specific disclosure requirements found in Regulation S-K

• Note: Disclosure ≠ Substantive Requirement

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Most likely places for climate change or GHG disclosures:

• Description of Business (Reg. S-K Item 101)• Management’s Discussion and Analysis of Financial

Condition and Results of Operations (Reg. S-K Item 303)• Risk Factors (Reg. S-K Item 503(c)) (and closely related,

cautionary language regarding forward-looking statements) • Financial Statements – Footnotes regarding commitments

and contingencies (FASB Statement No. 5, FIN 14, SOP 96-1, Statement 141R – fair value method)

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Description of Business (Reg. S-K Item 101)

• Material effects that compliance with environmental laws and regulations have on capital expenditures, earnings and competitive position

• Material estimated environmental capital expenditures for current year and the next year (and additional periods if material)

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (Reg. S-K Item 303)

• In addition to discussion and analysis of historical financial information, a company is required to discuss known trends, demands, commitments, events or uncertainties that will, or are reasonably likely to, materially affect liquidity, capital resources, revenue or net income.

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MD&A - continued

• Where a trend, demand, commitment, event or uncertainty is known, management must make two assessments: – Is the known trend, demand, commitment,

event or uncertainty reasonably likely to come to fruition? If not, no disclosure is required.

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MD&A - continued

• If management cannot make that determination, – It must evaluate objectively the consequences of the

known trend, demand, commitment, event or uncertainty, on the assumption that it will come to fruition.

– Disclosure is then required unless management determines that a material effect on the company's financial condition or results of operations is not reasonably likely to occur.

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MD&A - continued

• Consider in context of climate change and GHG emissions reporting, required reductions– Science becoming more coalesced

– Kyoto and subsequent international efforts

– Mandatory GHG emissions registration and reduction (direct and indirect) on the horizon

– Trading markets in allowances (CAIR ruling)

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MD&A - continued

• But the problem is – many elements are still unknown and unknowable; regional differences

• Consensus today – cap and trade or carbon tax likely – but different consequences of each

• Would we be engaging in premature release of little more than informed speculation to fill a perceived void?

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Risk Factors (Reg. S-K Item 503(c))

• Required to discuss the most significant factors that make an investment in a company’s securities speculative or risky

• Do not present risks that could apply to any issuer or any offeringExample: Energy Co. A is subject to numerous environmental laws and

regulations that require significant capital expenditures, can increase our cost of operations, and which may impact or limit our business plans, or expose us to environmental liabilities.

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Also may consider whether climate change or GHG issues would require disclosure under Reg. S-K Item 102 (Properties) or Item 103 (Legal Proceedings)

• Due to the $100,000 dollar threshold related to legal proceedings regarding environmental matters, discussion of otherwise “immaterial” environmental matters may none the less be required.

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Forward-looking statement disclaimers may also reference climate change or GHG issues• The issuer has no liability for forward-looking

statements in periodic reports that are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ from those anticipated (Exchange Act, Section 21E)

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Yes, yes, but is there any specific SEC guidance regarding climate change or GHG disclosure issues?

NO………………

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NO -- continued

• No FAQs or other interpretive pronouncements. Not even in the context of speeches by SEC Commissioners/Staff.

• Climate change and GHG issues are not

being addressed in the comment letter process.

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However, . . .

• The focus on this area has been intensifying over the last 5-10 years – beginning with environmental risk disclosure generally and increasingly moving toward climate change and GHG emissions.

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GAO Report regarding Environmental Disclosure • In 2002, GAO was asked to determine:

– Key stakeholders views on how well the SEC has defined the requirements for environmental disclosure (“Depends on who you ask.”)

– The extent to which companies are disclosing environmental information in their filings with the SEC (“It’s hard to tell.”)

– The adequacy of the SEC’s efforts to monitor and enforce compliance with disclosure requirements (“It’s hard to tell.”)

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GAO Report – continued

– What actions experts suggest for increasing and improving environmental disclosure:• Modify disclosure requirements and improve guidance

for reporting companies;• Step up SEC monitoring and enforcement of existing

requirements; and• Adopt non-regulatory approaches to improving

disclosure.

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GAO Report – continued

• GAO conclusions and recommendations:

“Without more compelling evidence that the disclosure of environmental information is inadequate, the need for changes to existing disclosure requirements and guidance or increased monitoring or enforcement by SEC is unclear.”

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GAO Conclusions – continued• SEC should take steps to ensure that information from Staff

examinations of corporate filings is electronically sorted and tracked to help the Staff allocate oversight resources and determine focus for additional guidance.

DONE (at least in part).• SEC should create a publicly available searchable database of its

comment letters and company responses to those letters. DONE.

• SEC should work with EPA to explore opportunities to take better advantage of EPA data relevant to environmental disclosure.

?

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Coalition for Environmentally Responsible Economies (CERES), and others – Petition for Interpretive Guidance on Climate Risk Disclosure, September 18, 2007

• Petitioned the SEC to issue guidance that climate change disclosure is required under existing law and regulations.

• The guidance should clarify that issuers must: – Assess the climate change risks they face; and

– Disclose those risks if material.

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CERES Petition – continued

• The guidance should address the assessment process and direct disclosure of the following risks, if material:– Physical risks associated with climate change;

– Financial risks associated with present or probable regulation of greenhouse gas emissions; and

– Legal proceedings relating to climate change.

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CERES – Supplemental SEC filing, June 12, 2008

• Reviews developments since the filing of the Petition– Legislative, regulatory and litigation developments re

climate change, GHG regulations, energy policy and financial disclosures

– Important reports and studies indicating the need for improved disclosure. (See Appendix 1 for links to some of these reports.)

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Investigation by New York State Attorney General (Andrew Cuomo)

• September 14, 2007, subpoenas were issued to five energy companies

• The New York State Common Retirement Fund is a “significant shareholder” of each company

• Raised concern that the companies have “failed to disclose material information about the increased climate risks [each company’s] business faces.”

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Investigation by New York AG – cont.

• “For example, any one of the several new or likely regulatory initiatives for CO2 emissions from power plants – including state carbon controls, potential EPA regulations under the Clean Air Act, or the enactment of federal global warming legislation – would add significant cost to carbon-intensive coal generation . . . .”

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Lieberman-Warner Climate Security Act (S. 2191)

• December 5, 2007, Lieberman-Warner bill was passed by the Senate Environment and Public Works Committee.

• First climate change bill to pass out of committee.• Current status – Placed on Senate Calendar of

Business (June 6, 2008) – effectively shelved until 2009 by procedural vote

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Lieberman-Warner Bill – cont.

• In addition to establishing a cap-and-trade program, the bill would require SEC to:– promulgate regulations requiring disclosures related to

global warming and – clarify that

• global warming is a “known trend” and

• U.S. commitments to reduce emissions under United Nations Framework Convention on Climate Change are a “material effect”.

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Recent Legislative Action

• July 18, 2008: In the report accompanying the Financial Services Appropriations bill for FY 2009, the Senate Appropriations Committee called on the SEC to “give prompt consideration to [the September 2007 CERES petition] and to provide guidance on the appropriate disclosures of climate risk.”

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Market activity – Carbon Principles

• February 2008 announcement by 3 large investment banks – will apply new environmental standards to evaluate power companies seeking new generation financing

• Requirement to demonstrate continued economic viability even if a cap system for GHG emissions is imposed

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Carbon Principles - continued

• Lay out a portfolio approach to meeting domestic demand through efficiency, renewable resources, low-carbon distributed power and conventional and advanced generation

• Practices emerging in financing power projects that target quantification, reduction and mitigation of climate change related risks

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Is SEC likely to respond? Short of Congressional legislation, probably not.

• Disclosure guidance on specific environmental issues has not been the SEC’s practice in the past, e.g. disclosures related to contingent liability for environmental remediation.

• Concern whether SEC would have the competence to provide specific guidance regarding climate change/GHG disclosures.

• Some cite Y2K example of what SEC can do.

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SEC Response? – continued

The SEC currently does not have an adequate assessment framework or the scientific expertise to make the determination that climate change risks are material to a particular company and will not push them to report specifically on climate change in the coming years.

Former SEC Commissioner Roel Campos (March 30, 2007)

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So where does this leave us?

• Market, and other, pressures (and company assessments) are having an impact.

• For example, Xcel Energy, likely seeking a settlement with the NY Attorney General, made specific disclosures regarding climate change risks in its 2007 Form 10-K filed in February 2008 (see Appendix).

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Congressional Testimony of Jeff Smith, past ABA Environment Disclosure Committee Chairman (October 2007)• Voluntary disclosure increasing dramatically• Best and most thorough reporting being done

outside the mandates of securities laws• Would be a mistake to believe this voluntary

activity, no matter how sophisticated and well-intentioned, could become a permanent substitute for mandatory reporting

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Congressional testimony – continued

• Voluntary reporting – no agreed format or objective, no ready basis for comparison among themselves or against vetted benchmarks

• SEC reporting – wide variation in depth, quality and format

• Urges SEC to move with deliberate speed to reassert gatekeeper role, but not over-react – do not want a flood of defensive filings of immaterial and premature information

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So where does this leave us? (cont’d)

• While SEC guidance specifically addressing climate change and GHG risks is unlikely, public companies should assess whether these issues pose material risks/opportunities that must be disclosed under current rules and regulations.

• This assessment, and decisions regarding whether disclosure is ultimately required, would not differ significantly from the processes currently employed for other types of environmental risks or legal proceedings.

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Appendix 1: Links to Reports

• Carbon Disclosure Project Reports, focusing on climate-change disclosure by world’s largest companies: http://www.cdproject.net

• Lehman Brothers Report—The Business of Climate Change II: http://www.lehman.com/who/intcapital

• Ceres—Corporate Governance and Climate Change: The Banking Sector: http://www.ceres.org/NETCOMMUNITY/Document.Doc?id=269

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Appendix 2: Examples of climate change/GHG disclosures by industry.

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