As shareholder and general public awareness regarding climate change escalates, public companies are increasingly being pressured to disclose information regarding the magnitude of their greenhouse gas ("GHG") emissions and any resultant climate-change liability risks.
Existing Securities and Exchange Commission ("SEC") regulations arguably already require companies to disclose any significant carbon emissions and related environmental liability exposure. However, there are those who argue that many companies are not complying with such disclosure obligations, perhaps because they have been slow to recognize the implications of several recent developments that are either caused by, or coincident with, heightened investor concerns about the deteriorating global environment and its potential impact on the value of their investments.1Among these developments is the recent filing of a formal rulemaking with the SEC asking that agency to clarify the nature and scope of public companies' duty to disclose how climate change could affect their financial condition or operating performance. Other important developments include a discernible increase in the number of climate change-related shareholder proposals submitted to public companies in 2007, and the issuance of subpoenas to certain energy companies by New York Attorney General Andrew Cuomo (one of the signatories to this rulemaking petition) challenging the adequacy of their respective disclosures of financial risks associated with the planned construction of several coal-fired power plants. In addition, several comprehensive climate change bills pending in the United States Congress could (among other things) impose enhanced risk disclosure obligations on public companies; there similarly is considerable legislative ferment at the state level. Finally, in April 2007, the U.S. Supreme Court handed down a landmark decision concerning climate change, Massachusetts v. Environmental Protection Agency (" Massachusetts v. EPA" ), holding that the EPA has the authority to regulate carbon dioxide and other GHGs under the Clean Air Act.
These developments may not affect all public companies, but do raise issues for those companies engaged in such varied lines of business as property and casualty insurance, energy production and transmission, and other manufacturing spheres that either result in, or combat, GHG emissions. Because the test for "materiality" under the federal securities laws is ultimately what the "reasonable investor" deems important to his or her investment decisions, investor perceptions definitely matter. And those perceptions are often, if not always, mirrored in regulatory and political events potentially (if not immediately) affecting a company's business and financial condition. Accordingly, companies have been analyzing these converging trends to determine how, if at all, they should influence disclosures called for by applicable SEC rules. To help companies now engaging in this analysis, we provide below a brief discussion of the developments enumerated above, with a view toward facilitating the determination whether any or all might militate in favor of disclosure in reports filed with the SEC. As part of this discussion, we address the important subject of the influence of at least some of these trends on Director and Officer ("D&O") liability insurance coverage.
Shareholder Influence - SEC Rulemaking Petition And 2007 Shareholder Proposal Activity
On September 18, 2007, a coalition of state treasurers and controllers, municipal treasurers, institutional investors and environmental groups petitioned the SEC to issue guidance that would require public disclosure of risks associated with climate change in specified circumstances described in the petition. The petition does not specifically seek the enactment of new regulations, but rather asks that the SEC construe its present regulations to elicit considerably more information in SEC reports on a company's exposure to material climate change risks. The petitioners argue that such risks have become very important to investors in many companies, yet in general have not been sufficiently transparent by these companies to permit informed investment decision making. In an accompanying letter to SEC Corporation Finance Division Director John White, the petitioners further ask that, regardless of whether the SEC itself acts on their petition, the staff should examine carefully the adequacy of disclosures made by companies in the context of the staff's regular review of annual and quarterly reports filed with the SEC. This letter may have more immediate consequences for companies filing their annual reports on Form 10-K (U.S. issuers) and 20-F (foreign private issuers) in 2008, as the SEC has no obligation to grant the rulemaking petition. Returning to the petition, its signatories assert that the risks associated with global climate change fall into three basic categories that, if material, should be disclosed in SEC reports: 1) physical risks associated with the company's financial condition or operations; 2) financial risks and opportunities associated with present or probable GHG regulation; and 3) litigation or other legal proceedings regarding climate change. Physical risks are those that could adversely affect both personnel and physical assets, such as real estate, equipment and supply and distribution chains. These types of risk could stem from rising sea levels, lack of sufficient clean water, a negative impact on employee health and/or changes in weather patterns. Financial risks associated with regulation could result from new state or federal regulations that limit emissions of GHGs or force corporations to quantify and report such emissions. If any or all of these proposed regulations are enacted, large-scale producers of GHGs could incur substantial costs to bring their operations into compliance, or face fines or other penalties for noncompliance.
Conversely, companies that are able more efficiently to limit GHG production, or that operate in "green" industries focusing on GHG clean-up, may reap material financial benefits that likewise should be disclosed on materiality grounds. The petitioners maintain that major emitters of GHG almost certainly will face lawsuits from government entities and citizens attempting to recover damages for injuries to the public or others in this context. Depending on a company's industry and degree of liability exposure as measured against a shifting background of increasingly more stringent regulation, it may even be necessary to establish reserves under generally applicable accounting principles (GAAP) in anticipation of litigation expenses. According to the petitioners, few companies make appropriate climate change disclosure in their public filings, even though SEC rules arguably already require companies to disclose this type of information. Under the current disclosure framework, there is no general duty to disclose all material information to the markets. However, public companies that file reports with the SEC are obligated to disclose information in those reports that the SEC decrees by line-item requirement to be per se material, or that otherwise would be necessary to make the mandatory disclosures not materially misleading by omission under applicable antifraud provisions. Petitioners argue that climate change risks are disclosable in periodic reports (i.e., annual and quarterly reports), as well as in securities offering documents, under certain provisions of Regulation S-K, namely: Items 101 (Description of Business), 103 (Legal Proceedings) and 303 (Management's Discussion and Analysis, or "MD&A"), as described below:
• Item 101 - requires the disclosure, by companies doing business in jurisdictions that have adopted greenhouse gas emission regulations, to discuss the material effects of compliance on capital expenditures, earnings and competitive position.
• Item 103 - mandates disclosure of material legal proceedings to which the issuer either is or may become a party, including proceedings "known to be contemplated" by government authorities. The petition further reminds companies that SEC Staff Accounting Bulletin No. 92 compels companies to accrue a charge for environmental liabilities if it is probable that the liability has been incurred and can reasonably be estimated.
• Item 303 - the MD&A section of annual reports in particular requires disclosure of information that is necessary to understand the issuer's "financial condition, changes in financial condition and results of operations" - not just for historical periods, but also in the case of "known trends, events or uncertainties that are reasonably likely to have material effects." (Material changes in these areas also are disclosable in the MD&A sections of quarterly reports). Although disclosure under Item 303 is limited to information available "without undue effort or expense," and is not required in connection with "forward-looking information," it can be difficult to distinguish between non-mandatory forward-looking information and the mandatorily disclosable "known trends and uncertainties."
Shareholders similarly are exerting pressure on individual companies through the submission of climate-related shareholder proposals under SEC Rule 14a-8. According to the RiskMetrics Group's Postseason Report on 2007 Shareholder Proposals subtitled "A Closer Look at Accountability and Engagement," 80 environmental-related shareholder proposals were filed in the first half of 2007, the most tabulated for any area involving a so-called "social issue." Of these 80 proposals, 14 were related to climate risks, double the number from 2006. In addition, the average vote in favor of such proposals where included in company proxy statements rose from 17 to 20 percent between 2006 and 2007. An additional 18 climate change proposals were withdrawn, which in RiskMetrics' view reflects an increasing willingness on the part of corporate management to engage its shareholders in discussion on these issues. For example, Calvert Asset Management withdrew resolutions at Hartford Financial and Prudential after the companies agreed to respond to the climate risk disclosure questionnaire submitted by the Carbon Disclosure Project, and to release public assessments of the effects of climate change on their businesses.
Part II of this article will appear in the May issue of The Metropolitan Corporate Counsel.
1 Many of the world's largest corporations already are providing the investment community with information about their GHG emissions and climate change management strategies through forums such as the Carbon Disclosure Project ("CDP"). The Carbon Disclosure Project CDP is an independent not-for-profit organization aiming to create a lasting relationship between shareholders and corporations regarding the implications for shareholder value and commercial operations presented by climate change. The CDP's goal is to "facilitate a dialogue, supported by quality information, from which a rational response to climate change will emerge." In 2007, 77% of the "Financial Times 500," which includes the world's largest 500 corporations, responded in varying degrees to the CDP's questionnaire on carbon performance. This was the highest response rate in the history of the CDP.
David R. Berz is the Managing Partner of Weil Gotshal's Washington DC office and head of the firm's Environmental Practice Group. Matthew Morton is an Associate in the Washington DC office and practices in the firm's Environmental Practice Group.