Want a surefire was to start arguments at a politically diverse party? Bring up climate change.
While pundits and true believers on both sides of the environmental fence bicker, public companies may want to focus their attention on more specific debates and developments that could influence their disclosure regime and what they quantify as material information for investors.
In recent years, companies have looked to the 2010 Interpretive Guidance issued by the Securities and Exchange Commission for help. With that document, the SEC attempted to clarify when companies should add climate change to the ever-growing list of risk factors they must disclose to investors, in particular in Management Discussion & Analysis reports for their 10-K filings.
The guidance directed companies to consider the potential implications of climate change from two perspectives: whether a changing climate itself might affect the filer’s business or operations; and how rules and laws pertaining to climate change or environmental protection (including international treaties) might affect the business or expose it to new litigation risks.
At the time, Chairman Mary Schapiro stressed 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.” Rather, she said, the guidance was intended to help companies decide what does or does not need to be disclosed. The goal, she stressed (over the objections of Republicans on the Commission) was not to amend well-defined rules concerning public company reporting obligations, or redefine interpretations and definitions of materiality.
Although the guidance has held up relatively well over the ensuing years, (the global climate change agreement reached in Paris late last year fits perfectly within it), there is growing pressure to, if not rethink the guidance, at least consider how it is applied and enforced.
In January, the Government Accountability Office, Congress’ investigative arm, looked into the SEC’s approach to policing climate change disclosures. “Disruptions to global supply chains, such as those caused by natural disasters, can hurt economic growth and productivity around the world,” it said. “These events may pose risks to private-sector companies by, for example, disrupting supply chains.”
The report examined: the types of climate-related supply chain risks companies are disclosing in their SEC filings and other channels; how the SEC considers climate-related supply chain risks when monitoring and enforcing compliance with disclosure requirements; and what actions, if any, it has taken to identify climate-related supply chain risk information that investors may need.
“ExxonMobil risks becoming an outlier among its peers who have publicly supported reining in climate change. As investors, we need to know how ExxonMobil’s bottom line will be impacted by the global effort to reduce emissions and what the company plans to do about it.”
Thomas DiNapoli, NY State Comptroller
According to SEC staff documents detailed in the report, it considers climate-related supply chain risks during routine monitoring processes and evaluates a company's disclosure “from the perspective of a reasonable investor.” When reviewers identify instances where a company can enhance its compliance with disclosure requirements, they may provide the company with written comments. A company generally responds in writing and, if appropriate, amends its filings.
Citing research by Ceres, an organization that advocates for climate change disclosure, from 2010 through 2013 the SEC sent comment letters related to climate change to 23 companies, with 17 letters sent in 2010 and fewer in subsequent years.
If reviewers identify potential violations, they may refer the potential violations to the SEC's Division of Enforcement for investigation. According to SEC staff, it has yet to file any actions concerning climate-related disclosure issues.
While the SEC and its Investor Advisory Committee have resisted changes in the approach to climate change disclosures, other efforts may be afoot, the GAO report said. These disclosures are expected to be addressed as part of the SEC’s ongoing project to review the effectiveness of its disclosure requirements.
External pressures are also at work. For example, Ceres continues to aggressively advocate for improved environmental disclosures and the Sustainability Accounting Standards Board is focused on bringing sustainability reporting into the mainstream.
The interpretive guidance
The following is from the Securities and Exchange Commission’s 2010 Interpretive Guidance regarding climate change disclosures.
Examples of possible consequences of pending legislation and regulation related to climate change 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.
We reiterate that climate change regulation is a rapidly developing area. Registrants need to regularly assess their potential disclosure obligations given new developments.
Registrants also should consider, and disclose when material, the impact on their business of treaties or international accords relating to climate change. We already have noted the Kyoto Protocol, the EU ETS and other international activities in connection with climate change remediation. The potential sources of disclosure obligations related to international accords are the same as those discussed above for U.S. climate change regulation. Registrants whose businesses are reasonably likely to be affected by such agreements should monitor the progress of any potential agreements and consider the possible impact in satisfying their disclosure obligations based on the MD&A and materiality principles previously outlined.
Indirect consequences of regulation or business trends. Legal, technological, political and scientific developments regarding climate change may create new opportunities or risks for registrants. These developments may create demand for new products or services, or decrease demand for existing products or services. For example, possible indirect consequences or opportunities may include:
Decreased demand for goods that produce significant greenhouse gas emissions;
Increased demand for goods that result in lower emissions than competing products;74
Increased competition to develop innovative new products;
Increased demand for generation and transmission of energy from alternative energy
Decreased demand for services related to carbon based energy sources, such as drilling services or equipment maintenance services.
Source: Securities and Exchange Commission
Energy companies may have more immediate concerns. Over the past several weeks, both the New York and California Attorneys General offices have pushed for more comprehensive and accurate climate change disclosures. In particular, they have investigated ExxonMobil for what they allege were misleading disclosures based on past research.
On Feb. 24, New York State Comptroller Thomas DiNapoli and the Church of England’s investment fund asked the SEC to reject ExxonMobil’s plan to block a shareholder proposal for information on how the company will be affected by public policies seeking to rein in climate change. In December, they filed the proposal, asking the company to publish an annual assessment of the impact of public climate change policies on its business. The company’s response was to notify the SEC of its intent to block the proposal from a shareholder vote at its annual meeting in the spring.
“ExxonMobil risks becoming an outlier among its peers who have publicly supported reining in climate change,” DiNapoli said. “As investors, we need to know how ExxonMobil’s bottom line will be impacted by the global effort to reduce emissions and what the company plans to do about it.”
The evolving challenge for companies and the SEC alike is that climate change advocates are increasingly turning their attention to businesses that are not energy specific, says Dennis Garris, a partner in law firm Alston & Bird’s corporate transactions and securities group.
“The SEC has a difficult job,” he says. “They have to decide how much of this a real issue for investors versus how much of it is just a social issue agenda by special interest groups. That’s what makes coming up with regulations in this situation difficult.”
Garris expects that the SEC will continue to just focus on their 2010 guidance, “but maybe push a little more in the comment process and raise these questions more.”
“I would be surprised if they came out with any proposed rules in the near future,” he says. “It seems like they have a lot going on with what hasn’t been dealt with yet under the Dodd-Frank Act and the JOBS Act. I haven’t heard that this is a priority for them.”
Garris tempers that observation by noting that with so many on the investor side who are looking at these issues, the SEC surely “isn’t sitting there thinking this is a non-issue.” There are a lot of smart people putting a lot of effort into this, and I think that will be enough to, at some point push the Division of Corporation Finance’s staff to make this a significant review issue when they are issuing comments.”
The SEC has good reason to stick with its existing guidance, Garris adds. More specific regulation is a herculean task given the wide range of environmental risks a company could face. “Public companies go through it all the time with their disclosures,” he says. “They look at events and assess situations and decide no disclosure is necessary. Some of these investor groups may just want to establish best practices to get disclosure in circumstances that may not otherwise be necessary, or at least include references that issuers considered these issues.
The concern is that these disclosures will be leveraged as part of a “name and shame campaign,” as is the case with the SEC’s controversial pay ratio and conflict minerals rules. “I don’t think that’s necessary, and I hope it doesn’t go that direction,” he says.
As for addressing these issues in the SEC’s disclosure review process, “What everyone is hoping comes out of that, from both the investor and issuer side, is that they just sort of clean out the underbrush and hopefully help to get disclosure documents back to something that is more helpful and to the point,” Garris says. “Then issues come up like climate change, and one could wonder if this ends up with boilerplate-type disclosure that’s just not helpful to either side.”