A coalition of state governments, institutional investors, and environmental groups is urging the Securities and Exchange Commission to get tough with publicly-traded corporations that don’t fully disclose risks tied to climate change on their financials.
The groups make their case in a 116-page legal action that petitions the SEC to issue a guidance to clarify existing disclosure and accounting rules so that companies are forced to report any material effect that global climate change – and attendant rules and lawsuits – have on their businesses.
Currently, the groups contend, Corporate America isn’t in full compliance with the existing disclosure rule. The coalition includes 11 state governments; the Environmental Defense Fund; Ceres, an environmental-advocacy group; and the California Public Employees’ Retirement System.
Two questions loom, however. One concerns the matter of whether the groups are doing a bit of environmental grandstanding. That is, are they using the hammer of potential SEC action to coerce companies to clean up their carbon footprint sooner, rather than later? The second question is more basic: would an SEC guidance have enough teeth to spur long-term change?
In any event, the appeal is aimed at the CFO’s jugular. The coalition is asking the SEC to push hard to get companies to comply with two fundamental rules, the Financial Accounting Standards Board’s venerable FAS 5, and the SEC’s Regulation S-K. Under FAS 5, Accounting for Contingencies, companies must disclose environmental contingencies if the liabilities are material to the financial condition of the company.
What’s more, if the liability is “probable and reasonably estimable” it must be recorded on a company’s balance sheet. If the cost can’t be estimated, the liability must be disclosed in financial-statement footnotes.
For many companies, the analysis of environmentally related financial risk hasn’t reached the level of certainty that requires a FAS 5 level of detail. In those cases, companies should be governed by Regulation S-K rules, say coalition members.
Reg S-K requires companies to prepare a narrative to describe material, but often unquantifiable, risks. Explanations of climate- change risk tend to be provided under three Reg S-K disclosures,practitioners say: Item 101, Description of Business; Item 103, Legal Proceedings; and Item 303, Management’s Discussion and Analysis.
Companies that publicly reveal climate-change liabilities also tend to draw up plans to mitigate the risk, noted Mindy Lubber, president of Ceres, and director of the Investor Network on Climate Risk, at a press conference on Tuesday.
Some suggest another FASB rule, FIN 47 is already spurring companies to clean up their environmental messes. Like disclosure rules, FIN 47 requires companies to show their future environmental liabilities in plain sight of investors — on the balance sheet.
FIN 47, the reinterpretation of FAS 143, Accounting for Asset Retirement Obligations, forces companies to recognize on their balance sheets the future environmental perils of permanently shutting down a facility. And that rule has hit some balance sheets hard.
For instance, Ford Motor Co. recorded a $251 million after-tax charge to 2005 net income tied to the pollution risk in permanent facility shutdowns, and United Technology posted a similar $95 million charge in the same year. Nevertheless, recognizing the future cost also prompts some companies to clean up, rather than mothball, contaminated facilities, environmental advocates contend. In that way, the assets can be shuttered or sold and exorcised from the corporate books. And the environment gets cleaned up in the bargain–which may be the prime motive behind the groups’ action.
The coalition leaders claim their purpose isn’t to get the SEC to introduce new regulations but simply to get companies to comply with old ones, Sean Donahue, an attorney with Donahue and Goldberg who represents the Environmental Defense Fund, said at the press event. Further, the petitioners want the SEC’s Division of Corporation Finance to scrutinize annual and quarterly financials once the new interpretation is released.
Donahue says the SEC likely agrees in principle that climate change “poses material financial risk” to public corporations. But, he contends that it’s hard to gauge whether the regulator will rework the existing rules.
SEC spokesman John Nester declined to comment on the appeal or statements made by the coalition leaders. But he did note that the commission “is committed to robust disclosure by companies of material environmental issues.” Nester also confirmed that Reg S-K, specifically Items 101, 103, and 303, were examples of provisions that require environmental disclosures.
Lubber was optimistic about the reactions corporations would have to new SEC guidance. “I’m not convinced there will be push-back,” she said, adding that some companies – including electric-power giants PG&E and AEP – are “shining” examples of companies that provide robust disclosures. They prove that although it takes work, the risk analysis can be done and documented, she said.