Despite what companies say, it isn’t difficult to accurately estimate the future cost of environmental liabilities, asserts Gayle Koch, a principal with The Brattle Group in Cambridge, Massachusetts. Koch says her firm regularly does so for both corporate and government clients. “Companies estimate liabilities all the time for insurance recovery, to get insurance, for mergers and acquisitions, and in divestitures,” she says. “Transactions go forward based on those estimates.” The problem isn’t the estimates, she says, but the disclosure.
“I’ve been in court cases where I’ve seen detailed cost recovery with very detailed distributions of costs,” says Koch. “And those same companies will disclose in their annual reports [only] the known minimum cost.”
Sanford Lewis, an attorney with the Investor Environmental Health Network (IEHN), an advocacy group, agrees that companies can and do produce accurate estimates of environmental costs — for internal use. A company that tells investors that it expects liabilities of $200 million during the next 5 years may advise its insurer to expect liability claims of $2 billion over a 50-year period, wrote Lewis in a recent report. “It is happening, it’s scandalous, and investors should be outraged,” Lewis told CFO.
Increasingly, lawsuits, bankruptcy proceedings, regulatory investigations, and independent research are revealing that companies often know far more about the cost of their environmental liabilities than they tell investors. For example, New York Attorney General Andrew Cuomo is currently investigating whether Chevron misled investors — including New York State’s pension plan — about the extent of its liability in a $27 billion lawsuit tied to “massive oil seepage” in Ecuador. Chevron is widely expected to lose the case in Ecuador but fight payment in the United States, and Cuomo has demanded that the company disclose estimates of potential damages and its cash reserves.
Litigation is bringing other environmental liabilities to light. In May, Tronox, a chemical company spun off from Kerr-McGee in 2006, filed suit against its former parent alleging fraudulent conveyance. According to the complaint, Oklahoma City-based Tronox claims that Kerr-McGee misled investors regarding the magnitude of the legacy liabilities it “dumped” on the spin-off, including environmental remediation costs. Tronox claims the liabilities left it “grossly undercapitalized” while the former parent sold itself to Anadarko Petroleum for a profit. The company filed for Chapter 11 bankruptcy protection last January. (Anadarko officials say that the suit has no merit and that the Tronox bankruptcy is unrelated to Kerr-McGee or the spin-off.)
Another chemical company, Solutia, emerged from bankruptcy in February. The Monsanto spin-off had inherited significant environmental liabilities from its parent. As part of its emergence, Solutia increased its environmental reserve from $78 million to $337 million, according to a spokesman.
Why Lowball Is Legit
If a company wants to lowball its environmental-liability estimates, accounting rules certainly make it easy. FAS 5 says companies must accrue for any loss that is “probable” — but only if the loss can be “reasonably” estimated, which means that a range of possible costs can be established. If a company concludes that no single price tag stands out, the rule says it may disclose the low end of the range. “That is mathematically wrong,” says The Brattle Group’s Koch. “If the whole range is equally weighted, math tells you to pick the average as the expected value.”