“Everyone is blaming FASB, but more often than not you find a lot more forward-looking information [about contingent liabilities] outside of the audited financial statements, which puts it outside of FASB requirements and mostly under SEC mandates,” says Kyle Loughlin, S&P’s team leader for the chemical sector, which covers companies included in Rogers’s analysis of reserves. He points out that much of the contingent-liability information is currently found in the footnotes or in the Management’s Discussion and Analysis section of the financial statements, as required by item 303 of the SEC’s Regulation S-K.
Rogers notes that most companies would be better off if they could publicly estimate the full value of their environmental liabilities, if for no other reason than to turn off an ongoing hit to earnings. To date, however, he says the best opportunity for companies to come clean is during a merger or acquisition, when different accounting rules apply.
The IEHN’s Lewis, meanwhile, is lobbying for an accounting rule that forces companies to release certain internal estimates that are often provided to insurance underwriters. “At a minimum there should be some level of disclosure to say, ‘We’re giving [investors] the known minimum, but we give a different figure to our insurers,’” Lewis says. “Either FASB or the SEC should issue a rule that says if a company is giving estimates of contingent liabilities to someone other than investors, it would be materially misleading not to also disclose the estimates [publicly].”
That’s unlikely to happen without a fight similar to the one over FAS 5 last year. But until more disclosure is mandated, investors will remain in the dark about the toxic liabilities that are eating away at corporate earnings.
Marie Leone is a senior editor at CFO. Tim Reason is editorial director of CFO.com.
The Truth about Reserves
A new study of public financial data for 24 oil, gas, and chemical companies shows that despite spending millions each year on cleanup, most of these companies take charges every year to replenish their environmental reserves. The study was performed by Greg Rogers, an environmental attorney and president of consulting firm Advanced Environmental Dimensions.
Of the 24 companies studied, 21 had a cash efficiency of less than 50 percent, meaning that they reduced their reserve by less than 50 cents for each dollar of cash spent on cleanup (see chart below). Nine companies actually had negative performance — that is, for each dollar they spent on cleanup, their reserves actually grew, as indicated by a negative cash-efficiency metric.
One company that fared well in the study was El Paso Corp. The oil company’s legacy environmental liabilities are chiefly related to hydrocarbon releases that contaminated facility soil and groundwater. Since 2001, the company has reduced its reserve from more than $500 million and a portfolio of 900-plus sites to less than $200 million and fewer than 500 sites. In 2008, its reserve shrank by 69 cents, net of mergers and acquisitions, for each dollar spent on site cleanup. “That result [is evidence of] the level of diligence that goes into our estimating,” says CFO Mark Leland. Each quarter the company performs a valuation analysis of every site and reflects the latest value of its liabilities in the company’s 10-Q.
El Paso doesn’t bother creating a range of potential costs. It calculates what it believes its actual costs will be and discloses them, along with a “worst case” scenario as required by SOP 96-1. “Whether the liability goes up or goes down, we put it in the books without regard to the P&L impact,” says Leland. — M.L. & T.R.