The Greening of Materiality

The SEC calls on companies to predict the legislative process when determining whether to disclose risks related to climate change.

New guidance from the Securities and Exchange Commission was intended to clarify how companies should explain the effects of climate change on their businesses, but last month’s 29-page interpretive release may raise more questions than it answers.

Investor groups have long been critical of companies’ lack of candor regarding climate-change risk, and of the SEC for allowing them to get away with it. Only 17% of companies made any reference to climate change or greenhouse-gas emissions in their annual reports filed in 2009, according to a review of about 400 companies by law firm McGuireWoods. (To be sure, not every company has material climate-change risk to disclose.)

By publishing new guidance, “the SEC is effectively saying, ‘You should think long and hard about whether or not greenhouse emissions and climate change are material to your shareholders,’” says Karl Strait, a partner at McGuireWoods.

Many observers were surprised at the timing of the release, which comes just as companies are finalizing their annual reports. The two Republican commissioners on the SEC also questioned the guidance’s timing, voting against its release in late January. “As we begin to emerge from the worst financial crisis in generations, our consideration of this release sends a curious signal to the investment community about what we view as the most pressing issues facing the commission,” said commissioner Kathleen Casey.

Others have implied that the commission is taking on a pet project for President Obama, but SEC chairperson Mary Schapiro counters that the commission “is not making any kind of statement regarding the facts as they relate to…global warming. We are not opining on whether the world’s climate is changing.”

Wrangling aside, an immediate concern for companies is whether some form of cap-and-trade legislation will become law, and what effects it could have on their financial condition — a key disclosure requirement emphasized in the guidance.

Such legislation seemed poised for quick passage when Obama first took office, but has since moved lower on the Administration’s agenda. Still, the SEC wants companies to consider both the likelihood and the effects that such a law would have on them, along with any existing or pending regional, state, and international environmental rules. The new guidance specifies the items companies should consider, such as the costs of buying credits under a cap-and-trade system or reducing carbon emissions.

Given so much uncertainty, companies will try to meet the regulator’s demands with boilerplate language and few details, predicts Gregory Bibler, chair of Goodwin Procter’s environmental practice. Other attorneys suggest that the key is to have clear processes for analyzing pending legislation. “As long as companies make reasonably informed analysis and judgment as to what to disclose or not disclose, and can defend that if asked, I think it’s sufficient,” says Howard Berkenblit, a partner at Sullivan & Worcester.

But Berkenblit acknowledges that uncertainty abounds: “Under the current rules, materiality can always be second-guessed or argued in hindsight if an issue was not anticipated.”

Which risks matter to investment managers when they are doing due diligence

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