SEC Issues Interpretive Guidance on Public Company Disclosures Relating to Climate Change Risks

Kelley Drye Client Advisory

The U.S. Securities and Exchange Commission on February 2, 2010, issued interpretive guidance outlining its views as to how existing disclosure requirements apply to a panoply of business risks associated with climate change. Coming in the midst of public company reporting season, the guidance could affect decisions on whether and how to include discussions of climate change risks in registrants’ public filings.

The guidance also coincides with a rapidly evolving regulatory landscape primarily affecting companies with significant carbon (or carbon equivalent) footprints. Congress is currently considering legislation that would establish a national cap and trade” program designed to reduce greenhouse gas emissions through mandatory limits on emissions, coupled with a system of tradable allowances to incentivize reductions. A similar program already has been put into effect for electric power generating facilities under a regional consortium of Northeastern states, known as the Regional Greenhouse Gas Initiative. The U.S. Environmental Protection Agency and Department of Transportation are also developing a greenhouse gas emissions standard for light duty vehicles (rule proposed on September 15, 2009), and a mandatory greenhouse gas emissions rule for facilities emitting more than 25,000 metric tons of greenhouse gas emissions went into effect on December 29, 2009.

In addition to disclosures that may be triggered by the costs of complying with these emerging legal requirements, the SEC guidance addresses a range of other actual or potential business impacts due to changes in supply chain costs (such as the cost and availability of certain fuels), and direct and indirect effects of physical impacts to facilities and operations due to changing weather patterns.

What You Need To Know

Does the guidance mandate greater disclosure concerning climate change risks?
The SEC’s interpretative guidance, which will become effective upon its publication in the Federal Register, does not create any regulatory obligations for registrants to disclose risks to their business relating to climate change beyond what is already required under existing law. However, because this represents the Commission’s first foray into how its disclosure requirements apply to climate change-related risks, it does clarify some of the uncertainties regarding how the Commission itself views and, presumably therefore, will enforce the disclosure requirements in the climate change arena. As such, the guidance offers a roadmap of how registrants should determine whether a disclosure requirement has been triggered.

Which rules are addressed in the guidance?
The guidance contains a summary of the specific disclosure rules that may be triggered by climate change-related risks. Other than financial statement disclosures, the pertinent rules covered in the guidance are: Item 101 (certain costs of complying with regulations); Item 103 (material pending legal proceedings to which the registrant or any of its subsidiaries is a party); Item 503(c) (risk factors that make an investment in the registrant speculative or risky); and Item 303 (management’s discussion and analysis). The guidance also covers similar requirements that also apply to foreign private issuers.

What types of risks does the guidance address?
Climate change presents different kinds of risks to an array of economic sectors. The SEC guidance groups these into four general categories, which may be summarized as follows:

Impact of Legislation and Regulation. Material capital expenditures needed to comply with regulations may need to be disclosed pursuant to Item 101. The business impacts of existing or pending legislation or regulation also may need to be disclosed as part of the risk factors discussion under Item 503(c) if the impact is of sufficient magnitude to render investment in the registrant speculative or risky, or in management’s discussion and analysis pursuant to Item 303 if it is reasonably likely to have a material adverse effect on the registrant’s financial condition or results of operation. In the case of pending legislation or regulation whose passage or adoption is, in SEC parlance, a known uncertainty,” the Commission stated that unless management determines that it is not reasonably likely to be enacted or adopted, it should proceed on the assumption that it will be. Examples of impacts that potentially could require disclosure include: costs to purchase allowances or credits under a cap and trade program; costs required to improve facilities to reduce emissions; and changes to profit or loss arising from increased or decreased demand for goods and services arising directly from legislation or regulation, and indirectly from changes in costs of goods sold.

International Accords. The effects of requirements adopted pursuant to international treaties, such the Kyoto Treaty or international accords being considered in Copenhagen, may need to be disclosed by registrants whose businesses are likely to be affected” by such agreements, according to the guidance. This language presumably would mean that domestic U.S. companies would have no such disclosure obligation for the most part, inasmuch as these treaties have not been ratified by the U.S. Senate and therefore have no legal force in the United States. However, companies with overseas operations presumably would be required to disclose the impacts of these laws on their operations overall if the materiality thresholds in Items 103, 503(c) and 303 are met.

Indirect Consequences of Regulation or Business Trends. The guidance also discusses disclosure that may be required under Item 503(c) or Item 303 due to adverse business impacts from developments in legal requirements, technology, political trends and science that may indirectly increase demand for new products or services and decrease demand for existing products or services. Among the specific examples pointed to by the SEC of such impacts are: decreased demand for goods that require significant greenhouse gases to manufacture; increased demand for products offered by competing businesses that require lower emissions to manufacture; increased demand for generation and transmission of energy from alternative energy sources; and decreased demand for services related to carbon-based energy sources, such as drilling services or equipment maintenance activities. Item 101 disclosure also could be required in some cases, according to the guidance, such as if a registrant plans to reposition itself to take advantage of potential opportunities resulting from these developments. The guidance also discusses the potential loss of reputation as a risk factor that may need to be disclosed under Item 503(c) if the public’s perception of publicly available data relating to the registrant’s greenhouse gas emissions could expose it to potential adverse consequences to its business operations or financial condition.

Physical Impacts of Climate Change. The final category of business risk addressed in the SEC guidance involves direct and indirect physical effects of climate change that potentially could affect a registrant’s financial condition or operations. Examples of such risks pointed to in the guidance include: property damage to facilities or operations located on coastlines; disruptions to customers or suppliers from increased weather severity, such as hurricanes and floods; increased claims for insurance and reinsurance companies; decreased agricultural production capacity in areas affected by drought or other weather-related changes; and increased insurance premiums and deductibles or decrease in coverage availability.

How Will The Guidance Affect You

Because the Commission’s interpretive guidance on the applicability of SEC disclosure rules is informative only, as noted above, it does not create any new regulatory disclosure obligations. However, public companies that previously have not considered the types of business risks outlined in the guidance should carefully assess when making a public filing whether their businesses are susceptible to any such risks and, if so, whether those risks are of a sufficient magnitude to require disclosure.

For more information or advise about complying with SEC disclosure rules with respect to climate change-related business impacts or on any other environmental matter, please contact:

Steven L. Humphreys
(973) 503-5936

John L. Wittenborn
(202) 342-8514