Electric utilities & climate risk disclosure in SEC filings: clearing the air.

• Author: Dimitt, Megan R.

1. INTRODUCTION II. BACKGROUND A. The Emergence of Environmental Disclosures in SEC Filings B. Disclosure of Environmental Issues in 10K Filings 1. 101-General Business Description 2. 103 Legal Proceedings 3. 303 Management Discussion & Analysis C. Current Means for Voluntary Disclosure 1. Global Reporting Initiative 2. Carbon Disclosure Project D. The Current Outcry for Clarification 1. Rose Petition 2. 2006 Multi-State Petition to the SEC 3. GAO Review of SEC Disclosure III. ANALYSIS A. Current Regional Accords 1. Regional Green House Gas Initiative 2. Midwestern Greenhouse Gas Reduction Accord 3. Western Climate Initiative B. Legal Maneuvers to Compel Disclosures 1. Shareholder Campaigns to Compel Disclosure 2. Court Battles to Compel Disclosure C. Problems with the Current Regulation S-K 1. Section 101 2. Section 103 3. Section 303 IV. RECOMMENDATION A. Why Change is Necessary B. Abandoning "Materiality" and Embracing Bright Lines 1. Implications for Section 101 2. Implications for Section 103 3. Implications for Section 303 V. CONCLUSION I. INTRODUCTION

   As scientific understanding of global warming develops, the public outcry to reduce man-made climate change will have far-reaching effects on U.S. companies. (1) Regulation of greenhouse gas (2) (GHG) emissions and the demand for enviromnentally friendly technology will impact every sector of the economy. (3) However, some industries will feel the financial impacts of global warming more significantly than others. (4) Industries that produce GHG emissions may be subject to future federal and state regulations mandating emissions reductions. (5) A mandated reduction in emissions may lead to large expenditures to develop the technology necessary to bring such companies into compliance.

   Investors are becoming increasingly concerned with their companies' environmental impacts and the effects that enviromnental compliance may have on their companies' finances. (6) In order to make more informed investment decisions, investors are seeking more information on companies' enviromnental risks. (7) Investors are working both within companies to improve internal reporting mechanisms, (8) and with external groups, such as the Securities Exchange Commission (SEC), to improve public reporting on enviromnental issues. (9) As academics and investors work with companies to improve reporting, they have noted a lack of consistency and uniformity in how companies disclose environmental risks. (10) Several large investor groups have petitioned the SEC for clarification in 10K filings--specifically on reporting guidelines--and enforcement of existing reporting guidelines. (11)

   Current SEC guidelines are vague and enable inconsistent reporting. This Note examines ways that the SEC can clarify its expectations in 10K filings for more consistent and informative reporting. While environmental risk disclosure guidelines apply across industries, this Note explores ways that the SEC could make clarifications that would benefit companies in the electric industry. Electric utilities are one of the most carbon-intensive industries in the U.S. economy and are therefore most vulnerable to future regulations. (12)

   Specifically, Part II of this Note examines the current means for electric companies to voluntarily disclose environmental risks. Part II.D details the most recent requests for clarification on SEC reporting guidelines. Part III analyzes regional accords and the types of information that electric companies have chosen to voluntarily disclose. Part III.B examines legal action taken by shareholders to force company disclosure of environmental risks. Finally, Part IV explains how the SEC can clarify reporting guidelines in 10K filings (13) based on the types of environmental risk information that companies are voluntarily disclosing.

2. BACKGROUND

   1. The Emergence of Environmental Disclosures in SEC Filings

      Under the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act), Congress imposed disclosure requirements on publicly traded companies. (14) In 1969, Congress passed the National Environmental Policy Act (NEPA), which set initial policy requirements for the disclosure of environmental matters. (15) NEPA required all government agencies, including the SEC, to consider protecting the environment in their rulemaking practices. (16) Pursuant to the mandate in NEPA, the SEC issued a release (17) in 1971 stating that disclosure of compliance with environmental laws in 10K filings was necessary when capital outlays would "materially affect" the earning power of the reporting company. (18) In addition, the release called for disclosure of pending legal proceedings arising under environmental laws. (19) In 1973, a follow-up release superseded that release, and required disclosure with respect to the material effects that compliance with environmental laws and regulations might have upon the capital expenditures, earnings, and competitive position of the reporting company and its subsidiaries. (20) The 1973 release focused on the future effects of environmental laws and the costs associated with compliance with those future laws. (21) The release also stated that all legal proceedings involving governmental entities required disclosure if the proceedings were "material" to the business or financial condition of the registrant. (22) At the time, "material" meant ten percent of the registrant's assets. (23)

      After the 1973 release, public interest groups brought suit against the SEC seeking additional environmental disclosure rules. (24) Although the proceedings were not successful, in 1976 the SEC added the requirement that companies should disclose expenditures for environmental control facilities. (25) Another release in 1979 addressed three topics: (1) when a registrant must disclose the total costs of compliance with environmental laws; (2) what disclosures a registrant must make concerning administrative proceedings involving environmental matters; and (3) when a company is required to disclose its policies concerning, or approach toward, compliance with environmental laws. (26)

   2. Disclosure of Environmental Issues in 10K Filings

      The Exchange Act and the Securities Act require publicly traded companies to file comprehensive periodic reports, including an annual 10K form. Depending on the size of the company, the 10K form must be filed within 60, 75, or 90 days from the end of the fiscal year. (27) Regulation S-K is a repository that sets forth disclosure requirements for periodic reports, including the 10K form. (28) Specifically, three sections of Regulation S-K directly address the disclosure of environmental liabilities: sections 101, 103, and 303. (29)

      1. 101--General Business Description

         Section 101 deals with the description of the company's business. (30) Specifically, section 101(c)(1)(xii) requires disclosure of

         [t]he material effects that compliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries. The registrant shall disclose any material estimated capital expenditures for environmental control facilities for the remainder of its current fiscal year and its succeeding fiscal year and for such further periods as the registrant may deem materials [sic]. (31) This section of the 10K form requires disclosure of effects that any environmental matters may have on the financial condition of the registrant. (32) As an example, if Congress passed a law regulating GHG emissions, a company would have to report any and all expenditures that would bring the company into compliance with the new law. Although section 101(c)(1)(xii) requires disclosure based on existing environmental laws, it also requires the company to project environmental compliance costs for two years and compare those costs to the costs of its competitors. (33)

      2. 103 Legal Proceedings

         Section 103 requires the disclosure of all legal proceedings. (34) Companies are to describe "any material pending legal proceedings, other than ordinary routine litigation incidental to the business," to which the registrant or any of its subsidiaries is a party, or to which any of their property is subject. (35) Instruction 5 gives further clarification. Meeting any of the three following criteria triggers the disclosure requirement: the proceeding is 1) "material"; 2) involves claims, sanctions, capital expenditures, or charges in an amount exceeding ten percent of the company's assets on a consolidated basis; or 3) a governmental authority is a party to material proceedings "pending" or "known to be contemplated" and there are potential monetary sanctions (unless the company reasonably believes there will be no sanctions, or they will be less than $100,000). (36)

         To determine whether a proceeding is material under Instruction 5, companies 10k to the test adopted in Basic v. Levinson. (37) Companies employing the Basic test must disclose any fact that a reasonable investor would view as significantly altering the "'total mix' of information made available." (38) While a "reasonable investor" standard is helpful in determining materiality, companies are confused as to what specific environmental information a typical investor considers important. (39)

      3. 303--Management Discussion &Analysis

         Section 303 addresses management's discussion and analysis (MD&A) of financial conditions. (40) As one of the most important parts of the 10K form, section 303 gives shareholders a look at the business's financial condition through the eyes of management. (41) In 1989, the SEC issued an interpretive release stating that "[a] disclosure duty exists where a trend, demand, commitment, event or uncertainty is both presently known to management and...