Disclosure Requirements for Environmental Liabilities Under U.S. Securities Laws
February 7, 2008
The core requirements in the United States for public company environmental disclosure arise under Securities and Exchange Commission (SEC) Regulation S-K, 17 C.F.R. § 229.101. Item 101 (c)(xii) requires disclosure as to material effects which compliance with environmental laws may have on earnings, capital expense or competitive positions. In addition, Item 303 of regulation S-K requires disclosure of any “known trends, demands, commitments, events or uncertainties” that are reasonably likely to have a material effect on a Company’s operations.
Id. at § 229.303(a)(1). A disclosure matter is considered material if there is a substantial likelihood that its disclosure would be viewed by a “reasonable investor” as having significantly altered the “total mix of information based on which he or she determines whether to invest.”
TSC Industries Inc. v. Northway, Inc., 426 U.S. 438, 448 (1976).
Under 1975 guidance from the Financial Accounting Standards Board (FASB) on accounting for contingencies; “Statement of Financial Accounting Standards No. 5” (FASB 5), public companies generally disclose environmental loss when probable and estimable. FASB 5 indicates that such a disclosure obligation would arise when a company becomes the subject of a governmental or third-party claim, and under circumstances where available information permits an estimate to be made (as with the selection of remedy under the superfund laws or verdict/settlement in the instance of a third party claim).
See also, Statement of Position (SOP) 96-1 “Environmental Remediation Liabilities” issued by the American Institute of Certified Public Accountants for a more detailed evaluation of practices to accomplish reporting of environmental loss contingencies. In addition, the American Society for Testing and Materials has issued two standards for the measurement (ASTM E-2137-01) and disclosure (ASTM E2173-01) of environmental contingencies. These guidance documents point to disclosures which adopt a range of “high/low” estimates of loss.
Environmental disclosures are made for the expense to be incurred through the current and future reporting periods to the extent such future reporting periods are deemed material. 17 C.F.R. § 229.101 (c)(xii). Item 101 has generally led to disclosure of two estimates: (1) Disclosure of environmental compliance expense; and (2) Disclosure of soil, groundwater and other remediation cost (including long-term, pump-and-treat remedies) for current sites, former sites, and locations to which hazardous substances were sent for treatment, storage, handling or disposal.
In addition, under Item 103 of Regulation S-K, public companies must disclose liabilities from (and furnish an estimate as to) actual or threatened material legal proceedings (including administrative proceedings) including any proceeding (irrespective of materiality) where monetary sanctions can exceed US$100,000. Here again, materiality is measured with reference to FASB 5 standards, such that a company may determine not to provide an estimate as to litigation where an outcome cannot be reasonably estimated. Where estimates are possible, FASB guidance requires a reasonable case estimate or a range across most likely values.
SAB 92
In response to Price Waterhouse and other published reports indicating non disclosure of Regulation S-K environmental liabilities, the SEC in June 1993 issued Staff Accounting Bulletin No. 92 (“SAB 92”), codified at 17 CFR § 211, which prohibits offsetting environmental losses against potential environmental recoveries (such as through insurance claims, other indemnity claims, or claims against other responsible parties) for purposes of justifying non-disclosure. SAB 92 also details the nature of relevant information to be disclosed; the registrant’s position with respect to joint and several liability for an environmental claim; the existence and terms of cost sharing agreements amongst potentially responsible parties for cleanup costs; the likelihood of recovery from insurance, indemnification agreements or other means, for unrecognized contingent losses.
SEC Enforcement Efforts
In conjunction with issuance of SAB 92, the SEC committed to increased enforcement of environmental disclosure requirements under securities laws. Commissioners have stressed that the SEC will commence enforcement actions against companies who have been deficient in their disclosure of environmental liabilities.
SEC and U.S. Environmental Protection Agency (“EPA”) Cooperative Efforts
SEC and EPA have cooperated on joint enforcement in two important efforts. First, the SEC now provides the EPA with financial data on companies and in return, the EPA provides the SEC with information regarding enforcement actions against companies (i.e. Potentially Responsible Party (“PRP”) status under Superfund laws).
Second, the EPA staff is now regularly asked to review SEC disclosure documents and provide technical comments both on cost estimates and completeness of regulatory disclosures.
Environmental Disclosure by Insurance Carriers
The Government Accounting Office (GAO) issued a report in June 1992 concerning environmental liability disclosure by property and casualty insurance carriers. GAO recommended that the SEC require insurance companies to fully disclose information relating to the quantity and types of environmental claims being filed by insureds and provide estimates of associated costs to cover such claims. A partial response occurred in 2004 with the adoption of Actuarial Standard of Practice 36 by the National Association of Insurance Commissioners (NAIC). Standard 36 requires insurers to reasonably estimate and quantify (and establish a range for) environmental contingent claims in responding loss reserves. The SEC took no comparable action, but did issue a proposed rule requiring both qualitative and quantitative disclosures as to loss contingencies, including a statement of assumptions and a “sensitivity” analysis which may require the statement of high and low estimates.
See Disclosure in Management's Discussion and Analysis About the Application of Critical Accounting Policies, 67 Fed. Reg. 35620 (2002).
The Sarbanes-Oxley Act (SarbOx)
As enacted on July 30, 2002, the Act requires the CEO and CFO of public companies to certify annual and quarterly reports as fair presentations of the companies financial condition, free of an material false statement or omission of fact and based upon appropriate internal controls and audits of the company’s affairs (
see Sections 302, 404, and 906). The sanctions established for failure to comply suggest the need for careful scrutiny of environmental disclosures.
In addition, SarbOx requires supplemental 8-K disclosures, often within a few days, as to material environmental events. Rules effective in August of 2004 indicate that such events would include: (1) sale or other disposition of company property which triggers an environmental remediation obligation (as with the New Jersey Industrial Site Recovery Act (ISRA) program transfer law) and (2) environmental events or new information which result in material impairment of asset value (as with a notice from an environmental authority seeking recovery of clean-up costs).
Asset Retirement Reporting Obligations
Statement of Financial Accounting Standards (SFAS) No. 143 “Accounting for Asset Retirement Obligations” (effective June 15, 2002) requires a charge to earnings equal to the fair value of the liability for an asset retirement obligation, in the period in which it is incurred, if a reasonable estimate of fair value can be made (retirement includes sale, abandonment, recycling or other disposal). The standard applies as well to valuation of assets at the time of an acquisition. Confusion arose regarding “conditional” asset retirement obligations; for example, how to report the cost for clean-up and closure of a hazardous waste storage area required under a permit, but where no closure date is specified.
In March of 2005, FASB issued Interpretation No. 47 (“FIN 47”) to SFAS 143 to clarify when an entity would have sufficient information to reasonably estimate the fair value of a future expense, and thus when a charge to income and disclosure must be made. Whereas the fair value of an expense deemed inestimable may previously not have been recognized under SFAS 143 (
i.e.: cleanup costs upon termination of facilities without a planned retirement date), such expense could require recognition and disclosure or at least disclosure and explanation why such values cannot be achieved under FIN 47.
FIN 47 makes clear that disclosure should be made where any legal obligation associated with a long-lived asset leads to an ascertainable expense, even though timing may be uncertain. This has lead many public companies, for example, to provide disclosure for end of facility life disposal of in-place asbestos containing materials. Many companies also provide asset retirement obligation (ARO) disclosure for costs of closure and post-closure care for landfill disposal facilities. Others have provided disclosure for clean up required under permits, lease provisions, indemnity agreements and other contractual obligations.
Reporting With Respect to Business Combinations
In December of 2007, FASB issued revised standard FAS 141R relating to accounting for liabilities and assets associated with business combinations (effective December 2008). Under the new standard, at the time a public company takes “control” over a new business, it must disclose contingent environmental liabilities associated with the business even though timing of such liability may be uncertain (similar to the position taken under FIN 47 with respect to ARO’s). FAS 141R specifically calls for disclosure of environmental indemnity obligations as well as environmental liabilities which may be covered by indemnities (or other offsets).
Reporting on Potential Climate Change Impacts
In September of 2007, a group of environmental organizations, state officials and institutional investors submitted a petition to the SEC seeking interpretative guidance on the obligation of public companies to disclose potential risk and expense associated with climate change and regulation of greenhouse gases, including cost of potential pollution control equipment and increase risk of flooding and other damage from climate events. A similar request was tendered by the Senate banking committee on December 7, 2007, but to date, the SEC has not responded. A number of public companies have already provided disclosure on climate change risk in response to shareholder resolutions. A not-for-profit consortium of 54 public companies and governmental agencies, the Climate Registry, is formulating a standard for verifying and disclosing greenhouse gas related expense.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Eric Rothenberg, an O'Melveny partner licensed to practice law in New York and Missouri, has contributed to the content of this newsletter. The views expressed in this memo are those of the author.
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