The Securities and Exchange Commission yesterday promulgated (by a 3-2 party line vote) interpretative guidance for disclosure of business or legal developments relating to climate change:
The interpretive release approved today provides guidance on certain existing disclosure rules that may require a company to disclose the impact that business or legal developments related to climate change may have on its business. The relevant rules cover a company's risk factors, business description, legal proceedings, and management discussion and analysis. ...
Specifically, the SEC's interpretative guidance highlights the following areas as examples of where climate change may trigger disclosure requirements:
Impact of Legislation and Regulation: When assessing potential disclosure obligations, a company should consider whether the impact of certain existing laws and regulations regarding climate change is material. In certain circumstances, a company should also evaluate the potential impact of pending legislation and regulation related to this topic.
Impact of International Accords: A company should consider, and disclose when material, the risks or effects on its business of international accords and treaties relating to climate change.
Indirect Consequences of Regulation or Business Trends: Legal, technological, political and scientific developments regarding climate change may create new opportunities or risks for companies. For instance, a company may face decreased demand for goods that produce significant greenhouse gas emissions or increased demand for goods that result in lower emissions than competing products. As such, a company should consider, for disclosure purposes, the actual or potential indirect consequences it may face due to climate change related regulatory or business trends.
Physical Impacts of Climate Change: Companies should also evaluate for disclosure purposes the actual and potential material impacts of environmental matters on their business.
"We are not opining on whether the world's climate is changing, at what pace it might be changing, or due to what causes. Nothing that the Commission does today should be construed as weighing in on those topics," said SEC Chairman Mary Schapiro. "Today's guidance will help to ensure that our disclosure rules are consistently applied."
In contrast, dissenting Commissioner Kathleen Casey opined that:
There is undoubtedly a constituency that is interested in, and has long pressed the Commission to require, more extensive disclosures on environmental issues in order to drive particular environmental policy objectives. The issuance of this release, however, at a time when the state of the science, law and policy relating to climate change appear to be increasingly in flux, makes little sense. ...
... I can only conclude that the purpose of this release is to place the imprimatur of the Commission on the agenda of the social and environmental policy lobby, an agenda that falls outside of our expertise and beyond our fundamental mission of investor protection.
Dissenting Commissioner Troy Paredes agreed:
To me, the effect of the discussions is to find the Commission joining the ongoing debate over climate change by lending support to a particular view of climate change. Although the release does not expressly take sides, the release emphasizes the "concerns" and potential harms of climate change and discusses a range of regulatory and legislative developments, along with international efforts, aimed at regulating and otherwise remedying causes of climate change. In particular, the release highlights new EPA regulations, proposed "cap-and-trade" legislation, the Kyoto Protocol (which the U.S. has not ratified), the European Union Emissions Trading System, and recent discussions at the United Nations Climate Conference in Copenhagen. While the release stresses the risks of climate change and ongoing efforts to regulate greenhouse gas emissions in the U.S. and abroad, the release fails to recognize that the climate change debate remains unsettled and that many have questioned the appropriateness of the regulatory, legislative, and other initiatives aimed at reducing emissions that the release features. In short, I am troubled that the release does not strike a more neutral and balanced tone when it comes to climate change — an area far outside this agency's expertise.
Turning to the securities disclosure aspects of the proposal, Paredes pointed out that the new interpretative guidance simply "reiterate[s] what Regulation S-K items 101, 103, 303, and 503(c) already provide," although he suggested that the SEC action might be superfluous given that "there are many publicly available analyses from law firms and other commentators explaining current disclosure requirements regarding climate change."
But Paredes also noted that the purported guidance may actually cloud the issues:
Let me single out two aspects of the release's substantive guidance for applying Regulation S-K to climate change that I am uncomfortable with because the guidance is apt to muddy the waters. First, the interpretive release includes harm to a registrant's reputation among the "indirect risks" of climate change that may warrant disclosure. Specifically, the release provides:
Depending on the nature of a registrant's business and its sensitivity to public opinion, a registrant may have to consider whether the public's perception of any publicly available data relating to its greenhouse gas emissions could expose it to potential adverse consequences to its business operations or financial condition resulting from reputational damage.
Second, the release states that companies "whose businesses may be vulnerable to severe weather or climate related events should consider disclosing material risks of, or consequences from," the "physical effects of climate change, such as effects on the severity of weather (for example, floods or hurricanes), sea levels, the arability of farmland, and water availability and quality."
The prospect that this guidance will in fact foster confusion and uncertainty about a company's required disclosures troubles me. What triggers a "reputational damage" or "physical effects" disclosure is far from certain, as is the scope of any such disclosure if and when required. More to the point, reputational damage and the impact on a company of the physical effects of climate change can be quite speculative. There is a notable risk that the interpretive release will encourage disclosures that are unlikely to improve investor decision making and may actually distract investors from focusing on more important information. Here, it is worth recalling that, in rejecting the view that a fact is "material" if an investor "might" find it important, Justice Marshall, writing for the Supreme Court in TSC Industries, warned that "management's fear of exposing itself to substantial liability may cause it simply to bury the shareholders in an avalanche of trivial information — a result that is hardly conducive to informed decisionmaking."
Christine Hurt points out that:
The guidelines actually deal more with risk factors created by (1) climate change regulation, domestic and international; (2) public perception of climate change, including changes in demand for certain products; and (3) almost as an afterthought, how climate change could physically impact a business.
Apropos # 1 on Christine's list, over at VC a commenter named Houston Lawyer (is that you Tom?) quips that:
It is difficult to politely write a risk factor that describes how the government is contemplating screwing your industry over.
Heh, as you know who would say.
Apropos #3 on Christine's list, Megan McArdle thinks "this is deeply silly." She continues:
Rising sea levels are not a good thing (IMHO), but they are a slow-moving disaster, which companies will have ample time to disclose as they actually happen. (And aside from the owners of beachfront hotels or real estate in Manhattan's downtown financial district, I'm hard pressed to think of companies that are at material risk from the rise). The other sorts of predicted disasters are far more speculative--no one really knows, for example, what effect this is going to have on hurricanes, because the science isn't that good yet. Any disclosures would involve taking a wild assed guess at what the outcomes of global warming might be, something that most business executives are probably not qualified to do.
One could disclose risks related to the imposition of a carbon trading regime--but that's regulatory risk, not global warming risk. Which business executives also aren't particularly qualified to assess.
Geoffrey Manne goes "silly" one better and calls it "nonsense on stilts":
... corporations are asked to disclose “information” about risks to the company posed by future, possible environmental conditions about which the firms know nothing, the science is utterly un-settled and speculative, and the actual physical and economic consequences of which are even less certain. ...
On the bright side, maybe this means the SEC is qualified to investigate the fraudulent disclosures in the UN IPCC’s Fourth Assessment Report.
Ezra Klein pertinently asks Doesn't the SEC have better things to do right now? and opines that:
I'm with the Republicans on this one. This seems like a massive subsidy to charlatans who'll draw up reports projecting the risk of climate change to an individual company's bottom line -- an estimate that will be so comically uncertain as to be totally useless. ...
So what do I think, you may be wondering.
First, as Troy Paredes correctly points out, the requirement that firms discuss climate change is not new. Companies must make extensive disclosures in registration statements, proxy statements, annual reports, Form 10-K, Form 10-Q, and elsewhere. The required disclosures set forth in each form are, in turn, governed by Regulation S-K. Item 303 of regulation S-K governs the MD&A section of annual and quarterly reports. It requires disclosure and discussion of any known “trends, uncertainties or other factors” that are reasonably likely to affect the company’s earnings, liquidity or capital expenditures. Many companies are already providing disclosure with respect to climate change legislation under this mandate.
Item 503 of Reg S-K requires disclosure and discussion of significant risk factors, which for some companies will include the potential impact of climate change legislation or even climate change itself.
Many firms, especially in the energy and utility sectors, are already addressing climate change and/or climate change regulation in their SEC disclosures.
Hence, I conclude that:
- Affected corporations already know that they need to provide climate change-related disclosure.
- Corporate lawyers already know how to write such disclosures.
- Accordingly, the claims that these disclosures will be "silly" or will produce a "massive subsidy to charlatans" are overstated.
- Paredes is right that the guidance may muddy the waters, however.
- Investors don't get much of value from disclosures as they were being made before this announcement and the most likely scenario is that the disclosures will become less rather than more valuable.
Finally, to be as clear as possible, I'll echo Chairman Shapiro's disclaimer: I am "not opining on whether the world's climate is changing, at what pace it might be changing, or due to what causes."
