by Herrick K. Lidstone, Jr., Lee E. Miller, and Alix L. Joseph
Corporate environmental disclosures are receiving greater scrutiny by the United States Securities and Exchange Commission (“SEC”) as a result of the Sarbanes-Oxley Act and a Congressional investigative report.
GAO Report
In July 2004, the Government Accountability Office (“GAO”) issued a report to Congress entitled “Environmental Disclosure: SEC Should Explore Ways to Improve Tracking and Transparency of Information” (the “GAO Report”) that highlights the problems with environmental disclosures in SEC filings.
Undisclosed environmental risks and liabilities impair the public’s ability to make sound investment decisions. SEC regulations require disclosure of environmental liabilities in their public filings. The GAO found, however, that little is known about the extent to which companies are disclosing environmental liabilities in their public filings.
GAO recommended that the SEC develop a system for tracking SEC comment letters that will: 1) enable the SEC to determine the most frequently identified problem areas; 2) enable the SEC to analyze trends over time within particular industries; 3) allow the SEC to assess the need for additional guidance in certain areas; and 4) enable the public to review SEC comment letters and company responses. Additionally, the GAO recommended that the SEC more closely track company’s disclosures with information available from the EPA detailing enforcement actions. SEC comments to the GAO Report indicate that the SEC agrees with the GAO’s recommendations and is likely to begin taking a closer look at corporate environmental disclosures.
The Securities Act of 1933
Both small and large companies are already required to disclose environmental liabilities in their public filings. This disclosure is required by several requirements of the securities regulations governing disclosure and by generally accepted accounting principles (“GAAP”).
Regulation S-K Item 101(c)(xii) requires disclosure of “the 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.” See, also, Regulation S-B, Item 101(b)(11).
Similarly, Regulation S-K, Item 103 requires disclosure of material litigation, including, but not limited to, proceedings “arising under any Federal, State or local provisions that have been enacted or adopted regulating the discharge of materials into the environment or primary for the purpose of protecting the environment . . . if financially material – or if the litigation involves a governmental agency and penalties could exceed $100,000 (regardless of materiality).” See, also, Instruction 3 to Regulation S-B, Item 103.
Regulation S-K, Item 303 requires that the management’s discussion and analysis set forth management’s view of known trends and uncertainties that may impact the company’s liquidity, capital resources, and results of operations. Potential environmental liabilities, whether or not they have resulted in litigation or an administrative proceeding, must be disclosed under this Item when known or should reasonably anticipated by the company. See, also, Regulation S-B, Item 103.
Generally accepted accounting principles require that the company make an assessment of actual, threatened, and potential liabilities to determine whether disclosure is appropriate. Actual liabilities must be determined (and estimated if necessary) and set forth on the company’s balance sheet, and may require an expense accrual on the company’s statement of operations. Contingent liabilities must be reviewed and a determination must be made whether they are material – and a materiality determination would require disclosure in the notes to the financial statements. Thus the disclosure requirement for material environmental liabilities exists under SEC regulation, and has existed for quite some period of time.
Sarbanes-Oxley Act of 2002, P.L. 107-204
SOA has several requirements that impact corporate disclosure, including environmental disclosures. 15 U.S.C. § 7266(a) (added by SOA) requires the SEC to conduct a regular and systematic review of disclosures made by certain classes of corporations.
In response to the requirements of 15 U.S.C. 7241(a) (added by SOA), the SEC adopted Item 307 to Regulation S-K (and Regulation S-B). This requires that the principal executive officer and the principal financial officer review the company’s disclosure controls and reach conclusions regarding their effectiveness to ensure that material information is brought to the attention of the appropriate officers within a timeframe necessary to make appropriate disclosure. Clearly this includes disclosure of environmental issues. SEC Rule 13a-14(a) requires that the principal executive officer and the principal financial officer certify as to the effectiveness of these disclosure controls on each annual report (Forms 10-K or 10-KSB) and quarterly report (Forms 10-Q or 10-QSB) filed with the SEC. See Exhibit 31, Item 601, of Regulations S-K and S-B.
Finally, 18 U.S.C. § 1350 (implemented by SEC Rule 13a-14(b) requires a second certification by the chief executive and financial officers. This certification, which carries criminal penalties if wrong, requires the chief executive officer and the chief financial officer to certify that the financial statements contained in a periodic report filed with the SEC “fairly presents, in all material respects, the financial condition and results of operations of the issuer to a similar effect.” See Exhibit 32, Item 601, of Regulations S-K and S-B.
Applicability to Environmental Disclosure
Thus, as a result of the GAO Report and the requirements imposed by the Sarbanes-Oxley Act, it is likely that the SEC will be reviewing all corporate disclosures, including environmental disclosure, with greater scrutiny. The key question for public companies is how corporate officers analyze any environmental information in determining what information is appropriate for disclosure. We recommend that any company designing a process to ensure compliance establish a communication process between business executives, environmental managers and consultants, and legal counsel. Each of these parties should carefully review pending and threatened litigation, current regulatory obligations, general enforcement trends and proposed regulations which may affect business operations or environmental compliance. Finally, executives and legal counsel should discuss disclosure requirements to determine which issues are appropriate for disclosure. Such regular communication and analysis will aid in ensuring that all appropriate information is disclosed.
Herrick K. Lidstone, Jr.
For more information, please contact Herrick K. Lidstone, Jr. at (303)796-2626 or e-mail . Mr. Lidstone is a senior member of the firm. Mr. Lidstone practices in the areas of business transactions, including corporate law, federal and state securities compliance, mergers and acquisitions, contract law, tax law, real estate and zoning law, and natural resources law.
Alix L. Joseph is an associate with the firm. She focuses her practice on water law, environmental law, and civil litigation. For more information contact Alix L. Joseph at 303.796.2626 or e-mail .
