On Climate Change, Capital Markets and Securities Disclosures
By Brandon Kline, Energy Law Fellow
A political heavyweight recently shared an open letter to his followers under the heading, “I Don’t Give a **** if we Agree About Climate Change.” This line was pulled, not from the journals of noted author and naturalist Henry David Thoreau. Rather, it's former California Governor Arnold Schwarzenegger, imploring his Facebook followers to open the door to “a smarter, cleaner, healthier, more profitable energy future.” The writing on the wall suggests that the Terminator is on point.
The underlying sentiment here reflects increasing concerns about the effects of greenhouse gas emissions on the environment and the economy, which have spurred international accords, federal regulations, and state and local measures that have had a material impact in the United States. The movement to tackle climate change should compel business leaders to consider adaptation strategies that prepare investors for the new normal.
Fossil-fuel companies are profoundly vulnerable to this dynamic; particularly when it comes to publicly traded companies. As previously noted, ExxonMobil provides a recent example of the ambiguous standard that fossil fuel companies face for public disclosures about climate change.
The main issues surrounding SEC disclosure laws as they relate to climate change have to do with what level of ongoing disclosure and governance obligations are placed on issuers like Exxon whose shares are publicly traded. This is not an easy task but could certainly be better defined and enforced by the federal government.
The Reasonable-Investor Standard Determines Materiality.
Congress established a framework based on the mandatory disclosure of information by the major participants in our securities markets—issuers, underwriters, national exchanges, broker-dealers and insiders—according to a securities regulation expert who has studied more than 800 federal court cases. The core doctrine in federal securities law rests on a single word – materiality. As a general rule, facts or information must be material before a legal obligation to disclose is triggered.
Under federal securities laws, certain companies with exposure to climate change risks are required to disclose material risks posed by climate change in annual filings with the Securities and Exchange Commission (SEC). See the Securities Exchange Act of 1934. The SEC in turn reviews these filings from the perspective of the reasonable investor.
SEC Evaluates Materiality in Four Broad Areas.
In February 2010, the SEC released guidance acknowledging the material risk posed by climate change. The SEC noted that four broad areas may create new opportunities or risks for registrants – legal, technological, political and scientific developments about climate change – including potential “decreased demand for goods that produce significant greenhouse gas emissions.”
For example, the U.S. Government Accountability Office (GAO) identified a beverage company that disclosed in its filing that extreme weather conditions could disrupt its supply chain, reduce water availability, or affect demand for its products, resulting in adverse impacts on its business.
The SEC’s 2010 Guidance was preceded by petitions for interpretive advice submitted by large institutional investors and others. While more companies started making climate-related disclosures after the SEC’s guidance was issued, as noted below, there does not appear to be much improvement since then.
A large number of companies fail to say anything about climate change in their annual SEC filings, according to independent industry observers.
A GAO report released last week concludes that SEC staff have not filed any actions concerning climate-related disclosure issues since releasing the 2010 Guidance. This suggests two possible inferences – either the clarity of the 2010 Guidance resulted in 100% compliance, or the SEC is falling down on the job.
Investor Response Suggests Materiality Standard is Fundamentally Flawed.
Local and state governments, as well as institutional investors, continue to argue that SEC rules enable oil and gas companies to provide little or no information to investors about the range of risks fossil fuel companies face from existing and future laws and trends, such as those related to carbon pricing, pollution and efficiency standards, removal of subsidies, fuel switching and other factors that may reduce demand for oil and gas.
The key standard imposed to trigger public disclosure of climate-change risks is fundamentally flawed because it hasn’t provided investors with sufficient information about material risks, which constitute “known trends” under SEC rules.
The response of industry watchdogs and large investors, together with the anemic number of climate-related disclosure violations referred to the SEC Division of Enforcement, leads to the conclusion that SEC should strengthen disclosure requirements through casting a wider net for climate-related information.
Common Sense Approaches to Increasing Disclosure.
There are a variety of straightforward approaches the SEC could take to increase disclosure and create a more robust materiality standard.
• Track the number of comment letters sent to companies suspected of violating climate-related disclosure requirements, in addition to documenting the cases referred to the SEC Division of Enforcement;
• Compare a company’s annual filings with its voluntary reporting, public statements and lobbying activity;
• Require companies to post all climate-related statements and SEC filings on either the registrant’s website or on EDGAR, the SEC’s online public disclosure system.
• Monitor climate-related statements made by registrants in a variety of settings, including climate-related statements in administrative proceedings (e.g., notice and comment), court filings, press statements and lobbying activity (i.e., third-party, interest-group statements made on the company’s behalf to regulators).
This approach ultimately closes a regulatory loophole, creating potential liability for omissions and misleading statements attributable to organizations that act as a conduit for corporate interests. Adjusting the current standard to encourage companies to disclose more information about supply chain risks will ultimately lead to better investment decisions, as well as a means for consumers to pay closer attention to the risks of climate change.