On July 14, 2004, the United States Government Accountability Office (GAO) issued a report on environ-mental disclosures by public companies in filings with the Securities and Exchange Commission (SEC) and recommended that the SEC take steps to improve the tracking and transparency of information related to the SEC's reviews of companies' filings and work with the Environmental Protection Agency (EPA) to explore ways to take better advantage of EPA data relevant to environmental disclosure.1
Why did the GAO conduct this study and issue this report?
The study was conducted in response to a request by Senators James M. Jeffords, Jon S. Corzine and Joseph L. Lieberman that the GAO determine:
the views of key stakeholders' on how well the SEC has defined the requirements for environmental disclosure;
the extent to which public companies are disclosing this information in their SEC filings;
the adequacy of the SEC's efforts to monitor and enforce compliance with its disclosure requirements; and
suggestions from experts for increasing and improving environmental disclosure.
The GAO noted that "environmental risks and liabilities are among the conditions that, if undisclosed, could impair the public's ability to make sound investment decisions."
What were the GAO's findings?
The GAO found that key stakeholders disagree about how well the SEC has defined the environmental disclosure requirements.
Investor organizations and researchers that use SEC filings, particularly groups with an interest in environ-mental protection or socially responsible investing, maintain that the requirements allow too much flexibility and are too narrow in scope to capture important environmental information. On the other hand, representatives of public companies that prepare SEC filings believe that current SEC disclosure requirements are adequate.
Stakeholders concerned about existing environmental disclosure requirements stated that companies may not be disclosing some potential environmental liabilities or minimizing those liabilities because the SEC disclosure requirements are not specific enough with respect to:
disclosing liabilities when their occurrence or amount is uncertain;
assessing the materiality of liabilities and potential risks; and
disclosing potentially significant environmental problems or regulatory initiatives that could pose future financial risks.
These stakeholders expressed the following specific concerns, among others:
The SEC's definition of monetary sanctions does not include certain costs related to the sanctions. Specifically, in determining when the $100,000 disclosure threshold has been met, SEC regulations and guidance exclude costs associated with (1) environmental remediation and (2) supplemental environmental projects conducted in lieu of paying sanctions.
Companies are not required to aggregate the estimated costs of similar potential liabilities, such as multiple hazardous waste sites, when assessing materiality.
Companies are not required to disclose information about their environmental assets or environmental performance.
Companies are not required to disclose quantitative information on the total number of environmental remediation sites, related claims, or the associated liabilities.
Conversely, stakeholders representing industry, independent auditors and financial analysts with general investment interests maintained that current disclosure requirements were adequate and that flexibility in the disclosure requirements was necessary to accommodate the various circumstances that may apply to different companies. These stakeholders believe that the existing requirements are sufficient to provide for the disclo-sure of material environmental information and that requiring additional information would not significantly improve the ability of investors to make sound investment decisions. These stakeholders emphasized that reporting companies need to have a framework that can accommodate a variety of circumstances and that developing more specific quantitative guidance would not be feasible. Due to the degree of uncertainty about the impact on a company's financial condition and operations, these stakeholders also oppose requiring more disclosure of future risks, such as the estimated costs associated with potential environmental regulations.
Reporting companies and financial analysts cited the following reasons as support for their position that the scope of the existing disclosure requirements is adequate to ensure that material environmental informa-tion is reported:
Companies typically disclose nonfinancial information, including information on corporate environmental performance, in other public documents, such as press releases and separate environmental reports.
Environmental information is generally less important to investors than other types of information, such as executive compensation or the percentage of stock owned by the board of directors, in assess-ing a company's condition and its desirability as a potential investment.
Asking companies to disclose more information in their filings, without any assurance that such information is material to the company's overall financial condition, would not add value and might burden readers of the filings with irrelevant data.
Environmental regulations and market forces, as opposed to SEC disclosure requirements, drive companies to comply with environmental laws and assess their environmental performance.
Requiring companies to aggregate similar types of environmental liabilities would not necessarily be useful to investors because rolling up the potential costs of individual sites and the uncertainties associated with each of them might distort the actual risks a company faces.
The GAO was unable to determine the extent to which companies are disclosing environmental information in SEC filings.
Without access to company records, one cannot readily determine whether this means that the company does not have any existing or potential environmental liabilities, that the company has determined that such liabilities are not material, or that the company has not adequately complied with environmental disclosure requirements.
The GAO was unable to determine the adequacy of the SEC's efforts to monitor and enforce compliance with environmental disclosure requirements without more information on the extent of environmental dis-closures by companies.
The SEC's primary means of overseeing company disclosures are reviewing filings and issuing comment letters to request revisions or additional information. In each of the last five years, the SEC has reviewed approximately 8% to 20% of annual SEC filings made by companies, but the SEC does not track the nature of its comments on filings to identify common problems or trends. The SEC does not maintain a database on the substance of its comments and company responses, and thus the SEC cannot use the information to identify trends or set priorities. Consequently, the SEC is unable to determine the most frequently identi-fied problem areas, analyze trends over time or within particular industries, or assess the need for additional guidance in certain areas. Instead, the SEC relies primarily on the reviewers' knowledge and experience to get a sense of the most common problem areas.
Additionally, there is currently little information sharing or other efforts between the SEC and the EPA to improve the accuracy of environmental disclosures by companies. Over the years, the SEC and EPA have made sporadic efforts to coordinate on improving environmental disclosure. However, information sharing between the SEC and EPA currently occurs less frequently and is focused on specific legal proceedings, such as those involving monetary sanctions for environmental violations. SEC reviewers use EPA data only to raise "red flags" which may point them to situations in which companies may not be disclosing potentially material information.
What Were the GAO's Recommendations and Conclusions?
The GAO concluded that the need for changes to existing SEC environmental disclosure requirements and guidance or increased monitoring and enforcement by the SEC is unclear absent more compelling evidence that current disclosure of environmental information is inadequate. The GAO noted that the SEC is already taking steps to collect information on the results of its reviews of company filings. As part of that process, the GAO stated that the SEC should ensure that it has the information it needs to allocate its oversight resources and determine where additional guidance might be warranted.
The GAO recommended that the SEC take the following steps to improve the tracking and transparency of information on environmental disclosure problems:
In developing its new procedures for closing memoranda following its reviews of company filings, the SEC should ensure that key information from the memoranda is electronically tracked and organized in a way that would facilitate its analysis across multiple filings and organize the information so that SEC officials can systematically determine the most frequently identified problem areas, analyze trends over time or within particular industries, and assess the need for additional guidance in certain areas; and
Create a searchable database of SEC comment letters and company responses that would be acces-sible to the public. It should be noted here that in response to the public disclosure of many SEC comment letters and company responses by certain SEC data vendors, obtained as a result of their Freedom of Information Act requests, the SEC has decided that all future SEC comment letters and company responses relating to the review of disclosure filings by the Division of Corporation Finance and Investment Management will be publicly available.2 As a result, those same SEC data vendors may themselves create the very database the GAO recommends.
The GAO also recommended that the SEC work with the EPA to explore ways to take better advantage of EPA data relevant to environmental disclosure.
What Are the Current Disclosure Requirements for Environmental Information?
SEC Disclosure Requirements
Beginning in 1982, the SEC integrated all of its disclosure requirements into one omnibus regulation, Regulation S-K. According to the SEC, three sections of Regulation S-K are most likely to elicit disclosure by companies of environmental information:
Regulation S-K Item 101, which requires companies to disclose the material effects of compliance with federal, state and local environmental provisions on their capital expenditures, earnings, and competitive position;3
Regulation S-K Item 103, which requires companies to disclose certain administrative or judicial legal proceedings arising from federal, state or local environmental provisions;4 and
Regulation S-K Item 303, which requires companies to discuss their liquidity, capital resources, and results of operations and is commonly known as Management's Discussion and Analysis of Financial Condition and Results of Operations.5
SEC regulations generally require disclosure of information only if such information is "material" to the company. In assessing the materiality of environmental information, the SEC's guidance says that compa-nies should consider information that a "reasonable person" would need to make an investment decision. Generally, the SEC's regulations and guidance do not establish any minimum thresholds for materiality. The materiality threshold is a broad benchmark for disclosure requirements and the SEC recognizes that only those persons who have all of the relevant facts can properly make materiality judgments. However, the disclosure of environmental-related legal matters is specifically addressed in Regulation S-K, Item 103, which requires companies to disclose material administrative or judicial proceedings that involve:
federal, state or local environmental laws, if the potential amount of the losses exceeds 10% of the company's current assets; or
potential monetary sanctions of $100,000 or more, if a government agency is a party to the proceed-ings.6
While the Sarbanes-Oxley Act of 2002 (the "Act") did not specifically address environmental disclosure, the GAO believes some of its provisions could lead to improved reporting of environmental liabilities. The Act requires the SEC to more frequently review company filings and for companies to make real-time disclosures of material changes in their financial conditions.7 Additionally, company officials are required to annually assess the effectiveness of internal controls and procedures for financial reporting and to certify that their SEC filings fairly present, in all material respects, the company's financial condition and results of operations.8 The Act also authorizes an increase in the SEC's funding for additional professional support staff necessary to strengthen the SEC's disclosure and fraud prevention programs.9
GAAP Disclosure Requirements
Generally Accepted Accounting Principles (GAAP) require companies to report liabilities, including environmental liabilities, in their financial statements if the occurrence of such liabilities is "probable" and their amounts are "reasonably estimable."10 A liability is reasonably estimable if management can develop an estimate or determine that the amount falls within a particular dollar range. Under GAAP, a company should always disclose its best estimate for a liability in its financial statements. If no one estimate is better than others, GAAP specifies that a company should disclose the lowest estimate in its financial statements. However, the company must still disclose the potential for additional liability in the footnotes to its financial statements.
If the liability does not meet one or both of the criteria for disclosure in a company's financial statements, it must nonetheless be disclosed in the footnotes if it is "reasonably possible." The term "reasonably possible" represents a range of possible outcomes that have a greater than remote chance of occurring.
AICPA Disclosure Requirements
The American Institute of Certified Public Accountants (AICPA) has issued guidance on the disclosure of environmental liabilities.11 The terms "probable," "reasonably possible," and "remote" are used by the AICPA as the benchmarks for determining the likelihood that a liability will occur and consequently whether disclosure is warranted. The AICPA guidance includes representative situations for these benchmarks. For instance, notification by the EPA that a company is a potentially responsible party at a hazardous waste site is an indication that a liability is "probable" and, if material, subject to disclosure. The AICPA guidance also contains a section on measuring the amount of environmental liabilities, which identifies the cost elements that should be included when estimating the dollar amount of a liability, including litigation, risk assessment and planning, cleanup, and monitoring.
What Suggestions Did the GAO Receive from Experts it Surveyed as Part of Its Study?
The GAO reported that most of the experts surveyed generally concurred with the concerns expressed by stakeholders and proposed the following suggestions for improving disclosure:
Clarify terms such as "probable," "reasonably possible," and "remote" relative to the occurrence of environmental liabilities, or require or recommend the use of expected value analysis in estimating the amounts of environmental liabilities.
Clarify the accounting and disclosure procedures for unasserted but enforceable claims related to the cleanup of environmental contamination at current and former company facilities. The clarification would specify the point at which the liabilities occur and a disclosure obligation may exist.
Clarify when certain potential environmental issues should be disclosed, in particular, the potential impacts of global climate change and controls over greenhouse gas emissions.
Require companies to provide information on their environmental performance (e.g., pollutant releases and remediation expenditures) or issue guidance stating that the information might be considered material by investors.
Change the definition of monetary sanctions to include supplemental environmental projects that companies fund in exchange for reduced sanctions so that investors have a more complete picture of a company's potential costs and issue guidance recommending that companies aggregate the estimated costs of similar liabilities before assessing materiality and the need for disclosure.
Issue new guidance that focuses specifically on environmental disclosure as a way of underscoring its importance.
Have the Public Company Accounting Oversight Board take action to improve procedures for evaluating the effectiveness of companies' internal control policies and procedures as they relate to environmental matters, in connection with the annual management assessment of internal controls required by the Sarbanes-Oxley Act of 2002.
Review more filings in industries for which environmental disclosure is more likely to be a concern and issue more comment letters for problematic filings to force companies to reexamine their internal controls for the reporting of environmental information.
Place more emphasis on enforcing environmental disclosure requirements to establish legal precedents for adequate disclosure, achieve greater consistency in company reporting of environmental liabilities, and ensure that companies take seriously the reporting of environmental information.
Seek better coordination between SEC and EPA and state environmental agencies to obtain information useful for evaluating companies' environmental disclosures.
What Were the SEC's Responses to the GAO Report and GAO Recommendations?
Prior to its release, the SEC was provided a draft version of the GAO report. The SEC generally agreed with the GAO's recommendations and stated that it is already taking steps to implement them. The SEC is currently creating a searchable electronic database that will facilitate analysis across multiple filings. In addition, as mentioned above, the SEC has agreed to make its comment letters and the company responses available to the public and accessible through its website.
The SEC and EPA agreed to consider the GAO's recommendation for better cooperation between the two agencies. EPA officials indicated that they would be willing to work with the SEC to explore options for improving the usefulness of the data. While SEC officials stated that they were willing to work with the EPA, they downplayed the need for additional coordination, stating that the information in the EPA's Enforcement and Compliance History Online Database is sufficient for the purpose of identifying potential disclosure problems.
Additionally, the SEC is establishing a new Office of Disclosure Standards. Among other things, this new office will be responsible for ensuring the quality and consistency of reviews across reviewers and different industry groups. In March 2004, the SEC began to require reviewers to prepare a closing memorandum con-taining a listing of all documents examined by the reviewers, a summary of the major issues raised during their review and how they were resolved. While these closing memoranda are in electronic form, the information is currently not coded or organized to facilitate analysis across multiple filings.
1 U.S. Government Accountability Office, Environmental Disclosure: SEC Should Explore Ways to Improve Tracking and Trans-parency, GAO 04-0808, http://www.gao.gov/new.items/d04808.pdf (July 14, 2004).
2 See Alston & Bird Securities Law Advisory, "SEC Staff Announces Plan to Publicly Release Comment Letters and Responses," http://www.alston.com/articles/SEC%20Staff%20Announces.pdf (June 30, 2004).
3 17 C.F.R. § 229.101(c)(xii) (2004).
4 See 17 C.F.R. § 229.103.
5 See 17 C.F.R. § 229.303.
6 17 C.F.R. § 229.103, Instruction No. 5.
7 See Sarbanes-Oxley Act of 2002, § 409.
8 See Sarbanes-Oxley Act of 2002, § 404.
9 Sarbanes-Oxley Act of 2002, § 601.
10 See Financial Accounting Standard (FAS) No. 5.
11 See AICPA, Statement of Position 96-1: Environmental Remediation Liabilities, (New York, NY: 1996).