Climate change is a topic of intense public discussion among scientists, government leaders, legislators, regulators, businesses, investors, analysts and the public at large. In recent years, institutional investors and social activists have called for the SEC to require public companies to address the impact of climate change on their businesses in their securities filings. While a few companies have provided a limited amount of climate change disclosure in the past, the practice has not been widely adopted outside of the energy industry and the level of disclosure has been largely limited to compliance with environmental regulation.

Electric utilities, as one of the most heavily regulated economic sectors in America, are accustomed to reporting the potential impact of regulatory decisions on their investment and operations strategies.

However, utilities’ needs to upgrade infrastructure
and generation reserves now stand to be affected by far more than state utility commission rate decisions.

Climate change is at the center of the American Clean Energy and Security Act of 2009, which is now before the Senate after having been passed by the House of Representatives and which contains greenhouse gas (GHG) reduction provisions and mechanisms.

Thomas P. Conaghan is a partner in the Washington, DC office of global law firm McDermott Will & Emery and is based in the Firm’s Washington, D.C., office.
He represents both publicly held and closely held businesses in a wide range of securities law matters.

Moreover, whatever Congress does, the Environmental Protection Agency (EPA) has already implemented a GHG reporting regime for utilities and many other heavy emitters, and EPA’s recent finding that GHGs threaten public health and welfare is likely a prelude to even more regulatory action. Government mandates for meeting GHG reduction targets will surely require additional capital investment and the assumption of new technology and regulatory risk.

The key question becomes: how much of this risk must utilities assess and report to investors through public securities filings?

Expanded GHG emission reporting and compliance will have significant impact on any company.

For those that are publicly held, on February 12, 2010, the U.S. Securities and Exchange Commission (SEC) released interpretive guidance on the application of existing SEC disclosure requirements to climate change issues.

In her remarks, SEC Chairman Mary Schapiro clarified that the SEC’s guidance is intended to ensure that existing disclosure rules are consistently applied by public companies in a manner that provides enhanced clarity to investors, and that the interpretive guidance is not an attempt by the SEC to weigh in on the existence or potential causes of global warming, or to amend well-defined SEC rules concerning public company reporting obligations or determinations of materiality.

The standard for determining the materiality of information (including climate-related matters) under the federal securities rules is whether there exists a substantial likelihood that a reasonable investor would consider the information important in deciding how to vote or make an investment decision. This standard does not take into account subjective sensitivities that certain investors have to issues such as climate change. With respect to contingent or speculative information or events (such as pending legislation), materiality depends at any given time upon a balancing of both the probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.

The SEC's interpretative guidance highlight the following four areas as examples where climate change may trigger disclosure requirements in a company's risk factors, business description, legal proceedings, and management discussion and analysis:

With respect to existing federal, state and local laws which relate to greenhouse gas emissions, companies should disclose any material estimated capital expenditures for environmental control facilities as part of an assessment of whether any enacted climate change legislation or regulation is reasonably likely to have a material effect on the registrant’s financial condition or results of operation.

The Release emphasizes that companies other than those in industries traditionally considered to be most at risk by “cap and trade” and greenhouse gas legislation (e.g., electricity, oil and gas, and heavy manufacturing) need to consider how they might be affected indirectly by potential legislation and regulation.

Companies should consider, and disclose when material, the impact on their business of treaties or international accords relating to climate change, such as the Kyoto Protocol, the EU Emission Trading System (ETS) and other international activities in connection with climate
change remediation.

Legal, technological, political and scientific developments regarding climate change may create new opportunities or risks for companies, either by creating demand for new products and services or reducing demand for existing ones.

Companies should be prepared to assess and disclose the impact of both, whether it involves increased demand for “green” products and renewable energy output, or decreased demand for goods that produce significant GHGs.

Climate change itself can have a material effect on a company’s business and operations through impact on personnel, physical assets, supply chains and distribution chains.

This can include the impact of changes in weather patterns (such as increases in storm intensity, rising sea levels, and temperature extremes), changes in the availability or cost of natural resources, or increased insurance risk from extreme weather.

Companies whose businesses may be vulnerable to such events should consider whether they constitute material risks and require disclosure.

Although the SEC Release was met with criticism from those who feel that the agency should not be inserting itself into a sensitive scientific and social debate, the release itself does not create any new disclosure requirements.

Instead, it merely reflects the SEC’s position that the federal securities laws only require disclosure of information that is “material” to investors (all investors, that is, not just the socially minded) and that current disclosure requirements already provide a basis for disclosures related to climate change, to the extent the requisite materiality standards are met.

For most utilities, the materiality standard discussed previously will have its greatest impact in the Management Discussion & Analysis (MD&A) section of the Form 10-K annual report. There management must identify and disclose known trends, events, demands, commitments and uncertainties that are “reasonably likely” (a lower disclosure standard than “more likely than not”) to have a material effect on the company’s financial condition or operating performance.

If management determines reasonable likelihood, disclosure is required unless management determines that the occurrence would not have a material impact on financial condition or operations.

Here are two examples of real-world events related to climate change that could fall under the materiality standard, depending on utility management’s evaluation:


Climate change is a subject ripe for litigation in ways that could directly impact electric utilities. Consider the reporting implications of a recent case that could have direct impact on utility operations.

In 2009, the US Court of Appeals for the Second Circuit, ruling in Connecticut v. American Electric Power, potentially opened the way for claims in tort for the abatement of greenhouse gas emissions as a public nuisance under Federal or State laws.

A lower court had considered GHG regulation to be a political issue for the executive and legislative branches, but the Second Circuit said GHG regulation has not advanced sufficiently to displace the federal common law of nuisance under which pollutants can be regulated.

The fact that a major electric utility was the defendant in the lawsuit is all the more reason to ask whether the court decision poses a material risk.

In February 2010, President Obama released his proposal for the 2011 federal budget. It proposes to phase out subsidies for fossil fuels that are provided under the Internal Revenue Code, and a number of tax preferences available for coal activities are proposed for repeal in the budget, which would have a direct impact on any electric utility.

These include the expensing of exploration and development costs, the percentage depletion for hard mineral fossil fuels, and the ability to claim the domestic manufacturing deduction against income derived from the production of coal and other hard mineral fossil fuels.

At the same time the budget proposal more than doubles the 2009 cap on the aggregate amount of tax credits made available in the American Recovery and Reinvestment Act for qualifying renewable energy projects – a definite plus for cogeneration and other renewable energy producers. Is one tax provision a material risk and the other a material advantage?

The question is there for each utility to decide.

Clearly, whatever risk factor disclosure is made, should state the risk and specify how the particular risk affects each specific company (rather than boilerplate disclosures applicable to all companies). Given this caveat, some commentators have suggested that the new SEC guidance is a signal that the SEC intends to scrutinize compliance with existing disclosure rules, and that the Release will serve as the basis for SEC comments issued to companies questioning the adequacy of companies’ climate-related disclosures in their SEC filings.

If that is the case, particularly legislation, regulation and court decisions continue to advance GHG regulation, public utilities are well advised to carefully consider these matters and update their disclosures to reduce the likelihood of receiving such a comment from the SEC.