Owning up to risk

New York Attorney General Andrew Cuomo and a handful of activist shareholders may have achieved what US Congress and the SEC has been unwilling or unable to thus far: force publicly listed US companies to disclose in useful detail climate change risks of their business activities. What this means is that environmental issues have been taken out of the CSR space to become a fundamental strategy issue.

In a landmark settlement last summer, Xcel Energy agreed to disclose climate change related risks to shareholders in its public filings. The company, one of the largest power utilities in the US and also one of the largest emitters of carbon dioxide (a significant contributor to the greenhouse effect and global warming), must now disclose to shareholders the financial risks associated with state and federal level lawsuits and potential carbon legislation.

The Xcel agreement is significant on a number of different levels. It is the first time that a public company has been required to disclose climate change risks beyond those defined in the Sarbanes-Oxley Act. While some companies already make such disclosures, they do so voluntarily.

So what exactly must Xcel do under the terms of the agreement? Firstly, it must disclose global warming risks in its Form 10K filings for the next four years. The company must also discuss current and pending regulations and the effect they might have on its financial position. Beyond regulation, Xcel has agreed to disclose current or future litigation or judicial decisions that could have a material financial effect on the company. Other elements of the agreement concern corporate governance changes with respect to climate change, the management of emissions, and the financial risks posed to the company by actual climate change as opposed to regulation or litigation.

Four other companies were also targeted in Cuomo’s investigation: Peabody Energy, Dominion Resources, Dynegy and AES. At the time of writing, however, only one other company, Dynegy, had agreed to make the disclosures sought by Cuomo’s team.

Powerful change

Xcel’s settlement is a sign of a broader trend within the power utility area. During 2007 and 2008, a number of the largest US utilities agreed to increase disclosure of climate change risks. Sempra Energy and Ameren both received shareholder proposals requesting greater disclosure on the financial risks of climate change, and more specifically, how pending and possible pollution abatement laws might impact profitability. Both of these proposals were filed by the New York City comptroller’s office. A third proposal filed at Allegheny Energy attracted 39.5 of votes in favor. Exxon has also agreed to increase climate change and sustainability disclosures although shareholder groups point out that the company is starting from a very low base on this front.

These companies join a growing list of power generators and suppliers that have agreed to increase climate change risk disclosures. In the past five years Southern Company, TXU, Reliant Energy, American Electric Power (AEP) and Cinergy (now Duke Energy) all received shareholder proposals and subsequently expanded climate change risk disclosures.

Xcel also received a shareholder proposal but it requested a no action letter from the SEC, which it received. The settlement with Cuomo took place after the initial issuance of the no action letter and the proposal is now effectively moot.

The fact that the company was able to obtain a no action letter and that, to this point, effective climate risk disclosure is limited to a small number of companies is proof, contend supporters, that the SEC needs to clarify its position on such disclosures. See ‘The current state of play’ on this page. Current disclosure requirements under SOX are ambiguous and confusion remains regarding the materiality threshold. This ambiguity inspired Cuomo and a group of powerful institutional investors including CalPERS along with CERES to petition the SEC for guidance that would clarify companies’ obligations and define the key elements of corporate disclosure of climate change related risks.

It might be tempting, given the companies that were the focus of Cuomo’s investigation and those that are currently reporting, to believe that this type of disclosure is isolated to utility companies or others that have a high degree of environmental impact. It is true that the power generation and distribution business is perhaps most affected by new carbon abatement and pollution laws and state regulation banning the construction of new coal-fired power plants, but the Cuomo settlement is likely to be felt far beyond the industry and could signal a much broader shift for all public companies.

All for one

Baird Brown and Robert McKinstry Jr, partners at Ballard Spahr Andrews & Ingersoll, declared in a recent briefing notice, ‘While this settlement affected a large electric generation company, the logic of the settlement, when coupled with other regulatory actions and litigation suggests that material climate change related risks affect many companies. Reporting companies’ businesses may be adversely affected by (i) change or volatility in weather or sea level, (ii) requirements for review of greenhouse gas emissions in connection with most air permit applications and (iii) costs imposed by government regulation on the use of fossil fuels in the production, distribution and use of a company’s products. In light of these developments, we encourage companies to review their SEC reporting practices relating to climate change.

‘Any public company whose stock trades on a New York-based exchange is now subject to the possibility of similar enforcement actions. Moreover, the terms of the settlement strongly suggest the scope of disclosure which should be considered by other publicly listed  companies.’

William Thompson, comptroller, City of New York, agrees that adoption of expanded disclosures is likely to spread beyond the utilities sector. In fact, his office is leading the charge for greater environmental and social risk disclosures. During 2007 the Comptrollers Office participated in 76 corporate social and environmental responsibility related shareholder proposals. Figures for 2008 are yet to be be released.

This is part of a wider trend. RiskMetrics reports that 179 social and environmental responsibility proposals were filed during 2008 and an additional 122 were withdrawn when companies agreed to terms. Of these, 88 referred specifically to climate change risks disclosure.

The Carbon Disclosure Project, in its 2008 US report explains that companies are increasingly viewing climate change risk as an enterprise-wide risk. CDP reports that many companies now address climate change at board level. The 2008 survey shows that the number of companies reporting that they have a board or executive-level officer with overall responsibility for climate change management rose to 204 (65 percent), up from 141 (50 percent) in 2007.

An unclear yet present danger

Given the general lack of clarity surrounding disclosure requirements, how was Cuomo able to force expanded disclosure? Like his predecessors, he leveraged the Martin Act and anti-fraud provisions of New York’s Executive Law. The Martin Act gives Cuomo authority to file civil and criminal charges against companies for investor fraud. Cuomo based his investigation on the argument that, by not disclosing climate change risk, Xcel was not meeting its public filing obligations. He suggested that by omitting or withholding important information that could potentially impact performance of the company, Xcel was defrauding its investors.


In particular, Cuomo highlighted the lack of disclosure regarding plans to build new coal-fired plants – something that is illegal in certain states – and the impact this would have on the company’s ability to conduct business.

As climate change related risk becomes more common, it will be even more important for senior management and board members to be familiar not just with multiple state regulations but also with internal business processes and how changes in legislation might impact corporate strategy.

The Xcel settlement and the voluntary adoption of more robust reporting standards at other utilities demonstrate that climate change and the environment are more than just CSR and sustainability issues; they are real problems with financial consequences and as such must be analyzed and reported.

Brown and McKinstry conclude: ‘Judicial decisions driving the Environmental Protection Agency (EPA) toward regulation of greenhouse gas emissions and the expansion of state laws and enforcement regarding emissions will require many companies to reevaluate their current climate change disclosures. Under existing SEC disclosure requirements, clarification of the reach of existing laws and regulations to include greenhouse gases may have a material effect on companies that are subject to permitting requirements or other direct regulation. Coming regulation of greenhouse gas emissions will have the effect of pricing those emissions and will disadvantage companies whose operations and supply chain impacts are more carbon intensive than their competitors. Under existing SEC regulations, such risks may now rise to the level of materiality that they must be disclosed to investors.’

It is also important not to underestimate the potential emboldening influence Cuomo’s success will have on other state officials. As the public continues to make calls for greater corporate responsibility and increased action against companies that are not outstanding citizens, it is likely that other state officials will be motivated to take similar action.