Limit environmental fine disclosures, lawyers say

Law firm Shearman & Sterling has backed regulators’ efforts to simplify corporate disclosure rules – and has called for companies only to be forced to reveal having been hit with environmental protection fines where a penalty will have a real impact on their business.

The SEC in July issued a proposal considering whether to propose amendments updating and simplifying certain disclosure requirements by dropping those that have become redundant, overlapping, outdated or superseded following changes in disclosure rules, accounting principles and technology. The commission is also considering whether other requirements should be modified, eliminated or included in US Gaap.

The proposal is part of a broader review looking at the effectiveness of the rules governing corporate disclosures, as well as companies’ presentation and delivery of information to investors. The planned changes would apply primarily to public companies, including foreign private issuers, but would also involve requirements applicable to other registered entities, such as investment advisers, investment companies and broker/dealers.

Earlier this year, the SEC also issued a concept release seeking feedback on modernizing certain business and financial disclosure requirements in Regulation SK (Reg SK).

In a recent comment letter, Shearman & Sterling welcomes the SEC’s efforts to modernize certain thresholds and eliminate redundant requirements – particularly dropping the obligation to state the ratio of earnings to fixed charges.

‘As the SEC noted in the release, investors rely on other metrics in assessing an issuer’s ability to service its debt,’ lawyers from the firm write. ‘Unlike other financial information, the ratio of earnings to fixed charges is generally used in offering documents only when required by [Reg SK].’ Debt investors are more focused on the information readily available from the financial statements and, frequently, earnings before interest, taxes, depreciation and amortization or similar metrics commonly used in debt markets, they add.

Shearman & Sterling also urges the SEC to limit the range of financial penalties companies must disclose. At present, Instruction 5C to Item 103 of Reg SK requires firms to reveal each administrative or judicial proceeding arising under any federal, state or local law regulating the discharge of materials into the environment ‒ or enacted primarily for the purpose of protecting the environment ‒ if a government authority is a party to the proceeding and it involves potential monetary sanctions of $100,000 or more.

‘The $100,000 quantitative threshold was set in 1982. It is clearly out of date and does not address whether such a proceeding is material,’ the attorneys write. ‘It bears remembering that the $100,000 threshold was originally introduced to avoid cluttering environmental disclosures with scores of immaterial proceedings.’ They suggest the SEC eliminate the $100,000 threshold and limit the disclosure to matters that would be ‘material to the business or financial condition of the registrant.’

The firm is not fully supportive of all potential simplifications, however. ‘Although combining the disclosure required by Item 103 of [Reg SK] with the requirements under US Gaap and disclosing all legal proceedings in a single place has a certain appeal, there are very practical obstacles to doing so,’ the lawyers write. These relate to the absence of the protections for forward-looking statements granted under the Private Securities Litigation Reform Act (PSLRA), and certain conceptual differences between a general materiality analysis under Basic, Inc vs Levinson and a loss-contingency analysis under an accounting standard, they say.

Specifically, the PSLRA protects forward-looking statements that are accompanied by appropriate meaningful cautionary statements, the lawyers say, adding that this protection encourages registrants in their Item 103 disclosure to be thoughtful and consider carefully what could be material to their business.

‘We fear that if the legal proceedings disclosures are effectively moved into the financial statements and analyzed in the Gaap’s probability/range of loss framework, the quality of the disclosure could suffer,’ the attorneys write. ‘More fundamentally, there is a question as to whether an income statement impact-based framework like Gaap, even when revised, would lead to disclosures that are most meaningful to investors.’

PROPOSAL HIGHLIGHTS

The proposing release covers issues including:

• Duplicative requirements that require substantially the same disclosures as US Gaap, IFRS or other commission disclosure requirements
• Overlapping requirements that are related to, but not the same as, US Gaap, IFRS or other commission disclosure requirements
• Outdated requirements that have become obsolete as a result of the passage of time or changes in the regulatory, business or technological environment
• Superseded requirements that are inconsistent with recent legislation, more recently updated commission disclosure requirements or more recently updated US Gaap rules.