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Now that chief executive officers and chief financial officers of all Securities and Exchange Commission (SEC) reporting companies must personally certify the accuracy of their annual and quarterly reports under �� 302 and 906 of the Sarbanes-Oxley Act of 2002, as well as the SEC rules implementing those requirements, there has been an upsurge of interest in disclosure controls and procedures. While the SEC has required disclosure of environmental liabilities for at least 20 years, the new obligations are causing CEOs and CFOs to sit up and take greater notice of such issues, which typically are delegated to those with environmental responsibilities and appropriate knowledge. The potential for personal liability can have that effect on top executives. While responsibility for environmental matters properly remains with those most capable and most appropriately tasked in this area, the certifying CEO/CFO should feel comfortable with the level of disclosure reaching him or her. The CEO/CFO’s obligations to disclose to the SEC extend to certification “that the company has properly designed, maintained, and periodically evaluated . . . disclosure controls and procedures . . . [to] ensure the essential information is accumulated and communicated to the appropriate executives with sufficient speed to allow ‘timely’ decisions regarding disclosure.” William J. Walsh, Marc D. Machlin and Jeffrey S. Tibbals, “New Initiatives to Encourage Disclosure of Environmental Costs and Liabilities,” Daily Envtl. Report, (BNA) No. 15, at B-9 (Jan. 23, 2003). Without a system in place to assure proper disclosure of environmental issues to the CEO/CFO, adequate disclosure to the SEC becomes highly unlikely, at best. The Sarbanes-Oxley Act requires public companies to establish and maintain disclosure controls and procedures and imposes increased penalties for violations. When the focus turns to environmental liabilities, the key issues are what to disclose, how to disclose it, when to disclose it and who wants to know. Because the effect of the act in the area of environmental disclosure is primarily the enhancement of procedural requirements, penalties and obligations-without specifically making any significant changes in pre-existing obligations to disclose-a brief overview of the obligations imposed in this area by the SEC is in order. Begin with substance The SEC promulgated Regulation S-K in 1982 “as part of a comprehensive disclosure system.” Steven L. Bray, “Sealing the Conceptual Cracks in the SEC’s Environmental Disclosure Rules: A Risk Communication Approach,” 18 U. Pa. J. Int’l Econ. L. 655, 661 (1997). There are three items in Regulation S-K that address disclosure of environmental costs and liabilities. First, Item 101 of Regulation S-K requires “[a]ppropriate disclosure . . . as to the material effects that compliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries. The registrant shall disclose any material estimated capital expenditures for environmental control facilities for the remainder of its current fiscal year and its succeeding fiscal year and for such further periods as the registrant may deem materials [sic].” 17 C.F.R. 229.101 (c)(1)(xii). Instruction 1 to Item 101 requires a registrant to “take into account both quantitative and qualitative factors” in determining “what information . . . is material to an understanding of the registrant’s business taken as a whole.” Id. at Instruction No. 1. The provided examples include: A relatively minor matter considered important to future profitability (significance). A matter that could affect numerous items (pervasiveness). The matter’s ability to distort trends (impact). Id. Further, “[s]ituations may arise when information should be disclosed . . . [that] may not appear significant to the registrant’s business taken as a whole” in quantitative terms when that information is considered “in qualitative terms.” Id. What is material? As further illustration, SEC Staff Accounting Bulletin No. 99 addresses the issue of materiality in the context of the preparation of financial statements and performance of audits of those financial statements. SAB 99 requires both quantitative and qualitative analysis in order to determine what should be deemed material. An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. “[T]here must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” TSC Indus. Inc. v. Northway Inc., 426 U.S. 438, 449 (1976). Secondly, Item 103 of Regulation S-K requires disclosure of any “material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the registrant or any of its subsidiaries is a party or of which any of their property is the subject.” 17 C.F.R. 229.103. The SEC provides no definition of what constitutes a legal proceeding. However, Instruction No. 5 specifically addresses “an administrative or judicial proceeding . . . arising under any Federal, State or local provisions that have been enacted or adopted regulating the discharge of materials into the environment or primary [sic] for the purpose of protecting the environment” as excluded from “ordinary routine litigation incidental to the business.” Such a proceeding must be described when certain criteria are met: Such a proceeding is material to the business or financial condition of the registrant. Such a proceeding involves primarily a claim for damages or involves potential monetary sanctions, capital expenditures, deferred charges or charges to income. In addition, the amount involved, exclusive of interest and costs, exceeds 10% of the current assets of the registrant and its subsidiaries on a consolidated basis. Or, a governmental authority is a party to such a proceeding and such a proceeding involves potential monetary sanctions, unless the registrant reasonably believes that such a proceeding will result in no monetary sanctions, or in monetary sanctions, exclusive of interest and costs, of less than $100,000; provided, however, that such proceedings, which are similar in nature, may be grouped and described generically. Id. at Instruction No. 5. Environmental disclosure The third provision of Regulation S-K that is “generally interpreted to require environmental disclosure,” Bray at 662, is codified at 17 C.F.R. 229.303. This requirement mandates disclosures in management’s discussion and analysis of forward-looking information-”any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way.” 17 C.F.R. 229.303(a)(1). Although � 303 does not expressly refer to environmental matters, the SEC issued a 1989 interpretive release concerning � 303 that uses an illustrative hypothetical case in which the registrant “has been correctly designated a PRP [potentially responsible party] by the EPA with respect to cleanup of hazardous waste at three sites.” SEC Interpretation: Management’s Discussion and Analysis of Financial Condition and Results of Operations, Release No. 33-6835 (May 18, 1989), available at www.sec.gov/rules/interp/33-6835.htm. Under the facts of the hypothetical case, management discussion and analysis disclosure would be required according to the SEC’s interpretation. Guessing at contingent environmental liabilities is one of the most difficult aspects of the disclosure obligations, because this involves making a determination concerning the likelihood of unknown or barely known events. Nonetheless, � 303 requires the management discussion and analysis to address such uncertainties that management cannot conclude are “not reasonably likely to occur,” in which case “management must assume that [such events] will occur.” Jeffrey A. Smith, Environmental Disclosure Requirements Under Securities Laws, in Environmental Aspects of Real Estate Transactions: From Brownfields to Green Buildings, at 423, 428 (American Bar Association, 2d ed. 1999). In addition, “currently known trends, events, and uncertainties that are reasonably expected to have material effects” must be described “unless management can determine that [their] occurrence is not reasonably likely to have a material effect on the company.” Id. How and when to disclose There is a great deal of guidance available concerning exactly how to calculate and estimate environmental liabilities for disclosure purposes. For example, an American Society of Testing and Materials (ASTM) subcommittee has published the “Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters” (available for a fee at www.astm.org/cgi-bin/ SoftCart.exe/DATABASE.CART.REDLINE_PAGES/E2137.htm?E+mystore). The International Federation of Accountants’ International Auditing Practices Committee has issued “The Consideration of Environmental Matters in the Audit of Financial Statements” in March 1998 and, in 1996, the American Institute of Certified Public Accountants prepared its Statement of Position 96-1 on “Environmental Remediation Liabilities” (a summary is available at www.aicpa.org/ members/div/practmon.recover/rvltr97e.htm). The nuts and bolts of these papers (and many others), however, are beyond the scope of this overview, as are an explanation of the specific items that do or do not require disclosure and the specific accounting and analyses to be employed. Of note, however, is at least one court’s interpretation of the SEC requirements as mandating the disclosure of both the costs of compliance and the costs of failing to comply with environmental regulations. See Levine v. NL Indus. Inc., 926 F.2d 199, 203-04 (2d Cir. 1991). And the registrant must not lose sight of the fact that the SEC requires presentation of these disclosures to be in “plain English”-avoiding boilerplate, legal and highly technical terminology, overly complex presentations and the like. See 17 C.F.R. 230.421. While in many ways it is safest to say that disclosure should be made as early as possible, determining the right time to disclose is very difficult in the case of highly uncertain or contingent matters. Yet even “the methodologies and assumptions used in the development of accounting estimates, and the sensitivity of financial results to changes in the assumptions used” must all be disclosed as well. Eileen Pleva and Peter Gilbertson, AIG Environmental: Reconciling Environmental Disclosure with Environmental Exposure in an Evolving Regulatory Climate, at 7 (2002). Finally, as one trenchant author has observed, when “one or more companies in a sector identify a significant risk or uncertainty attributable to environmental regulation, a rival company’s failure to address this may trigger a more detailed review by” the SEC. Walsh at B-6. Who wants to know While enforcement in this area falls exclusively within the SEC’s purview, the Environmental Protection Agency (EPA) has shown a significant willingness in recent years to coordinate its own enforcement efforts with those of the SEC. In January 2001, the EPA began distributing a “Notice of SEC Registrants’ Duty to Disclose Environmental Legal Proceedings” to potentially responsible parties in EPA-initiated administrative enforcement actions. See Guidance Memorandum from Mary Kay Lynch and Eric V. Schaeffer (Jan. 19, 2001), at www.epa.gov/compliance/resources/ policies/incentives/programs/sec-guid-distributionofnotice.pdf. The results of a 1998 study “conducted by the Office of Enforcement and Compliance Assurance . . . [which] found a non-reporting rate of 74 percent,” have given rise to the EPA’s concerns and a greater willingness to coordinate and cooperate with the SEC. See id. at 2. Providing still more momentum, a growing body of work supports linkage between environmental and financial performance. Nicholas C. Franco, Address at the Conference of Environmental Law (March 8-11, 2001). The consideration of such potential ties between performance and environmental compliance have generated interest from institutional investors, financial services firms and providers, regional and community groups, human rights and social justice organizations, as well as coalitions of environmentalists. See, e.g., David Bank, “Group Urges Enforcing Rules of Environmental Disclosure,” Wall St. J., Aug. 22, 2002, at B-2; Cheryl Hoag, “Groups Ask SEC to Require Clearer Environmental Disclosures to Shareholders,” Daily Envtl. Report (BNA) No. 240 (Dec. 15, 1998). Seeking rule clarifications As recently as September 2002, the Rose Foundation for Communities and the Environment, a private foundation, filed a “Request for Rulemaking for Clarification of Material Disclosures With Respect to Financially Significant Environmental Liabilities and Compliance With Existing Material Financial Disclosures.” See www.sec.gov/rules/petitions/petn4-463.htm. That foundation’s petition was joined by 25 other charitable foundations and seven investment companies in urging the SEC “to adopt new, specific disclosure standards . . . in accordance with guidelines issued by the . . . ASTM.” Rachel McTague, “SEC Urged to Enforce Rule to Require Disclosure of Environmental Liabilities,” Daily Envtl. Report (BNA) No. 163, at A-10 (Aug. 22, 2002). During a press briefing, the foundation’s co-founder and executive director stated, “Many companies today understate and under report their environmental liabilities . . . .We really believe this is the next shoe to drop in this wave of corporate financial accounting scandals.” Id. There is a great deal of current interest in harnessing market forces to provide greater incentives to regulated entities in their efforts to achieve environmental compliance. The requirement of full disclosure to investors can help tie environmental compliance to profitability, but there are many traps for the unwary, unfamiliar and unassisted along the way. Andrew C. Cooper serves as counsel at Washington’s Dickstein Shapiro Morin & Oshinsky, where he practices in several areas of environmental law including litigation, transactions and counseling.

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