“THE FINAL FRONTIER”
The evaluation and disclosure of environmental liabilities may represent one of the key responsibilities for Environmental Attorneys and/or Environmental Managers (“EM”). Generally, the financial reporting requirements of the Securities and Exchange Commission (“SEC”) associated with annual reports or financial statements for governmental and public companies have been a driver for this effort. Private companies are not required to report publicly but need to have regular reporting for their banking institutions and financial stockholders. Guidance documents from the Financial Accounting Standards Board (“FASB”)1, the Governmental Accounting Standards Board (“GASB”), ASTM International, the SEC, and many other sources are available to use as guidance in this effort. There is no real standardized framework for this process.
Usually the accounting, legal, environmental, and corporate management team will work together to complete the financial reporting disclosures. The EM may be required to consult with the accounting, finance, health, and safety or the real estate departments of the company to collect the required information. In addition, the EM may be required to evaluate and discuss material trends in regulations, potential litigation, or make cost estimates or assumptions on probability. Note that not every environmental liability requires detailed disclosure. Disclosure will be guided by the scope and objective of the financial statement, and accordingly by the materiality of the environmental liability and the level of information available.2 Note that the level of materiality may also be set by and subject to corporate accounting or regulatory policy decisions of the corporation’s management.
A key term to understand in the EM’s evaluation of environmental liabilities is “materiality”. The primary rule for deciding materiality appears in the Generally Accepted Accounting Principles (“GAAP”):3
Items are material if they could individually or collectively influence the economic decisions of users, taken from financial statements.
The GAAP definition is consistent with a more formal statement from the FASB responsible for GAAP. For FASB, materiality refers to:
The magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
The ASTM International also has a helpful definition of materiality.4
According to ASTM E2137-17:
“A material item is one that its omission or misstatement is of such a magnitude in the surrounding circumstances that either the judgment of a reasonable person relying on the financial statement would have been changed or influenced by its inclusion or correction or there is a substantial likelihood that the item, after assessing the inferences and their significance drawn from the given set of facts associated with the financial statement, would be viewed as significantly altering the information made available to the investor or shareholder. [Note that this definition is not intended to supercede the definition of materiality in SEC Staff Accounting Bulletin Topic 1.M, Financial Statements – Materiality].”
In most instances, the EM will be given a fixed dollar amount as a cut off for establishing materiality for items of concern (i.e., above a threshold of $100,000.00, $500,000.00, $1,000,000.00, etc.).
GET STARTED – DOCUMENTS
So where does the EM start? To evaluate environmental liabilities, you should look for available inventories of past and current operating facilities, Phase I Environmental Site Assessment (“ESA”) Reports5, and Phase II ESA Reports6, leases, purchase and sale agreements, liability cost-sharing agreements, merger agreements, spinoff agreements, claim adjudication with insurance carriers, and/or partnership agreements.
Other notable sources for identification of environmental risk are:
- When a new facility is constructed and placed in service that has an asset retirement obligation (“ARO”);7
- Notice of Insurance Claims;
- A regulatory determination of “imminent and substantial endangerment to human health and the environment” for a facility;
- When a facility violates the requirements of a permit, license or regulation (i.e., notice of violation, consent decree, administrative order); and
- When a current or proposed lawsuit against a facility for an environmental obligation is known.
In addition, you must identify any relationships to any company practices or sites, historical or current, with known liabilities under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA or Superfund”), or a state equivalent.8 Usually, a CERCLA 104(e) Request for Information from the Environmental Protection Agency (“EPA”) or state equivalent starts the CERCLA process.
The EM has to be comfortable with uncertainty. The existence and projected amount of environmental liability can be significantly altered by the final resolution of factual, technological, regulatory, judicial, or legislative matters. In addition, the EM likely will be relying on estimates or work products of third parties (i.e., environmental consultants, outside attorneys) which may or may not be completely accurate. Appropriate disclosure does not necessarily mean an exhaustive disclosure; discretion and professional judgment are used by estimators, auditors, and the reporting entity’s management in setting limits on the preparation cost, materiality, and volume of information worth disclosing as environmental liabilities.9 Be sure to document the source of the base information and qualifications of the individual EM who completes the information for environmental disclosure. One comforting thought for the EM is that subsequent disclosures that convey different information should not be construed as indicating that the initial or prior disclosures were inappropriate or incorrect. The EM will be judged by the reasonable interpretation and use of the information at the time when judgments were rendered.
The topic of “climate change” (or global warming) has been a hot topic among multinational corporations, governmental agencies, non-governmental organizations, environmental advocacy groups, and the public. There has been a growing demand from some pension funds and investors for climate change-related information in public disclosures. In January 2010, the SEC issued some relevant guidance to public companies about the evaluation and disclosure of environmental liabilities on business or legal developments on climate change.10 More recent information and possible guidance have been issued by the Task Force on Climate-Related Financial Disclosures in a Final Report – “Recommendation of the Task Force on Climate-Related Disclosures” (June 2017).
The importance of climate change issues to the corporate world is evident. For example, Satya Nadella, the CEO of Microsoft Corporation recently announced the establishment of a $1 Billion Climate Initiative Fund to address global warming. It is likely this information will be disclosed in financial statements. Another example of corporate acknowledgment of disclosure issues related to climate change, see the Exxon Mobil Corporation, Annual Report, and Form 10-K, p. 3, United States Securities and Exchange Commission (for the final year ended December 31, 2018).11
Climate change and greenhouse gas restrictions. Due to concern over the risks of climate change, a number of countries have adopted, or are considering the adoption of, regulatory frameworks to reduce greenhouse gas emissions. These include adoption of cap and trade regimes, carbon taxes, minimum renewable usage requirements, restrictive permitting, increased efficiency standards, and incentives or mandates for renewable energy. Such policies could make our products more expensive, less competitive, lengthen project implementation times, and reduce demand for hydrocarbons, as well as shift hydrocarbon demand toward relatively lower carbon sources such as natural gas. Current and pending greenhouse gas regulations or policies may also increase our compliance costs, such as for monitoring or sequestering emissions.
In the review of many annual reports, it is evident that, concerning climate change issues, there are inconsistencies in public reporting, the lack of context for the information reported and confusion as to what constitutes relevant information for investors or the public in asset valuation or financial impacts for the companies (immediate, medium, and also long-term).
The initial step in evaluating environmental liabilities for financial management reporting is to sit down with legal and corporate management to establish the dollar value for materiality. This initial step will guide you in eliminating the minor or non-material environmental issues and set limits to the preparation, cost, and volume of information to gather and which warrants potential disclosure.
The second step is to collect the appropriate data/records for a list of potential facilities, liabilities, processes, litigation, records, historical properties, assets, insurance, contractual obligations, and/or CERCLA or Superfund sites for which you believe meet the materiality threshold. Confirm with legal and corporate management the preliminary inventory or list of identified environmental liabilities before going forward.
The third step is to separate the list of identified environmental liabilities into separate categories based on relative background information.12 I would recommend separation by the quality of the information available to provide the estimate. For example, you could separate environmental liabilities into those with known cost estimates from those with sufficient information to provide some future relative cost estimates. A separate category would be appropriate for those with minimal information to provide some future cost estimate and that will require some form of estimation approach.13
The fourth step is to collect the environmental liabilities cost estimates for (1) known costs; (2) future costs; and (3) future costs estimates using the various estimation techniques for a final tabulation. It is important that you share the draft information with corporate management, legal, and accounting prior to the completion of the final disclosure. I generally recommend a formal presentation by the EM can be helpful to avoid future concerns.
The final step is to complete the final report for submission to the designated person or department of your corporation for inclusion in the financial disclosure.
ARIZONA STATE ISSUES
Arizona has some unique statutes as it relates to EM’s evaluation for environmental reporting. The Arizona legislature has been skeptical of the early efforts to regulate greenhouse gas emissions by the EPA and/or the Arizona Department of Environmental Quality (“ADEQ”). In response to climate change issues, the Arizona Legislature passed Arizona Revised Statute (“A.R.S.”) §49-191 in 2010 as follows:
REGULATION OF GREENHOUSE GAS EMISSIONS
49-191. Greenhouse gas programs; definition
A. Notwithstanding any other law, a state agency established under this title or title 41 shall not adopt or enforce a state or regional program to regulate the emission of greenhouse gas for the purposes of addressing changes in atmospheric temperature without express legislative authorization.
B. For the purposes of this section, “greenhouse gas” means carbon dioxide, methane, nitrous oxide, sulfur hexafluoride, hydrofluorocarbon or perfluorocarbon.
Therefore, an Arizona based corporation with facilities only in Arizona will not have any actual regulatory documents or ADEQ requirements for disclosure under climate change.
Also, note that under A.R.S. §49-109, if the EM located in Arizona identifies any felony convictions of environmental laws in any state or federal jurisdiction within five (5) years preceding the evaluation of environmental liabilities, the corporation must file a Certificate of Disclosure (under penalty of perjury) with the ADEQ. Under A.R.S. §49-109(G), the corporation’s 10K filed with the SEC can substitute for the required Certificate of Disclosure to ADEQ:
G. In lieu of the certificate of disclosure prescribed by this section, a corporation may submit to the director copies of annual reports filed with the securities and exchange commission pursuant to section 13 or 15(d) of the securities exchange act of 1934 (15 United States Code section 78), commonly known as a “10K form”, within ninety days of filing the annual report. The initial submission to the ADEQ director shall include 10K forms for the preceding five years.
I recommend the EM check the various state statutes or individual state environmental regulations to confirm any required climate change or other environmental disclosures for a particular state.
It is clear that corporate financial management disclosure and reporting on environmental liabilities and climate change impacts will continue to be pursued by various groups within the environmental community, including non-governmental organizations, pension funds, bankers, environmental advocacy groups, and others. I would also predict that in the future, additional attention will be paid to the effects of any corporate supply chain on climate change and this will also be pursued for potential disclosure.
Be sure and review any relevant guidance documents to assist in your evaluation of environmental liabilities. Gather the appropriate environmental documentation for your industry in general, and your company, in particular. Understanding the level of materiality set by the corporate accounting or regulatory policy decisions of corporate management is your first step in evaluating environmental liabilities for financial management reporting. Appropriate disclosure does not necessarily mean an exhaustive disclosure; discretion and professional judgment are used by estimators, auditors, and the reporting entity’s management in setting limits on the preparation cost, materiality, and volume of information worth disclosing as environmental liabilities. Be sure to document the source of the base information and qualifications of the individual EM who completes the information for environmental disclosure.
To paraphrase the immortal words of James T. Kirk, the Captain of the Enterprise:
Space: The Final Frontier.
“These are the voyages of the starship Enterprise. Its five-year mission: to explore strange new worlds; to seek out new life and new civilizations; to boldly go where no man has gone before.”
–Captain James T. Kirk
Environmental Disclosures: The Final Frontier.
“These are the responsibilities of the Environmental Manager. Their newfound mission: to explore the strange new world of environmental liabilities, climate change and financial statements; to seek out existing and new sources of potential liability; to boldly go where no man has gone before.”
-Attorney Jerry D. Worsham II
Jerry D. Worsham II is a shareholder with the firm. Mr. Worsham has an extensive practice in environmental compliance and litigation, natural resource development. His experience includes approvals and permits for natural resource development; litigation defense on numerous cases involving the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA); Climate Change including comment on issues and regulation development; compliance with the Resource Conservation and Recovery Act (RCRA); civil and criminal liability defense on environmental matters; ASTM Phase I and Phase II Environmental Site Assessments coordination; emergency incident responses; Prospective Purchaser Agreement negotiations; creation of Conservation Easements; and due diligence associated with mergers, acquisitions, and initial public offerings. Mr. Worsham reviews and comments on federal, state, and local laws, rules, and regulations on a regular basis and represents clients before federal and state environmental agencies.
1. The FASB is an independent, private sector, not-for-profit organization that establishes financial accounting and reporting standards for public and private companies and not-for-profit organizations that follow GAAP. The FASB is recognized by the SEC as the designated accounting standard setter for public companies.
2. See ASTM E2173-16 “Standard Guide for Disclosure of Environmental Liabilities”, Section 4.4.3, p. 4, ASTM International (October 1, 2016).
3. Generally Accepted Accounting Principles (“GAAP”) is the accounting standard adopted by the SEC.
4. See ASTM E2173-16 “Standard Guide for Disclosure of Environmental Liabilities”, Section 188.8.131.52, p. 3, ASTM International (October 1, 2016). See also ASTM E3123-18 “Standard Guide for Recognition and Derecognition of Environmental Liabilities”, Section 3.1.28, p. 3, ASTM International (February 1, 2018).
5. See ASTM E1527-13 “Standard Guide for Environmental Site Assessments: Phase I Environmental Site Assessment Process”, ASTM International (November 1, 2013).
6. See ASTM E1905-11 “Standard Guide for Environmental Site Assessments: Phase II Environmental Site Assessment Process”, ASTM International (June 15, 2011).
7. Common AROs include demolition, site remediation, surface reclamation, or abandonment. These are required to take an asset out of service and are commonly found in most Lease Obligations.
8. A state CERCLA equivalent in Arizona is the Water Quality Assurance Revolving Fund (“WQARF”) statute, A.R.S. §49-282 et seq.
9. See ASTM E2173-16 “Standard Guide for Disclosure of Environmental Liabilities”, Section 4.4.5, p. 5, ASTM International (October 1, 2016).
10. See “Commission Guidance Regarding Disclosure Related to Climate Changes”, U.S. Securities and Exchange Commission (2010).
11. www.exxonmobil.com (last visited on January 17, 2020).
12. For example, information that is: (1) publicly available; (2) obtainable from its source within a reasonable time and cost constraints; and (3) practically reviewable for confirmation.
13. See ASTM E2137-17 “Standard Guide for Estimating Costs and Liabilities for Environmental Matters”, Section 5, pgs. 4-17, ASTM International (March 1, 2017).
- ASTM E1527-13 “Standard Practice for Environmental Site Assessment: Phase I Environmental Site Assessment Process”, ASTM International (November 1, 2013)
- ASTM E1903-11 “Standard Practice for Environmental Site Assessment: Phase II Environmental Site Assessment Process”, ASTM International (June 15, 2011)
- ASTM E2137-17 “Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters”, ASTM International (March 1, 2017)
- ASTM E2173-16 “Standard Guide for Disclosure of Environmental Liabilities”, ASTM International (October 1, 2016)
- ASTM E3123-18 “Standard Guide for Recognition and Derecognition of Environmental Liabilities”, ASTM International (February 1, 2018)
- ASTM E2718-16 “Standard Guide for Financial Disclosures Attributed to Climate Change”, ASTM International (August 1, 2016)
- Final Report – “Recommendations of the Task Force on Climate-related Financial Disclosures”, Financial Stability Board (June 15, 2017)
- “Climate Change 2014”, Intergovernmental Panel on Climate Change, Fifth Assessment Report, Cambridge University Press (2014)
- GAAP (Generally Accepted Accounting Principles), https://www.wallstreetmojo.com/gaap-generally-accepted-accounting-principles (last visited January 16, 2020)
- “Commission Guidance Regarding Disclosure Related Climate Change”, [Release Nos. 33-9106; 34-61469; FR-82], Securities and Exchange Commission (February 8, 2010)
- “What is Materiality Concept?”, Materiality Concept as per GAAP and FASB, http://www.wallstreetmojo.com/materiality-concept (last visited January 16, 2020)
- “Materiality Concept in Accounting – How to Apply the Materiality Concept in 5 Steps, Concept Role and Purpose”, Business Encyclopedia, https://www.business-case-analysis.com/materiality-concept.html (last visited January 15, 2020)
- Exxon Mobil Corporation – Form 10K – Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2018
- “2019 Energy & Carbon Summary”, Exxon Mobil Corporation, https://corporate.exxonmobil.com/-/media/Global/Files/energy-and-carbon-summary/Energy-and-carbon-summary.pdf (last visited January 16, 2020)
- “Conceptual Framework for Financial Reporting”, Chapter 8, Notes to Financial Statements, Financial Accounting Standards Board (“FASB”) News Release (August 2018)
- “FASB Improves the Effectiveness of Disclosures in Notes to Financial Statements”, Financial Accounting Standards Board (“FASB”) News Release (August 8, 2018)
- “Costing and Disclosing Environmental Liabilities and the Impact on Loan Contingencies”, Presentation to the Environmental Bankers Association, Jeffrey S. Andrilenas, RG, L.HG, L.E.G., The TBLS Group, LLC (July 16, 2019)