Coming Clean

Whether, and to what extent, businesses should disclose climate change risks in their U.S. Securities and Exchange Commission filings is gaining the attention of a number of stakeholders, including those in the ethanol industry.
By Bryan Sims | March 05, 2009
Publicly held ethanol companies must not allow preoccupation with the economic crisis to distract them from the importance of focusing on climate change risk disclosure through the U.S. Securities and Exchange Commission, according to securities lawyers.

Attorneys who specialize in climate change litigation say pressure is mounting for public companies to report climate change risk and how it might affect their businesses in the SEC Regulation S-K. With greenhouse gas emissions (GHG) reduction requirements already under a microscope in industries outside the ethanol sector, how might this directly affect publicly held ethanol producers and their current reporting procedures and requirements to the SEC?

This backdrop of regulatory uncertainty has delayed investment decisions and prompted senior management to call for greater visibility on climate change related policy to better anticipate the impact of regulation-driven carbon markets.

"It's one of those great unknowns," says Greg Lynch, managing partner for Michael Best & Friedrich LLP's Madison, Wis., office. "I think potentially, ethanol companies could benefit because if they do a whole life-cycle analysis, given that they're using renewable bioproducts, they certainly have a much better carbon profile than gasoline so there could be a benefit, especially for those companies that capture and sell their carbon dioxide emissions for credits voluntarily."

Despite the uncertainty regarding regulation, the majority of global companies are acting to reduce GHG emissions, according to a report released in September by the Carbon Disclosure Project. The CDP includes exclusive data from 1,550 of the world's major companies on GHG emissions and climate change related strategies. According to the CDP report, 74 percent of public companies are now reporting emissions reduction targets, an indication that climate change mitigation measures are being taken seriously.

"It's not that you talk about climate change exclusively," says C. Baird Brown, a partner in the business and finance department and a member of the energy and project finance group for the law firm Ballard, Spahr Andrews & Ingersoll LLP. "The real question is, is this one of the risks to my business model that I should be disclosing and could it affect my financial standing with the company? Clearly, anything that has a significant impact on your business model needs to be reported to the SEC if you're a public reporting company."

To navigate through potential legal issues, it's important that public ethanol companies understand what and how to report to the SEC, and understand the reporting items, whether voluntary or involuntary.

Reporting Requirements
Although the SEC doesn't explicitly address climate change related disclosure, items 101 (Description of Business), 103 (Legal Proceedings) and 303 (Management Discussion and
Analysis of Financial Condition and Results of Operations) of Regulation S-K may trigger reporting requirements.

As currently written, item 101 requires the disclosure of the "material effects that government regulations or probable regulations would have on the company's business, including material costs of complying with environmental laws and, in the case of companies in the renewable energy or energy efficiency sectors, increased demand for products and services ," according to the SEC.

Item 103 requires disclosures regarding any material pending legal proceedings out of the ordinary course of business and proceedings known to be contemplated by governmental officials relating to environmental compliance.

Item 303 requires a company to disclose "information necessary to an understanding of its financial condition, changes in financial condition and results of operations," including any known trends, demands, commitments, events or uncertainties affecting liquidity, capital resources or results of operations in a material fashion relating to climate change.

According to Brown, the focus of these requirements is the materiality threshold, which the Supreme Court defined broadly as the importance of the information to the "reasonable investor" in light of the total information available.

Public companies are in a bind because the SEC doesn't explicitly address climate change related disclosure requirements for reporting procedures. This lack of clarity has sparked trends in itemized reporting to the SEC. As a result, a spate of activity aimed at increasing disclosure of GHG emissions information and risks may motivate public companies to analyze more closely the risks associated with climate change.

Outside Influences
In September 2007, a coalition of environmentalists, institutional investors and state investment officers led by CERES (an alliance of environmental groups, investors and other public interest groups and the Environmental Defense Fund), state officials, investment advisers and institutional investors, who collectively managed more than $1.5 trillion in assets, petitioned the SEC for "an interpretive release clarifying that material climate-related information must be included in corporate disclosures under existing law."

The coalition also urged the SEC to begin examining the adequacy of registrants' financial disclosures regarding climate change. In June 2008, the same coalition filed a supplemental petition with the SEC, discussing developments since its initial petition and reiterating its request that the SEC develop interpretive guidance.

Major institutional investors and state enforcement officials have also pressured the SEC. The question now is whether the SEC will respond to these petitions. According to John Eustermann, an attorney with Stoel Rives LLP, disclosure guidance on specific environmental issues has not been the SEC's practice in the past. "The SEC has basically taken the position saying that there are trends," he says. "They're legitimate trends, but they're not specific. I think what the SEC is going to say is that it probably bodes well for companies to include, to the extent that they can, some form of disclosure in the risks, in other words, the risks to the investment."

Preparing for a Carbon Market
As ethanol producers understand the need for a carbon market to firmly take shapeand soon, they are constantly on the lookout for effective and relatively inexpensive ways to reduce their carbon footprint should the federal government enact a cap-and-trade system. This may prompt the industry, where it could compete with other industrial sectors, to earn carbon credits instead of buying them.

Regardless of whether the SEC responds to the petitions it has received, the question remains: How can ethanol producers be better prepared for a mandatory cap-and-trade system? The consensual advice by climate change lawyers is to begin preliminary audits on the ethanol plant. This will save time, money and resources in the long run, if and when the new presidential administration adopts GHG reduction laws at the federal level. This tactic is prudent because it will protect investors who have a significant stake in the plant, according to Brown.

"In terms of reporting, I would say that you want to report what your carbon footprint is and what you think the impact of having that footprint under a coming regulatory scheme will be on your business model," Brown says. "Second, I would addressif there is anything to addresswhat actions could be taken to change that footprint."

Drafting disclosures regarding climate change risk can be challenging for any ethanol company, public or private, given all of the uncertainties surrounding climate change and the scope of financial risk to a particular company as a result of climate change.

According to Eustermann, much of the ambiguities on what to report stem from the subjective definition of climate change. Either way, producers must consider becoming more proactive and aware of climate change risk in their disclosure filing to the SEC. "To not acknowledge [climate change risk] at all would probably not be the recommended action to take," he says.

Bryan Sims is the Ethanol Producer Magazine staff writer and plant list manager. Reach him at or (701) 738-4950.