Update: Campaign has now concluded.
A shareholder campaign will try to get pulp and paper companies to be more forthcoming about the potential environmental liabilities they face.
Bruce Herbert of Newground Investments in Seattle, Wash., is spearheading the campaign, which is expected to target up to a dozen U.S. forest products companies. A longtime proponent of environmental resolutions, Herbert now is enlisting members of the Interfaith Center on Corporate Responsibility and the Social Investment Forum (ICCR) to serve as proposal sponsors and co-sponsors. Because the resolution addresses a core financial issue, Herbert is hopeful it will draw support from institutional investors that typically shun voting on social issues proposals, except in cases where a direct effect on shareholder value can be identified.
The impetus for the new campaign comes from two reports released earlier this year by the World Resources Institute (WRI), a leading environmental research center based in Washington, D.C. In October, WRI released Coming Clean: Corporate Disclosure of Financially Significant Environmental Risks. This report urges the Securities and Exchange Commission to clarify and better enforce its rules on corporate environmental disclosure.
Coming Clean’s findings were based on an earlier WRI report published in March, called Pure Profit: The Financial Implications of Environmental Performance. Pure Profit focused on six environmental issues facing the forest products industry and made related financial assessments for 13 companies. The researchers found that the likely effects of addressing these issues will have widely varying effects on share value—by as much as 20 percent for the companies in question.
By almost any measure, such undisclosed environmental liabilities are material and ripe for disclosure, the study’s authors contend. However, by looking at financial disclosure statements, they found that “Company reporting of environmental issues also falls far short of the full and adequate disclosure required for material issues, as set out in SEC rules and guidelines.” The lack of disclosure, they add, not only infringes on existing SEC reporting requirements but also misleads investors about the magnitude of environmental risks these companies face.
Herbert now is planning to address shareholder resolutions to each of the forest products companies examined in the Pure Profit report—asking management to respond to the report’s findings and provide an updated assessment of their companies’ particular environmental risks and liabilities. Herbert believes most of the companies can easily comply with this request, since they had representatives who participated in the Pure Profit study.
A key contention of WRI’s Pure Profit report and the Coming Clean follow-up is that future environmental issues can be translated into financial terms and integrated into traditional decision-making methods used by investment managers, bankers and insurers. Rather than focusing on past and present levels of corporate environmental performance, as other studies have done, Pure Profit uses a forward-looking and scenarios-based approach, consistent with the way investment analysts tend to evaluate business risks and opportunities.
As a starting point for their study, WRI researchers Robert Repetto and Duncan Austin solicited input from company executives and representatives of the American Forests and Paper Products Association. They asked the company officials to identify which impending environmental issues and regulations pose a “potentially financially significant” impact on their industry and asked them to gauge outcomes for various scenarios—assigning probabilities for each. The researchers then used this information to assign a range of potential financial impacts for each of the companies included in the study, taking into account geographic and technological issues that may affect their individual circumstances.
Of the 13 companies, the Pure Profit report found a wide disparity in the expected share-value impact of impending environmental issues. While three companies reasonably could expect a negligible or even slightly positive change in share value as they address these issues, three other companies could expect a greater than 10 percent loss in share value under most of the scenarios calculated by the researchers. The seven companies in the middle of the range had projected losses of 4 to 8 percent in share value.
At the conclusion of the project, the WRI researchers presented the company participants with the range of estimated financial impacts, while keeping individual results confidential as the companies had requested. None of the industry participants challenged the researchers’ estimates and about half later requested their individual company scores, according to co-author Austin.
Because the Pure Profit report does not name which companies have the greatest undisclosed risks, Herbert’s shareholder resolution wants them to “come clean” by providing a current status report on these environmental issues and describe their “liability projection methodology,” if different from that used by WRI. In addition, the resolution asks for management’s assessment of other major environmental risks, such as global climate change, that were not analyzed in the report.
The Pure Profit study recently received the Moskowitz Price for outstanding academic research in the field of social investing. Austin was on hand to accept the jury-awarded prize at the SRI in the Rockies conference held in Aspen, Colo., in early October. He also presented the study’s findings to investor groups now expected to file most of the shareholder resolutions on the issue. Austin says he supports the new shareholder campaign on the basis that it “would do two things—force [the forest products companies] to give updated opinions on the things that we looked at, and also to think about new issues. In addition, it sets a precedent for companies to do their own evaluation of current environmental pressures”—and communicate that information to shareholders—“not just rely on others’ work.”
Shareholder activist Herbert is equally excited about the campaign’s prospects. “We have here a unique opportunity to achieve social victories of great magnitude that can strengthen the corporate social responsibility movement, increase transparency and accomplish goals heretofore only dreamed of,” he wrote in a recent solicitation to prospective resolution sponsors. “I propose we call it the Newground Initiative, because we seek a new ground of understanding from which to approach and conduct corporate activity.”
WRI’s Pure Profit report not only laid the groundwork for the coming shareholder campaign, but also formed the basis for WRI’s more recent Coming Clean report, released on October 13, 2000. Having made calculations of the potentially financially significant environmental risks facing forest products companies, Austin and Repetto then turned to their 1998 and 1999 financial disclosure statements to see what, if anything, they had to say to investors about such risks. (The disclosure documents included Form 10Ks, 10Qs and 8Ks.) The researchers found that few of the companies disclosed any details about the financial risks or potential impacts arising from their exposures to “known environmental uncertainties.” None of them expressed such risks in quantitative terms.
Such lack of disclosure was in stark contrast to the detailed assessments given by high-ranking environmental officials who participated in the Pure Profit study. “This problem may stem from the SEC’s limited enforcement of rules governing disclosure of material environmental risks, and lack of clear guidance from the SEC or accounting standard bodies about the reporting requirements,” Austin and Repetto surmised in the Coming Clean report.
The WRI studies highlight two major environmental issues facing the forest products industry that bear out the researchers’ conclusions. The forest products industry has long known that reducing air emissions of smog-forming nitrogen oxides and reducing water effluent discharges are among its key environmental challenges. To achieve these reductions and meet national environmental protection goals, the federal Clean Air Act and Clean Water Act have set standards that all regulated companies are required to meet.
These laws also take into account prevailing local and regional environmental conditions, however, such as the amount of smog present in non-attainment areas and the amount of effluent loading in particular water bodies. Accordingly, pulp and paper companies with a higher proportion of manufacturing facilities in nonattainment zones—and especially those with facilities lacking best available pollution control technology—face the greatest financial burden in complying with these statutes. Conversely, pulp and paper companies operating mainly outside of these non-attainment areas—and those that have already installed state-of-the-art controls—face the lowest cost burden.
Because of these and other considerations, the Coming Clean report concludes there is a considerable disparity in relative company exposure to environmental risk. Companies in the best position may face the prospect of slightly positivechanges in share value as they come to terms with these and other environmental issues. At the same time, they face the smallest range of change in share value—or financial risk—regardless of which of the identified environmental scenarios play out. Meanwhile, companies in the worst position face the most negative and widest possible swings in share value—with projected market values dropping up to 22 percent if certain scenarios come to pass.
What especially troubles the WRI researchers, however, is that so many forest products companies have made no effort to distinguish their relative positions on environmental matters in the management discussions of their financial reports. Instead, they tend to use boilerplate language to convey the message that environmental statutes and regulations “will not have a material adverse effect on the company’s financial position,” in part because competitors are subject to the same set of obligations.
“[S]uch statements are erroneous and potentially misleading,” Repetto and Austin warned in the Pure Profit report. “The same environmental standards are likely to have quite different impacts across companies in the industry.”
In their follow-up Coming Clean report, the WRI researchers went even further, saying: “There is no reason to believe that pulp and paper is the only sector in which company reports are incomplete concerning environmental risks and differentials in environmental exposure between companies. Many other sectors are materially affected by environmental issues and regulations and would likely exhibit similar patterns of environmental exposure and nondisclosure.”
Repetto and Austin plan to continue their research in this area, turning next to the electric utility and oil and gas industries. Repetto left WRI two years ago to work for Stratus Consulting in Boulder, Colo., a firm with particular expertise on energy companies. Repetto and Austin plan to continue their collaboration to identify environmental scenarios that may have financially significant impacts on various industries.
Focus on the SEC
The recent reports from the World Resources Institute—and now Herbert’s shareholder campaign—are meant to draw attention not only to the purported shortcomings of corporate environmental reporting practices, but also the deficiencies of the SEC’s enforcement of existing environmental disclosure rules.
The key SEC rule on disclosing future material financial impacts is Item 303 of Regulation S-K, which sets guidelines for the Management Discussion and Analysis (MD&A) section in corporate financial disclosure statements. Under this rule, companies must disclose “material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or future financial condition.”
Materiality is not quantitatively defined under this rule, however. Instead, it is couched as information that a reasonable investor would be likely to consider important in the context of all information available.
In practical terms, companies have applied this SEC disclosure rule only as it pertains to their potential responsibility for cleaning up hazardous waste sites and for projecting capital expenditures on pollution control facilities in the current and next fiscal year. In addition, under Item 103 of Regulation S-K, companies are required to disclose any environmental legal proceedings that may involve government sanctions of greater than $100,000 or involve a claim for more than 10 percent of the company’s current assets.
Left out of the typical MD&A discussion is how management intends to address other environmental issues for which there are known impacts on the company, but uncertainty over their magnitude or timing. Such lack of disclosure often involves environmental issues for which state or federal laws have been passed but final regulations have not yet been issued (or are being contested in court).
In other instances, such lack of disclosure involves international treaties like the United Nations Framework Convention on Climate Change, which President Clinton signed in 1998 but has not yet been ratified by the U.S. Senate. Provisions of this treaty call for significant reductions in greenhouse gas emissions by chemical, electric power, petroleum and transportation companies—cuts that may have major economic repercussions for these industries. Yet while many of these firms have participated in industry-funded studies suggesting there may be dire financial consequences resulting from mandatory greenhouse gas controls, only a few have raised the issue in the MD&A discussions in their shareholder reports.
Critics of industry disclosure practices maintain that companies are taking advantage of “wiggle room” in the SEC disclosure rules that avoid setting quantitative thresholds for disclosure of “material effects,” and that allow companies to avoid environmental disclosures when they think “a material effect on the registrant’s financial condition…is not reasonably likely to occur.”
Ironically, these critics add, the SEC has issued several directives over the years intended to narrow a company’s ability to avoid disclosure on grounds of “uncertainty.” The SEC has even gone so far as to promulgate a “safe harbor” rule to protect companies making “reasonably based and adequately presented projections” that subsequently fail to materialize.
Finally, in a further effort to promote environmental disclosure, the SEC entered into a Memorandum of Understanding with the Environmental Protection Agency in 1994 to better coordinate monitoring and enforcement functions on environmental matters—adding an enforcement “stick” to the safe harbor “carrot.”
Lack of Enforcement
Yet for all of the SEC rules, directives and cooperative agreements, companies have found they have little to fear if they err on the side of brevity when it comes to environmental disclosure. Of more than 5,000 administrative proceedings initiated by the SEC over the last 25 years, only three have been based on insufficient disclosure of environmental risks or liabilities, according to WRI’s Coming Clean report. Over the same period, the SEC has brought only one civil action against a company on such grounds—and that action was filed in 1977.
In theory, companies in violation of SEC reporting requirements can find themselves in serious trouble, subject to fines of up to $500,000 for each violation. In addition, the SEC has the power to halt a company’s stock registrations, and it can petition the courts to require a violating company to provide more environmental liability data in its reports to shareholders.
Since 1980, however, the SEC has initiated just one enforcement action on an environmental disclosure matter—and that penalty was relatively minor. In 1998, the SEC found that Lee Pharmaceuticals, a maker of dental and cosmetic products, made material omissions and misstatements to shareholders about the nature and extent of its liabilities for cleaning up a Superfund hazardous waste site. Management estimated that its assigned costs would be only $700,000, but its final apportionment for the cleanup turned out to be $30 million. The parties settled the case by agreeing to enter into a cease and desist order. In addition, the company’s accountant was denied the privilege of appearing or practicing before the SEC as an accountant for a period of at least two years.
Corporate Sunshine Project
Over the years, several groups have urged the SEC to take greater steps on environmental disclosure—both in terms of reporting requirements and enforcement actions. The Natural Resources Defense Council, an environmental watchdog group, petitioned the SEC in 1974 to require companies to report on pollution, environmental practices, and the environmental impacts of their products and operations. After lengthy hearings and appeals, the SEC turned down the request, affirming that Regulation S-K defined appropriate economic criteria for corporate disclosure on environmental matters.
In 1998, the issue came up again when SEC Chairman Arthur Levitt made a speech imploring companies not to abuse the concept of materiality “to excuse deliberate misstatements of performance”—reminding them that SEC disclosure rules “require consideration of all relevant factors that could impact an investor’s decision.” Though Levitt’s remarks were aimed at inflated corporate earnings forecasts, an ad hoc coalition of labor, environmental and social investing groups seized on his comments to raise once again the issue of greater corporate environmental disclosure.
In an open letter to Levitt signed by representatives of more than 100 institutions, the so-called “Corporate Sunshine Working Group” urged the SEC to clarify its reporting requirements and step up its enforcement against companies that fail to disclose environmental as well as social matters that may have a material effect on their operations and performance. The working group’s letter chronicled alleged environmental reporting violations by four companies and went on to make recommendations to discourage further environmental disclosure abuses. The recommendations were as follows:
- Take enforcement action against companies that fail to meet rigorous disclosure standards.
- Revise and clarify SEC reporting requirements and guidelines to ensure greater enforceability of environmental and social disclosure.
- Review and formalize the SEC’s Memorandum of Understanding with the Environmental Protection Agency to better share information on companies’ environmental liabilities.
- Seek amendments to securities law so as to mandate standardized annual environmental and social performance reports by corporations.
Most of the conclusions of the Coming Clean report reiterate the Sunshine Group’s recommendations to the SEC (although the WRI researchers stopped short of calling for standardized environmental reports or corporate disclosure on broader social issues). The WRI report also urged companies to “begin to disclose more fully their known, financially material environmental risks and uncertainties, without waiting for SEC action.”
That final plea to corporations may be especially telling. While SEC officials have acknowledged shortcomings in their review and enforcement of environmental disclosure statements in corporate financial reports, they have also been candid that the situation is not expected to change anytime soon. In a December 1998 interview with the Environmental News Service, Robert Burns, the chief counsel in the SEC’s Office of Chief Accountant, said corporate financial reporting problems extend well beyond environmental disclosure. “The SEC sees a growing problem with a lot of companies just passing off required generally accepted accounting principles (GAAP) as immaterial right in front of our faces,” he groused. “It’s an attitude which comes across as telling us keeping good books is immaterial, and right now our primary focus isn’t the environment, but in preparing financial statements in general.”
When Repetto and Austin met with SEC officials a few months ago to discuss the recommendations of their Coming Clean report, the response was similar. Officials said the SEC lacked the resources to conduct their own staff assessments of the environmental liabilities that companies face. Moreover, SEC lawyers present at the meeting questioned whether there could be any meaningful measure of financial impacts for uncertain environmental liabilities that companies choose not to disclose. Consequently, prospects are slim that the SEC will take any further action in response to the Coming Clean report. However, Austin plans to bring a group of institutional investors and other interested parties to meet with SEC officials and regards the dialogue as “ongoing.”
2001 Shareholder Campaign
Bruce Herbert of Newground Investments is hoping that his 2001 shareholder campaign will help galvanize public support in favor of greater corporate environmental disclosure. “The fact that a substantive industry-wide study has been conducted, that it demonstrates significant liabilities, and that [these liabilities are] known to the companies involved but not the public gives us a rare opportunity to move our work forward—both with this industry and systematically,” Herbert said in his recent solicitation to prospective sponsors.
Going forward, Herbert sees his “Newground Initiative” as dovetailing with two other corporate disclosure initiatives favored by shareholder activists: the Global Reporting Initiative sponsored by the Ceres Coalition, and the Principles for Global Corporate Responsibility drafted by interfaith church coalitions in the United States, Canada and the United Kingdom.
Herbert believes that WRI’s recent research validates the proposition that corporate management of environmental issues has a direct bearing on shareholder value, which in turn strengthens the case for standardized environmental reporting. As an early supporter of the Ceres principles, Herbert now is backing the Global Reporting Initiative (GRI), a Ceres spinoff that seeks to expand the standardized reporting framework to social as well as environmental issues. Earlier this month, chief executive officers of the Fortune 500 received a letter signed by more than two dozen institutions urging them to have their companies join the GRI.
Finally, Herbert sees the possibility of incorporating the interfaith centers’ Principles for Global Corporate Responsibility as a “visioning” statement for the broader corporate social responsibility campaign, since its “draws social and environmental issues into the core design of economic enterprise.”
Such an effort to tie disclosure of potentially financially significant environmental issues to larger corporate social responsibility campaigns may be a turn-off to some investors who fear the so-called “slippery slope.” However, Herbert insists: “What we are really after is a radically expanded level of business transparency and reporting. With the proper ‘buzz’ over the significance of these undisclosed liabilities—along with the offer of a systematic program for evaluating, predicting and preventing them—we could see major shifts in public awareness of and sentiment toward our movement and our call for corporate accountability and transparency.”