Environmental Disclosure Rules: Despite Court Win, SEC Adopts Broad New Standard for Corporations

After nearly a decade of litigation and administrative proceedings, the Securities and Exchange Commission (SEC) seems finally to have established the extent of environmental disclosure required by corporations subject to the federal securities laws.¹ Environmental groups have long urged that a reporting corporation must be required to disclose not only the nature of environmental polluting effects of its activities but also the costs of achieving compliance with the relevant environmental laws. Although these groups ultimately lost in their bid to have the federal courts order the Commission to adopt rules to that effect, the SEC's recent settlement of an enforcement action and issuance of an interpretive release indicate that the legal battle may nonetheless have led to significant reform in the SEC's disclosure rules. The agency now seems clearly committed to requiring that investors be provided with information concerning the impact of corporate activities on the environment through more extensive disclosure.

Background

The federal securities laws require public corporations of a certain size to file registration statements and periodic reports with the SEC.² The SEC may require the disclosure of any information it deems "necessary or appropriate in the public interest or for the protection of investors."³ The benchmark for disclosure is "materiality," which is defined in the agency's regulations to mean information on "those matters as to which an average prudent investor ought reasonably to be informed"⁴ before purchasing the corporation's securities.

On June 1, 1971, the Natural Resources Defense Council (NRDC) filed a rule-making petition with the SEC arguing that the National Environmental Policy Act (NEPA)⁵ required the agency to expand its disclosure requirements, traditionally limited to matters of a financial or economic nature, to include information relating to the environmental impact of corporate activities.⁶ NRDC's aim was to obtain he disclosure of information necessary for investors to make socially responsible decisions.⁷ In response, the SEC issued a release describing its policy on environmental disclosure.⁸ In describing its business, a registrant had to indicate when compliance with statutory requirements might necessitate significant capital outlays, materially affect the earning power of the business, or cause material changes in the registrant's current or anticipated business. Registrants were also required to disclose information, where material, on legal proceedings arising under federal, state, or local environmental laws. If pending or anticipated litigation were omitted because the registrant deemed it not material, the SEC could require a supplemental submission describing the litigation and justifying the omission.

Dissatisfied with this response, NRDC and two other groups filed suit in the federal district court in the District of Columbia.⁹ The environmentalists sought to amend [9 ELR 10223] the SEC's registration requirements to require that companies disclose, with respect to each major activity or product:

(1) the nature and extent, quantified to the degree feasible, of the resulting environmental pollution or injury to natural resources;

(2) the feasibility of reducing such pollution or injury under existing technology, including a description of alternatives and their respective costs;

(3) the prospects for improving that technology;

(4) existing and projected expenditures for reducing such pollution or injury;

(5) legal requirements affecting the impact on the environment of the registrant's activities, including requirements for licenses and permits and outstanding court or administrative orders; and

(6) pending or threatened judicial or agency proceedings, whether initiated by private or governmental bodies, challenging the registrant's compliance with environmental protection standards.¹⁰

Shortly thereafter, the SEC issued a new release¹¹ which superseded its earlier environmental disclosure requirements. Release No. 33-5386 requires that the description of the registrant's business include disclosure of the material effects that compliance with environmental statutory provisions may have upon capital expenditures, earnings, and the company's competitive position. Disclosure is to be based on all information reasonably known to management and is to extend for an unspecified time in the future. Second, the registrant must disclose, in addition to pending proceedings, any administrative or judicial environmental proceeding "known to be contemplated by governmental authorities," including the factual basis and relief sought in the proceeding. Privately instituted proceedings are to be described if a claim for damages exceeds 10 percent of the registrant's current assets, but any proceeding brought by a governmental authority is deemed material without regard to this economic measure.

First District Court Decision

In Natural Resources Defense Council, Inc. v. Securities and Exchange Commission,¹² the court held that the SEC had violated the Administrative Procedure Act (APA)¹³ in formulating and promulgating Release No. 33-5386 and remanded the matter to the agency for further rule making. The court reviewed the effect of NEPA on the SEC's power under the securities laws and noted that the SEC must interpret the securities laws in accordance with NEPA's power to protect the environment "to the fullest extent possible." Specifically, Congress, speaking through NEPA, has declared that the "dissemination of information to … interested individuals can aid the purposes of NEPA."¹⁴ In concluding that the SEC had violated the APA, the court found that the public had not been given adequate notice that the rules in the release were intended to fulfill the agency's NEPA obligations and that the agency had failed to provide an adequate statement of the purposes of its rules.

On remand, the SEC scheduled a rule-making proceeding¹⁵ in which it would consider the NRDC's six proposed rules plus other disclosure proposals. One additional proposal was that a general statement of the registrant's policy towards environmental issues must be disclosed. Another proposal was for requiring limited disclosure in proxy statements and annual reports to the shareholders with more complete information to be contained only in documents filed with the SEC.The agency indicated that the overriding concerns of the proceeding were, following the court's directive, the extent of investor interest in this type of information and the avenues investors might pursue to eliminate corporate practices that are harmful to the environment.¹⁶

After a lengthy proceeding, the SEC announced its conclusions and proposed revised environmental disclosure rules.¹⁷ The Commission concluded that the securities laws are limited to requiring disclosure of information only of an economic nature. NEPA, in its view, did not overlay a broader mandate for environmental disclosure, and investor interest in such information was in any event speculative. The agency thus essentially affirmed the standards in Release No. 33-5386. The Commission did propose to require disclosure of estimated capital expenditures for pollution control facilities for current, the next subsequent, and future years if material. On the other hand, the SEC specifically rejected requests that registrants be required to disclose the environmental effects of their activities, pending environmental litigation initiated by nongovernmental parties, general corporate policy, and all capital expenditures for environmental purposes.

Six months later, the SEC issued a final rule making.¹⁸ In addition to affirming the requirements in Release No. 33-5386, the Commission adopted the proposal for reporting time periods for material estimated capital expenditures. [9 ELR 10224] Furthermore, the SEC explained that notices of violations in the nature of cease and desist orders issued by the Environmental Protection Agency were sufficiently concrete indication of contemplated governmental legal action as to require disclosure.

Second District Court Decision

The environmental plaintiffs were dissatisfied with the SEC's response, and, although they acknowledged that the agency had this time complied with the procedural requirements of the APA, they moved for summary judgment on the ground that the decision not to require additional disclosures was arbitrary and capricious in view of the Commission's legal obligations under NEPA. The district court agreed and remanded the matter again to the SEC for further rule making on the appropriateness of additional disclosure requirements.¹⁹ Although NEPA did not require the SEC to promulgate broad environmental disclosure regulations, the court held that the agency was required to consider alternatives to the fullest extent possible, which the SEC apparently did not do, and that the agency's cost balancing was not sustainable because of a lack of evidence in the record.

D.C. Circuit Decision

The case finally reached the Court of Appeals for the District of Columbia Circuit, which reversed the lower court and upheld the SEC on April 20, 1979.²⁰ The court carefully scrutinized the Commission's compliance with NEPA's procedural requirements, particularly the consideration of alternative proposals and the requirement to consult with the Council on Environmental Quality (CEQ). Despite this searching standard of review, the court held that, contrary to the finding of the lower court, the SEC did consult sufficiently with CEQ by carefully evaluating its proposal.

In its substantive review of the SEC's decision, the D.C. Circuit emphasized the discretion which Congress had granted the SEC to develop disclosure rules, acknowledging that judicial review must be deferential to the extent of relying to some degree on the agency's expertise. Furthermore, the court concluded that NEPA did not require the SEC to promulgate specific disclosure rules. The court then upheld the Commission's cost-benefit analysis, which had concluded that the cost of providing the environmental disclosures was high and the benefits to investors uncertain, primarily because of the voluminous nature of the material. Although lacking firm data, the SEC was nonetheless not precluded from ruling on environmental disclosures, the court explained, because this constituted a "quasi-legislative policy judgment" with which it had been entrusted by Congress.

The D.C. Circuit's decision may well have been influenced by the extensive attention the SEC gave to the issue of environmental disclosures. Since the agency has a great deal of discretion in promulgating disclosure rules, the very fact of a lengthy proceeding may have provided the "hard look" at environmental factors required by NEPA. On the other hand, the court's rather cursory rejection of the alternative of a limited disclosure rule for shareholder voting seems to fly in the face of evidence in the proceeding that there was explicit shareholder interest in this idea.²¹ The court did note, however, that the SEC would continue to review this issue. The anticipation of further agency action was soon borne out by the SEC's announcement of a new interpretive release regarding environmental disclosure.

U.S. Steel: New Disclosure Standards

On September 27, 1979, the SEC issued an order²² finding that the periodic reports filed by U.S. Steel with the SEC from 1973 to 1977 failed to comply with the agency's environmental disclosure requirements under § 13 of the Securities Exchange Act of 1934²³ and the agency's rules. Simultaneous with this order, the SEC issued an interpretive release, No. 33-6130,²⁴ that incorporated the new standards for environmental disclosure discussed in the U.S. Steel decision into the agency's general requirements.

The Commission first reviewed U.S. Steel's obligations under the Clean Air Act²⁵ and the Clean Water Act,²⁶ including enforcement actions and sanctions. It noted that the company officers and directors were aware as early as 1971 of U.S. Steel's environmental problems and their possible consequences and had made a number of estimates over the years of the financial impact of environmental regulations on the company. The SEC then concluded that the company had an active policy of resisting environmental requirements which it viewed as unreasonable and minimizing and delaying capital expenditures for environmental controls despite the risk of substantial civil and criminal penalties. Third, the Commission reviewed U.S. Steel's environmental disclosures and found that although some cost of compliance figures were set forth in reports, material future capital expenditures were not disclosed to shareholders or the investing public. In addition, although pending judicial proceedings were disclosed, environmental administrative proceedings, initiated both by the government and by U.S. Steel, often were not disclosed, particularly in years prior to 1977. The effect of this failure was that the potential capital expenditures necessary to overcome environmental problems and possible penalties were not fully disclosed.

The SEC set forth three issues which it saw raised by U.S. Steel's non-disclosures. First, in addition to the planned expenditures for the next two years, when must a corporation disclose the total cost of compliance with environmental statutes; second, what is the nature of the administrative proceedings that must be disclosed; third, when is a corporation required to disclose its policy concerning compliance with environmental laws.

As to the first question, the SEC noted that in order to [9 ELR 10225] keep disclosures from being misleading, further disclosure was required where a registrant expected that additional material capital expenditures, beyond those already authorized and disclosed, would be necessary. In addition to cost of equipment, this would include penalties or fines for noncompliance. Furthermore, if a registrant reasonably expected costs for a future year to be materially higher than those for the next two years, the registrant may be required to develop and disclose estimates.

On the second issue, the nature of administrative proceedings that must be disclosed, the SEC explained that it does not construe the term "administrative proceeding" narrowly. Then the SEC took its previous rule, which required disclosure of proceedings initiated by the government, a logical step farther by requiring disclosure of all proceedings to which a governmental authority is party, even if initiated by the registrant. In addition, disclosure is required of all administrative orders relating to environmental matters regardless of whether the order follows a "proceeding" and thus does not depend on whether a registrant chooses to contest an order.Because disclosure is keyed to the material consequences of environmental problems facing the registrant, disclosure of the relief sought in such proceedings must include an estimate of the level of expenditures necessary to install the pollution control equipment sought by the governmental authority.

On the third point, the SEC reiterated its earlier conclusion not to require an across-the-board disclosure of corporate environmental policies.²⁷ It did, however, add two caveats. If a corporation voluntarily chooses to disclose such policies, the disclosure must be accurate and complete enough to avoid being misleading. Furthermore, if a corporation has a policy toward compliance with environmental regulation that is reasonably likely to lead to substantial penalties or other material consequences, the likelihood and magnitude of such effects on the corporation may have to be disclosed.

The SEC concluded that U.S. Steel's reports to the Commission for 1973-1977 failed to comply with the foregoing standards but agreed to settle the matter. The corporation will be required to inform its shareholders and prospective investors, in proxy statements, annual reports, and prospectuses, of the order as well as making copies available to them. In addition, U.S. Steel is required to make a study to estimate the total potential cost, including noncompliance penalties, of bringing its facilities into compliance with applicable environmental requirements. This report is to be submitted to the SEC and to U.S. Steel's board of directors, which shall not only consider the company's prior environmental disclosures and the flow of information within the company but establish procedures for timely and complete disclosure of environmental matters to the SEC and the public.

Conclusion

Compared to the SEC's original position on disclosure of environmental matters, its new policy represents a significant step toward the proposals advocated by the environmental groups in their lawsuit. In particular, the required disclosure of present and future capital expenditures and an extensive array of adversarial and enforcement actions under the environmental laws, both of which were expanded in the SEC's recent release, present a clearer picture of the effect of corporate activities upon the environment. Attempting to quantify the aggregate environmental pollution resulting from a corporation's operations, as the environmentalists originally urged, seems an inherently subjective task. Requiring disclosure of interactions between the corporation and government agencies regarding compliance with established environmental standards, on the other hand, provides at least some objective measure of a corporation's effect on the environment. In addition, despite the drawn-out debate in the courts as to what mandate NEPA imposed on the SEC, the agency has apparently recognized that NEPA adds a new and significant factor to the mix of corporate information that must be disclosed. Furthermore, if the most recent release is a guide, the SEC will apply its specific environmental disclosure rules "broadly and liberally."²⁸

Two elements of the environmental disclosure controversy indicate that further rule making may be forthcoming from the SEC. The recent policy interpretation ties disclosure to the documents filed with the SEC, which can be made available to the investing public or shareholders on request. The SEC admitted, however, that there was interest in requiring the disclosure of such information directly to shareholders in proxy statements and annual reports so they might participate more knowledgeably in the shareholder voting process. The SEC acknowledged that it would continue to review this issue. Extending disclosure to shareholder documents, it should be noted, would be consistent with the agency's current concern for corporate democracy.

The second developing area is the SEC's requirements regarding the disclosure of corporate environmental policy. A corporation may understandably avoid publicly articulating a policy of resisting compliance with environmental laws. A pattern of actions such as those of U.S. Steel may clearly imply that an unspoken policy to that effect is in existence, however. In that event, under the new SEC standard, a corporation could not state that its policy is to comply with relevant environmental laws without also disclosing instances of resistance in order to avoid being misleading. This may cause a corporation to be overly cautious about making such image-polishing policy statements so as to avoid having also to disclose the less attractive side of its compliance record.

It thus appears that as a result of the exhaustive lawsuits and agency proceedings, and perhaps as a consequence of a changed political climate, the SEC has developed a more aggressive concern for environmental disclosure. The Commission has come to recognize that such information is important to investors and shareholders. [9 ELR 10226] Requiring corporations to air their difficulties in complying may to some extent feed the current backlash against environmental regulations. In any event, the SEC's new policy promises to illuminate corporate impacts on the environment and thereby at least educate the public and perhaps even lead to reform of environmentally destrucive corporate practices.²⁹

1. Securities Act of 1933, 15 U.S.C. § 77a et seq.; Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq.

2. 15 U.S.C. §§ 77g, 77j, 78m, 78o(d).

3. 15 U.S.C. § 77g.

4. Securities Act Rule 405, 17 C.F.R. § 230.405; Securities Exchange Act Rule 12b-2, 17 C.F.R. § 240.12b-2. See also Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54 (1972); Mills v. Electric Auto-Lite Co., 396 U.S. 375, 384 (1970).

5. 42 U.S.C. §§ 4321-4361, ELR STAT. & REG. 41009.

6. Early support for NRDC's position can be found in Sonde & Pitt, Utilizing the Federal Securities Laws to "Clear the Air! Clean the Sky! Wash the Wind!," 16 How. L.J. 831 (1971). See also Friedlob & Sanderson, The Environment and the Federal Securities Laws, 15 B.C. INDUS. & COM. L. REV. 721 (1973); Note, The SEC as Environmentalist: The Reluctant Champion, 53 NOTRE DAME LAW. 985 (1978).

7. See J. SIMON, C. POWERS & J. GUNNEMAN, THE ETHICAL INVESTORS: UNIVERSITIES AND CORPORATE RESPONSIBILITY (1972).

8. SEC Release No. 33-5170, 36 Fed. Reg. 13989 (July 19, 1971).

9. The suit was first filed in the Court of Appeals for the District of Columbia Circuit, where it was dismissed on procedural grounds. Natural Resources Defense Council, Inc. v. Securities and Exchange Comm'n, 3 ELR 20154 (D.C. Cir. Feb. 8, 1973).

10. Petition of Project for Corporate Responsibility and Natural Resources Defense Council, Inc. for Rulemaking Before the Securities and Exchange Commission (June 7, 1971), quoted in Comment, Corporate Disclosure of Environmental Information: The SEC Announces a Public Proceeding, 5 ELR 10039, 10040 (1975).

11. SEC Release No. 33-5386, 38 Fed. Reg. 12100 (May 9, 1973).

12. 389 F. Supp. 689, 5 ELR 20074 (D.D.C. 1974).

13. 5 U.S.C. §§ 553, 701-706, ELR STAT. & REG. 41002-03, 41005.

14. 389 F. Supp. at 695, 5 ELR at 20076.

15. SEC Release No. 33-5569, 40 Fed. Reg. 7013 (Feb. 18, 1975). See also Comment, Corporate Disclosure of Environmental Information: The SEC Announces a Public Proceeding, 5 ELR 10039 (1975).

16. The tone of the Commission's release announcing the proceeding leaves little doubt that it considered environmental disclosures largely irrelevant to economic concerns. At the same time, it sought to "take due care that its disclosure requirements elicit meaningful, effective disclosure without causing disclosure documents to be excessively technical or obscure." 40 Fed. Reg. at 7014.

17. SEC Release No. 33-5627, 40 Fed. Reg. 51657 (Nov. 6, 1975). See also Comment, SEC's New Corporate Environmental Disclosure Rules Hinge on Overly Narrow Reading of Both Its Law and NEPA, 6 ELR 10033 (1976).

18. SEC Release No. 33-5704, 41 Fed. Reg. 21632 (May 27, 1976).

19. Natural Resources Defense Council, Inc. v. Securities and Exchange Comm'n, 432 F. Supp. 1190, 7 ELR 20434 (D.D.C. 1977).

20. Natural Resources Defense Council, Inc. v. Securities and Exchange Comm'n, 606 F.2d 1031, 9 ELR 20367 (D.C. Cir. Apr. 20, 1979).

21. See SEC Release No. 33-5627, 40 Fed. Reg. at 51663-65.

22. In the Matter of United States Steel Corp., Admin. Proc. File No. 3-5819, Release No. 34-16223 (SEC Sept. 27, 1979). The full text of this order is available from ELR (13 pp. $1.75, ELR Order No. A-1013).

23. 15 U.S.C. § 78m.

24. SEC Release No. 33-6130, 44 Fed. Reg. 56924 (Oct. 3, 1979).

25. 42 U.S.C. §§ 7401-7642, ELR STAT. & REG. 42201.

26. 33 U.S.C. §§ 1251-1376, ELR STAT. & REG. 42101.

27. In Release No. 33-5627, the SEC rejected the requirement that registrants disclose their environmental policy on the ground that it "would result in subjective disclosures largely incapable of verification and highly susceptible to public-relations presentations." 40 Fed. Reg. at 51663.

28. SEC Release No. 33-6130, 44 Fed. Reg. at 56925.

29. Disclosure requirements can be a stimulus to change undesirable corporate behavior. "Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; the electric light the most efficient policeman." L. BRANDEIS, OTHER PEOPLE'S MONEY 92 (1932). "Disclosure concerning questionable situations has a prophylactic effect." Address by SEC Commissioner Loomis, Florida Institute of CPAs (Dec. 13, 1974), quoted in Comment, SEC's New Corporate Environmental Disclosure Rules Hinge on Overly Narrow Reading of Both ItsLaw and NEPA, 6 ELR 10033, 10035 n.12 (1976).