Tuesday, September 18, 2007

Temperature Rises on Climate Change Disclosure Issues

In prior posts (refer here) and other publications (here), I have written about the growing potential exposure to directors and officers of publicly traded companies arising from global climate change concerns. My views have been met with some interest, but also with significant skepticism. But while there are admittedly as yet no D & O claims from climate change issues, several recent developments confirm my view that climate change-related issues represent a growing are of D & O exposure.

First, on September 14, 2007, New York Attorney General Andrew Cuomo subpoenaed five large energy companies demanding that they disclose the financial risks of their greenhouse gas emissions to shareholders. The letters Cuomo’s office sent to the energy companies accompanying the subpoenas can be found here. The five companies are AES Corporation, Dominion Resources, Xcel Energy, Dynegy, and Peabody Energy.

In the case of Dominion Resources, the letter (refer here) states that the purpose of the subpoena to Dominion is to obtain information "regarding Dominion’s analyses of its climate risks and its disclosure of such risks to investors." The letter refers to the company’s plans to build a new coal-fired electric generating facility, which, the letter stated, together with the company’s other carbon emissions generating activities will "subject Dominion to increased financial, regulatory, and litigation risks." The letter goes on to state that Dominion has "not adequately disclosed those risks to its shareholders, including the New York State Common Retirement Fund, which is a significant holder of Dominion stock." The letter adds that "we are concerned that Dominion has failed to disclose material information about the increased climate risks Dominion’s business faces."

The letter states further that:

In its 2006 Form 10-K, Dominion made no disclosure of projected CO2 emissions from the proposed plant or its current plants. Further, Dominion did not attempt to evaluate or quantify the possible effects of future greenhouse gas regulations, or discuss their impact on the company. Dominion also did not present any strategies to reduce CO2 emissions, as new regulations would likely require. These omissions make it difficult for investors to make informed decisions.

Under federal and state laws and regulations, Dominion’s disclosures to investors must be complete and not misleading. Selective disclosure of favorable information or omission of unfavorable information concerning climate change is misleading. Dominion cannot excuse its failure to provide disclosure and analysis by claiming there is insufficient information concerning known climate change trends and uncertainties. (Emphasis added.)

The letter carefully does not say that Dominion engaged in selective disclsoure, it merely states that selective disclosure is misleading. The letter and accompanying subpoena purport to require a response by October 9, 2007. The letters to the other four energy companies are all in a similar vein. Press coverage further detailing the New York Attorney General’s subpoenas can be found here.

In addition to Cuomo’s subpoenas, 22 petitioners, including two environmental groups (Ceres and Environmental Defense), the financial officers of ten states and New York City, and several institutional investors, including the massive California Public Employees' Retirement System (collectively representing over $1.5 trillion in assets), announced that they will petition the SEC to require companies to assess and fully disclose their financial risks from climate change. Ceres’s September 18, 2007 press release describing the petition can be found here, and the petition itself can be found here. The petition is quite lengthy but for those interested in the topic it provides a comprehensive overview. The essential thrust of the petition is that current reporting disclosure of global climate change risks is inadequate to afford investors to make informed decisions, and that clarifying guidance from the SEC is required for investors to be provided with complete information.
An excellent summary of the goals and legal status of the petition, as well as the state of climate change disclosure generally, can be found on the CorporateCounsel.net blog, here.

A September Journal 18, 2007 Wall Street Journal article about the petition (here) quotes Florida’s chief financial officer as saying that in supporting the petition the states’ representatives are "responding to the interest of the general public" in climate change issues and are seeking to "push the agenda forward" to change behavior. A representative from Environmental Defense stated that the petition is "part of a multi-pronged effort to compel the SEC and other federal agencies to take an active role in combating climate change." Ceres’s news release quotes its President as saying that "shareholders deserve to know if their portfolio companies are well positioned to manage climate risks or whether they face potential exposure."
A representative of Ceres, citing their group’s own January 2007 study that over half of the companies in the S & P 500 index do a "poor job disclosing their climate change risk," notes that more than half of these same 500 companies’ sales occur overseas, in nations that are parties to the Kyoto Protocol, yet their risk disclosures are nonetheless inadequate.

The petition notes that disclosures of climate change risk is important not only for companies (such as utilities or energy companies) whose emissions are deemed to be linked to rising atmospheric carbon levels, but also to banks, health-care companies, insurance companies, telecommunications companies and other firms who, the petition states, do not consider themselves as major emitters and so may be disregarding their exposures to climate change related risks.

These recent developments follow on the heels of last week’s decision (refer here) by a federal district judge that Vermont can limit greenhouse-gas emissions from cars and trucks, a ruling that potentially opens the door for wider action by states with respect to climate change issues. The decision also underscores the fact that climate change related regulation is approaching from many different directions, increasing the likelihood that these regulatory concerns will affect an increasingly larger number of publicly traded companies.

The most important aspect of the most recent events is their emphasis on the importance of corporate disclosure. The adequacy or inadequacy of corporate disclosure on climate change issues is clearly going to be a key battleground as part of activist "multi-pronged effort" to raise the profile of climate change issues. The involvement of key representatives of several states – whose responsibilities include oversight of massive public pension funds – undercuts any suggestion that this disclosure movement can be treated as a fringe issue. There may be some truth in the Florida representative’s suggestion that their actions are consistent with the interest of the general public, but because of the massive asset value for which these representatives are responsible, their actions in this area matter.

The danger for publicly traded companies comes not just from the agitation for greater disclosure; rather, the danger comes from the implications embodied in the New York’ Attorney General’s letters. That is, if companies are subject to greater disclosure obligations or expectations, they are also potentially subject to allegations of the same kind as suggested in the letters – that the targeted energy companies engaged in misleading "selective disclosure" or "omission" of unfavorable information. And while these allegations appear only in a letter, it may only be a matter of time before allegations of this type make their way into civil complaints.

Whether or not these kinds of allegations would be meritorious is of course a question that will have to await another day. On a positive note, a federal judge yesterday tossed (refer here) the global warming lawsuit that California had filed against six automakers. But while California’s nuisance theory in that case was unsuccessful, the outcome has little to say about what might follow from a lawsuit alleging misrepresentations or omissions regarding climate change issues. A lawsuit must, of course, allege more than purported misrepresentations or omissions; the lawsuit must also allege causally related damages, and in the absence of any significant shareholder losses supposedly related to climate change disclosures, there would be little incentive for plaintiffs’ lawyers to pursue a climate change disclosure lawsuit. But as significant shareholders of the type behind the SEC petition described above evince their issues, the possibility that a climate change related disclosure might affect a company’s stock price increases.

In any event, some D & O insurers are beginning to take these issues very seriously. A senior official at one of the leading D & O insurers told me recently that climate change issues have moved to the top of their list of longer range concerns. While some might regard this reaction as alarmist, it is not surprising. The recent events involving the petition to the SEC and the New York Attorney General’s subpoenas are unlikely to be isolated or concluding events; they will be followed by many other initiatives with a similar goal, and climate change disclosures will inevitably become an increasingly important governance issue. As its importance increases, so will the disclosure risk.

Another Home Construction Company Sued: Regular readers know that I have been tracking (here) subprime lending related securities class action lawsuits, including subprime related lawsuits against home construction companies. In that regard, a shareholder has filed a purported securities class action lawsuit (refer here) against the CFO of Hovnanian Enterprises, alleging that the CFO violated his fiduciary duties and also violated Section 10(b) of the Securities Act of 1934. The plaintiff purports to represent a class of Hovnanian shareholders who bought the company’s stock between December 8, 2005 and August 17, 2007. The complaint alleges that the CFO knew but filed to disclose that the company lacked requisite internal controls and misrepresented the company’s business and future prospects. The complaint also alleges that the company lacked a reasonable basis to make projections about the company’s financial results, and so the defendant’s statements about the company’s business and future prospects were misleading.

Welcome Back to WVZ: After a lengthy hiatus, the With Vigour and Zeal blog (here) is back online. We here at The D & O Diary are big fans of WVZ and so we are pleased to welcome back the WVZ blog and we look forward to seeing future WVZ posts.

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