### American Bar Association Section on Environment, Energy, and Resources
Corporate Environmental Disclosure: Opportunities to Harness Market Forces to Improve Corporate Environmental Performance

Nicholas C. Franco U.S. Environmental Protection Agency"

Conference on Environmental Law Keystone, Colorado March 8-11, 2001

The views expressed in this paper are those ofthe author and do not necessarily representthe official views ofthe Environmental Protection Agency.

I. Motivation for EPA's Interest in Harnessing Market Forces

to Address Environmental Problems
Momentum has been building over the past 5 years in support of an environmental regulation paradigm shift. There is general consensus that the Environmental Protection Agency's (EPA) current regulatory structure is not capable ofmeetingthe most pressing environmental challenges we now face at the beginning of the 21st Century. Environmental groups, academics, and Congress have been calling for a "second generation" ofenvironmentalregulation to handle these 21st Century environmentalproblems.~ The United States environmental regulatory system has not changed significantly since it was first established in the 1970s. The system was set up to address the environmental problems of the time; large industrial point sources of pollution that had previously gone unregulated. The standards-based system established offered the regulated community little flexibility in achieving environmental performance goals, often dictating the use of specific pollution control technologies. The system has also been criticized for focusing on end-of-pipe solutions, providing little incentive to the regulated communityto move beyond compliance. Despite these criticisms, the command-and-control regulatory system established in the '70s was responsible
1See generally: Knopman,Debra S. (1996). SecondGeneration -A New Strategy forEnvironmental Protection. Washington, DC: Progressive PolicyInstitute. Kettl, DonaldF. (1998). TheFuture ofEnvironmentalRegulation. Brookings PolicyBrief, No. 37, October 1998.Washington, DC: The Brookings Institution. National AcademyofPublic Administration. (2000). environment.gov:TransformingEnvironmental Protection forthe 21 st

### Century. Washington, DC: National AcademyPress. Greenwood, Jim. (1999, November 18).H.R. 3448: SecondGeneration ofEnvironmentalImprovement Act of 1999. Washington, DC: U.S. House ofRepresentatives.

### for dramatic improvements in air quality, water quality, and the handling and disposal of toxic and hazardous substances.2 Though significant progress has been made, the environmental problems the US will face in the next 30 years are fundamentally different than the problems addressed by the current regulatory system. Sources of pollution are more dispersed (e.g. non-point source runoff from farms and urban areas that pollutes rivers and lakes, dispersed sources of ground level ozone and smog precursors), and cannot be addressed with regulatory solutions targeted at large industrial point sources. Addressing global problems such as reducing the production of greenhouse gases has the potential to broadly impactthe US economy, and affect all aspects of society. While acknowledging the environmental improvements attributed to the current regulatory system, those calling for a second generation of environmental regulation believe that the current system will not be able to address the most pressing environmental challenges in an efficient or cost-effective manner. The second-generation regulatory system is envisioned as a performancebased system, in contrast to the direct regulation of the existing standards-based system. In the performance-based system, regulators set environmental goals and the regulated community has flexibility to meet those goals in the most appropriate and cost-effective manner for them. A key distinction of the second-generation regulatory system is that it encourages the use of market forces, where appropriate, to address environmental problems. 3 A second-generation, performance-based regulatory system also:4

• Encourages prioritization and goal setting to focus limited resources on the most pressing environmental problems. • Fosters innovative approaches to addressing environmental problems; it does not dictate solutions. • Places a greater emphasis on high quality environmental information and environmental performance indicatorsto drive decision-making and priority setting. Information is also seen as a tool to increase public awareness and encourage participation. • Proposes decentralization of environmental decision making to the most appropriate level.
Increased scrutiny ofthe cost ofenvironmentalregulations provides another incentiveto consider more cost-effective, market-based solutions. The 106thCongress passed the "Truth in Regulating Act," which establishes a three year pilot program enabling the chairman, or ranking member of a committee ofjurisdiction in either House of Congress to request the General Accounting Office conduct a cost-benefit analysis of economically significant rules. 5 Using appropriation riders,

2U.S. EPA Office ofPolicy,Planningand Evaluation. (1996). U.S. EPA's 25thAnniversary Report: 1970- 1995.Retrieved January 17, 2001 fromtheWorld Wide Web: http://www.epa.gov/history/topics/25year/index.htm 3See generally: Hockenstein, JeremyB., Robert N. Stavins, andBradley W. Whitehead. (1997, May). Crafting theNext Generation ofMarket-Based EnvironmentalTools. Environment, pp.14-33. Knopman. Op. cit. 1,p. 12 National AcademyofPublic Administration. Op. cit. 1,pp. 190 - 192 4Knopman. Op. cit. 1,pp. 11-14 National AcademyofPublic Administration. Op. cit. I, pp. 190 -194 5Shelby, Richard C. (2000). S. 1198,The "Truth inRegulatingAct of2000." Public law 106-312Congress has required the Office of Management and Budget to produce annual reports on the costs and benefits ofall major federal regulations for years 1998-20006 Responding to this trend the EPA recently released major guidance on conducting economic analyses of environmental regulations and policies] The increased emphasis on weighing costs and benefits has heightened sensitivity to the need to strike an appropriate balance between environmental and economic concerns when crafting environmental regulations and programs. One often proposed solution to balancing environmental and economic policy concerns, explored in the next section, is to hamess market forces to achieve environmental protection goals.

II. Opportunities for EPA to Use Market-Based Solutions

to Address Environmental Problems Harnessing market forces to address environmental problems is an attractive altemative to the existing standards-based system because, in theory at least, they hold out the promise of being able to achieve the same level ofpollution reduction at a lower cost, or a greater level ofpollution reduction for the same cost. Market-based solutions are often easier to implement than direct regulation, and provide greater flexibility to the regulated community in meeting pollution reduction goals. A key advantage in terms of environmental protection is that market-based solutions extend the reach of regulatory programs much further than traditional command-andcontrol regulatory programs,g In order to better understand how to hamess market forces (or use economic instruments) to address environmental problems, one first needs to have a basic understanding ofthe underlying theory. Economic theory holds that in the idealized, perfectly competitive economy, the selfmotivated behaviors of individuals and corporations will result in efficient patterns of production and consumption. This equilibrium of production and consumption is efficient in the sense that no one person can be made better off without making another person worse off. However, economic theory recognizes there are commonly occurring exceptions to the underlying assumptions, referred to as market failures, which lead to inefficient patterns of production and consumption.9

6Copies ofthereports canbe foundon the OMB websiteundertheheading "RegulatoryPolicy," http://www.whitehouse.gov/omb/inforeg/ (RetrievedJanuary 16, 2001 fromtheWorld Wide Web) 7National CenterforEnvironmentalEconomics,US EnvironmentalProtectionAgency(2001). Guidelines forPreparing EconomicAnalyses.RetrievedJanuary 16, 2001 fromtheWorld Wide Web: http://www.epa.gov/economics/
sTwo additional advantageseconomistscite foreconomicinstrumentsversustraditional commandand controlregulatorysystemsare static efficiencyand dynamicefficiency. Static efficiency(or "cheaper now") denotesthat companieshavethe flexibilityto achieveemissionsreductionsin the costeffective manner. Dynamicefficiency(or "cheaperinthe future)denotesthat economicinstrumentsprovide a permanentincentivefor emissionreductionsand developmentofnewmethods and technologiesfor reducingpollution. Austin, Duncan. (1999, November).EconomicInstrumentsforPollution Control and Prevention- A BriefOverview. Paper presented atthe "EnvironmentalPoliciesfortheNew Millennium: Incentive-basedApproachesto Environmental Stewardship" conference,World ResourcesInstitute, Washington, DC. 9Weimer, DavidL., and Aidan R. Vining. (1992). PolicyAnalysis: Concepts andPractice,New Jersey: Prentice-Hall,Chapterthree.Two types of market failure, externalities and information asymmetry, are most relevant when analyzing environmental problems and how to address them. l° Externalities arise when the actions (production or consumption) of one party result in a benefit or cost accruing to some external party that did not consentto the impact. Actions that impose a cost on outside parties are classified as negative externalities. For example, a manufacturer releases pollutants into a river, resulting in a degradation ofwater quality. Their source ofdrinking water impaired, downstream cities are forced to spend more money filtering river water, or finding an altemative source of drinking water. Market failure results because the manufacturer bears no cost for dumping pollutants into the river; instead, costs are imposed on downstream parties that did not consent to them.
The premise for correcting the externalities market failure is to shift the cost of the externalities (e.g. pollution) from the non-consenting parties back to the generator ofthe externality. Ensuring the generator bears the cost of the externality forces them to internalize these costs, and factor them into their decision-making framework. The most straightforward method of addressing the pollution externality problem is to alter the incentives of the externality generator by placing a charge, fee, or tax on every unit of pollution released. Adjusting the level of the charge, fee, or tax over time controls the level of pollution. Another method for internalizing pollution costs is to facilitate, or create a market for the externality. Tradable permits are most often used to create a market for pollution externalities. Instead of paying a pollution charge or fee, a manufacturer must hold a permit to release a given quantity ofpollution. Ifadditional permits are required they can be purchased; likewise, excess permits can be sold. Capping the total number of permits available controls the level ofpollution. 11
EPA has implemented a number of successful tradable permit, or cap-and-trade systems. The 1990 Clean Air Act amendments established a tradable permit system to reduce sulfur dioxide (SO2) emissions (the primary source of acid rain) from electric utilities. The CAA amendments require an annual reduction in SO2 emissions of 10 million tons from their 1980 levels. The reductions are to take place in two phases; the first began in 1995 and ran through 1999, the second phase began in 2000. In the first phase annual SO2emissions were reduced by 4 million tons, 12 with cost savings on the order of $1 billion annually compared with the traditional regulatory approach. The EPA also successfully used tradable permits in the '80s to phase lead out ofgasoline~3Many states have also begun implementing their own tradable permit systems to control air and water pollution.~4
The second type ofmarket failure of interest is information asymmetry. Information asymmetry refers to variations across persons in the amount and quality of information about the characteristics of a good. Or, variations in the amount and quality of information between the generator of an externality and those affected. For example, buyers and sellers of a good may have different levels of information about the externalities that result from the production, use, or

10Economistsgenerallyrecognizefourtraditional sources ofmarketfailure: public goods, monopoly, externalities, and informationasymmetry. 11Pearce,David W. and R. KerryTumer. (1990). EconomicsofNatural ResourcesandtheEnvironment, Baltimore: Johns Hopkins UniversityPress, Chapter 8. 12U.S. EnvironmentalProtectionAgency.(2000). Innovation atthe EnvironmentalProtectionAgency:A Decade ofProgress. Washington, DC: U.S. EnvironmentalProtectionAgency,p. 13 13Hockenstein,Op. cit. 3, pp. 16-17 14 National AcademyofPublic Administration, Op. cir. 1, Chapter 3

4

### consumption of a good. Market failure results because individuals are basing economic decisions on incomplete or faulty information, and therefore, are unable to participate in the market in a way that best serves their interests)5
The premise for correcting the information asymmetry market failure is quite simple; ensure all parties have the same level and quality of information on which to base decisions. The Toxics Release Inventory (TRI) is the most well known of EPA's programs that addresses the environmental information asymmetry problem. Since 1987 certain manufacturing facilities, and more recently electric utilities, have been required to file annual reports detailing their emissions to air, land, and water of a list of chemicals:6 Public and environmental group scrutiny of this information is largely credited with pushing reporting industries to significantly reduce their emissions of reportable chemicals. Between 1988 and 1997, air releases declined by 55 percent, water releases by 63 percent, underground injection and on site disposal both decreased over 20 percent, while off-site disposal only increased by one percent)7 State agencies also use TRI data to identify pollution prevention opportunities, and as the basis for legislating additional environmental controls)8
EPA is undertaking many other activities to increase public access to environmental information, such as making more environmental information available on the Internet. The 1996 amendments to the Safe Drinking Water Act require water suppliers to provide consumers annual reports on the quality oftheir drinking water. It is hoped that public access to this information will have the same salutary affect on the quality of drinking water as access to TRI information did on decreasing chemical releases. One area that is beginning to receive more attention is the link between environmental and financial performance, and how disclosure of environmental information by publicly traded companies serves as an incentive for them to improve their environmental performance. This linkage, and EPA's interest in environmental disclosure are explored in the next section.

III. Motivation for EPA's Interest in Disclosure of Corporate

Environmental Performance Information


### A growing body of works supports that there is a link between environmental and financial performance. More specifically, companies that are superior environmental performers will outperform their peers in the stock market: 19
* A Boston nonprofit, Alliance for Environmental Innovation, reviewed 70 research studies in 1998, all of which found a positive relationship between environmental and financial

15Weimer, Op. cit. 8 16Currently, 20,000 facilities submit 80,000 reports annually listingbillions ofpoundsofchemical wastes. U.S. EnvironmentalProtectionAgency. Op cit. 12,p. 33 j7U.S. EnvironmentalProtectionAgency. Op cit. 12, pp. 32-34 isId. 19Blumberg,Jerald, Georges Blum, and Age Korsvold. (1997). EnvironmentalPerformanceand ShareholderValue. Geneva, Switzerland: World Business Council for Sustainable Development, See generally Chapter 6performance. Companies that outperformtheir peers environmentallywere also found to perform better on the stock marketby as much as two percent3°

• The Storebrand Scudder Environmental Value Fund, launched in 1996, uses nine ecoefficiencycriteria to select firms that rank in the top third in environmental performance within their industry sector. The fund grew 51 percent between 1996 and 1998, and outperformedthe comparable Morgan Stanley international World Index by eight percent overthe same period.

21

• A 1996 study by ICF Kaiser Consulting Group that looked at 327 S&P 500 firms found that companies could push up their stock price by as much as five percent by improving their environmentalperformance, z2
A recent review of the available academic research on the relationship between measures of corporate environmental performance and measures of financial performance found a moderate positive relationship between the two. This positive relationship was robust as well, showing up across the studies regardless of the measures of environmental and financial performance, the analytical technique, or the date of the study23 There is also abundant anecdotal evidence of financial benefits accruing to companies that take a proactive approach to environmental management. For example, 3M claims pollution prevention activities between 1975 and 1997 have saved the company $810 million. 24 Baxter International, a medical products manufacturer, proactively sets environmental performance goals and documents cost savings from environmental process improvements. In its most recent environmental financial statement Baxter lists income, savings, and cost avoidance attributable to environmental initiatives totaling approximately $98 million for 1999. Baxter achieved returns on environmental initiatives of approximately $111 million and $129 million for 1998 and 1997respectively. 25 Coinciding with findings of a positive relationship between environmental and financial performance is evidence of increasing demand for corporate environmental performance information from those participating in capital markets. Between 1997 and 1999 the amount of moneyinvested in socially screenedportfolios grew 183 percent, more than fourtimes faster than overall growth in assets under management in the same period. Total assets invested grew from $529 billion in 1997 to $1,497 billion in 1999, representing over nine percent of the approximately 16.3 trillion assets under management. Eighty percent of these screened funds employ an environmental screen, either screening out poor performers or including companies

20Deutsch,ClaudiaH. (1998,July 19).InvestingIt; For WallStreet,IncreasingEvidencethat Greenbegets Green.New YorkTimes. 21Id.,and Blumberg.Op. cit. 19, p. 23 22Feldman, StanleyJ., PeterA. Soyka,andPaulAmeer. (1996).Does Improvinga Firm's Environmental ManagementSystemand EnvironmentalPerformanceResult inHigher StockPrices? Fairfax,VA: ICF KaiserInternational,Inc. 23EnvironmentalCapitalMarketsCommittee.(2000). GreenDividends?:TheRelationshipBetweenFirms' EnvironmentalPerformanceand FinancialPerformance.Washington,DC: Office ofCooperative EnvironmentalManagement,U.S.EPA,p. 6 24Id.,p. 2. Also,see generally:Blumberg.Op. cit. 19, chapter 3 and appendixl 25BaxterInternational.(2000).EnvironmentalFinancial Statementfor 1999,RetrievedJanuary20, 2001 fromthe WorldWideWeb:

## http://www.baxter.com/investors/citizenship/environmental/index.html

6

### with good performance or environmentally friendly products. 26 A more direct demand for information occurred in November of 2000 when 39 financial investors, managing combined assets in excess of$140 billion, sent a letterto the CEO's ofthe 500 largest US companies urging them to begin reporting sustainability measures as defined by the Global Reporting Initiative (GRI). Established in 1997, GRI has developed sustainability reporting guidelines that provide a framework for corporate reporting ofeconomic,environmental, and social information. 27
In response to requests for sustainability information from asset and fund managers, Dow Jones introduced the Dow Jones Sustainability Index in 1999. The index tracks the economic, environmental and social performance of the top 10% of companies in the Dow Jones Global index. At end of June, 2000 approximately Euro 1 billion was managed on the basis of the index.28 Despite increasing demand for, and use of environmental performance information by equity investors, there is evidence that publicly-traded companies are not complying with their duty to disclose environmental information as required by securities regulations (see the following section for a description of applicable securities regulations). Studies indicate that environmental liabilities are not completely and accurately reported to the Securities and Exchange Commission (SEC). A 1992 Price Waterhouse survey of SEC registrants found that 62 percent ofrespondents had not accrued known environment-related exposures on their financial statements. 29 A 1996 study of environmental disclosure by companies involved in initial public offerings, who were known CERCLA potentially responsible parties at one or more sites, found a non-reporting rate of 54 percent, as compared to a non-reporting rate of 61 percent for currently registered companies.3° Additionally, a 1998 EPA study on the disclosure of environmental legal proceedings by publicly-traded companies in their 10-K statements (annual reports filed with the SEC) found a non-reportingrate of74 percent (the study is discussed in detail in section V.). The disparity between demand for corporate environmental performance information, and poor compliance with securities regulations requiring environmental disclosure by publicly-traded companies (arguably the most important source of corporate environmental performance information) points to an information asymmetry market failure. Investors and fund managers

26Schueth, Steve, Alisa Gravitz, and ToddLarsen. (1999). 1999Reporton Socially Responsible Investing TrendsintheUnitedStates. Social InvestmentForum, Section II. Retrieved December 12,200 fromthe World Wide Web:http://www.socialinvest.org/areas/research/trends/1999-Trends.htm 27Anon.(2000). LeadingInvestors UrgeCEO's to AdoptNew ReportingGuidelines. Press Release, Global Reporting Initiative, RetrievedJanuary 20, 2001fromtheWorld Wide Web: http://globalreporting.org/2qews/PressReleases/InvestorLetter.htm 28DowJones Sustainability Group. (2000). DowJones Sustainability Group IndexGuide, Version 2.0. Retrieved December 12,200 fromthe World Wide Web:http://www.sustainabilityindex.com/news/guidebook.html DowJones Sustainability Group. (2000). DowJones Sustainability GroupIndex- FAQ. RetrievedJanuary 20, 2001fromtheWorld Wide Web:http://www.sustainability-index.com/faq.html 29EnvironmentalServices Group, Price Waterhouse. (1992). AccountingforEnvironmentalCompliance: Crossroads ofGAAP, EngineeringandGovernment-SecondSurveyofCorporate America'sAccounting forEnvironmental Costs. Pittsburgh, PA: Price Waterhouse. 30Freedman, Martin andA. J. Stagliano. (1996). EnvironmentalDisclosure ofCompanies Involvedin Initial Public Offerings. RetrievedJanuary 20, 2001fromtheWorld Wide Web: http://panopticon.csustan.edu/cpa96/papers.htm/freedman.htm

7that want to take advantage ofthe link between environmental and financial performance to use corporate environmental performance as a criteria for selecting or screening stocks are at a disadvantage because ofthis information asymmetrymarket failure. Likewise, investors and fund managers that want to select or screen stocks based on corporate environmental performance to reflect an environmental ethic are at a disadvantage as well. EPA has an interest in correctingthis market failure. Ensuring that investors have adequate information to select superior environmental performers, or screen out poor performers, provides an incentive for corporations to improve their environmental performance. Also, facilitating this type of market-based incentive is in line with the second-generation principles discussed earlier, and a cost-effective wayto encourage improved environmental performance.
EPA also has a more direct interest in ensuring the full and fair disclosure of environmental performance information, as required by securities regulations, for the following reasons:

• Disclosure of environmental legal proceedings and violations of environmental law, and the accompanying public scrutiny, provides a specific and general deterrent to future corporate noncompliance.

• Disclosure of environmental liabilities provides corporations an incentive to address the liabilities expeditiously. It may also spur the development of innovative and lower cost remediation technologies, which supports EPA's strategic goal of restoring contaminated sites. 3~

• Disclosure of environmental performance information helps level the playing field for companies that are good environmental performers. A recent study that reviewed the impact of known, impending environmental issues on capital expenditures and future earnings of 13 publicly-traded corporations in the pulp and paper industry found a wide variation in impact. Expected financial impacts ranged from no impact, to over 10 percent oftotal shareholder equity. 32

• Disclosure of environmental performance information in periodic statements filed with the SEC raises the level ofawareness ofenvironmental issues in corporate management.

• Disclosure of environmental performance information facilitates the efficient functioning of capital markets by enabling them to account for corporate environmental performance when valuing companies. Additionally, EPA has been called upon to play a more prominent role in ensuring that the public has timely access to corporate environmental performance information. A 1999 letter to EPA Administrator, Carol Browner from the World Resources Institute calls on EPA to: 1) encourage the SEC to expand their environmental disclosure requirements, and 2) take steps to ensure that
3 L A 1997reportbyTheNational AcademyofSciencesstates that disclosureofenvironmentalliabilities provides companieswith an economicbasis forvaluingremediationtechnologies. When environmental remediationliabilities mustbe carriedon corporatebalance sheetsitprovides companies an incentiveto reducethese liabilities. Remediationtechnologiesarethen seen as value-addedtechnologiesbecause of their abilityto reducecorporate liabilities. The increasedvaluation ofremediationtechnologiesby corporationshelps to spurthe developmentofinnovative and lowercostremediationtechnologies. The reportcalls onthe SEC to enforceexistingenvironmentaldisclosurerequirementsmorevigorously. National AcademyofSciences. (1997). Innovations in GroundWater and Soil Cleanup: From Conceptto Commercialization.Washington, DC: National AcademyPress, pp. 62-67 32Repetto, Robert, and DuncanAustin. (2000). ComingClean: Corporate Disclosure ofFinancially SignificantEnvironmentalRisks. Washington, DC: World ResourcesInstitute


### 8EPA's environmental information is accurate, and available to analysts an investors in a usable forlTlat.33 Some proponents of a second-generation environmental regulatory system suggest that EPA take on an information gathering and enforcementrole similar to the SEC.34
Based on the evidence indicating an environmental information asymmetry (market failure) between publicly-traded companies and the investment community, environmental groups, and the public; and the reasons outlined above for EPA's interest in increased disclosure of corporate environmental performance information; the Agency decided to investigate compliance with SEC environmental disclosure requirements as a precursor to further action. Section IV. provides a brief overview of publicly-traded companies environmental disclosure requirements pursuant to SEC regulations. Section V. summarizes the results of a 1998 EPA study that looked at publiclytraded companies compliance with certain SEC environmental disclosure requirements. The paper wraps up with an overview of steps EPA is taking to encourage increased environmental disclosure. 

### IV. SEC Regulations RequiringEnvironmentalDisclosure Spurred by the 1929 stock market crash Congress passed the Securities Act of 1933 (1933 Act), and the Securities Exchange Act of 1934 (1934 Act). The purpose of the acts is to protect investors, and to ensure the fair and efficientfunctioning of securities markets. Congress set out a disclosure-based regulatory mechanism in both acts, requiring the disclosure ofmaterial financial and non-financial information in statements filed with the Securities and Exchange Commission (SEC).35 The 1933 Act requires companies to file a registration statement with the SEC before securities can be offered for sale to the public. The registration statement is intended to provide sufficient material information concerning the company, its financial statements, and the securities it proposes to sell, to enable investors to make an informed decision on the merits ofthe securities and whetherto purchase them.36 The 1934 Act is much broader, seeking to regulate all aspects of the subsequent public trading of securities.37 The 1934 Act requires corporate disclosure of material information when securities are registered for trading on an exchange or over the counter. This registration statement is similar to, but less extensive than that required by the 1933 Act.3s Thereafter, companies must file annual, quarterly, and other periodic reports with the SEC in order to update the original registration statement.39 Though registrations statements and periodic filings are required to present facts accurately, they do not guarantee this. However, the law does prohibit false and misleading statements. Section
33Lash, Jonathan (1999) Letterto Carol Browner,August 13, 1999 34Knopman. Op. cit. 1, p.16 35Note:The state securities regulations (blue sky laws) that existed atthetimethe '33 and '34 acts were passed implementedmerit-basedregulatorymechanisms,where state securitiesregulatorsevaluatedthe meritofsecurities offerings. Congressrejectedthis mechanismin favorofthe adopteddisclosure-based system. Hazen, Thomas Lee. (1996). The Law ofSecurities Regulation. (3rded.). St. Paul, Minnesota: West Publishing, p. 7-8 36U.S.Securities andExchangeCommission. (1998). The Work ofthe SEC. RetrievedFebruary02, 1998 fromtheWorld Wide Web: http://www.sec.gov/asec/wot.htm#genl 37The 1934Actregulatesexchanges,over-the-countermarkets, brokers and dealers. Hazen. Op. cit. 29 3SU.S.Securities and Exchange Commission. Op. cit 36 

### 39U.5. Securities and Exchange Commission. Op. cit 36, Williams p. 11 -Footnoteon othertypes of disclosurefromthe Williams article.

910(b) ofthe 1934 Act and the accompanying rule 10(b)-5 of regulation S-K make fraud, and the omission or misstatement of a material fact unlawful:° Section 17 ofthe 1933 Act also contains broad antifraud provisions and prohibits material misstatements and omissions41 Pivotal to ensuring the full and fair disclosure by SEC registrants in their periodic filings with the SEC is the definition ofthe term materiality. The Supreme Court has examined the definition of materiality in two cases. In TSC Industries, lnc. v. Northway the court examined the definition of materiality in the context of an alleged materially misleading proxy statement, in violation of §14(a) of the 1934 Act. The Court held that a fact was material "... if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.'42 They go on to state that this standard "...does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote." Instead, "... there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available.''43 In Basic, lnc. v. Levinson, the Supreme Court extended the TSC Industries definition of materiality to §10(b) of the 1934 Act and Rule 10(b)-5 of Regulation SK.44 More recently, the SEC rejected bright line tests, stressing that there are both qualitative and quantitative considerations when determining whether a fact or piece ofinformation is material 45
The rules set forth in Regulation S-K cover 1933 and 1934 Act registration statements, and all other periodic statements (e.g., annual and quarterly reports filed on Forms 10K and 10Q respectively) to be filed with the SEC by registrants as outlined in Regulation S-K.46 The three items in Regulation S-K that pertain to environmental disclosure are described below.
Item 101 - Description ofBusiness
Item 101 of Regulation S-K requires SEC registrants to describe general development of the business and any subsidiaries over the past five years47 With respect to environmental disclosure, section (c)(1)(xii) ofItem 101 requires registrants to disclose:

... the material effects that compliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge ofmaterials into the environment, or otherwise relating to the protection of the environment, may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiariesas

40 17 C.F.R. §240.10b-5 41 15 U.S.C. § 77q 42TSC Industries, Inc. v. NorthwayInc., 426 U.S. 438 (1976), 449 43Id" 44Basic, Inc. v. Levinson,485 U.S. 224 (1988) 45Securitiesand ExchangeCommission. (1999). SEC StaffAccountingBulletin No. 99 - Materiality. 17 CFR 211. Washington, DC: Securities and ExchangeCommission 46 17 C.F.R. §229.10 47 17 C.F.R. §229.101 4~ 17 C.F.R. §229.101 (c)(1)(xii)

10

### It should be noted that in Levine v. NL Industries, Inc., the court held that Item 101(c)(1)(xii) requires companiesto disclose not onlythe cost ofcomplyingwith environmentalregulations, but any material effects offailing to complywith environmentalregulations as well.49
Item 103 - Legal Proceedings
Item 103 of Regulation S-K requires registrants to disclose a factual accounting of "material pending legal proceedings, other than ordinary routine litigation incidental to the business," and "proceedings known to be contemplated by governmental authorities.''5° Instruction 5 to Item 103 requires disclosure ofenvironmental legal proceedings ~1when:
A. The proceeding is material to the registrant; B. The proceeding involves primarily a claim for damages that exceeds 10 percent of the current assets ofthe registrant and its subsidiaries; or C. A governmental entity is a party to the proceeding, and the proceeding involves potential monetary sanctions of $100,000 or more, unless the registrant reasonably believes the proceedingswill result in monetary sanctions less than $100,000:2
Instruction 5 prohibits environmental legal proceedings from being considered "ordinary routine litigation incidental to the business."
In a response to a No-Action letter, the SEC opined that costs incurred as a result of a CERCLA remedial agreement are not sanctions for the purpose of interpreting Instruction 5(c) to Item 103.53
Item 303 - Management's discussion and analysis offinancial condition and results ofoperations
Item 303 of Regulation S-K, Management's discussion and analysis (MD&A), requires registrants to provide a narrative description of financial statements to enable investors tojudge the quality of earnings, and whether past performance is indicative of future performance. The Commission'sview on MD&A is that it "is intendedto give the investor an opportunityto look at the companythrough the eyes ofmanagementby providing both a short and a long-term analysis ofthe business ofthe company.''54

49Levine v. NL Industries, Inc., 926 F.2d 199, pp. 203 -204 5o 17 C.F.R. § 229.103 5t Instruction 5 to Item 103 defines environmental legal proceedings as those "arising under any Federal, State or local provisions that have been enacted or adopted regulating the discharge ofmaterials into the environment or primary [sic] the purpose ofprotecting the environment." 17 C.F.R. § 229.103 52Id 53"While there are many ways a PRP may become subject to potential monetary sanctions, including triggering the stipulated penalty clause in a remedial agreement, the costs incurred pursuant to a remedial agreement entered into in the normal course ofnegotiation with EPA will not be viewed as "sanctions" within the meaning ofItem 103, Instruction 5(C)." The letter goes on to point out that CERCLA remedial agreement liabilities may have to be disclosed pursuant to Regulation S-K, Item 101, Instructions 5(a) and 5(b) ofItem 103, or Item 303. SEC No-Action Letter: 1989 WL 245541 (S.E.C.) 54US Securities and Exchange Commission. (1987). Concept Release on Managements Discussion and Analysis ofFinancial Conditions and Operations. Release No. 33-67 ! 1, 52 FR 13717


### 11MD&A requires a description of liquidity, capital resources, and results of operations. Registrants must also provide any "other information that the registrant believes to be necessary to an understanding of its financial condition, changes in financial condition, and results of operations.''55 In general, registrants are to describe any known material trends, demands, commitments, events, or uncertainties that will cause reported financial information to not be indicative of future results. Additionally, disclosures in other parts of the filing (e.g. pursuant to Regulation S-K, Items 101 and 103) must be discussed in the MD&A section ifthey will have an unfavorable impact on the financial condition ofthe company. 56
Of particular interest with respect to environmental disclosure is the requirement to describe "known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.''57 This requirement covers a broad array of environmental contingencies that may reasonably be expected to have a material impact on the registrants operations. Some examples of environmental contingencies that may have to be disclosed are:

• A pending change in environmental law(s) that would increase operating costs, shut down a facility, or affects the market for the company's products.

• An environmental legal proceeding that may result in material financial liabilities

• Revocation of, or the inability to obtain an operating permit, or a product registration
The holding in Levine v. NL Industries, Inc., would apply here as well. That is, a registrant would have to disclose a trend in their approach to compliance with environmental laws that is reasonably likely to result in significant effects on the corporation.58 Registrants are also encouraged to provide forward-looking information concerning liquidity, capital resources, and results of operations.59 Forward-looking information is distinguished from known facts that will have an impact on future operating results. Registrants are not held liable

55 17 C.F.R. § 229.303 56"Material facts that must be disclosedelsewhere in the filing also must be analyzed in the MD&A section ifthey have had or may have a favorable orunfavorable effectupon the amount ofnet income, the earnings trend, orthe financial condition ofthe company and its prospects." Levine v. NL Industries, Inc., 926 F.2d 199,pp. 203 -204 57 17 C.F.R. §229.303 (a) (3) (ii) 58"Disclosure ofpotential costs for violations ofenvironmental laws, ifmaterial, is ordinarily required. The SEC has stated, in the context offilings pursuant to section 13 ofthe Exchange Act (requiring periodical and other reports by specified corporations), that: ifa corporation has a policy or approach toward compliance with environmental regulations which is reasonably likelyto result in substantial fines, penalties, or other significant effectson the corporation, it may be necessary forthe registrant to disclose the likelihood and magnitude ofsuch fines, penalties and other material effects in orderto prevent from being misleading required disclosures with respectto such matters as descriptions or disclosures relating to description ofthe corporation's business, financial statements, capital expenditures for environmental compliance or legal proceedings. In re United States Steel Corp., Exchange Act ReleaseNo. 16,223, [1979-1980 Transfer Binder] Fed.Sec.L.Rep. (CCH)¶ 82,319, at 82,384 (Sept. 27, 1979)." Levine v. NL Industries, Inc., 926 F.2d 199,203 -204 59 17 C.F.R. § 229.303, Instruction 7 to paragraph 303(a)

12

### for projections made in forward-looking statements that later turn out to be incorrect, as long as they were made in good faith.6°

V. EPA Research on Disclosure ofEnvironmental Legal Proceedings 

### The Office of Planning and Policy Analysis, within EPA's Office of Enforcement and Compliance Assurance, completed a study of compliance with SEC environmental disclosure requirements in 1998.6~ Originally, the intention was to look at both the disclosure of environmental liabilities (e.g. Superfund liability) and environmental legal proceedings. However, due to the labor-intensive nature ofresearching and attributing environmental liabilities to SEC registrants, and budgetary considerations, the scope of the analysis was limited to environmental legal proceedings. The study focused on SEC registrants compliance with Regulation S-K Item 103 - Legal Proceedings, which requires registrants to disclose environmental legal proceedingswhen they meet certain criteria.
More specifically,the study focused on the disclosure of legal proceedingsthat result in monetary sanctions, as required by Instruction 5(c) to Item 103. Instruction 5(c) requires SEC registrants to disclose environmental legal proceedings that involve a government entity, when potential monetary sanctions of $100,000 or more are involved. The study examined disclosure, in registrants' 10-K statements, of civil and administrative legal proceedings involving: penalties, Supplemental Environmental Projects (SEP), and RCRA corrective actions, for calendar years 1996 and 1997. The following sections summarize how the database of legal proceedings was developed,the methodologyfor reviewing 10-K statements, and the study findings.
Database Development A separate database of legal proceedings was developed for each type of sanction reviewed in the study: penalties, SEPs, and RCRA corrective actions. The initial list of legal proceedings was derived from EPA's Enforcement Docket database (DOCKET). The study focused on 10-K reports filed for calendar years 1996 and 1997. Accordingly, the DOCKET database was queried for cases involving any ofthe sanctions in question that had a final order date during that period. The queries for civil and administrative legal proceedings were further restricted to cases that involved penalties of $100,000 or more. Likewise, the queries for legal proceedings involving SEPs and RCRA corrective actions were limited to those cases that involved five or fewer defendants, and had a total SEP or corrective action cost of $50,000 or more. Table 1 below summarizesthe results ofthe DOCKET database queries.
Table 1: Results ofDOCKET Database Queries 

### Penalties Supplemental RCRA Corrective

Environmental Projects Actions Number ofCases 253 234 492 in DOCKET Number of 318 278 725 Defendants

60Rule 3b-6 underthe Exchange Act, 17 C.F.R. §240.3b-6; and Rule 175 underthe Securities Act, 17 C.F.R. §230.175 61This studywas conductedby AbtAssociates Inc., Cambridge, Massachusetts, underContract #68-W98- 005, WA 1-07and WA-2-07.
13Number of SEC Registrants 151 90 148

The Dun & Bradstreet (D&B) database was used to determine whether defendants werepubliclytraded companies, or subsidiaries of publicly-traded companies. The first step was to associate each facility with a D&B identification number. Identification numbers were found for 69% of the facilities. Those facilities for which D&B identification numbers could not be found were not included in the study. Dun & Bradstreet's publicly-traded identifier was used to classify facilities with identification numbers as publicly-traded or not publicly-traded. Defendants with at least one facility identified as publicly traded were also classified as publicly traded. 62 Since 10-K statements of parent companies typically cover their subsidiaries as well, D&B identification numbers were also used to obtain parent company information for facilities and defendants.
10-K Review Methodology A two-step process was used to review defendants' 10-K statements to determine whether the legal proceeding in questions was correctly disclosed. First, the legal proceedings section was scanned for the case of interest. Ifthe case was found, information regarding the disclosure (e.g. amount disclosed, statute disclosed, disclosure narrative) was added to the database. If the case was not found in the legal proceedings section, a key word search was conducted on the entire 10- K statement. For penalty cases, terms such as: EPA, environment, fine, penalty, contingent(cies), and the name ofthe statute violated and its acronym were searched for. For cases involving SEPs the keyword search was expanded to include the terms: SEP, supplement, settlement, and liability(ies). For corrective action cases the following terms were added: corrective, compliance, settlement, and liability(ies). If the legal proceeding was found in a section other than the legal proceedings section, information on the disclosure and the section it occurred in was added to the database. Disclosure of legal proceedings otherthan the case ofinterest were also recorded. Findings A legal proceeding was considered to be correctly disclosed when the statute violated and the amount of the penalty, SEP, or corrective action was correctly identified, or referenced, in the legal proceedings section. Overall, correct disclosure rates were low for the two-year period 1996- 1997. Sixteen percent of civil and administrative proceedings involving penalties were correctly disclosed, while only 4% of proceedings involving SEPs and 1% of proceedings involving RCRA corrective actions were correctly disclosed. Including cases where the statute and sanction were disclosed correctly outside of the legal proceedings section increases overall disclosures rates 1-2% at best. The legal proceeding in question is disclosed with greater frequency, 26% for penalty proceedings, 16% for SEPs, and 4% for RCRA corrective actions. Complete results are summarized below in tables 2 and 3.

62Inthose instances wherethe DOCKET database listed multiple subsidiaries ofthe sameparentcompany as defendantsin a legal proceeding,theparent companywas countedas a single defendantinthe disclosure statistics.

14Table 2: Disclosure Statistics - As a Percentage of all Publicly-Traded Companies Reviewed

Type of Liability and Fiscal Year Number of

Defendant CompaniesI (Publicly Traded) Defendant

Companies Mentioning the Legal Case2 (%) Disclosure in Legal

Proceedings Section3
Statute Amount Statute Correct Correct

4 and (%) (%) Amount

Correct (%) Disclosure Outside of

Legal Proceedings Section
Statute Amount Statute Correct Correct and (%) (%) Amount

Correct (%) Disclosure in any Section
Statute Amount Statute Correct Correct and (%) (%) Amount

Correct (%)

PENAL TIES 1996 93 28% 27% 1997 43 23% 19% Both 136 26% 24% SUPPLEMENTAL ENVIRONMENTAL PROJECTS
1996 38 13% 1997 43 19% Both 8 ! 16% CORRECTIVE ACTIONS
1996 68 7% 1997 65 0% Both 133 4% 22% 20% 9% 7% 18% 16% 0%

2% <1% 0% 0% 27% 22% 20%

2% 2% 21% 12% 9% <1% <1% 25% 18% 17%

13% 5% 5% 0% 0% 0% 13% 5% 5% 7% 5% 2% 5% 0% 0% 12% 5% 2% 10% 5% 4% 2% 0% 0% 12% 5% 4%

6% 1% !% 1% 0% 0% 7% 1% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 3% <1% <1% <1% 0% 0% 4% <1% <1%

IThe numberofdefendantcompaniesfor which SEC 10-K filingswere obtained. 2In thistable, all percentages are based on the numberofpublicly-traded defendantcompaniesevaluated. 3Disclosure in other sections includedby reference in the Legal Proceedings Section are considered as disclosure in the Legal Proceedings Section when calculatingstatistics. 4An amount was considered correctly disclosed ifitwas within $1,000 ofthat mentioned in DOCKET. Table 3: Disclosure Statistics - As a Percentage of Companies Mentioning the Legal Case of Interest

Type of Liability and Fiscal Year Number of

Defendant Companies Mentioning the Legal CaseI Disclosure in Legal

Proceedings Section3
Statute Amount Correct 2 Correct

4 (%) (%) Statute

and Amount Correct (%) Disclosure Outside of Legal

Proceedings Section
Statute Amount Statute Correct Correct and (%) (%) Amount

Correct (%) Disclosure in any Section

Statute Amount Correct Correct (%) (%)

PENALTIES 1996 26 1997 10 Both 36 77% 73% 0% 0% 40% 30% 10% 10% 67% 61% 3% 3% SUPPLEMENTAL ENVIRONMENTAL PROJECTS 0% 96% 77% 73% 10% 90% 50% 40% 3% 94% 69% 64%

151996 5 1997 8 Both 13 CORRECTIVEACTIONS
1996 5 1997 0 Both 5 40% 40% 0% 0% 25% 13% 25% 0% 31% 23% 15% 0% 

# 1 1 J0. N/A N/A N/A N/A N/A 20% 20% 20% 0% 0% 0% 100% 40% 40% 0% 63% 25% 13% 0% 77% 31% 23%

0% 100% 20% 20%

N/A 100% N/A

20% N/A

20%

1 Expressed as a percentage (of all publicly traded companies reviewed) in Table A, 2 In this table, all percentages are based on the number of defendant companies mentioning the legal case. 3 Disclosure in other sections included by reference in the Legal Proceedings Section are considered as disclosure in the Legal Proceedings Section when calculating statistics. 4An amount was considered correctly disclosed ifit was within $1,000 ofthat mentioned in DOCKET.



### VI. Current Activities
In response to the findings summarized in the previous section, and the other evidence of a low level ofcompliance with SEC environmental disclosure requirements, EPA's Office of Enforcement and Compliance Assurance (OECA) has taken several steps aimed at improving corporate environmental disclosure. In January2001 OECA finalized guidance on distribution ofa notice informing publicly-traded companies oftheir duty to disclose environmental legal proceedings pursuant to SEC regulation S-K, Item 103, Instruction 5. The notice is to be distributed by EPA enforcement personnel to parties involved in administrative legal proceedings withthe Agency. The purpose ofthe notice is to inform publicly-traded companies oftheir duty to disclose environmental legal proceedings, and encouragethem to do the same. OECA also plans to update their analysis ofcorporate disclosure of environmental legal proceedings in 2001. Other EPA offices are also involved in activities related to environmental disclosure and investigating the link between financial and environmental performance. EPA's Office of PollutionPrevention and Toxics initiated the Environmental Accounting Project in 1992 to encourage industry to adopt environmental managerial cost accounting so they understand the full spectrum oftheir environmental costs. The hope is that if environmental costs arebetter understood then options such as pollution preventionwill be more attractive. The project has developed numerous case studies, benchmarks, guidance, and software tools to assist those interested in environmental accounting. EPA's Office of Policy, Economics, and Innovationhas sponsored workshops in 1999 and 2001 on capital markets and environmental performance. The purpose ofthe workshops is to assess the academic research on the link between environmental and financial performance, and identify areas that need additional research. Finally, the National Advisory Council for Environmental Policy and Technology, an independent Federal advisory committee to the EPA, formed the Environmental Capital Markets Committee to investigate the relationship between environmental and financial

16

### performance. The Environmental Capital Markets Committee authored the report, Green Dividends?: The Relationship Between Firms' Environmental Performance and Financial Performance.63 The report reviews the current state ofknowledge concerning the link between environmental and financial performance, and recommends actions EPA can take to improve access to environmental performance information, and encourage greater use ofthe same by capital markets and corporations.

63EnvironmentalCapitalMarketsCommittee.Op.cit.23 17