American Bar Association 

Section on Environment, Energy, and Resources 

Corporate Environmental Disclosure: 

Opportunities to Harness Market Forces to Improve Corporate Environmenta

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 of the author and do not necessarily represent 

official views of the 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 re

paradigm shift. There is general consensus that the Environmental Protection Agency

current regulatory structure is not capable of meeting the most pressing environmental ch

we now face at the beginning of the 21 st Century. Environmental groups, academ

Congress have been calling for a "second generation" of environmental regulation to han

21st Century environmental problems. ~ 

The United States environmental regulatory system has not changed significantly sinc

first established in the 1970s. The system was set up to address the environmental pro

the time; large industrial point sources of pollution that had previously gone unregula

standards-based system established offered the regulated community little flexibility in a

environmental performance goals, often dictating the use of specific pollution 

technologies. The system has also been criticized for focusing on end-of-pipe s

providing little incentive to the regulated community to move beyond compliance. Desp

criticisms, the command-and-control regulatory system established in the '70s was re

1 See generally: Knopman, Debra S. (1996). Second Generation -A New Strategy for Environmen

Protection. Washington, DC: Progressive Policy Institute. 

Kettl, Donald F. (1998). The Future of Environmental Regulation. Brookings Policy Brief, No. 37, 

1998. Washington, DC: The Brookings Institution. 

National Academy of Public Administration. (2000). environment.gov: Transforming Environmen

Protection for the 21 st Century. Washington, DC: National Academy Press. 

Greenwood, Jim. (1999, November 18). H.R. 3448: Second Generation of Environmental Improv

Act of 1999. Washington, DC: U.S. House of Representatives. 
for dramatic improvements in air quality, water quality, and the handling and disposal 

and hazardous substances. 2 

Though significant progress has been made, the environmental problems the US will fa

next 30 years are fundamentally different than the problems addressed by the current re

system. Sources of pollution are more dispersed (e.g. non-point source runoff from fa

urban areas that pollutes rivers and lakes, dispersed sources of ground level ozone a

precursors), and cannot be addressed with regulatory solutions targeted at large industr

sources. Addressing global problems such as reducing the production of greenhouse g

the potential to broadly impact the US economy, and affect all aspects of society. 

While acknowledging the environmental improvements attributed to the current re

system, those calling for a second generation of environmental regulation believe that th

system will not be able to address the most pressing environmental challenges in an ef

cost-effective manner. The second-generation regulatory system is envisioned as a perfo

based system, in contrast to the direct regulation of the existing standards-based system

performance-based system, regulators set environmental goals and the regulated commu

flexibility to meet those goals in the most appropriate and cost-effective manner for them

distinction of the second-generation regulatory system is that it encourages the use o

forces, where appropriate, to address environmental problems. 3 A second-gen

performance-based regulatory system also: 4 

• Encourages prioritization and goal setting to focus limited resources on the most 

environmental problems. 

• Fosters innovative approaches to addressing environmental problems; it does no

solutions. 

• Places a greater emphasis on high quality environmental information and envir

performance indicators to drive decision-making and priority setting. Informatio

seen as a tool to increase public awareness and encourage participation. 

• Proposes decentralization of environmental decision making to the most ap

level. 

Increased scrutiny of the cost of environmental regulations provides another incentive to 

more cost-effective, market-based solutions. The 106 th Congress passed the "Truth in Re

Act," which establishes a three year pilot program enabling the chairman, or ranking mem

committee of jurisdiction in either House of Congress to request the General Accountin

conduct a cost-benefit analysis of economically significant rules. 5 Using appropriatio

2 U.S. EPA Office of Policy, Planning and Evaluation. (1996). U.S. EPA's 25 th Anniversary Repor

1995. Retrieved January 17, 2001 from the World Wide Web: 

http://www.epa.gov/history/topics/25year/index.htm 

3 See generally: Hockenstein, Jeremy B., Robert N. Stavins, and Bradley W. Whitehead. (1997, Ma

Crafting the Next Generation of Market-Based Environmental Tools. Environment, pp. 14-33. 

Knopman. Op. cit. 1, p. 12 

National Academy of Public Administration. Op. cit. 1, pp. 190 - 192 

4 Knopman. Op. cit. 1, pp. 11-14 

National Academy of Public Administration. Op. cit. I, pp. 190 -194 

5 Shelby, Richard C. (2000). S. 1198, The "Truth in Regulating Act of 2000." Public law 106-312 
Congress has required the Office of Management and Budget to produce annual report

costs and benefits of all major federal regulations for years 1998-20006 Responding to th

the EPA recently released major guidance on conducting economic analyses of enviro

regulations and policies] The increased emphasis on weighing costs and benefits has he

sensitivity to the need to strike an appropriate balance between environmental and e

concerns when crafting environmental regulations and programs. One often proposed so

balancing environmental and economic policy concerns, explored in the next sectio

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 altemativ

existing standards-based system because, in theory at least, they hold out the promise 

able to achieve the same level of pollution reduction at a lower cost, or a greater level of 

reduction for the same cost. Market-based solutions are often easier to implement tha

regulation, and provide greater flexibility to the regulated community in meeting 

reduction goals. A key advantage in terms of environmental protection is that mark

solutions extend the reach of regulatory programs much further than traditional comm

control regulatory programs, g 

In order to better understand how to hamess market forces (or use economic instrum

address environmental problems, one first needs to have a basic understanding of the un

theory. Economic theory holds that in the idealized, perfectly competitive economy, 

motivated behaviors of individuals and corporations will result in efficient patterns of pr

and consumption. This equilibrium of production and consumption is efficient in the s

no one person can be made better off without making another person worse off. H

economic theory recognizes there are commonly occurring exceptions to the un

assumptions, referred to as market failures, which lead to inefficient patterns of produc

consumption .9 

6 Copies of the reports can be found on the OMB website under the heading "Regulatory Policy," 

http://www.whitehouse.gov/omb/inforeg/ (Retrieved January 16, 2001 from the World Wide Web

7 National Center for Environmental Economics, US Environmental Protection Agency (2001). Gu

for Preparing Economic Analyses. Retrieved January 16, 2001 from the World Wide Web: 

http://www.epa.gov/economics/ 

s Two additional advantages economists cite for economic instruments versus traditional command 

control regulatory systems are static efficiency and dynamic efficiency. Static efficiency (or "chea

now") denotes that companies have the flexibility to achieve emissions reductions in the cost effec

manner. Dynamic efficiency (or "cheaper in the future) denotes that economic instruments provide 

permanent incentive for emission reductions and development of new methods and technologies fo

reducing pollution. Austin, Duncan. (1999, November). Economic Instruments for Pollution Contr

Prevention - A Brief Overview. Paper presented at the "Environmental Policies for the New Mille

Incentive-based Approaches to Environmental Stewardship" conference, World Resources Institute

Washington, DC. 

9 Weimer, David L., and Aidan R. Vining. (1992). Policy Analysis: Concepts and Practice, New Je

Prentice-Hall, Chapter three. 
Two types of market failure, externalities and information asymmetry, are most releva

analyzing environmental problems and how to address them. l° Externalities arise w

actions (production or consumption) of one party result in a benefit or cost accruing 

external party that did not consent to the impact. Actions that impose a cost on outside p

classified as negative externalities. For example, a manufacturer releases pollutants into 

resulting in a degradation of water quality. Their source of drinking water impaired, dow

cities are forced to spend more money filtering river water, or finding an altemative s

drinking water. Market failure results because the manufacturer bears no cost for d

pollutants into the river; instead, costs are imposed on downstream parties that did not co

them. 

The premise for correcting the externalities market failure is to shift the cost of the exte

(e.g. pollution) from the non-consenting parties back to the generator of the externality. E

the generator bears the cost of the externality forces them to internalize these costs, an

them into their decision-making framework. The most straightforward method of addre

pollution externality problem is to alter the incentives of the externality generator by p

charge, fee, or tax on every unit of pollution released. Adjusting the level of the charge

tax over time controls the level of pollution. Another method for internalizing pollution 

to facilitate, or create a market for the externality. Tradable permits are most often used 

a market for pollution externalities. Instead of paying a pollution charge or fee, a manu

must hold a permit to release a given quantity of pollution. If additional permits are requ

can be purchased; likewise, excess permits can be sold. Capping the total number of 

available controls the level of pollution. 11 

EPA has implemented a number of successful tradable permit, or cap-and-trade system

1990 Clean Air Act amendments established a tradable permit system to reduce sulfur 

(SO2) emissions (the primary source of acid rain) from electric utilities. The CAA ame

require an annual reduction in SO2 emissions of 10 million tons from their 1980 leve

reductions are to take place in two phases; the first began in 1995 and ran through 1

second phase began in 2000. In the first phase annual SO2 emissions were reduced by 4 

tons, 12 with cost savings on the order of $1 billion annually compared with the tr

regulatory approach. The EPA also successfully used tradable permits in the '80s to ph

out of gasoline ~3 Many states have also begun implementing their own tradable permit sy

control air and water pollution. ~4 

The second type of market failure of interest is information asymmetry. Information as

refers to variations across persons in the amount and quality of information ab

characteristics of a good. Or, variations in the amount and quality of information betw

generator of an externality and those affected. For example, buyers and sellers of a go

have different levels of information about the externalities that result from the production

10 Economists generally recognize four traditional sources of market failure: public goods, monopo

externalities, and information asymmetry. 

11 Pearce, David W. and R. Kerry Tumer. (1990). Economics of Natural Resources and the Environ

Baltimore: Johns Hopkins University Press, Chapter 8. 

12 U.S. Environmental Protection Agency. (2000). Innovation at the Environmental Protection Age

Decade of Progress. Washington, DC: U.S. Environmental Protection Agency, p. 13 

13 Hockenstein, Op. cit. 3, pp. 16-17 

14 National Academy of Public Administration, Op. cir. 1, Chapter 3 

4 
consumption of a good. Market failure results because individuals are basing economic d

on incomplete or faulty information, and therefore, are unable to participate in the ma

way that best serves their interests) 5 

The premise for correcting the information asymmetry market failure is quite simple; e

parties have the same level and quality of information on which to base decisions. Th

Release Inventory (TRI) is the most well known of EPA's programs that addre

environmental information asymmetry problem. Since 1987 certain manufacturing facil

more recently electric utilities, have been required to file annual reports detailing their e

to air, land, and water of a list of chemicals: 6 Public and environmental group scrutin

information is largely credited with pushing reporting industries to significantly red

emissions of reportable chemicals. Between 1988 and 1997, air releases declined by 55 

water releases by 63 percent, underground injection and on site disposal both decreased 

percent, while off-site disposal only increased by one percent) 7 State agencies also use 

to identify pollution prevention opportunities, and as the basis for legislating a

environmental controls) 8 

EPA is undertaking many other activities to increase public access to environmental info

such as making more environmental information available on the Internet. The 1996 ame

to the Safe Drinking Water Act require water suppliers to provide consumers annual re

the quality of their drinking water. It is hoped that public access to this information will 

same salutary affect on the quality of drinking water as access to TRI information 

decreasing chemical releases. One area that is beginning to receive more attention is 

between environmental and financial performance, and how disclosure of enviro

information by publicly traded companies serves as an incentive for them to impro

environmental performance. This linkage, and EPA's interest in environmental disclo

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 

performance. More specifically, companies that are superior environmental perform

outperform their peers in the stock market: 19 

* A Boston nonprofit, Alliance for Environmental Innovation, reviewed 70 research 

in 1998, all of which found a positive relationship between environmental and 

15 Weimer, Op. cit. 8 

16 Currently, 20,000 facilities submit 80,000 reports annually listing billions of pounds of chemical 

U.S. Environmental Protection Agency. Op cit. 12, p. 33 

j7 U.S. Environmental Protection Agency. Op cit. 12, pp. 32-34 

is Id. 

19 Blumberg, Jerald, Georges Blum, and Age Korsvold. (1997). Environmental Performance and 

Shareholder Value. Geneva, Switzerland: World Business Council for Sustainable Development, S

generally Chapter 6 
performance. Companies that outperform their peers environmentally were also 

perform better on the stock market by as much as two percent 3° 

• The Storebrand Scudder Environmental Value Fund, launched in 1996, uses n

efficiency criteria to select firms that rank in the top third in environmental perf

within their industry sector. The fund grew 51 percent between 1996 and 19

outperformed the comparable Morgan Stanley international World Index by eigh

over the same period. 21 

• A 1996 study by ICF Kaiser Consulting Group that looked at 327 S&P 500 firm

that companies could push up their stock price by as much as five percent by im

their environmental performance, z2 

A recent review of the available academic research on the relationship between mea

corporate environmental performance and measures of financial performance found a m

positive relationship between the two. This positive relationship was robust as well, sho

across the studies regardless of the measures of environmental and financial performa

analytical technique, or the date of the study 23 There is also abundant anecdotal evid

financial benefits accruing to companies that take a proactive approach to enviro

management. For example, 3M claims pollution prevention activities between 1975 a

have saved the company $810 million. 24 Baxter International, a medical products manu

proactively sets environmental performance goals and documents cost saving

environmental process improvements. In its most recent environmental financial s

Baxter lists income, savings, and cost avoidance attributable to environmental initiatives 

approximately $98 million for 1999. Baxter achieved returns on environmental initi

approximately $111 million and $129 million for 1998 and 1997 respectively. 25 

Coinciding with findings of a positive relationship between environmental and 

performance is evidence of increasing demand for corporate environmental perf

information from those participating in capital markets. Between 1997 and 1999 the am

money invested in socially screened portfolios grew 183 percent, more than four times fa

overall growth in assets under management in the same period. Total assets invested gr

$529 billion in 1997 to $1,497 billion in 1999, representing over nine percent 

approximately 16.3 trillion assets under management. Eighty percent of these screen

employ an environmental screen, either screening out poor performers or including co

20 Deutsch, Claudia H. (1998, July 19). Investing It; For Wall Street, Increasing Evidence that Gree

Green. New York Times. 

21 Id., and Blumberg. Op. cit. 19, p. 23 

22 Feldman, Stanley J., Peter A. Soyka, and Paul Ameer. (1996). Does Improving a Firm's Environ

Management System and Environmental Performance Result in Higher Stock Prices? Fairfax, VA

Kaiser International, Inc. 

23 Environmental Capital Markets Committee. (2000). Green Dividends?: The Relationship Betwee

Environmental Performance and Financial Performance. Washington, DC: Office of Cooperative 

Environmental Management, U.S. EPA, p. 6 

24 Id., p. 2. Also, see generally: Blumberg. Op. cit. 19, chapter 3 and appendixl 

25 Baxter International. (2000). Environmental Financial Statement for 1999, Retrieved January 20, 

from the World Wide Web: http://www.baxter.com/investors/citizenship/environmental/index.html 

6 
with good performance or environmentally friendly products. 26 A more direct dem

information occurred in November of 2000 when 39 financial investors, managing c

assets in excess of $140 billion, sent a letter to the CEO's of the 500 largest US compani

them to begin reporting sustainability measures as defined by the Global Reporting 

(GRI). Established in 1997, GRI has developed sustainability reporting guidelines that p

framework for corporate reporting of economic, environmental, and social information. 27 

In response to requests for sustainability information from asset and fund managers, Do

introduced the Dow Jones Sustainability Index in 1999. The index tracks the ec

environmental and social performance of the top 10% of companies in the Dow Jone

index. At end of June, 2000 approximately Euro 1 billion was managed on the bas

index. 28 

Despite increasing demand for, and use of environmental performance information b

investors, there is evidence that publicly-traded companies are not complying with thei

disclose environmental information as required by securities regulations (see the f

section for a description of applicable securities regulations). Studies indicate that envir

liabilities are not completely and accurately reported to the Securities and Exchange Com

(SEC). A 1992 Price Waterhouse survey of SEC registrants found that 62 percent of resp

had not accrued known environment-related exposures on their financial statements. 29 

study of environmental disclosure by companies involved in initial public offerings, w

known CERCLA potentially responsible parties at one or more sites, found a non-repor

of 54 percent, as compared to a non-reporting rate of 61 percent for currently re

companies. 3° Additionally, a 1998 EPA study on the disclosure of environmen

proceedings by publicly-traded companies in their 10-K statements (annual reports filed 

SEC) found a non-reporting rate of 74 percent (the study is discussed in detail in section V

The disparity between demand for corporate environmental performance information, 

compliance with securities regulations requiring environmental disclosure by public

companies (arguably the most important source of corporate environmental perf

information) points to an information asymmetry market failure. Investors and fund m

26 Schueth, Steve, Alisa Gravitz, and Todd Larsen. (1999). 1999 Report on Socially Responsible In

Trends in the United States. Social Investment Forum, Section II. Retrieved December 12, 200 fro

World Wide Web: http://www.socialinvest.org/areas/research/trends/1999-Trends.htm 

27 Anon. (2000). Leading Investors Urge CEO's to Adopt New Reporting Guidelines. Press Release

Reporting Initiative, Retrieved January 20, 2001 from the World Wide Web: 

http://globalreporting.org/2qews/PressReleases/InvestorLetter.htm 

28 Dow Jones Sustainability Group. (2000). Dow Jones Sustainability Group Index Guide, Version 

Retrieved December 12, 200 from the World Wide Web: http://www.sustainabilityindex.com/news/guidebook.html 

Dow Jones Sustainability Group. (2000). Dow Jones Sustainability Group Index - FAQ. Retrieved 

20, 2001 from the World Wide Web: http://www.sustainability-index.com/faq.html 

29 Environmental Services Group, Price Waterhouse. (1992). Accounting for Environmental Comp

Crossroads of GAAP, Engineering and Government- Second Survey of Corporate America's Acc

for Environmental Costs. Pittsburgh, PA: Price Waterhouse. 

30 Freedman, Martin and A. J. Stagliano. (1996). Environmental Disclosure of Companies Involved 

Initial Public Offerings. Retrieved January 20, 2001 from the World Wide Web: 

http://panopticon.csustan.edu/cpa96/papers.htm/freedman.htm 

7 
that want to take advantage of the link between environmental and financial performanc

corporate environmental performance as a criteria for selecting or screening stocks 

disadvantage because of this information asymmetry market failure. Likewise, investors 

managers that want to select or screen stocks based on corporate environmental perform

reflect an environmental ethic are at a disadvantage as well. EPA has an interest in correc

market failure. Ensuring that investors have adequate information to select 

environmental performers, or screen out poor performers, provides an incentive for corp

to improve their environmental performance. Also, facilitating this type of mark

incentive is in line with the second-generation principles discussed earlier, and a cost-

way to encourage improved environmental performance. 

EPA also has a more direct interest in ensuring the full and fair disclosure of enviro

performance information, as required by securities regulations, for the following reasons: 

• Disclosure of environmental legal proceedings and violations of environmental 

the accompanying public scrutiny, provides a specific and general deterrent t

corporate noncompliance. 

• Disclosure of environmental liabilities provides corporations an incentive to add

liabilities expeditiously. It may also spur the development of innovative and lo

remediation technologies, which supports EPA's strategic goal of restoring conta

sites. 3~ 

• Disclosure of environmental performance information helps level the playing 

companies that are good environmental performers. A recent study that revie

impact of known, impending environmental issues on capital expenditures an

earnings of 13 publicly-traded corporations in the pulp and paper industry found 

variation in impact. Expected financial impacts ranged from no impact, to 

percent of total shareholder equity. 32 

• Disclosure of environmental performance information in periodic statements fi

the SEC raises the level of awareness of environmental issues in corporate manag

• Disclosure of environmental performance information facilitates the efficient fun

of capital markets by enabling them to account for corporate environmental perf

when valuing companies. 

Additionally, EPA has been called upon to play a more prominent role in ensuring that th

has timely access to corporate environmental performance information. A 1999 letter 

Administrator, Carol Browner from the World Resources Institute calls on EPA to: 1) en

the SEC to expand their environmental disclosure requirements, and 2) take steps to en

3 L A 1997 report by The National Academy of Sciences states that disclosure of environmental liabi

provides companies with an economic basis for valuing remediation technologies. When environm

remediation liabilities must be carried on corporate balance sheets it provides companies an incenti

reduce these liabilities. Remediation technologies are then seen as value-added technologies becau

their ability to reduce corporate liabilities. The increased valuation of remediation technologies by 

corporations helps to spur the development of innovative and lower cost remediation technologies. 

report calls on the SEC to enforce existing environmental disclosure requirements more vigorously

National Academy of Sciences. (1997). Innovations in Ground Water and Soil Cleanup: From Con

Commercialization. Washington, DC: National Academy Press, pp. 62-67 

32 Repetto, Robert, and Duncan Austin. (2000). Coming Clean: Corporate Disclosure of Financially 

Significant Environmental Risks. Washington, DC: World Resources Institute 

8 
EPA's environmental information is accurate, and available to analysts an investors in 

forlTlat. 33 Some proponents of a second-generation environmental regulatory system sug

EPA take on an information gathering and enforcement role similar to the SEC. 34 

Based on the evidence indicating an environmental information asymmetry (market 

between publicly-traded companies and the investment community, environmental gro

the public; and the reasons outlined above for EPA's interest in increased disclosure of c

environmental performance information; the Agency decided to investigate compliance w

environmental disclosure requirements as a precursor to further action. Section IV. pr

brief overview of publicly-traded companies environmental disclosure requirements pur

SEC regulations. Section V. summarizes the results of a 1998 EPA study that looked at p

traded companies compliance with certain SEC environmental disclosure requiremen

paper wraps up with an overview of steps EPA is taking to encourage increased enviro

disclosure. 

IV. SEC Regulations Requiring Environmental Disclosure 

Spurred by the 1929 stock market crash Congress passed the Securities Act of 1933 (19

and the Securities Exchange Act of 1934 (1934 Act). The purpose of the acts is to 

investors, and to ensure the fair and efficient functioning of securities markets. Congress 

disclosure-based regulatory mechanism in both acts, requiring the disclosure of material 

and non-financial information in statements filed with the Securities and Exchange Com

(SEC). 35 The 1933 Act requires companies to file a registration statement with the SE

securities can be offered for sale to the public. The registration statement is intended to 

sufficient material information concerning the company, its financial statements, 

securities it proposes to sell, to enable investors to make an informed decision on the mer

securities and whether to purchase them. 36 The 1934 Act is much broader, seeking to reg

aspects of the subsequent public trading of securities. 37 The 1934 Act requires c

disclosure of material information when securities are registered for trading on an exch

over the counter. This registration statement is similar to, but less extensive than that req

the 1933 Act. 3s Thereafter, companies must file annual, quarterly, and other periodic repo

the SEC in order to update the original registration statement. 39 

Though registrations statements and periodic filings are required to present facts accurat

do not guarantee this. However, the law does prohibit false and misleading statements. 

33 Lash, Jonathan (1999) Letter to Carol Browner, August 13, 1999 

34 Knopman. Op. cit. 1, p.16 

35Note: The state securities regulations (blue sky laws) that existed at the time the '33 and '34 acts 

passed implemented merit-based regulatory mechanisms, where state securities regulators evaluate

merit of securities offerings. Congress rejected this mechanism in favor of the adopted disclosure-

system. Hazen, Thomas Lee. (1996). The Law of Securities Regulation. (3 rd ed.). St. Paul, Minneso

West Publishing, p. 7-8 

36U.S. Securities and Exchange Commission. (1998). The Work of the SEC. Retrieved February 02

from the World Wide Web: http://www.sec.gov/asec/wot.htm#genl 

37 The 1934 Act regulates exchanges, over-the-counter markets, brokers and dealers. Hazen. Op. ci

3SU.S. Securities and Exchange Commission. Op. cit 36 

39U.5. Securities and Exchange Commission. Op. cit 36, Williams p. 11 -Footnote on other types o

disclosure from the Williams article. 

9 
10(b) of the 1934 Act and the accompanying rule 10(b)-5 of regulation S-K make fraud, 

omission or misstatement of a material fact unlawful: ° Section 17 of the 1933 Act also c

broad antifraud provisions and prohibits material misstatements and omissions 41 

Pivotal to ensuring the full and fair disclosure by SEC registrants in their periodic filings 

SEC is the definition of the term materiality. The Supreme Court has examined the defi

materiality in two cases. In TSC Industries, lnc. v. Northway the court examined the defin

materiality in the context of an alleged materially misleading proxy statement, in viol

§14(a) of the 1934 Act. The Court held that a fact was material "... if there is a su

likelihood that a reasonable shareholder would consider it important in deciding how to 

They go on to state that this standard "...does not require proof of a substantial likelih

disclosure of the omitted fact would have caused the reasonable investor to change hi

Instead, "... there must be a substantial likelihood that the disclosure of the omitted fac

have been viewed by the reasonable investor as having significantly altered the "total 

information made available. ''43 In Basic, lnc. v. Levinson, the Supreme Court extended 

Industries definition of materiality to § 10(b) of the 1934 Act and Rule 10(b)-5 of Regul

K. 44 More recently, the SEC rejected bright line tests, stressing that there are both qualita

quantitative considerations when determining whether a fact or piece of information is ma

The rules set forth in Regulation S-K cover 1933 and 1934 Act registration statements

other periodic statements (e.g., annual and quarterly reports filed on Forms 10K a

respectively) to be filed with the SEC by registrants as outlined in Regulation S-K. 46 T

items in Regulation S-K that pertain to environmental disclosure are described below. 

Item 101 - Description of Business 

Item 101 of Regulation S-K requires SEC registrants to describe general developmen

business and any subsidiaries over the past five years 47 With respect to enviro

disclosure, section (c)(1)(xii) of Item 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 of materials 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 subsidiaries as 

40 17 C.F.R. § 240.10b-5 

41 15 U.S.C. § 77q 

42TSC Industries, Inc. v. Northway Inc., 426 U.S. 438 (1976), 449 

43Id" 

44 Basic, Inc. v. Levinson, 485 U.S. 224 (1988) 

45Securities and Exchange Commission. (1999). SEC Staff Accounting Bulletin No. 99 - Materiali

CFR 211. Washington, DC: Securities and Exchange Commission 

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

requires companies to disclose not only the cost of complying with environmental regulat

any material effects of failing to comply with environmental regulations as well. 49 

Item 103 - Legal Proceedings 

Item 103 of Regulation S-K requires registrants to disclose a factual accounting of "

pending legal proceedings, other than ordinary routine litigation incidental to the busine

"proceedings known to be contemplated by governmental authorities. ''5° Instruction 5 

103 requires disclosure of environmental legal proceedings ~1 when: 

A. The proceeding is material to the registrant; 

B. The proceeding involves primarily a claim for damages that exceeds 10 percen

current assets of the registrant and its subsidiaries; or 

C. A governmental entity is a party to the proceeding, and the proceeding involves p

monetary sanctions of $100,000 or more, unless the registrant reasonably beli

proceedings will result in monetary sanctions less than $100,000:2 

Instruction 5 prohibits environmental legal proceedings from being considered "ordinary 

litigation incidental to the business." 

In a response to a No-Action letter, the SEC opined that costs incurred as a result of a C

remedial agreement are not sanctions for the purpose of interpreting Instruction 5(c) 

103. 53 

Item 303 - Management's discussion and analysis of financial condition and results of ope

Item 303 of Regulation S-K, Management's discussion and analysis (MD&A), 

registrants to provide a narrative description of financial statements to enable investors 

the quality of earnings, and whether past performance is indicative of future performan

Commission's view on MD&A is that it "is intended to give the investor an opportunity t

the company through the eyes of management by providing both a short and a long-term 

of the business of the company. ''54 

49 Levine 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 Fe

State or local provisions that have been enacted or adopted regulating the discharge of materials int

environment or primary [sic] the purpose of protecting the environment." 17 C.F.R. § 229.103 

52 Id 

53 "While there are many ways a PRP may become subject to potential monetary sanctions, includin

triggering the stipulated penalty clause in a remedial agreement, the costs incurred pursuant to a rem

agreement entered into in the normal course of negotiation with EPA will not be viewed as "sanctio

within the meaning of Item 103, Instruction 5(C)." The letter goes on to point out that CERCLA re

agreement liabilities may have to be disclosed pursuant to Regulation S-K, Item 101, Instructions 5

5(b) of Item 103, or Item 303. SEC No-Action Letter: 1989 WL 245541 (S.E.C.) 

54 US Securities and Exchange Commission. (1987). Concept Release on Managements Discussion 

Analysis of Financial Conditions and Operations. Release No. 33-67 ! 1, 52 FR 13717 

11 
MD&A requires a description of liquidity, capital resources, and results of operations. Re

must also provide any "other information that the registrant believes to be necessar

understanding of its financial condition, changes in financial condition, and re

operations. ''55 In general, registrants are to describe any known material trends, d

commitments, events, or uncertainties that will cause reported financial information to 

indicative of future results. Additionally, disclosures in other parts of the filing (e.g. pur

Regulation S-K, Items 101 and 103) must be discussed in the MD&A section if they will 

unfavorable impact on the financial condition of the company. 56 

Of particular interest with respect to environmental disclosure is the requirement to 

"known trends or uncertainties that have had or that the registrant reasonably expects wil

material favorable or unfavorable impact on net sales or revenues or income from co

operations. ''57 This requirement covers a broad array of environmental contingencies t

reasonably be expected to have a material impact on the registrants operations. Some e

of environmental contingencies that may have to be disclosed are: 

• A pending change in environmental law(s) that would increase operating co

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 registrat

The holding in Levine v. NL Industries, Inc., would apply here as well. That is, a r

would have to disclose a trend in their approach to compliance with environmental law

reasonably likely to result in significant effects on the corporation. 58 

Registrants are also encouraged to provide forward-looking information concerning l

capital resources, and results of operations. 59 Forward-looking information is distinguish

known facts that will have an impact on future operating results. Registrants are not he

55 17 C.F.R. § 229.303 

56 "Material facts that must be disclosed elsewhere in the filing also must be analyzed in the MD&A 

if they have had or may have a favorable or unfavorable effect upon the amount of net income, the 

trend, or the financial condition of the company and its prospects." Levine v. NL Industries, Inc., 9

199, pp. 203 -204 

57 17 C.F.R. § 229.303 (a) (3) (ii) 

58 "Disclosure of potential costs for violations of environmental laws, if material, is ordinarily requ

SEC has stated, in the context of filings pursuant to section 13 of the Exchange Act (requiring perio

and other reports by specified corporations), that: ifa corporation has a policy or approach toward 

compliance with environmental regulations which is reasonably likely to result in substantial fines, 

penalties, or other significant effects on the corporation, it may be necessary for the registrant to di

the likelihood and magnitude of such fines, penalties and other material effects in order to prevent 

being misleading required disclosures with respect to such matters as descriptions or disclosures re

description of the corporation's business, financial statements, capital expenditures for environmen

compliance or legal proceedings. In re United States Steel Corp., Exchange Act Release No. 16,22

[ 1979-1980 Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 82,319, at 82,384 (Sept. 27, 1979)." Levine 

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 

they were made in good faith. 6° 

V. EPA Research on Disclosure of Environmental Legal Proceedings 

The Office of Planning and Policy Analysis, within EPA's Office of Enforcem

Compliance Assurance, completed a study of compliance with SEC environmental di

requirements in 1998. 6~ Originally, the intention was to look at both the disclo

environmental liabilities (e.g. Superfund liability) and environmental legal proc

However, due to the labor-intensive nature of researching and attributing environmental l

to SEC registrants, and budgetary considerations, the scope of the analysis was lim

environmental legal proceedings. The study focused on SEC registrants complian

Regulation S-K Item 103 - Legal Proceedings, which requires registrants to 

environmental legal proceedings when they meet certain criteria. 

More specifically, the study focused on the disclosure of legal proceedings that result in m

sanctions, as required by Instruction 5(c) to Item 103. Instruction 5(c) requires SEC regis

disclose environmental legal proceedings that involve a government entity, when p

monetary sanctions of $100,000 or more are involved. The study examined disclo

registrants' 10-K statements, of civil and administrative legal proceedings involving: p

Supplemental Environmental Projects (SEP), and RCRA corrective actions, for calend

1996 and 1997. The following sections summarize how the database of legal proceedi

developed, the methodology for reviewing 10-K statements, and the study findings. 

Database Development 

A separate database of legal proceedings was developed for each type of sanction reviewe

study: penalties, SEPs, and RCRA corrective actions. The initial list of legal proceedi

derived from EPA's Enforcement Docket database (DOCKET). The study focused o

reports filed for calendar years 1996 and 1997. Accordingly, the DOCKET database was 

for cases involving any of the sanctions in question that had a final order date during tha

The queries for civil and administrative legal proceedings were further restricted to ca

involved penalties of $100,000 or more. Likewise, the queries for legal proceedings in

SEPs and RCRA corrective actions were limited to those cases that involved five o

defendants, and had a total SEP or corrective action cost of $50,000 or more. Table 

summarizes the results of the DOCKET database queries. 

Table 1: Results of DOCKET Database Queries 

Penalties Supplemental RCRA Corrective 

Environmental Projects Actions 

Number of Cases 253 234 492 

in DOCKET 

Number of 318 278 725 

Defendants 

60 Rule 3b-6 under the Exchange Act, 17 C.F.R. § 240.3b-6; 

and Rule 175 under the Securities Act, 17 C.F.R. § 230.175 

61 This study was conducted by Abt Associates Inc., Cambridge, Massachusetts, under Contract #68

005, WA 1-07 and WA-2-07. 

13 
Number of SEC 

Registrants 

151 90 148 

The Dun & Bradstreet (D&B) database was used to determine whether defendants were p

traded companies, or subsidiaries of publicly-traded companies. The first step was to a

each facility with a D&B identification number. Identification numbers were found for 

the facilities. Those facilities for which D&B identification numbers could not be found 

included in the study. Dun & Bradstreet's publicly-traded identifier was used to classify f

with identification numbers as publicly-traded or not publicly-traded. Defendants with 

one facility identified as publicly traded were also classified as publicly traded. 62 Sinc

statements of parent companies typically cover their subsidiaries as well, D&B ident

numbers were also used to obtain parent company information for facilities and defendant

10-K Review Methodology 

A two-step process was used to review defendants' 10-K statements to determine whe

legal proceeding in questions was correctly disclosed. First, the legal proceedings sec

scanned for the case of interest. If the case was found, information regarding the disclos

amount disclosed, statute disclosed, disclosure narrative) was added to the database. If 

was not found in the legal proceedings section, a key word search was conducted on the en

K statement. For penalty cases, terms such as: EPA, environment, fine, penalty, continge

and the name of the statute violated and its acronym were searched for. For cases involvi

the keyword search was expanded to include the terms: SEP, supplement, settleme

liability(ies). For corrective action cases the following terms were added: corrective, com

settlement, and liability(ies). If the legal proceeding was found in a section other than 

proceedings section, information on the disclosure and the section it occurred in was adde

database. Disclosure of legal proceedings other than the case of interest were also recorde

Findings 

A legal proceeding was considered to be correctly disclosed when the statute violated 

amount of the penalty, SEP, or corrective action was correctly identified, or referenced

legal proceedings section. Overall, correct disclosure rates were low for the two-yea

1996- 1997. Sixteen percent of civil and administrative proceedings involving penalt

correctly disclosed, while only 4% of proceedings involving SEPs and 1% of proc

involving RCRA corrective actions were correctly disclosed. Including cases where th

and sanction were disclosed correctly outside of the legal proceedings section increases 

disclosures rates 1-2% at best. The legal proceeding in question is disclosed with 

frequency, 26% for penalty proceedings, 16% for SEPs, and 4% for RCRA corrective 

Complete results are summarized below in tables 2 and 3. 

62 In those instances where the DOCKET database listed multiple subsidiaries of the same parent co

as defendants in a legal proceeding, the parent company was counted as a single defendant in the di

statistics. 

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

Type of 

Liability 

and 

Fiscal 

Year 

Number of 

Defendant 

Companies I 

(Publicly 

Traded) 

Defendant 

Companies 

Mentioning 

the Legal 

Case 2 

(%) 

Disclosure in Legal 

Proceedings Section 3 

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 Sect

Statute Amount Sta

Correct Correct a

(%) (%) Am

Co

(

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% 1

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% <

I The number of defendant companies for which SEC 10-K filings were obtained. 

2 

In this table, all percentages are based on the number of publicly-traded defendant companies evaluated. 

3Disclosure in other sections included by reference in the Legal Proceedings Section are considered as disclosure in the Legal 

Proceedings Section when calculating statistics. 

4 

An amount was considered correctly disclosed if it was within $1,000 of that 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 

Case I 

Disclosure in Legal 

Proceedings Section 3 

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% 

15 
1996 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 J 0. N/A N/A N/A N/A N/A 

20% 20% 20% 0% 0% 

0% 100% 40% 

0% 63% 25% 

0% 77% 31% 

0% 100% 20% 

N/A 

100% 

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 L

Proceedings Section when calculating statistics. 

4 

An amount was considered correctly disclosed if it was within $1,000 of that mentioned in DOCKET. 

VI. Current Activities 

In response to the findings summarized in the previous section, and the other evide

a low level of compliance with SEC environmental disclosure requirements, EPA'

Office of Enforcement and Compliance Assurance (OECA) has taken several steps 

at improving corporate environmental disclosure. In January 2001 OECA finalize

guidance on distribution of a notice informing publicly-traded companies of their d

disclose environmental legal proceedings pursuant to SEC regulation S-K, Item 10

Instruction 5. The notice is to be distributed by EPA enforcement personnel to par

involved in administrative legal proceedings with the Agency. The purpose of the 

is to inform publicly-traded companies of their duty to disclose environmental lega

proceedings, and encourage them to do the same. OECA also plans to update their 

analysis of corporate disclosure of environmental legal proceedings in 2001. 

Other EPA offices are also involved in activities related to environmental disclosu

investigating the link between financial and environmental performance. EPA's O

of Pollution Prevention and Toxics initiated the Environmental Accounting Projec

1992 to encourage industry to adopt environmental managerial cost accounting so 

understand the full spectrum of their environmental costs. The hope is that if 

environmental costs are better understood then options such as pollution preventio

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 Innovation has sponsored workshops in 1

and 2001 on capital markets and environmental performance. The purpose of the 

workshops is to assess the academic research on the link between environmental a

financial performance, and identify areas that need additional research. Finally, th

National Advisory Council for Environmental Policy and Technology, an independ

Federal advisory committee to the EPA, formed the Environmental Capital Market

Committee to investigate the relationship between environmental and financial 

16 
performance. The Environmental Capital Markets Committee authored the report, 

Dividends?: The Relationship Between Firms' Environmental Performance and Fin

Performance. 63 The report reviews the current state of knowledge concerning the l

between environmental and financial performance, and recommends actions EPA c

take to improve access to environmental performance information, and encourage g

use of the same by capital markets and corporations. 

63 Environmental Capital Markets Committee. Op. cit. 23 

17