Guest Article by WCEL member Warren G Lavey
University of Illinois
This piece first appeared in 33 The Environmental Forum 25 (March/April 2016)
Purchasers of products and services increasingly value suppliers’ environmental impacts. Environmentally motivated purchases affect corporate earnings, positively for environmental leaders and negatively for heavy polluters. Buyers’ preferences also direct companies’ operations toward lower life cycle costs (including environmental externalities), risks to ecosystems and harms to public health. While U.S. securities laws require publicly held companies to disclose material threats to earnings, companies generally fail to describe in their regulated filings important aspects of their environmental footprints influencing purchasers.
Securities and Exchange Commission (SEC) filings should reveal more on companies’ strengths and weaknesses with regard to the major environmental certifications and metrics which move purchasers. Such disclosures would inform investors and purchasers, improve the trustworthiness of environmental indicators, and incentivize companies to lighten their footprints. This article describes growing environmental purchasing preferences, summarizes relevant disclosure obligations under existing SEC regulations, points to benefits from describing environmental certifications and metrics in SEC filings, and samples a few SEC and non-SEC filings for such information.
Environmental purchasing preferences favor lower emissions and sustainable uses of natural resources. Mobilizing purchasers supplements environmental legislation and regulations. To illustrate, several large food retailers and processors require fish and agricultural producers to achieve certifications of sustainable operations, which go beyond compliance with U.S. Department of Agriculture and Food and Drug Administration regulations. Next, over 400 global consumer goods companies, representing 60% of palm oil trade, made zero deforestation commitments at the UN 2014 Climate Summit. Similarly, a State of Illinois procurement of delivery services required participation in an EPA program and assigned 20% of the evaluation points on the bidders’ carbon dioxide emissions from vehicles, actions to reduce fuel consumption, and uses of non-petroleum fuels and recyclable packaging. When the federal General Services Administration required bidders to participate in an EPA program and monetized the social costs of their greenhouse gas emissions, it observed: “Approximately 90% of federal agencies’ carbon footprint lies in the products and services they purchase”.
Three key elements of environmental purchasing are: information on vendors’ and products’ impacts; buyers’ willingness, to some significant extent, to pay more or reform buying practices to reduce environmental costs; and pressuring suppliers to improve their footprints. Several public boycotts mobilized buyers in reaction to environmental crises, such as targeting BP after the Deepwater Horizon oil spill or naming firms for rainforest destruction. Buyers along with investors pressured companies to restore wetlands and forests. Going beyond headlines, many buyers compare vendors on their energy and water intensity; achievements and plans in cutting fossil fuels and landfill waste; methods of harvesting natural resources; and safeguards in sensitive habitats.
Leading companies voluntarily disclose environmental indicators through corporate sustainability reports and databases, responding to large investors and rating organizations. Some efforts have made substantial progress in disseminating environmental information. However, many companies do not publicly disclose aspects of their environmental performance which purchasers find important. Also, the coverage, methods and metrics of such disclosures differ.
The U.S. federal government and other organizations are addressing the marketplace information deficits in several ways helpful for purchasers. For example, the EPA, Department of Energy and Department of Agriculture administer efficiency certifications and publish standardized measures for electrical products, chemically intensive products, water using products, vehicles and biobased products. Additionally, private sector organizations have extensive experience with sector-specific sustainability standards, such as Forest Stewardship Council International and other organizations for forest products, Green Electronics Council for electronic products, U.S. Green Building Council for commercial offices and other buildings, and Green Seal for cleaning products. Other organizations, like Global Reporting Initiative and Sustainable Purchasing Leadership Council, provide guidance, methodologies, and rankings.
In the past, purchasers – even those motivated to apply environmental preferences – spent trillions of dollars annually without information to guide them on vendors’ and products’ environmental footprints. This market condition is changing, with growing availability of information to buyers, analytic tools, and commitments to apply preferences. These changes raise the likelihood that companies’ environmental performance affects their earnings.
Turning now to the Securities Act of 1933 and the Securities Exchange Act of 1934, publicly held companies must disclose information that is “material” to potential investors and existing shareholders. Information is classified as material based on its relevance to understanding the past, current and future value and performance of their securities. Companies must disclose material information, avoiding material misstatements or omissions. SEC filings are subject to certification by executives, independent audits, and agency staff review; companies face liability for their disclosures In criminal, agency and private actions.
Securities filings have long addressed environmental issues such as liability for cleanups, financial and operational exposure in complying with regulations, risks of fines and other penalties for violating laws, and business opportunities from regulations. However, under existing SEC regulations, the scope of required disclosures should be expanding as customers as well as investors and communities apply environmental preferences.
Parts of SEC Regulation S-K and Rule 10b-5 deserve description here. Regulation S-K provides instructions for disclosures in company registration statements (for new securities), periodic reports, reports of extraordinary occurrences, and proxy statements. In describing its business pursuant to Item 101(c), the company must discuss its principal products and services; the dependence of a business segment on one or a few customers; competitive conditions in the business; and material effects of compliance with federal, state and local environmental provisions. Regarding competitive conditions, the regulation directs the company to identify and explain whether one or a small number of competitors is dominant in the industry, the principal methods of competition (e.g., price, service, warranty or product performance), and positive and negative factors pertaining to the competitive position of the company. Also, regarding compliance with environmental provisions, the disclosure should address the material effects “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”.
Two other provisions of Regulation S-K pertain to purchasing preferences. Item 303 requires management description and analysis of any known trends, events, or uncertainties that will or are “reasonably likely” to result in favorable or unfavorable material effects on the company’s liquidity, capital resources, or operating results, such as net sales, revenues, or costs from continuing operations. Item 503(c) requires a concise statement of risk factors, often including changes in the competitive landscape or market demand, and other variations in business conditions that may damage capital formation or financial performance.
Under Rule 10b-5, it is unlawful for any person directly or indirectly to “make any untrue statement of a material fact or to omit to state a material fact”. The Supreme Court held that materiality depends on the significance that the reasonable investor would place on the item in light of the total mix of information available. According to a 1999 SEC staff accounting bulletin, a misstatement or omission may be material even if it has less than a 5% impact on earnings, if it is probable that the judgment of a reasonable person relying on the report would have been changed by the inclusion or correction of the item.
In 2010 guidance on climate change, the SEC pointed to disclosure obligations when a company’s environmental footprint damages its reputation. After discussing potential direct business impacts of climate change, the agency addressed disclosing indirect consequences: “Depending on the nature of a registrant’s business and its sensitivity to public opinion, a registrant may have to consider whether the public’s perception of any publicly available data relating to its greenhouse gas emissions could expose it to potential adverse consequences to its business operations or financial condition resulting from reputational damage.”
As customers prioritize products’ environmental impacts in selecting vendors, the link between companies’ footprints and their earnings strengthens. The growing magnitude of this link increases the grounds for environmental disclosures under the securities laws. Consider three scenarios which may warrant disclosures in SEC filings in light of environmentally motivated purchasers.
First, a leading buyer or group of buyers requires, or strongly prefers, suppliers to achieve certain environmental certifications. To illustrate, Executive Order 13693 (“Planning for Federal Sustainability in the Next Decade”, 2015) directs U.S. federal agencies – large customers for many businesses – to include certain “environmental performance and sustainability factors … to the maximum extent practicable for all procurements”. The preferences include products designated by EPA for recycled content; energy and water efficiency (ENERGY STAR qualified or WaterSense certified); alternatives to ozone-depleting substances (Significant New Alternative Policy designated); chemically safer ingredients (Safer Choice labeled); and fuel efficient trucks (SmartWay Transport partners). The Executive Order’s acquisition standards also apply to products designated by the Department of Agriculture as BioPreferred and biobased, and products identified by the Department of Energy’s Federal Energy Management Program.
Similarly, suppliers to many state, county and municipal governments face environmental purchasing preferences. Examples include government entities applying the Green Electronics Council’s EPEAT standard in selecting computer hardware products – California, Colorado, Illinois, Massachusetts, New York, Ohio, Pennsylvania, and Washington as well as the cities of Phoenix, San Francisco, San Jose, Santa Clarita, and Seattle (as of mid-2015).
Vendors to many large corporations must achieve environmental certifications: companies committed to buying products certified by the Roundtable on Sustainable Palm Oil include Johnson & Johnson, H J Heinz, Hershey, ConAgra, General Mills, Mars, Wal-Mart, McDonald’s, PepsiCo, Procter & Gamble, and Colgate-Palmolive; Hewlett-Packard, Lowe’s, and Home Depot (each moving goods over 500 million miles annually) selected high-performing EPA SmartWay carriers for 98% of their shipments; Kimberly-Clark announced a goal of by 2025 sourcing 90% of all fiber from “environmentally preferable sources,” such as Forest Stewardship Council-certified or recycled fiber; Target committed to purchasing 100% sustainable, traceable seafood based on the Monterey Bay Aquarium’s Seafood Watch Program certification; and McKesson adopted EPEAT registration in selecting personal computers.
Vendors may have SEC disclosure obligations to describe large purchasers’ environmental preferences. Governments’ environmental purchasing standards or preferences (in legislation, regulations, executive orders, or other means) may fall within the section of Regulation S-K, Item 101(c) addressing material effects on a company of compliance with federal, state, and local environmental provisions — “provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment …”. More generally, large purchasers’ standards may significantly influence the earnings of their current suppliers as well as companies vying to sell to them. Vendors lacking the applicable certification may lose the business, or have to achieve the certification by incurring higher capital and operating costs. In contrast, such announcements may lead qualified vendors to expect decreased price competition and stronger demand. The earnings impacts could expand to other sales when announcements originate from buyers viewed as market leaders.
As a second scenario, one or more leading competitors in a market segment improve their attractiveness to environmentally motivated buyers by announcing they achieved, or are committed to achieving, a certification. Such environmental indicator may significantly affect the earnings of the holder (positively) as well as its uncertified competitors (negatively).
Vendors obtain and promote environmental certifications in many markets: 18% of global palm oil production was RSPO certified as of October 2014; more than 20,000 building projects worldwide representing 2.9 billion square feet of space were certified by the USGBC’s Leadership in Energy and Environmental Design standards in 2013; and EPA SmartWay carriers accounted for 22% of U.S. trucking miles in 2014. Some certifications identify market segment leaders; for example, Forest Stewardship Council leadership awards in 2014 highlighted one or two companies in forest land managing, paper manufacturing, wood product manufacturing, tissue products manufacturing, and lumber retailing.
Under Regulation S-K for securities disclosures, an environmental certification may emerge as a significant method of competition, factor affecting the competitive position of companies, or trend reasonably likely to affect operating results. One or more competitors that are likely to benefit materially from such status may need to inform investors of the criteria for such certification, likely effects on buyers, how distinctive its achievement is likely to remain, and costs of maintaining the certification. In making such disclosures, potential securities liability encourages companies to submit truthful information to certifying organizations. From the opposite perspective, a company lacking a certification held by some of its competitors may have to inform investors of such market condition, likely effects on buyers, and any plans it has to achieve such status along with major impacts on operations and costs.
Of course, there are numerous eco-labels and recognitions, and not all environmental certifications are likely to affect competition significantly. Competitively irrelevant environmental claims or awards should not clutter and distract from material information in securities filings. The demarcation turns on the extent to which potential customers or investors are likely to be influenced by a company’s environmental certification.
Another reason for securities disclosures to address environmental certifications deals with investors who see marketing information or news coverage highlighting a company’s environmental credential. In deciding whether to buy a stock, how much weight should investors give to an environmental certification held by one company but not by a competitor? What are the likely impacts on earnings and risks? Securities disclosures are intended to give investors analyses by companies’ managers covering important competitive factors. As environmental purchasing grows, so too should SEC disclosures of material environmental certifications. Additionally, SEC disclosures are subject to standards and penalties which is tougher than those applicable to corporate sustainability reports, marketing materials or press releases. Reflecting environmental claims in SEC filings would raise the reliability of such information. Currently, many environmental claims are not subject to independent third-party verification, rigorous monitoring systems or attention from senior company executives. Moreover, the claims may be misleading or present an incomplete picture.
As a third scenario for SEC disclosures, influential organizations announce from time to time new certification standards, ratings or reporting requests. To illustrate, purchasers reacted strongly when EPA pointed to Volkswagen’s false reporting of vehicle emissions in 2015, which contributed to investors’ shunning of the company’s stock. As shown by the State of Illinois contract noted above, some truck carriers which drop in EPA’s SmartWay rating risk early termination of contracts by certain purchasers. Among other changes in environmental certifications in 2013-15 are: EPA revised fuel economy figures for 12 vehicles; USGBC, intending to raise the bar, announced a new LEED rating system for buildings; Green Seal updated its standard for cleaning services; and GRI revised its Sustainability Reporting Guidelines.
To sort through the proliferation of developments in environmental certifications and reports, the relevant threshold is likelihood of affecting reasonable investors, such as a material impact on companies’ earnings. A new certification or rating likely to significantly affect customers’ purchases would warrant SEC disclosure. Similarly, changing an environmental rating that is an important factor in competitive positioning would make an SEC disclosure reasonable.
For governments and environmental organizations, inclusion in securities disclosures would raise their certifications’ visibility to investors and customers, spur companies to decrease their environmental impacts, and encourage companies to submit truthful data for ratings. To qualify as a material certification, ratings organizations must focus purchasers on the importance of their environmental indicators. More environmentally motivated purchasing means that certifications cause more material market impacts, leading to more securities disclosures. While the likely market response should determine which certification developments justify SEC disclosure, environmentalists’ ratings must credibly and reliably weigh various attributes of products and vendors.
The preceding sections showed that purchasing standards and preferences likely make environmental certifications and metrics material for some vendors, requiring securities disclosures under existing regulations. Turning to a small sample of recent SEC annual reports (2014 Form 10-K), some companies made such disclosures; this information fit with descriptions of strategy, competition, environmental matters and risks. On the other hand, a limited sampling also found companies that described their environmental certifications and market developments only in publications not filed with the SEC. Four cases discussed below demonstrate the feasibility of securities disclosures and gaps between SEC-filed information and other information provided to investors and purchasers. There is no intention to allege any securities law violations or claim a systematic survey.
First, KB Home’s SEC annual report described the strategy of differentiating this homebuilder from competitors through its ongoing commitment to become a national leader in environmental sustainability. This securities filing pointed to the company’s commitments to meet EPA ENERGY STAR and Watersense standards for homes and fixtures, to reduce construction and office waste, and to increase consumer awareness of the importance of sustainability in selecting a home and products. Outside of its securities filings, KB Home released annual sustainability reports and press releases providing further details relevant to environmentally preferred purchasing, including measures of energy and water savings of its new homes compared to typical resale homes, and earning highest EPA recognitions for energy efficiency and water conservation achievements. The company’s sustainability report, but not its SEC filing, showed GRI indicators of environmental performance.
In SEC disclosures on strategy and competition, paper manufacturer Domtar referred to its forest sustainability certifications: “We seek product differentiation through an extensive offering of high quality FSC-certified paper products [and]… through the certification of our pulp mills to the FSC chain-of-custody standard and the procurement of FSC-certified virgin fiber.” This description did not go as far as the sustainability goals and actions stated on the company’s annual sustainability report, including increasing FSC certified fiber procured for its mills from 16% in 2010 to 20% by 2020, seeking to procure 100% of fiber from FSC-certified sources, and reducing GHG emissions by 15% over this period.
In another variation on mixed disclosures, Office Depot’s SEC report states in the section on environmental matters its vision to “increasingly buy green, be green and sell green”. This section briefly lists several initiatives: recycling and pollution reduction; sustainable forest management; and issue awareness and market development for environmentally preferable products. It notes: “Operations in the US and internationally have been commended for our leadership position for our facility design, recycling efforts, and ‘Green’ product offerings.” The SEC filing then provides links to two company websites for additional information on its achievements and green product offerings. These websites include a list of key environmental awards and a dashboard with GRI indicators.
Finally, Lockheed Martin was the largest supplier to the U.S. government in 2014, with $32 billion in contracts; its SEC filing stated that 79% of its consolidated net sales were from the U.S. government. In about 2011, Lockheed Martin issued a report “Aligning with Customer Sustainability Goals” which highlighted the sustainability mandates for procurements by the U.S. agencies and another large customer, U.K.’s Ministry of Defence: “it is imperative that we recognize the sustainability goals of our customers and align our business practices to assist in achieving their missions.” Two months after release of Executive Order 13693, Lockheed Martin issued a chart depicting the alignment between the federal agencies’ sustainability goals and the company’s environmental sustainability goals/performance. Moreover, the company’s annual sustainability report details a range of environmental performance indicators, results, goals and recognitions. Of course, despite this “imperative”, the company’s business is affected by a large number of non-environmental conditions. In Lockheed Martin’s SEC filing, only a general statement of a risk appears to encompass environmentally preferred purchasing along with other conditions: “We must comply with and are affected by laws and regulations relating to the award, administration and performance of U.S. Government contracts”. As for environmental matters, the SEC disclosure addresses remediation liabilities and general compliance with environmental protection laws and regulations.
This small sample shows that, to varying degrees, some SEC filings inform investors of the forms and competitive impacts of environmentally preferred purchasing. Additionally, these SEC filings only partially reflect the companies’ environmental attributes which are important enough to purchasers, investors and communities for the companies to engage in extensive non-SEC reporting.
In conclusion, environmental advocates and securities lawyers should recognize the two-way relationship between environmentally preferred purchasing and disclosures in securities filings. One direction involves the effects of environmental information and motivated buyers on regulated filing obligations. Under existing securities laws and regulations, environmental attributes of vendors and products likely to have a material impact on companies’ earnings warrant disclosures. Because of the growth of environmentally preferred purchasing, environmental certifications and metrics can significantly affect companies’ business and competitive conditions. The materiality of market impacts is determined by the extent of customers’ preferences for environmental performance and suppliers’ use of environmental attributes in marketing and bidding. Material environmental attributes and purchasing preferences should be described in securities filings.
In the other direction, securities disclosures improve environmental information and purchasing preferences. Securities laws would increase the truthfulness of companies’ environmental statements, applying higher standards of verification and completeness than pertain to marketing material and sustainability reports. Along with the visibility of descriptions in securities filings, this legal framework enhances the influences of governmental and non-governmental environmental certifications. Investors, securities analysts and rating companies are more likely to react to disclosures in securities offerings than in databases of or reports by environmental organizations. Customers and environmental organizations can use such disclosures to expand environmentally preferred purchasing and thereby encourage lighter footprints.
The growth in environmentally preferred purchasing should raise the awareness of companies, securities regulators and lawyers to disclose more environmental attributes in securities filings. Conservationists are identifying best practices in actions by suppliers and purchasers, and guiding purchasers toward applying environmental standards and preferences. Purchasers increasingly recognize that some vendors lead in conserving ecosystems while others waste such assets. Furthermore, purchasers are grasping their power to channel toward conservation trillions of dollars annually. In fulfilling their traditional role of protecting investors, more securities disclosures of environmental attributes would also further the Executive Branch’s efforts to promote sustainable practices and fight climate change.
Adjunct professor, University of Illinois; member, Sustainable Purchasing Leadership Council; retired partner, Skadden, Arps
Warren Lavey teaches environmental law and policy at the University of Illinois, USA. He is a member of WCEL and IUCN; participates in environmentally-preferred purchasing initiatives through the U.S. Environmental Protection Agency, the State of Illinois, and the Sustainable Purchasing Leadership Council; and is a retired partner from the global law firm Skadden, Arps. He has published law review articles on many topics in environmental, administrative and corporate law. JD, MS, BA, Harvard University; Diploma in Economics, Cambridge University.