Remarks Of Richard Y. Roberts Commissioner* U.S. Securities and Exchange Commission Washington, D.C. Environmental Liability Disclosure Update Critical Environmental Issues for Corporate Counsel Conference New Jersey Institute for Continuing Legal Education New Brunswick, New Jersey May 5, 1995 ____________________ */ The views expressed herein are those of Commissioner Roberts and do not necessarily represent those of the Commission, other Commissioners or the staff. I. INTRODUCTION Issues related to the environment and the expected costs of remediation have garnered a great deal of attention in the United States. There are now many seminars and conferences such as this one that focus on the topic of the environment and related reporting requirements. I believe that most everyone agrees that environmental costs have reached staggering proportions in recent years and are one of the critical issues facing businesses today. These costs take two forms. The first cost, compliance costs, occur when regulations restrict development and limit harmful emissions. These compliance costs often have a material effect on a company's operating expenses. The second cost relates to existing liabilities which effect particularly past generators and transporters of waste materials. II. Staff Accounting Bulletin No. 92 - Background The magnitude of environmental liabilities often differentiates those liabilities from other obligations of an enterprise. Environmental liabilities also may differ from other contingent liabilities because of the amount of litigation involved and the number of external factors and uncertainties that affect the final cost and outcome of remediation. In the past, these distinguishing characteristics made the application of generally accepted accounting principles ("GAAP") to environmental liabilities more difficult. As a result, different accounting and disclosure practices were adopted by public companies, and, in some cases, the full magnitude of contingent environmental liabilities was not clearly depicted and the related disclosures were not sufficiently informative.-[1]- In an attempt to improve the accounting for and disclosure of environmental liabilities, the staff of the Commission ("Staff") in 1993, issued Staff Accounting Bulletin No. 92 ("SAB 92" or the "SAB").-[2]- SAB 92 sets forth the Staff's interpretation of GAAP with regard to contingent liabilities and is particularly relevant to registrants that may have incurred material product or environmental liabilities. The SAB was intended to promote the timely recognition of contingent losses and to address the diversity in practice with respect to the accounting for and disclosure of contingent liabilities. I suspect that SAB 92 has caused the most dramatic shift in the manner in which companies view environmental matters since CERCLA was enacted in 1980. If nothing else, I hope that the SAB has focused attention on the difficulties and prior weaknesses in financial reporting of potential environmental liabilities. III. Offsetting Probably the most controversial aspect of the SAB is the Staff's view that contingent liabilities must be displayed on the face of the balance sheet separately from amounts of claims for recovery from insurance carriers or other third parties. Before the SAB, some registrants offset or netted anticipated recoveries against the estimated liabilities, thereby minimizing the reported amount of the liabilities. Given the practice of netting, it was the Staff's view that some registrants may not have disclosed the true extent of exposure for probable environmental liabilities, because they presumed that full recoveries were available under insurance policies, notwithstanding the reality that coverage could be, and probably would be, contested by the insurance company. Again, in the Staff's view, presentation in the balance sheet of the gross, rather than the net, amount of the liability most fairly presents the potential consequences of the contingent claim on a registrant's resources. For example, a registrant's liquidity may be affected materially if it must settle a liability in cash prior to indemnification OR contribution from a third party. Separate display of the gross liability and the amount likely to be recovered highlights the different factors that affect these two estimated outcomes and the related cash flows. Offsetting the two components often left investors unaware of the full magnitude of the liability and may have lulled them into a less rigorous consideration of the legal sufficiency of the registrant's claims for indemnification or contribution, as well as of the creditworthiness of the party from whom such recovery was anticipated. The Staff believes, as do I, that separate display of a claim for indemnification or contribution will lead to a more rigorous consideration of the uncertainties affecting realization of that claim. Indeed, many practitioners have represented to the Staff that it is difficult to estimate the amount of recovery from third parties, especially insurance companies. Pursuant to the SAB, registrants can only recognize an asset representing recoveries from third parties if it is probable that the amounts will be realized.-[3]- The Staff takes the position that there is a rebuttable presumption that a claim for recovery should not be recognized as an asset when the person expected to pay that amount is asserting that it is not liable to indemnify the registrant. Registrants that overcome this presumption should disclose the amount of recorded recoveries that are being contested and discuss the reasons for concluding that the amounts are probable of recovery.-[4]- I should stress that the SAB's limitation on offsetting is consistent with the requirement enunciated in the Financial Accounting Standards Boards' ("FASB") Emerging Issues Task Force consensus number 93-5 that financial statement preparers must evaluate separately the circumstances under which the amount deemed recoverable from a third party may qualify for recognition as an asset. While the Staff remains sensitive to the concern which is continually expressed by some companies that disclosure of contingency information may undermine an enterprise's competitive position or litigation posture, SAB 92 was intended by the Staff to ensure that registrants furnish investors with all material information regarding the nature and magnitude of contingent liabilities that may materially affect a registrant. Full disclosure enables investors to make intelligent business decisions, and, thus, enables our securities marketplace to become more efficient. IV. Disclosures Before the SAB, too often disclosure regarding contingencies was overly general, did not fully convey the nature and magnitude of these contingencies, and did not clearly explain unusual developments or emergent trends that may affect an investor's assessment of the likely outcome. I am pleased to report that the issuance of SAB 92 has lead to improvements in environmental liability disclosure. I hope that this progress continues. Oddly enough, the issue of offsetting still remains the hottest topic of debate in the area. I understand that independent accountants are now asking lawyers to confirm that a disputed insurance recovery is probable before they will opine on the fairness of the financial statements. Some attorneys apparently have refused to opine on the likely outcome of disputes or litigation, while others say it is against ABA guidelines to issue such an opinion. Nevertheless, I am aware of several registrants that have recorded assets for insurance recoveries that are currently in litigation. As I suggested in my article in a recent edition of "The Business Lawyer", the issue of environmental disclosure is one in which legal and accounting concerns overlap. Certainly attorneys and accountants alike should be familiar with SAB 92. There apparently continues to be some confusion as what constitutes a liability that requires accrual under FASB Statement 5. Some have the mistaken impression that a commitment to comply in the future with environmental laws like the Clean Air Act requires recognition in the financial statement. Let me correct any such misimpressions. Statement 5 only pertains to LOSSES OR ASSET IMPAIRMENTS that exist at the balance sheet date. Commitments to perform a task in the future generally do not satisfy these criteria. However, SAB 92 suggests that registrants disclose amounts related to these types of expenditures, desegregated from other environmental expenditures like remediation. For those that seek future guidance on this issue, I refer you to question 6 of SAB 92. As I stated earlier, generally disclosures have improved since SAB 92 was issued, but room for improvement always exists. One common error is the failure to disclose the range of reasonably possible losses in excess of the amount accrued. Unfortunately, boilerplate disclosures are still fairly common too. Moreover, I should emphasize that segregated disclosure identifying particular sites that are individually material may be necessary for an understanding of a company's loss exposure. For example, sites on the EPA's National Priority List may be more expensive to remediate than other contaminated sites and may warrant separate disclosure. The Staff is of the view that identification of specific sites (including disclosure of the total estimate to remediate the entire site) may be appropriate when such sites are individually material and the likelihood of contribution by other significant parties has not been established. In the future, the Staff can be expected to continue to focus on disclosures of environmental exit costs. Registrants are expected to disclose whether a material obligation to remediate a particular site upon the sale, disposal, or abandonment of a property exists or is likely to occur. Appropriate disclosure generally would include the nature of the costs involved, the total anticipated cost, the total costs accrued to date and its classification on the balance sheet, and the range or amount of reasonably possible additional losses. At this juncture, it would probably be appropriate to point out that the FASB has undertaken a project to review the accounting for nuclear decommissioning costs. Currently, I understand that the cost to decontaminate a plant at closure is accrued ratably over the LIFE of the plant license from the NRC, even though the facility is contaminated at day 1. Display issues will also apparently be addressed by this project. I hope, and I know that the staff does too, that the FASB will address the broader issue of environmental exit costs, which are the subject of much debate. In any event, I do not expect any significant action on this particular project in the near term. V. Conclusion To wrap up, while many, including me, tout the issuance of SAB 92 as the first step toward better accounting and disclosure of environmental liabilities, some concerns persist. Practitioners continue to complain that the difficulty of quantifying environmental liabilities remains as the most formidable obstacle to better reporting. Given the number of external factors impacting the ultimate outcome (such as the extent of contamination, number of PRPs, prospects for recoveries, changes in legislation, etc.), management may be reluctant to specify any amounts for fear of misleading investors. Additionally, difficulties in meaningfully aggregating reasonably possible losses for numerous sites have created some disclosure problems. I hope that this summer the American Institute of Certified Public Accountants' ("AICPA") environmental accounting task force will issue an exposure draft of an environmental remediation liability accounting document, and that this document will further enhance the quality of accounting and financial reporting in this area. In terms of an update, it is my understanding that the AICPA Accounting Standards Executive Committee (AcSec) is currently revising its draft Statement of Position (SOP) entitled "Environmental Remediation Liabilities" (formerly the Environmental Liabilities Accounting and Auditing Guide). The current time schedule calls for the release of an exposure draft by June 30 and the issuance of a final SOP by year end. The SOP is intended to provide guidance on timely recognition of environmental liabilities and related disclosures, and apparently a chapter has been added regarding audit issues related to this topic. Certainly, I anticipate that the Staff will continue to pursue disclosure of more qualitative information from all registrants. I spoke at a conference this summer and was amazed at the number of companies that now issue separate environmental reports. Most of these companies are active in identifying environmental issues and in responding to those issues in a reasonable fashion. These companies appear to be very cognizant of stakeholder concerns for clear, unambiguous disclosures about a registrant's exposure to and interaction with the environment. My sense is that the disclosure in these reports may be of higher quality than the disclosures in financial statements and SEC disclosure documents. The two should be consistent. In closing, I wish to challenge each of you here today to acquaint yourselves, if you have not done so already, with the accounting literature regarding loss contingencies, including SAB 92. I also challenge each of you here today to focus seriously on whether your employer or client has adequately disclosed and accounted for the short-term and long-term effects of applicable environmental laws and liabilities on their operations. ENDNOTES -[1]- For example, a 1992 survey by Price Waterhouse noted the diversity in the timeliness of environmental liability recognition and in the practice of reducing environmental liabilities by potential recoveries. PRICE WATERHOUSE, ACCOUNTING FOR ENVIRONMENTAL COMPLIANCE: CROSSROAD OF GAAP, ENGINEERING, AND GOVERNMENT. (1992). -[2]- ACCOUNTING AND DISCLOSURES RELATING TO LOSS CONTINGENCIES, Staff Accounting Bulletin No. 92, 58 Fed. Reg. 32843 (June 8, 1993). The statements in staff accounting bulletins are not rules or interpretations of the Commission nor are they published as bearing the Commission's official approval. They represent interpretations and practices followed by the Commission's Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the federal securities laws. -[3]- The staff expects the threshold for determining whether a asset is probable to be the same level as that used to determine whether a liability is probable. -[4]- See SAB 92, note 4.