Tuesday, February 2, 2010

The SEC and Climate Change – What Are These Guys Thinking?

First, a brief reminder that my seminar “Fundamentals of Investor Relations” will be held February 24th in Houston. The seminar blends real world experience with some of the tools we teach in business school such as valuation, decision tree analysis and efficient markets as they interact with the finance, capital markets, legal and communications issues of investor relations. If you’re interested, go to my website, www.palizzapartners.com and click on the seminars tab.

The Securities and Exchange Commission faces a daunting array of issues that need attention - we’re just recovering from the most severe financial crisis our country has faced since the Great Depression which severely tested the structure of our capital markets, credit rating agencies face a crisis of confidence based upon their performance in rating complex mortgage backed bonds and the inherent conflict of interest they face in being paid by the issuers of the bonds they rate, the proper regulation of derivative instruments needs to be addressed, and their enforcement division wasn’t able to identify the billions of dollars being stolen by Bernie Madoff in spite of receiving complaints against him on at least two occasions. So what pressing issue does the SEC choose to tackle first? CLIMATE CHANGE! In the words of Commissioner Kathleen Casey (a Republican who voted against adoption of the release) “our consideration of this release today sends a curious signal to the investment community about what we view as the most pressing issues facing the Commission”.

The interpretive release, which the SEC commissioners adopted in a 3 – 2 party line vote (guess which party voted in favor of the climate change release) and which as of this writing still hasn’t seen the light of day (how’s that for timely disclosure of a material event?) purports not to change disclosure requirements. The last time I checked the definition of materiality as set out by the Supreme Court in Basic v. Levinson, it was “Information is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision”. In over thirty years of working in the field of investor relations I have never had an investor who owns, or is interested in owning shares, ask a climate change question. Could I have been dealing with unreasonable investors all these years? I have had questions from advocacy groups, but they are not investors, which is a crucial difference as far as disclosure requirements go.

Previous SEC interpretive releases have focused on areas such as analysis of long and short-term liquidity and capital resources, segment analysis, the effects of federal financial assistance on the operations of financial institutions, and the disclosure of preliminary merger negotiations. It seems to me that these are proper areas for the Commission to be concerned with; they are concrete, defined in scope and fairly immediate. Now we have a release, which according to the speeches of the SEC commissioners, requires companies to consider the reputational damage and its effect on their financial condition caused by their greenhouse gas emissions and requires them to disclose if their operations may be at material risk from the physical effects of climate change. So here are a couple of questions: How do you measure reputational risk in a meaningful and defined way? How do you know if your operations are at risk from climate change as opposed to normal weather shifts? Last time I checked hurricanes didn’t come with tags that say, “climate change related”. This is just bad regulation, requiring companies to engage in speculation about future events. In most other instances the SEC discourages speculation and requires you to make disclaimers about how the events may not come to pass, but this is an issue that is on the political agenda for the party with the majority of Commissioners on the SEC and so speculation is okay.

And just to remind you, the SEC also put out an interpretive release requiring companies to discuss Y2K issues, and we all know how material they turned out to be.

1 comment:

wcskjb said...

I had the same thought about you as you did about the SEC after reading your blog today: "What was John Thinking?"

Can't imagine what motivated you to condemn SEC guidance on climate change before you had read it.

Yes, most of your post was to condemn the SEC's decision to address the topic, but surely you must wince at some of what you wrote in light of the actual release.

For example: "In over thirty years of working in the field of investor relations I have never had an investor who owns, or is interested in owning shares, ask a climate change question."

The release makes plain, through advice and example, that it's talking to those for whom climate change has meaning. That might not be you or your clients. But it's certainly a heck of a lot of others.

Why, simply because you personally have apparently never represented an electric utility, chemical manufacturer, or solar-cell manufacturer, do you think the SEC should refrain from offering guidance to those that have (or do)?

I have represented several, and while the phrase "climate change" may not have been uttered in those conversations, the questions we faced were often squarely within the range of what we associate with that term today.

And your long lament about more pressing issues? Surely you're aware that the SEC is properly withholding its regs and/or guidance on many of them in deference to Congress's consideration of financial institution reform. That may strike you as an excuse; to many others, it's a considered judgment that issuing rules now in areas that are likely to be addressed by Congress soon would hurt, rather than help investors with horizons longer than a day or two.

And finally, you wrote "This is just bad regulation, requiring companies to engage in speculation about future events."
Yikes! What in the blue blazes do you think "important in making an investment decision" means? That investors are only concerned about stuff that has already happened?

I can only infer that your premptive strike is traceable to a instinctive political aversion to all things that have come to be associated with the words "climate change."
Perhaps if the SEC had said it was writing to remind companies to advise investors in filings about the potential impact of external events and trends (as it has many times before), and that some of those trends might be climate-related, perhaps you wouldn't have bloviated before reading?