Is there another Enron-size accounting scandal on the horizon? Environmental groups seem to think so, and they have gone to the Securities and Exchange Commission seeking new accounting guidelines to force polluting corporations to release the true extent of their environmental liabilities to shareholders and the public.
Friends of the Earth, along with The Conservation Land Trust, Alaska Conservation Foundation and a few other environmental groups, are demanding that the SEC adopt a disclosure standard for environmental liability that calls for materiality to be based on aggregate rather than individual environmental liabilities. Currently, companies can estimate environmental liabilities on a site-by-site basis. This leads to "systematic underreporting," according to Michelle Chan-Fishel, manager of the green investments program at Washington-based Friends of the Earth. If the SEC concurs–and that's a big "if"– the environmentalists contend that the financial disclosures will create the same kind of earnings craters that scarred the corporate landscape following the Enron Corp. and WorldCom Inc. revelations. "We'll find out what the real story is behind toxic waste cleanup, which can amount to hundreds of millions of dollars for any given company," says Chan-Fishel. "We just don't know."
Given the Bush administration's record on environmental issues, one might be inclined to breathe a sigh of relief and move on to the next crisis. No such luck: It's not just environmentalists agitating for change. Joining the greens is a small, but influential coalition of institutional investors, including the Rockefeller Family Fund. Their presence may require companies to keep this one on their radar screens.
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According to Tim Little, executive director of The Rose Foundation, an Oakland, Calif.-based charitable foundation, the disclosure campaign has the support of 27 foundations, representing $3 billion in institutional assets under management, plus the backing of half a dozen asset managers like Calvert, Trillium and Domini, with more than $13 billion in assets under management. "If a company has 20 leaking tanks, but each one on its own is not expected to have a material impact on a company's financial condition, then the whole lot of them can be deemed immaterial," explains Little, whose foundation controls $2 million in assets. "The SEC needs to close the environmental loopholes. Because information hasn't been disclosed, we don't know if we're looking at a company's true extent of environmental liability or just the tip of the iceberg. What's been going on is comparable to Enron-style accounting."
But can the SEC simply make it right by ordering compliance? In part, the fuzziness clouding the SEC's rules governing environmental liability disclosure stems from the difficulty companies claim they face estimating hypotheticals, such as a 75-year-old landfill leaching PCBs or other toxins into groundwater, and the cost of the subsequent cleanup. Hence, the yardstick has always been based on what a "reasonable investor" would view as material to a company's operating results. "If you're a [potentially responsible party] in a Superfund site, you have to ask yourself if it's probable that you will incur a financial impact in the coming year. If so, is this financial cost estimable?" Chan-Fishel says. "Companies typically claim it's too hard, so they simply underreport."
The environmental groups and institutional investors are recommending that companies adopt the standards for estimating and disclosing environmental liabilities developed by the American Society for Testing and Materials. The standard (E-2137) guides companies on how to provide the most robust estimate of environmental costs and liabilities through determining expected values, most likely values, a range of values and minimum values. ASTM also calls for materiality to be measured based on aggregate and not individual environmental liabilities.
Not surprisingly, insurance companies are right there cheering the agitators on since the property/casualty industry currently absorbs the brunt of environmental cleanup costs. "There are all kinds of environmental liabilities that companies are not disclosing, like post-closure obligations for their landfills," says Peter Breitstone, president of Breitstone & Co., a Cedarhurst, N.Y.-based insurance brokerage and consulting firm. "Either companies know they have far greater liability than they are disclosing or they're not aware of the magnitude and just don't want to find out. It is not unreasonable to imagine some type of Enron implosion once these environmental liabilities are disclosed."
Joe Boren, president of New York-based insurer AIG Environmental, concurs: "Companies are taking the lower end of what their [environmental] liabilities are and are not disclosing the full extent. I'm not suggesting they're violating the law. But there appears to be a new consensus that these liabilities are more estimable than they were before."
Not everyone is convinced the cost of environmental cleanups is an easy calculation. "It's very simple to estimate on the 'gee whiz, the sky is falling down' side of a cleanup," says Robert Johnston, vice president at the New York-based environmental contracting firm Malcolm Pirnie Inc. "Anyone can say it will cost $100 million to clean up a landfill. The real question is does it really? What if you sit on it for 30 years and mitigate any kind of release during that time, while letting natural attenuation and other things take place? A present-worth analysis of $100 million over 30 years may be non-material."
While the government wrestles with what to do, Breitstone and Boren advise companies to consider two kinds of insurance–cost cap coverage, which insures environmental exposures above the expected costs, and pollution and legal liability insurance, which covers the costs of unknown environmental liabilities.
Already, some companies are coming clean about their pollution problems. In late August, Kerr-McGee Corp., the Oklahoma City-based energy producer, restated its second-quarter results to reveal a net loss of $58 million and not the $7.6 million loss it initially reported. The culprit was unexpectedly high costs to clean up former oil, gas and chemical plants, including $20.5 million to clean up a Cushing, Okla.-based oil refinery and $7.2 million to clean a now-closed chemical plant.
Then, there is the sad tale of Dallas-based oilfield services company Halliburton Co., which bought rival Dresser Industries Inc. in 1998 for $7.7 billion. "When Halliburton acquired Dresser, it told shareholders the company had $24 million in asbestos liabilities," says Rose Foundation's Little. "I've read that the plaintiff attorneys when they were told that figure literally fell out of their chairs." On Sept. 1, Halliburton conceded that insurance would cover all but $602 million of its asbestos claims through 2017.
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