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December 23, 2003
Underreporting of Material Environmental Liabilities Persists
    by William Baue

Despite clear documentation of the problem, multiple solutions proposed, and petitioning to enhance enforcement, corporate underreporting of material environmental liabilities continues.

What’s wrong with this picture? Over the past decade, corporate underreporting of environmental liabilities has been documented by the US General Accounting Office (GAO), the US Environmental Protection Agency (EPA), and the US Securities and Exchange Commission (SEC). Solutions have been proposed by the EPA (in 1993), the American Institute of Certified Public Accountants (AICPA--in 1996), the American Society for Testing and Materials (ASTM--in 2001), and the Sarbanes-Oxley Act of 2002.

The Rose Foundation, an Oakland-based environmental advocate, petitioned the SEC in 2002 to close legal loopholes in the General Accepted Accounting Principles (GAAP) that allow corporations to hide material environmental liabilities from their shareowners. The SEC has yet to answer this rulemaking petition.

It would appear that the problem of corporate underreporting of material environmental liabilities persists not due to a lack of information or substantiation of the problem, but rather a lack of will amongst those with the power to solve it.

“Right now, you could drive a truckload of toxic waste through gaps in SEC environmental disclosure regulations,” said Tim Little, executive director and co-founder of the Rose Foundation. “Our petition to close these loopholes has been endorsed by charitable foundations, mutual funds, labor organizations and the stewards of some of our nation's largest pension funds representing over $1 trillion in combined assets.”

In its 10-point “Call for Action,” the Investor Network on Climate Risk (INCR), a coalition of institutional investors, urged the SEC to act on the Rose Foundation’s rulemaking petition.

“It's time for the SEC to heed the call and move into rulemaking,” Mr. Little told

Although the Rose Foundation has already advanced a compelling case for rulemaking in the 2002 report that was published concurrently with the petition filing (see related article), it released a follow-up report last week that adds even more logs to the fire. Entitled the The Gap in GAAP: an Examination of Environmental Accounting Loopholes, the report restates the case for stronger enforcement, retells the history sketched above, adds several new elements, and suggests some challenging questions.

First, the questions: why is the crucial report, a 1998 study conducted by the EPA’s Office of Enforcement and Compliance that finds 74 percent of companies underreporting their environmental liabilities, still unpublished? Despite the clear significance of the report’s findings, they are only publicly available in summary form in a paper presented by the EPA's Nicolas Franco at the 2001 American Bar Association (ABA) Conference on Environmental Law.

"EPA has never given a reason for not publicly releasing its report," said Mr. Little. "We can only speculate that there was political pressure, but we don't know."

Similarly, the SEC’s Division of Corporate Finance warned a number of Fortune 500 oil, gas, mining, and manufacturing companies about environmental and product liability disclosure. However, the Commission has yet to tell investors what companies it warned about what disclosures. The SEC seems to be exhibiting the same lack of transparency it finds in some companies, leaving investors wondering which companies are disclosing valuations that do not accurately reflect their material environmental liabilities.

The new Rose report also unearths a previous study documenting underreporting of environmental liabilities. In 1992, the well-known auditing firm Price Waterhouse (now Pricewaterhouse Coopers) surveyed 523 companies and found that 62 percent had known environmental liabilities that went unrecorded in financial statements in a quantitative manner. Two subsequent studies by Price Waterhouse found substantially the same trend, according to the Rose report.

Last but not least, the new Rose report identifies the specific gaps in GAAP that allow underreporting. First, GAAP allows corporations to report the minimum in a range of possible environmental liabilities. Second, GAAP allows corporations to treat individual environmental liabilities under $100,000 as if they did not exist, even when multiple such liabilities break this threshold when added together.

The Rose report recommends two solutions, both based on ASTM standards developed painstakingly over a seven-year process, to close these GAAP loopholes. First, require companies to do an “expected value probability analysis”. This would involve averaging the different possible environmental liabilities to produce a much more realistic estimate. Second, require the aggregation of environmental liabilities; in other words, make companies add up all their environmental liabilities and report them when this sum surpasses the $100,000 threshold defining materiality.


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