It seems that disclosure has become the primary product manufactured by public companies in this country. Companies are more regularly monitoring environmental issues, generating reports and sharing information regarding their environmental concerns with the people involved in the public reporting process, both inside and outside the company. This provides a new source for due diligence information.
Disclosure requirements
A quick review of the relevant federal laws and regulations brings a new focus to these requirements, many of which predate Sarbanes-Oxley.
* Regulation S-K. This acts as an instruction manual for companies filing periodic reports with the SEC. Item 101 requires reporting companies to describe their businesses and report on capital expenditures. Companies must review the anticipated costs of environmental compliance, both current and projected.
Item 103 requires companies to disclose any pending, nonroutine legal proceedings. Item 103(5) calls for all administrative or judicial proceedings relating to the environment to be disclosed if the company’s potential liability is material to its business or financial condition, the potential liability exceeds 10 percent of the company’s assets or a governmental agency is a party and the company’s probable liability exceeds $100,000.
Item 303 of Regulation S-K requires management to discuss known trends, events and uncertainties.
* FASB No. 5. Statement of Financial Accounting Standards No. 5 deals with disclosing loss contingencies. It requires a company to establish a loss contingency in its financial statements if available information indicates that it is probable the company suffered a loss and the amount of that loss can be reasonably estimated.
* Sarbanes-Oxley. The most relevant parts of SOX, with regard to environmental due diligence are Sections 302 and 404. Section 302 requires a company’s CEO and CFO to personally certify certain items in reports filed with the SEC. This personal responsibility spurs senior executives to demand more detailed information from environmental managers.
Under Section 404, a company has to establish and maintain adequate internal control structures and processes to allow for accurate financial reporting. Senior executives need to annually report on the effectiveness of these processes. Further, the company’s auditors must provide an independent report on management’s assessment.
Together, these measures require reporting companies to take specific actions, including reviewing environmental liability assessment and reporting practices; disclosing environmental enforcement actions in periodic reports; disclosing and valuing contingent environmental liabilities in financial statements; nd observing internal controls and procedures, including maintaining internal records, establishing milestones for regularly reviewing known problem areas, searching out new problem areas and providing reports to management
Due diligence resources
Many companies are now generating more information than just two years ago, resulting in a trail of reports, assessments and reassessments. Acquiring companies (and their lenders) can now learn about their targets’ environmental issues from the inside. Targets should remember that reports generated for internal review may become available to outsiders.
No longer can a buyer simply ask general questions about environmental history. Acquiring companies need to take action.
* Expand the review of publicly available information to include the EPA ECHO list and SEC reports.
* Review the target’s internal environmental policies.
* Examine the internal committees charged with monitoring and assessing the target’s environmental compliance.
* Obtain all minutes, reports, memoranda and valuations generated by these internal procedures.
Environmental counsel should make sure that due diligence checklists cover all the new information sources. When an acquisition arises, they should get involved in the due diligence process at the outset and stay involved.
Counsel for sellers or potential sellers should review (or establish) reporting processes and systems, and prepare (or monitor) the resulting reports as though they were the subject of a due diligence request. A company with effective internal procedures and controls in place will be more valuable than one without controls.
Mark R. High is a member in the Detroit office of Dickinson Wright PLLC. He has been practicing law for more than 25 years in the areas of international, corporate, and corporate finance. For additional information, visit www.dickinsonwright.com.
