Enforcement of Environmental Disclosure Obligations Sec v. Ashland, Inc. / OlasinApril 12, 2007 – Articles
This article describes a recent Securities & Exchange Commission enforcement matter on environment-related disclosures.
In November 2006, the Securities and Exchange Commission (“SEC”) announced that it had settled a significant enforcement action against Ashland Inc. and its Director of Environmental Remediation regarding accruals and disclosures for a docket of sites as to which Ashland had continuing environmental remediation responsibilities. This matter apparently was initiated when an environmental engineer working for Ashland blew the whistle on practices that included the application of summary discounts to remediation cost estimates that were otherwise carefully compiled. The engineer ended up filing a complaint with the Department of Labor under the whistleblower protection provisions of Section 806 of the Sarbanes-Oxley Act of 2002.
According to the SEC settlement with Ashland, Financial Accounting Standard No. 5, Accounting for Contingencies (“FAS 5”), required Ashland to accrue for future remediation costs if it was probable that the company had incurred a liability and it could reasonably estimate the amount of the loss. The American Institute of Certified Public Accountants’ Statement of Position 96-1, Environmental Remediation Liabilities, identifies future remediation costs that must be included in the company’s environmental reserve, such as pre-cleanup activities and performance of remedial action.
Ashland’s environmental reserve was a significant item in its financial statements from 1998 to 2005, ranging from a low of $152 million to a high of $178 million. Ashland explained in its annual reports and the notes to its financial statements that the reserve reflected the company’s “estimates of the most likely costs which will be incurred over an extended period to remediate identified environmental conditions for which the costs are reasonably estimable[.]”
According to the SEC, between 1999 and 2001, Ashland Inc.’s Director of Environmental Remediation reduced the cost estimates for remediating environmental contamination at dozens of chemical and refinery sites for which Ashland had responsibility. Ashland used those estimates to determine its environmental reserve, which Ashland disclosed in the periodic reports that it filed with the Commission. The SEC alleged that Ashland had no reasonable basis for reducing these cost estimates, which had been developed by a team of Ashland engineers, an outside consultant, and a computer program.
Among its findings, the SEC concluded that Ashland’s process for setting its environmental reserve did not establish adequate guidelines for, or require documentation or review of, adjustments to the cost estimates. Ashland included the reduced estimates in its reported environmental reserve and, as a result, Ashland materially understated its environmental reserve and overstated its net income in annual and quarterly reports filed from 1999 to 2001.
The SEC concluded that Ashland’s actions violated the reporting, books and records, and internal controls provisions of the Exchange Act, Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) and Rules 12b-20, 13a-1, and 13a-13 thereunder. In addition, it concluded that the Director of Environmental Remediation caused Ashland’s violations, and also violated Rule 13b2-1 of the Exchange Act.
The Director of Environmental Remediation was personally named in the enforcement action and he also resolved his liability through the November settlement. This matter reflects both the motivation that Remediation Managers may have to bring down the accrual numbers, especially as to long term remediation projects, and the risks that such behavior involves for the company and the manager in the Sarbanes-Oxley era.