RCRA’s ‘Financial Test’ for Financial Assurance Where Environmental and Accounting Rules Collide

April 12, 2007Articles

This article addresses one area where accounting standards and environmental requirements contradict each other, and how that contradiction, related to financial assurance for clean-ups, is currently addressed. This article is adapted from course materials developed by Mr. Roe and Mr. Wirt for the 2007 Pennsylvania Environmental Law Forum panel on corporate disclosures moderated by Mr. Roe.

In April 2003, the United States Environmental Protection Agency issued an Enforcement Alert regarding compliance with the Resource Conservation and Recovery Act financial assurance requirements. In recent years, regions have taken enforcement steps including through RCRA 3007 information requests and active enforcement, and based on anecdotal evidence, financial assurance still seems to be an enforcement priority.

There is potential mischief in stricter enforcement of financial assurance requirements (not only because closure of RCRA units may have migrated into other programs) but because the RCRA financial assurance regulations themselves, including the regulations governing the financial test, or ‘self test,’ were adopted in 1982, last updated in 1986, and are outdated. For example, the Rural Electrification Administration asked about in the self test form was abolished in the mid-1990s. More significantly, 40 CFR 264.143(f) expressly sets forth language that an accountant must use in providing the ‘special report’ required for the self-test. Unfortunately, accountants have been expressly forbidden by an organization that sets standards for their profession from using that language since September 1995. EPA issued guidance in 1997 allowing the language accountants could provide, and promised to change the underlying regulation. EPA never got around to changing the rule, though, and last year, California announced that it did not believe that it had the discretion to ignore the express requirements of the federal regulation (and its state counterpart).

The financial test requirement, 40 CFR 264.143(f), states:

  1. An owner or operator may satisfy the requirements of this section by demonstrating that he or she passes a financial test as specified in this subsection.
  2. . . . .
  3. To demonstrate that this test has been met, the owner or operator shall submit the following items to the Department:
  4. A special report from the owner’s or operator’s independent certified public accountant to the owner or operator stating that:
    1. the independent certified public accountant has compared the data which the letter from the chief financial officer specifies as having been derived from the independently audited, year-end financial statements for the latest fiscal year with the amounts in such financial statements; and
    2. in connection with that procedure, no matters came to the independent certified public accountant’s attention which caused that accountant to believe that the specified data should be adjusted.

The statement required of the independent certified public accountant that is set forth in subparagraph (C)(2) is commonly known as a “negative assurance.”

In September 1995, the Auditing Standards Board issued Statement on Auditing Standards No. 75 (SAS-75) and Statement on Standards for Attestation Engagements No. 4 (SSAE-4). The effect of these documents was to prohibit the use of negative assurances “in agreed upon procedures engagements.” (An agreed upon procedures engagement is one in which the independent accountant and the client enter into a written agreement defining the nature and extent of the accountant’s work. A third party may only rely upon the accountant’s report if the third party accepts the agreed upon procedures as sufficient.)

The EPA had issued a Memorandum on February 27, 1997, that discussed these changes to the accounting standards. The memorandum concludes as follows:

The Agency intends to change the regulations so that they conform to the new professional auditing standards. Until that rulemaking is completed, in addition to, or in lieu of, a CPA report stating that “no matter came to his attention,” EPA will accept a CPA’s report describing the procedures performed and related findings, including whether or not there were discrepancies found in the comparison, based on an agreed-upon procedures engagement performed in accordance with AICPA’s Statement on Auditing Standards No.75, Engagements to Apply Agreed-Upon Procedures to Specified Elements, Accounts or Items of a Financial Statement. (In an agreed upon procedures engagement an accountant is engaged by a client to issue a report of findings based on specific procedures performed on the specific items of a financial statement.) The Agency will regard this report as satisfying the requirements of the financial test or corporate guarantee for a special report by an independent CPA on the CFO’s letter.

According to California, Financial Test submissions which substitute an “agreed upon procedures” statement for the “negative assurance statement” not only do not comply with the express language of the RCRA and California regulatory requirements, but they also reflect “a lesser degree of scrutiny by the independent accountant.”

It remains to be seen whether California will follow through on its threat to essentially do away with the use of the financial assurance requirements for RCRA sites there, or whether other states will raise similar concerns.