Carrots over Sticks

The case for environmental self-audits

by Alexander Volokh
Washington Monthly, June 1997

When people think of environmental battles, spotted owls, old-growth forests, and Pacific salmon typically come to mind. Beer probably doesn’t. But that’s what touched off one of today’s most heated environmental debates: What sort of protection should companies be granted in exchange for conducting voluntary environmental audits?

Air pollution agencies used to think beer brewers were clean people. An Environmental Protection Agency document published in September 1985 found that volatile organic compound (VOC) emissions from beer fermentation were negligible. Likewise, a 1983 report by the California Air Resources Board concluded that the state's breweries produced 20.7 million barrels of beer each year and in the process released only 42.3 tons of VOCs.

But all that changed in 1992 when the Colorado-based Coors Brewing Company became the first major brewery in the United States to do a comprehensive, voluntary investigation of its VOC emissions. (Brewery scientists had long suspected that EPA figures underestimated company emissions.) The investigation found that when beer is spilled during the making, packaging, and disposal process, large quantities of VOCs are released into the air. As the producer of about 20 million barrels of beer per year, Coors alone was releasing 650 to 750 tons of VOCs -- about 17 times more than originally thought.

Environmentalists, regulators, and industry alike love the idea of audits. But after sharing the results of its review with public authorities, Coors discovered a significant downside to self-auditing. In July 1993, the Colorado Department of Health -- allegedly under pressure from the federal EPA -- issued Coors a compliance order containing a $1.05 million civil penalty for violations of state air pollution laws. The fine was also to include a to-be-determined- later "economic benefit payment" to the state for money the company had saved by not complying with the laws. The 23-page order listed 189 violations -- 100 air pollution emission notification violations, 56 permit violations, and 33 VOC violations. All but the 33 VOC violations were essentially claims that Coors had not submitted the proper paperwork to the Health Department -- for VOC sources that no one even knew about until the audit.

This was the largest fine ever imposed by the state for an air pollution violation. Coors argued that it was being unfairly punished for voluntarily revealing problems that both regulators and major brewers had missed, and warned that such fines would go a long way to discourage other companies from conducting self-audits. (Coors had already spent 18 months and $1.5 million conducting the study.)

In February 1994, the fine was reduced. Coors agreed to pay a $100,000 fine and a $137,000 economic benefit payment, relinquish 70 tons of pollution allowances it held for the release of VOCs, and reduce its annual VOC, sulfur dioxide, and nitrogen oxide emissions. The agreement also included a schedule to bring all of Coors's emission sources into compliance with state regulations within two years.

Carrots vs. Sticks

The Coors episode was the catalyst for Colorado's adopting an "audit privilege" law, based on the premise that it's wrong to punish someone for voluntarily discovered, voluntarily revealed information that they otherwise wouldn't have known about or disclosed at all.

Most "audit-privilege" laws have two components: privilege and immunity. The "privilege" component guarantees that the audit is privileged information. In other words, information discovered in an audit, the audit documents themselves, and any related testimony are inadmissible as evidence against a company in an administrative, civil, or criminal proceeding. The law does not, however, cover information that the firm is already required to reveal by other regulations or information about violations discovered independently, for instance, by a neighbor. In addition, the law requires that the company, having discovered evidence of a violation, promptly tell the regulating agency, in this case the state health department, and then fix the problem.

The "immunity" component protects companies that voluntarily find, reveal, and fix violations from penalties. The environmental agency can still require the company to take certain steps related to damage control, but punitive sanctions are forbidden. Again, the immunity is limited; it doesn't apply to intentional or reckless violations or to violations that caused on-site injury or substantial harm to people, property, or the environment.

Today, about 19 states have such laws. A handful of others are considering them, and bills to do the same on the federal level have been introduced in Congress. According to Russell Harding, commissioner of the Michigan Department of Environmental Protection, privilege is becoming increasingly necessary thanks to the popularity of ISO 14001, the International Standards Organization’s evaluation program that certifies companies as having sound environmental practices. ISO 14001 mandates self-auditing as a condition for certification. But many companies who want to pursue certification don't want to risk their own audits being used against them. "It is an issue of fear," says Harding. Regulated entities and the employees who provide the information for the audit feel that they can't be entirely candid for fear of what regulators or third parties -- through citizen suits -- will do to them. This is particularly troublesome for small businesses that can't afford to spend a lot of money on legal advice. When the costs of knowing the law are too high, companies will just risk violating it.

Corporate surveys suggest that privilege laws would significantly increase both the willingness of organizations to conduct self-audits and the effectiveness of the audits themselves. Around 75 percent of companies already do environmental audits, according to a 1995 Price Waterhouse survey. Of those, 81 percent try to protect the information acquired using existing legal mechanisms like the attorney-client privilege. But using the attorney-client privilege limits the audit's usefulness, since privilege is lost if you share the information with someone like the plant manager, company scientists, or environmental consultants. The survey also showed that nearly two-thirds of companies that conduct environmental audits would expand their programs if penalties were eliminated for problems that the organizations themselves identified, reported, and corrected. More than 45 percent of such companies explained that they're unwilling to expand their auditing program because the information could be used against them in a litigation or civil enforcement action. Among the companies that don't perform audits, 20 percent said that they fear the information could be used against them. And a separate survey of firms in Indiana, where audits are privileged, found that 66 percent of small businesses wouldn't do audits if government prosecutors could access the reports.

Many environmentalists oppose audit-privilege laws, branding them "secrecy laws." Nor is the federal EPA wild about the idea. As one EPA official recently told State Environmental Monitor, enforcement actions often depend on "tips and confidential sources," and if this information becomes privileged -- so that employees' testimony about an audit is unusable -- enforcers' jobs become tougher.

Many attorneys general agree. In a June 1996 letter to Rep. Gary Condit (D- Cal.), who supports audit privilege laws, the National District Attorneys Association wrote that corporate records are often needed to make a determination that "knowledge and intent" were involved in a violation and that criminal charges are warranted. They argued that to successfully overcome a privilege and prosecute a company criminally, the state would have to "undergo great hardship," and that the conviction may well be overturned "if any taint can be shown or even intimated."

Federal regulators are equally concerned about the immunity aspect of such arrangements. Economic benefit payments have become a staple of federal environmental enforcement, and the government believes such payments are necessary to prevent companies from profiting from violations. Immunity, which would prevent regulators from imposing any penalties, could make it difficult for the government to guarantee a "level playing field" for companies who have maintained sound environmental practices.

But state agencies, such as the Texas Natural Resources Conservation Commission, would dispute the claim that audits hinder enforcement. The TNRCC considers the Texas Audit Privilege Act of 1995 an additional enforcement resource. The commission reasons that it will never have enough resources to monitor everybody, and since environmental regulation already relies heavily on self-policing and self-reporting, we might as well encourage the regulated to do their job right.

So why, if they have immunity, would a company need privilege? For one thing, a good audit document is a frank discussion of the environmental effects of all company processes -- some of which may be proprietary -- revealing in detail the thoughts and judgments of company scientists. And while the public has an interest in knowing actual violations uncovered by an audit, it is not entitled to know about the specifics of a company's proprietary processes or scientific analyses.

Also, audit laws sheild a company from government-imposed penalties, but do nothing to prevent citizen plaintiffs from filing suit. If information uncovered during an audit could be used against the company in a lawsuit by any group other than the government, companies would have little incentive to ever open themselves up to voluntary review.

As for the EPA's point about fines being necessary to maintain a "level playing field," consider again the case of Coors, which did the $1.5 million audit, told the agency, then shelled out another $237,000 in fines. Even though other brewers benefited from the information Coors uncovered, they neither had to shell out the money for an audit nor face the resultant penalties. To Coors, talk of a level playing field must sound rich.

Battle of the Regulators

But suppose the EPA is right about audit laws making enforcement more difficult. This still begs the question of what should take precedence in environmental law: prosecuting a company or improving the environment? If the threat of prosecution prevents a company from taking action that would improve the environment, then making the enforcers' jobs tougher in those cases may be a good idea. After all, the ultimate goal of environmental regulation and enforcement shouldn't be to rack up fines and lawsuits, but to encourage companies to minimize their negative impact on the environment. As Howard Wetters, a Democratic state representative from Michigan, put it, "We want to make sure the environment is cleaned up. We're more interested in that than in simply punishing people. I think that philosophy, as I've seen it in agriculture, has been a far more successful way of enforcing and regulating than through the adversarial process we have used to enforce environmental laws."

Instead, the EPA has suggested (over the objections of Congress) that it may increase enforcement -- including "overfiling," or filing its own lawsuit if it dislikes what the state is doing -- in states with highly protective audit laws like Michigan, Colorado, and Texas. Moreover, the EPA is threatening to "take back" a whole range of activities currently delegated to the states, like solid waste management, wastewater permiting, or asbestos programs. The EPA has specifically targeted Idaho's air pollution operating permit program, which the state runs by delegation from the federal government under the 1990 Clean Air Act amendments.

This is where, for state environmental officials, it gets personal. James Seif, Pennsylvania's Environmental Protection Secretary, accused the EPA of being on a vendetta against states that don't toe the line; "it appears to be our turn in this pattern of public attacks," he lamented to The New York Times. Last November, Michigan's commissioner Harding and 14 other state environmental commissioners sent an angry letter to EPA administrator Carol Browner, asking that the agency not "unduly interfere" with state enforcement matters without solid evidence that audit laws "undermine state enforcement authority." These complaints are echoed by observers from both ends of the political spectrum. On the right, the Washington Legal Foundation, a public-interest law firm, has characterized the EPA's behavior as "bludgeoning" and "blackmail"; according to a WLF report, states with audit-privilege laws haven't reported a decrease in environmental enforcement activity or in environmental quality due to such laws, though they are now getting more environmental results for less money. On the left, the Progressive Policy Foundation has suggested that auditing makes "eminent sense" and that state laws should be treated as a "demonstration project" to find out which enforcement strategies work and which ones don't.

Currently, the EPA has its own audit-privilege policy, and notes that since its implementation in January 1996, 76 companies have disclosed violations -- with most paying no penalties. But the EPA's policy is substantially weaker than that of many state programs and ultimately can be expected to yield smaller benefits than other bills under proposal. The EPA puts more requirements on companies that want to benefit from audit privilege, and often only reduces fines instead of eliminating them. Moreover, the EPA's policy is not binding on the EPA and has no effect on the Department of Justice, which can prosecute criminal cases regardless of what the EPA recommends. It also applies only to government prosecution, providing no protection against suits by outside organizations; and it only covers corporate environmental violations, not violations by individual employees. Finally, it only protects the audit documents themselves, not testimony about them, so a prosecutor who wants to use audit information against the company can still make a member of the audit team testify about what was in the audit.

State audit-privilege laws don't constitute a rollback of environmental protection; they are not intended to pre-empt existing federal laws. All regulations on the books will remain on the books, which means that federal enforcers will continue to keep an eye on what smokestacks in Ohio are doing to the rivers or trees in Indiana. Therefore, any environmental "race to the bottom" would be unlikely.

Audit-privilege laws, in the end, are good policy. Whether you believe organizations conduct self-audits in the name of good corporate citizenship or because they want to keep regulators off their backs doesn't really matter. The result is the same: Companies pay greater attention to their environmental practices. These laws improve environmental quality by giving firms incentive to discover and correct problems. They save taxpayers money by allowing enforcement agencies to concentrate on prosecuting "bad actors" -- knowing violators who act recklessly and cause harm. They help move enforcement agencies away from a "bean-counting" mindset that leads them to obsess about the number of enforcement actions and monetary penalties issued because they have no other definition of "success." They promote fairness by not punishing people who voluntarily reveal information they didn't have to find out about in the first place. And most importantly, the laws foster an atmosphere of cooperation between the regulators and the regulated -- an atmosphere which is sorely needed.

Alexander Volokh is a policy analyst at the Reason Foundation, a public policy think tank in Los Angeles.