Public companies in the U.S. find themselves at a dynamic time of emergent environmental, social and governance (“ESG”) disclosures. Vocal socially conscious investors, activist stockholder environmental proxy proposals, and the like are driving companies to make ESG statements.
This blog post highlights the legal risk associated with ESG disclosures and proffers that with green building practices companies can mitigate their legal risk while still being responsive to the trend of investor demands for more disclosure.
Make no mistake, there is no U.S. law requiring businesses to make ESG statements, but I have posted about ongoing attempts to criminalize the matter, ESG Disclosure Simplification Act Passes Committee But Will Fail.
Of course SEC rules generally require public companies to disclose, among other things, known trends, events, and uncertainties that are reasonably likely to have a material effect on the company’s financial condition or operating performance in an annual report and other periodic filings, and there are the SEC’s Conflict Minerals Disclosure Rule, and the California Transparency in Supply Chains Act, but none of that equates to ESG disclosures.
Recent U.S. case law underscores that ESG disclosures may be actionable if found to be materially false or misleading. There has been relatively little judicial redress arising from ESG claims (largely attributable to a robust stock market in recent years) and much of it involving bad facts in extreme instances (i.e., against BP arising from the Deepwater Horizon incident, against Massey Energy arising from a fire in a coal mine, etc.) and the legal adage that bad facts rise to bad law may certainly have been at play in those instances.
But the risks associated with ESG disclosures are real and should not be underestimated.
It was widely reported in the media in December 2019 that the SEC was scrutinizing whether ESG claims “are at odds with reality.” The SEC sent examination letters to managers of funds touting their ESG bonafides, apparently focusing on criteria for claiming a company to be socially responsible and the methodology for applying those criteria.
The problem, of course, is there are no such accepted criteria.
SEC Commissioner Hester Peirce has publicly said, “we are seeing a similar scarlet letter phenomenon in today’s modern, but no less flawed world” but it is not Hester Prynne’s “A” for adultery in Puritan Massachusetts Bay Colony in 1642, but rather ESG in America in 2020. The SEC Commissioner has also questioned “the materiality of ESG” including finding fault with ESG for having no enforceable or common meaning, “while financial reporting benefits from uniform standards developed over centuries, many ESG factors rely on research that is far from settled.”
In what is widely viewed as a flawed rule only further slowing chronically weak European economies, the EU Parliament will require by the end of 2020 that EU member public companies publish their policies on integration of sustainability risks, with a much watered down definition of “sustainability risks .. as an ESG event that could cause an actual or potential negative impact on the value of the investment arising from an adverse sustainability impact.” Such offers no good guidance for U.S. best practices.
Michael Bloomberg funded the Sustainability Accounting Standards Board and more than 100 companies report information according to SASB guidelines, but the disclosures aren’t standardized like corporate financial disclosures including that they sometimes omit proprietary information or damaging data. Critics claim SASB simply provides more data the parent company can sell and such is a widely heard knock on many in the ESG space?
In a year when Billionaires are “out” and 401(k) Millionaires are “in” increasingly progressive in the U.S. are disgruntled when the most popular stocks held in ESG mutual funds are Microsoft and Apple, the same as in non-ESG funds?
Maybe most damning is that ESG mutual funds, on average, underperform the market. An analysis reported last month in The Wall Street Journal of 219 mutual and exchange traded funds classified by Morningstar are integrating ESG into their investment process of focusing on sustainable themes “underperformed the S&P 500 over both one and three years.” The Morningstar data does not rely on any particular criteria, but rather lets the companies self identify as integrating ESG.
People are free to invest in companies as they wish, but they can only do so if the peddlers of ESG are honest about the limitations of the three letter acronym. The broad breadth of issues that get dropped into the ESG bucket are too diverse to be given a number score.
I have for years advised public companies about environmental matters and sustainability including navigating the complexity of the emergent ESG disclosure decision making landscape. Of course, there are steps that companies can take to reduce the potential legal exposure created by these disclosures. While our most frequent advice is simply to use aspirational language in ESG statements, including using words like “should,” “expect,” or “strive,” possibly our most efficacious advice is to obtain third party verification of the accuracy of disclosures.
And there may be no better third party verification in the realm of environmental disclosures (the E of ESG) than a third party certified LEED green building. I posted about the concept in 2018 and today, still with no accepted criteria, the widely recognized LEED seal provides some sustainable panache, but most important mitigates risk from the modern scarlet letters ESG.