Public companies in the U.S. find themselves at a dynamic time of emergent environmental, social and governance (“ESG”) disclosures. New appointees in the Biden Administration, from the SEC and the Labor Department to the top White House economic advisor, all signal mandatory ESG disclosures.
The idea of ESG began in 2004 with a United Nations initiative to influence capital in non Western markets.
While the federal government has to date stymied the call for ESG disclosures by vocal socially conscious investors, activist stockholder environmental proxy proposals, and the like, companies now anticipate new government edicts commanding ESG statements. In an initial move, the only Department of Labor regulation listed for review by the Biden Administration is the so called ESG Rule published in the Federal Register on November 13, greatly limiting the use of ESG information in certain retirement plans.
I have been pleasantly surprised by the large number of virtual meetings we have had in recent days with representatives of public companies preparing for all but certain new regulation in this space.
There is legal risk associated with ESG disclosures and I have assisted companies for years in mitigating their liability while still being responsive to the trend of investor demands for these disclosures.
Make no mistake, today there is no U.S. law requiring businesses to make ESG statements, and I have posted about failed past attempts to criminalize the matter, ESG Disclosure Simplification Act Passes Committee But Will Fail. But that is all about to change.
Of course, existing 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 some of the risks 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 (.. yes, obviously pre Biden Administration) 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, that existed then and still exists today is there are no such accepted criteria for the very big space that is ‘environmental, social, governance’.
Current SEC Commissioner Hester Peirce, famously 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.”
But there is guidance out there and I have been advising companies to look to Europe and the EU Parliament requirement that by the end of 2020 EU member public companies must have published their policies on integration of sustainability risks. Theirs is a 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,” but still offers good guidance for U.S. best practices.
The U.S. Chamber of Commerce released principles on ESG disclosures, but they did so when all of this was voluntary, and the voluntary disclosures many public companies make today bare little if any relationship to what will be required by law; however, these principals are good and offer some guidance as companies get ready for new ESG rules.
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.
But, possibly of greatest concern to company boards of directors and other leaders are the limitations of the three letter acronym. The broad breadth of issues that get dropped into the ESG bucket are awfully large and diverse to be given a numeric 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, including companies responding to the EU disclosure codes. And with ESG disclosure regulation in the U.S. in short order all but certain, there are steps that companies should take now to reduce the potential legal exposure that will be created by these disclosures.
Okay, whilst our most frequent advice has been simply to use aspirational language in ESG statements, including using words like “should,” “expect,” or “strive,” possibly our most efficacious advice has been to obtain third party verification of the accuracy of disclosures (e.g., LEED certification for claims about buildings and the like), but the coming regulation of this space by the federal government requires a robust response by companies, beginning now, to mitigate risk from ESG. All of which can be consistent with a core belief of this law firm that we can repair the planet with capitalism.