Our earlier blog post, “Companies Should Know Benefits and Risks of ESG Reporting,” provided an overview of the Environmental, Social and Governance (“ESG”) metrics, why these metrics are important to companies and shareholders, and what some of the risks are of reporting ESG goals and the results of ESG improvement initiatives. Not surprisingly, over the last few months, it has become even more apparent that ESG initiatives are not just a “flash in the pan.” Companies should treat ESG as a top corporate priority and begin to navigate the ever changing landscape.
This post will expand on the importance of understanding and evaluating ESG metrics, the risks, and dig deeper into industry-specific issues.
Companies Eagerly Await the Finalization of SEC’s Proposed Rules to Create More Uniform Standards -The Enhancement and Standardization of Climate-Related Disclosures for Investors
As we mentioned in the last post, on March 21, 2022, the U.S. Securities and Exchange Commission (“SEC”) proposed a set of long-anticipated regulations, The Enhancement and Standardization of Climate-Related Disclosures for Investors, which require publicly-traded companies to make new climate-related disclosures and evaluate associated business risks and impacts. The proposed rule was published in the Federal Register (87 FR 21334) on April 1, 2022. The public comment period was set to close on May 20, 2022, but was extended until June 17, 2022.
As expected, the SEC received several thousand comments from interested public companies, trade organizations, public interest groups, law firms, financial management and investment firms, and other concerned stakeholders. Some comments were supportive of mandatory and standardized disclosures that would help to evaluate ESG risks, while others questioned the SEC’s overreach and the scope of the rules. The SEC will now consider these public comments as the agency works diligently to finalize the regulations. Given the vast number of comments from a diverse set of stakeholders and added attention in the news, it is unclear when a final rule is expected and how the final rule will deviate from the proposed rule based on those comments. Some believe, however, that the SEC is preparing to release the final rules by the mid-term elections in November.
Just as publicly-traded companies make ESG-related disclosures, so do investment advisors and investment companies. In another sign that ESG metrics and regulation is not going away, the SEC is looking for ways to ensure investors are provided consistent, comparable, and reliable information on ESG practices by funds and advisers. On May 25, 2022, the SEC proposed amendments to existing rules and reporting forms to: require additional specific disclosure requirements regarding ESG strategies in fund prospectuses, annual reports, and adviser brochures; implement a disclosure approach to allow investors to compare ESG funds more easily; and require certain environmentally focused funds to disclose the greenhouse gas emissions associated with their portfolio investments. The proposed rule was published in the Federal Register (87 FR 36654) on June 17, 2022. The public comment period ends on August 16, 2022.
The SEC Will Consider the Recent Decision inWest Virginia v. EPA When Crafting the Final Rules
In addition to the public comments, another factor being weighed by the SEC is the recent June 30, 2022, decision by the U.S. Supreme Court in West Virginia v. EPA, No. 20-1530. The Court addressed the so-called “major questions doctrine,” holding that, absent explicit congressional intent, the U.S. Environmental Protection Agency (“EPA”) does not have authority under Section 111(d) of the Clean Air Act to “force a nationwide transition away from the use of coal to generate electricity[.]”
Although the case involved the limits of EPA’s regulatory power, the holding will be applied to other federal agencies making policymaking decisions. It is clear from the decision that the Court is keeping an eye on governmental regulatory reach. As agencies finalize rules and regulations for the remainder of the Biden Administration, there will certainly be more litigation testing the scope and boundaries of the “major questions doctrine” and the West Virginia v. EPA ruling.
The SEC’s final rules related to ESG disclosures are no exception and will need to be re-examined and crafted with this decision in mind, which may alter the final promulgated version. Many of the public comments on the proposed rules and even public objections before the proposed rules were published challenged SEC’s broad interpretation of its statutory authority to promulgate climate-related disclosure requirements on this legal ground. If the SEC finalizes the proposed rules in substantially the same form, legal challenges will most likely follow.
If federal regulatory agencies like the EPA and SEC are forced to roll back their climate-related agendas, the current trend of stakeholders pressuring public and private corporations to establish ESG-related metrics and meet those targets will continue. Future posts in this series will focus on understanding and complying with the final regulations.
ESG-Related Litigation Is on the Upswing
While we wait for the final regulations and in light of what we have learned from the proposed regulations, companies should begin to develop internal due diligence processes and to establish effective compliance programs to understand, collect, and measure their ESG data and risks. Regardless of what the final regulations may look like and how extensive or not they may be, stakeholders will continue to demand ESG as a tool to help make better investment decisions regarding environmental and social issues, so it is good business practice to develop policies now. And when it comes to reporting, companies must be careful to understand and use widely accepted standards and be cautious not to make inaccurate statements. Companies need to be extra vigilant that they are making accurate and supportable statements regarding their ESG disclosures.
We identified a developing litigation trend in the last post where consumers and shareholders are challenging companies’ ESG statements as misrepresentations, unfair and deceptive trade practices, and securities fraud. We have seen a steady flow of ESG-related litigation filed in all of the federal courts and expect that when the regulations are finalized, there will be an increase in ESG-related claims filed.
The SEC has also moved forward with ESG-related enforcement suits against publicly traded companies. In April, the SEC filed a claim against Vale S.A., a Brazilian mining company publicly traded on the NYSE, alleging that false and misleading statements were made in the company’s public announcements and reports regarding the safety and security of certain of its tailings dams. In 2019, one of those dams failed, killing hundreds of people downstream, causing severe environmental damage, and resulting in a $4 billion loss in its market capitalization. Further, the SEC has begun to investigate asset management firms, related to the firms’ management of ESG-related mutual funds.
In March 2021, the SEC created a Climate and ESG Task Force (“ESG Task Force”) within the Division of Enforcement. According to the SEC, the ESG Task Force is charged with identifying potential violations including “material gaps or misstatements in issuers’ disclosure of climate risks under existing rules, and disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.” Now that the ESG Task Force has been operating for over a year, we expect additional enforcement claims, like the one filed against Vale S.A., to be brought against offending companies. In addition to an expected increase in enforcement actions, there may also be an uptick in criminal enforcement by the U.S. Department of Justice Criminal Division and Environment and Natural Resources Division as those cases run parallel with the SEC.
Future posts in this series will focus on tracking and highlighting these enforcement claims.
The Insurance Industry is Examining the SEC’s Proposed Rules Closely
One sector looking closely at these developments is the insurance industry. ESG covers a complex landscape and thus carries with it a broad set of risks, uncertainty, and exposure for insurers. Over the last few years, insurance companies have taken a deeper dive into policy holders' ESG programs, developing their own models, methods, and rating systems to monitor and measure ESG initiatives. But both underwriters and policyholders have had difficulty measuring performance and evaluating risks and exposures without clear standardized guidance and regulations. With the finalization of SEC’s new rules regarding climate-related disclosures and the creation of standardized metrics, these risks may now be crystalized, allowing for the development of more robust insurance products.
Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. The author has provided the links referenced above for information purposes only and by doing so, does not adopt or incorporate the contents. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.
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