Reuters Legal News
ESG regulatory landscape creates commercial pitfalls
By Rachel Goldman , Esq ., and David Shargel , Esq ., Bracewell LLP NOVEMBER 19 , 2021
With Environmental , Social and Governance ( ESG ) issues top of mind in almost every industry , including at the recently concluded COP26 climate change conference in Glasgow , the burgeoning U . S . regulatory landscape and accompanying litigation trends are giving rise to a variety of related commercial risks .
This investor focus on ESG issues and the resulting regulatory dragnet make clear that companies should develop identifiable and measurable ESG initiatives .
ESG-focused regulatory enforcement , shareholder litigation and shareholder activism , not to mention the associated risk of reputational harm , undoubtedly remain persistent and growing boardroom concerns . But these risks , which are summarized below , lay the groundwork for a new threat : ESG-related exposure from other entities with whom companies do business and in the value chain , such as joint-venture partners , suppliers , contractors , and subsidiaries , whose own ESG failures could have disastrous consequences for a company that otherwise has its ESG house in order .
These risks could potentially have far greater and longer lasting value consequences , including subjecting the company to additional enforcement activity , securities litigation and consumer litigation ; increasing the probability of commercial litigation with counterparties and third parties ; and impairing or even destroying the underlying transactional or project value .
ABCs of ESG
ESG comprises factors by which investors evaluate a company ’ s social and environmental conscientiousness and risk . The “ E ” focuses on climate risk and considers the impact a company has on the environment , such as greenhouse gas emissions , and the impact the changing environment has on the company , such as the transition to a carbon neutral economy . The “ S ” refers to a company ’ s human capital , including diversity and inclusion , as well as workplace conditions and human rights . The “ G ” embraces risk management and accountability : what are the firm ’ s business and investment strategies , commitments and risks ; is the firm appropriately ensuring compliance with those commitments and attending to the risks ; and is the firm properly disclosing material information related to “ E ,” “ S ,” and “ G ”?
Investors care deeply about these issues . A recent poll of more than 2,000 Americans conducted by Morning Consult revealed that approximately three quarters of frequent investors believe that ESG is “ very ” or “ somewhat ” important when it comes to investing .
Regulatory and shareholder litigation risks
Not surprisingly , regulators are aiming to keep pace with the investment community ’ s ESG concerns . Perhaps most prominently , in March 2021 the U . S . Securities and Exchange Commission created a Climate and ESG Task Force in its Division of Enforcement . The task force is focused on identifying material gaps or misstatements in public company disclosures of climate risks under the SEC ’ s existing disclosure requirements . The SEC is also in the process of formulating new climate disclosure requirements , spurred in part by President Biden ’ s executive orders implementing a “ whole of government approach ” to climate change .
These new disclosure rules are expected to be announced soon , and although the rulemaking process will take time , the SEC has made clear they will be designed to provide consistency , comparability and “ decision usefulness .”
Climate risk is not the SEC ’ s only area of focus , and new disclosures could also involve board diversity , human capital management and cybersecurity risks , among other ESG issues . The SEC ’ s Division of Enforcement has already begun to tackle these “ S ” and “ G ” matters , with investigations into companies like Activision , regarding an alleged failure to disclose risks related to sexual harassment and discrimination , and an action against First American Financial Corp ., charging failure to timely disclose cybersecurity risks .
The Department of Justice also has its eyes on ESG . In October of 2021 the Deputy Attorney General announced that the agency is taking aggressive new actions to strengthen its approach to corporate crime , including in the areas of environmental justice and cybersecurity .
Other regulators and government agencies have likewise taken notice . For example , the U . S . Treasury Department has called for enhanced disclosures ; stock exchanges like Nasdaq have implemented board diversity rules requiring listed companies to have at least one “ diverse ” board member by 2023 , and two by 2025 ; the Commodity Futures Trading Commission has formed
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