Managing ESG disclosures in an uncertain regulatory environment

May 2023 | SPOTLIGHT | RISK MANAGEMENT

Financier Worldwide Magazine

May 2023 Issue

Since the concept of environmental, social and governance (ESG) factors was first introduced in the 2006 United Nations’ Principles for Responsible Investment Report, regulators have grappled with whether – and how – to develop effective enforcement mechanisms for ESG compliance. In the meantime, pressure from investors and the broader public for companies to take ESG-supporting action has grown and ESG ratings providers, such as MSCI, S&P and ISS, have filled the regulatory void by ranking companies’ ESG practices. These ratings providers do not, however, always provide investors and the public with a useful assessment of companies’ ESG activities. Critics of these ratings providers express concern with the accuracy of the data produced and the fact that there is no standardisation in data collection which, in turn, leads to inconsistency across ratings providers even though they purport to measure the same conduct. This leaves companies with little certainty around how to incorporate ESG into their business in a way that minimises the risk of regulator scrutiny or shareholder activism.

Acknowledging the difficulty in collecting ESG-related data, or even defining the scope of ESG, several Securities and Exchange Commission (SEC) commissioners have voiced concerns over the development of ESG regulation in the US. In remarks before the Brookings Institute in July 2021, Hester Peirce, an SEC commissioner, described ESG as expanding to encompass “whatever the speaker or the news media are focused on at the moment” and in remarks on 27 January 2023, Mark Uyeda, an SEC commissioner, asserted “that standardized ESG measures are doomed to fail”. Both commissioners, as well as Elad Roisman, another SEC commissioner, have also taken issue with the need for additional ESG-specific regulation, with Mr Roisman noting in a speech on 3 June 2021 that, “[t]o the extent that other material risks to a company can be categorized as ‘E,’ ‘S’, or ‘G’, I do not see a legal justification for failing to disclose that information under our existing rules”.

Perhaps due to these concerns, or in recognition of the difficulty of creating or measuring ESG metrics, the SEC has yet to promulgate many regulations (though several are currently pending approval) or explain how materiality of ESG issues is to be assessed. Europe, for example, has adopted a ‘double materiality’ standard under which companies must report information material to the company’s financial position, as well as information relevant to the company’s impact on the climate or society. Some commentators would like to see the same approach from the SEC while others, including Ms Peirce, strongly oppose adopting a double materiality standard.

Despite the continued lack of regulatory clarity in the US, over the past few years, the SEC has taken steps to investigate and pursue actions against companies related to their ESG measures and disclosures. On 4 March 2021, the SEC announced the creation of a Climate and ESG Task Force to “proactively identify ESG-related misconduct”. It has also publicly announced investigations and settlements with respect to ESG-related disclosures. On 3 February 2023, for example, the SEC issued a cease and desist order against Activision Blizzard, Inc. based on the company’s purported failure to maintain disclosure controls and procedures and violation of whistleblower protections. The SEC noted that the company had made risk factor disclosures pertaining to its workforce in its annual reports, stating that it “may have difficulties in attracting and retaining skilled personnel” and that if the company is “unable to attract additional qualified employees or retain key personnel, it could have a negative impact on our business”. Despite these risk disclosures, according to the SEC, the company failed to maintain disclosure controls and procedures designed to collect or analyse employee complaints of workplace misconduct. This information, the SEC asserted, could be potentially material and subject to disclosure and yet was not made available to disclosure personnel. The SEC also found that the company’s separation agreements violated whistleblower protections by requiring former employees to notify the company of any requests from an administrative agency in connection with a report or complaint and ordered Activision Blizzard to pay a fine of $35m for its violations.

In a dissenting statement that does not explicitly mention ESG but echoes Mr Uyeda, Mr Roisman and Ms Peirce’s previously expressed concerns regarding ESG regulations, Ms Peirce criticised the SEC for finding a violation of the securities laws absent any “fraud, misrepresentation, omissions, or investor harm”. She accused the SEC of overstepping its role and playing ‘corporate manager’ in order to nudge companies “according to the metrics the SEC finds interesting at the moment”, highlighting the fact that the enforcement action came in the wake of public reports of rampant workplace misconduct at Activision Blizzard. Ms Peirce also noted that the SEC’s order requires disclosure of information that goes beyond the standard ‘materiality’ requirement – it requires disclosure of “an additional, vaguely defined category [of] information ‘relevant’ to a company’s determination about whether a risk or other issue reaches the threshold where it is ‘required to be disclosed’”.

Whether the SEC will ultimately be able to promulgate rules that provide a clear framework for ESG enforcement actions remains unclear. What is clear is that investor and public interest in ESG is not going away and the SEC seems intent on taking steps to regulate ESG disclosures in the absence of a fulsome regulatory regime and despite disagreement from certain commissioners. With that in mind, companies would be well served to take note of this increased risk and ensure that their procedures and internal controls adequately capture and correctly assess information related to ESG-associated risks. Often, this can be done by leveraging existing corporate compliance programmes and risk assessments. As Ms Peirce explains, “[s]ome of what we are excitedly calling ESG is simply the same old stuff on which companies have been reporting” within the existing materiality framework. By way of example, companies can often leverage the work done to comply with anti-corruption laws, human rights laws and labour laws, among others. Taking advantage of any overlap with existing policies and procedures can expedite a company’s establishment of a mature ESG programme and decrease its overall cost. The Activision Blizzard case demonstrates the importance in the current environment of quickly establishing programmes (to the extent they do not already exist) to ensure accurate assessments and disclosure of ESG-related risks, as the SEC is ramping up its enforcement efforts in this space (despite seeming internal disagreement and the lack of formal guidance or rules). While uncertainties in the ESG space can be daunting, companies with a mature system of internal controls should take comfort in the fact that they are already well placed to respond to any future ESG regulation.

Laura Perkins is a partner and Shayda Vance is an associate at Hughes Hubbard & Reed. Ms Perkins can be contacted on +1 (202) 721 4778 or by email: laura.perkins@hugheshubbard.com. Ms Vance can be contacted on +1 (202) 721 4705 or by email: shayda.vance@hugheshubbard.com.

Laura Perkins and Shayda Vance

Hughes Hubbard & Reed