If a newly-announced task force is any indication, the U.S. Securities and Exchange Commission (“SEC”) is gearing up to target formerly under-addressed environment, social, and governance (“ESG”) issues. In a release late last week, the U.S. securities regulator revealed that “increasing investor focus and reliance on climate and ESG-related disclosures and investments” has prompted it to launch a Division of Enforcement-wide Climate and ESG Task Force in order to “develop initiatives to proactively identify ESG-related misconduct” and to coordinate to “mine and assess information across registrants, to identify potential violations” by publicly-listed companies, investment advisers, funds, and other market participants.
According to the SEC’s March 4 announcement, the “initial focus” of the 22-member Task Force will be to “identify any material gaps or misstatements in issuers’ disclosures of climate risks under existing rules” – presumably from mandated disclosures to voluntary ones that are increasingly being made on companies’ websites and in press releases – and to “analyze disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.” This will see the Task Force work closely with other SEC Divisions and Offices, including the Divisions of Corporation Finance, Investment Management, and Examinations, in furtherance of its efforts to address what it calls ESG-specific “risks to investors.”
The increased attention from the SEC makes sense given that consumers are increasingly expecting companies to prioritize – and publicize – ESG issues, from addressing their carbon emissions to being transparent about the labor practices in their supply chains, and many consumer-facing companies are angling to meet such calls for action with relatively little regulatory attention being paid to the veracity of such vows. At the same time, “As the threat of climate change has risen, more and more investors have begun to factor sustainability into their investment decisions,” according to Sheppard Mullin attorney Richard Friedman, who claims that investors are similarly “making a conscious effort to invest in companies whose social policies, such as racial equity and community relations, align with their own values.”
The significance of ESG concerns is being increasingly cemented by companies across industries (with fashion and apparel companies firmly situated in the mix), and yet, “there is no precise legal or regulatory definition of ESG,” Katten Muchin Rosenman LLP stated in a recent client advisory, thereby, giving rise to ambiguities about the merit of companies’ alleged ESG efforts and difficulties in measuring their success (or lack thereof), particularly amid an enduring influx of eco-centric initiatives by companies.
“The SEC has provided little in the way of specific ESG investing guidance [to date], despite growing demand by institutional investors, ESG advocates, and other market participants for the SEC to do so,” according to Friedman. In addition to opting not to set out a specific definition for ESG, Friedman says that “it is important to note that at this time, the Task Force will be limited to enforcing existing disclosure requirements, rather than formulating additional ESG-related disclosures.”
Since federal securities laws generally do not require the disclosure of ESG data except in limited instances, the practice of companies making their ESG-specific goals available on their websites and/or in government filings is firmly within each individual entity’s discretion as of now. Those claims are, nonetheless, significant, as federal law mandates that even voluntary ESG disclosures must not be “materially misleading or false,” which means that even discretionary claims made by companies on the ESG front are subject to legal liability.
A potential crackdown on voluntary ESG claims appears to be in the cards, as Friedman contends that the SEC has stressed specific priorities, including “ensuring that actual practices conform with such disclosures.” He says that the SEC Task Force is also expected to prioritize “reviewing the consistency and adequacy of ESG disclosures, reviewing fund advertising for false or misleading statements, and assessing whether proxy voting policies align with ESG strategies.”
Climate and ESG disclosure issues “have not been the central focus of prior enforcement actions” for the SEC, according to Freshfields Bruckhaus Deringer LLP attorneys Kimberly Zelnick, Altin Sila, and Hannah Khalifeh. However, the “public pronouncements and internal actions in this arena” – from the launch of the SEC task force and the appointment of Satyam Khanna as the first Senior Policy Advisor for Climate and ESG to the SEC’s March 3 publication of its 2021 “Examination Priorities,” which cited an “enhanced” focus on climate and ESG-related risks – signal that the formerly lax “approach is poised to change, and send a clear message that the SEC expects companies and other market participants to consider how ESG issues may impact a company’s financial future and to make appropriate disclosures to investors.”
With these developments in mind, Katten suggests that investment advisers and other market participants begin preparations for the SEC’s ESG initiatives by “reviewing and revising, as appropriate, ESG disclosures in marketing materials, Forms ADV, fund offering documents and advisory agreements, along with reviewing their ESG proxy voting practices.” For public companies that have not engaged in “meaningful ESG discussions with their various stakeholders,” they “should consider whether and how to do so, including starting to educate management on ESG matters.” And finally, the firm suggest that “if they have not done so already, boards of directors should start thinking about company specific ESG matters and how the board oversees these ESG matters.”