Corporate stakeholders have a new normal to confront, as influential investors — and more recently, some regulators — have pushed corporate boards and executives to consider their companies’ own environmental, social, and governance (ESG) profiles and implement plans to become more sustainable and impactful. Regardless of the moral imperative, corporate leaders are recognizing the potential investment, regulatory, and legal risks of doing nothing when it comes to addressing issues like climate change, diversity and inclusion, or corporate transparency.
Focus on environmental issues — specifically, climate change, use of sustainable energy and materials, and other environmental management practices — began receiving more attention at least a decade ago. So, too, did the trend toward extracting greater corporate transparency and adoption of rules and policies to safeguard against corporate mischief and protect whistleblowers. But more recently, with numerous social justice events in the news and at the forefront of major policy debates, corporate leaders and risk managers find themselves putting in the work to understand their companies’ response to diversity and inclusion, sexual misconduct, consumer protection, labor conditions, and other human rights problems.
With good reason. Of course, it’s first and foremost the important thing to do. But what’s more, these ESG factors now reportedly weigh more heavily in investors’ decisions of whether to invest or stay invested in a particular company.
In July 2020, the U.S. Government Accountability Office issued a report concerning ESG disclosures among public companies, which showed that of the 14 institutional investors interviewed, 12 said they actively mine information on ESG issues to better understand risks that could affect company financial performance over time. That means companies will continue to see heightened demand for broader corporate disclosures on ESG assessments and plans. And as the regulatory landscape around various ESG topics broadens, investors now use ESG disclosures to monitor companies’ management of ESG risks, make stock purchasing decisions, inform their vote at shareholder meetings, or even bring lawsuits for allegedly misrepresented disclosures.
Increased shareholder interest in ESG factors has resulted in changes to shareholder activism. Even small activist investors have found success in waging ESG-focused campaigns with support drawn from larger institutional investors. In one example, after Exxon Mobil Corporation’s annual shareholder meeting in May 2021, a small activist investor firm owning only a 0.02% stake in Exxon won three of Exxon’s 12 board seats after a proxy fight based on the activist’s claim that Exxon had not developed an adequate business strategy around climate change. The activist investor appeared to gain support from many large investors including BlackRock, State Street, Vanguard, CalPERS, CalSTRS, and the New York State Common Retirement Fund, to name a few.
Regulatory scrutiny of ESG issues is also intensifying. On May 20, 2021, President Joe Biden signed Executive Order No. 14030, calling for “a comprehensive, [g]overnment-wide strategy” on, among other things, climate-related financial risk, which expanded upon climate-related endeavors undertaken by federal regulators including the U.S. SEC, Federal Trade Commission, Commodity Futures Trading Commission, Consumer Financial Protection Bureau, and the Federal Reserve.
Earlier this year, the SEC announced the creation of a Climate and ESG Task Force in the Division of Enforcement. The SEC stated that the task force will develop initiatives to proactively identify ESG-related misconduct and coordinate the use of sophisticated data analysis to identify potential violations, in line with increasing investor focus and reliance on climate and ESG-related disclosure and investment.
In a keynote address to the 2021 Society of Corporate Governance National Conference, SEC Commissioner Allison Herren Lee remarked, “We should consider whether public pledges on ESG issues are actually backed up by corporate action. That’s part of my message … that substantive consideration of ESG should be meaningfully integrated into board oversight … [a]nd why I’ve previously suggested that our disclosure regime should provide investors with adequate information to test public pledges like these.”
Federal officials are not alone. State attorneys general — led by those in New York and California — are imploring the SEC to direct broader ESG disclosures for climate-related financial risks.
California passed a law last year which now requires publicly held companies headquartered in that state to include board members from underrepresented communities by the end of 2021. That law followed the 2018 passage of another bill mandating that public companies headquartered in California have at least one woman on their boards of directors by the end of 2019, with further future increases required depending on the size of the board.
And in early 2021, several years after launching the “Boardroom Accountability Project” to persuade publicly traded companies to adopt policies requiring the consideration of both women and people of color for every open board seat and for CEO appointments, New York City Comptroller Scott Stringer used the power of the purse to make an ESG investment statement loud and clear. The Comptroller divested $4 billion in New York City pension fund money from fossil fuel companies in what the Comptroller described as “one of the largest divestments in the world.”
ESG-related lawsuits are also on the rise, ranging from diversity, equity and inclusion and #MeToo-related litigation on the social side, to litigation concerning companies’ roles in global climate change on the environmental side. According to a database maintained by the Sabin Center for Climate Change Law at Columbia Law School, there are over 2,100 lawsuits related to climate change pending in courts globally. Some of those are successful.
In May 2021, for example, a Dutch court ordered Royal Dutch Shell plc (Shell Oil) to reduce its overall carbon dioxide emissions by 2030 by at least 45% from 2019 levels, which was well past its existing pledge to reduce emissions. It is believed to be the first time any court has ordered a private company to comply with the 2015 Paris Climate Agreement.
Several large public companies have already been sued in board diversity derivative suits, while others have faced litigation centered on sourcing and supply chain risks that involve human rights and child labor issues.
With the SEC’s focus on ESG disclosure and issues of materiality, alleged ESG-related material misstatements and omissions could lead to SEC enforcement proceedings and civil securities litigation under Section 10(b) of the Securities Exchange Act of 1934. And to the extent companies might incorporate ESG disclosures into public offering documents, any alleged ESG-related misstatements in that context could lead to issuer securities actions under Section 11 of the Securities Act of 1933.
Corporate risk managers and D&O insurers might expect increased claim activity for ESG-related challenges. Like the harbingers of event-driven litigation which we saw with the opioid crisis and data privacy breaches, as examples, lawsuits stemming from significant environmental or natural disasters, superstorms, and social events like the #MeToo movement are all-but-certain to increase.
But while these “bad news” events not directly related to financial results might be difficult to forecast, lawsuits emanating from perceived poor governance standards, product problems, exploitation in the supply chain, etc. might be mitigated by corporate decision-makers evaluating their ESG risks and adopting policies to combat them. With the focus on ESG-related issues increasing, certainly it should be expected that companies and their leaders will undertake a thorough review of all types of risk which could impact their insurance coverage and review relevant provisions in their D&O policies.
Activism begets change, in the boardroom and in the streets. Companies’ ESG risks will continue to become more visible, as shareholders and regulators press corporate leaders to acknowledge their risk profiles and adopt policies to manage those risks. Confronting ESG issues will save companies time, money, and probably heartache in the long run, and it will allow companies to successfully plan and become sustainable and impactful.