The Situation: The SEC and private-lawsuit litigants are increasing their focus on ESG-related disclosures and statements. This is seen in recent SEC enforcement actions, increased "greenwashing" litigation activity, and the SEC's proposed rules on climate-related disclosures.
The Result: Companies' sustainability reports, and the goals and discussion provided therein, will likely be subject to greater scrutiny, and might result in increased reporting burdens in subsequent SEC filings.
Looking Ahead: Management should be communicating with its board, and boards should be actively engaged in oversight of management regarding ESG disclosure risks and appropriate disclosure controls and procedures relating to publicly available ESG information.
For many companies, summer is the time when they prepare and publish Sustainability Reports, which report on efforts with respect to environmental, social, and governance initiatives. Other companies may have already reported, but are refreshing materiality analyses or otherwise starting a process to prepare for 2023, particularly in light of proposed SEC rules. This year, there are three significant developments companies consider as they prepare those materials.
Securities Exchange Commission v. Vale S.A.
In our prior Alert, we discussed the charges the SEC filed against Vale S.A., on April 28, 2022, in the U.S. District Court for the Eastern District of New York. There, the SEC alleged that Vale engaged in a pattern of deceptive acts and practices between 2016 and 2019 when it caused its sustainability reports, periodic filings, and other ESG disclosures to be materially false and misleading by downplaying the risk of catastrophic financial consequences should any of its high-risk dams collapse. As we noted in the Alert, "the complaint demonstrates that the SEC is willing to target statements included in sustainability reports, in addition to traditional periodic filings, as a basis for enforcement actions alleging fraudulent misstatements and omissions."
Potential Increase in "Greenwashing" Litigation
The SEC's complaint followed a private securities fraud case filed almost two years earlier, also in the Eastern District of New York, in which the plaintiffs also alleged that Vale made materially misleading statements regarding safety and sustainability. In that vein, public- and private-plaintiff "greenwashing" litigation is on the rise. And some litigants are finding success arguing that companies' sustainability commitments are not merely opinions, predictions, or aspirations, even if relatively generic in nature. Thus, companies should consider and scrutinize statements made in sustainability reports with the same rigor applied to statements in their filings with the SEC.
SEC's Proposed Rules Relating To Climate-Related Disclosures
A prior Alert also discussed the SEC's proposed rules on climate risk disclosures (the "Proposal"). Although the Proposal does not specifically address sustainability reports, it contains provisions that could implicate information often provided in those reports. For instance, if a company (i) maintains an internal carbon price; (ii) has a separate board or management committee responsible for assessing and managing climate-related risks; (iii) has adopted a transition plan as part of its climate-related risk management strategy; (iv) uses analytical tools such as scenario analyses to assess the impact of climate-related risks on its business and consolidated financial statements; (v) sets a Scope 3 emissions reduction target; or (vi) sets other climate-related targets or goals, the Proposal would require significant disclosures regarding those matters. Companies should be cognizant of these disclosure obligations if the Proposal is adopted in its current form as they prepare their sustainability reports.
To take just a few examples, under the Proposal, if a company sets a climate-related target, it must explain the activities included within the target, the units of measurement to be used, the baseline against which the target will be measured, the defined time horizon by which the target will be met and how, and any interim targets. If a company sets a Scope 3 emissions target in particular, it must additionally disclose its Scope 3 emissions in a prescribed manner—a potentially burdensome process that requires discerning the company's "value chain," and collecting Scope 1 and/or Scope 2 emissions data from each link in that chain. Lastly, if a company uses scenario analyses to assess climate risk, the company must disclose potentially sensitive business information such as a description of the tool itself, and the parameters, assumptions and analytical choices made in utilizing the tool.
Although the Proposal is not yet a final rule, and it is not a certainty that its provisions will come into effect, the possible ramifications should not be ignored. As we describe in greater detail in a comment letter submitted to the SEC, the Proposal's disclosure requirements come with substantial operational burdens and risks. Thus, when preparing sustainability reports companies should consider the follow-on implications should the SEC adopt the Proposal in its current (or a similar) form.
Three Key Takeaways
- Management should update the board regularly regarding efforts to evaluate and develop appropriate disclosure controls and procedures relating to publicly available ESG information in light of increasing focus by SEC and plaintiffs.
- The board should be engaged in active oversight of management related to the risks involved in ESG disclosure and related risk mitigation strategies, and should document a record of the oversight process.
- The board and management should evaluate sustainability reports and disclosures through the lens of potential SEC rulemaking and any ongoing ESG materiality assessments that may be underway