Navigating Uncertain ESG-Related Risks at the SEC

Pillsbury Winthrop Shaw Pittman LLP

Market participants must manage risk of competing voices regarding direction of ESG rulemaking and the coming wave of enforcement actions.


  • The Securities and Exchange Commission’s near-term climate change and board diversity rulemaking process heralds what may become a period of significant reform to the SEC’s disclosure requirements relating to environmental, social, and governance (ESG) criteria generally.
  • Mixed signals from the SEC’s Commissioners may spell additional uncertainty for market participants.
  • Issuers and private fund managers can adopt certain measures to prepare for the wave of SEC enforcement and civil litigation regarding ESG issues, including by helping to shape the SEC’s agenda through participation in the rulemaking process.

Although the SEC’s ESG-related agenda is in its early stages, market participants should pay close attention to the emerging regulatory framework, which often portends both enforcement actions and shareholder litigation. As previously noted here, these regulatory developments call for careful evaluation, particularly in light of widely held expectations that the SEC will move swiftly on climate-related disclosure rulemaking following the conclusion of a notice-and-comment period this summer, as well as on potential rulemaking requiring public companies to disclose workforce metrics, including in relation to diversity.

The Creation of the SEC’s ESG Taskforce

The SEC’s institutional focus on ESG reached new heights on March 4, 2021, when the Commission announced the creation of a Climate and ESG Task Force in the Division of Enforcement. The Task Force’s primary focus is on developing initiatives to identify misconduct and potential violations relating to ESG, including the identification of “material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.” The Task Force’s scope of responsibility extends beyond climate-related disclosures; for example, included among its responsibilities is the analysis of “disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.” Given this broad scope, it is little surprise that the Task Force is expected to coordinate closely with other SEC divisions and offices, including the Division of Examinations.

The Division of Examinations’ Review of ESG Investing Includes a Focus on Private Funds

The Division of Examinations is slated to play an important role in the agency’s ESG initiatives. Indeed, on March 3, 2021—one day before announcing the creation of the SEC’s Climate and ESG Task Force—the SEC announced its 2021 examination priorities, “including a greater focus on climate-related risks.” In announcing these priorities, Commissioner Allison Herren Lee specified that the Division of Examinations would enhance its focus on climate and ESG-related risks by analyzing proxy voting policies and practices “to ensure voting aligns with investors’ best interests and expectations, as well as firms’ business continuity plans in light of intensifying physical risks associated with climate change.”

Shortly after its announcement of the 2021 examination priorities, the SEC issued a risk alert to “highlight observations from recent exams of investment advisers, registered investment companies, and private funds offering ESG products and services.” Among other things, the SEC identified rapid growth in demand for, and supply of ESG-related products and services, accompanied by a “lack of standardized and precise ESG definitions” that presented risks. To address these risks, the SEC emphasized that examinations of firms “claiming to engage in ESG investing” would focus on key areas including: (i) portfolio management; (ii) performance advertising and marketing; and (iii) compliance programs. In the light of the SEC’s examination priorities, fund managers should pay particular attention to how they conduct ESG-related business.

Relatedly, private equity firms should pay close attention to ensuring that their portfolio companies are, and remain, compliant with relevant ESG standards. Devoting attention to these issues has become part and parcel of PE firms’ ordinary course due diligence. As part of PE firms’ increased attention to ESG, it is important to ensure that PE board designees are well-trained to discharge their duties in overseeing ESG compliance trainings. Especially under the current administration, and mindful of a global emphasis on ESG concerns, PE firms are advised to take the time to enhance ESG training for those serving as their portfolio board designees. As ESG concerns grow, the SEC will expect more from board members who oversee the implementation of ESG standards.

Mixed Signals from the Commission

SEC Chairman Gary Gensler’s overall ambitious agenda includes a clear focus on ESG. As Chairman Gensler has publicly emphasized on multiple occasions, rulemaking regarding ESG disclosures is one of his top priorities. Nonetheless, not all Commissioners appear to be of one mind as to the extent to which the SEC should prescribe ESG disclosure requirements (i.e., as opposed to affording issuers the discretion to determine which items are material to shareholders).

Specifically, even as Chairman Gensler, and fellow Democratic Commissioners Caroline Crenshaw and Allison Herren Lee have emphasized their interest in addressing “risks and opportunities that climate and ESG pose for investors,” Republican Commissioners Hester Peirce and Elad Roisman have publicly questioned that approach. Commenting on the recent “steady flow of SEC ‘climate’ statements and press statements”, Commissioners Peirce and Roisman explained that the focus on climate-related disclosures should be seen as a “continuation of the work the staff has been doing for more than a decade and not a program to assess public filers’ disclosure against any new standards or expectations.” (emphasis in original). Relatedly, in an April 2021 public statement, Commissioner Peirce appeared to bemoan what she perceived as the SEC’s potential shift toward “common metrics demonstrating a joint commitment to a better, cleaner, well governed society” on the basis that such metrics “will drive and homogenize capital allocation decisions [and] constrain decision making and impede creative thinking.”

The SEC’s near-term climate change rulemaking process heralds what may become a period of significant reform to the SEC’s disclosure requirements relating to ESG criteria, as the SEC embarks on this rulemaking process in the coming months. Indeed, the SEC is poised to proceed in October 2021 with notices of proposed rulemaking (NPRM) not only regarding the enhancement of disclosures relating to issuers’ climate-related risks and opportunities, but also relating to the enhancement of disclosures relating to the diversity of board members and nominees. Similarly, the SEC is expected to issue an NPRM in April 2022 regarding requirements for investment companies and investment advisors “related to environmental, social and governance (ESG) factors, including ESG claims and related disclosures.”

As the SEC prepares and issues these NPRMs, the lack of agreement among the Commissioners presents a source of risk for market participants, which generally rely on clarity from their primary regulator.

Navigating Uncertain Regulatory Risk

Market participants—particularly entities and individuals responsible for disclosures—must manage the risk created by the Commission’s competing voices regarding the direction of ESG rulemaking. Relatedly, it is important to recognize that the Commissioners’ divergent views will not be limited to regulation. When investigating a potential violation of the securities laws in an area in which the Commission is divided, the Division of Enforcement typically is mindful of each Commissioner’s perspective and will craft its charging recommendations in a manner designed to secure the votes of at least three Commissioners.

As a starting point, companies should be aware that. while the Commission attempts to act with a consensus (when possible), a majority vote is sufficient to constitute Commission action, including adopting proposed rules or authorizing enforcement actions. Practically speaking, three out of five sitting members of the Commission appear to favor a robust regulatory regime concerning ESG-related disclosures. Mindful of pressure from both the White House and Congress—both of which consider ESG to be a priority—market participants should assume that the Commission will adopt rules requiring extensive ESG disclosure and that violations of disclosure requirements will be aggressively policed by the Division of Enforcement.

Accordingly, companies should proactively take steps to address the risks created by the SEC’s likely ESG agenda. As a starting point, companies should review their ESG-related policies and procedures to ensure that they are identifying items that may have to be disclosed publicly. While the SEC is determining the extent of required ESG disclosures, public companies should ensure that their ESG-related disclosures are timely, accurate, and complete. Relatedly, public companies should ensure that their Disclosure Committees are apprised of all relevant ESG-related risks and are prepared to react expeditiously and appropriately to relevant SEC rulemaking.

Preparing for the Coming Wave of Enforcement Actions and Shaping the SEC’s Agenda

The SEC’s rulemaking and increased focus on ESG clearly raises the stakes with respect to SEC enforcement actions. As history has taught us, the SEC has adopted an approach of “regulating by enforcement” and making an example out of violators. Similarly, it is important to anticipate an increase in private shareholder litigation because such actions typically follow flurries of SEC enforcement activity. There is little reason to believe that history will not repeat itself with respect to ESG.

In addition to adopting measures to prepare for potential SEC examination and enforcement, it is also worth noting that market participants are not without power to help shape ESG-related rules as they are formulated. One important tool is the rulemaking process itself. As the SEC proposes new rules relating to ESG criteria, the notice-and-comment period enables various constituencies, including corporations, investors, and other stakeholders to provide their insights and views about those rules. Prior to enacting a final rule, the Administrative Procedure Act requires the Commission to consider all comments that are submitted and determine whether the rule is consistent with the securities laws. Accordingly, insights and views from market participants will be critical to ensuring that the ESG parameters set by the SEC accord not only with the SEC’s mandate, but also with market needs.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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