SEC enforcer: Accurate ESG disclosures are ‘crucial’

Federal securities regulators are cracking down on ESG disclosures because investors care about them, the Securities and Exchange Commission’s top enforcer says.

“We are here to protect investors, and if they care, then we care,” enforcement division director Gurbir Grewal said in a February 23 speech to the Ohio State Law Journal. “And in that case, we have a duty to ensure that companies speak truthfully on these topics.”

The Commission isn’t an environmental regulator, Grewal acknowledged. Nor is it “the values police.” But “ESG issues are increasingly material to investors,” he said.

“It is therefore crucial,” Grewal said, “that when companies speak about the host of issues that may fall under the rubric of ESG – whether climate, social, corporate governance or others – they do so in a way that’s not materially false or misleading.”

The SEC currently is weighing two ESG rule proposals. One would require public companies to disclose their “carbon footprint” using standardized metrics. The commission is scheduled to vote on those rules Wednesday. The other would impose a suite of disclosure obligations on registered investment advisers that claim to factor ESG considerations into their investment decisions. A vote hasn’t been scheduled on that rules package.

Grewal and his team have shown they don’t need the new rules to crack down on industry: They’ve used the antifraud provisions of the Investment Advisers Act – buttressed by the SEC’s updated marketing rules and its substantiation requirements – to bring cases against investment advisers and public companies for misleading investors about their ESG policies.

‘Sticking to it’

“After all,” Grewal said, “saying you have an ESG-investment strategy is pretty easy; creating one and sticking to it is another matter.”

Private fund advisers have so far avoided Grewal’s dragnet. That may be only a matter of time. For a year or more, examiners have been using the marketing rule to ask private fund managers about their ESG policies. Regulators have been scanning websites and other public-facing claims right down to the portfolio company, and asking tougher and broader questions about how managers arrived at those claims.

Grewal says he and his team are worried about misleading statements in two directions. One is the classic “greenwashing.” Investor demand that companies weigh environmental or social concerns means firms “have more incentives to exaggerate or make misleading statements about their perceived positive ESG activities or products,” Grewal said. “For example, public companies may disclose that their operations satisfy certain ESG-criteria or investment firms may market investment strategies as ESG-focused, when that’s not the case.”

“Second,” Grewal added, “the investor focus on these issues may make it more tempting for companies to downplay or omit disclosures about negative ESG-related information. For example, they may make misleading statements about these events, or may omit them from their disclosures altogether, making the disclosures materially misleading.”

ESG litigation risks grow

It’s not just regulators that firms must worry about, lawyers at Seyfarth Shaw warn in their fourth annual Commercial Litigation Outlook, released just days before Grewal’s speech. ESG litigation remains a top risk for firms of all sizes and shapes, Seyfarth says.

The regulators’ focus on ESG questions “has not gone unnoticed by the plaintiffs’ bar, with putative investor class actions filed alleging a variety of ESG-related misstatements or omissions, such as carbon net-zero claims, sustainability efforts or commitments to [diversity], as well as breach of fiduciary duty claims,” the Seyfarth lawyers write. “In derivative actions, plaintiffs have successfully extended the duty of oversight to officers focused on improving corporate culture and other [diversity] initiatives.”

So far, none of those class-action suits have gotten far, Seyfarth says. “Regardless, it continues to be important for boards to adequately exercise their duty of oversight over climate and social initiatives to the extent it is important to the business,” the attorneys warn.

Editor’s note: Worried about ESG compliance? Private Funds CFO and Regulatory Compliance Watch are co-hosting a March 26 CLE/CPE webinar, “ESG: Risk, rewards and opportunities.” Our expert panel includes Seward & Kissel partner Debbie Franzese, PwC global private equity, real assets and sovereign wealth funds leader Eric Janson, and ILPA managing director Matt Schey. They’ll share their views of the dynamic ESG policy landscape and offer their tips for financial services professionals who are navigating it. The webinar is free but you must register. Find out more by clicking here.