With regulators casting a strong eye on how corporations are disclosing their ESG initiatives, what can GCs do to manage the message?
In 2021, the U.S. Securities and Exchange Commission (SEC), under Chairman Gary Gensler, began an ambitious rulemaking and enforcement agenda that included a razor-sharp focus on disclosures related to environmental, social, and corporate governance (ESG) issues. The SEC’s spotlight on sustainability follows the lead of institutional investors that, beginning in 2017, rung the clarion call for corporations to improve ESG disclosures.
In this installment of In Practice, Rose Ors, CEO of ClientSmart, speaks with Howard Fischer, partner at Moses & Singer and former SEC prosecutor, about what corporations can expect from the agency and the role general counsel can play in setting and driving ESG strategy.
Rose Ors: The SEC is expected to announce new disclosure rules for public companies on ESG-related matters, including enhanced climate and human capital management disclosures. What can we expect?
Howard Fischer: On climate, the SEC will likely require that companies provide fuller disclosures on their sustainability efforts. The agency could also mandate disclosures on companies’ climate burdens, what they are doing to ameliorate those burdens, and how they plan to measure their mitigation efforts. The new rules could also require disclosures on governance, strategy, and risk management related to climate matters.
On the human capital front, the SEC is focused on increasing diversity on corporate boards and in the workforce. The agency is likely to adopt an equivalent of Nasdaq’s Board Diversity Rule — approved by the SEC in 2021. The Board Diversity Rule — Rule 5605(f) — requires that Nasdaq-listed companies have a minimum of two diverse directors on their board or disclose the reason for noncompliance. It also mandates an annual board diversity data report in a prescribed format. To facilitate compliance with Rule 5605(f), the SEC also approved the creation of a diversity recruitment portal that companies can access to identify diverse candidates.
On workforce diversity, companies are now required to disclose the size of their employee base and any human capital objective they use to manage their businesses. The SEC seems likely to require companies to disclose their workforce diversity numbers, the diversity targets they have set, and periodic reports on where they stand in meeting those targets. The SEC has not defined the term “human capital” but requires companies to disclose any human capital factor that is “material to an understanding of the registrant’s business.”
The question that naturally arises is what is deemed “material?” The new rules may answer the question by mandating a host of disclosures, such as a company’s workforce recruiting and retention practices, the diversity of management personnel, as well as companies’ talent development and training programs.
Rose Ors: What is the impetus for the SEC’s push for more robust disclosures?
Howard Fischer: The SEC’s animating goal is that because investors consider ESG disclosures material in making informed investment decisions, the disclosures need to be detailed and accurate. Moreover, for investors to compare ESG data among comparable companies in the same sector, the data needs to be presented in a manner that facilitates an apples-to-apples review.
Rose Ors: Moving now to the enforcement side of the equation. How vigorously can we expect the SEC to investigate potential ESG-related violations?
Howard Fischer: Whenever the SEC creates a task force to identify and investigate violations, we can count on a full-court press enforcement effort. In March 2021, the agency signaled its intent to do just that when it created the Climate & ESG Task Force within the Division of Enforcement.
Rose Ors: Can we also expect an increase in criminal enforcement for environmental violations by the U.S. Department of Justice (DOJ)?
Howard Fischer: Top DOJ lawyers have publicly signaled just such a scenario. Last October, Deputy Attorney General Lisa Monaco made it unequivocally clear that the “absence of corporate compliance programs” will “inevitably [be] a costly omission”. She explained that individual accountability is the “first priority in corporate criminal matters” — and also that a company’s history of environmental misconduct will also be taken into account by prosecutors.
Then in December, Todd Kim, head of the DOJ’s Environment & Natural Resources Division, echoed the DOJ’s crackdown, noting that “enforcement of the criminal provisions of the environmental laws is a priority.” Kim also noted that the DOJ will continue its focus on supply chain issues and cautioned that companies should be “exercising due care over its supply chain in light of the prospect of criminal sanction.”
Rose Ors: Let’s move now to how companies can prepare for these regulatory changes. Specifically, what is the role of a company’s general counsel (GC) in these situations?
Howard Fischer: The GC should take a substantial role in infusing a sustainability lens into corporate governance, strategy, and business practices. On the governance side, for example, the board of directors must be fully apprised of their oversight responsibilities on sustainability-related risks. The same is true for the C-Suite.
The GC has the credentials, the credibility, and the access to lead the effort in educating and updating the board and the C-Suite on how current and emerging ESG regulations impact their respective roles.
Rose Ors: What’s an example of how the GC can work with the full board or the board’s ESG committee?
Howard Fischer: The GC can work with the committee on assessing sustainability risks and how best to disclose those risks by developing disclosure and reporting protocols. The GC also can play a role in determining what disclosures are material; and, because reporting standards are evolving, the GC should conduct periodic reviews to ensure disclosures continue to be material and accurate.
The GC should understand that ESG encompasses a broad set of issues that touches many functional areas in a company. That said, the GC should work with the heads of sustainability, strategy, risk, HR, communications, investor relations, and government relations. Bringing these groups to the table will ensure an all-hands compliance focus on fully integrating each element of ESG in strategy, operations, disclosures, and reporting.
Rose Ors: How should the GC work with regulators, and why is it essential to do so?
Howard Fischer: The GC should establish strong relationships with regulators for several reasons. First, the GC needs to actively engage with regulators to shape regulations that affect their company. Second, understanding the issues and priorities of these regulators allows the GC to anticipate and avert potential regulatory pitfalls. Third, the more regulators know the company’s business and the more credibility the GC has earned in their eyes, the greater the likelihood that in a dispute or crisis, the company’s position will be fully heard and taken into consideration.
Rose Ors: Is there an upside for companies amid this flurry of regulations?
Howard Fischer: I would argue that there is an upside because, in my experience, it is a strategic mistake to view ESG compliance solely as a risk and liability issue. The far better approach is to consider ESG compliance as a source of competitive advantage. Being ahead of the compliance curve in this space is a significant way a company can distinguish itself to investors, consumers, and employees.
My advice to companies is to know what their competitors are doing on ESG — and do it better.