It is no secret that the U.S. Securities and Exchange Commission (SEC) has recently ramped up its focus on environmental, social and governance (ESG) disclosures. In February 2021, Acting Chair of the SEC Allison Herren Lee directed the Division of Corporation Finance to enhance focus on climate-related disclosure in public company filings, including reviewing the extent to which public companies address the topics identified in the SEC’s 2010 Guidance Regarding Disclosure Related to Climate Change. Then, in March 2021, she requested public comment on climate change disclosures (which has generated over 600 comment letters, the vast majority of which are supportive of mandatory climate disclosure rules), and new SEC rules on climate risk and human capital disclosures are expected to be proposed yet this year. In addition, holding true to its “all-of-SEC” approach to ESG, the SEC has formed a Climate and ESG Task Force (composed of 22 members and led by the Acting Deputy Director of Enforcement), which will use data analytics to look for material gaps and misstatements in climate risk disclosures under existing rules.
This increased focus of the SEC is driven by increased investor interest in ESG, which is perhaps most strikingly apparent in the recent move by investors in getting three directors elected to the board of ExxonMobil, and the heightened public scrutiny of corporate political donations in the wake of the Capitol riot. But it is also evident in the record number of shareholder proposals on environmental and social topics in the 2021 proxy season, which have seen a significant surge in support from institutional investors. Businesses too have signaled a shift in focus, away from a single-minded pursuit of shareholder profit and toward creating value for all stakeholders.
Sidley has been tracking the progression of this focus on ESG, providing a multi-disciplinary website that includes insight on the landscape of ESG disclosures and the SEC’s going-forward priorities, industry-specific advice, and offering guidance on how companies can prepare for the potential for increased ESG in shareholder activism. But although these articles caution that companies lagging behind their peers may be more likely to see integration of ESG in shareholder activism campaigns and that outliers may find themselves potential targets for SEC enforcement, there is no clear understanding of what it means to be an ESG “laggard” or “outlier.” This Sidley Update benchmarks what it might mean to be an exception to these undefined ESG “rules” by analyzing the ESG disclosures in the most recent proxy statements of Fortune 50 companies.
As is evident from the name, “ESG” has three prongs: the environmental prong, which covers topics such as climate change, greenhouse gas emissions, air and water pollution, energy consumption, water usage, waste and recycling, and environmental justice; the social prong, which includes workplace and product safety, employee diversity, equity and inclusion, nondiscrimination and fair pay, collective bargaining, human rights, charitable contributions and community programs, cybersecurity and data privacy, and supply chain management; and the governance prong, which encompasses issues such as compliance, corporate purpose and stakeholder interests, board diversity, declassification and independence, executive compensation, and political contributions and lobbying. But it is not at all evident which information of this multitude may be most valuable to a company’s investors or what it means to provide meaningful disclosure with respect to any or all.
The (Major) Players
For U.S. public companies, the SEC is perhaps the most influential authority, but the SEC has only recently become focused on expanding mandatory ESG disclosures, and we do not anticipate formal rule proposals to be made until mid- to late fall. We do, however, have some sense of what to expect based on recent statements made by SEC Chair Gary Gensler.
During his confirmation hearing, Chair Gensler indicated his support for additional disclosures on climate risk, diversity, human capital, and political spending. While early statements by SEC officials reflected support for a global ESG reporting framework, Chair Gensler’s more recent statements suggest that the SEC will propose an ESG disclosure regime specific to the U.S. markets. Chair Gensler has also signaled that the human capital disclosure requirements could address metrics such as workforce turnover, skills and development training, compensation, benefits, workforce demographics (including diversity), and health and safety. Additionally, based on Chair Gensler’s more recent remarks on climate change and in particular on greenhouse gas emissions, it seems likely that the SEC will require Scope 1 disclosures (direct emissions) and Scope 2 disclosures (indirect emissions, associated with the purchase of electricity, steam, heat, or cooling); Scope 3 disclosures (indirect emissions from an organization’s indirect effects in its value chain) could also be required, but perhaps only under certain circumstances.
More generally, Chair Gensler has also said that the framework for disclosures will seek consistent and comparable information that is “decision-useful” (i.e., disclosures that contain sufficient detail such that investors gain helpful information in order to make an investment or voting decision) and that incorporates both qualitative and quantitative data. The framework will also likely include industry-specific metrics and support forward-looking commitments (e.g., “net zero” pledges, or commitments required by the jurisdictions in which companies operate). The SEC may require scenario analyses as well, on how a business might adapt to the range of possible physical, legal, market, and economic changes it could contend with in the future, and general governance, strategy, and risk management related to climate risk. The SEC is also considering where these disclosures belong, for example, in the annual report on Form 10-K — alongside other information that investors use to make their investment decisions — or elsewhere.
In the absence of a finalized comprehensive regulatory framework, however, proxy advisory firms, nongovernmental reporting organizations, state laws, and the continued listing requirements of securities exchanges have been the key players in standardizing ESG metrics. The introduction of the ISS Environmental & Social QualityScore in 2018 helped set the stage for public companies, and both ISS and Glass Lewis have since significantly expanded their evaluation of environmental and social topics. Nongovernmental reporting organizations have also gained prominence as standard setters, in particular the Taskforce on Climate-Related Financial Disclosures (TCFD), the Sustainability Accounting Standards Board (SASB), and the Global Reporting Initiative (GRI).1 Additionally, we are seeing states pass laws that impose varying requirements with respect to board diversity, such as California’s board diversity requirements and the diversity reporting requirements in Illinois, as well as requirements from securities exchanges that require listed companies to make certain diversity disclosures, such as those from Nasdaq. For a more comprehensive overview of applicable laws, regulations, and other actors, please see our colleagues’ chapter in Getting the Deal Through — Impact Economy 2021, which is available here.
But within this network of standards, what disclosures are actually being made by public companies in their SEC filings? To answer this question, we evaluated the most recent proxy statements of Fortune 50 companies. We recognize (and indeed, our review confirmed) that most of these companies publish more fulsome ESG disclosures on their websites in standalone ESG reports, and may also have relevant disclosures in other public filings, particularly in their annual report on Form 10-K as it relates to human capital management disclosures. That said, a review of the most recent ESG disclosures that Fortune 50 companies have made in their proxy statements is a useful indicator of what it may mean to be an “outlier” or “laggard” in SEC filings. Based on the expected rule proposals from the SEC, company disclosures are categorized into one of three broad categories — climate change, human capital, and board diversity — and we evaluated trends across the Fortune 50 as well as by industry. The analysis also notes the companies’ ESG governance structure and any areas of frequent disclosure that fall outside of these three categories.2
Understanding the ESG disclosure trends both within in your industry and more broadly is important because we expect that the SEC may propose disclosures of industry-specific metrics and that the rulemaking may be informed in part by current levels of disclosure. Moreover, we expect that the SEC will leverage data analytics to look for material gaps and misstatements in ESG disclosures across companies.
In addition to evaluating industry trends, it is also important to ensure that any disclosures made accurately reflect current ESG practices and are realistic about ESG goals (i.e., companies should avoid “greenwashing”). Companies should also have adequate policies, procedures, and controls in place to ensure they act consistently with such disclosures.
In sum, companies should
- compare their ESG disclosures to the disclosure trends in their industry to identify any gaps;
- evaluate whether and how the company can work to incorporate ESG disclosures into their proxy statements consistent with industry peers; and
- ensure that the company has procedures and controls in place to operate consistent with any disclosures.
Sidley Austin LLP provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship.
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