ESG Reporting Considerations Amid Murky Standards

By LaDawn Naegle and Vicki Westerhaus
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Law360 (July 7, 2020, 1:40 PM EDT) --
LaDawn Naegle
LaDawn Naegle
Vicki Westerhaus
Vicki Westerhaus
Fallout from the COVID-19 pandemic appears to be sharpening some investors' focus on environmental, social and governance, or ESG, matters, as evidenced by the U.S. Securities and Exchange Commission's Investor Advisory Committee's recent recommendation[1] that the SEC mandate disclosure of "material, decision-useful, ESG factors" as relevant to each company.

The push for SEC leadership on ESG issues continues, as Americans for Financial Reform, a coalition focused on Wall Street reforms organized in 2008, sent a letter to SEC Chairman Jay Clayton urging the SEC to mandate COVID-19 disclosures relating to worker health and safety, supply chains, political spending and workers' rights.[2] 

The desire for more clarity around ESG disclosure is understandable. More than a dozen nonprofit and for-profit ESG data providers have emerged in this complex, booming market, according to speakers at a May 28 webinar hosted by the Sustainability Accounting Standards Board and the Society for Corporate Governance.

The data providers generally fall into four distinct groups:

1. Providers that publish guidance for voluntary ESG disclosure, often with company feedback;

2. Providers that request data from companies using questionnaires and then based on the answers issue reports or ESG ratings;

3. Providers that compile publicly available ESG data about companies and issue ESG ratings based only on that publicly available information; and

4. Providers that create assessments of companies based on public and/or private information to sell to investors. 

The different ESG assessment methods and models are inconsistent and arguably unreliable in some cases. According to a recent update from the ESG Subcommittee of the SEC Asset Management Advisory Committee, fewer than 30% of public companies currently disclose ESG risks, and those disclosures lack clarity and comparability.[3]

For example, some providers focus on a company's performance on an absolute basis, while others use a peer group comparison, although it is unclear how the peer group is identified, according to the subcommittee presentation at the recent Asset Management Advisory Committee meeting.

Other differences noted by the subcommittee include whether the ESG data providers focus on financial materiality or stakeholder sentiment, how they determine what falls into the E, S or G categories, and whether they focus on ESG matters as a whole or an individual basis, among other things.

The subcommittee also expressed concern that current ESG disclosures are often backward looking, rather than forward looking, and that some issuers may be cherry picking the ESG information for use in marketing materials.

Under the current patchwork, a public company can be the subject of an ESG assessment without knowledge that it occurred or an opportunity to give input or correct misperceptions, particularly in situations where the company has very limited ESG disclosures because ESG issues were not deemed material and not required to be disclosed under SEC rules.

For public companies trying to navigate the maze of ESG issues and disclosures, particularly for small- and midsized companies that lack resources to complete requested questionnaires or provide feedback, frustration can easily emerge.

The surprise effect of a negative rating sold or provided to institutional and other investors can lead to investor relations headaches, as companies try to sort through the sources used for the assessment, correct misinformation and address shareholder concerns.

Despite the confusion and frustration over ESG disclosure, it is unlikely that the SEC will move forward with proposals to mandate general ESG disclosure in the near term. Commissioner Hester Peirce issued a statement at the May 21 Investor Advisory Committee meeting and appeared to be skeptical of the committee's urgent recommendation. According to Peirce:

A more general call to develop a new ESG reporting regime — without a clear explanation of why the past fifty years of discussion on the topic has not crystallized into a universally applicable set of material ESG items, but now is the magic moment — may not be as helpful. Otherwise, let's keep using our tried and true disclosure framework, which is rooted in materiality and is flexible enough to accommodate a wide range of issuers, each with its unique and ever-evolving set of risks.[4]

Similarly, Clayton, in opening remarks for the Asset Management Advisory Committee meeting on May 27, also continued to express concern about the value of mandatory ESG disclosures:

Turning to today's discussion specifically, I look forward to hearing from the Committee's recently-formed subcommittees focused on private investments and on environmental, social, and governance (or, "ESG") issues. ... I believe I have made it clear that, while I believe that in many cases one or more "E" issues, "S" issues, or "G" issues are material to an investment decision, I have not seen circumstances where combining an analysis of E, S and G together, across a broad range of companies, for example with a "rating" or "score," particularly a single rating or score, would facilitate meaningful investment analysis that was not significantly over-inclusive and imprecise. I have requested engagement on this topic, particularly from active portfolio managers with actual track records, and I greatly appreciate your efforts to inform the Commission in this area.[5]

The most recent call for rulemaking by Americans for Financial Reform approaches ESG-related disclosures differently, tying them to the COVID-19 pandemic and arguing that these "moral issues" are relevant to a company's financial performance:
Prior to the onset of COVID-19, it was often argued that human rights, worker protection and supply chain matters were moral issues not relevant to a company's financial performance. As millions of workers are laid off and supply chains unravel, the pandemic has proven that view wrong. Businesses that protect workers and consumers will be better positioned to continue operations and respond to consumer demand throughout the pandemic.

But it seems clear from the letter that the larger issue of ongoing ESG issues and disclosures is a critical underpinning of the current urging. As stated in the letter:

In addition, by requiring these disclosures, the Commission has the opportunity to encourage companies to review their current practices and consider whether updates are necessary in light of recent events. The process of preparing these disclosures may help some public companies to recognize that their current practices are not sufficiently robust to protect their workers, consumers, supply chains and, as a result, their investors' capital given the impact of the pandemic.

In the absence of rulemaking, some institutional investors are advocating for a common framework, such as the Sustainability Accounting Standards Board, which is working to provide standards for reporting sustainability information across a wide range of issues, including employment practices, business ethics and data privacy, among other things.

Despite acknowledging the significant amount of effort required, some institutional investors have asked investee companies to report on ESG matters using the Sustainability Accounting Standards Board framework by year-end. 

Meanwhile, shareholder proponents continue to submit shareholder proposals relating to the full array of ESG issues. A report early in this year's proxy season by Proxy Preview 2020 — a joint project of the Sustainable Investments Institute, Proxy Impact and As You Sow — reported over 400 shareholder proposals on ESG issues had been filed with public companies for 2020 annual meetings.

Over 20% of them related to the environment, primarily climate change, and another 18% related to corporate political activity. The balance focused on board diversity and oversight, human rights, sustainability and diversity, among other issues. 

These proposals would have been submitted well before the pandemic had resulted in nationwide shutdowns and market turmoil. By early May, however, Institutional Shareholder Services Inc. was reporting that among Russell 3000 companies, fewer ESG resolutions had been voted on as compared to 2019, but a larger share had received majority support and many had been withdrawn, presumably following negotiated resolutions between proponent and company.[6]

The sampling size was admittedly small, but Pat McGern, ISS general counsel, concluded:

Based on the high rate of negotiated withdrawals of environmental and social proposals heading into the season and the record-setting pace of majority votes on climate risk and sustainability-related resolutions so far, it appears that investors aren't folding their hands [as a result of the pandemic]. Instead, they appear to be doubling down on their bets that strong boards and best-in-class ESG practices will equate with resilient business strategies.

Similarly, proxy advisory firm Glass Lewis & Co. LLC recently issued new COVID-19 rules for ESG engagement, also noting that ESG shareholder resolutions increased sharply in early 2020 before the pandemic hit the U.S. and have seen higher levels of shareholder support.

Even investors with historically restrained approaches to ESG have signaled far more willingness to take companies to task on ESG, according to Glass Lewis. The forward-looking paper urges companies to focus on changes needed for the 2021 proxy season and the need for clear disclosure and explanations so investors can determine whether changes made as a result of the pandemic are justified and address material concerns.

Other areas of focus in the paper include:

  • Board risk management, diversity and succession planning, particularly for boards where the majority of directors are men age 65 and older;

  • Executive compensation and the possible need to rethink metrics, goals, and wider incentive structures to ensure that the compensation policy remains fit for purpose; and

  • Industry sector-based risks.

The paper states:

All companies and shareholders are now thinking the unthinkable across a wide variety of ESG risks that were routinely dismissed by many companies in the past. That won't be permitted by shareholders going forward, so companies should engage early and often, preparing for an inevitable wave of shareholder proposals coming in 2021.

With or without SEC-mandated ESG disclosure requirements, most public companies will need to spend more time and energy considering ESG matters and what they believe may be material to investors in light of investors' heightened focus on these areas and the proliferation of ESG data providers whose public assessments about public companies' ESG disclosures can raise investor concerns.

And with or without new SEC disclosure rules, public companies will no doubt be providing disclosures directly related to material impacts of the pandemic and its effects on companies' workforce, supply chain and customers, as well as how companies are positioning their ongoing operations and designing their new normal as businesses reopen.

In considering whether to move forward with voluntary ESG disclosures, companies should be mindful of the risks of anti-fraud litigation for misleading disclosures. Any disclosures should be carefully vetted by companies' internal disclosure committees and should include forward-looking statement disclaimers when appropriate.

Companies also might consider including some voluntary ESG-related disclosures on the company webpage, rather than in SEC reports, with regular updates to remove outdated information.

Finally, companies should review the ESG-related shareholder proposals submitted in 2020 to determine whether they are likely to receive similar proposals in 2021 and consider in advance how they would be best served to respond to those shareholder proponents. 

LaDawn Naegle and Vicki Westerhaus are partners at Bryan Cave Leighton Paisner LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Recommendation from the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee (as of May 14, 2020).

[2] Letter to Jay Clayton, Chairman, Securities and Exchange Commission regarding "Comprehensive disclosure requirements to allow investors and the public to analyze companies during the COVID-19 pandemic," dated June 16, 2020. 

[3] ESG Subcommittee, Report to the SEC Asset Management Advisory Committee, May 27, 2020.

[4] SEC Commissioner Hester M. Peirce, Remarks at Meeting of the SEC Investor Advisory Committee, May 21, 2020. 

[5] SEC Chairman Jay Clayton, Remarks at Meeting of the Asset Management Advisory Committee, May 27, 2020.

[6] ISS Insights, "A Tale of Two Seasons: Trends in Support for 2020 Shareholder Proposals," May 14, 2020.

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