The SEC
On May 4, 2021, the SEC established a Climate and ESG Task Force in the SEC’s Division of Enforcement. The aim of the ESG Task Force is to look into misleading ESG claims made by investment advisers and public companies, and to proactively identify ESG-related misconduct. Kelly Gibson, who is also the Director of the SEC’s Philadelphia Regional Office, is heading the ESG Task Force, which is comprised of 22 members drawn from the SEC’s headquarters, regional offices, and specialized enforcement units.
On November 3, 2021, Gibson was featured as a panelist in the Environmental Law Institute’s “People Places Planet Podcast,” and indicated in her remarks that the ESG Task Force will concentrate on detecting and bringing enforcement actions for “greenwashing,” which she defined as “exaggerating” a “commitment to, or achievement of climate . . . related goals.” Gibson explained that because there has been a “dramatic surge in popularity for ESG focused investment funds” without an associated evolution in U.S. law and ESG criteria, there is a high risk that investors may be misled by greenwashing. Gibson indicated that the SEC is focused on making sure that issuers and investment advisers are appropriately disclosing climate and ESG concerns to investors. Gibson noted that the SEC is “looking closely at what issuers say in their filings and elsewhere, and what investment advisers say and do in terms of their stated investment strategies . . . we’re looking at any market participant that is exaggerating its commitment to or achievement of climate-related goals . . . and that’s what we call greenwashing.” Gibson went on to emphasize that this problem of questionable ESG-labeling can have a significant negative impact on investors. She also noted that sustainable investments in the U.S. rose to 17 trillion in 2020, up 12 trillion from just two years prior, and that this sharp rise could be due in part to greenwashing.
Of note is a recent parallel investigation into a global bank’s asset management arm, commenced by the SEC and the U.S. Attorney’s Office for the Eastern District of New York (EDNY). The EDNY/SEC investigation was commenced after the bank’s former head of sustainability disclosed to the Wall Street Journal that the bank overstated how much it used sustainable investing criteria to manage its assets. Specifically, in its 2020 annual report, released in March 2021, the bank’s asset management arm stated that more than half of its $900 billion in assets at the time were invested using a system that evaluated companies based on ESG criteria. An internal assessment done a month earlier, however, indicated that only a fraction of the investment platform applied the evaluative process.
Additionally, in September 2020, the SEC settled with Fiat Chrysler Automobiles N.V. (Fiat) for disclosure violations concerning Fiat’s public descriptions on an internal audit of the emissions control systems of some of the company’s diesel vehicles. Fiat was required to pay a $9.5 million civil monetary penalty to the SEC. Although the SEC’s settlement with Fiat predated the SEC’s establishment of its ESG Task Force, Gibson noted the case during her remarks for the “People Places Planet Podcast” as an example of the kind of enforcement companies can anticipate from the SEC going forward as it relates to ESG.
SEC Chairman Gary Gensler has also recently addressed the SEC’s role as it relates to ESG. During a July 28, 2021 speech as part of a webinar on Climate and the Global Financial Markets, Gensler indicated that investors “increasingly want to understand the climate risks of the companies whose stock they own or might buy” and want “consistent, comparable, and decision-useful” disclosures around climate risks and human capital.
Given the SEC’s increased focus in the ESG compliance space, companies should expect increased scrutiny where funds have been raised after disclosing environmentally friendly policies or ESG advantages to investors. It will be important for companies to consider whether such disclosures could be potentially misleading and whether the information not included could be deemed material to an investor’s decision-making. Companies should be particularly careful in their methodology and reporting regarding ESG investments. In addition, companies involved in the defense or energy industries that are impacted by recent sanctions against Russia should closely evaluate how any changes to their business models resulting from these sanctions could impact their operations, and ensure that their related ESG disclosures remain accurate.
The DOJ
Based on the Biden administration’s increased focus on white-collar enforcement generally and ESG-related conduct specifically, it is likely that there will be ESG-related prosecutions by the DOJ’s Fraud Section. In fact, in October of last year, Deputy Attorney General Lisa O. Monaco issued a memo (Monaco Memo) instituting more rigorous policies with respect to companies overall.
Even prior to the issuance of the Monaco Memo, there has been an increased focus on environmental cases by the Fraud Section. For example, in February 2021 three Japanese nationals were indicted for an alleged long-running scheme to defraud the U.S. Navy and pollute Japanese waters by dumping contaminated water removed from U.S. Navy ships into the ocean. As alleged in the indictment, the company falsely stated to the U.S. Navy that it was properly treating the water before disposing of it.
As a result, companies should anticipate that the DOJ will initiate more parallel investigations into ESG-related fraud alongside the SEC’s new ESG fraud taskforce, such as the Eastern District of New York’s investigation of a global bank described above.
The DOL
ESG compliance is also being considered at the DOL. For example, on October 14, 2021, the DOL proposed a rule on fiduciary responsibility in selecting Employee Retirement Income Security Act of 1874 (ERISA) plan investments and exercising shareholder rights. The goal of this new rule is to protect workers from investments that might not otherwise be in their financial interest. The proposal would amend the “investment duties” regulation under ERISA and require fiduciaries of pension plans to choose investments “based solely on pecuniary factors” relevant to a certain investment.
Companies and asset managers should anticipate increased scrutiny surrounding ESG risk disclosures when evaluating investments for pension plans. It is likely that additional rules from the DOL will be forthcoming based on the Biden administration’s guidance.
The EPA
We can also expect to see additional ESG regulations from the EPA. On October 18, 2021, the Biden administration announced a joint effort with eight agencies to address the growing public health concern over certain polyfluoroalkyl substances (PFAs), long-lasting chemicals that are widely used in consumer products and can be harmful to people and animals. The EPA will be leading this effort to develop a four-year strategic roadmap to increase the regulation of PFAs under major environmental laws and regulations (for more information, visit reedsmith.com).
As the EPA and other agencies evaluate how to reduce the exposure of people and animals to PFAs, companies should anticipate additional rules surrounding these chemicals. The forthcoming regulations surrounding PFAs could affect companies operating in the manufacturing, packaging, or transportation sectors that rely on such substances.
Shareholder actions
In addition to recent regulatory focus on ESG violations, there have been several cases brought by plaintiff shareholders in Delaware for failure of board oversight or breach of duty of care as a result of companies allegedly not meeting ESG obligations. Recent rulings in Delaware involving Boeing Co. and Blue Bell Creameries LP indicate that judges are allowing more plaintiffs to proceed on such claims. For example, in September 2021, the Delaware Chancery Court allowed investors to pursue a Caremark claim (a claim established in In re Caremark International Inc. Derivative Litigation,698 A.2d 959 (Del. Ch. 1996) that alleges failure of board oversight) against the Boeing Co. board for failure to exercise sufficient oversight of aircraft safety that led to two fatal crashes of its 737 Max airplanes. Similarly, in July 2020, Blue Bell Creameries settled with a shareholder after the Delaware Supreme Court found that the board breached its fiduciary duty of oversight for failing to avoid a listeria outbreak.
While the underlying issues in both the Boeing and Blue Bell cases relate to corporate governance or public health issues, these rulings demonstrate the viability of plaintiff Caremark claims for ESG violations. With the recent increased focus on ESG, companies should anticipate a rise in Caremark cases. In light of this increased scrutiny and the recent successes of Caremark claims in Delaware state court, it will be important for companies to assess social and environmental risks, together with counsel.
Conclusion
With the Biden administration’s focus on addressing environmental issues and the rise in companies implementing ESG policies, increased ESG enforcement and litigation are to be anticipated. Additional rulemaking from federal agencies addressing ESG issues is also forthcoming. Accordingly, it will be important for companies to identify and mitigate environmental risks, and to make sure that their reporting regarding their ESG investments is clearly and accurately disclosed to shareholders.
In-depth 2022-067
