Ed. note: Today’s post was written in December 2021 by Advisory Board member Sarah Fortt. Sarah is the Global Co-Chair of the ESG practice at Latham & Watkins. She regularly works with boards of directors and senior management on their approaches to corporate governance, ESG oversight and disclosure, crisis management (including in the contexts of shareholder activism and cyber and data security breaches), succession planning and board education.
ESG disclosure, all the rage in recent years, is only becoming more common and more “required” even in situations where it remains voluntary. Both voluntary and, in certain jurisdictions, required environmental, social and governance (ESG) disclosures are becoming standard practice. Based on recent surveys, while in 2011 only approximately 20% of S&P 500 companies published sustainability reports, in contrast, now over 90% of S&P 500 companies are publishing sustainability reports. See, for example, State of Green Business 2021 – The Big Picture (February 17, 2021). This trend is trickling down through all U.S. public companies – more companies are publishing ESG-related disclosures today than ever before.
And some of this ESG disclosure is . . . imperfect.
And then, the SEC spoke up – on September 22, 2021, the SEC’s Division of Corporation Finance issued a sample comment letter regarding climate change disclosures. As a reminder, the SEC has yet to issue the promised climate change disclosure regulations or the other ESG disclosure regulations they have suggested we can expect in the near future, and yet the SEC has not let that stop them when it comes to regulation or enforcement. The fact that the SEC continues to reference its 2010 climate change guidance has been confusing folks, so let me explain in nine words – the SEC has already moved beyond the 2010 guidance. Way beyond. And the SEC is just getting started. For key takeaways from the SEC’s sample comment letter, see The SEC Sample Climate Change Comment Letter Is a Warning. While we all wait for climate change and ESG rule proposals out of the SEC, given all the recent developments, companies should stop making the below ESG disclosure errors.
- Touting compliance as an accomplishment. Referencing legal compliance as an accomplishment is so 2010. A company’s ESG or climate or sustainability report is not the place for touting its compliance with existing U.S. legal requirements. While compliance establishes an important baseline, ESG disclosure should preferably discuss how the company has moved beyond compliance and, ideally, beyond its peers’ performance as well. If portions of the company’s ESG disclosure simply talk about how well the company is complying with the law, the company may want to revisit its underlying ESG metrics and goals.
- Leaving out baselines or measurement periods. ESG disclosures should be as complete as required disclosures, and yet, it is not unusual to find ESG disclosure that establishes targets without providing baselines, or touts improvements without providing measurement periods. Baselines and measurement periods should be clearly stated, and should ideally be consistent across all ESG and sustainability disclosures.
- Failing to address materiality. Materiality is the complicated elephant in the ESG room. While the federal securities law definition of materiality has not changed in recent years, the broadly accepted concept of materiality has definitely shifted. I often recommend that companies consider materiality along five spectrums: (1) what is “material” to the company’s specific stakeholders (i.e., investors, employees, customers, communities and business partners); (2) what is “material” to the company, including with respect to how it wants to be viewed in the marketplace and compared to its peers and competitors, and how the company conceptualizes its impact on the marketplace and its stakeholders; (3) what external standards of materiality should apply to the specific area of disclosure (i.e., EU Sustainable Finance Disclosure Regulation, SASB, GRI); (4) how does the U.S. federal securities law definition of “Materiality” (i.e., “big M materiality”) apply to the company’s business, operations and financial statements, and what does that definition require in terms of disclosure; and (5) with respect to each of the foregoing, how does Point A compare to Point B, in other words, how is materiality moving and what will it mean tomorrow. Companies should consider how these five lenses of materiality map over their required and voluntary disclosures and internal reporting and recordkeeping, and should be transparent about what lenses of materiality are being used in their disclosures.
- Not creating a written data audit plan and record. Greenwashing is in the spotlight right now. While some greenwashing may be intentional, I think most greenwashing is probably the result of enthusiasm unchecked by common sense. ESG disclosure should not be approached as a marketing effort because it is fundamentally different from marketing information; instead, it should be approached like any business, strategy, or financial disclosure, and the appropriate internal controls should back up the disclosure effort. This means that obvious weak points in ESG disclosure should be identified and either strengthened or weeded out, and ESG data should not be manipulated to align to a marketing message. All ESG data should be able to be backed up by the company’s internal verified records.
- Retaining dated scenarios or failing to address fundamental changes in the space. The ESG space is moving quickly, as is the underlying science. For example, in 2020, the International Energy Agency (IEA), which publishes climate scenarios that many companies follow in creating their climate scenario modelling, published a global net-zero emissions scenario that assumes no use of offsets from outside the energy sector. In 2021, the IEA doubled down on this with a roadmap to net zero that, according to the IEA, needs no new investments in coal, oil or gas supply beyond projects already committed to as of this year. That’s . . . a big shift. Companies that use old IEA scenarios without addressing this new and noteworthy shift in methodology run the risk of being seen as outdated by their investors and potentially by regulators as well. In addition, as discussed in earlier articles, companies should be thoughtful about their use of offsets in general.
- Not addressing the “elephant in the room.” For any company, it can be tempting to lean into the areas of ESG that present fewer challenges. The company with “E” challenges that leans into the “S” or the “G,” and the company with “S” challenges that leans into the “E” or the “G.” The reality is that these disclosures are fooling no one. Companies have to proactively consider how to address their specific “elephant in the room.” For some companies, this may include an element of their corporate culture or a sacred cow—a person, product, practice, or principle that an organization will go to any lengths to protect. Regardless of what specific ESG challenge a company faces, it should lean into how to address that challenge in its internal risk and strategic considerations, as well as in its disclosure.
- Not connecting ESG efforts to the company’s strategy and operations or failing to discuss integration. A fair number of ESG and sustainability reports discuss the companies charitable and volunteer efforts, and sometimes include the volunteer efforts of the company’s employees. Voluntary and charitable efforts can be useful information but they rarely rise to the level of what the company does on a day-to-day basis. ESG disclosure efforts should be focused on what the company does daily – or its operations and risk mitigation and management efforts – and what the company is planning on doing – or its strategic efforts. ESG disclosures that do not directly touch on these matters are likely to be viewed by investors and the public as being of limited usefulness. Moreover, companies should avoid touting employees’ efforts as corporate endeavors unless the company financially supports those efforts.
- Failing to be sophisticated about risk analysis. Risk analysis is at the heart of most climate-related analysis. However, while many companies consider the implications of climate-related events in their risk analysis, it remains rare for companies to consider compounded risks. One of the central challenges of ESG is to consider climate-related risks in the context of social and political risks taking place at the same time. Companies that integrate complex risk analysis into their ESG profiles are likely to produce more thoughtful analyses. It is worth noting, however, that the more complex the risk analysis the more likely it is to include estimates and assumptions that may shift over time as new data emerges. For that reason and others, companies should always makes sure to include the appropriate cautionary language in their ESG disclosures.
- Making commitments without committing to a plan. Net zero is all the rage. Today, companies are being pushed to commit to establishing net zero or net neutral pledges with little or no planning going into some of those commitments. As we have mentioned in the past, pledges without plans are quickly becoming passé. Instead, companies should pause on the pledge until they have created an effective and vetted plan for implementation, even if the pledge does not come due for years. Companies should assume that investors and the public will expect updates on progress even if the company has not committed to providing these updates. Similarly, companies should avoid using terminology – like net zero and carbon neutral – if they mean something less than that. These terms are becoming terms of art, as are other terms in the ESG space, and companies should be clear about what they mean and use them accordingly.
- Not recognizing inconsistencies with the company’s litigation and political and lobbying strategies. I have been saying that “consistency” is the new ESG focus since late 2020; however, it remains a challenge for many companies. More than one company is likely to get caught having a litigation or lobbying strategy that clearly conflicts with its public ESG disclosures. While most companies will find a way to navigate this complexity, others will find themselves publicly wedged between the ESG rock and the hard place of their corporate interests. Considering these tensions in advance will not eliminate them, but it may help companies implement a more thoughtful approach or craft a more sophisticated and effective message.