Legal Alerts

SEC to Regulated Companies: Be Prepared for ESG Scrutiny

Washington, D.C. (April 23, 2021) - In actions announced by the Securities and Exchange Commission (SEC or Commission) over the past two months, the SEC is sharpening its focus on climate-related disclosures in public company filings. The emphasis is on how public companies address disclosures of actual and material impacts that climate change has on a company’s business and whether they comply with obligations under the federal securities laws. (See our previous alert from March 19.)

Acting SEC Chair Allison Herren Lee has stated that the Commission’s Examination Division will “focus on climate and ESG-related risks by examining proxy voting policies and practices to ensure voting aligns with investors’ best interests and expectations, as well as firms’ business continuity plans in light of intensifying physical risks associated with climate change.” Division Director Peter Driscoll reinforced this statement by declaring that the Division’s “priorities reflect the complicated, diverse, and evolving nature of the risks to investors and the markets, including climate and ESG.”

More recently, the Examination Division issued a Risk Alert to highlight deficiencies and internal control weaknesses from recent examinations of investment advisers, registered investment companies, and private funds offering ESG products and services. The alert also encouraged those promoting ESG investing “to evaluate whether their disclosures, marketing claims, and other public statements related to ESG investing are accurate and consistent with internal firm practices.” At this time, what is considered an “accurate” ESG disclosure metric is still being debated within the SEC. Regardless, similar to already established compliance programs, the SEC expects internal programs at registered investment companies and private funds engaged in ESG investing to identify and “guard” against potential misleading statements. Some of the deficiencies noted by the SEC in the Risk Alert included:

  • Lack of adherence to “global ESG frameworks”;
  • Inadequate controls around “negative screens” – e.g. prohibitions on investments in certain industries. As a result, a lack of adequate controls could actually allow prohibited industries to become a part of a client’s portfolio, despite marketing claims to the contrary; and
  • Inadequate or misleading marketing materials that did not account for actual risk to investors or conflicts of interest with ESG oriented funds.

Further, the Division will “continue to examine firms to evaluate whether they are accurately disclosing their ESG investing approaches and have adopted and implemented policies, procedures, and practices that accord with their ESG-related disclosures.” In other words, the SEC has put the business/investment community on notice that ESG disclosures will be scrutinized to uncover possible violations of the law.

These initiatives build on the SEC’s March 2021 establishment of a Climate and ESG Task Force (Task Force) in the Division of Enforcement, which will develop initiatives to proactively identify ESG-related misconduct and will also coordinate the effective use of enforcement resources, including through the use of sophisticated data analysis to mine and assess information across registrants, to identify potential violations. The creation of the Task Force indicates that the SEC will pay special attention to referrals, tips, and whistleblower complaints related to ESG issues. This intake of information will likely result in enforcement actions in the near future. Although the exact nature of such enforcement efforts is not yet clear, including what industries might be targeted, the SEC has telegraphed that it is willing to put time, money, and resources behind finding violations related to ESG.

But not everyone agrees with the SEC’s new direction. For example, Republican Members of the Senate Committee on Banking, Housing and Urban Affairs recently took issue with the SEC’s steps to impose new climate disclosure regulations on companies without Congressional authorization. The Senators confirmed that existing federal securities law already requires disclosure of material information, including climate-related information. The Senators warned that any additional requirements could force disclosure of non-material climate-related matters, including information based on speculative data and inconsistent standards.

In his confirmation hearing, new SEC Chair Gary Gensler emphasized that any new disclosure requirements for climate risks, diversity efforts, or companies' political contributions would be based on assessments of what is material to reasonable investors. Materiality of what is, or is not, disclosed will always be a critical element in an SEC examination or enforcement proceedings.

While companies may want to leap onto the ESG bandwagon, hasty disclosures or the dissemination of inaccurate information can result in a boomerang of potential legal risk, as the SEC has indicated. The SEC’s aggressive initiatives are intended to put companies on notice that ESG investments and disclosures will be closely scrutinized by the SEC and other federal authorities. Companies that do not recalibrate their internal compliance programs to recognize the “red flags” related to ESG reporting metrics, including possible “greenwashing,” may well find themselves in the crosshairs of the SEC and other government agencies.

For more information on this topic, contact the authors of this alert. Visit our Sustainability and Environmental, Social, and Governance (ESG) Practice page for additional alerts on this rapidly developing area of the law.


Karen C. Bennett, Partner

Thomas A. Brooks, Partner

Jane C. Luxton, Managing Partner - Washington, D.C.

Sean P. Shecter, Partner

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