Outside the United States, particularly in the European Union (EU), the assessment and reporting of corporate Environmental, Social, and Governance (ESG) considerations and risks have already become legal requirements. In the EU, additional ESG requirements are continuing to take form, including the first two chapters of the EU Taxonomy Regulation coming into force on January 1, 2022. So far, though, ESG-related undertakings for American companies have been indirectly driven, such as through investor pressures or transactional obligations to EU customers. This approach to ESG for American companies is expected to shift in 2022 and beyond. Regulations and enforcement initiatives directly affecting American companies are expected to emerge due to growing interest in ESG and corporate disclosure, increased litigation by shareholders, and the provision of incentives and disincentives by insurance companies based on ESG programs. This article highlights a few of these continued and emerging ESG trends affecting companies doing business in the United States.
Environmental: Greenwashing in the Spotlight(s)
Coined in 1986 by environmentalist Jay Westervelt, the term “greenwashing” refers to false or misleading representations by a company about its or its products’ environmental friendliness. Historically, the U.S. Federal Trade Commission (FTC) has enforced greenwashing claims under its authority to protect consumers. In 2022, however, the U.S. Securities and Exchange Commission (SEC) will expand the scope of greenwashing scrutiny to enhance investor protection. Accordingly, companies should assess and reduce exposure to these two tracks of enforcement:
- FTC Enforcement Focus on Greenwashing: Deceptive, unfair, or unsubstantiated environmental claims to consumers violate Section 5 of the FTC Act, and FTC greenwashing enforcement is nothing new. In fact, the FTC is now conducting its ten-year regulatory review of its “Guides for the Use of Environmental Marketing Claims” (known as the “Green Guides”). The FTC describes the Green Guides as non-binding guidance on the substantiation of environmental and sustainability marketing claims with competent and reliable evidence. The FTC does, however, use the Green Guides criteria to evaluate the veracity of “green” claims. The 2022 updated Green Guides will likely add guidance on “green” claims that have increased in usage over the past ten years in advertisements and other marketing claims by companies to consumers. Terms that may potentially be added are “sustainable,” “organic,” and “recyclable”. The terms that are added will serve as indicators of the areas of specific potential liability for companies that use them. The FTC may also pursue formal rulemaking to give the Green Guides the force of law. Either way, companies should be prepared for continued scrutiny and enforcement by the FTC related to environmental and sustainability claims. Additionally, as consumer appetite and expectations for information on companies’ ESG performance grows, companies should evaluate the legal and reputational risks triggered by any “green” claims.
- SEC Enforcement Focus on Greenwashing: In March of 2021 the SEC Enforcement Division created a Climate and ESG Task Force, clearly asserting an SEC role in protecting investors from greenwashing and similarly-misleading ESG claims. The Task Force’s priorities, per the Task Force’s leader, Kelly Gibson, include rulemaking to establish a mandatory ESG disclosure framework and enforcement initiatives “to proactively identify ESG-related misconduct.” Targeted conduct will include “material gaps and misstatements in issuers’ disclosure of climate risks under existing rules” and “disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.” SEC enforcement actions will focus on false or misleading statements related to climate and ESG that carry a high risk of misleading investors.The SEC rulemaking is anticipated to be issued this year and is expected to address climate change and other ESG issues (specifically, cyber risk governance, board diversity, and human capital management). In the meantime, however, companies can look to existing SEC guidance, such as the 2010 “Commission Guidance Regarding Disclosure Related to Climate Change” and the 2021 “Sample Letter To Companies Regarding Climate Change Disclosures,” as they consider disclosure of material impacts from climate-related developments.
Beyond this greenwashing enforcement focus, American companies can also expect stricter requirements related to the “S” and “G” in ESG, as discussed below.
Social: More Teeth Coming to DEI
Corporate policies and representations regarding diversity, equity, and inclusion (DEI) will also face increased and more formalized scrutiny in 2022. As noted above, the SEC’s ESG rulemaking will potentially include rules governing the disclosure of human capital management, including DEI initiatives. This focus on human capital management is by no means a new focus for the SEC—rather, it will build upon the prior SEC efforts to update and modernize public company disclosures. In fact, on November 9, 2020, the Modernization of Regulation S-K Items 101, 103, and 105 final rule went into effect and, among other things, it expounded upon the details that registrants must disclose under the Item 101(c) description of their human capital resources. Whereas before, only the number of persons employed by the registrant was required, the new rule will also “provide non-exclusive examples of human capital measures and objectives, such as measures or objectives that address the attraction, development, and retention of personnel.”
While the 2020 rulemaking required disclosure details, it took a principles-based approach to human capital disclosures and did not define “human capital”. This resulted in a wide variability between disclosures made by different registrants after November 9, 2020, as companies used qualitative descriptors for their DEI initiatives and only some companies opting to provide quantitative metrics related to those initiatives, such as gender and racial diversity. The anticipated ESG disclosure framework would establish prescriptive requirements, including a potential definition of “human capital”. This approach would help standardize DEI-related disclosures and allow quantitative analyses across different companies. Similarly, companies that list on the Nasdaq stock exchange will be required by August 2022 to disclose the composition and diversity of their boards using a standardized template.
As with “green” claims, companies should carefully evaluate the legal and reputational risks associated with any human capital claims they make, particularly as disclosure frameworks for public companies evolve. Additionally, as consumers and institutional investors embrace ESG branding and metrics, privately-held companies may respond to pressure to “walk the talk” and implement DEI and broader ESG programs.
Governance: Supply Chain Due Diligence & Compliance
Supply chain issues were a key theme of 2021 and are likely to remain in the spotlight in 2022. The Uyghur Forced Labor Prevention Act (UFLPA) will go into effect on June 21, 2022, creating a rebuttable presumption that goods from China’s Xinjiang Uyghur Autonomous Region (XUAR) are made with forced labor and are banned from U.S. markets. Importers of record will be required to provide evidence that the imported products were not made with forced labor. To support this burden, companies must implement due diligence, supply chain tracing, and supply chain management measures to demonstrate that goods are not “mined, produced, or manufactured wholly or in part with forced labor from the People’s Republic of China, especially from the [XUAR]”. Companies are required to cooperate in responding “completely and substantively” to all information requests from U.S. Customs and Border Protection (CBP). Therefore, companies should carefully assess XUAR (and similar) supply chain risks and whether their ESG programs can satisfy such supply chain due diligence and compliance requirements.
ESG in Vogue: New York Targets Global Fashion Industry
This year, ESG may be particularly in vogue within the fashion industry—for both retailers and manufacturers. The state of New York kicked off the new year by referring a landmark proposed bill to the Consumer Affairs and Protection Assembly Committee. The proposed Fashion Sustainability and Social Accountability Act (the Fashion Act), per a press release from State Senator Brian Kavanagh, takes aim at a “generally unregulated industry that contributes heavily to world greenhouse gas emissions at levels of 4-8.6 percent, pollutes billions of gallons of water-dye textiles, and has—knowingly or not—benefited from exploitative labor practices in the downward race to sell the cheapest clothes [the] fastest.” The proposed Fashion Act is considered historic in its scope and approach and will have implications well beyond New York’s borders.
The Fashion Act would apply to “every fashion retail seller and fashion manufacturer” doing business in New York and with global revenues exceeding $100 million—i.e., many of the world’s fashion companies. Among other things, regulated companies would be required to:
- Annually set and report on targets to prevent and improve their environmental and social impacts (e.g., water use, chemical use, greenhouse gas emissions, and fair wages);
- Ensure that greenhouse gas reporting is independently verified, includes absolute figures, and conforms with the Greenhouse Gas Protocol Corporate Accounting and Reporting Standard and the Scope 3 Accounting and Reporting Standard promulgated by the World Resources Institute;
- Make disclosures on prioritized activities, including how much of annual production is made up of recycled material, the median wages of workers of prioritized suppliers and how this compares with local minimum and living wages, and the company’s approach for incentivizing supplier performance on workers’ rights;
- Make disclosures publicly available, including posting required information on their websites within 12 months of the enactment of the relevant policies, processes, and outcomes; and
- Implement a risk-based approach to map a minimum of 50% of their supply chain across all stages of production, from raw material to final product.
The Fashion Act would vest the New York Attorney General (AG) with the authority to enforce its provisions via civil proceedings for injunctions, monetary damages, and specific performance. The AG would also be required to publish a list of non-compliant companies, which would have three months to come into compliance or else face fines of up to two percent of annual revenue. As with many environmental laws, the Fashion Act would also allow for citizen suits; consumers would be able to bring civil cases against companies for violating the law—an increasingly common tactic being used by environmentally- and socially-conscious consumers.
While this proposed legislation is aimed at the fashion industry, its implications are true for companies in general. That is, companies must now realize that the choice they face is how, and not whether, they will tackle ESG—lest ESG tackle them. Through market demands and regulatory requirements, companies face increasing pressure to assess and communicate the ESG impacts of their operations and products, including the operations and products of their suppliers. Prudent companies are studying trends, evaluating risks and opportunities, and taking proactive steps. They are using existing compliance programs and management systems to document ESG aspects, policies, and programs. They are working with legal and consulting teams to ensure ESG risks are identified, monetized, and mitigated. Finally, the most proactive are transitioning business strategies to turn risks into opportunities to decrease costs, increase revenue, and even diversify services and products offered.