Companies need to know that governments, investors, and litigators are making environmental, social, and governance (ESG) criteria a priority. As a result, it won’t be enough for companies to simply claim they’re ESG-friendly; they’ll have to have mechanisms in place to prove it, or potentially face serious consequences.
First, let’s look at government efforts. The National Law Review reported that “a permissive approach with respect to consideration of ESG factors in investments aligns with President Biden’s climate change and sustainability goals,” adding that “the Biden administration will encourage ESG investing … investments that, for example, assess criteria like risks associated with climate change.”
Here’s an example of how the Biden Administration intends to act. Effective January 12, 2021, the Trump Administration finalized a rule that is viewed as a barrier to ESG funds in investment plans. The rule states that plan sponsors and other fiduciaries selecting ESG funds must “separate the legitimate use of risk-return factors from inappropriate investments that sacrifice investment return, increase costs, or assume additional investment risk to promote non-pecuniary benefits or objectives.” The National Law Review notes further stated that President Biden has now “ordered a review of the rule and, in the short term, the Department of Labor may issue guidance clarifying that ESG factors are ‘pecuniary.’”
(Note: A “pecuniary” factor is defined as “a factor that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy established pursuant to section 402(b)(1) of ERISA.”)
The National Association of Corporate Directors (NACB) described more moves the Biden Administration is making, writing in a blog post that, “the recent appointment (Jan. 21, 2021) of Allison Herron Lee as acting chair of the US Securities and Exchange Commission, as well as the nomination of MIT Sloan School of Management’s Gary Gensler as future chair, promise to make non-financial reporting an even higher priority for boards.”
Next, let’s turn to investors. In his 2021 letter to CEOs, Laurence D. Fink, CEO of BlackRock, who oversees more than $8 trillion in assets as the head of the world’s largest asset manager, addressed the “E” in “ESG,” writing about sustainability: “climate risk is investment risk … assessing sustainability risks requires that investors have access to consistent, high-quality, and material public information.” Fink added that, “because better sustainability disclosures are in companies’ as well as investors’ own interests, I urge companies to move quickly to issue them rather than waiting for regulators to impose them.”
NACB added, “in 2020, BlackRock asked all companies to adopt disclosure recommendations from the Task Force on Climate-related Financial Disclosures and the Sustainability Accounting Standards Board (SASB) and in the 2021 letter [Fink] reported a significant increase in the use of both disclosure approaches, with SASB reporting almost quadrupling.”
With regard to litigators, the Securities and Exchange Commission has “introduced new disclosure requirements designed to provide stakeholders insight into human capital, from the operating model, to talent planning, learning and innovation, employee experience, and work environment. The disclosures may help stakeholders evaluate whether a business has the right workforce to meet immediate and emerging business challenges.”
The National Law Review added that, “last summer, the Securities and Exchange adopted amendments to Item 101 of Regulation S-K requiring, to the extent the disclosure is material to an understanding of a registrant’s business taken as a whole, a description of a registrant’s human capital resources, including any human capital measures or objectives that the registrant focuses on in managing the business. Although the SEC’s adopting release never uses the word ‘diversity,’ many companies are responding to the SEC’s new human capital disclosure mandate by discussing the diversity of their workforces.”
The irony here is that a company that makes such disclosures about diversity may attract litigation rather than praise for its efforts. This can be for several reasons:
Plaintiffs are likely to misconstrue statements of diversity as representations rather than goals.
Self-identifications of diversity may be challenged if they are perceived to be inconsistent with other facts.
Racial, ethnic, and other diversity terms are not consistently defined.
Company statements regarding their diversity efforts may actually constitute violations of laws banning discrimination.
Organizations that have the metrics to back up their ESG efforts will fare better under the ever more watchful eyes of governments, investors, and litigators. One such metric is pay equity, which is strongly interconnected with issues surrounding Diversity, Equity, Inclusion, and Access (DEI&A). Companies would do well to leverage external assistance to monitor pay equity on a monthly basis.
To find out more about how organizations can bolster their ESG efforts (specifically with regard to DEI&A) with the help of an expert partner, click here.