A new frontier for investigations: the shifting sands of ESG and allegations of ESG-related misconduct

In summary

Once considered a peripheral consideration, ESG is now central to the conduct of business across the world. ESG has greatly expanded the ways companies, their stakeholders and other interested parties think about their operations and their roles in society. Along with this expansion, companies operating in the United States and elsewhere are increasingly exposed to ESG-related risks in various forms, including government enforcement and regulatory action, private litigation, and reputational harm. Identifying and mitigating these interconnected risks only becomes more difficult as social and political headwinds inevitably (and often rapidly) change. This article provides an overview of the many sources of ESG-related risks that can be present at various stages of a company’s operations and provides practical tips for navigating common pitfalls and managing associated investigations in the ESG realm.

Discussion points

• For many companies, nearly every aspect of the ordinary flow of business can present ESG risk, including: the supply chain, investment and asset management, employer and employee relations, daily operations, and marketing practices.
• Governmental authorities at every level and across jurisdictions are wielding their regulatory power to enforce social and environmental policy, and as a consequence, the relevant legal frameworks are rapidly developing and expanding.
• Even where there is no applicable governmental policy established by statute, rule or otherwise, companies can still face substantial ESG risk given the amorphous ‘social’ component of ESG.

Referenced in this article

• SEC’s proposed Climate Change Disclosure Rule
• SEC’s proposed amendments to the Investment Company Act ‘Names Rule’
• The Trafficking Victims Protection Reauthorization Act of 2008
• State legislation involving Net-Zero initiatives
• Nasdaq’s Diversity and Inclusion Disclosure Rules
• Dobbs v. Jackson Women’s Health
• NGO ‘Name and Shame’ Reports

Introduction

Since the early part of this century, environmental, social and governance (ESG) issues have risen to the top of the priority list of many companies, investors and consumers. In the wake of the corporate scandals of the early 2000s and environmental disasters during the 1990s and thereafter, the term ‘ESG’ emerged from a joint initiative between the United Nations and the financial industry that sought to foster ‘stronger and more resilient financial markets’ through ‘better inclusion of environmental, social, and corporate governance (ESG) factors in investment decisions.’^[1] Since the early 2000s, ESG investing has grown significantly in popularity and market prominence.^[2] Now, almost twenty years later, the term is ubiquitous; it is regularly used to broadly refer to non-financial matters that can, and often do, impact a company’s financial success and public reputation.^[3] ESG is no longer merely a particular form of investment strategy intended to promote financial returns from business operations. It is now a full-fledged movement – an approach, and even a mindset, by which investors, consumers and governments seek to pursue moral and sometimes political gains, whether directly tied to financial returns or not.^[4] And although the growth of ESG investing shows no signs of slowing, companies worldwide are beginning to appreciate the variety and significance of risks posed by ESG.

ESG issues permeate the conduct of global business.^[5] They extend throughout the United States, the rest of the Americas, the European Union, and beyond. Latin America in particular has experienced significant growth in ESG investing over the past few years.^[6] And Canada is now recognised worldwide for its ESG leadership, particularly in its energy sector, which is producing some of the most ethically and environmentally sustainable oil barrels in the world.^[7] For its part, China has seen a significant increase in ESG investing in recent years.^[8]

The kinds of issues that may be categorised as ESG issues are also expansive and expanding. ESG is ultimately a reflection of ever-changing societal norms. The ‘S’, or ‘social’, component of ESG is especially difficult to define with any certainty. At the most basic level, it is difficult to ascertain what is actually meant to be included under the umbrella of ESG. As Joseph Grundfest of Stanford Law School aptly observed, ‘[t]he ‘S’ in ESG is a lot like the Supreme Court’s definition of pornography: “I know it when I see it.”’^[9]

ESG-related risks can be understood as falling into three overarching categories. The first is existential – the nature of the business itself carries risk of allegations of ‘ESG misconduct’ and of related litigation. Examples of companies facing existential ESG risk are those engaged in fossil fuel, plastics, or chemical production. The second category is comprised of those companies that would not otherwise be obvious targets for allegations of ESG-related misconduct but that might in effect overstate their ESG credentials, in response to the changing winds of investor or consumer sentiment. These companies may face ESG risk in the form of greenwashing or other similar consumer protection-based claims. The third category contains those businesses, such as financial institutions, that are prone to ESG-related secondary or derivative liability as alleged facilitators or aiders and abettors of primary ESG violations. This article will address situations within each of these categories.

Lawyer-investigators, trained in skills and concepts developed over centuries (eg, fact development, evidence, privilege, and application of law to the facts) and accustomed to reviewing allegations of wrongdoing under equally well-developed substantive standards of conduct, may find themselves at somewhat of a loss when attempting to fashion and execute investigations of ESG-related issues. ESG-oriented investors and interest groups have promulgated hundreds of ‘standards’ by which a company’s ESG commitments and conduct can be analysed.^[10] Assessing a company’s risk profile in this regard is even more difficult because many ESG concepts often lack concrete foundations in law.^[11] In some instances, such as environmental standards^[12] and disclosure obligations mandated by law,^[13] a company’s ESG-related obligations are reasonably well defined.^[14] But, as is increasingly the case, ESG-related obligations and commitments arise not only from clearly defined legal frameworks, but also from standards that are voluntarily adopted by companies, usually in response to cultural, political or other pressures.^[15]

The collection of external, self-imposed and at times ill-defined ESG standards and commitments against which the conduct of companies can be assessed provides fertile ground for plaintiffs’ attorneys, interest groups and governmental authorities to plow for corporate targets. This is particularly true because grounding complaints and official inquiries in ESG-related vocabulary often provides aggressive and vocal corporate stakeholders, civil litigants and enforcement officials with headline-grabbing fodder that may exponentially increase – in both nature and extent – the threat of harm to the subject company. When fuelled by ESG-charged rhetoric, what might otherwise be confined to a legal dispute between the parties involved can morph into a full-blown corporate crisis threatening substantial and lasting reputational damage on top of legal and financial harm. As such, it is increasingly important for companies to appreciate their own ESG risks in light of the legal, geographic, cultural and political contexts within which they operate. Companies must assess and mitigate these risks in particular circumstances, including through conducting appropriate ESG-related internal investigations and effectively responding to government investigations.

In this regard, the proliferation of ESG-based investigations and claims in recent years sheds light on the varied ways in which allegations of ESG-related misconduct, and the resultant damage, may arise. Although this article’s analysis focuses primarily on social and environmental risks, it ultimately seeks to survey different circumstances, common to many corporate entities, that are symptomatic of increased ESG-related risks and that can trigger allegations of misconduct. In addition, this article offers insights on mitigating such risks and on the range of issues typically in play once allegations of ESG-related misconduct are made, including whether to conduct an investigation into the allegations and, if so, how to structure, execute and report on the investigation.

Nearly every aspect of the ordinary flow of business can give rise to ESG risk and trigger an ESG investigation

The supply chain

Supply chain-related issues can pose significant ESG-related risks for corporations, particularly those that operate in multiple jurisdictions and whose activities tend to draw heightened scrutiny from government authorities, consumers and social interest groups. These risks arise from existing environmental laws, proposed new public disclosure obligations for public companies (and their suppliers), and laws directed at human rights abuses, among other sources. This should hardly be surprising, given that much of a corporation’s environmental impact occurs in the production of goods and services. In fact, in its 2020 Annual Global Supply Chain Report, the Carbon Disclosure Project (CDP) estimated that companies with leading global supply chains could face up to $1.2 trillion in increased costs over the next five years due to environmental risk.^[16] Additionally, companies with global manufacturing operations can be subject to liability in US courts for alleged human rights abuses in their supply chains, even if the relevant conduct occurred outside the United States.

Federal environmental legislation

Individuals and regulatory agencies can trigger investigations relating to environmental issues under US federal legislation such as the Clean Air Act (CAA) and the Clean Water Act (CWA). The CAA regulates air emissions by authorising the Environmental Protection Agency (EPA) to promulgate regulations relating to air quality and granting it enforcement power via civil and criminal proceedings.^[17] In addition, corporate whistleblowers may trigger EPA investigations by bringing to the attention of federal regulators the facts underlying alleged environmental misconduct.^[18] Companies ultimately found liable in civil or criminal actions can face monetary penalties and fines, and may also be required to undertake costly remedial action.^[19]

The CWA empowers the EPA to regulate wastewater standards and to implement national water quality criteria recommendations for pollutants in surface waters.^[20] As with the CAA, the EPA actively engages in enforcement efforts, and companies found to be violating the CWA may be subject to significant civil and criminal penalties.^[21] In July 2020, the EPA and the Texas Department of Justice announced a $3.195 million settlement agreement with E.I. Du Pont de Nemours and Company (Du Pont) arising out of CWA violations at one of Du Pont’s Texas manufacturing facilities.^[22] The settlement agreement represented the culmination of a years-long investigation by the EPA into the ongoing environmental fallout at the Texas facility.^[23]

SEC climate change proposal

In early 2022, the US Securities and Exchange Commission (SEC) voted to propose amendments to the federal securities regulations that would enhance climate-related disclosure requirements for public companies.^[24] Significantly, if enacted, this proposal would require public companies to provide comprehensive additional disclosures regarding downstream greenhouse gas emissions in their supply chains.^[25] In particular, the proposal would require public companies to disclose greenhouse gas emissions from upstream and downstream activities in its value chain if material to the company or when the company has set a greenhouse gas emissions target or goal that includes emissions of this kind.^[26] In addition, the proposal would require some qualifying public companies to provide ‘attestation reports’ from independent attestation service providers regarding their direct greenhouse gas emissions and indirect emissions from purchased electricity or other forms of energy.^[27]

Increasing the amount and nature of required disclosures regarding downstream greenhouse gas emissions will inevitably create significant litigation and regulatory risk for public companies. Indeed, the proposal will likely embolden the SEC and private litigants to identify specific misstatements or allegedly misleading statements in disclosures regarding value and supply chain greenhouse gas emissions.^[28] If adopted, companies subject to these requirements would need to vet vigorously all disclosures and communications regarding potential climate change-related financial risks to mitigate increased litigation and enforcement risks.^[29] Moreover, the attestation report requirement itself would require public companies to engage outside firms to conduct costly annual investigations of their own emissions.

Human rights abuses

Supply-chain-related human rights abuses are unfortunately common worldwide. According to a 2018 report from the United Nations’ International Labor Organization and Walk Free, approximately 40 million people are victims of modern slavery or human trafficking.^[30] These abuses are considered generally more prevalent in developing markets where companies engage in production, while seeking to reduce costs and increase efficiency.^[31] Corporations with human rights abuses in their supply chains face significant litigation risk, even when those abuses occur overseas.^[32] The Trafficking Victims Protection Reauthorization Act of 2008 (TVPRA) imposes civil and criminal penalties on any person or corporation that indirectly benefits from slavery and human trafficking ‘financially or by receiving anything of value from participation in a venture which has engaged in the providing or obtaining of labor of services’ by means of force, threats or abuse when the party knew or recklessly disregarded how the labour was obtained.^[33] The US Supreme Court’s recent 2021 decision in Nestlé v Doe re-emphasised that, under the TVPRA, the US Congress allows foreign victims of supply chain human rights abuses to bring suit in the United States against ‘defendants who are involved indirectly with slavery.’^[34]

Financial institutions also face potential liability under the TVPRA, even without traditional manufacturing operations that are typically the subject of these suits.^[35] Financial institutions may be implicated in supply chain-related human rights abuses related to companies they finance. Several international banks have in the past been named as defendants in supply chain-related human rights suits brought under the Alien Tort Statute (ATS) and other relevant law.^[36] More recently, a prominent plaintiffs’ attorney who is suing major tech firms for facilitating the sex trafficking of minors stated her intent to also pursue large financial firms for their alleged roles in sex trafficking.^[37] In a statement to The New York Times, the lawyer proclaimed that ‘[t]he bigger they are, the harder they fall.’

Companies should also consider the reputational risks posed by human rights abuses in their supply chains. Consumers are increasingly knowledgeable – and seemingly less tolerant – of even remote human rights abuses.^[38] Non-governmental organisations (NGOs) that are passionate about human rights abuses frequently utilise traditional news media as a means to promote corporate change by educating consumers about the downline abuses in the products they purchase.^[39] And social media networks provide increasingly effective platforms through which NGOs and other human rights advocates can push social change by facilitating the proliferation of abuse allegations and causing reputational damage.^[40]

Responsible investment concerns

In recent years, financial institutions in particular have recognised their ability to use investing power to shape society and address pressing issues such as climate change. Larry Fink, CEO and co-founder of BlackRock who is now famous for his annual letters to CEOs, has made clear his view that financial institutions must adopt sustainability-focused investment approaches to maintain long-term financial growth in the face of climate change.^[41] And financial institutions worldwide are listening. At the time of writing, 113 banks worldwide, representing nearly 40 per cent of global banking assets, have joined the industry-led Net-Zero Banking Alliance.^[42] Moreover, and in the aftermath of the 2008 financial crisis, financial institutions are also coming to terms with the ways in which their investing practices can impact real consumers and pose significant reputational risk.

Anti-ESG backlash: fossil fuels

On the other hand, a growing counter-movement to ESG investing poses risk to companies and financial institutions perceived to venture ‘too far’ into social and environmental issues.^[43] This counter-movement targets financial institutions in particular for ways in which ESG investing practices may run afoul of an increasingly complex and sometimes conflicting web of state laws.

Perhaps the clearest example of conflict can be found in laws about investing in fossil fuel companies and financial institutions that decline to finance fossil fuel producers. Several politically left-leaning US states have introduced legislation that would require state entities to divest from the fossil fuel industry. In 2021, Maine became the first state to actually enact such legislation, which requires the state treasurer to divest the assets of ‘any state pension or annuity fund’ from the ‘stocks or other securities of any corporation or company within the fossil fuel industry.’^[44] Similar bills are pending in California, New York and Virginia.

The reaction from fossil-fuel producing states was swift and strong. Over the past year, several petroleum producing states have enacted competing legislation prohibiting state entities from contracting with, and investing state funds in, financial institutions that boycott fossil fuels.^[45] Texas was the first to enact such legislation, and its law is arguably the most comprehensive. Specifically, Texas’s Prohibition on Investments^[46] law requires Texas public pension funds to divest from financial institutions that are deemed to be ‘boycotters’ of fossil fuels by the Texas state comptroller.^[47] In addition, its Prohibition on Contracts^[48] statute requires that most contracts between financial institutions and Texas governmental entities include a written verification that the financial institution does not boycott energy companies and will not do so for the duration of the contract.^[49] Texas Comptroller Glenn Hegar has already begun the enforcement process, and published his list of ‘boycotting’ financial institutions on 24 August 2022.^[50] Oklahoma, Tennessee, Kentucky and West Virginia have enacted similar legislation. In addition, several attorneys general from Republican-leaning states have issued guidance providing that it can be a violation of an investment adviser’s state-law fiduciary duty to choose investment strategies based on ESG considerations.^[51]

Relatedly, former Arizona Attorney General Mark Brnovich launched an investigation into a ‘coordinated effort to allocate markets’ relating to ESG.^[52] And in Texas, the SEC’s Fort Worth Regional Office was reported in January 2022 to be investigating ‘non-boycott verifications’ that certain companies had already provided to Texas agencies for consistency with those companies’ other statements and commitments related to emissions.^[53] These investigations are indicative of the larger conflicts that financial institutions will face going forward as they are squeezed between competing state laws that either require divestment from fossil fuels or forbid such divestment. Further, the stakes associated with submitting the non-boycott verifications required by state law will only become higher if the SEC finalises its currently proposed rule that would heighten scrutiny of climate change and fossil fuel emission disclosures.^[54]

Delinquent tax lien securitisations

Financial institutions also face reputational risks posed by their investing practices. The delinquent tax anticipation note (DTAN) market provides a particularly illustrative example. Many state and local governments sell the property tax debts of individual homeowners to major financial institutions as a means of enhancing municipal revenues.^[55] If the homeowner is ultimately unable to pay off the property tax debt and the accrued interest, the home can be foreclosed and sold.^[56] In at least 10 states,^[57] homeowners whose homes are sold at foreclosure do not receive any surplus sale proceeds over and above the amount of their debt.^[58] Meanwhile, the financial institutions that purchase and securitise these debts stand to receive returns on their investments of up to 18 per cent.^[59]

Although legal, participating financial institutions should consider the reputational risks that may result from negative press coverage of the practice. Notably, some commentators suggest that certain counties systematically overvalue these homes in tax assessments, which in turn makes it more difficult for lower income homeowners to pay their tax bills.^[60] Indeed, the significant negative media coverage of these transactions presents an opportunity for self-styled social justice-oriented plaintiffs’ attorneys to initiate litigation against both the relevant municipalities and the financial institutions involved in the securitisations.^[61]

Employment and management concerns

The social, ‘S’, and governance, ‘G’, components of ESG address how companies manage relationships with stakeholders – employees, customers, investors and the broader community. An upheaval of social movements and renewed corporate commitment to racial and gender justice has led to increased investor demands for a visible commitment to diversity, equity and inclusion (DEI) in connection with corporate ESG strategies.^[62] And as a new and more activist-minded generation of employees enters the corporate workforce, executives are eager to demonstrate that their priorities extend beyond the financial bottom line.^[63]

Diversity and racial justice

Investors and employees are increasingly demanding proof of corporate commitment to DEI initiatives, in part because diversity is good for business.^[64] According to a Forbes survey, companies with comprehensive DEI policies tend to have stronger employee recruiting and retention, higher profits, and projected financial sustainability.^[65] And diversity can facilitate flexible and accurate responses to ESG risks related to pay equity, sexual harassment and inclusivity.

While investors and consumers alike are driving increasingly visible corporate commitment to DEI matters, federal regulators are stepping in to try to ensure honesty and compliance in corporate DEI reporting. In August 2021, the SEC approved Nasdaq Stock Market LLC’s (Nasdaq) proposed rule changes, which require each Nasdaq-listed company to have at least two diverse directors or explain why it does not.^[66] The new rules will also require disclosure of information on the voluntarily, self-identified gender, racial characteristics and LGBTQ+ status of the company’s board, beginning in August 2023.^[67]

In addition to promoting boardroom diversity, the new Nasdaq rules may aid investors in challenging the accuracy of corporate diversity claims in court.^[68] Although private litigants have brought a series of diversity-related actions in the wake of the racial justice movement that accelerated following the events of 2020, these actions have thus far been largely unsuccessful.^[69] Indeed, a federal judge in March 2021 dismissed one such suit against a company in which the plaintiffs had challenged the company’s alleged lack of diversity, allegedly discriminatory advertising practices, and failure to curb hate speech as (1) a violation of the directors’ fiduciary duty to the corporation and its shareholders, and (2) false and misleading statements that were contrary to the company’s public proxy statements regarding its commitment to diversity.^[70] But Nasdaq’s new diversity rules would arguably make these kinds of claims easier to pursue in federal court.^[71] After the rules take effect, Nasdaq-listed companies that fail to disclose non-compliance with the rule’s diversity requirement arguably could be liable under federal law for that omission. And if a listed company misstates its reason for its lack of diversity, aggressive plaintiffs could seek to pursue the company for such misstatements or omissions under securities laws.^[72] Further, the risks to companies are not limited to statements regarding board diversity – there are a growing number of state pay equity laws^[73] that include much broader governmental disclosures of pay data than previously required – and these disclosures are fodder for governmental investigators and plaintiffs’ attorneys.

Moreover, companies that lack board diversity may suffer reputational consequences beyond increased risk of litigation. For example, Goldman Sachs in 2020 pledged to only underwrite IPOs of private companies that have at least two diverse directors.^[74] And the Institutional Shareholder Services (ISS) 2022 Proxy Voting Guidelines recommended voting against the nominating committee chair of companies in the Russell 3000 or S&P 1500 that do not have at least one woman and at least one apparent racially or ethnically diverse board member.^[75]

Anti-ESG backlash: abortion access

Many Republican-leaning states are discouraging public companies from providing abortion-related benefits in the wake of the Supreme Court’s decision in Dobbs v Jackson Women’s Health Organization.^[76] Amazon, Citigroup and Lyft are among the many companies that have pledged to cover abortion-related travel costs for employees who live in states with restricted abortion access post-Dobbs.^[77]

But organisations that offer these benefits could run afoul of legislation in Republican-led states. After Lyft announced via Twitter that it would provide abortion-related travel benefits to its employees living in Texas and Oklahoma, 14 Texas lawmakers made extensive threats to the company in a letter which stated in part that ‘[t]he state of Texas will take swift and decisive action if you do not immediately rescind your recently amended policy to pay the travel expense of women who abort their unborn children.’^[78] A measure under consideration by Texas lawmakers would bar companies from doing business in the state if they pay for Texans to receive abortions in other states.^[79] The proposal would also incentivise Texas shareholders to sue publicly traded companies that provide these benefits by defining these acts as per se breaches of fiduciary duty.^[80] The proposal would also impose felony criminal liability on officers and directors who allow corporate resources to fund elective abortions or to reimburse abortion-related expenses without first obtaining unanimous consent of the shareholders.^[81]

ESG and management practices

As noted by certain commentators, the success of a company’s ESG programme rests on continuous and effective efforts to monitor relevant issues both within and without the company and ensuring strategic alignment of those issues with corporate goals and board oversight.^[82] Most importantly, maintaining a successful ESG programme requires responsiveness to market needs and identification of employee and consumer interests. Companies can apply a range of methods to gather information from stakeholders. For example, some companies grant investors voting rights on issues relating to environmental and social objectives.^[83] A company may also gain market insight directly from consumers by offering incentivised requests for customer feedback.^[84] Once interests are identified, companies may determine which interests conceptually align with company goals and establish concrete objectives to achieve operational alignment. Ultimately, a successful corporate ESG strategy aligns with the company’s strategy and values, while appropriately mitigating the risk of ESG-related financial loss, litigation and reputational damage.

Investors may expect corporate leadership to track and report the company’s progress towards reaching its ESG-related goals.^[85] Thus, executives should design ESG programmes that incorporate sufficiently transparent reporting and disclosure based on accurate, balanced, comparable and contextualisable information.^[86] Senior executives can play a crucial role in integrating ESG strategy throughout the corporate structure and culture.^[87] Indeed, a board of directors may presented with opportunities consider strategies by which it can mitigate ESG-related risk.^[88] Implementing ESG disclosure controls that align policies and processes with the company’s existing disclosure controls should mitigate litigation and enforcement risks tied to ESG disclosures.

Whistleblowers

As ESG investing becomes more commonplace, whistleblowers claiming relation to corporate ESG issues will doubtless become more frequent and powerful. Such whistleblowers claim the ability to remedy information deficits and bring instances of corporate misconduct to the attention of investors, regulators and would-be plaintiffs.^[89] The proliferation of whistleblowers is evidenced in the SEC’s 2021 Annual Whistleblower Program Report to Congress, which notes that the SEC awarded a record-breaking $1.1 billion to over 200 individuals whose information resulted in successful regulatory actions by the SEC and other federal agencies.^[90] One example of ESG-related whistleblowing is a junior manager at HSBC Holdings who sparked an internal investigation when he compiled a 48-page report alleging specific instances of racism at the bank’s New York office.^[91] Undeniably, informed whistleblowers have the power and inclination to trigger public scrutiny, internal investigations, regulatory action and private litigation.

ESG marketing and greenwashing risk

In the absence of any consensus and measurable definition for ESG, companies can fall into ‘greenwashing.’ A company greenwashes when it creates a false, overly positive impression about, or otherwise exaggerates, its social or environmental policies and practices, in an attempt to capitalise on the growing demand for sustainable and socially responsible products and behaviours.^[92] As the former chief investment officer for sustainable investing at BlackRock has observed, ‘[w]hat you get is an industry that knows if they put ‘ESG’ or ‘green’ on something, they can make a lot more money out of it.’^[93] Greenwashing allegedly impacts investors as well as consumers. The SEC believes that the lack of consistent, comparable and reliable information surrounding ESG funds and the lack of definitive ESG disclosure regulations creates risk that self-identifying ESG funds may not match investor expectations^[94] and may exaggerate their ESG practices or the extent to which their investment products take into account ESG factors.^[95]

Greenwashing: federal regulation and enforcement

The SEC has indicated that it is planning a crackdown on ESG greenwashing,^[96] and has already begun rulemaking to that effect. In May 2022, the SEC voted to propose amendments to the Investment Company Act ‘Names Rule’ that would address changes in the fund industry that have developed over the 20 years since the rule was first adopted.^[97] Current regulations require that funds with certain names adopt a policy to invest 80 per cent of their assets in investments suggested by that name. The Names Rule, as proposed, would expand the existing 80 per cent requirement to apply to any fund name that suggests certain characteristics.^[98] This change would include funds with names indicating that the funds’ investment decisions are guided by one or more ESG factors.^[99] Thus, a fund claiming to invest with a socially responsible, sustainable or other ESG-related focus would be prohibited from naming itself as a socially responsible or sustainable fund if it did not in fact direct 80 per cent of its assets into socially responsible or sustainable investments.^[100]

The SEC simultaneously proposed further amendments requiring funds that consider ESG factors in their investment processes to provide additional disclosures in annual reports, fund prospectuses and adviser brochures.^[101] These amendments would require funds claiming to achieve a specific ESG impact to describe that impact and to summarise their progress towards achieving that goal.^[102] The SEC posits that these proposals would be a significant step towards combating greenwashing. But like the SEC’s earlier March 2022 enhanced climate change disclosure proposal, these rules would further subject fund disclosures to enhanced scrutiny from would-be private litigants and federal regulators, among other interested parties.

The SEC has gone beyond proposed rulemaking in its efforts against greenwashing. The Division of Enforcement’s Climate and ESG Task Force investigated BNY Mellon Investment Adviser in connection with alleged misstatements and omissions about the way in which it considered ESG factors in making certain investment decisions.^[103] Ultimately, BNY Mellon consented to a cease-and-desist order under which it agreed to pay a $1.5 million penalty.^[104] The BNY Mellon case may provide a roadmap for future cases.^[105]

Greenwashing: civil litigation

Similarly, private litigants rely on contract and consumer protection law to ‘call out’ companies that they believe have business practices that are inconsistent with the companies’ ESG-focused advertising. These cases broadly allege that a company’s claims, representations and advertisements regarding sustainability or social issues are misleading in light of that company’s operations and policies.^[106] For example, in Dwyer v Allbirds, plaintiffs filed a class action against ‘sustainable’ shoe brand Allbirds alleging, among other things, deceptive business practices and fraud relating to representations Allbirds made in its advertising, such as ‘sustainability meets style’, ‘low carbon footprint’, and ‘environmentally friendly’.^[107]

These lawsuits have largely failed to survive motions to dismiss. However, federal courts seem to be more amenable to claims that ESG-related statements can materially mislead consumers. For example, in March 2022, a district court judge in the Western District of Texas declined to dismiss claims against egg manufacturer Vital Farms, and found that aspirational statements on egg cartons, such as those indicating that operations were ‘ethical’ and ‘humane’, can be misleading if the terms used were susceptible to definition.^[108] Likewise, in Rawson v Aldi, a federal court in Illinois declined to dismiss a breach of express warranty claim in connection with salmon packaging that included the phrase ‘Simple. Sustainable. Seafood’. The court found this phrase to be actionable, and not merely ‘puffery’.^[109] Thus, advertising containing social and sustainability buzzwords without sufficient factual support can provide another source of ESG litigation risk.^[110]

NGO activism and ‘name and shame’ reports

NGOs are yet another source of ESG risk for business.^[111] Indeed, NGOs are particularly significant sources of ESG risk to companies where the absence of relevant, established legal authority makes the enforcement power of government regulators and private litigants less robust by comparison. As one NGO recently remarked, with respect to its anti-greenwashing mission, ‘the rapid acceleration of corporate climate pledges, combined with the fragmentation of approaches means that it is more difficult than ever to distinguish between real climate leadership and unsubstantiated greenwashing.’^[112] In these circumstances, NGOs attempt to use their bully pulpit to ‘name and shame’ corporations and financial institutions into recognising – and at times remedying – the social and economic consequences of funding decisions.

Examples of ‘naming and shaming’ abound: in 2021, several prominent NGOs published comprehensive ‘name and shame’ reports that investigated in-depth companies’ net-zero commitments and other climate-related statements.^[113] The Sierra Club’s report, which focused on global emissions of the US financial sector, criticised the alleged failure of those institutions to minimise financed emissions and take voluntary steps to put in place policies to minimise the credit exposure posed by the climate change transition.^[114] Similarly, NewClimate’s report evaluated 25 companies on ‘the transparency and integrity of [the] companies’ climate pledges.’^[115] The report was particularly critical of allegedly ambiguous pledges relating to net-zero and other emissions reduction commitments and of the use of carbon offsets as a means for accomplishing those commitments.^[116]

It should be noted that NGO ‘naming and shaming’ poses risks that go beyond potential reputational harm. NGOs have relied on their ‘name and shame’ reports to seek increased regulation by government agencies. Thus, in its letter to the SEC seeking mandatory disclosure requirements regarding carbon offsets, the Sierra Club relied in part on the NewClimate report and a similar study conducted by Oxford University.^[117] And in 2021, five NGOs collaborated to bring a groundbreaking complaint before the SEC, alleging that the Japan International Cooperation Agency (JICA) materially harmed US investors and threatened to exacerbate climate change by financing coal-fired power generation despite its explicit assurances that it would refrain from doing so.^[118]

Considerations relating to investigations into allegations of ESG-related misconduct

As described above, the growth in ESG-related risks for companies stems from many sources, some of which are rooted in law or other reasonably clear, enforceable standards of conduct, and others that emanate from evolving societal norms that can, or often do, differ across or even within jurisdictions. This dynamic necessarily and substantially expands the universe of parties that are – or simply feel – empowered to exercise real or imagined influence over the conduct of business. Consumers, would-be private litigants, NGOs and government agencies alike are increasingly scrutinising anything they can label as ESG-related corporate conduct for inconsistency with regulatory and legal rules, as well as uncodified – and frequently disputed – public policy preferences.

Against this backdrop, companies are well advised to devote more attention and resources to the circumstances that tend to give rise to ESG risks, mitigating those risks, and responding to credible allegations of improper ESG conduct. In this regard, companies should consider adopting policies and procedures to, among other things:

• ensure alignment of business strategy with ESG-related corporate activities among corporate leadership personnel;
• continuously monitor the increasingly complex enacted and proposed statutes and regulations, and related regulatory and judicial activity, touching on ESG-related issues;
• continuously monitor cultural and political ESG-related developments in relevant jurisdictions;
• develop and implement policies and procedures governing the consideration and approval of any corporate representations that are, or may reasonably be interpreted to constitute, ESG-related commitments or positions;
• consistently and accurately communicate ESG-related corporate policies, procedures, commitments and positions to key stakeholders and external parties, as appropriate; and
• prepare to respond to allegations, incidents and other occurrences that may expose the company to ESG-related legal, financial and/or reputational harm.

Responding to ESG-risk events can involve an internal investigation into the matter, if not also a parallel investigation by governmental authorities. Where the underlying alleged conduct related to ‘E’ (environmental) or ‘G’ (governance) concerns, an investigation of the allegations would typically be reasonably conventional – that is, undertaken and conducted in accordance with generally accepted investigative practices. The central question in such an investigation would ordinarily be whether applicable environmental or corporate governance laws (or related corporate policies) were violated.

By contrast, particularly where the alleged misconduct is tied to an ‘S’ (social) issue not specifically embodied in a legal rule, corporate policy or other established conduct standard, opportunities may exist to pursue an investigation or other review, if at all, in ways that may deviate from the standard investigation playbook. Here, relevant considerations may include the following:

Deciding whether to conduct an investigation into ESG-related conduct

The absence of an applicable, pre-existing legal rule or corporate policy would normally afford a company more room for the exercise of judgement in determining whether to formally investigate misconduct allegations. At root, internal investigations of misconduct seek to discover whether personnel violated applicable internal or external conduct rules. Where there are no such rules against which to evaluate a particular employee’s conduct or a particular business practice, seeking to determine whether an employee engaged in, or a practice constituted, misconduct may be untenable. And yet, in the ‘S’ context (as in the ‘E’ context), companies may be under increased pressure to conduct investigations of alleged misconduct simply because the purportedly interested stakeholders are likely to be numerous, high-profile and vocal. Ordinarily, the core interested parties in general compliance matters are often largely confined to corporate management and boards, shareholders, and governmental agencies, but a major company implicated in significant potential ‘S’ misdeeds will assuredly face hue and cry from a much broader range of organisations and individuals – domestic and foreign – with the threat of amplified reputational impact beyond any direct legal exposure. Whether the company bends to such pressure would presumably reflect the company’s approach to governance – for example, whether its leadership subscribes to a narrower, shareholder-centric view of corporate performance and accountability, or one that accords substantial weight to the views and concerns of a broader range of interested parties. Regardless, companies should clearly imbue their ESG programmes with their corporate values, and thus establish the foundation for principled decision-making under specific circumstances, including in determining whether to launch an investigation into ESG-related allegations.

Scoping the investigation

The scope of an ESG-related investigation will generally derive, at least in part, from the answer to the same basic question – namely, who are the relevant corporate stakeholders and other interested parties for the purpose of the investigation? And, relatedly, what is the company seeking to achieve with respect to those stakeholders and interested parties? An investigation that is principally oriented towards enforcement and regulatory authorities and shareholders could look significantly different in scope than one geared towards the concerns of other interested parties. Ultimately, the scope of an internal investigation into allegations of ESG-related misconduct should be informed by the principles and objectives of the corporate ESG programme, which, as noted above, should reflect the company’s core values.

Evaluating the facts and circumstances

The absence of specific applicable substantive rules against which the conduct of individuals (or even the entity as a whole) can be assessed would typically complicate the effort to evaluate and characterise that conduct as violative of any enforceable conduct standard. In such cases, it may be necessary to resort to assessing the conduct at issue against general ethical principles embodied in codes of conduct or other corporate policies (eg, policies that mandate ‘ethical’ or ‘honest’ behaviour). This can subject an investigation to a heightened risk of being accused of overly subjective judgements, especially as to ‘S’ investigations, where the benchmark can fairly be deemed to represent an uncodified, and even personal, policy preference. Where a company has essentially self-imposed a standard against which its conduct and that of its personnel may be fairly evaluated (eg, where the company has publicly announced – but then failed to satisfy – an ESG commitment), investigations into misconduct allegations will undoubtedly probe, among other things, the process by which the company developed that standard, the information upon which the company relied in doing so, the reasonableness of any assumptions and judgements underlying the standard, and whether any corporate officers or employees acted in bad faith. In any event, as with any investigation, the focus of an ESG investigation should be on the gathering of relevant facts; where personnel action may not be appropriate or advisable, the facts may nevertheless suggest various remedial actions that could provide for greater enforceability in future cases and reinforce the company’s ESG commitments overall.

Remediating

An internal investigation into allegations of ESG-related misconduct can be an opportunity to develop insight into components of the company’s ESG programme and to identify areas for potential improvement, including means of encouraging employees to behave in a manner more consistent with corporate ESG objectives. Such improvements could consist of, for example, personnel action, where warranted; the promulgation of new corporate policies and procedures to make that which was previously vague (if articulated at all) clear and enforceable going forward; and employee trainings tailored to the investigation’s findings.

Communicating the internal investigation findings and remediation

Particularly if the investigation’s scope accounts for the interests and concerns of a comparatively broad set of stakeholders and other interested parties, or if the investigation’s existence is known publicly, the company may face pressure to issue a public investigative report or to otherwise publish the investigative findings and related remediation. Any corporate desire to publish the investigative findings and the possible of benefits of publishing must be evaluated in light of the potential downsides to doing so, including any risk of waiver of the attorney-client privilege (where the investigation was covered by the privilege in the first instance) and any impact on pending or prospective litigation or government investigations relating to the same subject matter. Further, given the ‘activist’ nature of many external parties claiming interests in ESG-related matters, the decision to make public information about internal investigations should be informed with careful consideration of the appetite many ESG activists have for information. Those appetites are unlikely to be satisfied with anything but their versions of ‘full’ disclosure.

Dealing with government investigations

All of the considerations described above may also affect government investigations into the same ESG-related conduct. For example, just as the company may be challenged in identifying specific applicable conduct rules, so too might government authorities be challenged. And just as a company may resort to general corporate conduct principles in determining whether remedial action may be warranted against corporate personnel, so too might the government seek to shoe-horn conduct into broad legal theories, such as ‘fraud’ or ‘false statements.’ This possibility heightens the risk of government overreach in ESG investigations, making it imperative that companies be represented by able counsel who, as necessary, can push back on overreach and otherwise vigorously defend corporate interests in connection with the government investigation.

Conclusion

The emergence of ESG as a central business consideration has effected something of a paradigm shift for companies across industries and geographies. As companies push to adjust to, and maximise opportunities in, a new normal, they are well served by paying appropriate heed to the significance and diversity of risks posed by the rise of ESG. To mitigate the risk of legal, financial and reputational harm that ESG-related misconduct can trigger, companies should ensure that their approaches to ESG-related issues – in particular, their treatment of allegations of misconduct – conform to any legal requirements, reflect the companies’ values, respect the legitimate interests of corporate stakeholders, and result from informed assessments of the true nature and extent of the risks presented. Internal investigations into allegations of ESG-related misconduct, like other internal investigations, can be a valuable tool for a company not only in identifying and remediating any misconduct, but also in strengthening the company’s ESG programme and otherwise demonstrating the company’s commitment to responsible corporate stewardship.

^* With assistance from Alyssa L Aubuchon.

Footnotes