Companies are addressing today’s evolving ESG (Environmental, Social and Governance) issues like they never have before. From climate change to diversity, equity and inclusion, these topics are at the forefront of discussion for businesses, with many seeking to understand stakeholder concerns and implement strategies to improve their ESG efforts.
Stakeholders – consumers, investors and employees alike – have recently become more vocal and united in their demand for sustainable corporate behavior. In fact, 83% of consumers think companies should be actively working on Environmental, Social and Governance (ESG) program best practices and 86% of employees prefer to support or work for companies that care about the same issues they do.1 In turn, companies are addressing these issues like they never have before, in recognition of their importance as indicators of long-term value.
As the focus and scope of ESG programs have expanded in recent years, so have the legal exposures for companies, including officers and directors, who may be held legally accountable for failure to demonstrate the effectiveness of ESG initiatives. Pending regulations by the Securities and Exchange Commission (SEC) are likely to increase those challenges. New SEC rules would require public companies to capture, quantify and report their greenhouse gas emissions. Privately held companies, not subject to the same disclosure standards as publicly traded ones, are likely to be impacted by the downstream effects of that rule as part of the overall value chain (i.e. supplier, manufacturer or vendor) of a public company.
An Emerging Market for Directors and Officers Insurance
Meghan Marchica, managing director at The Hartford, says litigation around ESG business claims has increased in recent years. “ESG-related litigation is still evolving, but the frequency of those lawsuits is increasing,” said Marchica. This has given rise to emerging risks and liabilities under Directors and Officers (D&O) insurance, which can reimburse the costs incurred in a legal defense against claims made by shareholders or third parties for alleged wrongdoing. D&O policies also typically cover monetary damages, settlements and awards.
Traditionally, D&O insurance has been associated with securities-related litigation, including financial misrepresentation or insider trading advocacy groups, investors, consumers and employees place greater value on climate, diversity and equity-related issues, they are using litigation to hold companies accountable for delivering their ESG promises.
For instance, shareholders have brought legal action alleging securities fraud and breach of fiduciary duty based on a company’s ESG disclosures. This includes misleading claims about favorable environmental impact – known as “greenwashing” or disclosures about board diversity.2 In the U.S., more than six in 10 (64%) of individual investors say it’s difficult to judge a company’s actions and what they promise when it comes to the environment and society.3 Such lack of transparency and accountability has led to a rise in ESG-related litigation. In addition to targeting companies, these claims often look to hold individual directors and officers personally responsible.
As ESG programs have become more common, anti-ESG sentiment and legislation in many states has also increased, which has led to a greater need for D&O insurance. In Texas, for instance, companies contracted with the state must certify that they don’t – and won’t – boycott fossil fuel or firearms companies during their contract term.4
ESG Efforts Are Worth the Effort
Despite the challenges, corporate-focused research has shown that ESG initiatives are worth the effort. Companies with strong ESG programs usually perform better financially over time, including higher return on equity, return on assets and stock price. That’s because interest in values-based investing has increased, with more than half of adults wanting to ensure that their beliefs align with a company’s values.5 ESG programs have also proven to create operational efficiencies and better risk management, which are attractive to insurance companies.
Marchica says there are steps public companies – and their boards – can take to help reduce their ESG program’s legal exposure while building brand loyalty and making a positive impact on climate and social issues. They also represent better risks for insurers. ESG initiatives have also given rise to third party specialists. “Companies can engage outside consultants to help build out their ESG program and report on their ESG progress,” Marchica said.
“It’s important for public companies to substantiate ESG disclosure statements with specific metrics, regular progress updates and data, and not to overstate accomplishments,” she said.
Key Considerations for Building Out a Successful ESG Program
Building a robust ESG program involves several key considerations for company executives and board members to consider:
- Evaluate the investor and stakeholder perception of your company compared to your peer group.
- Create an ESG committee with board member representation.
- Make ESG-related issues a standard part of your board focus by establishing sustainability targets and creating a timetable for monitoring and reporting updates to the public.
- Develop policies and procedures that ensure consistency in your reporting across public filings, sustainability reports and investor communications related to ESG priorities and goals.
- Consider which ESG issues matter most to your stakeholders and have the potential to impact the company’s long term financial and operational goals to establish how your company defines “materiality.” Engage independent, outside sources when necessary.
- Review the Federal Trade Commission’s Green Guides, which provides federal guidance on environmental marketing and guidance on marketing tactics that might be considered “greenwashing.”
- Establish reporting frameworks and disclosure frequency to meet with needs of investors and other stakeholders.
- Integrate ESG into your company’s business strategy and assign accountability across various divisions of the company.
- Consider the ESG impacts of your supply chain to ensure consistency and high standards related to your company’s ESG efforts.
Climate-related and social equity issues are likely to continue to be challenging for public and private companies to address. Delivering on ESG initiatives will remain important to appeal to large groups of investors, attract and retain an engaged employee-base, avoid shareholder litigation, protect officers and directors and to reduce regulatory risks.
1 PWC, “Beyond Compliance: Consumers and Employees Want Business to Do More on ESG”
2 Harvard Law School Forum on Corporate Governance, “Seven Gaping Holes in Our Knowledge of Corporate Governance”
3, 5 2021 Workiva ESG Consumer Survey, “The Power of Transparency: New Survey Reveals Individual Investors Demand ESG Data They Can Trust”
4 Bloomberg Law, 2022, “Why Companies Should Watch Anti-ESG Litigation”
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