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By Benjamin C. Knuth | LexisNexis Subject Matter Advisor (Corporate and Securities Law)
Corporate social responsibility has long been a topic at business conferences and corporate meetings, but it’s clear that we’ve entered into a new era in which there will be sustained focus on the environmental, social and governance (ESG) conduct of American companies.
There are different drivers behind the emergence of ESG as a key priority for chief executives. Three-quarters of executives responding to a recent survey by Intelligize, a LexisNexis company, said their companies “possessed a legitimate desire to achieve positive outcomes” on ESG matters, while one in four cited factors such as pressure from activist investors and a desire to avoid bad publicity.
A September 2021 survey of general counsel by the Center for Corporate Governance at Stanford University found that the greatest source of pressure behind ESG initiatives comes from company employees (cited by 48% of respondents), followed by investors (44%), customers (41%), third-party advocacy groups (33%) and then ESG ratings firms (24%).
Regardless of the source, the reality is that ESG compliance must now be a key focus for legal advisors to their executive teams because it is officially on the radar for government regulators and private litigants alike. ESG compliance has implications across virtually every area of legal practice, from capital markets and private equity to real estate and tax.
Beyond the “table stakes” of staying on top of today’s news and ESG requirements, it is important for legal professionals to stay ahead of the curve on ESG issues by identifying legal trends that are likely to emerge in the future.
LexisNexis recently hosted a webinar on this topic that featured three partners from Ballard Spahr LLP: Lorene L. Boudreau; April Hamlin; and Kahlil Williams. Based on comments shared by these experts in the field, here are three legal ESG trends to monitor in the years ahead:
SEC Task Force
The U.S. Securities and Exchange Commission created a new task force in March 2021 to “proactively identify” misconduct involving ESG disclosure violations by public companies. It is important for legal professionals to keep a close eye on this task force in the months and years ahead as it is a potential source of regulatory challenges for companies who might least expect it.
The task force will analyze corporate ESG disclosures by harnessing sophisticated data analysis to identify potential violations. It will also evaluate and pursue whistleblower tips related to ESG concerns, inviting members of the general public to file any tips or complaints via its website. Mr. Williams warned that some companies risk enforcement actions by making representations about themselves—e.g., as an ideal workplace for women and minorities or environmentally-friendly—that do not match reality.
And while the SEC Task Force should have legal professionals taking notice, it is not the only federal regulator to monitor. “When we speak about the potential disconnect between what a company says and what it is doing on ESG issues, it’s important to understand that the SEC is not the only potential plaintiff,” said Ms. Boudreau. “There are other fraud-related claims that a company could be exposed to, such as actions brought by the Federal Trade Commission.”
Shareholder Derivative Litigation
Shareholder derivative litigation — claims brought by a shareholder on behalf of the corporation itself — is an ESG risk for legal professionals to monitor in the future because they often arise in instances when shareholders allege that the board of directors has abrogated its duty of oversight of corporate officers, thereby exposing the company to liability and potential financial harm.
“Investors are increasingly focused on board oversight and making sure that the board is on top of issues that have the potential to damage the company,” said Mr. Williams. “I think we will see more companies receiving inspection demands to review the materials of the board in order to ensure that the board is correctly overseeing ESG issues. If this review suggests the board is failing to effectively monitor these really important things, that could be the basis of litigation on corporate governance grounds in the form of a shareholder derivative lawsuit.”
Indeed, litigation challenging alleged misstatements or inconsistencies by companies in their ESG communications is already on the rise. A number of shareholder derivative lawsuits have been filed in federal courts, with the intention of holding corporate directors and officers accountable for failing to deliver on various stated ESG commitments. While defendants in these lawsuits have been successful so far, it seems likely that shareholder derivative actions will increase in the future as public pressure on improved corporate ESG conduct comes into greater focus.
The rise of ESG investing, which now accounts for one-third of total U.S. assets under management, has increased the power of shareholders who are motivated by ideological commitments to social goals — ranging from environmental activism to diversity and inclusion progress. These activist investors are likely to test their newfound strength in the form of shareholder resolutions and other challenges to the executive teams and corporate boards at public companies of all sizes.
“For companies that had activist investors approach them in 2021 and warn them of upcoming shareholder proposals in 2022, they should be very much recognizing that the ground has shifted and any procedural or other advantage they may have had has really been eroded,” said Ms. Hamlin. “The better course in a lot of cases is to work with those proponents to figure out how to address their concerns. That’s because this is not a one-off concern but is representative of a much broader trend.”
Companies should be especially cautious in the months and years ahead to evaluate any ESG disclosures or changes to corporate governance in the context of a potential ESG-themed investor activist campaign.
Watch a recorded playback of the LexisNexis webinar, “When Compliance Isn’t Enough: Why Companies Must Stay Ahead of the Curve on ESG,” to learn more about emerging legal trends associated with ESG issues.