Over the past few years, the term “Environmental, Social and Governance” or “ESG” has been both first used and brought into daily use by capital market participants. Multiple publications have been written on the subject, Nasdaq has published an ESG Reporting Guide, the House Financial Services Committee has debated multiple bills that would require various ESG disclosures and the SEC top brass is vocal, and divided, on the subject. SEC Chair Jay Clayton and Commissioner Hester M. Peirce both believe that ESG matters are too abstract and undefined to result in meaningful disclosure while Commissioners Robert J. Jackson Jr. and Allison Herren Lee just issued a joint statement expressing disappointment in the recently proposed changes to Regulation S-K (see HERE) for omitting the topic of climate risk.
It is clear that ESG matters are an important factor for analysts and investors and thus for reporting companies to consider. It is also clear that companies have increasing pressure to report ESG matters and will be judged on those reports by different groups with different criteria in a current no-win environment (pun intended).
What is “Environmental, Social and Governance” or “ESG”
In the broadest sense, “Environmental, Social and Governance” or “ESG” refers to categories of factors and topics that may impact a company and that investors consider when making an investment and analysts and proxy advisors consider when making recommendations about investments or voting matters for corporate America. However, from a micro perspective, ESG means different things to different constituencies and has become a sort of catch-all phrase for a spectrum of topics ranging from very real and serious societal issues to the topic de jour touted by paid special interest groups and influence peddlers.
As noted by Commissioner Peirce in a recent speech, the G (governance) in ESG is a little more concrete, including, for example, whether there are different share classes with different voting rights, the ease of proxy access, or whether the CEO and Chairman of the Board roles are held by two people. The environmental category can include, for instance, water usage, carbon footprint, emissions, what industry the company is in, and the quantity of packing materials the company uses. The social category can include how well a company treats its workers, what a company’s diversity policy looks like, its customer privacy practices, whether there is community opposition to any of its operations, and whether the company sells guns or tobacco.
However, once a topic is fitted into a category, the measurement of that category and the meaning behind the information is much more nebulous. Furthermore, ESG topics are being heralded by non-shareholder stakeholders influencing investors. A number of self-identified ESG experts have developed and many groups produce ESG ratings. The ratings are not standardized, allowing the ESG expert or rating organization to further their own agenda, which may be a paid effort or based on personal preferences. The analysis can be arbitrary as it may treat similarly situated companies differently and may even treat the same company differently over time for no clear reason.
It is clear that ESG matters carry great weight with the investment community, especially powerful investors such as hedge funds, ESOPs, pension funds, family offices, unions, and private equity groups, and as such companies cannot ignore potential ratings and analyst coverage on these matters. Unfortunately, this is resulting in increased internal expenses without increased benefit. Some rating organizations send out surveys requiring a company to respond or risk receiving a bad review. Senior counsel for The Travelers Cos., Inc., reported at a recent Investor Advisory Committee meeting that her company had received 55 survey and data verification requests from ESG rating organizations in the last year. It took 30 employees and 44.8 work days to respond to just one of these surveys.
When a rating organization uses public information, such as sustainability reports, the results can be arbitrary as there is no clear standard. For instance, a “practice” may be rated differently than a “policy” such that a company doing more for the environment than another company may receive a lower rating as a result of terminology. For example, one rating organization gave Tesla a lower ESG rating than other car companies because it did not believe Tesla’s ESG disclosures to be sufficient, and not because of a review of its actual environmental impact.
Another issue is purported ESG financial advisors and money managers. As ESG is not standardized, as Hester Peirce states, “A statement that you are an ESG manager may not require much to back it up. It may be enough to buy an ESG scorecard, hire a proxy advisor, or invest according to an index that incorporates an ESG filter.”
ESG Disclosure Requirements
As mentioned above, both SEC Chair Jay Clayton and Commissioner Hester M. Peirce believe that ESG matters are too abstract and undefined to result in meaningful disclosure. In a recent interview, Chair Clayton justified his position noting that if a matter, whether falling under an ESG category or not, would impact a company’s financial position and is material to that company and its investors, it should be disclosed. However, because the categories under ESG are so broad and so diverse, it is not appropriate to try and impose regulatory disclosure obligations. Chair Clayton states, “[M]y view is that in many areas we should not attempt to impose rigid standards or metrics for ESG disclosures on all public companies. Such a step would be inconsistent with our mandate, would be a departure from our long-standing commitment to a materiality-based disclosure regime, and could effectively substitute the SEC’s judgment for the company’s judgment on operational matters.”
Nevertheless, there are some current and potential ESG disclosure requirements. The Nasdaq stock market has published an ESG Reporting Guide, which is discussed below. As touched on above, countless memorandums and publications have been written on ESG matters including what in particular and how they should be reported (with countless differing opinions). The recent proposed changes to Regulation S-K added the topic of human capital as a disclosure item including any human capital measures or objectives that management focuses on in managing the business, and the attraction, development and retention of personnel (such as in a gig economy). In making this proposal, the SEC noted that human capital matters fall within an ESG disclosure.
Non-U.S. countries have also been beating the ESG drum with Europe requiring increased disclosures and the International Organization of Securities Commissions or “IOSCO,” without the participation of the SEC, issued a statement “setting out the importance of considering the inclusion of environmental, social, and governance matters when disclosing information material to investors’ decisions.”
Nasdaq ESG Reporting Guide
Nasdaq has had a corporate sustainability program in place for six years and has a decidedly positive viewpoint on ESG seeing these factors as beneficial to investors, “but also for public companies trying to increase operational efficiency, decrease resource dependency, and attract a new generation of empowered workers.” Nasdaq continues with “Effective management of sustainability issues helps Nasdaq (and our listed companies) better understand operational performance, address resource inefficiencies, and forecast enterprise risk. In addition, there is a growing body of academic and analytic evidence suggesting that ESG excellence correlates with other benefits, such as lower costs of capital, reduced shareholder turnover, and enhanced talent recruitment and retention. With a renewed market emphasis on long-term value creation, we also believe that ESG is an effective and mutually beneficial communication channel between public companies and the investment community.” Clearly Nasdaq and Commissioner Peirce have differing views on the subject.
With that said, the Nasdaq ESG Reporting Guide is merely a recommendation for the record keeping and reporting of material information on ESG matters. In determining materiality, Nasdaq suggests that companies consider impacts to external stakeholders and ecosystems in addition to those directly affecting the company. Nasdaq does not impose financial or legal reporting requirements beyond that required by Regulations S-K and S-X. Many companies choose to report ESG matters in separate ESG reports made available to investors on their website, rather than in formal reports to the SEC.
The Nasdaq guide focuses on economic principles and specific data, rather than moral or ethical arguments. The ESG topics that Nasdaq address include:
- Environmental – (i) GHG Emissions (i.e., greenhouse gas emissions); (ii) emissions intensity; (iii) energy usage; (iv) energy intensity; (v) energy mix; (vi) water usage; (vii) environmental operations; (viii) climate oversight/board; (ix) climate oversight/management; and (x) climate risk mitigation.
- Social – (i) CEO pay ratio; (ii) gender pay ratio; (iii) employee turnover; (iv) gender diversity; (v) temporary worker ratio; (vi) non-discrimination; (vii) injury rate; (viii) global health and safety; (ix) child and forced labor; and (x) human rights.
- Corporate Governance – (i) board diversity; (ii) board independence; (iii) incentivized pay; (iv) collective bargaining; (v) supplier code of conduct; (vi) ethics and anti-corruption; (vii) data privacy; (viii) ESG reporting; (ix) disclosure practices; and (x) external assurance.
For each topic, Nasdaq provides an explanation as to why such a measurement is important and a formula for completing the measurement or setting a policy addressing the topic.
As most people that follow my blog know, I tend to agree more with Chair Jay Clayton and Commissioner Peirce than with Commissioner Jackson. In this case, although I do agree with the commentary of Chair Clayton and Commissioner Peirce on the topic, I also think that it would be helpful in eliminating the vast differential on ESG metrics if the SEC would issue guidance on the subject. With that said, I believe the guidance should be along the lines of Nasdaq’s ESG reporting manual, setting clear formulas and definitions, and avoiding moral or ethical arguments. In July, the House Financial Services debated five draft bills that would require companies to disclose information about climate change risk, political contributions and other ESG topics. Although I doubt any one of these bills will ultimately be passed into law, I do think the SEC will begin to heed the call and increase ESG disclosure items in its continuing disclosure effectiveness initiatives.
Laura Anthony, Esq. Founding Partner Anthony L.G., PLLC A Corporate Law Firm LAnthony@AnthonyPLLC.com
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including sitting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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