ESG Enforcement and the Effect on Private Companies
Private companies that do business with public ones must pay close attention to the SEC’s ESG enforcement agenda.
In recent years, the SEC has stepped up its focus on ESG regulation of public companies and investment advisers. While this uptick in focus and enforcement by the SEC does not have a direct effect on private companies, private companies should monitor these developments and, in some cases, adjust their approach to ESG issues accordingly.
Gary Gensler, chair of the SEC, announced the formation of an ESG task force in March 2021, shortly after President Biden appointed him to the position. While the SEC has brought a smattering of enforcement actions related to ESG concerns going back to at least 2008, these concerns previously had not been an articulated focus of the SEC’s enforcement division. In the announcement, Gensler stated that, at the outset, the focus of the task force would be to identify “material gaps in issuers’ disclosure of climate risks” and to analyze disclosure and compliance related to “investment advisers’ and funds’ ESG strategies.”
In 2022, the task force kicked into high gear, with the SEC highlighting six enforcement actions brought in this area (the list is not exhaustive). Three of those involved misleading ESG disclosures by public companies — two related to environmental concerns and one to governance concerns — and three involved misleading disclosures by investment advisers related to ESG investment strategies.
Of the public company actions, two involved misleading disclosures by the mining companies Compass Minerals International and Vale S.A., a Brazilian company. The third public company matter involved misleading disclosures by the former CEO of a health insurance distributor. In SEC v. Vale S.A., brought in April 2022, the SEC charged Vale with making misleading disclosures about the safety of the Brumadinho dam in Brazil, which was built to contain the toxic by-products of its mining operations in the area. The SEC claimed the company knew the dam did not meet international safety standards. The dam collapsed in 2019, causing significant environmental damage.
In the Compass Minerals matter, the SEC settled its charges with the company, levying a civil money penalty and requiring the appointment of an independent compliance monitor. The SEC had charged the company with misleading investors about technology that should have reduced costs at its largest mine and for failing to properly assess the financial risks associated with the environmental contamination caused by mercury discharged at one of its Brazilian facilities.
The third public company action highlighted by the SEC concerned charges brought against Health Insurance Innovations and its former CEO. In that matter, the SEC alleged that the company and its management misled investors about the quality of its compliance program and about statistics related to its customer satisfaction figures.
In the investment adviser and fund spaces, the SEC announced settlements with Goldman Sachs Asset Management, BNY Mellon Investment Adviser Inc. and a robo-adviser for making misleading ESG disclosures to their customers. In the Goldman Sachs and BNY Mellon matters, the SEC charged the advisers with misleading investors about the ESG research and review process that they employed when including companies in their funds that were marketed as funds having ESG investment strategies. In the robo-adviser matter, the SEC charged that the adviser marketed itself as providing investment advice that complied with Islamic law when it had no policies and procedures in place to ensure that it could meet those standards. Finally, most recently, the SEC brought an enforcement action against DWS Investment Management Americas Inc. for making materially misleading statements about the ESG factors it uses to make investment recommendations.
These actions highlighted by the SEC are significant both in their substance and in their number. The substantive charges brought by the SEC largely align with the goals of the ESG task force set forth by Gensler when he announced its formation. The takeaway from these matters is that a public company must do what it says it is doing in its disclosures with respect to ESG concerns.
What does it mean, though, for private companies? First, when private companies do business with public companies — as customers, joint venture partners or vendors — the public companies may demand transparency about ESG practices of their private company partners or vendors and require that they maintain the same standards with respect to ESG practices. This may help public companies ensure that their own ESG disclosures remain accurate.
Second, customers and employees of private companies may demand transparency even if there is no legal obligation to follow certain ESG standards. If a private company is seen as engaging in (and concealing) similar activities as those described in the recent enforcement actions, it could draw unwelcome scrutiny that could affect a company’s ability to attract new customers and recruit new talent.
Finally, though by no means exclusively, if a company wants to attract new investors or seek new capital, those investors or lenders may demand information on how the company’s approach to ESG issues measures up to what the SEC appears to be demanding from public companies through the actions taken by the Enforcement Division. A private company’s access to capital may depend, in part, on its commitment to ESG goals.
Accordingly, it is very much in the interest of private companies to follow developments in the ESG space. The ESG issues a company focuses on depends largely on the focus of the company’s business. The SEC, though, will continue to pursue cases wherever it sees public companies running afoul of meeting ESG goals that those companies set for themselves and disclose to their investors. Through these actions, the ESG regulatory space will continue to evolve, and until the SEC issues more formal ESG regulations, all companies, including private companies, should monitor the actions of the Enforcement Division closely.
Alex Breckinridge is a partner at Jones Walker and a member of the corporate compliance and white collar defense team.