Shifting ESG landscape and misconduct allegations present new frontier for investigations in the United States Karen P Hewitt, Henry Klehm III, Terri L Chase, Howard Sidman and Samir KaushikJones Day
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 pit falls
Shifting ESG landscape and misconduct allegations present new frontier for investigations in the United States
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Shifting ESG landscape and misconduct allegations present new frontier for investigations in the United States
Karen P Hewitt, Henry Klehm III, Terri L Chase, Howard Sidman and Samir Kaushik
Jones Day
15 August 2024
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This is an Insight article, written by a selected partner as part of GIR's co-published content. Read more on Insight
In summary
Once considered a peripheral consideration, environmental, social and governance (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
Government 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
Securities and Exchange Commission’s (SEC) Climate Change Disclosure Rule
SEC’s amendments to the Investment Company Act ‘Names Rule’
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 20 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.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.[4]
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 and has proposed new sweeping ESG rules.[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 refers to the wider relationship that a business has with its employees and the communities in which they operate, but it is especially difficult to define with any certainty.[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 government authorities to plough 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
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 US$1.2 trillion in increased costs over the next five years due to environmental risk. In fact, the CDP estimated that companies will face up to US$120 billion in costs by 2026 from environmental risks in their supply chains.[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.[17]
