The days when ESG meant "warm and fuzzy"are over

A veteran general counsel I spoke to recently said that in the old days, ESG was the “warm and fuzzy” stuff a company did in the community that generated goodwill.

Oh, how times have changed. If only things were that simple now.

The Securities and Exchange Commission recently gave legal departments another jolt by proposing two rule changes that would prevent misleading or deceptive ESG claims by mutual funds and other investments.

The SEC said its motivation was to prevent “greenwashing” by asset managers seeking higher fees for funds touting an ESG focus—a sector that has exploded in popularity. But the upshot for companies in the investment game was to further escalate the litigation, regulatory and reputational risks related to ESG.

Even without those rules being in place, the SEC already is flexing its muscles in this realm. In May, it slapped the investment arm of Bank of New York Mellon Corp. with a $1.5 million fine for making ESG-related misstatements about certain mutual funds it managed.

The SEC said that from July 2018 through September 2021, BNY Mellon Investment Adviser stated or implied that all investments in the funds had undergone an ESG quality review, even though numerous investments had not.

The bank settled the matter without admitting or denying the allegations. It agreed to a cease-and-desist order, a censure and the penalty.

“As this action illustrates, the commission will hold investment advisers accountable when they do not accurately describe their incorporation of ESG factors into their investment selection process,” said Adam S. Aderton, co-chief of the Enforcement Division’s Asset Management Unit and a member of the SEC’s climate and ESG task force.

It’s not just in-house counsel at asset managers who are feeling ESG angst these days, of course.

ESG disclosures are a legal minefield that is sure to spur a torrent of lawsuits and regulatory actions in the coming years, according to attorneys of all stripes.

Norton Rose Fulbright’s 17th annual litigation trends survey, released in March, found that 37% of the 250 general counsel and in-house litigators surveyed reported being more concerned about ESG-related disputes, up from 21% in the previous survey.

One of the ripest realms for disputes is sure to be climate-related disclosures—an area the SEC targeted in March with a proposed rule requiring all publicly traded companies to disclose data about climate-related risks that have a “material impact on their business.” That includes greenhouse gas emissions and energy consumption, which the SEC classifies as Scope 1 and Scope 2 emissions, respectively.

A particularly thorny part of the 510-page proposal would require some companies to report Scope 3 emissions, which a business generates indirectly through its dealings with third parties, such as customers and suppliers. These types of emissions can be difficult—and expensive—for companies to measure.

“The SEC’s climate disclosure proposal is the most extensive, comprehensive and complicated disclosure initiative in decades,” Wilmer Cutler Pickering Hale and Dorr partner Meredith Cross, a former SEC official, said in a statement responding to the proposal.

The complexity of climate data makes the disclosures likely terrain for legal tangles. Opportunistic lawyers are going to be poring through the data to find errors, omissions or potentially misleading statements.

Attorneys say businesses and their legal teams must be vigilant now in trying to identify areas where they might be vulnerable—before they find themselves in regulatory or legal hot water.

“To mitigate the threat of being targeted, businesses need to devise and implement robust compliance policies to ensure no wrongdoing is happening in the first place. Their actions and commitments in relation to all aspects of ESG must also be able to withstand public and regulatory scrutiny,” Daniel Barton, managing director of disputes and investigations at Alvarez & Marsal, wrote in a recent Law.com column.

Greg Andrews is an editor/reporter for ALM Media’s In-House desk. He previously was editor of Indianapolis Business Journal and business editor of The Indianapolis Star. Contact him at gandrews@alm.com. On Twitter: @Greg_Andr