Esg Disclosure: How to Report Accurately and Avoid Liability

Regulation S-K, which governs non-financial disclosures in SEC filings, has been amended to require specific disclosures about human capital resources and risk factors addressing material ESG-related risks. Companies evaluating their ESG disclosure framework should seek ESG compliance legal counsel to assess whether existing disclosures satisfy the materiality standard and identify gaps that create securities law exposure.

Under Section 10(b) and Rule 10b-5, failure to disclose material ESG risks creates liability for material misstatements or omissions in connection with the purchase or sale of a security. Companies assessing the materiality of ESG information should seek disclosure statements legal counsel to evaluate each ESG risk factor against the legal materiality standard and document the analysis before the annual report is filed.

The SEC's proposed climate disclosure rule, issued in March 2022, would require SEC-reporting companies to disclose Scope 1 greenhouse gas emissions (direct emissions from owned operations), Scope 2 emissions (indirect emissions from purchased electricity), and for large accelerated filers with material Scope 3 emissions, Scope 3 emissions (indirect emissions from the company's value chain). Companies preparing for climate ESG disclosure compliance should seek climate change legal counsel to assess the current state of the rule, evaluate Scope 3 data collection challenges, and develop a disclosure strategy that satisfies the rule's requirements without creating securities fraud exposure.

Corporate governance and social disclosures are a well-established component of ESG disclosure that predates the current focus on climate reporting. Companies developing ESG disclosure programs for the social and governance components should seek corporate governance legal counsel to evaluate the adequacy of current director disclosure, board committee disclosures, and human capital reporting against SEC requirements and investor expectations.

Greenwashing in securities disclosure occurs when a company makes statements about its environmental or sustainability practices that are materially misleading because they overstate performance, omit material contrary information, or use undefined or unverifiable claims. Companies reviewing ESG disclosure for greenwashing risk should seek ESG compliance review legal counsel to audit existing sustainability claims for accuracy, identify potentially misleading statements, and implement a review process before ESG claims are published.

The SEC's ESG enforcement program has targeted both investment advisers and operating companies for misleading ESG disclosure. The SEC's Climate and ESG Task Force, established in March 2021, has brought enforcement actions against investment advisers for making materially false and misleading statements about ESG investment processes and for failing to implement ESG policies as described in marketing materials. Companies under SEC ESG scrutiny should seek sustainability and ESG legal counsel to evaluate the adequacy of existing disclosures, respond to SEC comment letters, and assess whether prior filings require amendment.

The accuracy of ESG disclosure depends entirely on the quality of the underlying data. Greenhouse gas emissions data must be calculated using recognized methodologies, such as the Greenhouse Gas Protocol, and must reflect actual operational data rather than estimates or industry averages when the company has the ability to collect actual data. Companies building ESG data infrastructure should seek ESG compliance advisory legal counsel to design data collection processes that produce disclosure-quality information and to implement verification procedures that support the accuracy of published ESG claims.

Defendants in ESG disclosure litigation typically argue that the challenged information was immaterial, that alleged misstatements were nonactionable puffery, or that the disclosures contained sufficient cautionary language to defeat reliance claims. Securities class actions alleging material misstatements in ESG disclosure have been filed against companies in energy, financial services, consumer products, and technology sectors. Companies defending ESG disclosure litigation should seek sustainable finance legal counsel to evaluate the legal basis for the claims, assess the materiality of the challenged disclosures, and develop a defense strategy that addresses both the securities fraud and corporate governance theories of liability.