Environmental, social and governance (ESG) issues are becoming increasingly important to consumers, investors and companies alike. The rise of ESG reflects changing attitudes that companies should consider how their actions affect their employees, customers and the communities in which they operate.
Historically, many ESG issues were seen as beyond the scope of the board of directors, but that view is quickly changing. While the SEC has not yet imposed formal disclosure requirements specific to ESG, recent publications and the creation of a Climate and ESG Task Force suggest that regulation is to come. Boards of directors should take this signaling to preemptively integrate ESG into their functions, and the concrete actions outlined in this article can help.
1. Incorporate ESG into the traditional roles of risk management and board oversight.
Directors must uphold their duty to oversee the company’s operations. For instance, the Caremark case in 1996 set up board obligations to ensure adequate internal compliance information and reporting systems or controls to identify, deter and confront issues the company faces. Boards must also monitor the operation of those systems or controls. These obligations naturally flow into ESG as a duty for the board to ensure that it is properly informed on ESG risks. Boards must oversee these risks, ranging from reputational concerns to physical hazards presented by climate change. ESG risks and opportunities should be regularly included on the agenda for board meetings, and procedures should be put in place to keep an eye on potential risks.
2. Identify a team and increase board knowledge and ESG expertise.
One of the first steps a board can take to fulfill its oversight and risk management duties is to gain the appropriate level of ESG expertise. They can achieve this on the director level or create a committee focused on ESG management. In the first instance, the board may choose to include ESG criteria in its hiring decisions to increase ESG expertise and diversity on the board. Increasing the board’s diversity will improve a company's ESG metrics in addition to bringing in varying perspectives.
The board may also decide to include ESG training for its members. An increasingly popular approach has been to set up a committee charged with overseeing environmental sustainability matters. This type of approach can apply to more generalized ESG committees as well. Having an overall ESG point person or lead can be helpful given the sheer breadth of ESG considerations.
Finally, boards may choose to include ESG metrics in executive compensation assessments to monetarily incentivize a commitment to ESG.
3. Incorporate ESG into corporate strategy and measure progress.
When incorporating ESG into directors’ duties, the board should identify the ESG risks and opportunities that best apply to the company. Each company will have a different set of ESG factors that are most relevant to it. Likewise, the company may opt to use one or more of the existing ESG reporting frameworks, independently tell its own story, or apply a combination of both approaches.
Asking key stakeholders about their priorities can help inform decisions on the type and level of ESG reporting. Once the board has agreed to focus on a set of factors, it should develop a baseline upon which it can measure improvement. Going forward, this baseline can be used to establish procedures to evaluate whether the company’s actions match its public ESG goals. Taking this step will help the company clarify how to best address potential legal risks and opportunities presented by ESG in terms of both growth and liability.
4. Avoid greenwashing.
While making these changes is important, companies must also remember to be measured in their approach. Backlash can be swift for so-called “greenwashing” and “woke-washing”– terms used when companies are seen as spending more resources announcing their purpose as opposed to taking action. Companies should treat all ESG statements — from sustainability reports to social media posts — as SEC filings in terms of accuracy and potential liability. Decision-makers need to educate themselves about the potential for backlash and SEC regulatory action. It is important to stress accuracy in this arena, as many of the ESG statements may be forward-looking commitments and should be qualified as such. Boards should proactively review current sustainability or ESG-related public statements or policies for consistency and to make sure they can substantiate these claims.
While the SEC has not yet issued specific, formal disclosure requirements for ESG, a board’s duties may be inferred from their current responsibilities under state law. The best course is for boards to act now to add ESG to their board oversight and risk management practices. Please contact Alan Harrell, Madison Guerinot or any member of Phelps’ ESG team if you have questions or need compliance advice and guidance.