Practice What You Preach: As ESG Expectations Rise, So Do the Risks of Not Measuring Up

The following alert is included in Insights 2023, a collection of articles and videos addressing important emerging legal issues in the year ahead.

Companies large and small want to demonstrate responsible corporate behavior, but an ESG label can come at a cost. As the pressure to meet ESG expectations increases, so do the potential risks for failing to measure up. Investors, regulators, employees, and the public now closely scrutinize ESG-related statements, demand more disclosure, and, increasingly, take legal action if they don’t like what they see.

As companies navigate this increasingly complex ESG landscape, they should consider these litigation trends and upcoming reporting changes to ensure that their responsibility initiatives attract the right kind of attention:

Voluntary ESG Disclosures Can Invite Regulatory Scrutiny and Litigation

Last year, the SEC charged mining giant Vale S.A. with making false and misleading statements about dam safety—not in required company filings but in voluntary sustainability reports and ESG-related presentations and webinars. The charges relate to a dam collapse that killed 270 people and led to a loss of US$4 billion in market capitalization. The case is a warning that regulators will look beyond mandatory regulatory filings for statements that might mislead investors.

“Greenwashing” Lawsuits on the Rise

ESG- adjacent statements are also increasingly the target of consumer class actions and regulatory action. As companies have recognized the value of green branding, they’ve been hit with a growing number of “greenwashing” claims under consumer-protection laws. In these cases, regulators and private plaintiffs seize on vague labeling statements—such as “sustainable,” “recyclable,” “responsibly sourced,” or “carbon neutral”— to allege that consumers are misled into buying products. Upcoming revisions to the FTC’s Green Guides are likely to result in a further bump in these lawsuits. The Greens Guides, which provide guidance on how consumers are likely to interpret certain sustainability claims and how these claims can be substantiated, are in the process of being updated, with the agency requesting public comments by February 21, 2023. Among other changes, new guidance on carbon offsets and “net zero” emissions representations are expected, with companies facing potential exposure to enforcement actions and consumer class actions for alleged failures to comply. Companies looking to minimize litigation risks should consider maintaining reliable data that support their sustainability-related statements, ensure compliance with federal guidance and state law, and offer aspirational rather than definitive statements on ESG attributes.

Mandatory ESG Supply-Chain Diligence is Coming (at Least in the EU)

Along with minding their voluntary statements, companies that do business in the EU will soon have more required ESG disclosures. The EU has proposed a Corporate Sustainability Due Diligence Directive that will add requirements for larger EU companies and non-EU companies with €150 million of business in the EU (or less for certain sectors deemed high risk). Those companies will have to identify actual or potential adverse human rights and environmental impacts in their own operations and throughout their value climate plans demonstrating that their business models are compatible with the transition to a sustainable economy and with limiting global warming to 1.5 degrees Celsius. This is one of several directives expected to be enacted that will significantly increase diligence and reporting burdens on companies located or operating in the EU, and follows similar laws already in place in member states France and Germany.

Efforts to Harmonize Sustainability Reporting Standards are Increasing

Standards for voluntary statements will change too. Most of the largest public companies now voluntarily report ESG- related information based on standards set by the Global Reporting Initiative. In 2022, the International Sustainability Standards Board (ISSB) released drafts of its own reporting standards for sustainability and climate-related disclosures. The ISSB aims to harmonize the various voluntary standards, a process that could shape the mandatory disclosure efforts underway in the EU, the UK, and the US. With US companies likely to become subject to EU reporting under the new supply-chain directive, harmonized standards should reduce reporting burdens.

O’Melveny’s ESG Task Force can assist clients in navigating the complex regulatory and litigation landscape as they look to frame ESG benchmarks and disclosure commitments.