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The SEC Bares its Teeth on ESG

June 2022
Nathan Penny-Larter and Samuel Attwood

What is ESG?

The focus on Environmental, Social and Governance (‘ESG’) compliance is a business practice which has quickly become commonplace in international and domestic business.

Generally speaking, ESG policies should set out how an organisation intends to operate in the community, including its Corporate Social Responsibility (‘CSR’) aims, how it intends to uphold and improve its impact on the environment and how it intends to structure itself to operate as a sustainable and resilient business.

Whilst ESG review has its origins in the financial industry, it has been adopted by all major business sectors in recent years. Clear ESG policies in principle allow investors and/or consumers to analyse a business’ ‘behaviour’ before committing to investments and/or purchases. Most notably companies produce public ESG policies and marketing materials which outline the key areas of focus for investments as well as setting out future operations for the company.

By producing these ESG policies, the company enables, in theory, potential investors and/or consumers to make an informed decision in relation to the types of investment and business practices for which the company will use their funds.

Strong ESG polices go far beyond the usual investment materials which look to outline potential returns and perceived risk. Good ESG policies often require the company to provide evidence of the potential percentage of funds which will be used in so-called “green investments” including renewable energy and/or sustainable agriculture. Companies can also be required to set out limitations and warnings, including being transparent about the percentage of funds that will be used in profitable, yet often controversial, investments such as arms and fossil fuels.

Developments in North America

Last month saw the US Securities & Exchange Commission (‘SEC’) levy a $1.5M fine against the Bank of New York Mellon, for misleading the SEC in relation to its ESG practices.

BNY Mellon reportedly agreed to pay the fine on 23 May 2022 having admitted no wrongdoing.[1]

Specifically, BNY Mellon was accused of allowing elements of its US Mutual Fund Portfolio to be operated without adequate reviews into the ESG impact of the fund’s investments. The alleged breaches were reported to have taken place between July 2018 and September 2021. Whilst the alleged breaches are not particularised, the lack of review into the impact on ESG, rather than a proven negative ESG impact to investors appears to have been all that was required for BNY Mellon to be considered to have breached its obligations and therefore liable to a fine.

This follows the creation of the new ‘ESG Task Force’ in March 2021, this is an increasingly active part of the SEC’s Enforcement Division. It is anticipated that the ESG Task Force will continue to levy similar fines and/or prosecute further non-compliant businesses in the near future and is part of a wider trend and more pro-active approach to regulation being adopted by the Biden administration.

Public Perception and Company Duties

The SEC fine is one of the first of its kind and prefaces the new hard-line approach that regulators are taking with corporations who are held to overstate their ESG practices and/or mislead potential investors on the reality of their business practices.

The regulator’s actions also run parallel to the growing public criticism of large corporations which are seen to ‘green wash’ otherwise unsustainable business practices. These public criticisms were most notably observed throughout COP26 when a variety of activists and keynote speakers criticised large corporations for maintaining a public image purporting to prioritise ESG factors, which did not correlate with the reality of the business’ practice. The first half of 2022 is further evidence of this continuing trend and we have recently seen the canals of Venice alive with protestors taking to gondolas to voice their anger at reported greenwashing by Italian companies.

Both the SEC fine and sustained public pressure highlight an important duty for companies which operate in the British, North American and International markets. It is clear that companies need to consider carefully if the statements that they make in public, via ESG policies and marketing materials are, in fact, an accurate reflection of their daily practices.

There is also an apparent implied duty for companies to conduct ongoing and regular reviews of their public materials and internal ESG practices. The recent BNY Mellon settlement has highlighted that even partial inconsistencies between the perceived public image and the realities of corporate operations can lead to substantial fines. It would therefore be prudent of companies to conduct regular and public reviews of ESG practices and for Boards to record in Board meeting minutes, the steps the company is taking in relation to ESG.

McGaughey v USS – the British Perspective

Most recently in the UK, the case of McGaughey v USS, saw Dr McGaughey and Dr Davies of the Dickson Pool School of Law and University of Bristol respectively, issue a claim against the University Superannuation Scheme (‘USS’) for losses allegedly incurred due to the action of USS’ directors. Both Dr McGaughey and Dr Davies are members of the USS’ pension scheme and reportedly received over 1700 public donations to fund the dispute.

The claim centred around four key allegations:

1) that the scheme has been undervalued due its opting to be valued prior to the prescribed date for valuation;

2) in breach of the Equality Act 2010 the fund made cuts which disproportionately affected women and minority groups;

3) operating costs including executive pay were allowed to increase substantially; and

4) that the fund failed to create a credible plan to divest from fossil fuels.

The claim therefore focussed on the common themes of allegedly poor business practices causing loss to investors in relation to both CSR and environmental factors.

On 24 May 2022 the High Court of England and Wales handed down its judgment in the case. It was held, for each of the four elements of the claim, that neither a statutory derivative action, nor a double derivative action could be pursued and that no further action would be considered.

Although ultimately unsuccessful, the claim is interesting as it is the first time that the Court has considered that there could be circumstances where pension scheme members had the ability to bring a derivative claim relating to ESG breaches. The Court provided guidance that, in order to bring such an action, a claimant would need to fulfil the following tripartite test and prove that it has:

  1. a sufficient interest to pursue the claim on a derivative basis on behalf of a company, and that the Claimant had a prima facie case that each individual claim fell within the four exceptions of Foss v Harbottle 67 ER 189, [1843] 3 WLUK 93 (a judgment which established that where it is alleged that a wrong has been done to a company, the only true claimant is the company itself);
  2. a prima facie case on the merits in respect of each claim – this is high standard of proof, which is considered higher than a ‘seriously arguable case’, to meet this standard a Court must be satisfied that in the absence of a response from the defendant, the claimant would be entitled to judgment;
  3. an appropriate claim in all circumstances to be permitted to pursue a derivate claim applying the rule established in Prudential Assurance Co Ltd v Newman Industries Ltd [1982] Ch 204, [1981] 10 WLUK 35.

Reviewing the Court’s findings, it stands to reason that breaches of potential ESG policies are an actionable loss. This is clear as the apparent criticism of the claim did not stem from the alleged losses culminating from the fund’s alleged breaches of ESG. Instead, it was concluded separately that Dr McGaughey and Dr Davies had no actionable derivative claim against the directors as pension scheme members due to their failing to meet each of the three legal tests above.

Although this approach appears to dissent from NY Mellon settlement and the new ESG Task Force, it is clear that both the North American and British regulators are alive to the continuous alleged breaches of ESG policies and the potential impact that this has on investors.

The Current Law and Likely Developments

We are yet to see a unified piece of British legislation outlining a company’s comprehensive ESG requirements for both Environmental and Non-Environmental factors. However, Directors’ and Officers’ duties continue to be underpinned by the requirements set out in Companies Act 2006. These duties are continuously seen to extend to compliance with, and implementation of, reasonable and proper ESG policies. It is therefore possible that we will see future successful claims pursuant to alleged breaches of Directors’ duties under the Companies Act 2006 if companies fail to adhere to their ESG Policies.

This is particularly true following the recent passing of The Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022; and the Limited Liability Partnerships (Climate-related Financial Disclosure) Regulations 2022. Both of these sets of Regulations stipulate that Companies or Partnerships with over 500 employees and/or an annual turnover of £500m must produce a sustainability information report outlining:

  • a listing and description of environmental risks identified as impacting the company’s operations.
  • the company’s governance strategy for assessing and managing environmental risk that takes into account different environmental outcomes.
  • the scope for the assessment.
  • list and description of environmental goals and key performance indicators (KPIs) used to measure environmental risk performance.
  • the process used to identify, assess and manage environmental risks.
  • the company’s process for integrating environmental risk into the broader enterprise risk management (ERM) strategy.

Both sets of Regulations came into force on 1 April 2022 but are limited to ‘Environmental Risk Factors’ only. We are yet to see how the Courts enforce the reporting requirements and it is likely that we will see further legislation passed relating to ‘Non-Environmental Risk Factors’ in future Bills.



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