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How to mitigate ESG-related securities enforcement and litigation risks

Public companies are facing pressure to provide more robust disclosure around environmental, social, and governance (ESG) issues.

06/01/2023 · 6-minute read

This article is co-authored by Marsh and Norton Rose.

Public companies are facing unprecedented pressure from multiple sources to provide more robust disclosure around environmental, social, and governance (ESG) issues. ESG disclosures have become more detailed and concrete, and regulators and potential plaintiffs are scrutinizing companies more closely, looking for material inaccuracies and shortcomings, increasing the risk of regulatory enforcement actions and shareholder lawsuits.

Courts are also taking a harder look at internal board minutes and materials when assessing whether directors are complying with their oversight and risk assessment obligations. Director and officer (“D&O”) insurance underwriters are likewise taking these increased ESG-related securities liability risks into account when designing and pricing D&O insurance policies to protect directors and officers from personal liability.

Amid heightened scrutiny, public companies should be increasingly vigilant in complying with federal securities regulations on ESG-related issues, implementing appropriate disclosure controls, and performing director-level oversight and risk assessment exercises. Failure to make accurate and compliant disclosures could result in personal liabilities for corporate directors and officers.

ESG disclosure obligations and pressures

Companies face pressures from various sources to make more robust and detailed ESG disclosures. Activist investors — including ESG-themed investment funds — have sponsored shareholder resolutions and mounted proxy campaigns to prompt energy companies to disclose information about climate change financial risk, energy transition arrangements, pollution output, plans for reducing greenhouse gas (GHG) emissions, and other environmental metrics and initiatives.

Businesses also face increased commercial pressure to portray themselves as environmentally and socially conscious and identify concrete achievements, plans, and objectives for reducing their environmental impact. Yet several states are seeking to restrict or prevent investors from taking into account environmental and other ESG factors in their decisions. Whether successful or not, these bills add to uncertainty and could result in court cases over the next few years.

The Securities and Exchange Commission (SEC) also remains poised to require more detailed ESG disclosures from public issuers. In March 2022, the SEC proposed rule changes that increase public companies’ disclosure obligations.

There is a significant likelihood these rules will be adopted within the next several months, though they will likely face legal challenges on statutory authority and First Amendment grounds.

Enforcement and litigation risks

Public companies face increased D&O-level enforcement and litigation risks over their environmental disclosures and compliance practices, especially companies in the energy sector and other environmentally sensitive industries. In March 2021, the SEC’s Division of Enforcement launched a climate and ESG Task Force to pursue claims against public companies over misleading or noncompliant environmental disclosures. The task force recently obtained a $55.9 million settlement against a Brazilian mining company for making allegedly misleading safety and environmental disclosures about a dam that later collapsed. Companies may also face lawsuits from state attorneys general and other governmental enforcement authorities over misleading environmental disclosures.

There is also an increased risk of federal securities fraud class actions, as a result of more detailed environmental disclosures. In recent years, there have been elevated levels of so-called “event driven” securities class actions, where shareholders sue after an environmental incident or adverse regulatory action, arguing that a company’s prior disclosures about environmental practices and compliance were misleading.

Even more generalized statements about environmental stewardship can potentially be viewed by courts as material if senior management is aware of specific, undisclosed facts that paint a substantially different picture from the public disclosures. If the SEC adopts the proposed ESG rule changes, companies may also face higher risks of omission-based claims, as plaintiffs will argue that the omission of information required by the rules is intrinsically misleading. 

There will also likely be more shareholder derivative breach of fiduciary duty suits seeking to hold officers and directors personally liable to the company for failing to prevent alleged environmental disclosure or compliance shortcomings. Derivative plaintiffs have become increasingly adept in using pre-suit state law “books and records” inspection rights to obtain board minutes and other corporate records before filing suit, which allows plaintiffs to file more detailed derivative complaints that are better positioned to survive motions for early dismissal. The risk of derivative liability increases when the board materials show that the directors consciously ignored “red flags” showing noncompliance with environmental regulations, or that the company had no formal mechanism for elevating concerns over mission-critical risks to the board. Directors can also face liability if the minutes and materials show the directors were aware of information contradicting the company’s public disclosures.  

How to reduce ESG enforcement and litigation risks

Public companies — especially energy companies and those in other environmentally sensitive industries — should be vigilant and seek ways to minimize the growing liability risks from ESG-related disclosures and practices. Companies may be required to:

  • Disclose facts about the company that may be considered unflattering.
  • Correct or update previous ESG-related disclosures.
  • Understand implications of environmental data and align public disclosures accordingly.
  • Bolster processes and identify a cross-functional team to capture, gather, and analyze ESG data sources.

D&O insurance implications

Although ESG disclosures have consequences for a number of insurance lines, there are unique implications for D&O insurance. D&O is designed to respond to shareholder, derivative, and event-driven litigation, as well as regulatory actions, and other threats to companies and boards.

D&O insurers are acutely concerned about the emerging risk exposures arising out of new regulatory and disclosure requirements. Underwriters are increasingly questioning a company’s ESG initiatives, and their scrutiny extends to businesses’ general oversight and investment in transparency and disclosure practices. 

Amid a heightened risk landscape, businesses — especially energy and power companies — should consider taking action to reduce their ESG-related enforcement and litigation risks, including:

  • Document processes in place for socializing key environmental, sustainability, social, governance, and public relations risks with the board, and for addressing key environmental risks, as they arise. This is due to the increased scrutiny of board materials in shareholder derivative suits.
  • Form an environmental and safety committee and include regular ESG-related agenda items and management presentations in board meetings to show that directors are exercising adequate oversight of ESG matters.
  • Examine whether there are appropriate procedures in place for identifying new risks not incorporated into prior analyses and whether the risk assessment and disclosure control practices are consistent with that of competitors.
  • Engage an experienced insurance advisor or broker with vast industry knowledge to help communicate the ESG strategy to underwriters. Before meeting with underwriters, prepare responses to address potential red flags that may help in negotiating pricing and limit.
  • Be prepared to market your program, seeking insurers that are knowledgeable of the industry’s specific risk. Work with your insurance advisor or broker to negotiate favorable D&O coverage terms, such as accessing products that allow companies in environmentally sensitive industries to take a proactive approach to managing ESG risks with enhanced terms and conditions in their D&O insurance policies.

With increased focus on ESG issues, organizations are under more pressure to ensure that their climate disclosures are accurate. A robust D&O insurance program can help protect your directors and officers as scrutiny increases, leading to potential enforcement action and litigation.

Our people

Maureen Groman

Maureen Gorman

Managing Director

  • United States

Michael Gaudet

Michael Gaudet

Managing Director, FINPRO

Sarah Baldys

Sarah Baldys

Senior Client Advisor, FINPRO

Kevin Harnisch

Kevin Harnisch

Head of White-Collar and Co-Head of RISC, Norton Rose Fulbright US LLP

Peter Stokes

Peter Stokes

Partner, Norton Rose Fulbright

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