Abstract
Environmental, social, and governance (ESG) policy has become prominent in recent years as the effects of climate change on the environment have revealed themselves. According to the International Comparative Legal Guide: “the chief concerns of proponents of ESG are (1) management of climate change risks, including adaptation to a low-carbon economy, (2) human capital management, particularly racial and gender diversity, and inclusion in the workplace, and (3) questions around corporate purpose and how companies are serving the interests of all their stakeholders.” (Lu, Carmen; Silk, David. “Environmental, Social & Governance Law USA 2022.” ICLG.com. 13 December 2021.)
Early ESG policy was focused primarily on the environment, but over the past few years, ESG has taken on a broader meaning. Social and governance policies encompass those factors which contribute to the creation of a business that does good instead of causing harm, including but not limited to worker health and safety, environmental protection, transparent administration, and accountability. This paper seeks to highlight the policy developments that have been implemented in the United States and to explain further developments that are expected to be implemented over the next several years. The US has taken a market-driven approach to ESG policy that is likely to gain legislative support in the coming years. ESG policy is designed not to make the company’s operation more difficult; rather, it is designed to make a company’s operation more efficient, safer, and better for the world.
Background
As of the publishing date of this paper, the United States does not require ESG disclosures at the federal level (Lu, Carmen; Silk, David. “Environmental, Social & Governance Law USA 2022.” ICLG.com. 13 December 2021), but the next several years will likely see the introduction of federally mandated disclosures. For the most part, any emphasis placed on ESG policy in the United States was placed there by the market and private sector rather than the government. For example: “BlackRock’s Chairman and Chief Executive Officer, Larry Fink, has requested that its investee companies disclose in accordance with SASB (or similar) and TCFD’s guidelines.” This pressure has driven regulatory agencies such as the Securities and Exchange Commission (SEC), the Occupational Safety and Health Administration (OSHA), and the Department of Labor (DOL) have all made public their determinations to focus on ESG policy in the near future.
The SEC already requires companies listed on Nasdaq to provide information regarding diversity on their Boards (Geber, Marc S.; Norman, Greg; Toms, Simon; Howard, Adam M.; Kim, Caroline S.; Crompton, Kate; Gamble, Kathryn; Tsitsaros, Patrick; Williams, Eleanor F.; Luttgen, Luisa; Mirza, Mustafa; Smouha, Harry. “ESG: 2021 Trends and Expectations for 2022.” Skadden, Arps, Slate, Meagher & Flom LLP. 11 February 2022), and on March 4, 2021, the SEC announced the “creation of a Climate and ESG Task Force in the Division of Enforcement.” This Task Force is not capable of writing or passing legislation, but its creation is a signal to corporations and the American public that ESG policy developments are on the horizon in the United States and there will be agencies in place to enforce those policies. An SEC press release stated that: “The initial focus will be to identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules. The task force will also analyze disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.” (“SEC Announces Enforcement Task Force Focused on Climate and ESG Issues.” SEC Press Release 2021-42. U.S. Securities and Exchange Commission. 4 March 2021)
In addition to the SEC’s commitment to support the development of ESG policy, the Department of Labor presented a policy which would permit retirement funds to consider ESG matters when deliberating and making investment decisions. (Geber, Marc S.; Norman, Greg; Toms, Simon; Howard, Adam M.; Kim, Caroline S.; Crompton, Kate; Gamble, Kathryn; Tsitsaros, Patrick; Williams, Eleanor F.; Luttgen, Luisa; Mirza, Mustafa; Smouha, Harry. “ESG: 2021 Trends and Expectations for 2022.” Skadden, Arps, Slate, Meagher & Flom LLP. 11 February 2022.) For entities that are not retirement funds, this development is important because it indicates a transition toward investments in companies and groups that prioritize ESG. On one hand, there is a certain aesthetic appeal to investing in companies that are considered “sustainable.” On the other hand, the reality is that investors are unlikely to invest unless they expect to be able to profit off that investment. ESG considerations become increasingly valuable in this regard. Hank Smith, Head of Investment Strategy at The Haverford Trust Company, explained that: “By considering ESG factors, investors get a more holistic view of the companies they back, which can help mitigate risk and identify opportunities.”(Napoletano, E.; Curry, Benjamin. “Environmental, Social and Governance: What Is ESG Investing?” Forbes. 24 February 2022.)Therefore, the more information a company makes available, the more informed potential investors can be before deciding whether to invest.
General Disclosure Requirements
The United States operates a federal system in which state law has a significant amount of power compared to other parts of the world. As a result, there are often situations in which a company is presented with both federal and state requirements. In such cases, the more strict requirement is the one that should be adhered to unless the legislation specifically states otherwise.
Companies founded in the United States, both private and public, must file with the Secretary of State’s office in whichever state they plan to become incorporated. (“Exchange Act Reporting and Registration.” U.S. Securities and Exchange Commission. 11 February 2022.) Public companies in the United States face some mandatory disclosure requirements, but none to the extent of what has been implemented in the EU, for example. The Securities and Exchange Commission, which is the financial oversight agency in the United States, requires public companies to file annual (Form 10-K) and quarterly reports (Form 10-Q) that include a “comprehensive overview of the company’s business and financial condition and includes audited financial statements.” (“Form 10-K.” U.S. Securities and Exchange Commission. investor.gov. 2022.)The US’s disclosure requirements make no specific mention of ESG, and private companies face even fewer requirements.
Companies must also submit quarterly and annual financial reports to the SEC for review. Specific requirements for different types of companies are listed by the SEC. Private companies are required to disclose information as well, but to a far lesser extent. They are not required to disclose financial information to the SEC because they do not answer to shareholders like a public company. However, both public and private companies must file financial and incorporation documents with their Secretary of State, and both must file tax estimates to the IRS. (Tarver, Evan; Beer, Katharine. “Are Private Companies Required to Public Financial Statements?” Investopedia.com. 15 January 2022.)These documents, unlike SEC filings that are required for public companies, are not available to the public and are used solely for government purposes.
Under the US Securities Act of 1933, public companies and companies that want to offer shares on the public market must disclose certain financial information to the SEC for review. All registered offerings (companies offering their stock on the public market) must submit audited (and sometimes unaudited) financial statements including but not limited to: balance sheets; statements of comprehensive income, cash flows, and changes in stockholders’ equity; any information regarding businesses acquired in the last twelve months. All information submitted for review to the SEC by public companies must be made available to the public under the Freedom of Information Act. (Cohen, Alexander F.; Dudek, Paul M.; Trotter, Joel H.; Guthart, Jonathan R.; Brown, Timothy, D.; McCloskey, Erin L. “Financial Statement Requirements in US Securities Offerings.” Latham & Watkins LLP; KPMG LLP. 2022.)
Companies that are not yet registered public offerings may submit their information to the SEC for anonymous review. (Cohen, Alexander F.; Dudek, Paul M.; Trotter, Joel H.; Guthart, Jonathan R.; Brown, Timothy, D.; McCloskey, Erin L. “Financial Statement Requirements in US Securities Offerings.” Latham & Watkins LLP; KPMG LLP. 2022.)Emerging Growth Companies (EGC), which are companies with an annual gross revenue of less than $1.07 billion during its most recent fiscal year,(“Emerging Growth Company (EGC).” Thomson Reuters Practical Law. 2022.) also qualify for an anonymous review of their information.
The most recent disclosure policy development in the United States is a proposal by the SEC that would obligate companies to disclose information related to their environmental footprint. Any “information about climate-related risks that are reasonably likely to have a material impact on their business” must be reported, along with a report on a company’s greenhouse gas (GHG) emissions. Companies would be required to report about its direct GHG emissions, indirect emissions from purchased electricity, and emissions from both up- and downstream activities in their value chains. ( “SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors.” SEC) A phase-in period will be implemented based on the size and status of the filer. Large Accelerated Filers must meet compliance standards by fiscal year 2023 (filed in 2024); Both Accelerated and Non-Accelerated Filers have until fiscal year 2024 (filed in 2025); and Smaller Reporting Companies (SRC’s) have until fiscal year 2025 (filed in 2026). SRC’s will be exempted from Scope 3 GHG emissions metrics, which involves reporting emissions on a company’s value chain. (“Enhancement and Standardization of Climate-Related Disclosures.” SEC Fact Sheet )
Disclosure requirements in the United States are primarily focused on financial information, and public companies are more affected than private companies. Public groups must make information available to potential investors because investors must be provided a fair opportunity to decide whether to invest in a company. Because private companies do not have external investors, they are not required to disclose the same information. Over the next decade, it is likely that both federal and state disclosure requirements in the United States will expand. Until federal legislation is passed, however, companies are advised to monitor major investment groups like BlackRock who may require their investees to report at a higher standard than is required by U.S. law.
Environment
Environmental issues in the United States are managed mostly by the Environmental Protection Agency (EPA), which is delegated authority by congress so that it can carry out the enforcement of environmental policy in the US. This means that the legislation passed by congress rarely includes specific information and requirements. Rather, the legislation will state that the EPA has the power to establish and enforce environmental standards as outlined by the legislation. For example, the Clean Water Act’s declaration of goals and policy states that: “the Administrator of the Environmental Protection Agency shall administer” the legislation.(33 U.S. Code §1251)This sentence indicates the delegation of authority over the Clean Water Act from congress to the EPA, and this regulatory framework has been used again in numerous other environmental statutes. The EPA is thus one of the more powerful and independent agencies in the US.
Of the three pillars of ESG, environmental concerns are the oldest and have the strongest foothold in the American political landscape. The EPA was first established by Richard Nixon in December, 1970, (“EPA History.” 2 February 2022) and its power has expanded since then. In fact, the EPA may have more power than it is capable of wielding. Today, the EPA’s workforce is about 18% smaller than it was even a decade ago. (“EPA’s Budget and Spending.” 2 February 2022.) In regards to the broad direction of environmental policy in the US, it is likely that this regression is temporary, like a stock’s price retracing before a substantial jump. The EPA’s budget has increased every year since 2017, (“EPA’s Budget and Spending.” 2 February 2022.) even under the more conservative, business-friendly Trump administration, and it will likely continue to increase over the next decade. COVID-19 is the most likely explanation for the reduction in EPA staff.
Both public and private companies must adhere to environmental regulations in the United States. The EPA sets environmental standards at the federal level, but individual states sometimes have more strict environment standards as well. Companies should consult with the EPA to determine the exact scope of coverage for individual organizations because the EPA’s regulations are so specific. In cases in which state regulations are more strict than federal ones, the state regulations must be met. In all cases, the EPA reserves the right to enforce environmental law by performing inspections (announced or unannounced), examining internal company documents, and opening court cases against companies in violation of requirements. The SEC has also entered the environmental realm with their new proposal that would mandate disclosure of environmental information for all companies. “The proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.” These disclosure requirements are unlikely to include anything that has not been seen before, but the proposal signifies the legitimization of environmental sustainability policy in the United States.
The best way to prepare for upcoming environmental regulation in the United States is to contact the EPA. Their staff is highly knowledgeable, and their goal is to help your business meet all requirements in a way that is most feasible and least disruptive for the company.
Social
Particularly in the United States, social policy is tied to the ethics of a company. Those companies which take better care of their employees are more likely to also prioritize the environment and employees’ well-being in their business plan, and vice versa. OSHA has taken a strong stance on sustainability because the organization realizes the interconnected nature of sustainability policy. Environmental considerations are important, of course, but they cannot outweigh the importance of taking care of one’s employees, for: “Employers are only truly sustainable when they ensure the safety, health, and welfare of their workers.” (“Sustainability in the Workplace: A New Approach for Advancing Worker Safety and Health.” OSHA 3409. December 2016.) Examples of social policy at the corporate level are increased paid time off, extended maternity/paternity leave, hours restrictions (to avoid overworking), and improvements to the workplace.
Transparency becomes crucial to sustainability because it allows for companies to receive external feedback regarding their business strategy. To some, external feedback is worthless, and the common thought driving that standpoint is that someone outside the company cannot possibly understand the company as well as someone who works there. ESG policy developments represent a different way of thinking entirely. Rather than relying only on those people within the confines of the company to review its performance, proponents of ESG policy would support external reviews of their company because an external view often provides a much wider perspective. After all, that is the point of ESG policy: to understand and utilize the interconnectedness of our world. Companies which are best able to understand their position within the global business community will be better equipped to prepare for the future.
Governance
Much of the emphasis on accountability and transparency in the American private sector stems from the private sector itself. The aforementioned CEO of BlackRock as well as many other high-ranking American business leaders have recognized the importance of transparency as a tool to determine a company’s value from the perspective of an investor. BlackRock, for example, requires companies to meet SASB reporting standards despite those standards being more strict than federal U.S. regulation requires. With information on how the company is run by its executives, investors can better understand their decisions and can gain a better perspective on the direction a company is headed. Moreover, an emphasis on transparency and accountability in the operation of a company will create a system that is easier to maintain and requires less artificial stimulation to create growth.
Some governance policies have already been implemented in the United States, but they affect the public sector more than private. A combination of organized crime and corruption throughout the 20th century led to the passage of an anti-bribery statute, which prohibits the bribery of public officials or witnesses, but does not mention private agents. (18 U.S. Code §201)Another development from the anti-corruption era of American politics was the Whistleblower Protection Act, passed in 1989. Like anti-bribery policy, however, the Act protects only federal employees.(5 U.S. Code §1201.2(b).)
Most recent policy developments regarding financial disclosures in the United States have been targeted at individuals, such as elected officials. However, the younger American generation has shown a tendency to push for ESG policy, and it is likely that more disclosure requirements for both private and public companies will be passed into law over the next decade. Governance emphasizes purpose in the operation of a company, specifically, a purpose other than profitability. A company that is strong in ESG policy seeks to achieve profitability alongside a greater purpose, and a focus on corporate policies and governance enables leadership to curate the purpose and direction of a company. As of March, 2022, the United States only mandates financial disclosures regarding the governance of a company, but the scope of governance legislation will likely expand along with the expansion of environmental and social policy.
Outlook
The overall direction of environmental, social, and governance policy in the US is likely to remain on course, but close attention should be paid to which party holds power at a given time. When there is a Democratic majority in Congress or a Democratic president, ESG policy tends to expand; under Republican leadership, ESG policy is often limited to create a more business-friendly environment. Ideas being presented in recent years, however, seem to represent an adjusted line of thinking. The Green New Deal is one example of a policy proposal that would seek to create the more business-friendly market as envisioned by Republicans, but it would do so by focusing on the environmental and social issues that Democrats continue to promote. Other policies have been pitched, but the United States is still in the early phases of its transition toward a more environmentally and socially conscious society. ESG concerns are especially prominent among younger American generations, and the next decade will likely see younger people taking office and impacting change, especially in the financial and business sector. Environmental, social, and governance concerns do not stem solely from their ethical impact. An emphasis on ESG policy within a company will create a more efficient, effective, and ethical business model that will catalyze long-term growth and success.
