By Joe Donnelly, Partner, CPA – Baker Tilly and Patricia Wellmeyer, CPA, CGMA, Ph.D. Director – Baker Tilly and Assistant Professor in Accounting, University of California-Irvine Merage School of Business

With several recent high-profile enforcement actions and the creation of a new Climate and ESG Task Force, the Securities and Exchange Commission (SEC) has made it clear that it intends to proactively pursue companies for ESG-related reporting misconduct.

These actions send the message that the SEC’s focus on company ESG-related disclosures extend beyond those to be required in a soon anticipated final SEC climate disclosure rules. Given the increasingly wider SEC regulatory umbrella over ESG reporting, companies need to be taking steps to review their policies and controls around ESG-related disclosures to ensure they don’t fall prey to misleading statements, and consequently, public SEC scrutiny, regardless of the proposed rule.

What should companies know about the SEC Climate and ESG Task Force and Recent Enforcement Cases?

The SEC launched its Climate and ESG Task Force within the Division of Enforcement in 2021 to identify potential violations under existing disclosure rules of material gaps or misstatements in issuers’ disclosure of climate risks and ESG strategies; the latter being of special focus in the case of investment advisers and funds.

In 2022, the Task Force was involved in pursuing several high-profile enforcement actions, all charging companies with fraudulently misleading investors on ESG-related matters. Violations noted in these enforcement actions were primarily in three areas: (1) Exaggerated disclosures around company commitments to ESG goals, (2) failure to disclose material information relevant for assessing the reasonableness of and/or progress towards meeting publicly disclosed ESG targets, and (3) failure to establish effective controls around ESG-related policies and reporting.

The SEC contends these actions violate the antifraud, reporting, and internal controls provisions of the Securities and Exchange Acts and has remarked that it will continue to pursue companies for misleading ESG disclosures under these mandates[1].

What should companies be doing to ensure they don’t trigger an ESG-related SEC enforcement review?

Given the SEC’s increasing scrutiny on ESG disclosures and impending new climate disclosure rule, it is important that companies and investment advisors/funds prioritize the readiness and effectiveness of controls designed to ensure consistency in application of ESG policies/procedures firm-wide and the faithful representation of ESG claims and disclosures. In doing so, company management and boards of directors should consider the following:

• Has the company assessed its ESG readiness? A recent study performed by the International Federation of Accountants and AICPA[2] show that over 95 percent of large companies now report on ESG-related matters in corporate reports, and 86 percent of these companies report using multiple frameworks and standards in tracking and reporting ESG data. This type of fragmentation can create significant risks to data quality and consistency, and importantly for SEC filing companies, impede preparedness for new climate disclosure requirements. For more information on preparing for the proposed SEC climate disclosure rule see https://www.bakertilly.com/insights/prepare-for-proposed-climate-disclosure. 
• Is the company’s internal audit function actively involved in assessing ESG-related risks and reviewing ESG governance procedures and the accuracy, relevancy and consistency of ESG disclosures? As ESG-related considerations become more prevalent and significant in corporate decision-making, internal audit functions should incorporate ESG risk management and reporting into their audit plans. Internal audit can play an important part in the development of ESG-related controls and in providing assurance over the reliability of ESG disclosures.
• In establishing ESG-related controls, has adequate attention been given to developing effective detective controls over ESG reporting? While robust preventative process controls are essential to ensuring proper data tracking and integrity, the importance of robust detective controls in ensuring that a company’s ESG claims and metrics are supportable and consistent across all public disclosures/reports cannot be overstated. Companies should make sure controls exist to monitor/review the consistency and reliability of ESG disclosures across the organization, especially in routine responses to requests for proposals and information, due diligence questionnaires, and any investor presentation materials. Given recent enforcement cases and SEC proposed rule amendments[3] seeking to enhance and standardize disclosures ESG factors considered by funds and advisers, investment advisors should be especially vigilant in ensuring effective controls exist that promote consistency between how ESG strategies are implemented and how they are marketed and described.  Could the company benefit from third party assurance over ESG-related metrics and other disclosures? Assurance over ESG information from a third party can enhance confidence in the integrity of information provided in ESG disclosures as well provide perspective on the quality of a company’s ESG reporting and associated processes. 

As the SEC continues to increase its focus on ESG reporting, it is likely that other regulatory bodies will follow suit. Impending regulation, however, is not the only reason companies need to worry about the consistency and supportability of their ESG disclosures. Investors, advocacy groups, and other stakeholders are all actively filing public complaints, lawsuits, and proxy battles alleging misleading reporting by companies on ESG-related matters. Pulled together, these forces can leave unprepared companies with a perfect storm of reputational and regulatory risks with which to contend. 

Establishing an effective, cohesive, and sustainable organization wide ESG strategy and control framework will be key to successfully navigating through ESG reporting challenges.

About the authors:

Joe Donnelly, CPA is a Partner at Baker Tilly. Patricia Wellmeyer, CPA, CGMA, Ph.D. CPA is a Director at Baker Tilly and an Assistant Professor in Accounting – University of California-Irvine – Merage School of Business.

https://www.aicpa.org/professional-insights/download/global-benchmarking-study-state-of-play-in-sustainability-assurance

[1] (2023 Examination Priorities Report (sec.gov) and Commissioner Uyeda’s January 27, 2023 speech on ESG-related disclosures here (https://www.sec.gov/news/speech/uyeda-remarks-california-40-acts-group)

https://www.aicpa.org/professional-insights/download/global-benchmarking-study-state-of-play-in-sustainability-assurance
[2] https://www.aicpa.org/professional-insights/download/global-benchmarking-study-state-of-play-in-
[3] Proposed rules – https://www.sec.gov/rules/proposed/2022/ia-6034.pdf