The Securities and Exchange Commission (“SEC”) has signaled that it wants to increase enforcement against “greenwashing” – misrepresentation of a company’s environmental actions. It is not yet clear, though, whether these enforcement efforts will expand the risk of corporate criminal liability. In a new paper, I argue that they will, and that businesses should think about their risks regarding potential criminal fraud in the environmental area.
Setting the Stage for the SEC’s ESG Actions
Frustration with greenwashing has been growing as more and more money chases ESG investments. The term “ESG” – environmental, social, and governance initiatives – is frustratingly vague, as it can include everything from deforestation to diversity and inclusion to the ethics of lobbying. I focus here on climate change and the United States.
Norms around climate change are changing very fast. In 2021, 76 percent of Americans age 33 to 40 thought that climate change represented a serious risk to society. The investment community is responding. By the end of 2019, 564 actively managed U.S. funds had added ESG criteria to their prospectuses. Twenty-three of the funds had over U.S. $ 1 billion in assets.
As evidenced by the repeated failure to enact national climate change legislation by June 2022, the U.S. is still politically paralyzed over what our reaction to the issue should be. But there is plenty of money to be made from responding to the public’s feelings of urgency. And there is even more money to be made when companies tell the public – customers, investors, employees, and others – what they want to hear to get their money but do little, or none, of what they promised to earn it. That’s a recipe for fraud.
Will it be civil fraud or criminal fraud? I think it will be both.
First, changing norms tend to lead to enforcement, and a debate about whether civil, criminal, or other penalties are most appropriate. Professor David Skeel has written about how intertwined shaming sanctions are with enforcement norms. Professor Samuel Buell has written about the social value of labeling certain corporate behaviors as criminal, above and beyond the shaming value of civil liability. Professor Jennifer Arlen has noted recently the important political economy of having criminal sanctions as corporate enforcement tools. Professor John C. Coffee, Jr. has expressed skepticism about criminal sanctions actually being worse than civil ones in the corporate context, but finds that we need both – and possibly new tools as well.
Second, there is a thin line in U.S. corporate enforcement between civil and criminal liability. Part of the problem is the nature of corporate cases. They tend to involve so much documentary evidence that it can be difficult, especially with the availability of willful blindness instructions, to deny sufficient coordinated intent. Similarly, with that level of documentation, it can be easier to meet the burden of proof for criminal behavior “beyond a reasonable doubt” in evaluating the behavior of the corporation as a whole.
The SEC’s Recent Actions
In March 2021, the SEC created a new Climate and Environmental, Social, and Governance (ESG) Task Force (Task Force) within the Division of Enforcement. In explaining the focus of the Task Force, Acting Deputy Director Kelly L. Gibson highlighted greenwashing as a particular priority.
The SEC has implemented an “all agency” approach, fusing ESG enforcement into many of its actions. Even before formation of the Task Force, in February, April, and March 2021, the SEC’s divisions of Examinations and Corporation Finance announced that they would focus on climate-change related risks, as the agency was concerned about “deficiencies and internal control weaknesses from examinations of investment advisers and funds regarding ESG investing.”
We are starting to see enforcement results. On the civil front, on May 23, 2022, the SEC charged BNY Mellon Investment Adviser, Inc. for “misstatements and omissions about Environmental, Social, and Governance (ESG) considerations in making investment decisions for certain mutual funds that it managed.” The company has agreed to pay $1.5 million to settle the charges. On June 10, 2022, news broke that the SEC was investigating Goldman Sachsfor potentially misrepresenting ESG claims about its funds.
On the criminal front, in December 2021, the Department of Justice informed Deutsche Bank AG that it may have violated a criminal settlement for failing to inform prosecutors of its failures to live up to ESG disclosures. In March 2022, Deutsche Bank agreed to extend the term of its outside compliance monitor on this basis. Stemming from the U.S. developments, on May 31, 2022, German authorities raided DWS and Deutsche Bank offices for evidence of greenwashing allegations. The next day, the head of DWS resigned.
What Should We Do from Here?
Although the U.S. Deutsche Bank penalty derived from an existing criminal settlement rather than new charges, the DOJ has also indicated that it wants to step up corporate criminal enforcement. In her October 2021 keynote address, Deputy Attorney General Lisa Monaco explained that the Biden administration is “going to find ways to surge resources to the department’s prosecutors” to combat corporate crime. Enforcing the truth of ESG promises seems like low-hanging fruit.
So what should U.S. businesses do, given the threat of potential corporate criminal liability for ESG initiatives?
- U.S. businesses should train and prepare their people to understand responses to climate change as part of the compliance function. One of the largest sources of concern for law departments already is climate change and sustainability, but counsel feel ill-equipped to respond in this area. According to a new joint study between Harvard Law School’s Center on the Legal Profession and EY, 61 percent of 1,000 general counsel expect to have to increase their collaboration with the business on sustainability issues. Ninety percent of company law departments report challenges in creating policies on environmental issues because there are not enough specific regulations to follow.
- Businesses should support the SEC’s new ESG regulations out for notice and comment. Professor Coffee has already noted that many of the worst-polluting businesses would not be affected, and the remainder of businesses should welcome the reassurance of having standards that give guidance and help act as safe harbors from enforcement actions. In the face of potential criminal liability, it is not a healthy sign for U.S. businesses that 90 percent of company law departments are concerned that current U.S. regulations are too vague to follow.
- Businesses should support national, standardized climate change legislation to comport with their international obligations. The United States’ meager response to climate change puts U.S. companies with a global presence in an uncomfortable position when regulatory expectations from abroad are becoming more uniform. Courts in Pakistan, Colombia, Nepal, Germany, Belgium, the Netherlands, and other countries have found a duty of care or a fundamental right for people to be protected from the effects of climate change. Private businesses must respond to climate change as well. As the Dutch courts have said:
The responsibility of business enterprises to respect human rights, as formulated in the UNGP [United Nations Guiding Principles on Business and Human Rights], is a global standard of expected conduct for all business enterprises wherever they operate. . . . [I]t is not enough for companies to monitor developments and follow the measures states take; they have an individual responsibility.
U.S. businesses should want standardization and articulation of expectations and their liabilities. Instead, U.S. businesses may be caught in the ad-hoc system of liability now emerging in the United States, with exposure to charges on many theories, including criminal fraud. These changes should be honing businesses’ attention and rallying them behind uniform climate change standards and legislation.
This post comes to us from J.S. Nelson, visiting associate professor at Harvard Business School and associate professor of business ethics on leave from Villanova’s Charles Widger School of Law. It is based on her manuscript, “The Future of Corporate Criminal Liability: Watching the ESG Space,” available here, and her book with the late Lynn Stout, “Business Ethics: What Everyone Needs to Know,” available here.