When most people think of Securities and Exchange Commission (SEC) enforcement actions, their minds probably jump to sensational crimes seen on the news, like insider trading and Ponzi schemes. Indeed, these do make up a fair number of SEC enforcement actions. But the SEC conducts hundreds of different enforcement actions every year, collecting billions of dollars in penalties.
In its 2022 fiscal year, the SEC initiated 760 enforcement actions representing a record $6.4 billion in penalties and disgorgement, including some high-profile ESG violations.
SEC increasingly exercises broad enforcement mandate
Prosecution of high-profile white-collar criminals like Martha Stewart, Bernie Madoff, or Elizabeth Holmes might grab the most headlines and media coverage, but the SEC has a very broad mandate. The commission is increasingly focusing its efforts on corporate ESG policies and statements, in addition to some of the more stereotypical subject matter, like inflating earnings numbers or hiding various liabilities.
One of the key triggers for any SEC enforcement action is the existence of fraud. Fraud could mean inflating sales revenue or misrepresenting other financials, but the SEC is increasingly interested in companies that commit fraud by exaggerating or making up ESG efforts and outcomes.
As hard as it may be for some to believe, profits aren’t the only thing investors have in mind when considering investing in a company’s stock. Increasingly, more and more investors have insisted that companies they invest in don’t unnecessarily and negatively impact the environment, are socially responsible and aligned with the investors’ own social positions, and are governed and managed appropriately.
This shouldn’t come as a surprise as the agency sounded the alarm in 2021 when it said that it would be evaluating companies’ ESG disclosures with greater scrutiny.
ESG issues increasingly important to investors and others
Collectively, environmental, social, and governance issues are referred to as “ESG” issues, and investors care a great deal about them. Both companies and individuals are at risk of fraudulently inducing investors to buy securities based on incorrect reporting of ESG metrics. That fraud risk puts ESG within the purview of the SEC. They’ve been exercising their authority here in recent enforcement activity.
Companies can run afoul of SEC rules on ESG commitments by exaggerating or inventing their commitment to ESG goals. This might mean lying about a company’s investments in green energy, inflating corporate diversity numbers, or misleading investors about the protection of whistleblowers within the company.
Risk is relevant and costly
While misguided executives might think of exaggerating ESG data as relatively harmless puffery, many investors use that information to determine where they invest their money. The SEC takes false or misleading ESG statements very seriously.
Consider these three enforcement actions from the 2022 SEC fiscal year as examples:
- BNY Mellon Investment Adviser, Inc. was charged with materially misleading statements and omissions about its ESG principles and how they were used when making investment decisions for certain mutual funds
- Vale S.A., one of the world’s largest iron ore producers, has been involved in litigation for allegedly making false and misleading claims to local governments, communities, and investors related to the safety of its dams before the Brumadinho dam in Brazil collapsed. The collapse resulted in the death of 270 people in addition to the environmental and social impact. The event reduced Vale’s market by more than $4 billion.
- Wahed Invest, LLC, a robo-advisor that had marketed its services as being compliant with Islamic, or Shari’ah law, but failed to actually adopt and implement policies to ensure that this would be the case
These enforcement actions illustrate the range of impacts that could lead a company to come under scrutiny resulting in both monetary and reputational damage.
In addition, though, companies are also at risk from a diversity, equity, and inclusion (DEI) standpoint
DEI, ESG, the SEC, and you
DEI statements also fall under the ESG umbrella, meaning false or misleading statements on DEI efforts could trigger enforcement action by the SEC. According to the Association for Corporate Council (ACC), courts have traditionally found that incorrect reporting or board member or workforce diversity fails at the pleadings stage and does not generally create viable causes of action. However, recent moves by major stock exchanges to require listed companies to report certain DEI data may make future enforcement actions more likely.
On August 6, 2021, the SEC approved Nasdaq’s proposed rule on requiring Nasdaq-listed companies to have at least one woman and at least one person who identifies as an underrepresented minority or LGBTQ on their board of directors一or to explain why they do not have such members. This means that reporting on the diversity of their boards of directors is now a required disclosure for Nasdaq-listed companies. Those that report false or misleading diversity data could find themselves in the crosshairs of the SEC’s enforcement unit.
Of course, DEI goals go well beyond the diversity of the board of directors. Pay equity, or equal pay for equal work, is also a key aspect of any serious DEI program. Tools like our PayParity software solution are specifically designed to help organizations achieve, prove, and sustain pay equity一something strongly embedded in the “S” of ESG. In addition, PayParity can help organizations understand their workforce diversity and ensure they have equitable access to opportunity.
SEC enforcement actions are just one reason companies should pay close attention to ESG goals. Investors, stakeholders, and employees too are increasingly evaluating employers based on their commitment and demonstrations to ESG.
To help organizations demonstrate authenticity and genuine progress in the realm of “S” in ESG reporting, organizations should choose a software solution like PayParity. With PayParity employers can monitor pay equity continuously, certify that their workforce is equitable, and demonstrate to all stakeholders that fair pay is a top priority.
For more information on the role of DEI in ESG Reporting, download our whitepaper below.
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