February 24, 2020

MD&A Guidance: What About ESG Metrics?

Well, it didn’t take long for the Division of Enforcement to focus everybody’s attention on the SEC’s recent guidance on the use of key performance indicators in MD&A, did it? This Fried Frank memo focuses on how that guidance may influence the use of ESG metrics in MD&A. While the guidance itself only references ESG metrics in a footnote, this excerpt says that what it had to say about them is consistent with recommendations of some well-known sustainability frameworks:

Although the Metrics Guidance is largely silent with respect to ESG metrics as a specific category, it does note that some companies “voluntarily disclose environmental metrics, including metrics regarding the observed effect of prior events on their operations.” In a footnote, the Metrics Guidance provides examples of metrics to which the guidance is intended to apply, which include a number of ESG metrics, such as total energy consumed, percentage breakdown of workforce, voluntary and/or involuntary employee turnover rate and data security breaches.

While the Metrics Guidance addresses ESG metrics only via footnote, it is consistent with the recommendations in certain voluntary sustainability frameworks that require both qualitative and quantitative disclosure associated with ESG metrics. For example, SASB’s Conceptual Framework notes that sustainability metrics should be accompanied by “a narrative description of any material factors necessary to ensure completeness, accuracy, and comparability of the data reported.”

In addition, the TCFD recommendations note that reporting companies should provide metrics on climate-related risks for historical periods to allow for trend analysis and, where not apparent, should provide a description of the methodologies used to calculate the climate metrics. Similarly, both SASB and TCFD emphasize the importance of having effective disclosure controls and governance, as well as verifying ESG data (by third-party auditors, if possible).

As the memo also points out, many companies have been criticized by stakeholders for using ESG metrics that aren’t “easily comparable, decision-useful, and verifiable.” The new guidance on MD&A key performance indicators heightens the stakes for these ESG disclosures, and companies that don’t respond appropriately may face a bigger downside than complaints about “greenwashing.”

ESG: Building Value Through Good Disclosure

This Latham memo says that companies have an opportunity to build value through their ESG initiatives & disclosure. The memo says that clear and transparent ESG disclosures can “build trust and demonstrate the company’s thoughtful management of ESG risks and opportunities.” This excerpt offers some specific suggestions for preparing ESG disclosures:

– Companies should take steps to ensure the consistency of disclosures in financial and sustainability reports.
– Even if information is included in the sustainability report, ESG information should be included in financial reports if material and called for by the regulations underpinning the disclosure documents.
– Information disclosed in sustainability reports is subject to the antifraud provisions of the securities laws even if not filed with the SEC. The information in companies’ sustainability reports should be scrutinized and verified to ensure its accuracy and completeness as if it were filed with the SEC.
– Companies should explain the importance of the ESG factors in their disclosures to help the reader to understand why the information is meaningful to the company and how it fits within the company’s strategy.

In today’s environment, I don’t think companies that want to address their ESG performance have any alternative to real transparency. The audience for ESG disclosures is increasingly sophisticated & extremely skeptical, so the historically preferred alternative of having the marketing department “put lipstick on the pig” when it comes to describing corporate ESG performance is likely to get you clobbered.

Transcript: “Conflict Minerals – Tackling Your Next Form SD”

We have posted the transcript for our recent webcast: “Conflict Minerals – Tackling Your Next Form SD.”

John Jenkins