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The future of climate change disclosures: 4 critical risk areas boards should address

Brian McLoughlin, claims officer, Complex Management Liability Claims, Ironshore 
The future of climate change disclosures: 4 critical risk areas boards should address

In a 2020 study on climate outlook in business, 78 percent of leaders at the world’s top 500 companies reported that managing climate-related risks will be critical in keeping their jobs over the next five years. They know that climate change is a vital business issue — and it’s particularly urgent for companies in the U.S., where experts anticipate that mandatory climate disclosure requirements are on the horizon.

The Securities and Exchange Commission (SEC) has considered climate change a risk area since 2010, and many companies already voluntarily disclose information. But in July 2021, Gary Gensler, chair of the SEC, spoke about his plan to submit a proposed rule for mandatory climate disclosures — and based on an outpouring of public messages, that proposal will likely pass. Mandatory disclosures should make it easier for buyers and investors to access consistent, comparable data about climate impact, and for companies to showcase their positive work. However, these new regulations can feel daunting for board members, particularly at companies with less experience in this area.

“In July 2021, Gary Gensler, chair of the Securities and Exchange Commission (SEC), spoke about his plan to submit a proposed rule for mandatory climate disclosures — and based on an outpouring of public messages, that proposal will likely pass.”

Here are four critical areas of concern boards should address to prepare for new climate-change disclosure regulations and directors and officers (D&O)-related claims.

1. The impact of greenwashing on brand reputation and investor goodwill

Companies that voluntarily disclose their environmental impact data often have good intentions. But if new regulations pass, this data may put them at risk of greenwashing allegations. The word “greenwashing” is a derogatory term that describes the act of deliberately misrepresenting or hiding true environmental impact. While companies wouldn’t actively engage in such acts, there is still a risk of being accused of greenwashing simply because new disclosure requirements reveal errors in old reporting or construe data less favorably.

Unfortunately, even allegations of greenwashing can have a negative impact on finances and public relations. Accused companies may lose current investors and buyers, or struggle to attract new ones. Greenwashing allegations can be avoided if your company stays ahead of reporting inconsistencies and prepares to disclose data now, rather than waiting for a surprise later. It’s also important to note that the long-term goal of mandatory disclosures is to ensure that climate reporting is consistent and reliable — which should help reduce the risk of greenwashing across all industries in the future.

2. The risk of shareholder lawsuits

If companies are required to disclose information they might not have been sharing before, they may be at an increased risk for shareholder lawsuits and D&O claims. These could include securities class-action suits or shareholder derivative claims:

  • Securities class-action lawsuits. These frequently involve investor accusations that a company acted with “knowing falsity.” Essentially, investors can sue a company and its directors and officers for not disclosing essential information that impacted their investment decisions. Suits might include event-driven litigation, in which investors sue for damages after an environmental disaster, or accounting-based litigation, in which investors sue to regain losses caused by delayed or inaccurate financial reporting connected to a climate-related issue. 
  • Shareholder derivative claims. Companies’ directors and officers may be at risk if they don’t adequately protect investments, or the company itself, from climate-change risks. In these situations, shareholders file a lawsuit on behalf of the company against the corporation’s directors and officers for financial damages suffered by the company due to directors’ and officers’ mismanagement, dishonesty, or fraud. For example, a shareholder derivative claim might arise if there is evidence that board members actively ignored, misrepresented, or covered up a climate-change-related risk and the company suffered financial loss or reputational harm as a result. 

3. Avoiding SEC investigations and enforcement actions

If climate disclosures become mandatory, companies that aren’t prepared to comply may fall under scrutiny from the SEC. Failure to comply with regulations can lead to fines and penalties, along with legal fees that can impact the company’s bottom line. These are some examples of damages to the company that are likely to be sought in a future shareholder derivative action.

While it is still unclear exactly what information companies will need to disclose if the proposal passes, a company should be ready to share information such as:

  • its overall view of climate-change issues
  • its current commitment to reducing its carbon footprint
  • the total carbon impact of the company, including a view down the supply chain

4. An expanded view of materiality

While additional guidance is still needed, it is likely, based on a sample letter released by the SEC, that the specific information a company may be asked to disclose will be tailored to the organization, its industry, and any disclosures it has already shared.

Boards should be familiar with the concept of materiality, which measures how important a piece of information might be to a reasonable investor. Historically, materiality is based on the impact to a company’s finances — but that definition might be expanding. Many investors and companies are now talking about double materiality, which includes both financial and environmental risks. Essentially, double materiality measures how information affects a company’s bottom line as well as the environment.

While financial materiality will always play a significant role in awarding damages, companies should be aware that double materiality could be used to determine qualitative impacts on stakeholders. For example, investors might argue that a company’s carbon footprint is material if consumer habits shift toward sustainable businesses. Those qualitative assessments may be found to have real, financially material implications.

For now, double materiality is a grey area, and courts will likely rule on a case-by-case basis. But it’s critical that business leaders start to lay out steps to determine material information related to climate risks. Directors and officers are usually in the best position to evaluate this information — which also means that failing to address double materiality could lead to future lawsuits and D&O claims.

“To stay ahead of coming regulations, boards should be ready to talk seriously about climate issues.”

Putting climate change risk management on the agenda

Mandatory climate disclosures are a new and uncertain prospect for companies in every industry — but avoiding this issue could put your brand and your bottom line at risk. Consider that even if a meritless suit is brought against your company, it would still be expensive and time-consuming to defend.

Ultimately, these new regulations mean that climate change must become a regular item in your board-meeting agenda. For some companies, that might require bringing in expert consultants, but companies should at least consider working with all internal and external business partners to evaluate climate-related risk, including legal counsel, the compliance department, accountants, auditors, real estate managers, and operations managers to get a full view of climate risks across the supply chain. After all, it’s only by asking questions that companies can uncover gaps in their knowledge — and take the necessary steps to help protect themselves in the future.

Directors and officers of organizations are facing higher scrutiny than ever before. Learn more about how our directors and officers (D&O) liability insurance solutions from Ironshore can help protect an organization’s leaders from claims arising from management decisions and actions here.

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