Sustainability and Liability Risk

Tom Riesenberg is Director of Legal Policy & Outreach at the Sustainability Accounting Standards Board; Elisse Walter is Former SEC Chair and a member of SASB’s Foundation Board. This post is based on a SASB publication by Mr. Riesenberg and Ms. Walter. Related research from the Program on Corporate Governance includes Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

As the Sustainability Accounting Standards Board (SASB) marches forward with its standard-setting efforts, public companies are not always receptive, with responses that are reminiscent of the rabbi’s prayer in Fiddler on the Roof: “May God bless the Czar, and keep him far away from us.” In our experience the three reasons most often given by public companies for wanting to maintain their distance from SASB are: it is not clear that investors really want or need this information or that the information is material; it would be too expensive to provide accurate information; and there are too many legal uncertainties.

The response to the first of these concerns is that there is a mountain of evidence that investors want better, more standardized, more useful information about a company’s sustainability. Much of this evidence is available in various forms on SASB’s website. [1] And the crux of SASB’s standard-setting approach is to identify, through extensive research and analysis, information that is reasonably likely to be material to companies within a particular industry. In this regard, although sustainability disclosures are often referred to as non-financial information, they are best characterized as descriptions of a company’s long-term risks and thus perhaps more accurately described as pre-financial statement information.

As for the second of corporate America’s oft-stated objections to SASB, the costs of using the standards are difficult to appraise. To mitigate potential costs, SASB has sought to rely upon metrics that already are in use in the marketplace. In addition, to better gauge the cost issue, SASB has engaged a group of leading economists at the University of Chicago to study this further, and a report is expected later this year.

This blog note will focus on the third of these issues, that is, the legal concerns. Here, there seems to be considerable misunderstanding. The nature of the liability concerns was discussed in some depth at a roundtable discussion on legal issues relating to sustainability disclosures sponsored last year by SASB together with the Harvard Law School. The roundtable included nearly 30 of the top securities law professors and practitioners in the country, including former top SEC officials. A detailed report on the roundtable can be found on SASB’s website, [2] and a detailed legal memorandum prepared for the roundtable by the law firm of K&L Gates is also available. [3]

Let’s start with a few basic principles. A company, as well as it officers and directors, can be sued for fraud for any statement, no matter where it might be made. Section 10(b) and Rule 10b-5 of the Securities Exchange Act allow for an SEC or a private lawsuit against persons who make a fraudulent statement, no matter where it is made (although, of course, to succeed in such a lawsuit a private party must show many things, including reliance, causation, materiality, damages, and intent or “scienter”). Thus, it is wrong to conclude that companies can avoid securities fraud liability merely by putting sustainability information in communications (e.g., in corporate sustainability reports, or on websites) rather than in SEC filings. [4]

Companies could try to avoid liability risk altogether by saying nothing at all about sustainability issues. As the Supreme Court has said, silence, absent a duty to disclose, is not misleading. And, as a corollary principle, there is no duty to disclose information merely because such information is material—there must be an SEC rule that imposes such a duty. [5] Silence may be particularly attractive to issuers because the duty to disclose sustainability information is frequently uncertain and companies do not typically face liability for immaterial misstatements or omissions.

So with these basic principles as background, what can be said about liability risks relating to use of SASB standards in SEC filings? There are several important points.

One is that, while silence might theoretically be a way to avoid liability, it really is not an option for most companies. Public companies are already making loads of statements about sustainability and long-term risks—statements made in the risk factor or MD&A sections of their SEC filings, in their standalone sustainability reports, on their websites, in press releases, and elsewhere. [6] Moreover, some of these statements may in fact be required under the federal securities laws. Item 303 of Regulation S-K (MD&A) requires disclosure of a “known trend or uncertainty” that is “reasonably likely” to have a material impact a company’s operating performance or financial condition. So with respect to much sustainability information silence is not an option for most companies.

Further, a company can be sued for nondisclosure of material information if it is required to be disclosed. Of course, whether certain sustainability information is material as a general matter is often a matter of debate, but as noted the rudiments of the SASB endeavor is to develop standards for matter that are reasonably likely to be material for companies in a particular industry. And, given the raft of “boilerplate” type disclosures in this area, there is likely a risk of liability for “half truths,” where securities fraud liability can arise if an issuer fails to provide all the information necessary to make a statement not misleading. This legal doctrine provides that once a company speaks on an issue or topic, there is a duty to tell the whole truth. [7]

If silence is not likely an option, some suggest the best approach for companies would be to continue as they do now, making disclosures outside of the SEC filing. An issuer might indeed opt for a middle-ground, that is, use the SASB standards (once they become final, likely later this year) in a sustainability report or on their website. As noted, it is not evident that this approach would result in a meaningful reduction in risk, given the potential liability no matter where a statement is made. And, while such an approach would likely improve sustainability disclosures generally, the participants at the Harvard roundtable noted many reasons why companies might actually be better off including this information within an SEC filing.

One such benefit would be the likelihood of better and more accurate reporting. One participant at the roundtable referred to the environment for production of sustainability reports as “loosely-controlled,” and several speakers noted that they can more easily backfire, particularly after an accident or incident that can be traced back to the sustainability report. The most prominent example of where this has happened is the British Petroleum Deepwater Horizon explosion, where one of the bases for a securities fraud lawsuit against BP was an allegedly misleading statement about the frequency of BP’s safety inspections made in BP’s sustainability report. [8]

Several participants at the Harvard Law School forum said that the BP episode made a compelling case for putting sustainability information through the rigor of the traditional financial reporting process, which reduces risk by using accounting standards, effective internal controls, sound data governance, well-established regulatory oversight, and external audits or reviews. Such a process, they argued, adds protection. Boilerplate sustainability reports issued outside the traditional financial reporting process may be more vulnerable to litigation liability. One former high-ranking regulator wondered why companies are not “petrified” when they release sustainability information in reports or on websites without the benefit of the scrutiny that goes into a 10-K filing.

Another possible benefit from the use of the standards in an SEC filing is liability protection under the safe harbor from liability for forward-looking statements that was established by the Private Securities Litigation Reform Act of 1995. The safe harbor precludes liability for a forward-looking statement when the forward-looking statement is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ from those in the forward-looking statement. Boilerplate warnings often will be insufficiently “meaningful” to trigger the statutory protection. For example, in one district court case in California, the court concluded that warnings that the issuer could not be sure either that “it has been, or will at all times be, in complete compliance with all environmental requirements” or that it “will not incur additional material costs or liabilities in connection with these requirements in excess of amounts it has reserved” were not specific enough where company knew of significant environmental exposure. [9]

Also at the Harvard Law School forum a speaker made a broader point: he said that a company might be better off in a lawsuit involving a sustainability disclosure if it were able to state that it had used the SASB standards. Defendants in financial fraud lawsuits typically argue that they complied with Generally Accepted Accounting Principles (GAAP) in making their financial statement disclosures, and, if they can establish that, a finding of liability is highly unlikely. The case law in this area suggests that compliance with a set of well developed, transparent standards might reduce the risk that disclosures will be found to be misleading or made with fraudulent intent.

Finally, a securities law professor at the roundtable went outside the federal securities laws and noted the “increasing awareness” that plaintiff lawyers have about books and records lawsuits under Section 220 of the Delaware General Corporation Law, which authorizes shareholders with a proper purpose to demand a potentially broad array of corporate books and records. For example there is a case in which a public company made vague statements about child labor policies in its supply chain, thereby giving rise to a successful books and records inspection request. [10] Companies sometimes may be able to avoid or defeat a books-and-records demand by disclosing additional information. [11] The professor also observed that for certain industries there is the possibility of state attorney general investigations. Thus, from a corporate issuer’s perspective, “there’s something to be gained” by a “carefully thought-through way toward implementing SASB.”

In sum, the law in this area is unclear and the case law is sparse. But companies would be rash if they were to conclude, without further weighing the advantages and disadvantages, that use of the SASB standards in an SEC filing is too great a liability risk. And, given the many other benefits (too many to explore here), both reputational and operational, the pluses seem likely to outweigh the minuses.

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4See, e.g., In re BP P.L.C. Sec. Litig., 922 F. Supp. 2d 600 (S.D. Tex. 2013) (sustainability report was a potential basis for securities fraud claim).(go back)

5Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1321–22 (2011). Accord City of Livonia Emps.’ Ret. Sys. v. Boeing Co., 711 F.3d 754, 759 (7th Cir. 2013) (“There is no duty of total corporate transparency.”).(go back)

6See, e.g., Sustainability Accounting Standards Board, The State of Disclosure—2017 (Dec.1, 2016), available at; Governance and Accountability Institute, FLASH REPORT: EIGHTY-ONE PERCENT (81%) OF THE S&P 500 INDEX COMPANIES PUBLISHED CORPORATE SUSTAINABILITY REPORTS IN 2015 (March 15, 2016), available at; EY, Disclosure effectiveness:What companies can do now (October 2014), available at$FILE/EY-disclosure-effectiveness-what-companies-can-do-now.pdf.(go back)

7See, e.g., Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1088, 1094 (1991); Universal Health Servs., Inc. v. United States, 136 S. Ct. 1989, 2000 & n.3 (2016); Meyer v. Jinkosolar Holdings Co., Ltd., 761 F.3d 245, 250 (2d Cir. 2014) (“once a company speaks on an issue or topic, there is a duty to tell the whole truth”); Kleinman v. Elan Corp., 706 F.3d 145, 152 (2d Cir. 2013) (“Even a statement which is literally true, if susceptible to quite another interpretation by the reasonable investor, may properly be considered a material misrepresentation.”).(go back)

8See note 4, supra.(go back)

9Loritz v. Exide Techs. et al., Fed. Sec. L. Rep. (CCH) at 98,142 (C.D. Calif. 2014).(go back)

10Rulings of the Court From Oral Argument on Exceptions to the Master’s Final Report, La. Mun. Police Emps. Ret. Sys. v. Hershey Co., No. 7996-ML (Del. Ch. Mar. 18, 2014).(go back)

11In Delaware, shareholder demands are limited to documents that are “essential” to the shareholder’s purpose and “unavailable from another source.” Espinoza v. Hewlett-Packard Co., 32 A.3d 365, 371–72 (Del. 2011).(go back)

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