Tipsters May Be Key To Financial Regulators’ ESG Efforts

While the new SEC rules address corporate disclosures, the SEC has also focused on ensuring accuracy of ESG-focused investment products, thereby preventing so-called greenwashing. It established an enforcement unit dedicated to these climate-related issues in 2021.

Another financial regulator, the U.S. Commodity Futures Trading Commission, launched its environmental fraud task force last June, an initiative that will focus on rooting out fraud in voluntary carbon credit markets, among other climate-related areas. In December 2023, the CFTC also proposed new guidance for tackling fraud and manipulation of voluntary carbon credit derivatives.

The SEC and the CFTC have both publicly stated that they will seek help from whistleblowers to assist with enforcement in these areas.

Both agencies have robust whistleblower programs that can pay awards to eligible whistleblowers who provide original information that leads to a successful enforcement action. The agencies have credited whistleblowers with providing invaluable assistance to their enforcement efforts generally.

Indeed, whistleblowers, particularly insiders who work at companies engaged in misconduct, are often the best, and in some cases the only, way for financial regulators to identify fraud and take action.

SEC’s Enforcement Focus on Corporate Disclosures and Greenwashing

The SEC’s Division of Enforcement established the Climate and ESG Task Force in March 2021, announcing it would focus on (1) gaps and misstatements in public company disclosures relating to climate risks, ESG and sustainability; and (2) misrepresentations about ESG factors used in selecting investments and driving ESG investment strategies.[2]

The SEC has relied upon existing disclosure and accuracy rules to bring such actions in the past,[3] and recently it has adopted new regulations to specifically address climate and ESG-related issues. In 2010, the SEC issued guidance outlining its view on how existing disclosure requirements applied to climate issues.[4] In adopting its new climate-related corporate disclosures rules, it recognized “a need to both standardize and enhance the information available to investors about such matters.”[5]

The new rules cover, for example, disclosure of material climate-related risks; efforts to mitigate those risks; emissions information for larger companies; costs and losses incurred in connection with severe weather and other natural conditions like wildfires, floods, droughts and sea level rise; costs related to carbon credits and renewable energy credits; and other disclosures.[6] Challenges to the new rules have been consolidated and are headed to the U.S. Court of Appeals for the Eighth Circuit.

As part of its efforts to address greenwashing in investment products, the SEC
adopted amendments to expand the scope of the Investment Company Act “Names Rule” on Sept. 20, 2023.[7] The Names Rule requires investment companies whose names suggest a focus in particular types of investment to adopt a policy to invest at least 80% of their assets in those investments.[8]

In expanding the scope of the rule to, in part, address greenwashing, the SEC stated that “the breadth of ESG-related terms, as well as evolving investor expectations around terms like ‘sustainable’ or ‘socially responsible,’ compound the possibility of investor confusion and potential ‘greenwashing’ in fund names.”[9] The amended rule applies to any fund with terms in its name “indicating that the fund’s investment decisions incorporate one or more ESG factors.”[10]

Prior to these new rules, the SEC brought enforcement actions based on existing disclosure and accuracy rules. For example, in March 2023 the SEC announced that the Brazilian mining company Vale SA agreed to pay $55.9 million to settle charges brought by the SEC arising from Vale’s allegedly false and misleading disclosures before the January 2019 collapse of its Brumadinho dam killed 270 people.

The SEC’s complaint alleged that Vale’s public sustainability reports made false statements to investors that its dams were certified as stable.[11] In connection with the Vale settlement, the SEC stated that “public companies can and should be held accountable for material misrepresentations in their ESG-related disclosures, just as they would for any other material misrepresentations.”[12]

In 2022, the SEC brought cases against both BNY Mellon Investment Adviser Inc. and Goldman Sachs Asset Management LP relating to ESG investment products.

In May 2022, the SEC charged BNY Mellon for allegedly making materially misleading statements and omissions about how it considered ESG principles when making investment decisions. In its press release on the BNY action, the SEC stated that “the Commission will hold investment advisers accountable when they do not accurately describe their incorporation of ESG factors into their investment selection process.”[13]

In November 2022, the SEC charged Goldman Sachs with allegedly failing to have written policies governing the selection of companies for its ESG investment portfolio and at other times failing to follow its own policies.[14]

The CFTC’s Climate-Related Enforcement: Voluntary Carbon Credit Markets and Greenwashing

The CFTC has similarly announced a focus on climate-related enforcement.

On June 29, 2023, the CFTC announced that it created its Environmental Fraud Task Force, which is dedicated to identifying misconduct “relating to purported efforts to address climate change and other environmental risks.”[15]

According to the agency, the task force will address fraud relating to derivatives markets and spot markets, such as carbon credit markets; statements about environmental benefits of carbon credits; and “misrepresentations regarding ESG products or strategies.”[16]

On Dec. 4, 2023, the CFTC issued proposed guidance regarding the listing of voluntary carbon credit derivatives on CTFC-regulated exchanges to “help to advance the standardization of voluntary carbon credit derivative contracts in a manner that fosters transparency and liquidity, accurate pricing, and market integrity.”[17] CFTC Chair Rostin Behnam called the proposed rules “the most significant step of a financial regulator to promote fundamental standards for high integrity [voluntary carbon credits].”[18]

The SEC and CFTC Look to Whistleblowers for Help with Climate and ESG-Related Enforcement

The SEC and CFTC both have successful whistleblower programs that were established in 2010 by the Dodd-Frank Wall Street Reform and Consumer Protection Act, under which the agencies will, under certain circumstances provided by law, pay awards to eligible whistleblowers who provide original information about violations that lead to successful enforcement actions.

The number of whistleblower tips submitted to the SEC and CFTC has soared in recent years.[19] As the SEC stated in November, “the impact of the Whistleblower Program was evident in the unprecedented level of public participation in the Program in FY 2023.”

Nonprofit organization Better Markets published in December a report tallying $6.3 billion in monetary sanctions from enforcement actions that relied on information from SEC whistleblowers since the program’s inception.[20] The SEC awarded almost $600 million to 68 individual whistleblowers in fiscal year 2023 alone.[21]

The CFTC whistleblower program has enjoyed similar success. In its Whistleblower Program’s 2023 annual report, the CFTC stated that the total amount of sanctions ordered in all whistleblower-related enforcement actions since its inception in 2010 exceeds $3 billion.[22] It awarded over $360 million to whistleblowers over the same period.[23]

The SEC and CFTC have both publicly credited whistleblowers for providing a significant boost to their respective enforcement efforts generally. The SEC calls its Office of the Whistleblower “an integral part of the Enforcement Program.”[24] In October, SEC Chair Gary Gensler remarked that “the public’s tips, complaints, and referrals are essential to our work as a cop on the beat.”[25]

Similarly, the CFTC’s Behnam said in February that “whistleblowers play a critical role assisting the CFTC. … Much of our Division of Enforcement’s success is tied to the strength of our Whistleblower Office.”[26] The director of the CFTC’s Whistleblower Office, Brian Young, added that “leads generated from insiders are critically important to any financial enforcement program.”[27]

It is therefore no surprise that both agencies are looking to whistleblowers to provide a similar boon to climate-related enforcement efforts. When the SEC announced the creation of the Climate and ESG Task Force, it stated that the task force would “evaluate and pursue tips, referrals, and whistleblower complaints on ESG-related issues.”[28]

Indeed, the new SEC disclosure rules govern corporate disclosures, and the SEC has received over 5,000 tips from whistleblowers that related to corporate disclosures just since

2021.[29] The CFTC has similarly emphasized the role whistleblowers will play in its climate-related enforcement efforts.

On June 20, 2023, the CFTC Whistleblower Office issued an alert calling for whistleblower tips relating to misconduct in the carbon credit markets.[30] The CFTC’s enforcement director said that “whistleblowers are invaluable [to] fighting fraud and manipulation,”[31] and the CFTC’s chair added that “information from whistleblowers advances the Commission’s enforcement mission and, in turn, further builds integrity and trust in the carbon markets by rooting out fraud and manipulation.”[32]

Neither the SEC nor the CFTC publicly link whistleblower awards to specific enforcement actions, in light of whistleblower confidentiality considerations. However, it seems likely that many of the most significant climate and ESG-related enforcement actions brought by the SEC and CFTC in the coming years will start with a whistleblower’s tip.