Industry the November 2023 issue

Rowing the ESG Rapids

From DE&I to emissions reporting, brokers and insurers are headed for some regulatory breakers.
By Scott Sinder Posted on November 1, 2023

The latest chapters in the saga—in June, the United States Supreme Court issued its decision in Students for Fair Admissions, Inc. v President and Fellows of Harvard College, in which the Court held that the consideration of race by Harvard and the University of North Carolina as a “plus” factor in their college admissions processes violates the U.S. Constitution’s 14th Amendment Equal Protection Clause.

In October, California Governor Gavin Newsom signed two bills into law—SB 253, the “Climate Corporate Data Accountability Act,” and SB 261, “Greenhouse Gases: Climate-Related Financial Risk.” Together, these two laws essentially replicate and expand upon the U.S. Securities and Exchange Commission’s proposed climate disclosure regulations. Moreover, although Gov. Newsom noted before he signed the bills into law that some of the details as well as the implementation schedule likely will need to be modified during the rulemaking process, there is still an excellent chance that the California regime will be fully implemented prior to the SEC’s proposed rule, given the inevitability of protracted litigation over the SEC’s rule which likely will commence almost immediately after it is finalized.

The Harvard “Social” Decision

Every legal analysis of this college admissions case starts with the assertion that the Supreme Court’s opinion has no direct bearing on employers. This is in part because Title VII of the Civil Rights Act of 1964 generally bars employers from considering an individual’s race or other protected status (nationality, religion, sex or sexual orientation) in making any employment-related decisions. The Harvard Court, though, grounded much of its analysis on its view that the consideration of “opaque racial categories undermines, instead of promotes,” diversity, equity and inclusion goals and objectives.

Immediately on the heels of the issuance of the Harvard decision, 13 state attorneys general, relying in part on this statement, sent letters to Fortune 100 companies noting that the companies will face “serious legal consequences” if they are engaging in a wide swath of DE&I-oriented activities, including applying racial “preferences in hiring, recruiting, retention, promotion and advancement.” In July, Sen. Tom Cotton (R-Ark.) sent a letter to 51 of the country’s largest law firms warning that their DE&I programs and the DE&I programs maintained by their clients may violate civil rights laws, and he instructed the firms to preserve documentation related to those programs in preparation for potential legal challenges.

At least two dozen lawsuits have been filed since, challenging a wide swath of DE&I initiatives. Most recently, two major law firms were sued because they maintained diversity scholarship programs. Both lawsuits were dismissed after the firms agreed not to restrict the availability of the scholarships based on membership in a protected class.

All of that said, DE&I initiatives that do not involve the consideration of race for employment-related decisions but that instead focus on expanding the pool of job applicants to include more diverse candidates and fostering more inclusive workplaces do not trigger the kind of scrutiny that undergirds this latest round of legal challenges and therefore do not appear to pose any material legal liability. These are exactly the type of commitments embodied by The Council’s “Diversity, Equity & Inclusivity Pledge” to which many Council members have subscribed. To be meaningful, of course, you have to live the pledge, not just sign on to it.

California’s “Environment” Requirements

The California SB261 “Greenhouse Gases: Climate-Related Financial Risk” law will require any U.S.-based company with over $500 million in gross revenues that does business in California to be in compliance with the Task Force on Climate-related Financial Disclosures reporting framework and to post that report on a publicly accessible website. It is critical to note, however, that any entity that is regulated by the California Department of Insurance or by the insurance department of any other state is expressly excluded from the obligations imposed by SB261.

The California SB253 “Climate Corporate Data Accountability Act” will require any U.S.-based company with over $1 billion in gross revenues that does business in California to do a full, audited report of its “Scope 1,” “Scope 2” and “Scope 3” emissions. There is no industry exclusion from SB253.

It is critical to note, however, that any entity that is regulated by the California Department of Insurance or by the insurance department of any other state is expressly excluded from the obligations imposed by SB261.

Unless modified as promised by Gov. Newsom, the “Scope 1” (emissions generated directly by the company) and “Scope 2” (emissions from energy purchased by the company) reporting obligations would commence in 2026 (for 2025 data), and the “Scope 3” reporting (for emissions generated by any entity in the company’s “value chain,” including suppliers and customers) would commence in 2030 (for 2029 data).

These reporting obligations go beyond the SEC’s proposed rule in two respects. First, the SEC rules apply only to publicly traded companies; the California rules will apply to all companies doing business in California that exceed the revenue thresholds (except that insurance entities are not subject to the SB261 requirements as noted above). Second, the California “Scope 3” reporting obligations as currently written apply to all of a reporting company’s “Scope 3” emissions, whereas the proposed SEC “Scope 3” reporting obligation would apply only if the “Scope 3” emissions are “material” or if the company has included its “Scope 3” emissions in any net-zero or other emissions target to which it has purported to commit itself.

The California SB253 “Climate Corporate Data Accountability Act” will require any U.S.-based company with over $1 billion in gross revenues that does business in California to do a full, audited report of its “Scope 1,” “Scope 2” and “Scope 3” emissions. There is no industry exclusion from SB253.

As Gov. Newsom himself noted and has been widely discussed in conjunction with the SEC’s proposed rules, there are a plethora of Scope 3 emissions reporting issues that need to be addressed to operationalize that reporting requirement, and those requirements effectively could impact almost every business in America (because one company’s Scope 1 and Scope 2 emissions are Scope 3 emissions for the other companies in its “value chain”). For brokers and carrier partners, the Scope 3 reporting obligation could theoretically encompass every client/policyholder given the untethered legislative reporting obligation.

There also are technical issues with applying the revenue thresholds. Do they apply only to the specific entity doing business in California (which would be the case under the statute as written), or do they apply to that entity’s entire corporate holding company (which, of course, would vastly expand the number of companies subject to the reporting requirements)? And why are non-U.S. entities doing business in California excluded from the ambit of these reporting obligations (litigators, take your mark and get ready to go)?

Scott Sinder Chief Legal Officer, The Council; Partner, Steptoe Read More

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