Greenwashing and Regulatory Concern
All is not plain sailing in the ESG world, however. There are concerns that “ESG” can sometimes represent form over substance.
In July 2021, the Financial Conduct Authority of the United Kingdom (UK) published a letter on the “design, delivery and disclosure of ESG and sustainable investment funds,” advising that a number of applications for ESG funds “contain claims that do not bear scrutiny.” The Securities and Exchange Commission (SEC) is also looking at funds and products that are marketed as “green” or “sustainable” without objective evidence to support those claims—a practice known as “greenwashing.” SEC, Prepared Remarks of Chair Gary Gensler before the Asset Management Advisory Committee (July 7, 2021).
The European Union is introducing an ESG regime under the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation. Last year, the UK government published a “Roadmap towards mandatory climate-related disclosures,” which envisaged mandatory disclosures across the economy. In the run-up to the United Nations Climate Change Conference of the Parties (COP26), Her Majesty’s Treasury published its Greening Finance road map, with details on sustainability disclosure requirements. These will eventually require every investment product to disclose the environmental impact of the activities it finances.
Amongst the COP26 noise, there is a clear trend towards mandatory and detailed ESG disclosures across the UK economy. Issuers are today providing more and more ESG-related disclosures in their reporting, albeit currently in a voluntary and non-uniform manner. It should be said that due to recent developments around COP26, we have focused in this piece predominantly on discussing climate-related disclosures. Disclosures relating to the S and G of ESG can have just as much import and effect and should not be overlooked.
Against this background, there appears to be a risk of shareholder litigation where ESG disclosures prove to be erroneous or exaggerated and the issuer’s share price falls when the true position becomes known. While there are various routes available for shareholder claims, there is increasing appetite for statutory claims against listed companies pursuant to section 90 and section 90A/Schedule 10A of the Financial Services and Markets Act 2000 (FSMA). There exist other avenues for shareholder redress in respect of corporate disclosures, such as by section 2 of the Misrepresentation Act 1967 and the torts of negligent misstatement and deceit.
Section 90 of the FSMA enables investors to recover losses as a result of any untrue or misleading statements, or any omission of “necessary information,” in listing documents, such as prospectuses. Such a claim can be brought against any person responsible for the document, including the issuer and its directors. By contrast, section 90A permits recovery of losses from issuers concerning recklessly untrue or misleading statements or dishonest omissions via a recognised information service, such as a Regulatory News Service feed.
There are complexities with these types of claims. Many factors affect the price of securities, and it can be difficult to extricate isolated share price movements (and their causes) from wider market noise to evidence loss. However, financial experts are increasingly well practised in determining movements in the price of securities occurring as a result of new information hitting the market. Section 90A/Schedule 10A contains an express requirement for investors to show that they reasonably relied on the information in question in buying or holding the securities. (Section 90 contains no express reliance requirement, although there is no judicial authority on this point yet.) Reliance can be a difficult hurdle, but might it be easier to show where an investor is bound by a mandate to invest only in sustainable businesses? Might it enable investors to point to their mandate and the disclosures in question as a reason for making the investment? Whether an investor can credibly claim that it relied on the issuer’s information will likely depend on the nature of the misleading information. With no shareholder cases relating to ESG disclosures having yet reached the courtroom, it remains to be seen how this will work in practice.
Such questions are of concern to companies, directors, and “persons discharging managerial responsibilities,” or PDMRs, a term used in FSMA 2000. (Broadly speaking, the term refers to those occupying the position of director (by whatever name it is called), a member of the issuer (where its affairs are managed by its members), or any senior executive within the issuer who had responsibilities in relation to the published information.) They and (and their auditors) should, as a first priority, consider whether they have the necessary understanding of ESG matters to keep pace with regulation in this fast-moving sector. Parties considering securities litigation claims should bear in mind that they are potentially complex—but by no means impossible—claims to bring, and should seek specialist advice accordingly.