Greenwashing – Clarity arrives with ASIC's first court regulatory enforcement outcome

What you need to know

• ASIC's test case against Vanguard Investments confirms the law on misleading or deceptive conduct applies to greenwashing where an investment fund makes false or misleading representations to investors that the fund offered an ethically conscious investment opportunity and, before being included in the fund, securities were researched and screened against applicable ESG criteria.
• This decision provides guidance on the types of representations to the market the regulator considers to be greenwashing and sets a minimum standard of conduct in terms of what the regulator expects.
• Further clarification is pending on the types of greenwashing misconduct and the range of civil penalties a Court is likely to impose in terms of the deterrence objective and relevant mitigating factors – the Vanguard penalty hearing will be in August this year and the outcome of two other ongoing ASIC civil penalty cases (Mercer Super and Active Super) will also be relevant.

What you need to do

• Ensure all ESG-related representations have reasonable grounds for making them and accurately reflect the implementation of exclusions and screening practices.
• Regularly review and monitor statements in PDSs, media releases, published reports and on websites to maintain accurate information on the nature of the entity's business and the financial products and financial services it offers to investors.
• The need for accuracy and reliability of information will become even more important in view of the recent exposure draft of the Treasury Laws Amendment Bill on the proposed new standards for sustainability and climate related financial disclosures, which contemplate assurance requirements as part of the annual statutory financial reporting requirements under the Corporations Act.

Regulatory enforcement and greenwashing

Greenwashing is seen to be a prominent issue in the market, given the increased importance of sustainable product investment in recent times and entities working towards reaching net zero positions.

ASIC has increased its scrutiny of sustainability-related financial products since the introduction of INFO 271 in June 2022, which sets out questions for financial services providers to consider to help avoid misleading or deceptive practices when promoting their products and services.

ASIC's position is that greenwashing "erodes investor confidence in the market" and it has actively taken enforcement action through the infringement notices regime against participants in the financial services, superannuation and energy sectors.

To date, there are three ASIC test cases regarding alleged greenwashing. These are civil penalty proceedings commenced in the Federal Court of Australia in 2023 (in order of filing) against Mercer Superannuation (Australia) Ltd in February, Vanguard Investments Australia Ltd (Vanguard) in July and LGSS Pty Ltd (the trustee of the Active Super super fund) in August.

The law on misleading or deceptive conduct is not new but the concentrated attention from regulators on pursuing entities for greenwashing is.

ASIC's test case against Vanguard

The Vanguard proceeding is in relation to claims about ESG exclusionary screens applied to investments in one of Vanguard's funds, the Vanguard Ethically Conscious Global Aggregate Bond Index Fund (Fund).

Investments held by the Fund were based on an index, the Bloomberg Barclays MSCI Global Aggregate SRI ("Socially Responsible Investing") Exclusions Float Adjusted Index (Bloomberg SRI Index) which was claimed to exclude issuers with significant business activities in certain industries. The excluded securities were purportedly based on research and screening against ESG criteria relating to fossil fuels, alcohol, tobacco, gambling, military weapons, civilian firearms, nuclear power and adult entertainment.

This test case seeks to illustrate how important it is that potential investors can rely on investment screens to assist with their decision-making.

The impugned representations

ASIC alleged, and Vanguard admitted for the most part, that during the period 7 August 2018 to 17 February 2021 certain statements in its PDSs and on its website conveyed the following representations:

• that the Fund offered an ethically conscious investment opportunity and the Fund did this by seeking to track the Bloomberg SRI Index;
• that before being included in the Bloomberg SRI Index, and therefore the Fund, securities were researched and screened against applicable ESG criteria; and
• that securities that violated applicable ESG criteria were excluded or removed from the Bloomberg SRI Index and therefore the Fund.

ASIC also alleged, and Vanguard admitted in their entirety, that the same representations (save for the reference to the index) were conveyed in Vanguard's media release in respect of the launch of the Fund, an interview given by a manager of Vanguard with Finance News Network (FNN) that was published on YouTube and a presentation given by a manager at a FNN fund manager event a video of which was published on FNN's website.

The representations were misleading because:

• not all issuers of securities that were included in the Bloomberg SRI Index were researched and screened against the ESG criteria, and only companies, and generally only publicly listed companies, were researched and screened against the ESG criteria, meaning that government-related and private companies were not;
• for companies with multiple issuing entities that shared a particular stock exchange “ticker”, the ESG research was only conducted for the company with the largest debt outstanding by market value and was then applied to all other companies with the same ticker;
• the fossil fuel screen, as in effect from 15 July 2020, did not cover companies that derived revenue from the transportation or exploration of thermal coal;
• a significant proportion of securities in the Bloomberg SRI Index and the Fund were from issuers that were not researched or screened against the ESG criteria; and
• the Bloomberg SRI Index and the Fund included issuers that violated the ESG criteria.

Factors relevant to the Court's determination

The Court determined, and made declarations, that:

• engaging in conduct that was liable to mislead the public as to the nature, the characteristics and the suitability for their purpose of Vanguard's financial services was in breach of s 12DF of the ASIC Act; and
• making the alleged false or misleading representations (other than in the PDSs) that Vanguard's financial services were of a particular standard, quality or grade, and had certain performance characteristics or benefits, was in breach of s 12DB of the ASIC Act.

The four-step process that the Court endorsed for assessing misleading conduct in a greenwashing claim (the same as any other non-greenwashing claim) involved:

• identifying with precision the contravening conduct (including making representations);
• considering whether the identified conduct was conduct "in trade or commerce";
• considering what meaning that conduct conveyed; and
• determining whether that conduct in light of that meaning was misleading or deceptive or likely to mislead or deceive – it is not necessary to prove an intention to mislead or deceive or that the conduct in question actually deceived or misled anyone, but rather whether it has the tendency to lead a person exposed to the conduct into error.

The third and fourth steps require the Court to consider objectively the conduct as a whole and its effect on the state of mind of the ordinary and reasonable members of the relevant class of persons, judged by reference to the relevant context. That context includes "the words in the document or other communication and the manner in which those words are conveyed, not just a word or phrase in isolation – and the broader context of the relevant surrounding facts and circumstances".

In this case, each of the alleged communications were considered in its context and surrounding circumstances. However, the allegations made by ASIC necessarily required a focus on each communication rather than the conduct of Vanguard considered as a whole.

On the horizon

The Court has yet to determine the pecuniary penalties in respect of the contraventions it has declared, and adverse publicity orders sought by ASIC which require the entities to disclose and publish any contraventions found. A hearing in relation to those issues is listed on 1 August 2024.

The Vanguard decision confirms ASIC's enforcement priority in this area and its stated vision that "only meaningful, responsible and transparent disclosure will effectively combat greenwashing practices".

However, the potential need for fund managers to undertake their own research and analysis to ensure that exclusionary screens are applied appropriately may result in higher costs and therefore higher fees on investment products.

While the risk of regulatory enforcement action is currently generating a lot of attention, companies involved in making or vetting statements about green credentials should also be mindful of the risk of class actions.

As discussed in our recent update, there are various features of greenwashing and climate-related claims that may lend themselves to class actions, although there are some substantial challenges for claimants as well.