Red flags for green investors

ESG is an increasingly prominent feature of investment decisions across the investor gamut. As ESG-related disclosures come under scrutiny, there is a risk of investor and activist claims if those disclosures are inaccurate.

Once upon a time ESG matters were considered a niche interest. That is no longer the case. Alongside other strategic and financial information, investors routinely analyse information through an ESG lens to better understand the future prospects of companies. That is equally true for private capital and publicly listed securities. Understanding the headwind that is ESG has never been more important, not least because long term it will be the driver for what generates and depreciates value.

New opportunities and emerging risks

At the core of this rapidly maturing space is the ability to identify new opportunities and manage emerging risks. According to the Pitchbook 2020 Sustainable Investment Survey, 95 per cent of limited partners are either already evaluating ESG risk factors or will be increasing their focus on ESG risk factors in the coming year. Climate change and climate change action, as well as enhanced human rights and good governance practices that respect and uphold the former two, are becoming an ever-present feature of good investment decisions. That should not come as a surprise if one agrees with the views expressed by the US Securities and Exchange Commission that “climate change, unlike other types of risk, is potentially irreversible in terms of the damage it can cause”.

As previous sectorial developments have shown, areas of growth and opportunity are but one side of the coin. On the flip side, there is risk. Investor scrutiny of ESG performance should be accompanied by equal (if not greater) scrutiny of the entity making those representations, public statements or filings. Such an approach is of equal relevance to asset owners, asset managers, banks, brokers and investment consultants.

ESG & securities litigation

ESG risk can manifest itself in many guises. We do not explore here the multifaceted incarnations of ESG risks/disputes. Instead, we look at the risk of securities litigation in the UK. For further information, please refer to our more detailed separate briefing available here and our ESG litigation risk webinar.

As the flood of regulation, guidance and investor/stakeholder pressure to provide ESG information voluntarily shows no sign of abating, there is a corresponding risk of liability for damages in respect of any misstatement or misrepresentation. That risk is on the rise. Litigation following alleged misstatements or misrepresentations often derives from a distinction between what a company says it does and what it actually does and potential claimants will be alert to that distinction. As such, the need for carefully managed, accurate and precise disclosure is a key mitigator. The degree of vigilance afforded to public statements, and/or company filings generally, is of equal importance for ESG matters.

That is particularly relevant for issuers (but the same approach should be applied for all ESG related representations). Where a company’s disclosures are proven to be inaccurate, it may cause a subsequent fall in share price. Consequently, the shareholders may seek to recover their losses. This type of ligation, commonly referred to as “securities litigation”, is well developed in the US but its foothold remains to be tested in the UK – even if, as the signs suggest, it is a developing trend in the UK.

Two obvious candidates emerge for this securities litigation ‘foothold’: sections 90 and 90A of the Financial Services and Markets Act 2000 (FSMA). Both are deceit-based statutory remedies for shareholders who acquire securities and suffer loss as a result of statements or omissions made either (i) in prospectuses or listing particulars (section 90 FSMA), or (ii) in published information such as annual reports or accounts (section 90A FSMA).

Section 90 FSMA – prospectus and listing liability

A shareholder who:

• Acquires securities or any interest in securities offered by the prospectus or listing particulars, and
• Suffers loss as a result of any untrue or misleading statement, or omission of any matter required to be included, may be able to claim compensation for those losses.

Claims can be brought by those who contract to acquire any interest in the relevant securities or purchasers of the securities.

There are two notable elements:

• First, the net is cast wide over the pool of possible defendants. Claims can be brought against: (i) any person responsible for the relevant document, (ii) those stated as accepting responsibility for the document, and (iii) any other person who has authorised its content. That will always include the issuer of the relevant securities but may also extend to directors and sponsors.
• Second, there is no need to prove that the claimant relied on the said misleading statement or omission. That circumvents some of the substantial hurdles faced by other similar common law claims.

Both these aspects may explain why it is viewed in some sectors as the paradigm example of a group litigation case. As a result, it is likely to be a point of interest for both claims management companies and the ever-increasing pool of those looking to fund, in particular, group litigation claims.

Section 90A FSMA – published information

The second of these ‘footholds’ relates to published information:

• Where an issuer makes an untrue or misleading statement or omission, or dishonestly delays publishing that information, those that acquired, continued to hold or disposed of shares “in reliance” on the published information and suffer loss as a consequence, may bring a claim for compensation.
• Relevant publications include annual reports and accounts and interim results but could also include interim management statements, any preliminary statement published in advance of a report, and information published through a recognised information service.
• The issuer is liable if a person discharging managerial responsibility knew or was reckless as to such statements, omissions or delay.

Unlike section 90 FSMA, to successfully bring a section 90A FSMA claim, an investor needs to demonstrate it was reasonable to place reliance on the published information when it acquired, disposed of or continued to hold the shares in question. That is an important point of difference, which makes the prospect of a group litigation more complicated: each claimant would need to evidence that it relied on the published information, which is no small feat. It also raises the spectre of materiality: was the published information sufficiently material for the investor to rely on it in that manner? That is a point of law that, for now, remains unanswered, making the prospects of any such claim more speculative (and perhaps less attractive).

ESG-related shareholder litigation is very much in its infancy in the UK but lessons can be learnt from previous cases and other jurisdictions. The main tenets of these types of claims are also available to shareholders in Europe, the US and Australia and they illustrate the tightrope between aspirational forward-looking statements and representations that impact investor assessment of the financial position and prospects of a company. As the US experience demonstrates, where ESG credentials are inaccurately represented, investors are willing to pursue group claims, for example, ExxonMobil Corporation, in which the state regulator filed a suit and separately a shareholder class filed a securities class action with the US District Court for the Northern District of Texas, making similar allegations to the state regulator.

In the UK, both these causes of action are largely untested since the handful of cases brought on those bases, thus far, have settled. That cannot be a coincidence when you consider the reputational risk, unhelpful precedents and potential for large payouts from the defendant’s perspective.

Given the almost fledgling stage of both group litigation and ESG claims in the UK to date, it remains to be seen whether ESG-related claims will shift that approach. However, with the rise of the ‘activist’ and/or ‘ethical’ investor, monetary compensation may no longer be the sole aim. As with most activist-driven litigation, a desire for change may influence how these disputes play out and may reduce the impetus for settlement (at least from a claimant perspective). How this will interplay with the wish for a return on investment from any funder of such litigation will be an interesting dynamic and something to watch.

Authors: Lynn Dunne, Partner and Anna Varga, Senior Associate