Steering clear of litigation pitfalls that can arise from ESG disclosures

With the popularity of impact investing increasing, evaluating a company’s Environmental, Social and Governance (ESG) disclosures – or determining whether the company has issued ESG disclosures at all – is on the rise. Impact investing involves considering a company’s positive environmental and social impact alongside its financial performance. An increasing number of companies are including ESG disclosures into mandatory filings with the U.S. Securities and Exchange Commission (SEC) as well as publishing such disclosures on their websites, and showing them in presentations to investors. Although ESG disclosures are widely viewed as a step in the right direction towards corporate social responsibility, the content of ESG disclosures can subject a company to liability if they are not drafted carefully and accurately.

ESG disclosures could become the subject of a lawsuit, regardless of whether the statement is incorporated into an official SEC filing. These lawsuits generally center upon two theories of liability: (1) securities fraud claims under federal law for statements made in SEC filings, and (2) consumer protection/fraud claims arising under federal or state law for statements made to the public. A company may also be subject to state or federal government investigations as a result of the content of its ESG disclosures. Plaintiffs commonly allege that the defendant company provided false or misleading information in a disclosure or that they omitted material information from such disclosure. Plaintiffs generally claim that they relied on the false or misleading statements in making an investment or purchasing decision with the defendant company.  Stakeholders may also bring these lawsuits after incidents involving the company reveal the misstatements or omissions contained in the company’s disclosures.

Securities Fraud Claims
Securities fraud claims are typically brought pursuant to Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and SEC Rule 10b-5, which require companies and their directors and officers to make accurate and truthful statements to investors. To meet the materiality requirement, “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”[1] Directors and officers can also face “control person” liability under Section 20(a) of the Exchange Act.  Claims have also been brought under Sections 11 and 12(a)(2) of the Securities Act of 1933, which provide strict liability for material misstatements and omissions made in connection with securities offerings. 

Securities fraud claims have been largely unsuccessful where aspirational language or forward looking statements in ESG disclosures are at issue, especially if cautionary language or disclosures are also used.  Securities claims have been more successful when factual statements are the subject of the dispute because the accuracy of such statements can be disproven.  For example, in March 2020, a large company settled a securities class action lawsuit for $240 million because statements in its code of conduct and code of ethics concerning its policies and procedures against sexual harassment were directly at odds with statements in the Plaintiffs’ complaint and were therefore determined to be false or misleading.[2] 

Consumer Fraud Cases
Consumer fraud or protection claims are generally brought pursuant to state or federal statute, and we are seeing a growing number of such claims filed concerning statements made in ESG disclosures on websites or marketing materials. To date, these cases are not as successful as securities fraud lawsuits have been. Many of the cases that have advanced such arguments with respect to ESG disclosures have been brought under California’s consumer protection statutes.  For example, a California court affirmed the dismissal of the plaintiffs’ complaint, but held that the plaintiffs could have recovered against the defendant company on an affirmative misrepresentation theory under California’s consumer protection statutes had the plaintiffs pled that they relied on the company’s alleged misrepresentations on its website concerning its supplier code of conduct, and the steps that it would take to curtail human trafficking in its supply chain.[3]

Drafting Tips
There are several considerations and steps that a prudent company can make to decrease the risk of liability in making ESG disclosures:

• Consider what can be “material.”  Think about what can be interpreted as “material” and misleading. 
   
• Don’t make promises that you cannot keep or statements that ae factually untrue.  Case law provides that if a statement is deemed vague or aspirational, then courts typically conclude that it cannot be false, misleading, or material to a reasonable investor. The context of timing of such statements, however, are considered. For instance, courts have refused to dismiss claims when statements were made in response to investors’ concerns, especially when those statements follow highly publicized incidents or were made during an investigation of the company’s ethics or activities. Keep in mind that if your company pledges to meet a specific goal by a certain date and fails to do so, it may have a duty to report that it did not meet the goal by the deadline as hoped.
   
• Make sure everyone is on the same page. Adopt an overarching ESG disclosure policy to align board oversight, ownership, reliability, and verification of the disclosure. Draft clear governance regarding the disclosures so everyone internally understands what is expected.
   
• Audit the statements before filing or publication. Engage internal and external sustainability disclosure experts to audit company disclosures. Such internal and external auditors should review ESG disclosures for misstatements, embellishments, or statements of fact that are capable of becoming misleading or untrue by circumstances outside of the company’s control.
   
• Include disclaimers in the publication. 
   
• Verify your business has appropriate directors and officers (D&O) Insurance coverage.  Standard D&O coverage should cover alleged misrepresentations or omissions in securities filings and other public statements, but companies should confirm whether or not the policy requires any special terms or conditions to ensure coverage for ESG misstatement or omission claims. Companies should consider obtaining A-B-C coverage which will indemnify directors and officers where the underlying claim is non-indemnifiable, reimburse the company for proper indemnification payments made to its directors and officers, and cover the company for claims against it.

Overall, liability risks should not dissuade a company from making ESG disclosures. By being thorough and prudent in the ESG disclosure process, it is increasingly likely that a company will gain investor preference for making such disclosures. 

McDonald Hopkins LLC can assist you in determining whether to make an ESG disclosure and how to properly craft such disclosures to decrease the risk of liability relating to such disclosures.  We are also able to assist you in the event you have already made such disclosures and are currently dealing with litigation and/or disgruntled shareholders or investors. If you have any questions regarding the contents of this post, please feel free to reach out to Sarah Mancuso or Amy Wojnarwsky, whose contact information is listed below.