You do not need to look too far to find a raft of statistics which show the substantial growth of ESG investment in recent years, with Bloomberg predicting that by 2025 ESG investments will represent a third of total assets under management.
However, the focus on sustainable investments is not all good news. In parallel with this growth, there are increasing concerns, including from the FCA, of so-called "greenwashing". Earlier this year, the FCA wrote an open letter to the Fund Management industry on this important topic. In essence, the letter reflected a concern that funds were looking to take advantage of consumer interest in ESG investments, without those funds having material ESG substance.
There may be unscrupulous firms looking to cash in on investor appetite for ESG investment by simply putting a "green" wrapper around funds without true ESG credentials. However, as there is currently no single benchmark or metric for measuring ESG compliance, it may well be difficult to isolate the disingenuous from those trying to make a difference, but missing the mark. The FCA is currently consulting on a regime for ESG disclosures, with set standards for measurement of ESG credentials which if implemented (which seems likely) will at least provide a firm footing for measuring ESG claims. In the meantime, firms might reasonably be uncertain as to their "greenwashing" risk.
In this article, we consider some of the litigation risks for inaccurate reporting of ESG credentials. In Part 2, we will focus on the regulatory risk for firms and individuals, now and following implementation of the new ESG disclosure regime.
Choosing investments based on their ESG credentials is an easy way for consumers to take action to support sustainability and, indeed, in the lead up to COP26 investors have been encouraged to clean up their existing portfolios and make new investments based on ESG credentials. There is little question many investors are now selecting ESG-branded investments, specifically because of their stated ESG credentials (and will continue to do so). Where an investor has made a specific investment choice based on purported ESG credentials, but finds out the investment does not in fact possess those benefits, they are likely to feel aggrieved. They may feel sufficiently angered to seek some form of compensation, as well as selling out of the investment.
However, what is the position where the fund has in fact generated a positive return? Will an investor be able to bring a claim in those circumstances?
When a product is sold on inaccurate information, the classic claim is for misrepresentation. Depending on the circumstances, the investor might also have a claim for breach of contract. The remedy for misrepresentation is rescission or damages and, for breach of contract, it is damages. If the investment has not performed, then there will be an identifiable loss, being at least the difference between the amount invested and the current value.
What if the value of the investment has gone up? Can the investor make a claim?
If the investment has increased in value, when an investor discovers it does not live up to ESG claims, they can simply sell out and recover the sums invested (plus potentially a return). Even if the investment was sold on a false basis, there would be no point in an investor embarking on costly and stressful litigation if they can achieve the same outcome by simply selling. Most everyday investors, whilst feeling disappointed, or even angry at the thwarting of their good intentions, will not want to embark upon litigation just to try to hold the firm to public account.
However, a firm would be ill advised to discount litigation risk where investments are financially performing, but failing to live up to their ESG credentials.
The investment may be performing now, but what happens if the fund does not continue to perform? Investors cannot bring claims for poor investment performance, but in circumstances where the investment does not in fact have the characteristics promised, once performance falters, claims will find a firmer footing. Added to this, under the scheme set out in the current FCA consultation, larger asset managers will be required under FCA rules, from June 2023, to make detailed ESG disclosures at a product level, against standard metrics. The rules will not just apply to new funds. If the life of an investment crosses into the new regime, compliance with the disclosure framework will likely make it glaringly obvious where ESG credentials have been previously overstated.
Even where the investor has not suffered a loss on the investment itself, fraudulent misrepresentation still presents a risk. An investor can claim fraudulent misrepresentation if a fund’s ESG-related credentials were stated in the knowledge they were false, or careless as to whether they were true or false. Where fraudulent misrepresentation is found, in addition to being entitled to unwind the transaction, an investor can claim compensation for all consequential losses, not just those that were reasonably foreseeable. Most obviously, claims would include damages to compensate for the return investors would have made on alternative investments, but there may be other amounts which could be claimed. Whilst calculation of damages based on alternative investment performance may be complex, it is unlikely the firm at fault would have the ear of the court in relation to any reasonably claimed amounts.
Of course, a finding of fraudulent misrepresentation would also have significant reputational and regulatory implications for the firm and the individuals responsible, and allegations of this nature can be almost as damaging. Regulatory implications will be considered in Part 2 of this series.
There have been a number of recent developments in the litigation landscape in England and Wales, which increase litigation risks relating to ESG claims or disclosures.
First is the increase in specialist law firms whose focus is representation of claimants in group actions and the growth of the litigation funding market, so these group actions are no longer dependent on private funding. The business model of claimant firms depends on their identification of failings giving rise to potential claims and their proactive establishment of claimant groups to represent. Claims with simple but repeating fact patterns, against institutions who have either resources or a reputation to protect (or both), are appealing to funders and claimant law firms, even more so if they can be formulated as a representative action. That each claim might have a low value matters less if there is a sufficient volume of individuals affected. The availability of funding and law firms in the market for such claims goes a long way to addressing the hurdle of lack of investor appetite for litigation.
The second key development is in the English court’s approach to collective actions. Many of the recent examples of collective litigation have been in the data privacy or competition spheres. However, claims relating to inaccurate investment disclosures are fertile ground for a collective approach. Of particular note are developments in so-called "opt out" regimes, which do not require those affected to be involved in the litigation to benefit. The framework for claims involving multiple claimants has long existed in the English Civil Procedure Rules (CPR), but most group claims have been under the Group Litigation Order (GLO) process. Under a GLO, claimants have to join the proceedings ("opt in") to benefit. A GLO has benefits for claimants, but because it is "opt in", there is a considerable burden on funders and claimant law firms to ensure there is a sufficiently large number of claimants signed up at the outset to make the claim financially viable.
The alternative approach is the representative claimant procedure (under CPR 19.6). This is more akin to the US-style class action. A representative claim does not need members of the represented group to be joined to the claim, or even identified, but the claimants have to have the "same interest" in the claim. Historically, the "same interest" requirement has been applied restrictively by the courts and has, arguably, acted as a barrier to representative claims. However, the Court of Appeal recently held the "same interest" test to be satisfied in Lloyd v. Google (overturning the first instance decision) and that decision might be taken as an indication that the door is open to a more permissive approach. In that case, unknown to an estimated 4 million IPhone users, they had data about their browsing habits (known as BGI) harvested by Google, which is said to have allowed Google and its customers to target advertising, based on the BGI. As the represented claimants all had their BGI taken without their consent, in the same period and the same circumstances, and they were not seeking to rely on any individual circumstances, meaning Google would not be able to raise a defence against one that would not apply to others, the Court of Appeal concluded that the represented class had the "same interest".
If the "same interest" requirement can be met in a claim about overstatement of ESG credentials, this could present a material risk to the firm. Where an investment is sold to consumers, on the same platform, with the same materials, over the same period, that test might be satisfied. If so, there could be the basis for an attractive claim for a commercial funder. It would be relatively straightforward to formulate a claim for a representative claimant and, if successful, because the funder is likely to take a share of the proceeds, it would benefit from the judgment being binding on all investors in the represented class. The difficulty in mounting a representative action in an investment scenario may turn on whether individual circumstances can be excluded and whether there is the same calculation of loss. If these factors prevented a representative claim, the other forms of group action would still be available.
In summary, where a financial product is sold to multiple customers based on standard information, and that information is inaccurate, there is a foundation for a group action, exposing the firm to the risks, financial and reputational, that sort of litigation presents. As noted earlier, the risk of claims may be small if the investments are performing but, as investors are regularly reminded, future performance is never guaranteed.
Even if the investor has not suffered a financial loss, an investor might be able to claim compensation for distress. Traditionally, in civil claims, damages for distress and inconvenience have been awarded in very limited circumstances. However, ESG-related claims present the prospect of an expansion of this area of compensation.
It will be open to consumers to complain to the Financial Ombudsman Service (FOS). The approach of the FOS is to assess complaints based on what is fair and reasonable in the circumstances, and so may well depart from a strict legal analysis. FOS also commonly makes awards based on distress and inconvenience to recognise the impact on the customer of what went wrong. It is not too far of a stretch to think the FOS may make distress-based awards where a consumer’s positive decision to make a contribution to society through their investment choices has been ignored, particularly if the firm is not otherwise held to account.
When it comes to the courts, damages for distress in relation to ESG claims are more of stretch, but should not be dismissed out of hand. One of the issues in Lloyd v. Google1 was the question of whether IPhone users, who had no idea their personal data was being harvested, suffered loss. After much debate, the Court of Appeal reached the view that, as the harvested data had value, the IPhone users had lost something of value, for which they should be compensated. The facts are not the same, but the court’s approach demonstrates a willingness to take a creative approach to achieve a just outcome. The claim was allowed, even though the users had suffered no financial loss or distress (they did not know the information was being harvested) but on the basis their user preferences had value and so loss of the data was loss of something of value. How different is an investor preference to invest their money in ESG funds? That preference must have a value. If it did not, surely there would not be a surge in promotion of ESG investments?
Whether awarded by the courts or the ombudsman, individual payments for distress may not be large but, faced with multiple similar or identical claims, the risks mount up.
Much of the commentary about ESG litigation focuses on the headline worthy, the responsibility for catastrophic environmental events, or accountability of big business for decisions which have a negative societal impact. Over-egging ESG credentials in investments might seem harmless or mundane in comparison. However, the risk of being held to account in litigation should not be under-estimated. The combination of angered investors, and claimant law firms and litigation funders looking for opportunities, will likely be a dangerous cocktail.
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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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ESG Investments: Assessing the litigation and regulatory risk of ESG failings – Part 1: Litigation risk from investment "greenwashing" – JD Supra
