Can Shareholder Lawsuits Police Companies’ Climate Disclosures?

In March 2022, the SEC proposed mandatory climate disclosures for public companies.[1]  While climate activist investors applauded the proposed rules, opponents lamented their scope and cost, arguing that the SEC lacks the authority to promulgate such rules. But the debate  largely overlooked a key point: The success of a climate disclosure regime – mandatory or voluntary – rests on accuracy of the disclosure.  By some accounts, the private right of action is the most effective way to prevent companies from providing misleading information to their shareholders.  The SEC lacks the resources  and, in a controversial area like climate, may also lack the political will to police the climate disclosures of all public firms.

Evidence of whether private enforcement by shareholders can make up for the SEC’s shortcomings is already beginning to emerge. As activist investors have pressed for climate action, public firms have responded with voluntary disclosures, and some of these disclosures have generated shareholder lawsuits.  To determine what shareholder litigation under an enhanced disclosure regime could look like, I investigate the features of the climate-related shareholder litigation that already exists. I examine a sample of all shareholder lawsuits from 2011 to 2021 based on firms’ climate-related actions.  In scouring the filings of these lawsuits, I develop a typology of the circumstances under which climate-related shareholder claims are likely to be brought and shed light on  where the accuracy of climate disclosures may be over- or under-enforced.

Most climate-related shareholder litigation falls into three categories.  First, many lawsuits relate to what I broadly call “greenwashing.”  Some greenwashing cases involve misrepresentations regarding products such as fuel cells that emit more CO2 than advertised or biodegradable plastics that in fact emit methane. These cases are most often based on facts discovered by short-sellers, who conduct an in-depth investigation of the firm and its products before taking short positions in the firm’s stock and publishing their reports.  Other greenwashing cases relate to practices that violate laws or regulations, such as major energy companies that do not comply with crucial safety regulations, causing massive wildfires.  These have been based exclusively on facts developed by regulators.  The second category of lawsuits involve voluntary disclosures discussing the risks of climate change to the firm’s business and the measures the firm has taken to mitigate these risks.  These cases to date have revolved around voluntary disclosures released by ExxonMobil, which drew scrutiny from state attorneys general for potential violations of state blue sky laws. The facts exposed in these state prosecutions gave rise to shareholder lawsuits.  The third category of cases consists of claims by investors that climate-related shareholder proposals were wrongfully omitted from corporate proxy statements. These cases are, however, less consequential than the other two types, as victory by the plaintiff only results in the inclusion of the proposal rather than damages, and the number of such lawsuits has declined in recent years.

What does this tell us about how private actors enforce the accuracy of climate-related shareholder disclosures? First, virtually all consequential climate-related shareholder litigation consists of follow-on lawsuits, based either on investigative findings by a government regulator or a short-seller report.  This is likely to persist because of the high pleading standards for most shareholder lawsuits; follow-on shareholder litigation is common because plaintiffs must plead specific facts that they could otherwise unearth only with expensive investigations of their own. But in the climate context, this follow-on model means that some misstatements may fall through the cracks.  Although government regulators might investigate the accuracy of climate disclosures for its own sake, other market actors, such as short-sellers, are unlikely to actively dig up misstatements unless those inaccuracies have serious implications for the firm’s business or relatively short-term bottom line.

Consequently, in most cases, the alleged misstatements or omissions actually affected the firm’s bottom line.  The greenwashing cases involve claims that a firm marketed its flagship product as climate-friendly when it wasn’t or stated that it complied with key climate-related regulation when it did not.  The cases about voluntary disclosures involve a petro-giant’s purported misstatements on how it calculated the costs of transitioning away from a carbon economy, allegedly causing it to write down $2 billion in assets. Shareholder litigation has so far arisen where bad facts have already been revealed either by the government or by market participants willing to do substantial digging, usually because they have an interest in the offending firm’s short-term financial prospects.  Put another way, climate-related shareholder litigation, like other shareholder litigation, follows  the money.

If the SEC’s proposed disclosures become mandatory, claims that a firm engaged in greenwashing may not increase in number but may be more successful as the requirements are more clearly defined.  Claims involving firms’ disclosures of climate risks to their businesses are likely to proliferate as rising floodwaters and drought, as well as more intense  regulatory scrutiny and public pressure, increasingly affect the bottom line.

As for misstatements that don’t   fundamentally affect a firm’s business, such as greenhouse gas disclosures,  I argue that they are likely to go undetected without government intervention.  Many large public companies alreadyissue voluntary reports on their greenhouse gas emissions.  Yet not one of the lawsuits in my sample challenges their accuracy, probably for two reasons.  First, inaccuracies in such disclosures may be difficult to detect.  Second, unless such inaccuracies have a substantial effect on the firm’s business, few market participants have any incentive to try to detect them.

Although climate activist investors who pushed so hard for the SEC’s draft climate disclosures seem like obvious candidates to conduct investigations, these groups almost never sue and generally do not publish investigative reports that would facilitate shareholder lawsuits for others.  This means that, for items such as greenhouse gas disclosures, an enforcement gap may persist if the government does not do the heavy investigatory lifting.  But if government investigations are the sole basis for climate-related shareholder lawsuits, private enforcement in this area will be duplicative of government enforcement, and both types will wane in administrations where climate disclosures are enforced less rigorously.  Though accuracy of climate-related disclosures is essential, it is unclear whether shareholder litigation is up to the job of enforcing it.

ENDNOTE

[1] SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors, March 21, 2022, https://www.sec.gov/news/press-release/2022-46.

This post comes to us from Emily Strauss, visiting professor at the University of California Berkeley School of Law and lecturing fellow at Duke University School of Law. It is based on her recent paper, “Climate Change and Shareholder Lawsuits,” available here.

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