Reported by James J. Park is a Professor of Law at UCLA

The 2019 collapse of the Brumadinho dam in Brazil not only released 12 million tons of mining waste and took 270 lives, it prompted the filing of a major securities fraud enforcement case in the United States by the Securities & Exchange Commission (SEC). Vale, the public corporation that owned the dam, had New York Stock Exchange-traded securities, which lost 25 percent of their value in the wake of the crisis. The government lawsuit argued that Vale misled investors about the risk of its 2019 dam collapse, not only in the quarterly reports it must file with the SEC as a public company, but also in sustainability reports that it had voluntarily provided to investors.

The Vale case, which resulted in the payment of $55 million to settle the SEC’s action, is one of a number of high-profile securities fraud cases filed over the last decade by the SEC and investors alleging that a public company misled investors about the risk of a scandal or disaster. Such enforcement has coincided with the growing importance of Environmental, Social, and Governance (ESG) matters to the modern public corporation. Investors are more concerned about the economic risks of corporate misconduct, which can result in reputational harm and governmental sanction.

Partly to reassure investors, public corporations are increasingly issuing ESG disclosures. Many of these disclosures are voluntary and provide representations about a company’s efforts to manage ESG risk. The SEC has also recently proposed significant mandatory disclosure requirements relating to ESG issues such as climate change and cybersecurity. As corporations increasingly make representations about their management of ESG risk, there will be more opportunities to contend that they misrepresented such risks. Some commentators have described ESG securities fraud cases as event litigation, where any corporate event that causes a significant stock price decline could potentially violate Rule 10b-5.

The criticisms of ESG securities fraud cases in many ways mirror longstanding concerns about Rule 10b-5 litigation arising out of business failures. Whenever a business suffers a significant setback that prompts its stock price to fall, there is an opportunity for investors to argue that corporate managers misrepresented the risk of such a setback. Such litigation often turns on the extent to which the corporate defendant and its agents had knowledge about such risk and issued misleading statements denying the existence of the risk. Like cases involving the misrepresentation of a business risk, cases alleging misrepresentations about ESG risk are complicated partly because they involve assessing knowledge about the risk of failure rather than a setback that is known. On the other hand, ESG securities fraud cases differ from business failure risk cases because they relate to deceptions concerning a wider range of risks that can be more difficult for corporate managers to predict.

Because of the concerns relating to adjudicating ESG risk, courts have aggressively dismissed ESG securities cases, particularly those brought by private plaintiffs. They have done so primarily by applying the puffery doctrine, a longstanding presumption that rosy statements of optimism should not be taken literally. For example, if a company claims that it is “committed to product safety,” even if it knows there is a high risk that its products are defective, a court may find under the puffery doctrine that there was no material misrepresentation to investors.

This Article argues that the current approach taken by courts in deciding ESG securities fraud cases, which emphasizes the puffery doctrine, misses the core issue raised by these cases, and should be replaced by a more holistic approach that emphasizes assessment of the materiality of the ESG risk at issue.

Read full report: https://corpgov.law.harvard.edu/2023/05/15/esg-securities-fraud/