by Christopher Menendez*
Section 11 of the Securities Act of 1933 imposes liability on issuers of securities for statements that are found to be materially misleading, which are statements containing the type of information a reasonable investor would find significant when making an investment decision. In conjunction with the rising salience of climate issues and concern about “greenwashing,” there has been a push by some investors to bring section 11 claims based on the professed, but ultimately unsuccessful, commitments of companies to combat climate change. However, these claims are unlikely to be successful in combatting greenwashing, as sustainability issues are not normally the sort of information that courts presume investors consider material. This Contribution argues that section 11 is ill-suited to address climate-based misstatements and encourages the adoption of rules the Securities and Exchange Commission has recently proposed to more effectively cover climate disclosures.
As the general public’s awareness of and concern about environmental issues and climate change has increased, so have the number of companies attempting to situate their products and operations within this drive for more sustainable practices. This has led to an increase in “greenwashing,” the act or practice of making a company’s products or operations appear more environmentally friendly than they really are.1 As this practice has become increasingly common in recent years, climate activists and some investors have attempted to utilize tools currently available in the law to combat it, including suits under Section 11 of the Securities Act of 1933 (“Section 11”). Section 11 imposes strict liability on the issuer of a security for making material misstatements or omissions in connection with the issuance of that security.2 As Section 11 demonstrates, materiality lies at the heart of most private suits brought under our securities laws. Courts test materiality by determining whether it is substantially likely that a reasonable investor would have viewed the disclosure of the fact in question to significantly alter the “total mix” of information available when making an investment decision.3 Since climate concerns are generally not the sort of information that courts find material, the traditional materiality analysis, along with exceptions for liability such as puffery and a safe harbor for forward-looking statements, makes Section 11 ill-suited to combat greenwashing in the vast majority of cases.4 In recognition of this reality, the Securities Exchange Commission (“SEC”) recently proposed new rules that create further disclosure duties in this context.5 By creating new environmental disclosure obligations, the SEC will expand the scope of liability to cover certain claims relating to environmental performance that have been left outside court interpretations of materiality. Implementation of these rules would be a positive first step toward addressing greenwashing and should therefore be adopted.
The traditional materiality analysis for Section 11 claims has centered around the core aspects of an issuer’s business, or the aspects that a reasonable shareholder would be substantially likely to consider important in making an investment decision.6 Courts have typically found facts to be material when they directly relate to the profitability of a corporation or a key aspect of its operations, such as safety standards in the context of an issuer engaged in deep water drilling.7 In most cases, the sustainability of a company’s products are peripheral to its business model. For example, a generic shoe company’s ability to maintain a certain profit margin will only center around the biodegradability of its shoes in rare and specific instances. Courts have only found materiality in these arguably tangential aspects of the issuer’s business when an issuer closely aligns them with the company’s success.8 For example, if a shoe company centers its business model on the biodegradability of its shoes, under Section 11 the SEC and courts would likely view biodegradability as material and impose liability for omissions or misstatements regarding this fact. However, this fails to address the typical circumstances of greenwashing.
Section 11 materiality analysis also suggests the SEC would choose whether to impose liability based on an objective standard of the reasonable investor.9 This objective standard further limits the reach of Section 11 liability, because even if one investor may have considered an omitted fact material to their investment decision, courts will still look to a vague conception of what the general pool of investors in the market would have found important.10 While the standards of a reasonable investor may vary depending on the particular security market,11 it is unlikely environmental indicators would be material unless an issuer put them front and center in communications about the offering. The vague nature of the reasonable investor standard has proven to be a source of frustration for practitioners and legal scholars alike.12 The standard offers little concrete guidance to issuers of what investors find to be material and, at the same time, functionally forecloses bringing suits based on greenwashing because environmental concerns traditionally have not been at the forefront of investment decisions until recently, if at all.
In addition to the inherent problems with materiality, the doctrine of puffery and the safe harbor for forward-looking statements under the Private Securities Litigation Reform Act of 1995 (“PSLRA”) further prevent Section 11 claims from effectively addressing greenwashing. Courts have recognized puffery as a defense for issuers in Section 11 actions13 where the statements at issue are optimistic and vague or indefinite in nature.14 Puffery offers a defense to issuers because investors, both professional and amateur, are considered able to sufficiently devalue corporate executives’ optimism.15 In short, Section 11 imposes no liability on puffery statements because no investor would reasonably rely on them when making an investment decision and they therefore cannot be material.16 A more concrete standard for evaluating whether a statement could constitute puffery is whether it could be “proven or disproven using standard tools of evidence.”17 Puffery adds another barrier to considering an environmentally-conscious investor because many issuers speak about environmental, social, and governance (ESG) standards with vague language. Such statements are in many cases analogous to claims that an issuer will “do business with integrity and respect for the environment.”18 While such a statement might give a general impression of environmental consciousness, it is difficult to measure what the statement means. Does respect for the environment mean minimal emissions, or simply that an issuer will choose a sustainable production method when economically feasible? This vagueness makes it difficult for a court to impose liability without more concrete statements from the issuer and present regulations provide no incentive for an issuer to do so.
Similarly, the safe harbor provision for forward-looking statements shields an issuer from liability if the forward-looking statement is “accompanied by meaningful cautionary statements” identifying factors that could have an impact on the statement’s subject matter and cause it to differ from what the issuer has communicated.19 An issuer will not be liable for making aspirational statements about an environmental goal as long as they are “adequately tinged with caution.”20 The rationale for the provision is that a reasonable investor is assumed to know that such statements are aspirational and not a concrete statement about the current state of the issuers’ operations.21 This is problematic in the context of greenwashing because statements about the future are usually also an implicit assertion that the statements are feasible given the current state of a company’s operations. For example, an issuer’s statement that it seeks to have 80% of its product line completely biodegradable by a certain date implies that a non-insignificant percentage of its product line has already reached that threshold or is close to reaching it. However, the PSLRA standard suggests that as long as the forward-looking statement includes cautionary descriptors that could impact the feasibility of this goal, an investor is not able to successfully bring suit if only a small portion of the issuer’s product line is currently biodegradable.22 This safe harbor consequently creates a gap in our securities regime where greenwashing may thrive, and where issuers are able to make statements that give an impression of their commitment to sustainable practices that are not actually consistent with their current business and practices.
Section 11’s shortcomings in addressing issues related to environmental disclosures have not gone unnoticed by the SEC, and the commission recently proposed new rules in March 2022, to address the issue.23 These new rules would specifically impose disclosure duties on issuers for climate-related risks reasonably likely to have a material impact on a public company’s business and the issuer’s greenhouse gas emissions, as well as require the inclusion of climate-related financial metrics in the issuer’s financial statements.24 These proposed rules and the imposition of a duty to disclose greenhouse gas emissions are a significant step toward combatting greenwashing for two reasons. First, rules of this type have been referred to as “name and shame” rules because the obligation to disclose is likely to influence corporate behavior.25 Issuers are likely to want to avoid being seen as major contributors to climate change. Second, these disclosure duties will reduce the number of misleading environmental claims from issuers. Issuers will be presented with a choice of either reducing the optimism of such claims to bring them in line with their actual disclosed practices, or face suits from investors arguing that their own disclosures show that the challenged claims are materially misleading.
However, the proposed rules alone do not solve many of the present problems with climate-related statements. First, the rules do not create a general imposition of liability for greenwashing. Issuers would still be likely to make vague commitments and statements about areas uncovered by these rules, such as biodegradability, and evade liability for failing to meet their aspirational standards. Second, these proposed rules may not be adopted because members of the SEC and issuers have pushed back on them.26 These critics argue that combatting climate change is not within the SEC’s mission.27 And, lastly, these rules are likely to be challenged on First Amendment grounds just as prior name and shame provisions have been.28
The SEC’s proposed rules reflect the increasing public interest in ESG initiatives, suggesting investors may start paying closer attention to climate issues and the role corporations play in them.29 While these rules would impose new disclosure burdens on issuers, they would also facilitate the efficient allocation of capital by allowing investors to accurately invest in companies that are making serious efforts to reduce their carbon footprint. Such measures are likely necessary to ensure that the United States remains competitive in the emerging green economy. Even if the proposed rules do not completely stamp out the issue of greenwashing, they represent a significant and encouraging step toward closing a major gap within our securities regime.
* Christopher Menendez is a J.D. Candidate (2023) at New York University School of Law. This Contribution arose from the problem presented at the 2022 Irving R. Kaufman Memorial Securities Law Moot Court Competition hosted by Fordham University School of Law. The question presented asked whether an issuer’s statements about sustainability and the biodegradability of its products were materially misleading under a Section 11 claim. This Contribution presents a distillation of arguments from the competition and does not necessarily represent the views of the author.
1. Merriam-Webster, “Greenwashing” Definition, https://www.merriam-webster.com/dictionary/greenwashing (Oct. 20,2022).
2. 15 U.S.C. § 77k.
3. Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 38 (2011) (quoting Basic Inc. v. Levison, 485 U.S. 224, 232 (1988)).
4. See In re Cutera Sec. Litig., 610 F.3d 1103, 1111 (9th Cir. 2010) (holding that investors can sufficiently “devalue the optimism of corporate executives” and puffery therefore is not materially misleading); see also 15 U.S.C. § 77z-2(c) (providing safe harbor for forward-looking statements).
5. SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors, SEC (Mar. 21, 2022), https://www.sec.gov/news/press-release/2022-46.
6. See TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
7. See Bricklayers & Masons Local Union No. 5 Ohio Pension Fund v. Transocean Ltd., 866 F. Supp. 2d 223, 243 (S.D.N.Y. 2012).
8. In re Massey Energy Co. Sec. Litig., 883 F. Supp. 2d 597, 615 (S.D.W.V. 2012) (finding statements about safety to be material when the energy company issuer placed emphasis on them in press releases, quarterly and annual SEC filings, and in conferences with analysts).
9. United States v. Litvak, 889 F.3d 56, 64 (2d Cir. 2018).
10. See id. at 65 (holding there must be evidence of a nexus between the views of one specific trader and the mainstream belief of investors in a particular market).
11. See id. (asserting as part of its materiality analysis that courts can assume the reasonable investor in a market that only institutional investors trade in is more sophisticated than the reasonable investor in a market that includes many individual investors).
12. See Amanda Rose, The “Reasonable Investor” of Federal Securities Law: Insights from Tort Law’s “Reasonable Person” & Suggested Reforms, 43 J. Corp. L. 77 (2016) (comparing the costs of the reasonable investor standard to tort law’s reasonable person standard, and suggesting changes to the doctrine).
13. See In re Cutera Sec. Litig., 610 F.3d 1103, 1111 (9th Cir. 2010).
14. See Boca Raton Firefighters & Police Pension Fund v. Bahash, 506 Fed. App’x. 32, 37 (2d Cir. 2012).
15. In re Cutera Sec. Litig., 610 F.3d at 1111.
16. In re Fusion-io, Inc. Sec. Litig., No. 13-CV-05368-LHK, 2015 WL 661869, at *14 (N.D. Cal. Feb. 12, 2015).
17. See City of Monroe Emps. Ret. Sys. v. Bridgestone Corp., 399 F.3d 651, 674 (6th Cir. 2005).
18. See Commitments, Policies and Standards, Shell, https://www.shell.com/investors/environmental-social-and-governance/commitments-policies-and-standards.html (last visited Nov. 8, 2022).
19. 15 U.S.C. § 78u-5(c)(1)(A).
20. In re Synchrony Fin. Sec. Litig., 988 F.3d 157, 172 (2d Cir. 2021).
22. See Reiner v. Teladoc Health, Inc., No. 18-CV-11603, 2020 U.S. Dist. LEXIS 163686, at *27 (S.D.N.Y. Sep. 4, 2020) (holding an undisclosed breach of company standard of conduct inactionable when statements at issue are explicitly aspirational).
23. SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors, SEC (Mar. 21, 2022), https://www.sec.gov/news/press-release/2022-46.
25. See generally Keith Paul Bishop, SEC (Securities and Exchange Commission) Conflict Mineral Rules: Name and Shame No More?, Nat’l L. Rev. (Apr. 15, 2014), https://www.natlawreview.com/article/sec-securities-and-exchange-commission-conflict-minerals-rules-name-and-shame-no-mor.
26. See Colin J. Diamond et al., SEC Proposes Long-Awaited Climate Change Disclosure Rules, White & Case (Mar. 24, 2022), https://www.whitecase.com/insight-alert/sec-proposes-long-awaited-climate-change-disclosure-rules; Hester M. Pierce, We Are Not the Securities and Environment Commission – at Least Not Yet, SEC (Mar. 21, 2022), https://www.sec.gov/news/statement/peirce-climate-disclosure-20220321.
27. See Pierce, supra note 26.
28. See Nat’l Ass’n of Mfrs. v. SEC, 800 F.3d 518, 530 (D.C. Cir. 2015) (“By compelling an issuer to confess blood on its hands, the statute interferes with that exercise of the freedom of speech under the First Amendment.”).
29. See generally Georg Kell, The Remarkable Rise of ESG, Forbes (Jul. 11, 2018), https://www.forbes.com/sites/georgkell/2018/07/11/the-remarkable-rise-of-esg/?sh=74f775941695.