As we have discussed in previous chapters of our ESG Handbook, companies are under increasing pressure to improve the sufficiency and transparency of their ESG disclosures. The universe of stakeholders seeking to hold companies accountable with respect to the implementation and progress of their ESG policies is broad and includes, among others, investors, consumers, regulators, and employees.
In their efforts to demonstrate to these stakeholders their commitment to sustainability and ethical labor practices, it is important that companies consider the risks inherent in incorporating ESG initiatives into their strategic and operational plans and give careful consideration to how to manage those risks.
In this chapter, we will review the principal types of claims presented by ESG factors and provide strategic advice for mitigating those risks. The chapter concludes with a discussion of the types of insurance coverage that may be available to policyholders for certain ESG-related risks.
The heightened level of scrutiny placed on ESG-related subjects in recent years has given rise to a corresponding increase in shareholder litigation risk under the federal securities laws and common law. This section provides an overview of the types of ESG-related shareholder claims filed over the past several years, both directly and derivatively, and presents a number of suggested best practices for public companies and their boards and officers.
ESG CLAIMS BROUGHT BY SHAREHOLDERS
Federal and state securities laws establish causes of action in favor of shareholders and prohibit false or misleading statements of material fact or omissions of material fact in connection with the purchase or sale of securities. These claims have most commonly been brought under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (Exchange Act), Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission (SEC), 17 C.F.R. § 240.10b-5, and Sections 11 and 12 of the Securities Act of 1933, 15 U.S.C. §§ 77k, 77l (Securities Act). Liability for ESG-related misstatements or omissions under these securities laws may extend beyond the issuer of the securities to the individual directors and officers who:
- Disseminated or approved false statements which they knew to be misleading (or recklessly disregarded their misleading nature);
- Failed to disclose the material facts necessary to avoid misleading statements; or
- Exercised control over the issuer of the securities.
In addition to direct actions under the federal securities laws,1 shareholders also can and have initiated putative derivative actions against corporate directors and officers alleging that the corporation itself has been harmed by its own allegedly false or misleading ESG disclosures under Sections 10(b), 14(a), and 20(a) of the Exchange Act. These claims often are paired with common law breach of fiduciary duty claims brought against individual directors and officers, alleging that these individuals breached their duties of care and loyalty to the company.
Although ESG disclosures have drawn increasing interest from the plaintiffs' bar in recent years, the underlying legal standards governing the claims are well established. ESG-related shareholder claims are subject to the same pleading standards applicable to other shareholder claims. Claims alleging fraud are subject to the stringent pleading standard imposed by Fed. R. Civ. P. 9(b), and putative class action claims alleging securities fraud are subject to the even more demanding pleading standard imposed by the Private Securities Litigation Reform Act of 1995.
Claims based upon disclosures or other statements that are nonactionable "puffery,"2 expressions of opinion, or forward looking and accompanied by meaningful cautionary language are susceptible to attack by motion whether or not the statements are ESG-related. Similarly, courts have dismissed some ESG-related shareholder claims based on statements that courts found to be aspirational or overly general and, thus, not actionable. See, e.g., Fogel v. Vega, 759 F. App'x 18, 23 (2d Cir. 2018) (holding "general statements about honesty and integrity, including those about general compliance with the law, are not sufficient to state a claim"); Ocegueda v. Zuckerberg, 526 F. Supp. 3d 637 (N.D. Cal. 2021) (dismissing Section 14(a) claim because statement in proxy that Facebook was "committed" to diversity was aspirational and not actionable); City of Pontiac Gen. Emps.' Ret. Sys. v. Bush, 2022 WL 1467773 (N.D. Cal. Mar. 1, 2022) (dismissing Section 14(a) claim because statements in proxy that Cisco "embraces diversity" and "believes it is important to consider diversity of race . . . in evaluating board candidates" were merely aspirational); Reiner v. Teladoc Health, Inc., 2021 WL 4451407, *13 (S.D.N.Y. Sept. 8, 2021) report and recommendation adopted by 2021 WL 4461101 (S.D.N.Y. Sept. 29, 2021) (statement that all directors, officers, and employees "are expected to comply with all provisions of this Code [of ethics]" deemed "aspirational and hortatory").
As discussed below, ESG-related shareholder litigation can stem from allegedly false or misleading public disclosures issued by a company about its ESG-related policies or practices, or from a company's alleged mishandling of ESG-related events.
Environmental issues:
Climate change, sustainability, greenwashing, and environmental disasters
Although only recently labeled as "ESG-related," claims based upon alleged false or misleading environmental-related statements are not a new phenomenon.
For example, in the aftermath of the Deepwater Horizon oil spill, dozens of individual investors brought claims based on both English common law and federal securities laws that ultimately were consolidated in a multi-district litigation in the Southern District of Texas as In re BP P.L.C. Securities Litigation. The shareholders alleged that the company made numerous material misrepresentations in public statements about the impact of the spill, including statements regarding the flow rate of the oil spill, BP's emphasis on and commitment to process safety, and BP's ability to respond to an oil spill. On a motion to dismiss several related complaints,3 the court dismissed many of these statements as not actionable because they reflected opinion, were future-looking, or were not false, or because the plaintiffs failed to adequately plead scienter. In other suits, shareholders have alleged material misrepresentations in public statements concerning the risks of climate change or the impact of climate-related governmental policies.4 Public statements about a company's products have also been the target of ESG-related suits, where shareholders have targeted purported misrepresentations about a product being safe, eco-friendly, biodegradable, or recyclable.5
Social issues:
Diversity and inclusion, sexual harassment and misconduct, discrimination, and workplace culture
Shareholders have filed putative derivative actions based upon allegedly false or misleading allegations about a company's commitment to diversity on the board or among executives.
In Ocegueda v. Zuckerberg, 526 F. Supp. 3d 637 (N.D. Cal. 2021), for example, a shareholder brought a derivative action related to Facebook's alleged lack of diversity on its board, among senior management, and in its workplace, as well as Facebook's alleged discriminatory advertising practices and failure to curb hate speech on its platform. The plaintiff claimed that Facebook's directors breached their fiduciary duties through these actions. Additionally, specifically with respect to the alleged lack of diversity, the plaintiff asserted a claim under Section 14(a) of the Exchange Act, alleging that statements made in 2019 and 2020 proxy statements were materially false because they indicated that Facebook was committed to diversity, which the plaintiff purported to contrast with statistics about the demographics of directors, officers, and employees of Facebook.6 (The court dismissed the complaint because the complaint alleged "conclusions," "not facts" concerning the board's commitment to diversity.)
In City of Pontiac General Employees' Retirement System v. Bush, 2022 WL 1467773 (N.D. Cal. Mar. 1, 2022), the plaintiff brought a derivative action asserting claims under Section 14(a) of the Exchange Act based upon Cisco's statements that it "embraces diversity across the spectrum at every level," that "[d]iversity, inclusion, collaboration, and technology are fundamental to who we are," and that the Cisco "Board believes it is important to consider diversity of race . . . in evaluating board candidates in order to provide practical insights and diverse perspectives." The court held that these statements were nonactionable because "they were neither misleading nor material to investors." Additionally, the #MeToo movement has led to suits related to sexual harassment or misconduct by directors or senior executives,7 along with claims related to an allegedly "toxic" workplace environment.8
Governance issues:
Internal controls, mismanagement, data breaches, and executive compensation
Shareholders have long scrutinized board governance and have asserted claims based upon alleged failure to implement internal controls to address product safety issues,9 properly manage and protect customer data,10 or adequately control executive compensation and perks.11 For example, in In re Marriott International, Inc. Customer Data Security Breach Litigation, 2021 WL 2401641 (D. Md. June 11, 2021), aff'd, 31 F.4th 898 (4th Cir. 2022), a shareholder brought a derivative action asserting claims under Sections 10(b), 14(a), and 20(a) of the Exchange Act, as well as Rules 10b-5 and 14a-9, in addition to state common-law claims including a claim for mismanagement of the company, related to the breach of the guest reservation data of Starwood Hotels and Resorts Worldwide after Marriott acquired Starwood. Under Sections 10(b) and 20(a), the plaintiffs alleged material misrepresentations regarding the importance to the company of protecting customer privacy, privacy statements on Marriott's website, and cybersecurity risk disclosures. The court dismissed these claims because the plaintiff failed to adequately plead materiality, scienter, or loss causation. The court also dismissed the Section 14(a) claim because the alleged misrepresentations pertained to the officers' and directors' compliance with a code of ethics, which included safeguarding customer data. The court reasoned that this was essentially a claim that the defendants violated the code of ethics because they "did not disclose their own mismanagement," and that Section 14(a) does not "impose a freestanding disclosure requirement, particularly regarding unadjudicated allegations." Id. at *14. In another data breach case, shareholders in In re Facebook, Inc. Securities Litigation, 405 F. Supp. 3d 809 (N.D. Cal. 2019), brought claims under Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5, alleging that Facebook directors and officers made materially false or misleading public statements regarding Facebook's response to data misuse and privacy violations, including the Cambridge Analytica breach; failed to disclose the existence and magnitude of the risk created by Facebook's failures to protect user privacy; and misled investors by assuring them that Facebook was compliant with European privacy laws. The court dismissed plaintiffs' claims because the statements were forward-looking or "puffery," were not sufficiently alleged to be false, or relied on documents on which a reasonable investor would not consult when making purchasing decisions, such as Facebook's privacy policy.
Shareholders also have asserted derivative claims against directors claiming their oversight failures led to illegal activity. For example, in In re Telefonaktiebolaget LM Ericsson Securities Litigation, Case No. 1:22-cv-01167 (E.D.N.Y.), shareholders brought a derivative action under Sections 10(b) and 20(a) of the Exchange Act alleging that the defendants materially misled investors and failed to disclose that the company, which had already been fined more than $500 million on two occasions for bribery, allegedly had bribed ISIS in order to continue operations in Iraq. Specifically, the plaintiff alleged material misrepresentations in statements related to the company's internal controls and anti-bribery program, compliance with the company's code of ethics, and the company's zero tolerance for corruption. The defendants, as of this writing, have not responded to the complaint, and it remains to be seen whether these alleged misrepresentations will fare better than similar statements in other cases.
THE RISE OF OVERSIGHT CLAIMS AND IMPACT OF BOOKS-AND-RECORDS DEMANDS
Though a number of ESG-related cases have failed to survive the pleading stage,12 plaintiffs have found some recent success in cases asserting claims based upon alleged board failure to adequately perform its oversight duties.
Such oversight claims, also known as Caremark13 claims, have historically been regarded as among the most difficult for plaintiffs to prove. Caremark claims require plaintiffs to show that the directors either completely failed to implement reporting systems or controls or, if the controls are in place, consciously failed to monitor or oversee the controls such that they kept themselves uninformed of risks or problems.14 In Marchand and Boeing,15 however, both of which involved claims related to safety issues, the plaintiffs succeeded in pursuing Caremark claims in large part because, before they filed their respective derivative claims, they utilized books-and-records demands under Section 220 of the Delaware General Corporation Law (Section 220). Section 220 allows stockholders to access the corporation's books and records for a "proper purpose." 8 Del. C. § 220(b). Historically, courts gave corporations latitude to object to Section 22016 demands where it appeared stockholders were merely fishing for evidence of misconduct with no meaningful prospect for success. In recent years, however, courts and commentators have been increasingly skeptical of corporations' efforts to refuse demands under Section 220 and have begun to expand the boundaries of shareholder rights under the Section.17 This broader interpretation of Section 220 has led to a dramatic increase in the number of ESG-related Section 220 demands and related litigation.
An example of a recent ESG-related Section 220 demand is Sjune AP-Fonden v. Activision Blizzard, Inc., C.A. 2022-0281-KSJM (Del. Ch. 2022). In that case, a stockholder of Activision Blizzard, Inc. (Activision) pursued a Section 220 demand related to Activision's alleged culture of sexual harassment and discrimination. The demand sought, among other documents, board materials regarding Activision's planned sale to Microsoft and the compensation and employment of Activision's chief executive officer (CEO), Robert Kotick. After Activision refused the Section 220 demand, the stockholder filed a complaint in the Delaware Court of Chancery for the inspection of books and records.
The complaint alleges that Activision's planned sale to Microsoft was put into place to take advantage of the company's depressed stock price, which was the result of the ongoing scandals at the company. The complaint further alleges that the planned sale to Microsoft was an improper attempt to protect Mr. Kotick from calls for his termination because the planned sale would keep him as CEO during the sale and allow him to cash out his stock options. As of this writing, the Chancery Court granted a joint stipulation of the parties to stay the Section 220 action while the parties attempt to resolve the demand privately.
The Activision case is just one example of an increase in Section 220 demands related to ESG claims—a practice that the plaintiffs in Marchand and Boeing employed with success. In both Marchand and Boeing, the plaintiffs were able to base their claims on what the books and records did not show: (1) the lack of a board committee charged with addressing safety issues; (2) no protocol requiring management to report on safety issues; and (3) no discussion identified in board minutes related to safety issues. In Boeing, after the company made changes, such as the establishment of a board committee to oversee and ensure safety and a mandatory safety reporting program, the parties engaged in mediation to discuss the actions Boeing had already taken, as well as additional governance proposals from the plaintiffs. Ultimately, the parties reached a settlement agreement that incorporated governance changes (such as, in addition to steps Boeing had already taken, the election of an additional board member with engineering or product safety oversight experience), as well as a landmark monetary settlement of $237.5 million. This trend, therefore, underscores the importance for directors to identify critical ESG and oversight issues and build and maintain a proper record of these issues, to reflect their efforts and avoid distracting and expensive challenges to their oversight activities.
Footnotes
1. Shareholders can also bring claims under state securities laws. For example, in Smith v. Firexo Grp. Ltd., 3:21-cv-2266 (N.D. Ohio), the plaintiff brought claims under both federal and Ohio securities laws, as well as a common law fraudulent misrepresentation claim, alleging that the defendant, a manufacturer of fire extinguishers, induced plaintiff's investment by misrepresenting that its fire extinguisher was eco-friendly and had attained a European safety certification. As of this writing, the defendant has filed an answer to the plaintiff's second amended complaint, but no further action has occurred in the case.
2. See, e.g., Singh v. Cigna Corp., 918 F.3d 57, 64 (2d Cir. 2019) (statements which "suggest[] a company actively working to improve its compliance efforts, rather than one expressing confidence in their complete (or even substantial effectiveness" deemed to be "a textbook example of puffery")); UA Local 13 Pension Fund v. Sealed Air Corp., 2021 WL 2209921, *4 (S.D.N.Y. June 1, 2021) (deeming to be puffery as "too generic" and lacking in "enforceable standards" statements which "described Sealed Air's and its employees' responsibility to conduct business ethically").
3. In re BP P.L.C. Sec. Litig., 2017 WL 7037706 (S.D. Tex. June 30, 2017); see also In re BP P.L.C. Sec. Litig., 2013 WL 6383968 (S.D. Tex. Dec. 5, 2013).
4 See, e.g., Ramirez v. ExxonMobil Corp., 334 F. Supp. 3d 832 (N.D. Tex. 2018) (with the exception of one claim dismissed for failure to sufficiently plead scienter, investors adequately pleaded securities fraud claims that Exxon and Exxon officials made material misstatements concerning the company's use of proxy costs for carbon in business and investment decisions). The Ramirez case is still pending and, as recently as June 2022, the parties are litigating the plaintiff's motion for class certification.
5 Smith v. Firexo Grp. Ltd., supra n.1; In re Danimer Sci. Inc. Sec. Litig., Master File No. 1:21-cv-02708 (E.D.N.Y.) (asserting claims under Sections 10(b), 14(a), and 20(a) of the Securities Exchange Act, and related regulations, as well as Sections 11, 12(A)(2), and 15 of the Securities Act, alleging material misrepresentations in connection with the acquisition of Danimer regarding the development of a 100% fully biodegradable plastic alternative).
6 See also Elliemaria Toronto ESA v. NortonLifelock Inc., 2021 WL 3861434 (N.D. Cal. Aug. 30, 2021) (alleging a claim under Section 14(a), as well as common law claims, including breach of fiduciary duty, related to statements in proxies indicating that the company was committed to diversity).
7 Constr. Laborers Pension Tr. for S. Cal. v. CBS Corp., 433 F. Supp. 3d 515 (S.D.N.Y. 2020) (asserting claims under Sections 10(b) and 20(a) of the Exchange Act based on misrepresentations and failure to disclose the risk that the head of CBS, Les Moonves, would be exposed for his alleged sexual misconduct); Ferris v. Wynn Resorts Ltd., 462 F. Supp. 3d 1101 (D. Nev. 2020) (asserting claims under Sections 10(b) and 20(a) alleging misrepresentations and failure to disclose risks related to alleged sexual misconduct of the CEO, Stephen Wynn); In re Liberty Tax, Inc. Sec. Litig., 435 F. Supp. 3d 457 (E.D.N.Y. 2020) (asserting claims under Sections 10(b), 14(a), and 20(a) of the Exchange Act related to misrepresentations and failure to disclose risks related to alleged sexual misconduct of the CEO).
8 Chau v. Musk, Case No. 1:22-cv-00592 (W.D. Tex.) (derivative claim alleging breach of fiduciary duty in directors' failure to perform oversight duties and allowing an allegedly toxic workplace culture to persist at Tesla, Inc.); see also Section V, infra.
9 Marchand v. Barnhill, 212 A.3d 805 (Del. 2019) (holding that, in derivative action, plaintiff sufficiently alleged that directors failed to implement reporting and monitoring protocol to address safety issues, resulting in a listeria outbreak in the company's ice cream factories); In re Boeing Co. Derivative Litig., 2021 WL 4059934 (Del. Ch. Sept. 7, 2021) (holding that, in derivative action, plaintiff sufficiently alleged that directors failed to implement reporting and monitoring protocol to address safety issues, resulting in two crashes of the company's 737 MAX airplane); In re Yum! Brands, Inc. Sec. Litig., 73 F. Supp. 3d 846 (W.D. Ky. 2014) (asserting claims under Sections 10(b) and 20(a) alleging failure to disclose suppliers' unfavorable food safety test results).
10. Nelson v. Bezos, Case No. 2:22-cv-00559 (W.D. Wash.) (derivative action alleging breach of fiduciary duty for Amazon's alleged failure to properly manage and protect biometric data in violation of Illinois state law).
11. In re Willis Towers Watson Plc Proxy Litig., 937 F.3d 297 (4th Cir. 2019) (reversing district court's dismissal of complaint alleging material omissions in proxy statements related to conflict of interest in merger and negotiation of executive compensation agreement in violation of Sections 14(a) and 20(a) of the Exchange Act).
12 See, e.g., Ocegueda v. Zuckerberg, 526 F. Supp. 3d 637 (N.D. Cal. 2021); Falat v. Sacks, 2021 WL 1558940 (C.D. Cal. Apr. 8, 2021); Kiger v. Mollenkopf, 2021 WL 5299581 (D. Del. Nov. 15, 2021); In re Yum! Brands, Inc. Sec. Litig., supra n.9.
13 In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996).
14 Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370 (Del. 2006).
15 See Yum! Brands, Inc., supra n.9.
16 In Pettry v. Gilead Scis., Inc., 2020 WL 6870461, at *2 (Del. Ch. Nov. 24, 2020), the Court of Chancery lamented that the defendant corporation "exemplified the trend of overly aggressive litigation strategies by blocking legitimate discovery, misrepresenting the record, and taking positions for no apparent purpose other than obstructing the exercise of Plaintiffs' statutory rights." The Court further noted that feeshifting may be appropriate in such circumstances. See also In re Facebook, Inc. Section 220 Litig., 2019 WL 2320842 (Del. Ch. May 30, 2019) (rejecting Facebook's opposition to plaintiff's Section 220 demand, noting that Facebook's "implicit suggestion" that the court must consider the merits of a Caremark claim before allowing an inspection demand is improper and that the "credible basis" standard for a Section 220 demand "imposes the lowest burden of proof known in our law"); James D. Cox et al., The Paradox of Delaware's "Tools at Hand" Doctrine: An Empirical Investigation, 75 Bus. Law. 2123, 2151 (2020) ("Delaware should give serious consideration to awarding plaintiffs their attorneys' fees in cases where the defendants make untoward efforts to delay the resolution of these summary cases."); Randall Thomas, Improving Shareholder Monitoring of Corporate Management by Expanding Statutory Access to Information, 38 Ariz. L. Rev. 331, 335 (1996) (arguing that for Section 220 to facilitate effective stockholder monitoring, it must be significantly streamlined, including shifting attorneys' fees to deter frivolous refusals to produce information).
17 See, e.g., Lebanon Cnty. Emp. Ret. Fund v. AmerisourceBergen Corp., 2020 WL 132752 (Del. Ch. Jan. 13, 2020), aff'd, 243 A.3d 417 (Del. 2020) (holding that a stockholder is not required to state the objectives of his investigation, nor is he required to show that the alleged wrongdoing was actionable); Employees' Ret. Sys. of Rhode Island v. Facebook, Inc., 2021 WL 529439, at *8 (Del. Ch. Feb. 10, 2021) (holding that plaintiffs are entitled to materials beyond just formal board materials).
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