Juridische procedures en ESG
Legal actions and the responsible investor
by Marcel Jeucken, founder and director SustFin BV
Note and disclaimer: This is a Deepl translation of the original article in Dutch that has been published in Financial Investigator, March 2022. The translation is for personal use or can be used in alternative ways as long referencing the original source on this website.
The world of legal actions and responsible investing is becoming increasingly connected. This extends from risk to the position of the investor himself, to investment risk and opportunity for the responsible investor.
Although a few institutional investors have already thought about and developed policy and approach in the field of legal proceedings on share ownership, whether as part of ESG policy or responsible investment policy focused on ESG factors or not, the interface between responsible investment and legal proceedings is still unknown territory for many. There are often two separate worlds.
The experience with and acceptance of legal actions differs from country to country. Whereas it is already more commonplace in the United States, it is much less so in the Netherlands. However, the instrument of legal action is also gaining ground here. Legal actions can: 1. be initiated by investors, 2. be initiated by other interested parties and directed at companies in which they invest, and 3. be directed at the investor himself.
Legal issues started by investors
Institutional investors can initiate, support or passively (via class actions) participate in legal proceedings themselves. This requires active monitoring and analysis of possible cases. Class actions and active forms of legal proceedings in the field of share ownership are usually better known. Less well known are the opt-in (outside the US) and opt-out (inside the US) variants and possibilities within other investment categories or parts of the investment organization. Antitrust cases surrounding FX fixing are an example of the latter. All of these actions offer the possibility of achieving compensation for financial losses suffered and/or achieving ESG objectives and thus also have a preventive effect.
ESG improvements can also be the reason for initiating a case (as (co-)lead plaintiff or via opt-in), or for doing an opt-out (because the designated lead plaintiff(s) does not sufficiently insist on ESG improvements). A well-known example is the settlement reached by PGGM as co-principal plaintiff in the case against Bank of America concerning deception around a takeover situation. In addition to damages for the 'class' of approximately $2.5 billion, a package of corporate governance improvements was enforced. Legal actions can also be relevant in impact investing. An example is the case against QuantumScape Corporation, which, partly because of an expected 'green premium', is alleged to have misled investors about the inadequate battery technology for the electrification of cars.
By the way, in the US there does not always have to be a deception. An investor can start a so-called 220 route for a company listed in Delaware (this applies to many US companies). This is an interesting tool for concerned shareholders for whom engagement with a company on an ESG issue has been unsuccessful. Via the 220 route, an investor can demand transparency and an audit of the company's policy and ESG activities by means of legal proceedings. Any discrepancies or gaps can then be resolved through a settlement, leading to adjustments within the company and thus limiting any past or future financial and ESG damage for the investor. For example, Swedish pension fund AP7 reached a settlement with Alphabet Inc in 2020 regarding diversity and sexual harassment and US SCERS reached a settlement with 21st Century Inc in 2018 to address harassment, discrimination and other misconduct in the workplace.
Legal cases started by other stakeholders
Institutional investors may also face legal actions initiated by other stakeholders targeting companies or entities in which they have investments or to which they have exposure as investors. Well-known examples are the legal actions targeting tobacco companies, which have resulted in huge settlements. Consider the longstanding settlement with states in the US totaling USD 368 billion.
Other examples are cases due to the use of asbestos (worldwide) or more recently the sale of opioids in the US. These, too, concern human health and therefore have a clear link to ESG. A new development are legal proceedings due to companies' inadequate climate policy. In 2020, Milieudefensie won a case against Shell, forcing it to reduce CO2 emissions by 45% by 2030.
According to a 2021 report by the London School of Economics, approximately 800 cases were filed worldwide between 1986 and 2014, compared to more than 1,000 in the past six years. In the area of climate alone, this growth is expected to continue. Increasingly, an investor needs to understand and manage the investment risks of such legal proceedings and settlements. In a 2021 report, a global network organization of central banks highlighted the importance of adequate oversight of financial institutions' management of these risks.
Legal actions aimed at the institutional investor itself
Legal actions directed at the institutional investor itself are a growing area. This can focus, for example, on misleading the prospectus about the risks of a financial product or on climate policy. Well-known examples in the Netherlands are the share leasing and usury policy affairs. Legal actions are now also focusing on institutional investors with respect to their contribution, or lack thereof, to ESG or sustainability issues. For example, the Australian pension fund REST was sued by a participant for the lack of a climate policy and approach at the fund. This eventually led to a settlement in which the pension fund committed to shaping and implementing a far-reaching climate policy. This includes carrying out scenario analyses, achieving net-zero emissions of CO2 by 2050 and preparing reports in accordance with the TCFD. Closer to home, ABP faced the threat of legal action from fund participants in 2021 because of its investments in fossil energy. The NGO Milieudefensie has ABP and PFZW in its sights in 2022, following its success in the Shell case.
Collaboration of great importance
Every institutional investor should conduct a policy and risk analysis on the three dimensions mentioned above. It is advisable that this not take place in isolation from the legal department, but in cooperation with the investment department, ESG specialists, product development and communication departments. Every institutional investor should ask itself what the influence of legal actions can be and how cooperation between different bodies can help to achieve the objectives of the (responsible) investment policy. This requires a sound policy, approach and process and should, at a minimum, be a policy item on the governance agenda. In this sense, it is encouraging that some pension funds are meeting in (closed) roundtables to develop a better understanding of the interface between legal procedures and responsible investment.
- The world of legal action and responsible investment is becoming increasingly connected.
- An institutional investor can initiate legal proceedings aimed at financial compensation and/or ESG improvements.
- If another stakeholder initiates legal proceedings, an investor may have to deal with them if they are directed at a company in which the investor invests.
- Legal actions aimed at the institutional investor itself are a growing area.
- This issue requires better understanding and more attention on the governance agenda of every institutional investor.