The New 'Reasonable Investor' and Changing Frontiers of Materiality: Increasing Investor Reliance on ESG Disclosures and Implications for Securities Litigation

Abstract

Over the past decade, a growing number of investors has expressed interest in sustainability-related data pertaining to companies in their portfolios. They have been demanding that companies officially disclose more of their environmental, social, and governance (ESG) risks. These investors, and a host of scholars, have been arguing that ESG data is relevant to effective asset management, and thus that it is legally “material” for their purposes. This trend undermines a traditional approach in U.S. securities doctrine that has defined materiality in relation to the needs of the “reasonable investor”, interpreting that as limited to statements concerning financial performance. The increased demand for ESG disclosures by investors challenges a traditional characterization of the “reasonable investor”, and, by extension, the scope of “material” corporate disclosures.

A number of recent securities cases highlight incongruities between established securities doctrine and the needs and expectations of contemporary investors. These cases are prompted by the increased prevalence of voluntary corporate ESG disclosures in securities reporting like in form 10-K, as well as by corporate communications like public statements, sustainability reports, and sustainability reviews. Plaintiffs reference these publications to allege that a statement or omission concerning some aspect of a company’s ESG performance diverges from actual practice and constitutes a material misrepresentation. To a great extent, district and appellate courts have assimilated cases concerning ESG disclosures within the broader doctrine of securities litigation. However, courts have dismissed forward-looking ESG statements, commitments, aspirations and intentions as exempt from liability under the Private Securities Litigation Reform Act safe harbor provision or otherwise as puffery that is inactionabl as a matter of law.

This article makes the case that the courts’ treatment of forward-looking ESG statements, commitments, aspirations and intentions is incompatible with the needs and expectations of today’s reasonable investors. It elaborates a more discerning framework for distinguishing between material disclosures and puffery in the ESG context that is based on recentering the element of reliance in a section 10(b) securities claim. Under this framework, a statement’s materiality would be based on the divergence between the reasonable expectations it induces, on the one hand, and actual steps taken by corporate management in furtherance of the statement and/or the magnitude of the violation underlying the cause of action on the other hand. This revised approach would better reflect actual investment dynamics, meet contemporary investor needs, and further the objectives of the securities disclosure regime.

Keywords: Responsible Investing, Sustainable Finance, Securities Disclosure, Materiality