ESG Litigation: A Top Concern for Financial Institutions in 2023

The financial services industry identified disputes related to environmental, social, and governance (“ESG”) issues as an area of top concern for 2023 according to the recently-released Annual Litigation Trends Survey by Norton Rose Fulbright, which surveys more than 430 general counsel and in-house litigation counsel in the United States and Canada across a variety of industries.

The number of ESG-related lawsuits and regulatory enforcement actions filed against financial institutions remained relatively low in 2022 according to Norton Rose Fulbright’s survey data. But current litigation and regulatory trends, as well as industry sentiment, suggest that financial institutions should be prepared for ESG-related disputes to increase in the coming year.

ESG disputes affecting the financial services industry may include not only misrepresentation-based claims directly involving financial institutions, but similar disputes involving the financial institutions’ borrowers, insureds, portfolio companies, and the like, rather than the financial institutions themselves. In addition, financial institutions appear to be a particular target of anti-ESG activism, which may also be a source of disputes.

The anticipated increase in misrepresentation-based claims stems from the growing pressure for businesses to disclose their goals and performance on key ESG issues, including climate change, human rights, and diversity, equity, and inclusion. Regulatory action will be a particular source of pressure in the coming year, especially in relation to climate change. For example, the Securities and Exchange Commission (SEC) has proposed rules on climate-related financial disclosures, and its final rules are imminent. While the SEC rules will apply across industries, other regulatory attention is focused specifically on the financial services industry.

In March of 2022, the Federal Deposit Insurance Corporation (FDIC) issued a request for public comment on draft principles for large financial institutions to manage climate-related financial risks. Public comments on these principles are currently under review. Both the SEC’s and FDIC’s upcoming rules are anticipated to affect what information financial institutions must report related to climate change.

Regardless of whether disclosures are made as a result of regulatory action or pressure from other stakeholders, public statements on ESG topics carry litigation risk. They are increasingly scrutinized by potential plaintiffs. When these disclosures are perceived as misleading, they open the door to a variety of misrepresentation-based causes of action, including securities and consumer protection claims.

Such claims could be filed against a financial institution directly, but these claims can also affect financial institutions’ customers. For example, an increase in ESG disputes — many of which are asserted against company directors and officers — could lead to increased exposure for providers of directors and officers liability insurance.

Other types of ESG disputes are especially relevant to the financial services industry itself. Financial institutions that offer “ESG friendly” investment products — such as mutual funds or ETFs that solely invest in companies with high ESG scores — may be the target of increased litigation and regulatory enforcement action in the coming year.

The SEC, in particular, has turned its focus to ESG investing, announcing on February 7, 2023, that ESG would be a top priority in 2023 for its Division of Examinations (the “Division”). In particular, the Division announced an intent to focus on the following three ESG investing issues: (1) whether ESG funds “are operating in the manner set forth in their disclosures”; (2) “whether ESG products are appropriately labeled”; and (3) “whether recommendations of [ESG] products for retail investors are made in the investors’ best interests.”

This third issue — whether ESG investing is in the investors’ best interests — is a large part of the anti-ESG movement, which focuses on challenging ESG investment efforts. For example, on August 4, 2022, 19 state attorneys general sent a letter to BlackRock, Inc. (a large investment company on the forefront of ESG investing), challenging its use of ESG investment criteria in state pension funds at the alleged expense of shareholder profit.

Similarly, a group of 25 Republican-led states filed a lawsuit in Amarillo, Texas, on January 26, 2023, challenging the DOL’s new rule allowing retirement plan fiduciaries to consider ESG-related factors when choosing investment options for employee 401(K) plans. As the focus on ESG continues to grow, this type of “backlash” litigation will likely grow as well.

ESG-related litigation and regulatory enforcement actions do not appear to be slowing down anytime soon. Financial institutions should consult with legal counsel to prepare for the unique challenges these disputes present, which will likely require increased accountability for — and scrutiny of — ESG disclosures and investment products.

Authors: Rachel Roosth and Kate Ergenbright of Norton Rose Fulbright US LLP