[Kamal Nambiar is a 3rd year B.A., LL.B. (Hons.) student and Shruti Ghosh is a 2nd year B.A., LL.B. (Hons.) student at NALSAR University of Law, Hyderabad]
The integration of Environmental, Social, and Governance (“ESG”) metrics into capital markets has made sustainability credentials a meaningful driver of investment decisions across several jurisdictions, including India. As ESG investment has grown here, supported by the Securities and Exchange Board of India’s (“SEBI”) expanding reporting framework, so too has the risk of “greenwashing” — the practice of making false, misleading, or incomplete representations regarding a company’s sustainability credentials. These practices undermine the foundational principles of fair disclosure and market transparency.
India’s ESG disclosure regime is grounded in regulation 34(2)(f) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) and the SEBI circular dated 12 July 2023 which mandates the top 1000 companies to prepare a Business Responsibility and Sustainability Report (“BRSR”) as part of their annual reports. This paper examines whether and to what extent greenwashing in BRSR disclosures attracts liability under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (“PFUTP Regulations”). It further argues that enforcement under the PFUTP regime is preferable to enforcement under the LODR Regulations or the residual provision under section 15HB of the SEBI Act, 1992 (“SEBI Act”) as the anti-fraud framework captures the offence of greenwashing most appropriately in terms of the nature of the crime, and the penalties and enforcement attached to it. Liability under the PFUTP is attracted where the misstatement is material, and is capable of inducing investors to deal in securities.
Applicability of the PFUTP Framework to ESG Misstatements
The primary purpose behind the PFUTP Regulations is to protect investors from manipulative practices that disrupt ordinary market forces and to promote transparency and fair disclosure for all listed companies. The concept of fraud under the PFUTP Regulations is broad and expansive. The key ingredient to constitute fraud is the inducement of investors to deal in securities. For instance, in the case concerning Dewan Housing Finance Corporation Limited, misstatements in financial statements were held fraudulent because investors rely on such reports when evaluating a company’s financial health.
In the context of BRSR, this inducement can be achieved by a wilful misrepresentation of material facts, knowingly publishing false or misleading information in a reckless or negligent manner, or through any other action that might constitute fraud under regulations 3(a), 4(2)(a), 4(2)(f), and 4(2)(k). Regulations 4(2)(a), 4(2)(f), and 4(2)(k) predicate liability on the knowledge of falsity. A director or compliance officer who signs off on a BRSR without awareness of errors, solely to discharge their obligations under regulation 34(2)(f) of the LODR would not attract liability under these provisions. However, to establish fraud, the regulator is not required to prove the existence of deceit.
Does ESG Reporting Induce Dealing in Securities?
There are two approaches to understand the impact of ESG reporting on investor activity. The first is that the BRSR framework is less focused on the risk to investors and aimed broadly at benefiting the stakeholders of a company. ESG investing in India is still at a nascent stage and therefore, any consideration regarding inducing investors must be made contextually. At the same time, it could also be argued that ESG investing in India is gaining traction. As SEBI continues to standardise and amend its BRSR requirements to promote sustainability, investors might seriously consider a company’s sustainability credentials as research has also suggested that ESG-integrated assets have consistently outperformed their non-ESG counterparts.
Given the gravity of a violation under the PFUTP Regulations, there is a high burden of proof to establish a charge. Minor misstatements in ESG disclosures are unlikely to rise to the level of materiality required to induce an investor’s decision to deal in securities, unless the misstatement exposes the company to significant adjudicatory risk or fundamentally undermines its sustainability credentials in the eyes of the market. Moreover, the BRSR framework itself imposes a standard of “reasonable assurance” upon the company, meaning that absolute certainty in reporting figures is not a prerequisite to avoid fraud. This must be established on a preponderance of probabilities by taking into account all the surrounding circumstances.
An important consideration within the BRSR framework also involves the liability invoked as a result of third-party assurance providers. Since SEBI mandates third-party assurance of a company’s BRSR, it is the duty of the board of directors to ensure that an assurance provider possesses the necessary expertise and to avoid conflicts of interest. The existence of a conflict of interest, while a breach of the BRSR Circular prima facie also aids in establishing liability within the anti-fraud provisions as a compromised assurance process is probative of the issuer’s knowledge that the verified disclosures were unreliable, supporting the mens rea element under regulations 4(2)(a) and 4(2)(f).
Market Positioning and the Materiality of ESG Misstatements
The identity and market positioning of the company making the misstatements is also a material consideration in assessing the gravity of ESG fraud. ESG metrics are industry-specific, with the lines of business, production processes, and operational context of a company determining which ESG issues have the most potential in inducing an investor to deal in the company’s securities. For instance, the eligibility of a fossil fuel company to obtain ESG-screened funds and green financing instruments may depend on its ESG reporting figures. Consequently, misleading statements or selective disclosures that conceal important information have a high likelihood of inducing investors. By contrast, software companies may require a higher threshold of materiality before ESG misstatements attract liability under the PFUTP Regulations, as investors are generally more likely to evaluate such issuers on the basis of other metrics related to profitability and capabilities as opposed to typical ESG disclosures.
Why PFUTP is Preferable to LODR-Based Enforcement
The LODR regime contains enforcement mechanisms for breaches resulting in non-compliance with its provisions. Regulation 98 of the LODR Regulations empowers the Stock Exchanges to impose fines, freeze accounts, suspend trading or any other measure in accordance with circulars or guidelines issued by SEBI. However, the SEBI Master Circular for Compliance with the LODR Regulations that outlines the Standard Operating Procedure (“SOP”) for stock exchanges only imposes penalties on a company for not filing the annual report within the stipulated timeline; these penalties do not address concealment of material information or misleading statements in the BRSR.
Furthermore, section 15HB of the SEBI Act acts as a miscellaneous provision that addresses non-compliance with SEBI’s Regulations. Apart from non-compliance with the PFUTP, which is already covered under a separate provision, section 15HB may be applied for cases involving non-compliance with the LODR Regulations. In the case of the BRSR, a violation would only occur where a top 1000 listed company fails to publish the BRSR, or alternatively, does not adhere to the compliance requirements under the SEBI Circular.
Where the “true and fair view” approach is adopted to argue that misleading statements in the BRSR would impact the true and fair view of the company’s affairs, this may signal non-compliance under the LODR Regulations. In such cases, SEBI may pursue enforcement and determine the appropriate penalty by considering the factors mentioned under section 15J. However, to capture egregious violations arising from greenwashing that harms investors, enforcement under the PFUTP Regulations may be the most suitable since it adequately addresses misleading statements, false statements, and fraudulent disclosures while providing appropriate penalties.
Enforcement Consequences under the PFUTP Regulations
Section 15HA of the SEBI Act provides the penalty for violations of the PFUTP, which may amount to an upper limit of Rs. 25 crore or alternatively, three times the profit made by any violative practice. This is significantly higher than the fines imposed under the LODR regime, where a non-compliant company would incur a fine of Rs. 2000 for every day it stays non-compliant, or under the miscellaneous provision where a penalty may extend up to Rs. 1 crore. In terms of the penalties alone, a weak enforcement regime would be inadequate to deter companies from making misleading claims to induce ESG investments whose profits outweigh the penalties by attracting several potential investors.
Given that companies with inflated ESG credentials gain preferential access to green bonds, sustainability-linked loans at a lower cost of capital, and consideration for ESG mutual funds, greenwashing has a significant impact on both the market and investors. PFUTP’s enforcement structure can curb the potential exploitation of these developments by deterring greenwashing. Enforcement authorities in Australia and the United States have similarly imposed significant penalties amounting to AUD 12.9 million and USD 19 million respectively to deter companies from misleading investors and to outweigh the potential advantages obtained by greenwashing.
Conclusion
Greenwashing disrupts the transparent and fair functioning of the market by artificially inflating a company’s sustainability credentials. In light of that, it is imperative that regulatory bodies use the appropriate channels to penalise such actions to ensure that investor losses and unfair profits are disgorged and to enshrine the principle of fair disclosure. Although the LODR Regulations mandate third-party assurance systems to maintain the integrity of the BRSR, this acts as a preventive step while PFUTP operates as the penal consequence that follows where these provisions are not complied with, resulting in harm to the market. As ESG investing deepens in India and BRSR disclosures increasingly inform the decisions of investors, SEBI must correspondingly strengthen the trust in the market by enforcing PFUTP violations.
– Kamal Nambiar & Shruti Ghosh
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