The phenomenon of greenwashing is certainly not new in the financial sector. Now German prosecutors have also taken up the trail – and are looking closely at banks and investment companies. Research by a fund company at the end of May 2022, which was highly publicized, shows that the issue is likely to gain momentum in the future in terms of criminal law. However, it is problematic that clear standards on terms such as sustainability do not yet exist.
The problem
Greenwashing is the term used to describe methods to create a positive perception of a company, its products or its activities with regard to the respect of ecological or social standards. Such efforts are particularly common when it comes to product sustainability, environmental compatibility, climate friendliness or carbon neutrality.
The financial sector has reacted to the increased environmental and social awareness of investors. More and more, they offer products that are supposed to allow you to invest money with a clear conscience. Whatever alluring names these products carry, the end goal is to invest only in “good” companies and “good” products. There is nothing wrong with that, on the contrary. The problem is often: are the promises true? Or: what exactly can the investor expect behind the good-sounding names?
Personal liability of the investor
The Federal Financial Supervisory Authority (BaFin), as Germany’s highest regulatory authority, warns against misunderstandings. He points out that there are no consistent minimum standards for sustainable investments. Terms like “ecological”, “social”, “ethical”, “green” or “climate friendly” hide different criteria. Ultimately, each vendor can mean something different. In order to be able to judge whether the investment corresponds to the individual understanding of sustainability, the investor must, according to BaFin, inform himself precisely.
ESG criteria
So-called ESG criteria offer at least some objectivity. ESG stands for Environment, Social and Governance. For example, these buzzwords may include the following:
- Environment: climate, resource conservation, water, biodiversity
- Social: employees, security, demographic change, food security
- Governance: risk management, oversight structures, compliance
These criteria can be important when selecting a sustainable investment. They make it possible to exclude investments in certain companies or in entire sectors where the criteria are not met. For example, criteria such as nuclear energy, environmental destruction or exploitation can be defined as part of an ESG investment strategy to exclude certain investments out of hand. On the other hand, it is possible to include only companies that make a particular effort to comply with ESG criteria (best-in-class principle). On the market, rating agencies offer sustainability ratings that allow the calculation of ESG scores and aim to ensure comparability for investors.
EU taxonomy
Attempts are also underway at EU level to define sustainability standards in a legally valid way. The EU taxonomy is a classification tool for this purpose. The objective is to classify the activities of companies according to whether or not they make a “green” contribution. In this way, investors should be able to assess whether a company they wish to invest in is operating sustainably. With this project, the EU wants to promote investments in ecologically sustainable economic activities. For an economic activity to be considered sustainable, it must meet four criteria:
- It makes a substantial contribution to at least one of the environmental objectives.
- It does not cause significant harm to any of the other environmental objectives.
- It complies with minimum requirements in the areas of labor standards and human rights.
- It meets the technical selection criteria defined by the European Commission. These are quantitative and qualitative criteria, such as thresholds, used to determine the environmental sustainability of activities.
The EU taxonomy automatically becomes legally binding unless member states vote against by qualified majority or the European Parliament votes against by absolute majority.
Legal situation in German criminal law
German criminal law contains a special provision for prosecuting misleading behavior on the capital market, namely capital investment fraud (§ 264a German Criminal Code). Anyone who, in connection with (1) the sale of securities, subscription rights or shares intended to allocate to the holder a participation in the profits of the company or (2) an offer to increase the capital invested in such shares, makes false favorable statements or conceals adverse facts in prospectuses or in statements or surveys of net assets which are given to a considerable number of persons and in connection with circumstances relevant to the acquisition decision or increase shall be liable to imprisonment for a term not exceeding three years or one property.
On the one hand, the provision protects the individual assets of the investor, but on the other hand, it also protects the general confidence in the integrity of the capital market. In this context, the limit of criminal liability is crossed much earlier than, for example, in the case of general fraud (Article 263 of the Criminal Code). Capital investment fraud does not require the investor to be wrong or suffer financial loss. It is enough to make erroneous advantageous statements or to conceal disadvantageous statements.
On the one hand, this means that the threshold for a criminal offense is crossed more quickly than some people think. On the other hand, the prosecuting authorities have the right and the obligation to open investigations much more quickly if there is a first suspicion. And because German criminal law does not (yet) recognize the own liability of companies, it is mainly the acting persons themselves who are liable.
What behavior is punishable?
The offense is making incorrect advantageous statements or concealing disadvantageous facts by written or oral statements to a wider circle of potential investors.
Due to their incorrect content, the statements must be appropriate to create misconceptions among investors about investment risks or investment opportunities. It is problematic that the term “fact” is interpreted broadly in this context: it also includes opinions, value judgments and forecasts. Statements are incorrect if they do not correspond to objective facts. Forecasts and value assessments are incorrect if the facts on which the forecast is based are not correct or are not sufficiently based on facts.
The case law has not yet decided whether and, if so, to what extent product-related claims on sustainability-related aspects are protected by criminal law. However, the specialist literature is consensual in its opinion that erroneous statements about sustainability can also be punishable.
Problem: conceptual blur
In practice, this can lead to considerable difficulties. At least until there is a clear understanding of the meaning of terms such as “sustainable”, “ecological”, “climate friendly”, etc. law seems necessary.
First of all, there is a lot to be said about the regulator’s point of view that it is up to the investor to inform himself sufficiently precisely so that he can make an individual judgment on compliance with the sustainability criteria. which are particularly important to him. Criminal law must take into account this fundamental distribution of risk, which is based on the model of the responsible and informed investor. Criminally relevant behavior only comes into consideration if such an informed decision by the investor is prevented.
Only clear cases punishable
According to the opinion expressed here, the limit to which a criminal prosecution authority can intervene is only exceeded when information is objectively clearly inaccurate and subjectively intended to create a false idea in a reasonable investor.
An increased risk of criminal prosecution is likely to exist in particular if, for example, the consideration of ESG criteria is ensured in the distribution of a product but is not subsequently implemented. Anyone who describes a fund in the prospectus as specifically ESG-compliant, or adopts such a description in the distribution, risks being charged if it later turns out, for example, that investments have been made in companies or sectors expressly excluded by the investor. The extent to which the classifications according to the EU taxonomy can be used for criminal law will have to be examined after its entry into force. In principle, however, it cannot be excluded that the assessment of the sustainability of a financial product carried out according to the EU taxonomy is likely to create a misconception regarding the investment. Inaccurate information would then be potentially punishable
Possible consequences
Investment fraud can be punished by imprisonment for up to three years or a fine. In addition to these personal sanctions, there is the risk of criminal sanctions against the bank or the fund company. An administrative fine (Art. 30 of the German Administrative Offenses Act) may be imposed on them or the confiscation of the proceeds of the offense (Art. 73 et seq. of the German Criminal Code) may be ordered. Additionally, reputational losses can be even more costly due to the negative publicity that often accompanies investigative actions.
