Economy and Society June 21, 2022: SEC Goldman Sachs probe causing ripples

Economy and Society is Ballotpedia’s weekly review of the developments in corporate activism; corporate political engagement; and the Environmental, Social, and Corporate Governance (ESG) trends and events that characterize the growing intersection between business and politics.

ESG Developments This Week

In Washington, D.C.

Goldman Sachs investigation is causing ripples

The Securities and Exchange Commission (SEC)’s ESG probe aimed at Goldman Sachs reportedly has retail investors concerned, according to Bloomberg:

“Retail investors are slowly starting to look under the hood of the $40 trillion environmental, social and governance industry that’s increasingly steering their savings, and many aren’t liking what they see. What’s more, some of the biggest names in finance are facing probes of their ESG businesses, with Goldman Sachs Asset Management and the investment arm of Deutsche Bank AG among the most prominent.

The cracks in the ESG firmament appear to be widening elsewhere, too. After attracting huge amounts of money for three straight years, demand for ESG is cooling. Flows into ESG funds globally slumped 36% in the first quarter, according to data provided by Morningstar Inc. It’s the worst showing since before the pandemic began and was followed by another decline in April, Bank of America analysts reported. In May, investors made the biggest-ever monthly redemptions from US exchange-traded ESG funds, Bloomberg Intelligence estimates….

[P]erhaps more importantly, doubts about how much good ESG actually does risk becoming a more lasting turn-off for regular people….

While ESG fund managers may have good reasons for building their portfolios the way they do, the gap between the complex strategies they’re applying and the expectations regular people have of what ESG should do is starting to be a problem that’s playing out in real life. For example, the investment arm of Danske Bank A/S this year adjusted an ESG portfolio amid complaints from consumer advocates about the presence of fossil-fuel stocks. Danske initially pointed out it was playing by the rules, but eventually removed the assets in question. 

Financial professionals that deal directly with retail clients are starting to speak out about the disillusionment they’re seeing. For non-institutional investors trying to navigate ESG, “there’s confusion across the board,” said Dan Lane, a senior analyst at UK-based online retail broker Freetrade Ltd….

[British construction worker Neil] Baker ended up ditching ESG altogether and going with a broad index fund. He might be among the few who even bothered to look into ESG in the first place, according to a recent survey by Charles Schwab. It found that 66% of UK retail savers don’t care whether their allocations are sustainable, and instead only want to maximize returns. 

If those survey results play out in real life, the ESG industry could be facing an abrupt halt to a party that Bloomberg Intelligence estimates has inflated to roughly a third of the global total for assets under management….

Against that backdrop of confusion, disillusionment and outright anger, regulators are sharpening their teeth. In Germany, the authorities stunned the ESG asset management world on May 31 by launching a raid on the headquarters of Deutsche Bank and its fund unit, DWS Group, amid allegations of greenwashing. Over the weekend, it emerged that the US Securities and Exchange Commission is investigating potentially dubious ESG claims at the investment management unit of Goldman Sachs Group Inc.”

Are Goldman and DWS just the tip of iceberg?

On June 14, The Financial Times reported that many in the ESG investment movement are concerned that the companies that have already been targetedor that are, at least, under investigationfor alleged deceptive ESG marketing may be the tip of the proverbial iceberg:

“When about 50 German police officers raided the Frankfurt office of fund manager DWS last month as part of an investigation into greenwashing, the move marked the beginning of what many believe will be a long legal reckoning for the asset management industry.

Interest in sustainable investing has taken off in recent years, with assets managed in ESG-labelled funds globally ballooning to some $2.7tn, but the industry has also been hit by claims its green credentials are inflated.

DWS, whose chief executive Asoka Woehrmann resigned the day after the police arrived to gather materials and question staff, has been in the sights of regulators in Germany and the US since former executive turned whistleblower Desiree Fixler accused the firm of greenwashing last year.

But with regulatory scrutiny growing on both sides of the Atlantic — and an army of lawyers primed to pursue allegations of mis-selling — few believe the shakeout will end with DWS.

“There’s nothing to suggest DWS is a one off,” said Fiona Huntriss, a partner at legal firm Pallas who specialises in financial litigation. “I think it’s almost inevitable litigation will be brought in lots of different jurisdictions.”

“Where you’ve got statements and documents that are highly regulated [that have been given] to a group of investors who can then work together to litigate against that, that is prime territory for mis-selling claims,” she said….

Rumblings that an industry-wide mis-selling scandal may be brewing began when Fixler made her allegations about DWS public, and former BlackRock sustainability executive Tariq Fancy said ESG investing was little more than “marketing hype”.

The debate was given fresh impetus when Stuart Kirk, HSBC’s head of responsible investing, gave a controversial speech last month in which he claimed central banks and policymakers had overstated the financial risks of climate change.

ESG “has become a bureaucratic tax and we need to get it back on track”, Fixler told the Financial Times. The DWS raid “is the real wake-up call for all ESG practitioners to back up statements and products with substance and data.””

On Wall Street and in the private sector

Meet BlackRock’s stewardship team

Ever since Larry Fink put his company, BlackRock, in the ESG driver’s seat, opponents have argued that, in their view, it’s unfair and unethical for the firm (and others like it, who specialize in index and exchange-traded funds) to utilize ordinary investors’ wealth to advance what they view could be considered non-pecuniary goals. At BlackRock, a group of 70 analysts decide where and how this wealth will be invested and what sort of ends it will be used to pursue, in part by deciding how the firm will vote on various ballot proposals.

On June 18, The Wall Street Journal took a crack at explaining who these 70 analysts are and how they approach the massive responsibility they shoulder:

“BlackRock, Inc. casts votes on tens of thousands of proxy proposals a year. The responsibility rests with a team of about 70.

Millions of people are invested in the stock market through BlackRock’s index-tracking funds. As these passive investments have grown in popularity, so have the firm’s stakes in 13,000 companies world-wide. And so has the clout of BlackRock’s investment stewardship team.

The tiny group of analysts—BlackRock has around 18,400 employees all told—looks after the interests of investors in the firm’s $4.6 trillion worth of passive funds. That means weighing in on matters as varied as executive compensation, climate change and abortion access. Chief executives jockey for time on analysts’ calendars. They have the power to unseat directors and upend corporate decision-making. 

The team last year engaged with 2,300 companies via emails, phone calls and meetings and ultimately voted on 165,000 proposals at 17,000 shareholder meetings. 

“It can feel like a lot of power sometimes,” said a former investment stewardship team analyst….

BlackRock’s growth and the way it has sought to wield its influence has rankled corporate executives, particularly those in the oil-and-gas industry. BlackRock’s stewardship team voted in favor of 47% of environmental and social shareholder proposals last year. Its support helped an activist investor win board seats at oil giant Exxon Mobil Corp.

“We have a new bunch of emperors, and they’re the people who vote the shares in the index funds,” Charlie Munger, the vice chairman of Berkshire Hathaway Inc. and Warren Buffett’s business partner, said earlier this year….

Vanguard Group and State Street Corp. , BlackRock’s two biggest rivals, also have small stewardship teams. Vanguard has around 60 analysts focused on stewardship. State Street doesn’t disclose the size of its stewardship team, but a 2020 Columbia Law Review article on corporate governance estimated its head count at 12. The team has grown since then, a company spokesman said. 

BlackRock Chief Executive Larry Fink has said he wants to get to a place where all individual investors can vote their own shares. The firm has given that option to institutional investors that control some $2.3 trillion in assets. Investors representing about a quarter of that sum have taken the company up on the offer. 

For now, the stewardship team is looking out for those who can’t, or aren’t ready to, vote their own shares….

The investment stewardship team is led by Sandy Boss, who spent two decades at McKinsey & Co. before joining BlackRock in April 2020. 

Its analysts range in seniority—their average tenure is 15 years—and some are fresh out of college, a BlackRock executive said. The team includes climate scientists, engineers and corporate-governance specialists. They speak a total of 20 languages and work in 10 countries.

Each stewardship analyst is assigned to cover a specific industry. They dissect company proxy reports and third-party research, including ESG ratings from MSCI Inc. and corporate-governance transparency scores from the nonpartisan nonprofit Center for Political Accountability. Analysts also conduct their own research.

The team subscribes to research from Institutional Shareholder Services Inc. and Glass Lewis but doesn’t “blindly follow” the proxy-advisory firms’ voting recommendations, BlackRock said in a recent report.”

In the spotlight

Is ESG Anti-Israel?

A memo published last week by the Foundation for Defending Democracies warned that the ESG investment businessthrough its ratings servicesmay, in its view, be supporting anti-Israel activists, even if unwittingly. The memo begins:

“Last year, Morningstar, Inc. hired outside law firm White & Case LLP to conduct an investigation into allegations that: 1) Morningstar’s environmental, social, and governance (ESG) research subsidiary, Sustainalytics, negatively rates companies doing business in Israel, based on politically biased information; and 2) Sustainalytics at times serves as a conduit for the Boycott, Divestment, Sanctions (BDS) campaign targeting Israel. On June 2, following the conclusion of that investigation, Morningstar Executive Chairman Joe Mansueto and Chief Executive Officer Kunal Kapoor released White & Case’s final, 117-page investigative report (the “Report”).

In the introduction to its Report, White & Case presents three core conclusions of its investigation:

“Morningstar’s Sustainalytics products do not recommend or encourage divestment” from Israel or from companies connected to Israel.

“The investigation found neither pervasive nor systemic bias against Israel in Sustainalytics’ products or services.”

“[T]he independent investigation did find scattered instances of processes and procedures which can be improved.”

Mansueto and Kapoor have touted these findings, including in a June 2 public statement, as evidence supporting Morningstar’s prior assertions that “[n]either Morningstar nor Sustainalytics supports the anti-Israel BDS campaign.”

Yet, notwithstanding the conclusions set forth at the beginning of the Report, the evidence collected and presented in the Report tells a different story. On a full reading of the Report, rather than exonerating Morningstar, the White & Case investigation instead demonstrates conclusively that Sustainalytics’ processes and products — including its flagship ESG Risk Ratings product — are infected by systemic bias against Israel. Specifically, the Report conclusively demonstrates that:

Sustainalytics relies heavily, if not quite exclusively, on deeply flawed, anti-Israel sources, including anti-Israel non-governmental organizations (NGOs) such as Who Profits, Human Rights Watch, and Amnesty International.

Companies that are in any way involved in the Israeli economy are automatically identified as complicit in human rights abuses in all Sustainalytics’ core products and are thus disproportionately punished in Sustainalytics ratings compared to companies doing business in any other country.

In response to the Report, Morningstar announced that it would implement minor remedial measures to enhance the transparency and reliability of its ESG products.”