Economy and Society, August 16, 2022: ESG becomes a campaign theme

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.

Is an SEC ESG crackdown imminent?

According to Bloomberg Law, a recent spate of activity by the Securities and Exchange Commission’s (SEC) Climate and ESG Task Force “Hints at [a] Looming Crackdown on ESG Claims.” Last Wednesday, the newswire noted that SEC Chairman Gary Gensler is facing political pressure to ramp up ESG enforcement and suggested that this pressure might be the source of the task force’s recent activity and might also portent even more action:

“A new SEC task force to police corporate environmental, social and governance disclosures is gradually ramping up enforcement, putting companies on notice.

The Securities and Exchange Commission created its Climate and ESG Task Force a year and a half ago. The unit has mostly kept working behind the scenes. But in the last four months, it has helped bring at least three enforcement actions, according to agency records.

Companies that have faced allegations of misleading ESG claims include Bank of New York Mellon Corp., health insurance distributor Benefytt Technologies Inc., and Brazilian mining company Vale S.A.

The SEC is working on new rules to combat bogus ESG claims by investment funds and to force companies to disclose how climate change affects their operations. New rules or not, SEC Chair Gary Gensler is facing pressure from Democrats and investor advocates to guard against misleading corporate disclosures about climate change and other ESG issues.

The task force’s actions, which started to become public this spring, are likely just the beginning, with more cases expected soon, corporate lawyers told Bloomberg Law. SEC investigations often take more than a year to complete, they said.

The SEC’s fiscal year-end in September traditionally brings a flurry of cases, said Kevin Muhlendorf, a Wiley Rein LLP partner and former agency lawyer, who advises companies on ESG matters.

“I don’t think it’s all bark and no bite,” Muhlendorf said of the task force. “Anytime you create one of these task forces, there’s going to be actions.””

Bloomberg continued, suggesting that financial giant Goldman Sachs may well be the next target in the task force’s sites:

“Goldman Sachs Group Inc. may be the task force’s next announced case.

The SEC is investigating claims the banking giant’s funds didn’t align with ESG metrics touted in marketing material, Bloomberg News reported in June.

The report came after the agency announced in May that BNY Mellon agreed to pay $1.5 million to settle claims of ESG misstatements concerning its funds, without admitting or denying any wrongdoing.”

On Wall Street and in the private sector

A new fund makes waves

On August 9, Strive Asset Management – the newest startup venture from author and entrepreneur Vivek Ramaswamy – launched trading on its first ETF, an energy fund tagged DRLL on the New York Stock Exchange (NYSE). Bloomberg described the launch as follows:

“An anti-activism exchange-traded fund of sorts has launched to supposedly “unshackle” energy companies from climate concerns that some investors have forced them to reckon with. 

The aim of the Strive US Energy ETF (ticker DRLL), which began trading Tuesday, is to accumulate enough assets for the Ohio-based manager to have say in the boardroom, according to co-founder Vivek Ramaswamy. Strive launched in 2022 with backing from billionaire investors including Peter Thiel and Bill Ackman.

DRLL joins a small but growing wave of so-called anti-woke ETFs after issuers such as BlackRock Inc. put their heft behind environmental, social and governance-focused funds in recent years….

“We are post-ESG,” Ramaswamy said in a phone interview. “US energy stocks have tremendous potential if they’re unshackled from the shareholder-imposed ESG mandates.”…

Roughly $27 million traded in DRLL on Tuesday, Bloomberg data show. While most of that likely came from investors lined up ahead of time, it’s an impressive amount of day-one volume for an “indie ETF,” according to Bloomberg Intelligence senior ETF analyst Eric Balchunas.”

In the Wall Street Journal’s “Weekend Interview” with James Taranto, Ramaswamy had an opportunity to describe Strive and its new fund in his own words:

“The standard advice to retail investors is to buy passively managed index funds, which invest in the stocks of a broad range of companies. That’s an excellent way to balance risk and return, to ride waves of economic growth and offset losses from individual companies that sink beneath them. But Vivek Ramaswamy, a newly minted investment-fund executive, says that politics have quickly come to dominate index funds too. He has an ambitious plan that aims to break its grip.

The problem arises from what’s known as “the separation of ownership from ownership.” When you invest in, say, a BlackRock fund, you own shares in the fund, which in turn owns stocks or other underlying assets. Formal ownership of a company share gives BlackRock a vote in elections for the board of directors and on resolutions governing corporate policy. Multiply that share by hundreds of millions, and it adds up to real clout.

The three biggest fund managers—BlackRock, Vanguard and State Street—manage a combined total of some $20 trillion in assets. Their holdings of Exxon Mobil Corp., to take a prominent example, totaled more than 890 million shares, or about 21% of the company, as of March 31. When they vote as a bloc, that can easily tip the balance, as it did in 2021 when the big three backed a slate of Exxon Mobil directors put forth by the tiny activist fund manager Engine No. 1, which held fewer than a million shares.

“It was an accident of this investment structure that gave that much voting power to that concentrated group of actors with an unprecedented aggregation of capital,” Mr. Ramaswamy says in a Zoom interview from his home office in Columbus, Ohio. The big fund managers began only a few years ago “to exercise that voting power to advance social and political agendas.”…

When a fund manager uses your money “to advance agendas that do not serve the capital owner’s interest,” Mr. Ramaswamy says, “that represents a large-scale fiduciary breach.” But what can you do about it? Litigation is prohibitively expensive, and regulatory solutions are unpromising with an ESG-friendly administration in Washington. Buying stocks directly and voting them yourself is a high-risk investment, not to mention a labor-intensive one, and for a nonbillionaire the return in recovered voting power is trivial. Besides, pursuing any of these possible remedies would take you down a political rabbit hole, exactly what you’re trying to avoid.

Enter Mr. Ramaswamy, a 37-year-old wunderkind. He founded a biotech investment firm in 2014, at 28, then left it in 2021 and published two books, “Woke, Inc.: Inside Corporate America’s Social Justice Scam” last August and “Nation of Victims: Identity Politics, the Death of Merit, and the Path Back to Excellence,” forthcoming next month. “I enjoyed writing the books,” he says. “I thought I was going to keep going at it.”

Instead he decided that “problems in our culture, created in the market, . . . needed to be solved through the market,” and Strive Asset Management was born, with Mr. Ramaswamy as executive chairman. Its first offering, the Strive U.S. Energy ETF (ticker symbol DRLL), began trading this week on the New York Stock Exchange, where Mr. Ramaswamy will ring the closing bell on Wednesday.

Strive is an activist investment manager. “Our mission,” its website declares, “is to restore the voices of everyday citizens in the American economy by leading companies to focus on excellence over politics.” The firm won’t do this, Mr. Ramaswamy emphasizes, by selecting stocks in accord with “right-wing values” the way ESG funds promote left-wing values.

Instead its first few funds, including DRLL, will be managed passively, and subsequent ones actively, for profit, not politics.”

In a letter to supporters late in the week, Ramaswamy reported that the fund had done well in its launch – even better than Bloomberg had noted:

“We launched our U.S. energy index fund ($DRLL) on the New York Stock Exchange yesterday. Our aim is to liberate the U.S. energy sector from Environmental, Social, and Governance (ESG) constraints by delivering a new shareholder mandate to American energy companies….

Our first two days showed strong trading with over $60 million in flows already. The folks at NYSE told us this is one of the biggest launches of its kind.”

In the States 

ESG becomes a campaign theme

The states continue to be the main battleground for much of the ESG debate, and according to Bloomberg, concerns about investing, environmental and social mandates, and the perceived politicization of capital have started slipping into various state election campaigns:

“To Blake Masters, the newly minted Republican Senate nominee in Arizona, ESG scores are an existential threat to the US economy along with inflation — an issue worth campaigning on as ardently as securing the border, preventing voter fraud and challenging Big Tech.

“They represent a further merger of government and corporation,” Masters said, comparing ESG scores to the tactics of the Chinese Communist Party in a statement to Bloomberg Government on Wednesday. “These scores have absolutely no place in our country.”

Masters’ advocacy is part of a growing movement among Republicans to make ESG scores — the grading of companies’ performance based on their environmental and societal effects, as well as their governance structure — a cultural issue alongside Democrats’ social justice and environmental advocacy. Those Republicans could seek legislative avenues to limit use of the scores if they take control of the next Congress….

If elected, Masters could seek to limit the incentives for companies to value factors other than their bottom line.

The Securities and Exchange Commission, which has oversight of some firms that offer ESG scores and a Democratic chairperson, is unlikely to ban the scores or severely restrict firms that offer them. But a Republican-controlled Congress could pressure the agency to ramp up its scrutiny of the ratings or stop it from taking actions to encourage ESG scores, which socially conscious investors use to compare companies.

ESG scores have been around for about two decades but only attracted negative political attention more recently. One of ESG’s most prominent critics is Republican megadonor Peter Thiel, who is backing Masters’ campaign. Masters’ refrain on the campaign trail may be replicated by other like-minded candidates.”

In the Ivory Tower

New paper examines ESG ratings effectiveness

On August 4, David Larcker and Brian Tayan of Stanford, Edward Watts of the Yale School of Management, and Lukasz Pomorski of AQR Capital Management published a paper examining the reliability and effectiveness of ESG ratings. The paper, titled “ESG Ratings: A Compass without Direction,” found that ratings tend to fall short of their claims on both counts.

“In this Closer Look, we examine these concerns. We review the demand for ESG information, the stated objectives of ESG ratings providers, how ratings are determined, the evidence of what they achieve, and structural aspects of the industry that potentially influence ratings. Our purpose is to help companies, investors, and regulators better understand the use of ESG ratings and to highlight areas where they can improve. We find that while ESG ratings providers may convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies, and incentives which detract from the informativeness of their assessments.”

Among other specific critiques, the authors noted the following:

“Having reviewed the objectives and methodological choices of ESG firms, we can better understand the research evidence regarding ESG ratings quality, consistency, and effectiveness. Unfortunately, it is rare for ratings providers to offer concrete, systematic evidence to back up claims about their ratings….

Systemic patterns are observed in ESG ratings. One pattern is related to company size: Large companies receive higher average ratings than smaller companies. This might be due to the more significant resources large firms are able to invest in ESG initiatives, or it might be due to the fact that large companies have greater disclosure of ESG data. A second pattern is industry-related: While some ESG ratings are industry adjusted, those that are not may have higher average scores for certain industries (such as banks and wireless communications) than for others (such as tobacco and gaming). It is not clear if these patterns are due to fundamental differences in ESG quality across industries, or a result of the methodological choices and input variables that underpin ESG ratings models. A third pattern is country-related: European companies have higher average ESG scores than U.S. companies, which might be due to political and regulatory differences across countries. Firms in emerging markets also have lower ratings than firms in more developed economies….

Studies find that ESG ratings have low associations with environmental and social outcomes.

A review of MSCI ratings conducted by Bloomberg finds that most upgrades occur for what Bloomberg calls “rudimentary business practices” rather than substantive improvements. In justifying 155 upgrades, MSCI cited governance improvements almost half (42 percent) of the time—significantly more than social (32 percent) or environmental (26 percent) improvements. Upgrades were often driven by check-the-box practices, such as conducting an employee survey that might reduce turnover, and rarely for substantial practices, such as an actual reduction in carbon emissions. Half of companies were upgraded for doing nothing—the result of methodological changes.

Raghunandan and Rajgopal (2022) find that companies in ESG portfolios (those with high Sustainalytics ratings) have worse records for compliance with labor and environmental laws relative to companies in non-ESG portfolios during the same period. Companies added to ESG portfolios also do not subsequently improve compliance with labor or environmental regulations.”