Economy and Society, August 23, 2022: Attorney General ESG push back across the states

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.

BlackRock warns SEC about its proposed ESG rule

Last week, BlackRock – the world’s largest asset manager, with $10 trillion in assets under management – warned the SEC about its proposed new rule for regulating ESG funds. Unlike various state attorney generals, who recently indicated that they believe the SEC is overstepping its authority, BlackRock argued that the new rule would confuse investors and would create larger problems than it solved:

“The world’s largest asset manager BlackRock Inc. (BLK.N) warned the U.S. Securities and Exchange Commission (SEC) this week that its proposed rules aimed at fighting “greenwashing” by fund managers will confuse investors.

BlackRock made the claims in a letter filed this week in response to a SEC May proposal to stamp out unfounded claims by funds about their environmental, social and corporate governance (ESG) credentials. The rules also aim to create more standardization around ESG disclosures….

While BlackRock acknowledged the need to boost oversight, it questioned the SEC’s demand for more details on how funds should categorize strategies and describe their ESG impact, arguing such details could mislead investors about how much ESG really matters when managers pick stocks and bonds.

“The proposed requirements would increase the potential for greenwashing and lead to investor confusion,” BlackRock wrote in its letter.

“The granular nature of requirements will inevitably lead to the disclosure of proprietary information about these strategies, reducing the competitive advantage of those unique insights.”

Also at issue is how the SEC’s proposal outlines how ESG funds should be marketed and how investment advisors should disclose their reasoning when labeling a fund.”

Nevertheless, the SEC continues to push ahead

The Securities and Exchange Commission (SEC) continued last week to do as its Chairman Gary Gensler promised it would when he took over the Commission in the spring of 2021, namely cracking down on what it sees as a discrepancy between ESG funds’ promises and their records:

“US regulators are expanding their crackdown on misleading labels of investment products with a probe focused on whether managers of funds that are marketed as sustainable are trading away their right to vote on environmental, social and governance issues.

For the past several months, Securities and Exchange Commission enforcement lawyers have been peppering firms offering ESG funds with queries, including how they lend out their shares and whether they recall them before corporate elections, according to four people with knowledge of the matter. The practice lets asset managers earn fees that benefit investors, but it can also impact the ability to cast ballots. 

The SEC’s investigation delves into whether asset managers are making the proper disclosures to investors, said the people, who asked not to be named because the queries are private. It drives at the heart of whether ESG investment funds are able to meet their promise of helping combat societal ills through long-term investments in certain companies, especially if shares they lend out wind up with short-sellers taking an opposing view….

When it comes to proxy voting specifically, ESG money managers have been on the defensive at the SEC for more than a year. 

In March 2021, Allison Herren Lee, a former Democratic Commissioner who was acting as SEC chair, said funds should disclose more on how they vote for investors on related issues. The pressure has continued with Gensler pushing a plan introduced in May that could require funds to explain how proxy voting fits into strategies that purport to consider ESG factors….

The SEC enforcement division’s asset management unit, which polices fund disclosures, is leading the probe, according to one of the people familiar with the investigation. 

While it’s unclear if the securities-lending probe will lead to the regulator suing firms or investment advisers, the agency has started bringing cases over ESG disclosures.”

On Wall Street and in the private sector

Is ESG a Thing? Or should E, S, and G be unbundled?

Recently, Util, an ESG data company, conducted an analysis of thousands of US investment funds and determined that the “ESG” label is not helpful in determining which funds, investments, and corporations are, in its words, good from an ESG perspective and which ones are not:

“An analysis of 6,000 US funds has concluded there is no such thing as a “good” or “bad” investment in terms of the UN’s Sustainable Development Goals.

Instead, the picture is far more complex, according to Util, a sustainable investment data specialist, which is calling for the unbundling of environmental, social and governance (ESG) factors in a report that identifies leaders and laggards according to UN SDGs.

“Almost every company, industry and fund impacts some goals positively, others negatively,” Util said in its report released on Thursday that used machine learning in its assessment.

For example, it found that the 10 laggards on Climate Action were mostly utilities funds. Against other SDGs, however, every one of them is among the top 100 leaders in terms of the Quality Education; Affordable and Clean Energy; Decent Work and Economic Growth; and Industry, Innovation and Infrastructure metrics.

The “E”, “S” and “G” represented such different, even conflicting, objectives that it was time for the concept to be scrapped, the company argued.

“What our research highlights is the need for an approach that allows for a lot of different investor preferences,” said Patrick Wood Uribe, chief executive of Util, adding that attempts to categorise companies as only good or bad did not meet the need for nuance.

“This is more accurate,” Wood Uribe said, adding that it fitted with a global trend towards more personalisation.”

In the States 

18 states join Missouri Attorney General investigation over Morningstar ESG

Last month, Missouri Attorney General Eric Schmitt began an investigation of Morningstar, Inc. and its ESG-ratings subsidiary, Sustainalytics, for alleged consumer protection violations.  Specifically, Schmitt’s scrutiny has focused on accusations that Sustainalytics has used sources in developing and implementing its ESG ratings that violate state laws prohibiting discrimination against Israeli companies. Last week, the AG’s office announced that it had been joined in its inquiry by Attorneys General in 18 other states:

“Attorneys general in 18 U.S. states have joined Missouri’s probe into whether Morningstar Inc (MORN.O) violated consumer-protection law with its evaluations of companies’ performance on environmental, social and governance (ESG) issues, staff for Missouri Attorney General Eric Schmitt said on Wednesday.

Schmitt began the probe last month, and spokesman Chris Nuelle said the office invited attorneys general from states including Texas and Virginia “to widen our pool of resources and share information.”

A list from Schmitt’s office identified Republican attorneys general from 15 states while three more attorneys general were not identified because this was not allowed under their states’ rules, Nuelle said.

Schmitt on July 26 sent questions to Morningstar, asking among other questions about which news sources the research firm uses for ESG analysis. The probe is also looking at whether the firm and its Sustainalytics ESG ratings unit violated a Missouri law aimed at protecting Israel from a campaign to isolate the Jewish state over its treatment of Palestinians.

Morningstar in June said it would cancel a Sustainalytics human rights product after an independent review sparked by complaints by Jewish groups found the product focused disproportionately on the Israeli-Palestinian conflict.

But the review by a law firm hired by Morningstar said it “found neither pervasive nor systemic bias against Israel” by Sustainalytics.”

State AGs push the SEC on ESG

On August 17, West Virginia Attorney General Patrick Morrisey (R) led a group of state attorney generals in filing comments with the Securities and Exchange Commission (SEC) opposing the Commission’s proposed rules for ESG funds. Morrisey and the others appear to be planning to challenge the SEC in the same manner as Morrissey recently (and successfully) challenged the Environmental Protection Agency (EPA) for overstepping its statutory authority:

“West Virginia Attorney General Patrick Morrisey has signaled that he plans to take a page from his recent Supreme Court climate win to challenge the Securities and Exchange Commission’s proposed rule for funds that are marketed as socially and environmentally responsible.

In formal comments filed yesterday with the SEC, 21 Republican state legal officers led by Morrisey argued that the agency is trying to transform itself from the federal overseer of securities “into the regulator of broader social ills.”

And they say SEC’s move runs afoul of West Virginia v. EPA, the landmark Supreme Court decision that curbed the federal government’s authority to regulate carbon emissions from power plants….

At issue is an SEC proposal that would require firms to prove that investments that purport to be green or socially aware live up to those claims (Climatewire, May 26).

While the rule cannot be challenged in court until it is finalized, the letter from West Virginia and other states provides an early look at the claims opponents are likely to raise.

Morrisey argued in the comment letter that the proposed SEC rule violates the “major questions” doctrine, which he said was “settled” in the Supreme Court’s June 30 decision in West Virginia. The high court’s conservative majority agreed with Morrisey and other parties in the case that the doctrine — which says Congress must speak clearly if it wants a federal agency to act on a matter of “vast economic and political significance” — precludes a broad EPA carbon rule like the Obama-era Clean Power Plan.”

Notable quotes

Wall Street Journal: “The ESG Investing Backlash Arrives”

On August 15, The Wall Street Journal published an editorial titled, “The ESG Investing Backlash Arrives,” which featured two issues previously detailed in this newsletter, the state AGs’ efforts to push back against BlackRock’s ESG program and the rise of new, “post-ESG” investment vehicles like Strive Asset Management:

“Recent events show that the backlash against ESG investing has finally arrived…. Arizona Attorney General Mark Brnovich explains how he and 18 other state AGs are seeking answers from the investing giant BlackRock about its political agenda. BlackRock—a titan of passive investment funds—has been a leader in impressing ESG standards on the corporations it invests in.

The letter is significant politically and financially. These AGs represent states with public pension funds that invest in BlackRock and other funds on behalf of state employees. The states need to know they are getting the best financial returns possible in the market to meet their commitments to retirees….

“Based on the facts currently available to us, BlackRock appears to use the hard-earned money of our states’ citizens to circumvent the best possible return on investment, as well as their vote,” says the AGs’ letter.

It adds: “BlackRock’s past public commitments indicate that it has used citizens’ assets to pressure companies to comply with international agreements such as the Paris Agreement that force the phase-out of fossil fuels, increase energy prices, drive inflation, and weaken the national security of the United States.”

The eight-page letter goes on to ask detailed questions about BlackRock’s relationship with climate-change advocacy groups, its support for net-zero carbon emissions, and how its ESG advocacy conflicts with its fiduciary duty to investors, among other things. The AGs add that “BlackRock’s coordinated conduct with other financial institutions to impose net-zero also raises antitrust concerns.”…

Meanwhile, an intriguing new investment alternative to ESG funds has gone public. Strive Asset Management last week announced its first exchange-traded fund, DRLL, a passively managed energy index fund designed to mimic BlackRock’s passive U.S. energy index fund, IYE. Strive says it raised more than $100 million in assets under management and had $160 million in traded volume in its first week.

We have no brief for any particular business model. Let everyone compete for the investment dollar and see who prevails and offers the best return. But the Strive model is notable because it says it will use shareholder engagement and proxy voting to impress a non-ESG policy on companies. Strive says it will use proxy measures to persuade companies to pursue the overriding goal of maximizing return to shareholders. This is an antidote to the “stakeholder” model of corporate governance that is the fraternal twin of ESG standards.”