Shareholder activists sue the SEC, alleging bias

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.

NCPPR sues the SEC, alleging bias

The National Center for Public Policy Research (NCPPR), a non-profit organization, on April 28 filed a lawsuit against the Securities and Exchange Commission (SEC), alleging that the Commission was biased against NCPPR because the organization files shareholder proposals that are opposed to ESG.

American First Legal Services, co-counsel for NCPPR with Boyden Gray & Associates, describes the case against the SEC as follows:

NCPPR is a communications and research foundation that focuses on providing free market solutions to public policy problems and is a longtime Kroger Co. (“Kroger”) shareholder.

In its “Framework for Action: Diversity, Equity & Inclusion,” Kroger indicates that it “strives to reflect the communities we serve and foster a culture that empowers everyone to be their true self.” As part of its effort to associate its brand with diversity and inclusion, Kroger’s board adopted The Kroger Co. Policy on Business Ethics, which commits Kroger “to a policy of equal opportunity for all associates without regard to race, color, religion, gender, national origin, disability, sexual orientation, or gender identity.”

NCPPR sent a proposal to Kroger requesting, as shareholders, that Kroger issue a public report detailing the potential risks associated with omitting “viewpoint” and “ideology” from its written equal employment opportunity (EEO) policy. 

Kroger submitted a letter to the SEC’s Division of Corporation Finance arguing that the Proposal “deals with matters relating to the Company’s ordinary business operations” because it pertains only to “Kroger’s management of its workforce and policies concerning employees.” Kroger, and the SEC, effectively turned a blind eye and blocked the proposal, ignoring the fact that conservatives often face employment discrimination due to political ideology, while acknowledging other factors like “gender.” 

NCPPR argued that the SEC was engaging in viewpoint discrimination by giving the green light to identical proposals about certain forms of discrimination (e.g., against sexual orientation and gender identity) while agreeing companies could exclude proposals about other forms of discrimination that are at least as significant to society (e.g., viewpoint and ideology, especially against conservatives).

NCPPR operates the Free Enterprise Project, which, by its own description, “files shareholder resolutions, engages corporate CEOs and board members at shareholder meetings, petitions the Securities and Exchange Commission (SEC) for interpretative guidance, and sponsors effective media campaigns to create the incentives for corporations to stay focused on their missions.”

FEP Director Scott Shepard says that the SEC has been discriminating against it and others, favoring ESG in its policy:

For years we’ve watched the SEC staff discriminate against center/right proposals, including ours. In doing so and in failing to provide meaningful explanations for its decisions, it has violated the law in ways that breach its statutory duties and our First Amendment rights. This action is a first step in ending that illegal discrimination.

In the states

Louisiana attorney general launches ESG investigation

Louisiana Attorney General Jeff Landry (R) launched an investigation on April 25 into Climate Action 100+, which describes itself as “an investor-led initiative to ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change.” Landry’s office says the investigation seeks to determine whether some asset management companies that are part of the initiative have violated their fiduciary duties by focusing on ESG investment factors:

Landry’s office on Tuesday announced a “multi-pronged” effort focusing on the Climate Action 100+ Steering Committee, specifically scrutinizing Franklin Templeton and the California Public Employees’ Retirement System. The investigation will look into whether the groups breached their obligations to investors by prioritizing climate initiatives….

“ESG investing puts politics over people and raises significant concerns that companies guided by these green-energy fantasies may be engaging in unfair and deceptive practices that harm Louisiana consumers,” Landry said, according to the Washington Times. “Franklin Templeton is deeply embedded in Climate Action 100+; and we are troubled that, by focusing on the radical ESG agenda, it may be violating its fiduciary duties to shareholders in our state.”…

Franklin Templeton has some $1.5 trillion in assets under management, while CalPERS, the country’s largest public pension fund, had more than $440 billion in assets under management as of last year.

Last year, congressional Republicans, led by Rep. Jim Jordan (R-OH), sent a letter sent to executives of the steering committee for Climate Action 100+ demanding documents that show the group’s network of influence. In the letter, they said the coalition “seems to work like a cartel to ‘ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change.’”

Kansas bill opposing ESG to become law

A Kansas bill aimed at opposing the influence of ESG in state investments will become law.  The bill was passed by both houses of the legislature on April 6, but there was some question about whether Gov. Laura Kelly (D) would veto it. Last week, the governor announced that she would not veto the bill, meaning it will now be enacted:

The law restricts the $24.3 billion Kansas Public Employees Retirement System, Topeka, from entering into any contracts with money managers that consider environmental, social and governance factors.

Specifically, the bill prohibits the system from ESG factors involving restrictions in investments in fossil fuel-based energy, nuclear energy, agriculture and lumber production, mining and greenhouse gas emissions, firearms manufacture or sales, facilitating or assisting with abortion or gender reassignment.

In Kansas, a bill can become law whether the governor signs a bill or declines to do so. In a statement on Monday, Ms. Kelly said: “Because I have reservations about the potential unforeseen consequences of House Bill 2100 for the state and for local governments, I will allow the bill to become law without my signature.”

The bill passed the House of Representatives 76-47 and the Senate 27-12 on April 6.

Indiana House passes bill opposing ESG in state investments

The Indiana House passed a bill on April 24 restricting the use of ESG funds in state investments, following the lead of the state Senate. The bill now goes to Gov. Eric Holcomb (R) for consideration.

Indiana Republicans pushed through a proposal Monday taking a stand against socially and environmentally conscious investing although disagreements within their legislative majorities narrowed it from what conservatives first sought.

House members voted 66-29 for final passage of the bill aimed at preventing leaders of the state’s pension funds for teachers and other government workers from investing any of their some $45 billion with firms that consider environmental, social and governance principles in their investment decisions….

Such a ban is needed in Indiana to ensure that “financial returns trump all,” said Republican Rep. Ethan Manning of Logansport, the bill’s sponsor.

“Our concern is when these large asset managers on Wall Street are using their outsized market power to force decisions on companies when it’s not best for them,” Manning said….

The Indiana Chamber of Commerce, the state’s largest business group, and some other business organizations objected to earlier versions of the bill, calling proposed investment limitations “anti-free market.” An analysis of the first version of Manning’s proposal projected that the limitations would cost the state pension system $6.7 billion over 10 years.

Business groups dropped much of their opposition after the initial proposal was rewritten and the GOP-dominated Senate later removed provisions such as one that would have had the state treasurer’s office compile and publish a list of companies it found had made ESG investment commitments….

Democratic Rep. Carey Hamilton of Indianapolis argued the anti-ESG bill was “carving out protections for certain sectors for political reasons.”

“We’re creating bigger government to oversee a system that works today for our retirees,” Hamilton said.

In academia

NYU business professor criticizes ESG at Morningstar conference

Last week, investment research company Morningstar held its annual conference in Chicago, hosting Aswath Damodaran, among others. Damodaran, a professor of finance at NYU’s Stern School of Business and ESG opponent, criticized the investing strategy in a talk. Morningstar is the parent company of Sustainalytics, one of the world’s foremost ESG rating services.

ESG is a failure, its advocates are to blame, and the concept should be retired, according to Damodaran….

Damodaran is known as the “dean of valuation” for his analysis of security prices. He touched on the topic of valuations, but his most provocative remarks were about ESG.

Once the “S” was put in the middle of ESG, the concept was doomed, he said. It is impossible to achieve a consensus on any social issue, much less the full range of socially responsible concerns that permeate the ESG landscape.

Indeed, the fundamental issue for Damodaran is that there is no consensus about what constitutes “good” or “bad” companies when it comes to ESG….

Advisors are putting trust in a scoring system that companies will “game,” he said. “We created a scoring system that makes us feel we are doing good rather than a system that does good.”

“The best thing would be to retire the concept,” he said.

Damodaran said that ESG proponents oversold the concept when they claimed that ESG could deliver excess returns (alpha) along with values-based portfolio construction. A constrained strategy (like ESG) cannot beat an unconstrained one. The positive alpha that has benefitted some ESG investors is a result of outsized flows into those strategies, driven in part by aggressive asset management marketing.

Once those flows subside, returns from ESG investing will suffer.

“If your clients think they can earn alpha,” he said, “bring them back to reality. You can’t claim ESG is always good for returns.”…

Eric Hofer, a great American thinker, once wrote that, “Every great cause begins as a movement, becomes a business, and eventually degenerates into a racket.”

Damodaran has put ESG in the same context: “These ideas start by repackaging an existing concept or measure and adding a couple of proprietary tweaks that are less improvement and more noise. Then they get acronyms, before being sold relentlessly.”

London Business School professor also pushes back against ESG

ESG Clarity published an article on April 27 covering London Business School finance professor Alex Edmans’s comments criticizing ESG on the “ESG Out Loud” podcast on April 6. Edmans argued that ESG creates conditions for confusion in the market:

You cannot reduce the cost of capital and improve investor returns, London Business School finance professor Alex Edmans has said.

Speaking in an episode of the ESG Out Loud podcast, Edmans said despite “basic finance theory” suggesting that if you are having positive impact by reducing a company’s cost of capital, you must be reducing your return because the company’s cost of capital is the return to investors, many investors, finance professors and policymakers are still making this claim.

“This is not possible. And if you can only have one or the other, that’s fine. Just be honest about it. When I go and buy organic food, I do this because I think it’s good for society. I don’t think it’s good for my wallet, but that’s fine because my motivation is not a financial one, it’s an impact one.”

Acknowledging the similarities between his points on this matter and those of ex-BlackRock CIO for sustainable investing Tariq Fancy, Edmans said, “You can’t have both [impact and improving returns] but funds that claim they can are likely to get more investors than those that don’t….

Clarity on terminology will help, Edmans said. “The phrase ESG investing is confusing. For some people, ESG investing is just investing, it’s a way of creating long-term financial returns. It’s not to save the world.

“And then people like Larry Fink have climate risk is investment risk. He says ESG is capitalism, it’s about creating financial value.

“Then there’s a separate reason for ESG, which is to create social value and to change the world, for example to encourage companies to decarbonise, change the mix of their workforce, even if this doesn’t improve returns.”

Edmans suggested instead using the phrases “intangible investing”, which uses intangible information but tries to create long-term returns; “impact investing”, which involves financial sacrifice; and “values-based investing”, where you can divest from sectors or companies you don’t like but realise you’re not depriving them of capital.