21 Dec ESG: Tennessee and the Evolving Battleground
The following commentary/analysis is one I wrote in my capacity as a senior fellow at “the nation’s oldest consumer protection agency,” Consumers Research, where, among other things, I compile a weekly letter for public pension-fund managers. I am sharing it here today because I thought it might be useful to some of you.
Where the Action Is
On Monday, December 18, the state of Tennessee sued BlackRock, Inc., in a first-of-its-kind consumer protection action. Bloomberg provides the details:
State Attorney General Jonathan Skrmetti said BlackRock funds that don’t take into account ESG factors are being unfairly impacted by the asset manager’s membership in climate groups, its shareholder-voting record and the pressure it puts on companies to meet environmental goals, according to a complaint filed Monday in state court. This shows a “pattern of deception” that has hurt investors, the complaint says.
“BlackRock has engaged in a series of unlawful ESG-related misrepresentations and omissions in connection with the marketing or sale of its investment products and services to Tennessee consumers,” Skrmetti said in the complaint.
The lawsuit is the first by a GOP official against an investment firm for its ESG strategy. Republican politicians have criticized BlackRock and its chief executive officer, Larry Fink, for championing environmental, social and governance principles, an approach that takes into account topics like global warming. Florida and other GOP-led states have collectively pulled billions of dollars from the world’s biggest money manager. In response, Fink has said he no longer uses the ESG label because it’s become too politicized.
There are several things worth noting about this suit and about the trends it represents.
First, the “deception” that Attorney General Skrmetti cites is real and it has long been an issue of concern, particularly regarding the “Big Three” – BlackRock, Vanguard, and State Street. These firms have used the entirety of their assets – not just ESG assets, but ALL of them – to pursue ESG-related ends. In his 2020 letter to CEOs, for example, Larry Fink noted that his firm had just “announced a number of initiatives to place sustainability at the center of our investment approach, including: making sustainability integral to portfolio construction and risk management; exiting investments that present a high sustainability-related risk…and strengthening our commitment to sustainability and transparency in our investment stewardship activities.” He called this a “fundamental reshaping of finance.”
Likewise, when the Big Three – plus CalPERS and CalSTRS – supported Engine No. 1’s hostile partial takeover of the Exxon-Mobil board in 2021, they did so not just with their ESG-derived proxy votes, but with the votes of all their assets. Had they used only their ESG funds – which constitute a rather small portion of their total AUM – Engine No. 1’s insurgent board candidates would have lost spectacularly. For Big Three fund owners – the overwhelming majority who are not invested in ESG – this use of their wealth for the express purpose of advancing the companies’ political agenda is both deceptive and unwelcome.
A second point worth noting is that perceived justification notwithstanding, this suit will be probably difficult to win, as the damages will be difficult to prove. As John Authers notes in his Bloomberg column on the suit, the data on the returns derived from ESG are conflicting. While logic, theory, and most recent studies show that ESG investments underperform over time, some researchers continue to insist that ESG screening produces greater returns. (Authers himself cites research showing that investments in high-rated ESG companies produce higher returns. He seems blissfully unaware, however, that 3 of the “Magnificent 7” are among the highest-rated ESG companies in the world, although their success has little to do with E and S. But that, I suppose, is a story for a different day.) In any case, like everything tied to ESG, the data on returns are muddied by acute ambiguity in definitions and classifications, which will undoubtedly complicate the state of Tennessee’s case.
Finally, and most notably, it is worth noting here that this suit is a harbinger. What started as a politically tainted market phenomenon and quickly evolved into a full-blown political issue, has now become a mostly administrative and judicial matter.
Another high-profile suit is pending in New York state courts, where pensioners have sued three of New York City’s pension funds over their divestment from traditional oil companies, and similar cases are sure to follow. One can presume that suits from the opposite perspective – i.e. “I lost money because my state pension quit using BlackRock” – will also undoubtedly pop up in the near future. Some of these suits may, indeed, seriously affect the industry.
All of that noted, this isn’t necessarily to say that lawsuits on behalf of those who believe they have been defrauded and disadvantaged by ESG will determine the future of the practice. It is, rather, to say that the future of ESG is now likely beyond the control of investors and voters and in the hands of administrators and especially judges.
Last week, Mary Foley, an expert strategy director at Enhesa, a sustainability intelligence provider, penned a column for Forbes in which she warned the American business community to “ignore the SEC’s ESG agenda at your own risk.”:
Think the Securities Exchange Commission’s (SEC) recent delay of its Climate Related Disclosure Standards is a sign that the United State is going to ease its stance on sustainability and corporate environmental, social and governance (ESG) regulation? Think again. A closer look at the global state of climate disclosure legislation, recent state level initiatives and the SEC’s own recent enforcement actions make it clear: U.S. public companies need to get serious about sustainability and ESG, regardless of when we see the final SEC climate disclosure rules are determined….
ESG and climate-related reporting requirements are here to stay, regardless of when the SEC finalizes its Climate Related Disclosure Standards. Although the SEC still has work to do in hammering out the details of the regulation, that does not mean ESG has fallen off its regulatory agenda. And, if the fines the SEC Enforcement Task Force has already levied on firms that run afoul of anti-greenwashing mandates are any indication, failure to comply with climate related disclosures will be an enormously costly undertaking.
Foley misses the mark wildly here. The SEC’s enforcement actions have been and will continue to be directed at those who embrace the ESG premise, not its opponents. More to the point, neither the SEC nor Blue states are likely to be able to do whatever they want regarding ESG and climate disclosures. Just this week, the 5th U.S. Circuit Court of Appeals vacated the SEC’s new rule on stock buybacks and has indicated that is not done pushing back on the Commission’s overreach. When one adds in the precedent set by West Virginia v. EPA and the pending U.S. Supreme Court decisions in Loper Bright v. Raimondo and Relentless Inc. v. Department of Commerce, both of which will be heard in January, the outlook for bold regulatory action on emissions reporting grows rather dark. The two latter cases offer the Supreme Court the opportunity to overturn the Chevron Doctrine (Chevron Deference), which would radically alter the power of administrative agencies to weigh in on matters outside of their narrow legislative mandates, preemptively handcuffing the SEC.
The point here is that the fights over ESG continue to evolve and, at present, are evolving in a way that favors administrators and judges. The implications of their decisions will, of course, prompt further action from elected officials, but for the time being at least, the center of gravity in these fights has shifted.
The suit by the state of Tennessee against BlackRock is important, if for no ither reason than the new era it heralds.
