The “anti-ESG” movement: Balancing conflicting stakeholder concerns and inconsistent regulatory regimes

While environmental, social and governance (ESG) considerations have captured the attention of corporations, investors, lawmakers, and regulators across the US and globally in recent years, a so-called “anti-ESG” or “ESG backlash” movement has emerged recently in the United States. ESG critics cite, among other concerns, global economic uncertainty, antitrust concerns, unreliable ESG data and “greenwashing,” state anti-boycott and other anti-ESG legislation and other legal risks associated with ESG.

In the midst of this movement, earlier this month, Arizona Attorney General Kris Mayes announced that Arizona would no longer participate in the investigations into major American banks and other financial practices over ESG investing, signaling that at least some state regulators may be tempering ESG skepticism. Meanwhile, other US states have begun efforts to decarbonize their state investment portfolios and adopt more aggressive regulations promoting corporate sustainability, and these issues have become divisive topics at the federal level.

Companies developing sustainability initiatives must balance not only competing stakeholder interests, but also monitor compliance with these often conflicting legal regimes.

In this client alert, we discuss:

• The major factors driving the anti-ESG movement, including
• Economic uncertainty
• Antitrust concerns and
• Concerns about ESG data reliability and greenwashing
• Inconsistent regulatory regimes at the US state and federal level, including
• State anti-boycott laws
• Texas Senate Bill 13
• The “sole interest rule” and other state legal challenges
• State decarbonization and sustainability laws, and
• Federal political division on sustainable investing and SEC climate rules
• Different types of ESG investors
• Tools for balancing competing stakeholder interests, and
• Key takeaways for companies balancing competing stakeholder interests and inconsistent regulatory regimes

On Wednesday, February 22, DLA Piper will be leading a lunch roundtable in Houston to discuss state anti-energy boycott law compliance. Seating is free, but limited. If you are interested in joining the roundtable, RSVP to anna.colin@us.dlapiper.com.

A. ESG in an era of economic uncertainty

With inflation on the rise, general global economic uncertainty and such events as the war in Ukraine which has, most notably, destabilized a major source of global natural gas, some investors may expect companies, particularly those with scarce resources, to focus on managing costs and consider scaling back on spend related to climate transition efforts. An unprofitable company is an unsustainable company, and companies managing limited resources, particularly in a time of crisis, might consider forgoing the production of voluntary, glossy ESG reports requiring extensive and complex data collection, or pursuing other costly ESG projects to focus on the company’s “mission-critical” initiatives. In 2020, while demands from investors for more robust ESG information reached fever pitch, some publicly traded companies that had long produced annual sustainability reports did not issue one during the first year of the coronavirus pandemic.

While some investors may expect companies to protect the bottom-line during times of economic uncertainty or turmoil, we expect ESG to remain a major concern of major asset managers, customers, employees and other stakeholders, and that ESG will continue to serve as a critical lens through which to view corporate risks, opportunities and business decisions. Additionally, it is all but certain that companies will be subject to increased regulation concerning corporate carbon emissions, ESG reporting, and the environmental and social sustainability of corporate value chains in individual US states like California, Europe, the United Kingdom, and other parts of the world.

Further, regardless of legislative efforts, stakeholders such as investors, value-chain participants and employees, will continue to demand information from companies regarding climate and other ESG goals, initiatives and results, though these demands might be tempered somewhat by economic concerns and shifting attitudes and priorities.

B. Antitrust and ESG

Another chief concern of lawmakers, investors and other stakeholders is that ESG activities, like other types of competitor collaborations, raise concerns under antitrust laws such as the Sherman Act, which generally prohibit agreements or understandings between independent economic actors that unreasonably restrain competition. For example, coordinated conduct among financial firms or pension funds to ban investment in carbon-based energy be viewed as a boycott on the energy industry as a whole, and some group boycotts are unlawful per se under antitrust law.

Additionally, coordinated conduct by purchasers within a particular industry or other arrangements between competitors or other independent actors to restrict trade, such as a commitment to only do business with a list of certain “ethical suppliers,” may pose an unreasonable restriction on competition. Other agreements or understandings, such as standard-setting among industry participants, may also raise antitrust concerns. Depending on the facts, coordinated conduct may be permissible if the activities do not produce anticompetitive effects that substantially outweigh any procompetitive benefits.

Violations under antitrust law can carry severe consequences, including criminal liability for companies and individuals, treble or punitive civil damages, the imposition of burdensome conditions on a company’s business, debarment from government contracts, and significant reputational damage. Accordingly, climate transition plans and, in particular, coordination with other industry participates, should be assessed for antitrust risk and compliance.

C. ESG data reliability and “greenwashing”

Individual states, federal regulators like the Securities and Exchange Commission (the “SEC”) and Federal Trade Commission, as well as corporate stockholders, have raised concerns about the reliability of ESG data and “greenwashing” and even concerns about the value of ESG generally. Companies must ensure that their ESG practices and reporting are not false or misleading, while understanding that their data will be viewed through the lens of stakeholders who may have competing concerns.

Measuring the effectiveness of a company’s ESG initiatives depends on who you ask, what data they use and how they analyze the data. ESG is rife with data challenges- including data that is unstandardized, unreliable, difficult to collect and/or housed in different silos of a company or even outside of the company. Information about scope 3 GHG emissions and sustainability practices, in particular, is generally controlled by third parties up and down the company’s value chain and can be difficult to collect and verify. These data challenges are a major driving force behind the Biden SEC’s call for mandated GHG emissions reporting. In addition to these data challenges, there are many different ways to analyze whether ESG initiatives produce economic value and different measures of profitability- short term profitability, long term profitability and future projections about profitability relying on assumptions and hypotheses.

As ESG critics like Vivek Ramaswamy note, these data challenges create an opportunity for analysts, academics, consultants, executives and others to “cherry pick” ESG data to fit a particular agenda or narrative. It also creates an opportunity for companies to practice “greenwashing,” a term used for the practice of making false or misleading claims about the company’s impact on the environment.

To avoid “greenwashing” accusations, is important that companies avoid vague statements or words with no clear meaning (like “eco-friendly”), avoid puffery or stretching the company’s achievements, and rely on measurable data that is verified by effective disclosure controls and procedures. For example, in the environmental sphere, resources permitting, a company can utilize developed frameworks like the Taskforce for Climate-Related Financial Disclosures, or TCFD, to report GHG emissions and the Science Based Targets initiative, or SBTi’s methodologies and practices to set and measure emissions reductions and net zero targets.

In the social sphere, a best-in-class diversity disclosure would publish the company’s EEOC data and describe the company’s ongoing diversity and inclusion programs, instead of proclaiming that the company is a diverse and inclusive workplace.

D.  Inconsistent state and federal regulatory regimes

Anti-boycott laws

Recent “anti-energy boycott” lawmaking and activism has impacted the financial services sector and companies that do business with state governments. Generally, anti-energy boycott laws refer to the governments of states reliant on certain industries, like West Virginia and Texas, which are both reliant on the fossil fuels industry, divesting their pension funds from, or otherwise boycotting, funds, asset managers or companies that boycott fossil fuels.

In August 2022, attorney generals from several states joined together to challenge ESG practices of a prominent investment management firm and to launch an investigation into an ESG ratings company. Among other theories, these states argue:

• First, as a fiduciary, financial firms, pension funds and other funds have a duty to act in the best interest of their clients to maximize profitability, while acting impartially. By focusing on ESG initiatives, investors are prioritizing social objectives ahead of financial returns.
• Second, coordinated conduct among financial firms, pension funds and other funds to boycott the energy industry may violate antitrust law.
• Third, ESG initiatives impede the US’s energy independence.
• Fourth, ESG investment strategies may violate state anti-ESG legislation.

In addition to Texas, whose anti-ESG bill, SB 13, is discussed in more detail in the next section, 13 states- Arizona, Florida, Idaho, Indiana, Kentucky, Louisiana, Minnesota, North Dakota, Oklahoma, Pennsylvania, South Carolina, Utah and West Virginia and have adopted similar legislation limiting state business with ESG investment funds or financial services and other companies that boycott coal, oil and gas or other energy companies or other critical industries impacting the environment like agriculture, lumber or mining. Similar laws have also targeted fund and asset manager boycotts of other “sin industries”- like the firearms- or individual countries like the country of Israel. An August 2022 attorney general letter sent to an ESG ratings company primarily concerns the practice of assigning lower ESG scores to companies doing business in Israel.

Texas anti-ESG legislation

In September 2021, the Texas governor signed Senate Bill 13 (SB 13) – widely referred to as the anti-ESG bill in Texas. The primary purpose of SB 13 is to protect the energy industry in Texas from decarbonization of investment portfolios by funds and asset managers. Under SB 13, Texas state investment entities, such as state pension funds and public school endowments, are prohibited from investing in companies that boycott the fossil fuel industry. The law also prohibits governmental entities from entering into contracts valued over $100,000, unless the contracting company expressly represents that it does not and will not boycott energy companies during the term of the contract. Following the passage of SB 13, five of the largest municipal bond underwriters have exited from the state of Texas.

A concern with SB 13 is its ambiguous definition of “boycott”: “without an ordinary business purpose, refusing to deal with, terminating business activities with, or otherwise taking any action that is intended to penalize, inflict economic harm on, or limit commercial relations with a company because the company [is in the fossil fuel industry or does not commit to or pledge to meet any environmental standards beyond applicable federal and state law] or a company that does business with such a company.”

This broad definition invites subjectivity in the implementation of the law. This definition could arguably be stretched to apply to such situations as a company deciding to purchase a fleet of electric vehicles instead of gas-powered vehicles in a given year. Additionally, a financial services company or fund’s decarbonization strategy may have multiple business rationales, including predictions about the future price of fossil fuels, carbon taxes or credit and funding opportunities, and it is unclear how the state determines if a strategy is based in sound business judgment or an intent to inflict economic harm on a particular industry.

One aspect of SB 13 that may provide clarity to financial services companies on how the law will be applied is its requirement that the Texas Comptroller provide a list of companies that boycott energy companies based on its judgment and publicly available information regarding companies, research firms, nonprofit information and other similar information. To date, ten financial companies and 342 individual investment funds have been listed by the Texas Comptroller as companies that boycott energy companies and subject to divestment by the state of Texas under SB13.

The “sole interest rule” and other state legal challenges to ESG

In recent years, several more states with Republican-controlled legislatures have begun to look at model legislation to prevent asset managers from investing their state funds or exercising shareholder rights to advance ESG-related political and social goals. Examples of such model legislation considered are the American Legislative Exchange Council’s State Government Employee Retirement Protection Act and the Heritage Foundation’s State Pension Fiduciary Act. Both of these legislative models seek to define fiduciary obligations to explicitly exclude ESG factors in investing through a “sole interest” rule. These model codes would also withdraw proxy-voting authority from all outside asset managers to further lessen the influence of ESG and other nonfinancial goals on investments. These laws may also reduce the ability of asset managers to elect directors or support shareholder resolutions.

Additionally, states have already proposed or enacted bills or taken other actions that would restrict ESG investing. In September 2022, the Indiana Attorney General issued an opinion stating that the Indiana Public Retirement System’s Board was prohibited from choosing investments or investment strategies based on ESG considerations, and that it must not invest for any reasons other than interests of fund beneficiaries. Earlier this month, the State of Florida announced plans to propose comprehensive anti-ESG legislation which, among other goals, prohibits the consideration of ESG factors in all investment decisions at the state and local level and codifies that only pecuniary factors can be considered in investing state funds. In January 2023, Wyoming introduced the Stop ESG State Funds Fiduciary Act which would, like the Florida bill, restrict ESG investing from state pension funds.

Lastly, state attorney generals and treasurers have either joined on letters or have worked together to challenge the use of ESG factors. One example is the Mississippi State Treasurer David McRae and the state treasurers signing a letter sent to congress urging federal law makers to challenge the Biden Administration’s rule permitting the Department of Labor to allow fiduciaries of workplace retirement plans to consider environmental, social and governance risk factors when selecting plan investment options.

State decarbonization and sustainability laws

While some states have enacted anti-ESG legislation, others have enacted laws and rules that mandate the decarbonization of the state’s investment portfolio, the consideration of ESG factors in investment and corporate sustainability due diligence. For example, around the same time of passage of Texas’s SB 13, the state of Maine passed a law prohibiting the Maine Public Employees Retirement System from investing in the 200 largest publicly traded fossil fuels companies as determined by their carbon reserves. Additional states might take similar steps to decarbonize their state investments.

Additionally, several state treasurers have signed statements and letters further affirming their approval of ESG factors while opposing bans on using such factors in investment decisions, and state attorney generals have also signed letters strongly supporting the consideration of ESG factors in investment decisions and supporting various social causes.

Other states are considering more aggressive action mandating sustainability considerations by companies doing business in the state. For example, the New York Senate has in Committee Senate Bill S7428A, also known as the Fashion Sustainability Act. If made into law, it would require fashion sellers to be accountable to standardized environmental and social due diligence. It would also establish a fund to implement environmental benefit projects of labor remediation projects that benefit the workers and communities directly impacted.

Federal political division on sustainable investing and SEC climate rules

Since the 2022 election, the Republican-led House has ramped up its criticisms on environmental, social and governance investing. The House Financial Services Committee is preparing to hold hearings questioning SEC Chair Gary Gensler on his agency’s plans to require climate disclosures from companies, which generated over 14,000 comment letters. Some of the concerns raised in the comment letters were raised by Republican SEC Commissioner Hester M. Peirce in her March 21, 2022 statement “We Are Not the Securities and Environment Commission- At Least Not Yet,” which argued that the SEC’s proposed climate disclosure rules were unnecessary and imprudent and exceeded the scope of the SEC’s authority. In addition to challenging these rules, the Republican House Financial Services Committee members have further raised concerns about the SEC helping shareholders get ESG proposals on companies’ proxy ballots.

Since the change of power in the House, the Index Act and the Mandatory Materiality Requirement Act have regained the attention of House Republicans with Senator Bill Huizenga of Michigan seeking to re-introduce these bills this year. The Index Act intends to dilute the voting power of major investing firms by requiring investment advisers to vote proxies according to the specific wishes of the investors. The Mandatory Materiality Requirement Act would insert statutory language into the Securities Act of 1933 and the Securities Exchange Act of 1934 which would require that the SEC determine if “there is a substantial likelihood that a reasonable investor of the issuer would consider the information disclosed to the commission under the requirement to be important with respect to an investment decisions regarding the issuer” when imposing a new disclosure obligation.

Responding to increased anti-ESG activism in the House, a group of House Democrats have formed a caucus to advocate for sustainable investing. The caucus notes that its goal is to educate members of Congress on the market-driven benefits of sustainable investing and to support federal agencies in advancing proposals and regulations which recognize the importance of using ESG criteria in the investment process through regular events and discussions.

While companies can expect to see increased climate and ESG-related regulation from individual US states like California and globally, particularly in the United Kingdom and Europe, political division in the United States make the federal ESG regulatory regime uncertain.

E. Conflicting investor priorities

Companies must not only grapple with conflicting regulatory regimes within the United States and globally, but also conflicting investor priorities. ESG investors are betting that a company’s ESG investments will create long-term value and that companies that invest in sustainability and ESG initiatives will be better prepared to deal with climate-related physical risks, climate transition risks and rising carbon prices, and that these and other ESG investments will eventually pay off in the form of improved relationships with the company’s employees, customers, business partners and other key stakeholders, typically on a longer time frame. Other investors will solely focus on profits, and perhaps, given their investment strategy, only seek short-term gains, and may see ESG as a hinderance to their investment goals.

Meanwhile, for other investors, traditionally called “socially responsible investors,” ESG may be an end in itself. Socially responsible investors are willing to accept potentially lower rates of return to ensure the companies they invest in create a positive social impact or avoid harmful social impacts. In sum, for some investors and other stakeholders, like values-driven employees or socially responsible investors, ESG is about a company’s values. For others, ESG is about the company’s value, particularly value over the long-term. For many investors and other stakeholders, ESG is about both. And some investors view ESG as a distraction that is not correlated with, or even a barrier to, profitability.

F. Tools for balancing competing interests

How can companies balance these competing interests, particularly since investors and other stakeholders are not monolithic and may have differing concerns and priorities? One tool is stakeholder engagement, particularly engagement with investors. Through communication with stakeholders, presentations and conference calls, and responding to stakeholder requests for information, a company can better understand the priorities of its investors, employees and other key stakeholders. This engagement could, resources permitting, be used to inform a “materiality assessment,” a process of soliciting priority ESG issues from a number of different stakeholders and analyzing these concerns to identify those ESG issues that are most important to the company and its core mission.

Another tool is conducting competitive studies and peer group analysis to determine the ESG practices of similarly positioned companies and consumer and labor market preferences. These tools – stakeholder engagement, materiality assessments, competitive studies and peer group analyses – can inform a company’s ESG mission and story.

Officers and directors of for-profit corporations generally only owe fiduciary duties to the corporation and its stockholders. However, for most officers and directors, ESG decisions should be made with the best interest of the company and its investors in mind. Officers, directors and management may face increasing pressure from agenda-driven activist investors, values-driven employees or other stakeholders to make environmental, social or political commitments, investments or statements, or to take certain actions to promote a particular environmental, social or political cause. Companies that maintain open and frequent lines of communication with their investors and other stakeholders, and not just those actively engaging with the company on ESG, have conducted a materiality assessment, and/or have conducted competitive studies and peer group analysis, and have used these tools to inform a clear ESG mission, might be better prepared to respond to these demands in a thoughtful and deliberate manner.

G. Key takeaways

Companies navigating these competing stakeholder interests and regulatory regimes should consider the following:

• If feasible given the company’s financial resources, engage with the company’s stakeholders, particularly its investors, and conduct ESG materiality assessments, competitive studies and peer group analyses to determine ESG priorities, as well as non-ESG priorities. The company’s mission-critical initiatives should be its lodestar, and these tools can be used to create a thoughtful and deliberate ESG strategy that furthers the company’s mission.
• Financial services companies and companies with state law contracts or other important relationships with state governments should consider whether their existing practices violate any recent or proposed state anti boycott or other anti-ESG laws or opinions of state agencies.
• Consider whether prior and future ESG statements or commitments may have legal risks, including state laws regarding corporate fiduciary duties, antitrust laws and federal securities laws. Withdrawal from third party commitments may become necessary if the third party is pursuing an agenda that may not be in the best interest of the company and its stockholders. Additionally, companies experiencing a crisis or limited financial resources may decide that it is in the best interest of the company to divert corporate resources from voluntary ESG initiatives like detailed, complex ESG reports to focus on the company’s bottom line. Finally, financial services firms and funds have special fiduciary obligations to consider when formulating an ESG strategy.
• Engage antitrust counsel to assess activities involving communications and/or coordination with other companies, especially competitors, and other activities that may exclude or disadvantage certain parties, such as fossil fuel companies, from or in the market.
• Some ESG data and messaging may be housed in marketing, investor relations or other silos- and may appear in different formats for different audiences- such as sustainability reports, sustainability websites, investor presentations, third party ESG questionnaires and SEC filings. Ensure that the company’s ESG data, statements and commitments are accurate, consistent and complete and verified by effective disclosure controls and procedures.
• Notwithstanding the rise of the anti-ESG movement, sustainability will continue to be a major concern for regulators, investors and other stakeholders, and an important topic of discussion in boardrooms and day to day corporate operations- See our client alert “10 considerations for companies on the path to sustainability.”

As noted previously, on Wednesday, February 22, DLA Piper will be leading a lunch roundtable in Houston, Texas to discuss state anti-energy boycott law compliance. Seating is free, but limited. If you are interested in joining the roundtable, RSVP to anna.colin@us.dlapiper.com.

For more information about the subject of this Alert, please contact any of the authors of this alert or your DLA Piper relationship attorney.

For more information about ESG competitive studies and peer group analysis, please contact our ESG Data and Benchmarking group at DLAPiperCorporateDataAnalytics@us.dlapiper.com. Please also visit our Sustainability and Environment, Social and Governance portal for our latest information on sustainability and ESG developments.