Navigating Fiduciary Duties amidst the Rise of Anti-ESG Rulemaking
In recent years, companies and investment managers have increasingly considered environmental, social, and governance (“ESG”) issues in corporate strategy and decision-making, whether in response to investor pressure or due to self-imposed changes via internal processes. Indeed, a market has developed for ESG-compliant investments over the past few years. And while ESG-focused investing is more popular than ever, the topic has become increasingly politically fraught. At the same time that the federal government, along with many liberal-leaning state governments, has taken a strong pro-ESG stance, several conservative states have recently passed or proposed legislation intended to discourage state entities from working with companies and funds that practice ESG-focused investing. Among those caught in the middle of this debate are a broad swath of fiduciaries, including investment managers looking to invest across state lines, companies who operate nationally, and private equity funds with national portfolios. In this article, we discuss the recent explosion of pro- and anti-ESG state legislation and regulation over the past few years, provide suggestions for how to navigate these various state laws while continuing to operate on a national level, and suggest certain proactive steps fund managers and investors may utilize to enable them to operate in the face of these conflicting laws and regulations.
With nationwide attention on ESG, companies and investors alike are increasingly examining sustainability-based metrics to assess financial opportunities. Interest in ESG has exploded in recent years, including among retail and institutional investors. This trend has been driven, in part, by a growing consensus that companies can only deliver sustainable long-term growth when they manage their resources prudently, treat their employees well, and act as responsible stewards with an eye to the long-term viability of their surrounding natural environments. The importance of this new form of ESG-focused investing cannot be understated. Globally, asset managers are expected to increase ESG-related assets under management nearly twofold up to $33 trillion by 2026, an increase from $18.4 trillion in 2021. One of the country’s largest asset managers, which oversees some $8 trillion in assets, has been particularly outspoken on the issue of sustainability, and has taken the position that “climate risk is investment risk.” This asset manager is not alone, as many others believe that ESG-focused investments can lead to above-average returns.
At the same time, several federal regulators in the Biden Administration have also taken concerted steps to encourage investors to consider ESG factors in their investment decisions. On March 21, 2022, the U.S. Securities and Exchange Commission (the “SEC”) proposed new climate-related disclosure requirements for registrants in an effort to “advance consistent, clear intelligible, comparable, and accurate disclosure of climate-related financial risk.” While these rules are not yet in effect, the SEC has already initiated enforcement actions based upon allegedly false and misleading ESG disclosures (including investors who falsely claim to be assessing opportunities based on ESG metrics), as well as “greenwashing” schemes. Additionally, on November 22, 2022, the U.S. Department of Labor released a final rule under the Employee Retirement Income Security Act of 1974 (ERISA) to “clarify that fiduciaries may consider climate change and other environmental, social, and governance (ESG) factors when they make investment decisions and when they exercise shareholder rights, including voting on shareholder resolutions and board nominations.” And most recently, the Biden Administration issued a final rule that will better enable employers to consider climate change and other ESG factors when picking investment funds for their employee’s 401(k) plans.
At least nineteen states—particularly those where Democrats are politically dominant—have embraced the new ESG trend in investing by passing bills through state legislatures or instituting rules and regulations that encourage or even require the consideration of ESG factors, particularly concerning the investment decisions by public pension funds. For example, in 2021, Maine became the first state to enact divestment legislation that expressly bars the state’s public retirement system from investing in 200 of the largest publicly traded fossil fuel companies. Maine’s law also requires state pension funds to divest from these restricted companies by January 1, 2026.
Yet not all states have aligned with the pro-ESG movement. At least twenty-three states just last year enacted laws, rules or regulations intended to prohibit state investment vehicles from contracting with ESG-focused investors, citing concerns that ESG-focused investing improperly places political and social considerations above financial returns. The anti-ESG laws vary among states, yet almost all require state entities to either divest from companies engaged in ESG-focused investing or to refuse to enter into contracts with companies engaged in ESG-focused investing. For example, Florida’s Governor Ron DeSantis has proposed legislation that would prohibit state fund managers from even considering ESG-related factors when investing the state’s money.
Caught in the crosshairs of this political divide are fiduciary investors, including some of the nation’s largest financial institutions, whose investing practices may run afoul of new pro- and anti-ESG state laws. Being on the wrong side of anti-ESG investor legislation has caused significant problems for certain major financial institutions. Just last year, Texas blacklisted ten major financial firms from securing state banking contracts because they were deemed to “boycott” fossil fuel companies. One prominent asset manager was included on the list despite its own protestations that it oversees around $310 billion of investments in energy firms worldwide, and over $115 billion in Texas alone.
This example is illustrative of the bind many investors now encounter. Companies operating nationally or at least in both red and blue states, as well as institutional investors, must navigate a growing minefield of legislative incongruence impacting the expanding field of ESG-focused investment. Doing so will require specific attention to the growing body of state law concerning ESG-focused investing.
II. The Gathering Storm of State-Level ESG Legislation
As already noted, many fiduciaries, including financial institutions, fund managers, and companies, have chosen to incorporate ESG factors into their company missions, policies, governance and management structures. This has provoked competing reactions from states on both the right (skewing anti-ESG) and left (skewing pro-ESG) of the political spectrum.
A. State Legislative, Regulatory and Policy Approaches that Promote ESG-Focused Investing
On the left, several states have passed legislation intended to promote the use of ESG factors in investment decisions to capture the expected monetary and social benefits that accrue from such investments. In addition to legislation, several funds themselves, or the entities that oversee their operations, have put forth policies that prioritize ESG-focused investing. The pro-ESG initiatives taken by states can be divided into two general categories: sustainability directives and divestment rules.
Sustainability Directives: Several states have passed or are working to enact legislation or regulations that require public fund managers to incorporate ESG criteria and other non-financial information into their investment strategies. Occasionally, these entities are required to report ESG criteria to state legislatures or other regulatory bodies.
- Illinois Sustainable Investing Act PA 101-473: Signed into law on August 23, 2019 and in effect as of January 1, 2020, this bill directs state and local government entities that manage public funds to “develop, publish and implement sustainable investment policies applicable to the management of all public funds.” The entities’ sustainable investment policies are directed to include “material, relevant, and decision-useful sustainability factors” for each public agency to “prudently integrate . . . into its investment decision-making, investment analysis, portfolio construction, due diligence, and investment ownership in order to maximize anticipated financial returns, minimize projected risk, and more effectively execute its fiduciary duty.” Relevant sustainability factors include consideration of a company’s corporate governance and leadership, environmental, social capital, human capital, and business model, as well as innovation factors.
- Hawaii Senate Bill 801: Introduced on January 22, 2022, the bill would “[require] a public investment fund to develop, publish, and implement socially responsible investment policies applicable to management of all public funds under the public investment fund’s control and submit an annual report to the legislature on disclosing its investments in accord with environmental, social, and governance investing and socially responsible investment policies.”
- New Jersey Assembly Bill 1865: The New Jersey legislature introduced a bill on November 11, 2022 that would require the State’s Division of Investment to “develop a comprehensive plan for the State Investment Council to assess and identify the environmental, social, and governance . . . ‘ESG,’ risk and exposure characteristics of managed investment portfolios.”
Divestment Rules: Other states have taken a more restrictive approach, barring state agencies and public funds from holding stakes in, for example, major fossil fuel producers and other companies in industries often viewed as non-sustainable.
- New York Pension Fund Net Zero Target: The target, set by the New York State Common Retirement (Fund) in December 2020, requires the Fund to transition its investments to achieve a net zero portfolio by 2040. To achieve this goal, the Fund is directed to review (every four years) its energy-sector investments and to make appropriate adjustments to decrease exposure to climate-related investment risk by divesting from companies that fail to meet certain minimum standards.
- California S.B. 1173: Introduced on February 17, 2022, this bill would prohibit the Boards of the Public Employee’s Retirement System and the State Teachers’ Retirement System “from making new investments or renewing existing investments of public employee retirement funds in a fossil fuel company.” It also requires they liquidate investments in fossil fuel companies on or before July 1, 2027.
- Massachusetts Bill H.4170: The Massachusetts legislature introduced a bill on September 30, 2021, which would, inter alia, forbid the state pension fund’s board (known as the PRIM Board) from approving or ratifying any fossil fuel investments or investments in other industries that “may have a negative impact on the global climate, that scientific evidence has established as contributing to climate change [or] that conflict with or undermine the commonwealth’s climate goals[.]”
B. Anti-ESG Rulemaking at the State Level
While ESG-focused investing has proliferated, the efforts against this movement in Republican-dominated states have been significant. In the past year, at least twenty-three states have proposed or adopted some form of state legislation or regulation aimed at preventing state pension funds or agencies from doing business with investors or companies that consider ESG criteria. These “boycott” bills often invoke the concern that consideration of ESG factors is politically or socially motivated and taken at the expense of shareholder returns. In turn, conservative-leaning politicians have advocated two general categories of bills to stamp out ESG-focused investing in their states: boycott and divestment bills.
Boycott Bills: Several states have passed or are working to enact legislation that would prevent states from using their assets to do business with financial institutions that “boycott” or “discriminate” against companies that operate in particular industries disfavored by the ESG movement, such as fossil fuel producers or firearms manufacturers.
- Texas S.B. 13: Enacted on September 1, 2021, S.B. 13, one of the most far-reaching anti-ESG laws on state books, applies to numerous state retirement funds. The law first requires the state’s Comptroller to maintain a list of financial institutions that boycott energy companies. It then prohibits these aforementioned state institutions from investing in listed companies and requires the state fully divest, within 360 days, from all listed companies that fail to cease their boycotting of energy companies within 90 days of receiving notice from the state. Importantly, the new law does not apply to indirect holdings in actively or passively managed investment funds or private equity funds. However, it does require that fund managers remove listed companies from funds or create new funds that do not involve listed companies.
- Louisiana H.B. 25: The Louisiana legislature has proposed legislation that would prohibit the state’s pension funds from investing in companies that refuse to invest or do business with energy companies.
Anti-ESG Rules: Other states have proposed or passed legislation, or have taken binding regulatory action, that aims to bar public entities, including state pension funds, from considering ESG criteria when investing state resources. These rules would bar the consideration of factors outside those that seek specifically to maximize investment returns.
- Florida’s Resolution on ESG: On August 23, 2022, the State Board Administration of Florida (“SBA”) approved a resolution proposed by Governor Ron DeSantis that will prohibit large banks, credit card companies, and other financial firms from “discriminating” against customers based on their religious, political or social beliefs. The new policy also prevents SBA fund managers from considering ESG factors when investing state resources and requires fund managers focus solely on maximizing investment returns on behalf of Florida’s retirees.
- Pennsylvania H.B. 2799: The Pennsylvania House of Representatives has proposed a bill that would prohibit any business operating in Pennsylvania from using, inter alia, social credit scores or ESG factors as a sole condition of financing or providing services. The bill also aims to prevent ESG scores from being exclusively or primarily used in decision-making in consumer transactions and would block state Treasury and retirement funds from exclusively using ESG scores when making investment decisions.
III. Navigating Anti-ESG Rules
The proliferation of anti-ESG legislation and regulations poses serious concerns for investment managers, including public pension funds and large institutional investors who work with state agencies or invest in markets across the country. For example, Texas’ pension funds and other state agencies are prohibited from investing in financial products that avoid investment in fossil fuel companies. Additionally, any fund or institutional investor that has incorporated ESG factors into their investment strategies (as many do) would be barred from underwriting state infrastructure projects.
The impact of anti-ESG rules and legislation is far from theoretical. On December 1, 2020, Florida’s chief financial officer, Jimmy Patronis, announced that the state would remove about $2 billion in assets from a prominent asset manager. The decision relieved the entity from managing about $600 million in short-term investments and, eventually, $1.43 billion of long-term securities. Those monies will be reallocated to other money managers in 2023.
Texas has taken similar action against ESG-focused investors in its state. The state recently removed 348 funds from state pensions, including several funds managed by prominent financial institutions. Texas also blocked ten other firms from contracting with state and local entities. In addition, several major banks were banned from underwriting bond markets.
Managers looking to navigate the proliferation of anti-ESG rules have a number of options. Many of these laws are relatively new, untested, and open to interpretation. On the surface, the scope and application of these laws often appears to be broad, yet there are narrow exceptions that prudent investors and investment managers can use to avoid violating these new laws and safeguard their investments. Legislation and regulations in Texas and Florida provide useful examples for how investors can maintain ESG-focused investment strategies without violating relevant anti-ESG state law.
A. Texas S.B. 13
As noted above, Texas S.B. 13 mandates state retirement and school funds divest from companies that allegedly “boycott” energy companies. At first blush, Texas’ law appears extremely broad as “boycott” constitutes “any action” intended to limit business with a company that engaged in the energy industry. This language could encompass financial institutions that merely invest in other funds that avoid fossil fuels. However, a more precise analysis reveals several major exceptions exist that companies may use to avoid being blacklisted from working with the state of Texas (or its pension funds).
First, Texas S.B. 13 expressly provides that “a state governmental entity is not subject to a requirement of [the statute] if the state governmental entity determines that the requirement would be inconsistent with its fiduciary responsibility with respect to the investment of entity assets or other duties imposed by law relating to the investment of entity assets, including the duty of care . . . .” This enables a governmental entity that believes such divestment would be at odds with its fiduciary responsibilities to continue to maximize value and avoid divestment.
Second, the statute expressly allows fund managers to refuse to deal with fossil fuel companies so long as that decision is based on an “ordinary business purpose.” Therefore, companies that are interested in working in Texas can arguably still refuse to invest in fossil fuel companies, so long as they are doing so for economic-based reasons.
Third, the statute expressly authorizes state government entities to cease divesting from one or more blacklisted financial companies if clear and convincing evidence would show the state entity would “suffer a loss in the hypothetical value of all assets under management by the state governmental entity as a result of having to divest from listed financial companies.” Before it ceases divesting, however, the governmental entity must provide a written report to the state comptroller, the presiding officer of each house of the legislature, and the attorney general, setting forth “the reason and justification, supported by clear and convincing evidence,” for its decision.
Fourth, the statute also expressly authorizes individual state portfolios, otherwise subject to Texas S.B. 13 to hold investment in financial companies included on the state’s blacklist if the portfolio uses a benchmark-aware strategy and divestment would subject the portfolio to an aggregate expected deviation from its benchmark, so long as a report setting forth the reason and justification is submitted to the state comptroller, the presiding officer of each house of the legislature, and the attorney general.
Fifth, to constitute “boycotting” under the statute, a company’s decision to discriminate must be based on the fact that an energy company: (1) engages in fossil fuel production, transport, or sales and (2) does not commit or pledge to meet environmental standards beyond applicable federal and state law. One could argue that under Texas S.B. 13, it would be permissible for a state fund to invest in a company that refuses to engage in business with any fossil fuel companies so long as the investor does not distinguish among fossil fuel companies based on their differing levels of commitment to environmental standards.
Sixth, Texas S.B. 13 has a carve-out such that state governmental entities are “not required to divest from any indirect holdings in actively or passively managed investment funds or private equity funds.”
B. Florida’s Resolution on ESG
Florida’s Anti-ESG Resolution, passed by the State Board of Administration in August 2022, requires state pension funds to limit their investments to companies that solely consider pecuniary rather than political or social interests when investing. The statute provides in relevant part that:
“[t]he evaluation by the Board of an investment decision must be based only on pecuniary factors. As used in this section, ‘pecuniary factor’ means a factor that the board prudently determines is expected to have a material effect on the risk and return of an investment based on appropriate investment horizons consistent with the fund’s investment objectives and funding policy. Pecuniary factors do not include the consideration of the furtherance of social, political, or ideological interests.”
On its face, the law is extremely restrictive, requiring state pension funds focus solely on “pecuniary factors” and disregard “social, political, or ideological interests.” While the law appears to suggest that pecuniary factors and social, political, and ideological interests are mutually exclusive, it stops short of declaring such. Rather, the drafters appear to be focused on situations in which investment advisors subordinate the financial interests of beneficiaries and sacrifice investment return in favor of social interests. Nonetheless, the resolution fails to specify what “pecuniary factors” investors are required to consider, and leaves open the possibility that if certain ESG considerations were determined to maximize the fund’s return, consideration would not only be proper but required under the new law. Therefore, despite political statements to the contrary, Florida’s new rule does not actually declare that state pension managers cannot consider ESG factors when making investment decisions.
IV. Next Steps
While many institutional investors, companies, the federal government and various Democratic-leaning state legislatures have favored ESG-focused investing and considering ESG factors when making business decisions, several Republican-leaning state legislatures and governments have exerted significant effort to combat this trend. In today’s world, large institutional investors and corporations are not generally confined to the jurisdiction of one or two states, but instead conduct business on a national or even international level. As a result, there is increased attention on states with new anti-ESG legislation or regulation that have loudly pressed the issue and publicized the states’ intentions, including to stop doing business with companies who do not act in conformance with their rules.
Institutional investors, state-sponsored funds, and companies have a number of options for navigating these new rules. At the most extreme end, companies and institutional investors (headquartered outside of states with anti-ESG legislation) can cease doing business in the relevant state or abandon their ESG policies. Alternatively, they could simply proceed with their current investment strategies and risk litigation or other forms of state retribution. But such polarizing strategies are not necessary as several paths exist to help investors, including financial institutions and fund managers, navigate these laws while avoiding a violation of their fiduciary duties.
We recommend that investors take the following proactive steps to prepare for the impact of anti-ESG legislation:
- Monitor Pro- and Anti-ESG Legislation: This is a rapidly evolving regulatory space. In the past several years, at least twenty-three states have either adopted or proposed anti-ESG bills. Over the past several years, at least nineteen states have either adopted or proposed pro-ESG policies. As noted, there are important discrepancies between these laws and numerous exceptions exist that may help companies preserve their current investment strategies without violating anti-ESG legislation. Staying abreast of new legislation, rules and regulations promulgated in this space is critical to avoid losing business, particularly for those institutions that do business in states with large public investment portfolios.
- Strengthen ESG Approaches: Companies and institutional investors should pay close attention to their policies, procedures, and public disclosures to ensure they do not violate new anti-ESG rules and regulations. In certain states, such as Florida, fund managers can avoid breaking state rules or avoid being blacklisted if they demonstrate, with clear guidance and data driven evidence, that their investments are based primarily, if not exclusively, on pecuniary factors aimed at generating the highest returns, rather than environmental, social or governance based indicators.
- Divide Between “Red” and “Blue”: Navigating carve-outs in anti-ESG laws may not be a viable option for some of the largest institutional investors. Companies that have already been subject to blacklists in states such as Texas, Florida, and Arizona may struggle to comply with certain state rules given the explicit public commitment they have made to using ESG factors. In this case, it may be possible for companies to “divide” their business into pro- and anti-ESG entities, to enable doing business in both types of jurisdictions—e.g. by creating “BlueCo” and “RedCo.”
- Consult with Attorneys: It is critical for financial investors to understand the nuances of new ESG-focused laws and regulations, including both pro- and anti-ESG rules. Consulting with knowledgeable attorneys before deploying new investment strategies is critical to ensure ESG-focused investment policies do not violate the laws and regulations in particular states.
 Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans,’ Business Roundtable (Aug. 19, 2019), https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans.
 PwC Report: ESG-focused Institutional Investment Seen Soaring 84% to US $33.9 trillion in 2026, Making up 21.5% of Assets Under Management, PriceWaterhouseCoopers (Oct. 14, 2022), https://exelerating.com/en/uk-market/alerts/pwc-report-esg-focused-institutional-investment-seen-soaring-84-to-us33-9-trillion-in-2026-making-up-21-5-of-assets-under-management/.
 Larry Fink, Larry Fink’s 2020 Letter to CEOs, BlackRock (Jan. 14, 2020), https://www.blackrock.com/americas-offshore/en/larry-fink-ceo-letter.
 Subodh Mishra, ESG Matters, Harv. L. Sch. Forum on Corp. Governance (Jan. 14, 2020), https://corpgov.law.harvard.edu/2020/01/14/esg-matters/ (indicating some evidence of a correlation between ESG and financial performance).
 Jacob H. Hupart, et al., A Brief Summary of the SEC’s Proposed Climate-Related Rules, Mintz (Mar. 30, 2022), https://www.mintz.com/insights-center/viewpoints/2451/2022-03-30-brief-summary-secs-proposed-climate-related-rules.
 Jacob H. Hupart, et al., SEC Proposes Regulations to Address “Greenwashing” by Investment Funds, Mintz (June 13, 2022), https://www.mintz.com/insights-center/viewpoints/2022-06-13-sec-proposes-regulations-address-greenwashing-investment.
 Jacob H. Hupart, et al., ERISA Fiduciaries May Consider ESG Factors in Selecting Investments and Exercising Shareholder Rights, Mintz (Nov. 30, 2022), https://www.mintz.com/insights-center/viewpoints/2786/2022-11-29-erisa-fiduciaries-may-consider-esg-factors-selecting.
 In addition, the Biden Administration has further signaled its commitment to ESG issues by rejoining the Paris Climate Agreement. See Matt McGrath, US Rejoins Paris Accord: Biden’s First Act Sets Tone for Ambitious Approach, BBC (Feb. 19, 2021), https://www.bbc.com/news/science-environment-55732386.
 Ross Kerber, New Maine Law Marks U.S. First on Fossil Fuel Divestment, Reuters (June 17, 2021), https://www.reuters.com/business/sustainable-business/new-maine-law-marks-us-first-fossil-fuel-divestment-2021-06-17/.
 Pete Schroeder, How Republican-led States are Targeting Wall Street with “Anti-Woke” Laws, Reuters (July 6, 2022), https://www.reuters.com/world/us/how-republican-led-states-are-targeting-wall-street-with-anti-woke-laws-2022-07-06/.
 Press Release, Governor Ron DeSantis Eliminates ESG Considerations from State Pension Investments, Office of Governor Ron DeSantis (Aug. 23, 2022), https://www.flgov.com/2022/08/23/governor-ron-desantis-eliminates-esg-considerations-from-state-pension-investments/.
 Richard Vanderford, Texas Blacklists BlackRock, UBS and Other Financial Firms Over Alleged Energy Boycotts, WSJ (Aug 24, 2022), https://www.wsj.com/articles/texas-blacklists-blackrock-ubs-and-other-financial-firms-over-alleged-energy-boycotts-11661381425.
 Silla Brush & Shelly Hagan, BlackRock Tells Texas It Supports Investments in Oil and Gas, Bloomberg (May 18, 2022), https://www.bloomberg.com/news/articles/2022-05-18/blackrock-tells-texas-it-supports-investments-in-oil-and-gas#:~:text=BlackRock%20Inc.,its%20advocacy%20for%20sustainable%20investing.
 The examples chosen in this section are representative; this article is not intended to provide a comprehensive compilation of all current and proposed ESG legislation and regulation among the various states.
 Ellen Meyers, Republicans Ride ESG Backlash to State Financial Offices, Roll Call (Nov. 17, 2022), https://rollcall.com/2022/11/17/republicans-ride-esg-backlash-to-state-financial-offices/ (quoting Republican state Representative Steven C. Johnson, the state’s next treasurer, as saying that “ESG funds only invest in companies based on their environmental and corporate policies, making returns on investment a secondary concern.”).
 Ross Kerber, Florida Pulls $2 bln from BlackRock in largest anti-ESG divestment, Reuters (Dec. 1, 2022), https://www.reuters.com/business/finance/florida-pulls-2-bln-blackrock-largest-anti-esg-divestment-2022-12-01/.
 Ellen Kennedy, The ESG Investing Backlash, Kiplinger (Sept. 6, 2022), https://www.kiplinger.com/investing/esg/605184/the-esg-investing-backlash.
 A Resolution Directing an Update to the Investment Policy Statement and Proxy Voting Policies for the Florida Retirement System Defined Benefit Pension Plan, and Directing the Organization and Execution of an Internal Review, State Board of Administration of Florida (Aug 23, 2022), https://www.flgov.com/wp-content/uploads/2022/08/ESG-Resolution-Final.pdf.