ESG Governance and The States
The Louisiana Treasurer and Attorney General have announced that the state is divesting BlackRock, an investment firm that uses Environmental, Social, and Governmental Standards (ESG). They are selling off, over time, nearly $800 million in BlackRock investments.
BlackRock is the world’s largest investment manager. The company takes the environmental impact of carbon into consideration as they make investment choices. Louisiana claims the firm chooses investments based on ESG standards without adequately disclosing its ESG program, which violates fiduciary duties within the state. Other conservative states have been considering political action against BlackRock as well.
Contrarily, the federal government has taken proactive steps to encourage ESG investments. In 2021, the Securities and Exchange Commission (SEC) announced the creation of a Climate and ESG Task Force in the Division of Enforcement. The division’s aim is to review disclosures of climate risks and ESG disclosure and compliance.
The two forces, ESG standards and fiduciary duties, are in conflict.
This article will examine ESG standards, fiduciary duties, and B Corps, and investigate how they are related and why they are important for the political future of Louisiana.
What is ESG?
Let’s talk about ESGs. ESG stands for Environmental, Social, and Governance. ESG represents a certain standard or criteria that organizations consider when making investments. Each ESG fund uses its own principles to include or rule out investment in companies.
There are no general principles that all businesses agree to. Some companies have their own ESG standards, which can make it easier for investors to choose them as ESG investments.
Some frequently used criteria include:
- Environmental: Taking steps to avoid climate change, working with land conservation, lessening the use of fresh water, and more
- Social: Supporting living wages for workers, fair trade with suppliers, unions, and more
- Governance: Backing transparency, disclosure, board composition, lobbying, and more
There is also no universal standard for ESG governance. While many ESG funds are tied to environmental and liberal ideals, that’s not a necessity. For example, a conservative group could develop its own ESG based on Christian religious principles or other desired criteria.
Many organizations hear ESG and think only about the environment. However, social and governmental best practices are also included in ESG governance. They should not be overlooked just because the environmental goals are currently getting a lot of press.
Pros and Cons of ESG Investments
Investors can choose whether they wish to invest in companies or portfolios based on ESG.
Benefits of Choosing ESG investments:
- People want to invest in companies that share their core beliefs. By investing in ESG companies, they are making money while also supporting the environmental, social, and economic movements that they believe are important.
- ESG investors generally have a good faith belief that the companies they choose will do better in the long run. They reason that as grassroots movements that underpin environmental and social goals become more mainstream these companies will benefit.
Reasons to Avoid ESG Investments:
- BlackRock as an example, but other ESG investors may not be transparent about the effects of ESG on the bottom-line of the companies they invest in.
- Companies may be pressured to adopt ESG standards as a condition of investment even if those standards may not be the best choice for that company.
- There is a belief among some anti-ESG organizations that large hedge funds coordinate their activities across many companies that they are invested in to promote and advocate values and policies that may have significant economic or cultural effects. More importantly, this level of coordination is usually non-transparent.
- ESG standards do not match your core beliefs. For example, Louisiana officials felt that BlackRock’s ESG principles were at odds with their economic goals for Louisiana.
What is Louisiana Doing?
Louisiana is liquidating all investments with BlackRock investments. The reason? BlackRock uses ESG principles. Specifically, Louisiana does not support BlackRock’s ESG standard to de-carbonize the economy by taking money out of coal and oil investments and putting it into renewable energy.
Louisiana’s economy depends on oil and gas. Louisiana has the second-largest number of refineries in the United States, after Texas. The state’s leaders argue that they should not invest their money in a program that was designed to undermine their economy.
Louisiana officials are counteracting ESG investments using two separate approaches:
- Divestment: Selling stock in companies or funds that have ESG goals
- Changing the Law: Making ESG investment (or just state investment) illegal
In a letter to BlackRock, Louisiana Treasurer John Schroeder wrote, “This divestment is necessary to protect Louisiana from actions and policies that would actively seek to hamstring our fossil fuel sector. In my opinion, your support of ESG investing is inconsistent with the best economic interests and values of Louisiana.”
Louisiana Attorney General (AG) Jeff Landry ties this conduct to a law about making false statements. He says that investment firms that do not disclose the ESG standards they use are in breach of their fiduciary duty.
ESG Investments in Other States
West Virginia was the first state to pull out of ESG investments. Other states considering doing so are Indiana, Texas, Kentucky, Oklahoma, Florida, South Carolina, Arizona, Idaho, Utah, Wyoming, Arkansas, and North Dakota.
A big conflict is about to happen on a federal level. Most Republicans want to get rid of ESG investing altogether. However, the SEC is encouraging ESG investing by adding it to their regulatory framework.
What is the Fiduciary Duty?
Simply put, the fiduciary duty means an investor has only one duty: to make money for their clients, codified in Louisiana Revised Statues Title 11 §264.3. Anything that impedes making money has to be put aside. A person found in breach of fiduciary duty is typically required to pay damages.
We can break this duty down into a variety of different duties in different states. The List of Fiduciary Duties includes:
- Duty of Care: Directors and officers decide based on all available information looked over with a critical eye.
- Duty of Loyalty: Directors and officers must act without personal economic conflict.
- Duty of Good Faith: Directors and officers advance corporate interests without violating the law.
- Duty of Confidentiality: Directors and officers keep corporate information confidential.
- Duty of Prudence: Trustees must administer a trust with the care, skill, and caution of a prudent trustee.
- Duty of Disclosure: Directors give stockholders “all the facts and circumstances” that led to a decision.
Landry relies upon Louisiana Revised Statue Title 51, §712, “[It shall be unlawful for any person (2) To offer to sell or to sell a security by means of any oral or written untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, the buyer not knowing of the untruth or omission, if such person in the exercise of reasonable care could not have known of the untruth or omission.” He calls this (perhaps incorrectly) the duty of loyalty.
Landry says that ESG status is a material fact not stated, making ESGs misleading and therefore illegal. If this ruling goes to court, there will likely be questions about how clearly businesses and investors state ESG status, as well as claims made under a general fiduciary duty and the duty of loyalty.
Louisiana’s Duty of Loyalty
Courts interpret the duty of loyalty as keeping corporate leaders from making decisions that benefit themselves, rather than the corporation. However, several states are urging a wider reading of the duty of loyalty.
Louisiana is one such state in which the duty of loyalty is being redefined. The state Treasurer says BlackRock’s divestiture is necessary because ESG governance shows disloyalty to the state’s current economy, which breaks the duty of loyalty.
How do Fiduciary Duty and ESG Interact?
If investing in ESGs is voluntary, framed as a choice, and openly displayed, an investor can choose other duties above a fiduciary duty. Legally, this is shown through an ESG or B Corp status. The state should be able to choose among investment groups based on their various priorities.
However, in the state of Louisiana, many officials are arguing that because the ESG disclosures aren’t clearly defined, ESG status and fiduciary duty cannot co-exist. As their case moves forward, it will be up to judges to decide whether ESGs can co-exist with fiduciary duty. Secondarily, it is unclear whether individual investors are given the choice. Any investor in a hedge fund or asset management company gives that company the power to choose investments on their behalf. Louisiana argues that if individual investors knew how their investments were being deployed in support of ESG they would see it as a violation of the firms fiduciary duty.
Problems Determining Fiduciary Duties
Making money focuses on the short term. Which stocks are performing now? This measure can write off stocks that have long-term, slow gains. The question then becomes, does fiduciary duty mean short- or long-term gains? Investors can choose if they know they are making a choice.
For example, if you invest in oil stocks, you may make a lot of money today, but your long-term outlook would be less certain. On the other side, if you invest in wind power, you may see fewer gains in the present, but wind power is forecast to be a much larger part of our fuel mix in the future, making it a stronger long-term investment. Conservative leaning states want to ensure that the right of the individual to make this choice is present. ESG at times can be oblique, and hidden in how it is determined, how it is scored, and whether it truly does look out for the interests of investors.
ESG principles set up different rules that may or may not conflict with fiduciary duties. They can drive long-term investments and can support procedures (such as employee retention or waste reduction) that they see as making a company stronger.
B Corps: Another ESG Example
Louisiana has approved B Corporations, or benefit corporations, noted in Louisiana Revised Statutes Title 12 §1801 et seq. The goal of these B Corps is to allow companies to set their own values and ideals as part of the rules that guide the B Corp. Directors are required to consider multiple factors, not just fiduciary duties. This generally means environmental and social goals, but the wording is flexible and different ideals can guide different B Corps.
Louisiana Approves B Corps
B Corps developed because people were upset that the fiduciary duty (making money for shareholders) was interpreted as the only goal of a corporation. Louisiana was the 8th state to allow B Corps. Existing corporations can also become B corps.
These goals are often environmental, such as reducing carbon footprints or considering post-consumer waste as an issue. Other goals may be social, including employee ownership or employee retention rates. The idea is to “do well by doing good.”
Certified B Corporations
A certified B Corp is another type of B Corp, one that gains B Lab certification by making a certain score on the B Corporation Impact Assessment.
Difference Between B Corps and Corporations with ESG goals
Louisiana specifically allows B Corps, yet it is divesting from companies with ESG goals. However, both ESGs and B Corps allow the weakening of the fiduciary duties of corporations in roughly the same manner.
So, why does Louisiana support B Corps and not ESGs?
The answer is likely transparency. While the specific goals of ESGs for corporations or investment companies are often unclear, B Corps are clearly labeled. The transparency of B Corps sets them apart from ESGs.
What Choice Is Left for Louisiana Investors?
Investors can still choose funds that are explicitly ESG. The Louisiana ruling was concerned with disclosure, so investors or investment managers made their investment choices clear to potential investors. Most ESG funds announce their ESG status as a selling point. However, as funds buy other funds or invest in fund groupings, the rules governing a particular fund can disappear into the whole.
In Louisiana, the fight for ESGs will be ongoing. The state itself pulled its investments from BlackRock and placed them with another investment house. This is part of a wider conservative movement to make ESG goals illegal if they are not explicitly stated to investors and given honest proformas of the impact of ESG.
It will be interesting to see what the courts and enforcers do with this complex topic. Divestment is one thing. Calling the entire program illegal is another. Officials have said ESG is illegal, but they may need a stronger case to win in court. If you have questions about your investments and shareholder’s rights, contact an attorney. At Morris & Dewett, we can provide general legal guidance. For complex matters, we can refer you to a qualified, high reputation, law firm.