What the war on ESG means to you

Several states have or hope to pass rules that target ESG investing, including one that proposes to make it a criminal offense to invest funds via “environmental, social and governance” criteria.

Expect things to only intensify on this front.

“This is going to be a busy, busy year with this because it’s an election year,” said Lance Dial, a partner with K&L Gates in Boston. “There’s definitely politics” involved, he continues. These anti-ESG laws prove to be “a good way to get press attention” for politicians.

An example of an anti-ESG law

But they can drive crazy advisers that advance ESG strategies for their clients. Take a couple of new Missouri rules, one targeting advisers; the second broker-dealers, that require ESG advisers to get their clients to sign a state-approved form attesting that the client acknowledges that “a social objective or other nonfinancial objective… will result in investments and recommendations/advice that are not solely focused on maximising a financial return for me or my account”.

The anti-ESG laws are “an attempt to interfere with important information that investors really need to make financial decisions”, said Rachel Curley, director of policy and programmes at the US Sustainable Investment Forum in Washington, DC. “That’s all to kick up a political discussion that is not based on what investors are really doing in the capital markets.”

The Missouri rules, which took effect last year, prompted a lawsuit from SIFMA in federal court that claims the state’s actions violate the National Securities Markets Improvement Act of 1996 (NSMIA), which holds that only the federal government can promulgate rules for SEC RIAs.

Discovery in that case is scheduled to begin in May.

Neither the association or Missouri’s Securities Commissioner Doug Jacoby returned Regulatory Compliance Watch inquiries, and NASAA passed on commenting as well. Even the Investment Adviser Association wouldn’t comment directly on SIFMA’s legal challenge but the IAA did recently write Wyoming authorities to discourage that state’s anti-ESG measures by asserting NSMIA rules the day.

A thumb on the scale

“We don’t think regulators should be putting their thumb on the scale,” IAA Associate General Counsel William Nelson told RCW. “We think that the adviser, as the fiduciary for the client, should be allowed to make those decisions” regarding which investments are in a client’s best interest.

In legal filings, SIFMA claims the Missouri rules are “exactly the type of piecemeal state securities regulations that Congress prohibited” by NSMIA.

Missouri countered that SEC RIAs are technically exempt from their ESG disclosure rules, which “merely require that customers know and give consent before professionals make these decisions with their money”.

The IAA’s Nelson acknowledges the Missouri rules technically exempt SEC RIAs but it would impact their reps who serve clients in the Show Me state. “It’s only the reps but who oversees the reps?” he asked, adding that it’s the advisory firm that “creates the marketing material” that could trigger the necessary disclosures.

Missouri insists its rules don’t outlaw ESG investing. “The Rules do not prohibit any professional from considering, or any client from investing in, investments driven by nonfinancial objectives, but merely require that the customer be made aware that the nonfinancial objective is the purpose – or one of the purposes – of the investment advice,” the state continued.

While some states like Missouri, Florida, Texas and West Virginia have passed laws regarded as anti-ESG, others, such as California, New York, Illinois and Maryland, have pushed pro-ESG efforts. These mirror the political divide in Washington. Opponents regard ESG as wokeism gone amuck that could harm traditional industries. Proponents see ESG as one solution to deter the dangers of climate change.

Handcuffs for advisers?

The new anti-ESG proposal in New Hampshire might alarm ESG advocates the most. The year was barely new when House Bill 1267 was submitted. It would prohibit “state-controlled investments” from being “based on environmental, social and governance (ESG) criteria”. Violations would be a felony “punishable by not less than one year, and not more than 20 years imprisonment”, the bill reads.

In Texas, an adviser that wishes to manage the state’s money must represent that it doesn’t boycott energy companies, noted Dial. All of these efforts around the country represent the “next step in the escalation of the pro- and anti-ESG debate”, he added.

Keep an eye out for state action

If you manage state pension funds or offer ESG strategies, you should monitor these efforts. Last year, “Republican lawmakers in 37 states introduced 165 pieces of legislation” that could be seen as anti-ESG, reports the Pleiades website, which tracks these efforts. Morgan Lewis charts the action by state.

The outcome of SIFMA’s lawsuit “could have a waterfall effect”, predicts Dial, depending on which way it goes. A strike against NSMIA could have wider implications for advisers around the country and open the door to more state actions. But “SIFMA has a very strong claim”, he believes, especially around its free speech argument.

In the meantime, USSIF’s Curley said “our members are doing what they’ve always been doing”, serving clients who wish ESG investments.

Final tips

Nelson’s advice reminds you to “do what you say, say what you do…  Always make sure that your marketing materials are consistent” with your investment strategies.

Dial recommends that you share “clear and accurate disclosures [about] what you’re doing with ESG”. If you’re not engaging in ESG, “don’t say that you are”, he said. Be sure not to place clients who don’t want ESG investments into such strategies.

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