Earlier this month the U.S. Department of Labor put another nail in the coffin of environmental, social and governance (“ESG”) disclosures.
Media sources have reported that the Employee Benefits Security Administration in the Department of Labor sent letters to a group of Registered Investment Advisors requesting detailed information within 2 weeks about their use of ESG disclosures in retirement plans.
Those enforcement letters, as described in Think Advisor and other outlets, make it more likely that ESG will be consigned to the ash heap of history, as the letters followed in short order from the August 3 deadline for comment on the Department of Labor’s proposed rule, greatly limiting the use of ESG information in certain retirement plans,
The proposal is designed, in part, to make clear that ERISA plan fiduciaries may not invest in ESG vehicles when they understand an underlying investment strategy of the vehicle is to subordinate return or increase risk for the purpose of non-financial objectives.”
Together these actions are already having a chilling effect not only on investment managers who want to profit from the use of ESG factors, but also on public companies that make ESG disclosures, when the rule provides clear regulatory guideposts for fiduciaries in light of recent trends involving ESG investing.
Private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan,” said Secretary of Labor Eugene Scalia. “Rather, ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers.”
The idea of ESG began in 2004 with a United Nations initiative to influence capital in non Western markets.
The Department has acknowledged that ESG factors can be pecuniary factors in U.S. public companies, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories. There has been much discussion of the analysis reported in the Wall Street Journal last year, found “maybe most damning is that ESG mutual funds, on average, underperform the market.”
ESG based investment advice, appealing to those predisposed to believe, has been likened to answers provided by a Ouija Board, and the participants who trust in the board as a divining tool.
I have for years advised public companies about environmental matters and sustainability including navigating the complexity of ESG disclosures while recognizing the business’ purpose of generating value for shareholders, in the SEC decision making landscape. The risks associated with making ESG disclosures are real and should not be underestimated. I wrote a blog post earlier this year, LEED can Help Mitigate Legal Risks in ESG Disclosures, that included the quote,
SEC Commissioner Hester Peirce has publicly said, “we are seeing a similar scarlet letter phenomenon in today’s modern, but no less flawed world” but it is not Hester Prynne’s “A” for adultery in Puritan Massachusetts Bay Colony in 1642, but rather ESG in America in 2020. The SEC Commissioner has also questioned “the materiality of ESG” including finding fault with ESG for having no enforceable or common meaning, “while financial reporting benefits from uniform standards developed over centuries, many ESG factors rely on research that is far from settled.”
There are still a small but vocal group of investors in the U.S. that are concerned with matters of ESG, and there is some U.N. inspired interest in Europe, so while we carefully monitor the actions of the several federal government departments active in this space, irrespective of political bent we will continue to advise and offer guidance to public companies on mitigating their risk from the modern scarlet letters ESG.
If President Trump is reelected, it appears more likely than not that ESG disclosures will be made extinct like the dodo bird, not unlike as the federal government banned the 100 watt Edison light bulb out of existence, but that course will all be certainly see a polar opposite reversal and ESG will be embraced in a Biden Administration. Either prospect is consistent with a core belief of this law firm that our clients can repair the planet with capitalism.