Congressional Scrutiny Muddies the Path Ahead for ESG
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Congressional Scrutiny Muddies the Path Ahead for ESG

Brownstein Client Alert, June 12, 2023

Note: This is the third in a series of alerts focused on the overlapping ESG scrutiny between state attorneys general and Congress. Our first discussed how to prepare when ESG inaction and action both yield risk. Our second set forth the potential legal grounds for parallel investigations, underlying factual disputes surrounding ESG and how companies should prepare for additional action.

A month ago, Alabama Attorney General Steve Marshall and Utah Attorney General Sean Reyes asked Congress to take action to limit the impact of ESG. Congress is answering the call. On Tuesday, June 6, two House Oversight and Accountability subcommittees held a joint hearing entitled, “ESG Part II: The Cascading Impacts of ESG Compliance.”

As federal lawmakers and state attorneys general continue to hone their scrutiny of ESG practices, the path ahead for ESG and related compliance questions gets murkier. In this alert, we explore key themes that emerged from the hearing—including ESG disclosures, ESG scoring, environmental factors, fiduciary duty and ESG rulemaking—and highlight key takeaways.

The June 6 Hearing

This latest committee hearing was held jointly by the House Oversight Subcommittee on Economic Growth, Energy Policy, and Regulatory Affairs and the Subcommittee on Health Care and Financial Affairs. The following individuals gave testimony at the hearing:

  • Mandy Gunasekara, director of the Center for Energy and Conservation at the Independent Women’s Forum
  • Jason Isaac, director of Life:Powered at the Texas Public Policy Foundation
  • Stephen Moore, a distinguished fellow in economics at the Heritage Foundation
  • Shivaram Rajgopal, a professor of accounting and auditing at the Columbia Business School

Unsurprisingly, the political divide was on full display during the hearing. Both GOP subcommittee chairs repeated common refrains in anti-ESG rhetoric. Rep. Pat Fallon (R-TX)—who chairs the Economic Growth, Energy Policy, and Regulatory Affairs Subcommittee—emphasized that some asset managers prioritize ESG considerations over profit, which risks the stability of investor funds. Similarly, Health Care and Financial Services Subcommittee Chair Lisa McClain (R-MI) made the point that it’s not the job of money managers to pursue political agendas. She added that some companies do not inform their clients about the risks of adopting ESG factors.

In contrast, Democrats highlighted consumer protection principles in ESG. The economic growth subcommittee’s Ranking Member Cori Bush (D-MO) said ESG factors have material benefits for companies’ profitability and stability, emphasizing that ESG practices work to protect investors from the financial risks of bad business practices by providing detailed data. Likewise, the Health Care and Financial Services Subcommittee Ranking Member Katie Porter (D-CA) said ESG factors expand economic freedom by providing investors with material information to best inform investment decisions. Withholding that information from the market, according to Porter, denies investors the freedom to accurately decide where they invest their money.

Key Themes

ESG Disclosures: Democrats focused some of their questions on why it is important for companies to publicly release ESG disclosures. According to Rajgopal, the Columbia accounting professor, the current reporting and disclosure model is inadequate, and ESG metrics serve as leading indicators of future performance. He also believes that the ESG conversation is much more complicated than credit reporting forecasting since there are a multitude of factors to consider.

The discussion also focused on the efficiency of ESG funds and the balance of different obligations. The Heritage Foundation economics fellow Moore pointed to studies on both sides but said most studies show that ESG funds correlate with lower returns. In response to questions over if investors and asset managers want to consider ESG factors, Rajgopal said fiduciaries should be responsible for looking at material risks such as climate change. ESG factors force companies to think about the tail risks associated with future cash flows, he said. When it comes to the availability of ESG data and how it impacts workers, most companies report very little on their workforce but investors should still care about the quality of human capital since it can serve as an indicator for future performance, according to Rajgopal.

ESG Scoring: Republicans also focused on the inconsistency of ESG scoring, although Rajgopal pointed out that ESG rating agencies are a work in progress. Rep. Jake LaTurner (R-KS) claimed that two companies control over 90% of all proxy advisory services. When asked if there are any antitrust concerns, Moore said he does not believe in antitrust regulation but advocated for a market solution with additional firms that present a more free-market view.

In response to Rep. Glenn Grothman’s (R-WI) question whether ESG ratings vary from fund to fund, Isaac from the Texas Public Policy Center cited ratings across different funds and added that gun manufacturers are denied capital and insurance by certain financial institutions. Gun manufacturers receive lower ESG scores, according to Isaac.

Environmental Factors: In response to GOP questions over the viability of prioritizing green energy over fossil fuels, Gunasekara from the Independent Women’s Forum said when oil and gas workers can produce openly, they do it in a clean and efficient way. When regulations tighten, demand shifts to countries such as Russia and China, which have worse environmental records than the United States, she said.

When the discussion turned to why the fossil fuel industry fights against the inclusion of ESG factors, Rajgopal said changing business models can be difficult, and fossil fuel companies are reluctant to pivot. During questions about climate change activists using the threat of political action to pressure banks to avoid lending to the fossil fuel industry, Moore said the U.S. economy cannot operate without fossil fuels and claimed that California’s transition away from fossil fuels has led to power blackouts and other problems.

Fiduciary Duty: Chair Fallon asked if money managers owe a fiduciary duty to their clients under federal law, and Moore responded that individuals should be free to invest in ESG funds if they would like to. The issue, he said, is that asset management companies vote on ESG resolutions without the knowledge and approval of their clients.

ESG Rulemakings: Rep. Jamie Raskin (D-MD), ranking member on the full House Oversight Committee, clarified that the Department of Labor’s ESG rule does not impose a mandate but permits fiduciaries to consider responsible investing factors. In response to Rep. LaTurner’s question about the impact of the Biden administration’s ESG standards on retirement investments, Moore said ESG investing reduces investor returns and the value of a given fund.

Two Takeaways

First, this hearing highlights the need for companies to conduct an internal review of all ESG statements made to consumers to determine whether those statements present any risk for congressional or regulatory scrutiny. This suggestion applies not only to companies in the financial services industry but any company using ESG as a decision-making tool. Congresswoman McClain’s allegation that some companies do not inform clients about the risks of their use of ESG directly implicates the authority of state attorneys general. More specifically, state attorneys general have authority to enforce UDAAP (“Unfair, Deceptive, or Abusive Acts or Practices”) laws. These UDAAP laws typically provide state attorneys general the authority to launch investigations and regulatory actions related to deceptive trade practices, consumer fraud and unfair business practices. The alleged failure to provide consumers with material ESG risks could unquestionably provide fodder for a single-state or multistate investigation across industries.

Second, companies that integrate ESG considerations should prepare for the most efficient mechanisms to articulate to Congress and state attorneys general the underlying business case related to ESG. The time to prepare for congressional or regulatory scrutiny is prior to receiving an inquiry from Congress or a state attorney general. Proactive risk management is often cited as the core motivation behind companies’ ESG-related endeavors. Given the current polarized climate, ironically or not, a sound ESG management approach must also call for proactive planning and precautionary measures related to the risks for congressional and regulatory scrutiny.

While some lawmakers bemoaned the hearing and the possibility of follow-up hearings—“Let there not be a part three,” Rep. Katie Porter (D-California) said—we doubt this is the final word on coordinated investigations targeting ESG. We expect additional scrutiny, and more specifically, the House Oversight and Accountability Committee could hold a third ESG-related hearing in the coming weeks. Although the underlying goal of these hearings is unclear, it does signal that lawmakers are keen to till new ground in this area—possibly meaning new regulations or subpoenas targeting companies from other committees typically tasked with investigating private-sector actors. As such, companies should consult with counsel with experience navigating the halls of Congress and the unique complexities surrounding state attorneys general.

This document is intended to provide you with general information regarding ESG-related investigations. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions. The information in this article is accurate as of the publication date. Because the law in this area is changing rapidly, and insights are not automatically updated, continued accuracy cannot be guaranteed.

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