The Republican-led “anti-ESG” (environmental, social, governance) movement over the last two years has largely been a legislative effort, comprised primarily of state-level bills that attempt to halt the consideration of climate risk and other commonplace factors in investment decisions connected with government funds, contracts, and pensions. Hundreds of these proposals have failed in state legislatures across the country. But some have succeeded. Since 2021, more than 30 rules, guidelines, boycotts and laws have been passed by various states to thwart ESG goals and bolster industries such as fossil fuels and firearms.
Investors who want the flexibility to consider all relevant risks to their investments have challenged these rules and laws in court, and, in both state and federal cases, the effort has succeeded. Recent wins depend on a range of claims, with one particularly significant victory involving the freedom of speech in Missouri, another based on pension obligations set forth in Oklahoma’s state Constitution, and a third addressing fiduciary duties in the state of New York.
This validation of responsible investment decisions, particularly investors’ need to consider the financial risks of climate change, is a promising step towards curbing efforts to downplay these risks and bolster unsustainable fossil fuel industries. But there are important decisions on responsible investing now pending, and crucial cases on the horizon.
Recent Victories
The decision from Missouri, Securities Industry and Financial Markets Association [(SIFMA)] v. Ashcroft, was a strong rebuke of anti-ESG disclosure requirements. Missouri’s attorney general had promulgated two rules that required securities firms and professionals to obtain consent forms from Missouri investors before incorporating a “social objective” or other “non-financial objective” into their securities recommendations or investment advice. The consent form mandated an acknowledgment that the professional’s advice would result in investments and recommendations not solely focused on maximizing financial returns. SIFMA, a trade association representing the securities industry, challenged this requirement.
The federal court ruled resoundingly in favor of SIFMA, finding for plaintiffs on all counts. The court issued a permanent injunction barring the state rules, finding that the rules are preempted by the Employee Retirement Income Security Act (ERISA), a federal law which sets out minimum standards for employee benefit plans, and the National Securities Market Improvement Act (NSMIA), a federal securities law designed to ensure capital and financial market efficiency and comparability in part by harmonizing paperwork requirements. The court also found that the disclosures failed to withstand intermediate scrutiny under the First Amendment of the Constitution, because the compelled speech (here, the required statement that “incorporating a social objective or other nonfinancial objective … will result in investments… that are not solely focused on maximizing a financial return”) is controversial, and the rules are more extensive than necessary to further the government’s interest. Notably, the court observed that the government has less coercive means of advancing its political views on social investing, such as an advertising campaign. Finally, the court found the rules to be unconstitutionally vague, given the difficulty of providing notice for what behaviors would be prohibited, as the term “non-financial objective” was ill-defined.
In finding the two laws were preempted by existing federal law, the court highlighted the broad preemption clause contained within ERISA. That clause states that ERISA’s requirements “shall supersede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan described [herein].” The court found that the Missouri rules “relate to” an ERISA plan simply by having “a connection with such a plan,” because they could restrict what investments might be recommended or selected, and mandated inconsistent recordkeeping requirements. Further, the court noted that ERISA’s savings clause, essentially an escape hatch from preemption, would not allow for the rules’ survival because the laws “pose an obstacle” to ERISA’s comprehensive scheme.
Within ERISA’s framework, from which state-by-state deviation is not allowed, is language at issue in an appeal in Utah v. Walsh, an important pending discussed further below. That language allows for fiduciaries to consider collateral or nonfinancial objectives in certain circumstances when selecting investments. If that language continues to be upheld on appeal, the SIFMA decisions foreshadows the strength of ERISA’s protections for fiduciary autonomy in making sound investment decisions, so long as plan fiduciaries are steadfast in their commitment to their legally mandated duties.
The issue with imposing inconsistent recordkeeping requirements is not limited to ERISA—the same problem arose under NSMIA. Federal schemes apply across all states to harmonize requirements and create consistency. For these reasons, Defendant’s attempt to require additional disclosures violated both ERISA and NSMIA. This may prove to be a common obstacle for state anti-ESG bills that seek to circumvent federal schemes with politicized disclosure requirements.
Defendant Attorney General Ashcroft had used this case as a political rallying point, attempting to crowd-fund the defense earlier this year, but he declined to appeal. The loss has already had ramifications in other cases, including in Oklahoma, where state pensioner Don Keenan sued the state over its boycott of financial institutions that allegedly discriminate against the oil and gas industry.
Under Oklahoma’s anti-ESG law, companies seeking to contract with Oklahoma must certify in writing they do not and will not boycott energy companies. The law had resulted in a 15.7% increase in borrowing costs for municipalities, and $184 billion in expenses, as it limited competition among financial institutions and tightened the competitive bond market for municipalities. Keenan won a permanent injunction against the law, having advanced several arguments: that the boycott law violates the Oklahoma Constitution’s requirement that public pensions operate for the sole purpose of providing benefits; that the law violates freedom of speech principles, and due process principles; that it is “unconstitutionally vague;” and that it runs afoul of two other statutes. The injunction was granted based on the law’s vagueness, just as in the SIFMA decision, and on the constitutional requirement that plans focus on providing benefits to plan members, not on benefiting industries operating within the state. Keenan subsequently filed a second motion for summary judgment to seek closure on legal arguments the court did not address when granting the injunction. In a recent supplemental brief, Keenan cited the SIFMA decision as analogous, given the similar speech requirement under the Oklahoma law, which compels prospective contractors to perpetuate the state’s anti-ESG message by affirming they will not boycott energy companies. On October 25th, the judge decided in favor of Keenan’s second motion, finding that the boycott law unconstitutionally abridges the freedom of speech because the act is more extensive than necessary to serve the governmental interest (which, according to the Defendant, was “ensur[ing] that private entities managing State retirement money are focused solely on financial return”). Moreover, the judge relied on the SIFMA language, quoting extensively from the Missouri decision to note that statements discussing political priorities (in that instance, anti-ESG) are controversial speech and thus justify intermediate scrutiny from the court.
In both the Missouri and Oklahoma cases, plaintiffs successfully challenged their state’s anti-ESG rules. In a recent New York case, the state action at issue ran in the opposite direction: several state pension plans had taken steps to reduce dependence on fossil fuels and climate-related financial risk for beneficiaries by divesting from fossil fuel companies. In Wong v. NYCERS, plaintiffs alleged that the pension plan trustees had violated their fiduciary duties to plan beneficiaries by choosing to divest. The New York court dismissed the case for lack of standing, finding that the plaintiff-beneficiaries of the New York state public pension plans had no plausible injury, because they have defined-benefit plans (meaning their retirement payments do not fluctuate with the performance of the portfolio holdings, and even if the plans went bankrupt, New York taxpayers would be obligated to cover the shortfall). Defendants’ appealed the decision. Although the case failed to reach the merits, the court expressed skepticism about plaintiffs’ legal theory, and foreclosed similar cases under the common law of trust and New York’s general municipal law §51, which may reduce the likelihood of future lawsuits.
Key Questions of Fiduciary Duty and Free Speech
These recent victories involve legal principles of fiduciary duty and free speech, which have been central areas of contention in litigation surrounding climate-related financial risk. Broadly, fiduciary duty is the requirement that a person with a legally-defined relationship to a beneficiary – for example, a trustee – must act in the best interests of the beneficiary. What risk factors may be considered by the fiduciary has been the subject of debate. Detractors argue that the analysis of ESG-related risk factors is inconsistent with fiduciary duty, because the fiduciary should be solely focused on maximizing “pecuniary” (e.g. monetary) gain for the beneficiary. However, as ESG-proponents point out, the evaluation of ESG risks to a given investment can be important precisely because they do impact pecuniary value.
Free speech issues arise with compelled ESG disclosures for corporate entities. Such disclosures are a form of commercial speech, and the government has a right to compel corporations to speak on certain topics where the government has a “substantial interest.” There are different levels of scrutiny when evaluating First Amendment free speech claims: the lowest level, for “purely factual and uncontroversial information,” was established by a case called Zauderer, and an intermediate scrutiny level is set out by a case called Central Hudson. Central Hudson deploys a four-part test, including whether the government’s interest in the contested speech is substantial, and whether the regulation is narrowly tailored. It is harder for a regulation to survive in court when it trips the Central Hudson inquiry. With respect to ESG and climate-related risk disclosures, the debate thus often focuses on whether the compelled disclosures are purely factual and require a lower level of justification, and if they serve a legitimate purpose or a purely political end.
The issue of standing must also be considered. Standing is a legal threshold issue that determines whether a plaintiff is entitled to raise an issue in court. To have standing, a plaintiff must have suffered an injury due to defendant’s action, and it must be redressable by the court. The flexibility courts have shown in evaluating whether a plaintiff has standing has raised questions in recent years, and the Supreme Court has shown a willingness to construe standing on unusually broad terms to allow it to rule against major federal initiatives. In the student loan forgiveness case (Biden v. Nebraska) commentators noted that Republican State plaintiffs struggled to assert any injury, eventually landing on attenuated harm to a state agency, and the Court was willing to stretch to reach the merits of the case anyway. Simultaneously, the Court has narrowed standing for private plaintiffs, in cases like TransUnion LLC v. Ramirez, potentially making the pathway to vindicating ESG initiatives more challenging. TransUnion involved a credit rating agency’s statutory violation, which resulted in the dissemination of inaccurate information for approximately 23% of plaintiffs. While that same inaccurate information was internally collected about the remaining plaintiffs, in violation of the law, that information was never disseminated, and the Court found those plaintiffs had no standing because they were not harmed, despite the statutory violation, applying a flat rule: “[n]o concrete harm, no standing.”
Important Decisions to Watch For
Several cases that grapple further with these questions of law are fully briefed and awaiting decisions. The outcomes may impact the future of climate-related financial regulations. Spence v. American Airlines went to trial in district court in Texas last June, and the court has yet to issue a decision. As with the NYCERS case discussed above, this litigation was filed by a pension plan beneficiary, who alleged that American Airlines violated its fiduciary duty by including ESG-investment vehicles among the options that plan beneficiaries could allocate their money to. Plaintiffs also pointed to managers within the fund portfolio who pursue ESG objectives, an alleged failure to adequately supervise managers within the portfolio, and defendant’s corporate ESG goals, as violations of fiduciary duty.
Defendants noted that the ESG funds are only accessible to plan beneficiaries through self-directed brokerage accounts, and no inferior financial performance has been shown for ESG-associated investment options. They also observed that plaintiffs failed to identify managers or alternative investments that would have outperformed the fund’s selection. The case survived an initial motion to dismiss and subsequent motion for summary judgment because the judge found that some of the plan investments “pursue[d] ESG objectives rather than focusing exclusively on maximizing financial benefits,” and that there were genuine issues of material fact as to whether American Airlines violated its fiduciary duty by failing to monitor and address ESG proxy voting by asset managers.
This case will offer a federal comparison to the fiduciary duty case that already failed to gain traction under New York state law. The absence of harm to the fund’s financial performance, and thus the lack of injury to the plaintiff, should be sufficient to demonstrate that there is no violation of fiduciary duty, particularly when funds simply provide optional access to ESG investment vehicles. The same lack of injury should also undermine plaintiffs’ claim of standing, as they suffered no quantifiable financial loss. However, the court does not seem inclined to make such a finding. It noted in denying the motion for summary judgment that “the mere demonstration that Defendants disregarded, or otherwise failed to act regarding, the established record of ESG underperformance [emphasis added] is sufficient” to find a violation of fiduciary duty, even without any pecuniary damage.
The appeal of Utah v. Walsh (now called Utah v. Su) also involves fiduciary duties under ERISA. Recently remanded, following the Supreme Court’s Loper Bright decision that rejected a longstanding doctrine that required courts to defer to reasonable agency interpretations of law, the case addresses the 2022 Investment Duties Rule. That rule clarifies the duties of fiduciaries of ERISA employee benefit plans concerning investment selection and actions, which have been repeatedly revised by the last several administrations. Up until 2020, fiduciaries under ERISA could consider collateral or non-financial benefits of competing investments that had equal strategic and economic merit (i.e. expected returns). In 2020, the Trump Administration announced that the tiebreaker was only available when fiduciaries were unable to distinguish investments based on pecuniary factors alone. The Department of Labor (DOL) subsequently found that this created confusion for fiduciaries about whether ESG factors were pecuniary and had a chilling effect on integrating ESG risk analysis into the investment selection process. The DOL thus rolled back the Rule, explicitly allowing for consideration of ESG factors and the tiebreaker test, and updated the rule to make clear that decisions must be based on “factors that a fiduciary determines are relevant to a reasonable risk and return analysis.”
A group of Republican attorneys general and fossil fuel interests sued the federal government in the northern district of Texas, ensuring review by a notoriously conservative judge, Mathew Kacsmaryk. However, Judge Kacsmaryk found that ERISA does not foreclose consideration of non-pecuniary factors. Applying an analysis set forth in the Supreme Court’s 1984 Chevron decision, the court found, “all that [was] necessary is a minimal level of analysis from which the agency’s reasoning may be discerned.” The court also found that the rule was not arbitrary and capricious because the record supported the agency’s responsiveness to public comments, and its decision to alter the rule based on comments received. But in dicta, the court noted that it “is not unsympathetic to Plaintiffs’ concerns over ESG investing trends, and it need not condone ESG investing generally or ultimately agree with the Rule to reach this conclusion.” Challengers appealed, and, following the Supreme Court’s Loper Bright decision overruling Chevron in June, the appeals court remanded the case for reconsideration in district court. Initial briefing from both parties was filed last week, on October 16th. The outcome of this case may not only determine whether ESG considerations fit within the landscape of fiduciary duties for ERISA plan trustees, but also may act as a harbinger for cases revisiting agency decisions in the post-Chevron legal landscape.
A third case, which has also been fully briefed and awaiting a decision in the Fifth Circuit since May, addresses ESG-focused shareholder proxy proposals. NCPPR v. NAM considers whether shareholder proposals included under Rule 14a-8 can be compelled speech. Challengers argue that the SEC should not require a corporation to use its proxy statement to discuss topics that intervenors call “contentious issues unrelated to its core business or the creation of shareholder value”. In this case, an investor sought to make a corporation include a pro-ESG shareholder proposal repeatedly, and the corporation sought to exclude the resubmitted proposal on two bases: first, that it was substantially the same as the initial proposal, which received less than 2% shareholder support, and second, that this type of speech cannot be compelled under Rule 14a-8. The SEC has argued the petition is moot because it already allowed the corporation to exclude the proposal, but the case remains open, and intervenor party NAM (the National Association of Manufacturers) is still pursuing the case. A favorable ruling for NAM on First Amendment grounds, finding that the simple dissemination of shareholder views in proxy statements under Rule 14a-8 is compelled speech, could drastically alter the shareholder engagement process. Such a finding would undermine a reliable, long-tested shareholder engagement mechanism, limiting the ability of shareholders to engage with boards, management, and fellow shareholders, and could even expose corporations to increased litigation risk. Shareholders often identify ongoing and future risks through proxy statements, and the SEC already polices shareholder proposals vigorously.
On the Horizon
Related questions are likely to animate litigation over climate risk considerations and other ESG analysis for the foreseeable future. A new lawsuit was recently filed in Texas, by a business group seeking to block the state’s boycott law. The law, Senate Bill 13, is similar to the Oklahoma boycott law that was recently enjoined. It restricts state investments from certain financial firms based on the firms’ energy policies. The case, American Sustainable Business Council v. Hegar, was filed in August, and defendants recently filed a motion to dismiss. Plaintiffs have a strong First Amendment Claim, on a different basis than the SIFMA case. Plaintiffs instead note that Texas’ law is viewpoint and content discriminatory, which is subject to an even higher level of scrutiny. The First Amendment prohibits the government from restricting speech based on the views expressed by the speech, in this case, the firms’ energy policies if they are engaged in anti-oil and gas rhetoric. The law also infringes on rights to freedom of association, and compels speech by including a requirement that a corporation certify it aligns with Texas’ position on fossil fuels as a condition to obtaining a state contract or investment. This case will be another litmus test for climate risk analysis, as plaintiffs and defendants square off about the First Amendment’s embrace or foreclosure of ESG investing practices.
Perhaps most significantly, the legal grounds for corporate climate risk disclosure requirements promulgated by the SEC and the state of California will also soon be tested in court. The SEC’s climate rule was issued in March, and promptly challenged in a series of petitions by a coalition of Republican attorneys general and various fossil fuel interests. Petitioners’ claims include that the rule runs afoul of the First Amendment by forcing companies to engage in “costly speech against their will on matters of contentious political debate”, that it violates the Administrative Procedure Act (APA) – which governs agency rulemaking, and that it exceeds the SEC’s statutory authority. The petitions are consolidated in the Eighth Circuit, and briefing recently concluded, though no date has been set for oral argument.
The litigation over California’s climate disclosure rules, which were issued in late 2023, is further along. Briefing is complete, and the case was slated for oral argument last week, on October 15th, though the court abruptly decided to forgo the hearing and rule on briefing alone. A decision is expected on several motions, including a motion to dismiss and a competing motion for summary judgment. Again, the First Amendment is central to the litigation, as plaintiffs allege that the disclosures are controversial speech and companies will be compelled to disclose information “untethered to any commercial purpose or transaction” and are for the “explicit purpose of placing political and economic pressure on companies” to make them conform to California’s stance on climate risk.
Taken together, court decisions in the litigation over the California and SEC climate disclosures rules, along with NCPPR v. NAM, have the potential to significantly impact the application of First Amendment jurisprudence to climate risk analysis. Courts will soon announce whether climate-risk disclosures should be considered purely factual – analogous to other types of financial risks routinely evaluated in investment decisions – or controversial, political speech that the government should not require. The outcomes will have a significant impact on ESG disclosures and investments in the coming years, just as the financial risks of climate change are escalating rapidly.
Chloe Field is the Initiative on Climate Risk and Resilience Law Fellow at the Sabin Center for Climate Change at Columbia Law School.
Cynthia Hanawalt is the Director of Climate Finance and Regulation at the Sabin Center for Climate Change Law.
