As the war against environmental, social, and governance (ESG) standards rages on in the states, the avenue for ESG reform at the federal level is starting to take form. Both the U.S. House and Senate are proposing policies to combat ESG. Bills, such as those introduced by Rep. Andy Barr (R-Ky.), Rep. Bryan Steil (R-Wis.), and Sen. Marco Rubio (R-Fla.) have the potential to be combined into a larger legislative package that will focus on maximizing retirement money for federal government and private sector employees, while also limiting reliance on totalitarian regimes.
Congress has legislative authority over two large pools of assets, the Thrift Savings Plan (TSP) and private employer-sponsored retirement plans as governed by the U.S. Department of Labor (DOL). TSP, which is overseen by the Federal Retirement Thrift Investment Board, is the retirement savings plan for federal government employees and members of the U.S. armed services. TSP invests over $689 billion in assets, making it the largest retirement fund in the U.S.
DOL governs the Employee Retirement Income Security Act of 1974 (ERISA). According to a DOL fact sheet, “there are approximately 2.5 million health plans, 673,000 other welfare plans, and 747,000 pension plans covered by ERISA in the United States that cover roughly 152 million private sector workers, retirees, and dependents and have estimated assets of $12 trillion.”
Private Sector Retirement Plans
Rep. Barr recently reintroduced the Ensuring Sound Guidance Act, which requires managers of 401(k) plans, employee stock ownership plans (ESOPs), and other private-sector employer-sponsored retirement plans to focus solely on “pecuniary factors” when making investment decisions. The bill clarifies in federal statute that ERISA plans must focus returning monetary benefits to retirees, not social or environmental benefits. Fifth Third Bancorp v. Dudenhoeffer determined that the benefits under ERISA-plans are meant to be financial in nature.
DOL is refusing to allow the Advisory Council on Employee Welfare and Pension Benefit Plans (ERISA Advisory Council) to review Interpretive Bulletin No. 95-1. Potential political pressure to ignore the study of annuity contracts for ERISA-regulated pension plans is in direct contravention to Congress’s intent in SECURE 2.0 Act of 2022 to consult industry stakeholders when making changes to regulatory guidance. This further exemplifies the political agenda that DOL is pursuing. This political pandering could also metastasize into pressuring private sector employers to consider “collateral benefits” of ESG, as reflected in the misguided final rule on fiduciary duties of prudence and loyalty. Rep. Barr’s bill would prevent political shenanigans at DOL by forcing managers of retirement assets to focus on their fiduciary duty and legal precedent that explicitly state that returns must be financial.
Thrift Savings Plan
Sen. Rubio has introduced the TSP Fiduciary Security Act (S. 149) and the Taxpayers and Savers Protection (TSP) Act (S. 1650). S. 149 creates procedures where the TSP and 401(k)s overseen by the DOL will avoid voting proxies that would behoove a company that is based in or operates within countries controlled by a totalitarian regime, such as China. S. 1650 prohibits managers of TSP funds from investing in any securities that are listed on a foreign securities exchange or are issued by a publicly traded company that is incorporated in a “country of concern” or earns more than 50 percent of its revenue in a country of concern. Currently, the TSP’s International Stock Index Investment Fund, which tracks the Morgan Stanley Capital International Europe, Australasia, Far East Index (MSCI EAFE), holds $61.6 billion in assets. Three percent of this fund is invested in companies in Hong Kong. This equates to $1.85 billion of federal government employees’ retirement money being invested in companies located in a jurisdiction controlled by China.
Proxy Voting and Corporate Governance
“Woke capitalism” is a direct result of activist investors pressuring public companies to adopt policies that fail to impact the financial performance of a public company within a reasonable investment time horizon. One of the ways activist investors are enabling this behavior is through the proxy voting process. Section 14 of the Securities Exchange Act, and Rule 14a-8, outline the framework for how investors can submit policy proposals to company management.
Proxy advisory firms (e.g., Institutional Shareholder Services and Glass-Lewis) advise and consult investors on how to vote on shareholder proposals. Rep. Steil introduced the Putting Investors First Act (H.R. 448) to force proxy advisory firms to register with the SEC and disclose any conflicts of interest that might arise from their business activities. Other avenues to impede shareholder activism include:
- Eliminating all exclusionary provisions (except when proposals conflict with state law or relate to the nomination of directors) while capping the number of shareholder proposals that may be accepted onto a company’s proxy card.
- Require that shareholder proposals affect the composition of the financial statements for: cash flow; assets and liabilities; income; and shareholder equity of the issuer. Proposals must also maximize the pecuniary interest of shareholders.
- SEC no-action letters must be reviewed by all the Commissioners and undergo a formal vote. Any action taken in response to the no action letter may only be approved if there are at least three Commissioners voting in favor and at least one of those Commissioners is aligned with the minority political party.
- Enforce proper disclosure of “control” of public companies through Section 13(d) disclosures.
Elimination of Renewable Tax Credits/Subsidies
The Inflation Reduction Act (IRA) enacted trillions of dollars in government spending on renewable energy initiatives. According to Goldman Sachs, the spending could be upwards of $1.2 trillion. A paper from the Brookings Papers on Economic Activity estimates about $1 trillion in costs from IRA tax credits.
Additionally, BloombergNEF estimates that reaching net-zero greenhouse gas emissions by 2050 could cost up to $200 trillion. McKinsey estimates spending could reach $275 trillion. The Glasgow Financial Alliance for Net Zero (GFANZ) approximates that it will cost $100 trillion.
It would be interesting to study to what degree these government subsidies will have an effect on the performance of ESG funds. The study could find that government subsidies have, in certain cases, propped up the performance of ESG funds, and the asset pricing of these funds is significantly bolstered only by the government’s intervention, which has stoked demand for renewables.
Foreign ESG Influence
Sen. Tim Scott (R-S.C.) and Rep. James Comer (R-Ky.) are shedding light on the obsession with molding U.S. investment metrics to match those of the European Union. The lawmakers sent a letter calling out Treasury Secretary Janet Yellen and SEC Chair Gary Gensler for “seeking to circumvent American courts, and our democratic process, by collaborating with the E.U. to ensure that the desired outcomes of the E.U.’s ESG agenda reach the U.S. through extraterritorial means.”
Republican members of the House Committee on Financial Services also sent a letter earlier this month highlighting concerns that the Biden administration is allowing EU ESG regulators to impose their rules on American businesses. Lawmakers are worried about Europe’s “extraterritorial application” of the Corporate Sustainability Due Diligence Directive (CSDDD) on small businesses in industries such as “textiles, footwear, clothing, agriculture, forestry, fisheries, food, live animals, wood, beverages, mineral resources, natural gas, coal, lignite, metals, construction materials, fuels, and chemicals.”
Codification of new laws are necessary to expressly ensure that managers of assets comply with current court precedent and law that compels them to the fiduciary duty they owe to retirees and other Americans that hold the economic interest of retirement investments.
Ten avenues should be considered in the federal fight against ESG:
- Retirement plan managers and asset managers of ERISA-plans and TSP need to be required by law to focus solely on “pecuniary factors.”
- Reconsider China as an investment option for TSP.
- Open proxy advisory firms to more transparency while limiting the amount of extraneous shareholder proposals that will be accepted on a company’s proxy card.
- Repeal SEC Staff Legal Bulletin No. 14L
- Proxy advisors shall be designated as ‘investment advisers’ as defined in 15 USC 80b-2 and be treated as a fiduciary that owes each of its clients a duty of loyalty and prudence. Any contracts agreed to by the proxy advisors must be carried out in such a way as to only focus solely on the pecuniary factors with respect to providing advice and analysis for proxy voting recommendations.
- No action letters must be reviewed by all the Commissioners and undergo a formal vote. Any action taken in response to the no action letter may only be approved if there are at least three Commissioners voting in favor and at least one of those Commissioners is aligned with the minority political party.
- Reintroduction and passage of the INDEX Act, which aims to allow beneficial owners of passively managed assets the option to vote their own proxies.
- Require ratings firms (e.g., MSCI, S&P Global, Sustainalytics) to disclose methodologies for determining what qualifies as “ESG compliant.”
- Codify definition of “materiality” in federal statute instead of relying on court precedent. Rep. Bill Huizenga (R-Mich.) and Rep. Barr have a bill to do just that.
- Ensure that asset managers are issuing the proper disclosures under Section 13(d) of the Securities Exchange Act.
Many of these recommendations are outlined in a preliminary ESG report issued by the House Committee on Financial Services’ ESG Working Group, and a report issued by the Senate Committee on Banking, Housing, and Urban Affairs under the leadership of former Sen. Pat Toomey (R-Pa.).
States have been enacting mainly two types of anti-ESG bills, “fiduciary model bills” and “boycott bills.” Fiduciary model bills, such as the one enacted in Arkansas, require asset managers to focus solely on making investment decisions based on “pecuniary factors.” This is similar to what Rep. Barr has in his bill, but it applies to state pension funds instead of 401(k)s.
Boycott bills, such as Texas Senate Bill 13, was enacted in 2021 to prohibit businesses from contracting with the state government if they have a policy of boycotting fossil fuels.
As a result of the ESG debates, Larry Fink, Chairman and CEO of BlackRock, an investment management company, decided that he is no longer using the term “ESG.” However, he claims BlackRock will continue to follow the goals of ESG.
ATR launched the “BlackRock Tracker” as a one-stop-shop resource for anyone wondering how much in dollar assets states have divested from BlackRock. This map tracks which states are actively withdrawing funds from BlackRock and will be continuously updated at www.atr.org/esgradar.