Environmental, social, and governance (ESG) investing has been subject to increased US state and federal regulation over the last several years, and 2023 continued that status quo. As of January 1, 2024, 20 states have enacted anti-ESG investing rules, eight have enacted pro-ESG investing rules, and three have enacted disclosure of ESG investing rules. Many more proposed pieces of state legislation remain in the works, while at the federal level congressional interest has also seen an uptick.

As we have discussed in previous Morgan Lewis publications, some US states have been particularly focused on limiting or discouraging the investment of state assets for “nonpecuniary” and “nonfinancial” purposes, while others have sought to protect, and in some cases incentivize, ESG-related investments. Others still have been more focused on reporting, disclosure, and consumer protection concerns surrounding ESG investing activities.

The last months of 2023 saw a flurry of activity in this space, including the updates set forth below.

CONGRESSIONAL & STATE ATTORNEY GENERAL DEVELOPMENTS

While ESG investing has remained an area of congressional focus for both sides of the aisle for years, there has recently been an uptick in both state and congressional involvement.

These issues are the subject of highly partisan actions and we anticipate that businesses will find themselves in situations in which they may become the subjects of legal and other actions no matter the position they take.

In December 2023, 18 Attorneys General (AGs), led by Minnesota AG Keith Ellison and Arizona AG Kristin Mayes, sent a letter to the US Congress to defend fund managers’ use of ESG factors as “consistent with prudent investment decision-making.”

The AGs urged Congress not to prohibit fund managers from using ESG factors in investment decision-making, arguing that ESG considerations can offer key insights and inform fund managers’ risk-return analyses resulting in reduced risks and greater returns for investors.[1]

Also in December, House Judiciary Committee Chair Jim Jordan (R-OH) subpoenaed several large and prominent financial services firms as part of the committee’s probe into the adequacy of US antitrust laws to address “collusive agreements” relating to pro-ESG investing laws and activities. This followed an earlier document and information request by the committee to a member of the Climate Action 100+ and the Glasgow Financial Alliance for Net Zero focused on investigating whether advancement of the consideration of ESG factors by these firms violated antitrust rules.[2]

The House Judiciary Committee has also subpoenaed several proxy voting advisory firms as part of a probe into possible violations of antitrust laws based on alleged coordination on ESG issues.

STATE-LEVEL ACTIVITY

Tennessee Litigation

In December 2023, Tennessee’s AG filed a consumer protection lawsuit against a prominent financial services firm alleging that the firm made false or misleading statements to consumers regarding the extent of its ESG investing activities and strategies and, in particular, allegedly “downplayed” its use of ESG factors in violation of consumer protection laws.

Oklahoma Divestment

Oklahoma is one state that has adopted a “No-Boycott Rule,” the Energy Discrimination Elimination Act of 2022 (EDEA), which prohibits government entities such as public pension funds from investing state assets with firms determined to be boycotting the fossil fuel industry.

To implement this rule, Oklahoma’s State Treasurer published a restricted financial companies list, and Oklahoma government entities have been divesting on a grand scale from those restricted companies to comply with the EDEA (including a divestment in November 2023 of $184 million by the Oklahoma Teachers’ Retirement System).

In December 2023, however, the $3.5 billion Oklahoma Firefighters Pension and Retirement System approved the exercise of an exemption from the EDEA, allowing it to avoid an $8 million divestment from entities on the restricted financial companies list. The EDEA allows public funds to use this “fiduciary” exemption in cases where the governing board of the fund determines that a divestment would be inconsistent with its fiduciary duty.

This is not the first time an Oklahoma pension plan has used the fiduciary exemption: the $11 billion Oklahoma Public Employees Retirement System approved the use of the same exemption in July 2023, allowing it to continue investing in two entities on the restricted financial companies list and thus avoid a divestment of more than $6 billion.

Oklahoma’s State Treasurer in October 2023 asked legislators to clarify and regulate the use of fiduciary exemptions to the EDEA, and as such it is possible that we may see amendments to the EDEA in the future.

Texas ‘Boycott’ Lists and FAQ

Texas has been particularly active in its recent anti-ESG efforts. Similar to Oklahoma’s rule, Texas Government Code Chapter 809 (the Texas Boycott Rule) requires divestment of Texas assets, including public retirement plan assets, from financial companies that are deemed to boycott fossil fuel industries. The Texas Boycott Rule empowers Texas to place either individual funds or entire entities on “restricted lists” if the Texas Comptroller’s office determines they are “boycotting” energy companies.

If a fund is placed on Texas’s restricted fund list, certain Texas state assets may not be invested in that fund and any then-current holdings in that fund must be divested.

If an entity is placed on Texas’s restricted entity list, Texas state assets may not be invested in publicly traded securities issued by that entity and any then-current holdings in that entity must be divested, and Texas state agencies and political subdivisions are prohibited from entering into certain types of contracts with that entity.

A number of other states have similar rules in place and, as of the date of publication, three others (including Oklahoma, as discussed above, West Virginia, and Kentucky) have published boycott lists.

The Texas Comptroller’s office first published lists of restricted entities and restricted funds in 2022 and recently published updated lists of restricted entities and restricted funds that the office has determined “boycott” energy companies in violation of the Texas Boycott Rule. In connection with the release of the updated lists, the Texas Comptroller published a Frequently Asked Questions sheet, breaking down how it determined that listed funds and entities were “boycotting” energy companies.

The FAQ yields a few takeaways that provide insights into both the comptroller’s evaluation of ESG-related investment issues and possibly the broader treatment of ESG investment strategies and considerations by other states.

Broad Range of Info—From Public Statements to Proxy Voting Records—Used for ‘Boycotting’ Determination

In creating the boycott lists, the Comptroller’s office appears to have considered information from a broad range of sources, including entities’ responses to verification request letters issued by the Comptroller’s office in summer 2023, public records (including publicly available prospectuses and other investment documents), public statements, and entities’ status as signatories to certain ESG-related initiatives.

Crafting the Restricted Funds List: Screens, Exclusions, and Restrictions Assessed

Texas appears to have focused its inquiries and determinations related to funds specifically on the presence of screens and similar means of excluding or limiting investments in energy companies. The FAQ states that the goal was to “identify the subset of funds that include a specific prohibition or limitation on fossil fuel-based energy investments” (emphasis added).

The FAQ also highlighted that the Comptroller’s office looked at whether a fund had a “policy, procedure, or investment guideline” that restricted or prohibited investment in the fossil fuel–based energy industry. For purposes of its assessment, a mere limitation on investments in fossil fuel–based energy companies would meet the definition of a “boycott.”

Broader Scope of Factors Evaluated for Restricted Entities List

For the restricted entities list, the Comptroller’s office appears to have considered a broader scope of factors.

The FAQ referenced many factors beyond the existence of a companywide screen or exclusion on investment in fossil fuel–based energy companies, including the following:

• Third-party ESG data and ratings.
• Public pledges to industry initiatives such as Climate Action 100+ and the Net Zero Banking Alliance/Net Zero Asset Managers Initiative, among other net-zero commitments.
  • The FAQ noted, however, that status as a signatory to one of these industrywide initiatives was not on its own determinative.
• For an entity, having 10 or more funds that include energy industry screens or limitations.
  • The FAQ noted that offering at least 10 funds including “a prohibition, limitation, restriction, or negative screen on oil and gas investments” tilted the scale toward classifying an entity as “boycotting.”
• Proxy voting records that demonstrate antagonism toward the fossil fuel–based energy industry.
  • The FAQ stated that the Comptroller’s office specifically looked for whether “the financial company [had] a proxy voting record that demonstrated antagonism towards fossil fuel-based energy industry.”
  • The FAQ also specifically noted that they considered “votes against exploration, production, utilization, transportation, sale or manufacturing of fossil-fuel based energy . . . as well as the imposition of environmental standards beyond applicable federal and state law.”
  • The FAQ also previewed that in the future the Comptroller’s office will look at whether proxy voting records “demonstrate merely a focus on corporate disclosures or support the imposition of non-fiduciary prescriptive requirements upon the fossil fuel-energy industry.”

Notably, the Comptroller’s office appears to have deemed certain entities as “boycotting” even when such entities held direct or indirect investments in fossil fuel–based energy companies. This suggests that an entity or fund could be viewed by Texas as boycotting and put on Texas’s boycott list even if it is not screening out fossil fuel investments.

If a fund or entity is included on one of the boycott lists, a next step could be to approach the Comptroller’s office to appeal such inclusion and seek removal from the list. While presently there is no formal process for removal, the comptroller has informally stated a willingness to consider removal requests and engage in a discussion. Any requested changes to a list would likely not be able to be made until February 2024 at the earliest, given the statutory limitation on updates of lists no more frequently than quarterly.

Legal practice assistants Barbara de Alfaro and Niki Nguyen contributed to this LawFlash.

[1] Press Release, Minnesota AG Keith Ellison, Attorney General Ellison Calls on Congress to Defend Consideration of ESG Factors (Dec. 14, 2023).

[2] Press Release, House Judiciary Chairman Jim Jordan, Chairman Jordan Subpoenas As You Sow and GFANZ in ESG Investigation (Nov. 1, 2023).

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