It is a common refrain, mostly on the political right, that considering environmental, social, and governance (“ESG”) factors when investing is probably illegal. The basis for this argument derives from the fiduciary duty of loyalty and its corollary, the “sole interest” or “exclusive benefit” rule, enshrined in both federal and state law, which prohibits fiduciaries from investing for any purpose other than the financial well-being of the beneficiary. Investing to advance a societal goal constitutes a mixed motive, a fiduciary violation.
The attorneys general of a number of states have drafted legal opinions prohibiting their public entities from ESG investing on this basis. These opinions rely on an assumption that ESG investing is non-pecuniary and therefore entails a mixed motive. This assertion is generally presented with little factual support other than the cherry-picked statements of journalists or consultants. For example, the Indiana AG has stated that, “ESG is an investment strategy that focuses less on the financial health of a company and more on its social and environmental impacts…,” citing a Forbes article written by two journalists. The citation ignores an accompanying passage in the same article: “companies that put in the work to balance the benefits for each of their five stakeholders [workers, communities, customers, shareholders, and the environment] simply become well-run companies. And well-run companies become good stocks to own.” The motive here is not mixed; it is pecuniary.
Among the most authoritative sources cherry-picked by the AGs is a well-regarded Stanford Law Review article by Schanzenbach and Sitkoff. As the Kentucky AG notes when citing this piece of scholarship, “ESG investing is an ‘umbrella term that refers to an investment strategy that emphasizes a firm’s governance structure or the environmental or social impacts of the firm’s products or practices.’” What goes unsaid is a complete depiction of the umbrella. Schanzenbach and Sitkoff go on to say:
we clarify the umbrella term “ESG investing” by differentiating it into two categories. We refer to ESG investing for moral or ethical reasons or to benefit a third party, what had been called [Socially Responsible Investing], as collateral benefits ESG. We refer to ESG investing for risk and return benefits—that is, to improve risk-adjusted returns—as risk-return ESG…. Risk-return ESG investing…can be permissible on the same terms as any other kind of active investment strategy that seeks to exploit market mispricing (what we will call active investing) or shareholder control rights (what we will call active shareholding) for profit.
Further, in separating these ESG flavors, the authors challenge “common knee-jerk reactions that ESG investing necessarily violates the duty of loyalty.”
While Utah’s state treasurer, who has decried ESG investing as part of “Satan’s plan,”admits that “financially material ESG factors are already part of investment analysis,”most commentators who hold the anti-ESG position don’t often allow for the mere existence of “risk-return ESG investing.” Yale Professor Jed Rubenfeld and former U.S. Attorney General William Barr stated in the Wall Street Journal that the belief that ESG factors are material to profitability “appears to rest more on hope than fact.” A recent post averred that “proof that ESG increases investor return is wholly lacking.”
Considering a Company’s ESG Record ReducesRisk
Examples abound of pecuniary benefits accruing to investors who pay attention to companies’ environmental, social, and governance characteristics. In July, 2017, the stock of NYSE-traded Tahoe Resources dropped 33 percent when the Supreme Court of Guatemala suspended its license to operate the world’s third-largest silver mine. The suspension was the result of a lawsuit claiming that the company ignored an Indigenous group’s right to consultation in advance of granting the license and was the culmination of a long history of alleged human rights violations in the area that went undisclosed to investors. Shareholders who were attentive to the company’s human rights risk, and as a result avoided Tahoe stock before the license suspension, saved a significant amount of money. A litany of similar stock declines have followed the discovery of environmental violations, harassment claims, safety issues, community impacts of opioids,allegations of forced labor, and other disagreements with local communities that affect corporate reputation and social license to operate. Academic studies have found that these “ESG controversies” are quite common, lead to significantly negative returns, and increase the odds that a company will not survive in a competitive market. Active investing and shareholding to mitigate the risks of ESG controversies is pecuniary.
Corporate Environmental and Social Impacts Affect the Broader Economy
When a company’s problems create volatility in the price of its assets, investors term the problems as “idiosyncratic risks.” Another level of risk affects the volatility of an entire portfolio. This is “systematic risk,” exemplified by the 2008 Global Financial Crisis, which essentially affected the price of every asset. Currently, one of investors’ most salient and foreseeable systematic risks has an environmental source: Climate change poses a massive risk for the global economy and investment portfolios. The world hit a record level of carbon emissions in 2022 and is projected to warm by 2.5-3°C by 2100.Estimates of climate-related losses include: 18 percent global GDP loss by 2050 under a business-as-usual case (Swiss Re); nearly 25 percent cumulative loss in global output in the next two decades if mitigation actions are not taken (BlackRock); 10 percent GDP loss by 2050 for temperature increases above 3°C (Vanguard); 15-20 percent cumulative reduction in GDP by 2100 and equities 10 percent permanently lower (Thinking Ahead Institute); over $150 billion in stranded oil and gas infrastructure assets to be borne by developed market investors; and a 13 percent decrease in European pension asset values if policies needed to limit warming to 2°C are delayed until 2030 (European Insurance and Occupational Pensions Authority Stress Test).
Other environmental and social systemic risks have been less precisely estimated but still point to significant pecuniary harm if unaddressed. These include socio-economic inequality and even the rise of authoritarianism. When fiduciaries investigate and mitigate material risks to beneficiaries’ and customers’ portfolios through active shareholding, they are considering the pecuniary effects such risks can pose. Indeed, if one reads ERISA to broadly require that fiduciaries “minimize the risk of large losses,” then investors may violate their duties by avoiding active shareholding with regard to systemic issues.
ESG Fund Performance is a Poor Pecuniary Indicator
A common argument against ESG funds is that they don’t outperform funds that explicitly lack a sustainability focus. It is true that various meta-analyses undertaken to determine whether ESG produces superior investment returns have not been as conclusive as hoped, for or against. Any financial professional could come up with myriad reasons why this might be the case, however. For example, companies with impeccable social and environmental credentials may draw more socially-aware investors, driving up their stock prices but contributing to longer-term underperformance through mean reversion.Another explanation may be that investors in companies with inordinate exposure to regulatory and litigation risks, such as those in the oil and gas sector, may demand higher returns to compensate for high volatility. Just as bonds, which are less volatile than equities, historically provide lower returns than stocks, so may companies with less-volatile stock prices provide lower returns than companies with the potential to be rocked by controversy. The trade-off between risk and return is nothing more than Finance 101.
ESG Ratings Performance is a Poor Pecuniary Indicator
Another argument against ESG investing is that ESG ratings vary widely from one provider to the next. ESG ratings are proprietary weighting schemes, often grounded in self-reported company data, published by for-profit firms angling for subscription revenue. Serious ESG investors recognize their limitations, and their centrality in the ESG debate is a straw man. In any event, the most recent scholarly research indicates that there may be a performance premium associated with certain ratings schemes.
Most Evidence Suggests That ESG Investing Is Pecuniary
Attention to investment risk from the environmental and social performance of corporations has pecuniary benefits on both stock-specific and portfolio-wide levels. While fiduciaries practicing “collateral benefits ESG” certainly exist, they are typically socially responsible investment firms that disclose their aims, or representatives of entities with a charitable purpose. Mainstream asset owners and asset managers undertake ESG analysis for pecuniary purposes. When next the reader hears a speaker asserting that ESG factors are immaterial to profitability, refer them to me. I have a silver mine to sell them.
 Jed Rubenfeld and William P. Barr, “ESG Can’t Square With Fiduciary Duty,” September 6, 2022. Available at https://www.wsj.com/articles/esg-cant-square-with-fiduciary-duty-blackrock-vanguard-state-stree-the-big-three-violations-china-conflict-of-interest-investors-11662496552
 Mixed motives are acceptable for fiduciaries of colleges, universities, philanthropic foundations and other endowed nonprofit institutions, who must balance financial obligations with consideration of the charitable purposes of the institution.
 In addition, in Utah v. Walsh, a coalition of attorneys general from 25 states use similar reasoning to allege that the Department of Labor’s ESG Rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” conflicts with ERISA.
 E. Napoletano and Benjamin Curry, “Environmental, Social And Governance: What Is ESG Investing?” February 24, 2022. Available at https://www.forbes.com/advisor/investing/esg-investing/.
 Max M. Schanzenbach & Robert H. Sitkoff, “Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee,” February 2020. Available at https://review.law.stanford.edu/wp-content/uploads/sites/3/2020/02/Schanzenbach-Sitkoff-72-Stan.-L.-Rev.-381.pdf
 Supra note 6 at 389.
 Id. At 386.
 Aaron Kliegman, “Utah state treasurer, leader in movement against corporate wokeness, says ESG part of ‘Satan’s plan’”, March 16, 2023. Available at https://nypost.com/2023/03/16/utah-state-treasurer-says-esg-part-of-satans-plan/
 Marlo Oaks, “Opinion: Why Utah’s state treasurer is against ESG investing,” April 3, 2023. Available at https://www.deseret.com/opinion/2023/4/3/23663085/marlo-oaks-uath-treasurer-esg
 Supra note 1.
 Cecilia Jamasmie, “Tahoe Resources forced to halt Escobal mine in Guatemala.” Mining.com, July 6, 2017. https://www.mining.com/tahoe-resources-forced-halt-escobal-mine-guatemala/
 Request to Investigate Tahoe Resources for Failure to Disclose Material Information. Filed by: Shin Imai, Justice and Corporate Accountability Project, May 8, 2017. https://justice-project.org/wp-content/uploads/2017/12/FINAL-BCSC-Disclosure-Complaint-re-Tahoe-May-15-2017.pdf
 Tom Bergin, “BP shares drop as oil spill worsens,” April 29, 2010. Available at https://www.reuters.com/article/us-bp/bp-shares-drop-as-oil-spill-worsens-idUSTRE63S3A720100429; Benjamin Snyder and Stacey Jones, “Here’s a timeline of Volkswagen’s tanking stock price,” September 23, 2015. Available at https://fortune.com/2015/09/23/volkswagen-stock-drop/.
 Michael Sheetz, “Wynn shares tumble 10% after reports of ‘decades-long pattern of sexual misconduct’ by CEO Steve Wynn,” January 27, 2018. Available at https://www.cnbc.com/2018/01/26/wynn-stock-drops-7-percent-after-alleged-sexual-misconduct-by-steve-wynn-report.html; Lauren Thomas, “This jewelry brand’s stock plummets after sexual harassment allegations surface,” February 28, 2017. Available at https://www.cnbc.com/2017/02/28/signet-jewelers-stock-drops-as-sexual-harassment-allegations-surface.html; Samantha Subin, “Activision Blizzard shares drop after report CEO allegedly knew about sexual misconduct,” November 16, 2021. Available at https://www.cnbc.com/2021/11/16/activision-blizzard-shares-drop-after-reports-allege-sexual-misconduct.html. See also Au, Shiu-Yik and Dong, Ming and Tremblay, Andreanne, How Much Does Workplace Sexual Harassment Hurt Firm Value? (January 25, 2022). Journal of Business Ethics, Available at SSRN: https://ssrn.com/abstract=3437444
 Paula Laier, “Vale stock plunges after Brazil disaster; $19 billion in market value lost,” January 28, 2019. Available at https://www.reuters.com/article/us-vale-sa-disaster-stocks/vale-stock-plunges-after-brazil-disaster-19-billion-in-market-value-lost-idUSKCN1PM1JP
 Walgreen Boots Alliance stock dropped 6% a day after a ruling found the drug store retailer partially responsible for contributing to Ohio’s opioid epidemic. Alexis Garcia, “Is WBA Stock A Buy Or Sell In November 2022 After Major Acquisition, Q4 Earnings?” November 29, 2022. Available at https://www.investors.com/research/wba-stock-buy-now/
 Shalini Nagarajan, “Boohoo stock tumbles 30%, wiping $1.25 billion off its market value, after an explosive report into working conditions at one of its factories,” July 7, 2020. Available at https://markets.businessinsider.com/news/stocks/boohoo-stock-price-reaction-criticism-over-low-factory-worker-wages-2020-7-1029371727
 Carla F. Fredericks, Mark Meaney, Nicholas Pelosi, and Kate R. Finn. Social Cost And Material Loss: The Dakota Access Pipeline. November 2018, https://www.colorado.edu/program/fpw/sites/default/files/attached-files/social_cost_and_material_loss_0.pdf; Sonali Paul, Australia court ruling on Santos raises risks for offshore gas projects, December 2, 2022. Available at https://www.reuters.com/business/energy/australia-court-rejects-santos-bid-resume-barossa-gas-drilling-2022-12-02/
 Douglas Dwyer, Mateusz Giezek, Richard Loeser and Maitena Pineiro. The Business Impact of ESG Performance. June 2022, https://www.moodysanalytics.com/-/media/article/2022/esg_business_impact_june2022.pdf.
 Irene Fafaliou, Maria Giaka, Dimitrios Konstantios and Michael Polemis. Firms’ Sustainability Performance and Market Longevity. June 2020, https://mpra.ub.uni-muenchen.de/101445/1/MPRA_paper_101445.pdf.
 William Mathis, “Global CO2 Emissions Hit a Record Even as Europe’s Decline,” March 2, 2023. Available at https://www.bloomberg.com/news/articles/2023-03-02/global-co2-emissions-hit-record-in-2022-even-as-europe-s-dipped
 Climate Action Tracker CAT Thermometer. Available at https://climateactiontracker.org/global/cat-thermometer/
 Swiss Re Group, “World economy set to lose up to 18% GDP from climate change if no action taken, reveals Swiss Re Institute’s stress-test analysis,” April 22, 2021. Available at https://www.swissre.com/media/press-release/nr-20210422-economics-of-climate-change-risks.html
 BlackRock Investment Institute, “Launching climate-aware asset class return expectations,” February 2021. Available at https://www.blackrock.com/corporate/literature/whitepaper/climate-aware-investing.pdf
 Vanguard research, “The economics of climate change: Assessing the impact of global warming and the transition to ‘net zero’ on the economy,” April, 2022. Available at https://corporate.vanguard.com/content/dam/corp/research/pdf/the_economics_of_climate_change.pdf
 Thinking Ahead Institute, “Pay now or pay later? Addressing climate change sooner rather than later is in the best interests of investors and their beneficiaries,” November 2022. Available at https://cdn.roxhillmedia.com/production/email/attachment/1090001_1100000/cb299e9d546ef327a6bd5a78de2c9474e0dd7434.pdf
 Semieniuk, G., Holden, P.B., Mercure, JF. et al. Stranded fossil-fuel assets translate to major losses for investors in advanced economies. Nat. Clim. Chang. 12, 532–538 (2022). Available at https://www.nature.com/articles/s41558-022-01356-y.pdf
 European Insurance and Occupational Pensions Authority, “Climate stress test for the occupational pensions sector 2022,” December 13, 2022. Available at https://www.eiopa.europa.eu/eiopas-first-iorps-climate-stress-test-shows-material-exposure-transition-risks-2022-12-13_en.
 See, for example Pascal Paul. 2022. “Historical Patterns of Inequality and Productivity around Financial Crises,” Federal Reserve Bank of San Francisco Working Paper 2017-23; Buckman, Shelby R., Laura Y. Choi, Mary C. Daly, Lily M. Seitelman. 2021 “The Economic Gains from Equity,” Federal Reserve Bank of San Francisco Working Paper 2021-11.
 29 U.S.C. § 1104(a)(1)(C).
 Sanjai Bhagat, “An Inconvenient Truth About ESG Investing,” March 31, 2022. Available at https://hbr.org/2022/03/an-inconvenient-truth-about-esg-investing; see also Terrence Keeley, “Vanguard’s CEO Bucks the ESG Orthodoxy,” February 26, 2023. Available at https://www.wsj.com/articles/vanguards-ceo-bucks-the-esg-orthodoxy-tim-buckley-net-zero-emissions-united-nations-initiative-nzam-f6ae910d.
 See, for example, Atz, Ulrich and Van Holt, Tracy and Liu, Zongyuan Zoe and Bruno, Christopher, Does Sustainability Generate Better Financial Performance? Review, Meta-analysis, and Propositions (July 22, 2022). Journal of Sustainable Finance and Investment, Available at SSRN: https://ssrn.com/abstract=3708495. The Utah State Treasurer (supra note 11) incorrectly cited this article as demonstrating “a statistically significant negative relation between environmental, social and governance investing and investor returns.” In reality, the authors state that “the financial performance of ESG investing has on average been indistinguishable from conventional investing (with one in three studies indicating superior performance)…”
 Gantchev, Nickolay and Giannetti, Mariassunta and Li, Rachel, Sustainability or Performance? Ratings and Fund Managers’ Incentives (March 30, 2023). Swedish House of Finance Research Paper No. 21-4, European Corporate Governance Institute – Finance Working Paper No. 747/2021, Available at SSRN: https://ssrn.com/abstract=3731006
 Harrison Hong and Marcin Kacperczyk, “The price of sin: The effects of social norms on markets,” Journal of Financial Economics, Volume 93, Issue 1, 2009, Pages 15-36. Available at https://doi.org/10.1016/j.jfineco.2008.09.001.
 Berg, Florian and Kölbel, Julian and Rigobon, Roberto, Aggregate Confusion: The Divergence of ESG Ratings (August 15, 2019). Forthcoming Review of Finance, Available at SSRN: https://ssrn.com/abstract=3438533
 Berg, Florian and Lo, Andrew W. and Rigobon, Roberto and Singh, Manish and Zhang, Ruixun, Quantifying the Returns of ESG Investing: An Empirical Analysis with Six ESG Metrics (February 27, 2023). Available at SSRN: https://ssrn.com/abstract=4367367
This post comes to us from Paul Rissman, the co-founder of human-rights organization Rights CoLab.