State Legislation Targets Company Policies on ESG

Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita; Does Enlightened Shareholder Value Add Value? (discussed on the Forum here) and Stakeholder Capitalism in the Time of COVID (discussed on the Forum here), both by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr.; and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark J. Roe.

Over the past several years of political discord, many CEOs have felt the need to voice their views on important political, environmental and social issues. For example, after the murder of George Floyd and resulting national protests, many of the country’s largest corporations expressed solidarity and pledged support for racial justice. After January 6, a number of companies announced that their corporate PACs had suspended—temporarily or permanently—their contributions to one or both political parties or to lawmakers who objected to certification of the presidential election.  Historically, companies have faced reputational risk for taking—or not taking—positions on some political, environmental or social issues, which can certainly impair a company’s social capital and, in some cases, its performance.  These types of risks can be more nebulous and unpredictable than traditional operating or financial risks—and the extent of potential damage may be more difficult to gauge. As if it weren’t hard enough for companies to figure out whether and how to respond to social crises, now, another potent ingredient has been stirred into the mix: the actions of state and local governments—wielding the levers of government—to enact legislation or take executive action that targets companies that express public positions on sociopolitical issues or conduct their businesses in a manner disfavored by the government in power.  As described by Bloomberg, while “companies usually faced mainly reputational damage for their social actions, politicians are increasingly eager to craft legislation that can be used as a cudgel against businesses that don’t share their social views.” And many of these actions are aimed, not just at expressed political positions, but rather at environmental and social measures that companies may view as strictly responsive to investor or employee concerns, shareholder proposals, current or anticipated governmental regulation, identified business risks or even business opportunities. How will these legislative trends affect the difficult corporate balancing act?

According to Reuters, some “states have unleashed a policy push to punish Wall Street for taking stances on gun control, climate change, diversity and other social issues, in a warning for companies that have waded in to fractious social debates. Abortion rights are poised to be the next frontier.” For example, Reuters reports, last year, states passed legislation sidelining companies “that ‘boycott’ energy companies or ‘discriminate’ against the firearms industry from doing new business with the state,” contending that the “policies of such companies deprive legitimate businesses of capital.” According to a new Reuters analysis, in 2022, there were at least 44 bills or new laws in 17 states “penalizing such company policies, compared with roughly a dozen such measures in 2021….The growing restrictions show how America’s culture wars are creating new risks for some of the most high-profile U.S. companies, forcing them to balance pressure from workers and investors to take stances on hot-button issues with potential backlash from conservative policymakers.”  Some state officials accuse the targeted companies of “using the power of their capital to push their ideas and ideology down onto the rest of us.” These new prohibitions can create serious impediments to companies’ ability to conduct state business, implicating billions of dollars.

In addition, Reuters reports, the “issues such measures target are also mushrooming. Guns and energy were the focus of the roughly dozen state laws and bills last year and of at least 30 legislative measures this year. But this year there were also more than a dozen bills relating to social and other issues,” including many divisive concepts, such as mandatory COVID-19 vaccines.

Not that these measures come solely from one side of the political spectrum—Bloomberg reports that some politicians have taken aim at tax breaks for companies that oppose workers’ union organizing activities, offering a bill that “would propose that employers’ spending on anti-union activities qualifies as political speech under the tax code, barring those companies from deducting the costs on their taxes.” In addition, some states are reportedly advocating more restrictive ESG policies for state funds or considering actions such as a “climate resiliency fee” for institutions that fund fossil fuel projects or a prohibition against state pension plan investment in fossil fuel companies. Still, Reuters indicates that states favoring ESG policies are “not pursuing as many punitive measures, according to the review and sources.” Of course, that could change. And the review conducted by Reuters showed that it’s not just states that are sitting clearly on one side of the culture line or the other that are adopting these types of measures; some “swing” or purple states are also getting into the mix.

As the FT observes, the criticism of ESG can be “shrugged off as political posturing, but the anti-ESG laws being enacted” in some states are “adding significant risks for asset managers worldwide.”  In this article, the WSJ reports about one state’s proposed legislation and executive actions that take aim at the ESG movement, including actions to prohibit “state fund managers from considering ESG factors when investing government money, and to bar banks from discriminating against customers for their political and social beliefs.” And other states are being encouraged to take similar actions, with organizations suggesting “model legislation that provides states a template for laws to keep pension funds from following so-called environmental, social and governance trends.” Reuters reports that one state’s Attorney General is investigating whether a financial services firm violated a state consumer-protection law through its evaluations of ESG issues. Bloomberg also indicates that several states have “passed legislation that requires financial firms to say whether they have policies that limit doing business with oil, gas and coal companies, a common practice for firms that have made pledges to reduce their own carbon footprint. Banks that demur could lose their licenses in those states. Another 12 states are considering similar measures.” And this article from the FT reports that, in reaction, there are now a “clutch of global financial services firms that have been touting their business relations with oil and gas companies.”

Bloomberg suggests that a new Congress could well pressure the SEC “to ramp up its scrutiny of [ESG] ratings or stop it from taking actions to encourage ESG scores, which socially conscious investors use to compare companies.” Currently, although unlikely to pass in this Congress, a representative has introduced H. R. 8589, which would prohibit the SEC from finalizing its proposed climate disclosure, or implementing or enforcing the rule or any similar rule.


Of course, while the SEC has proposed new climate disclosure regulations, it has also set up a task force designed to scrutinize ESG disclosures. As discussed in this Bloomberg article, the SEC’s task force, established over a year ago, has been devoted to examining corporate and fund ESG disclosures to combat greenwashing, securities fraud and other ESG-related misconduct.  According to the SEC’s press release, the initial focus of the Task Force was to identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules, giving us all another reason to excavate the staff’s 2010 interpretive guidance regarding climate change. (You may recall that the guidance addressed in some detail how existing disclosure obligations, such as the Reg S-K requirements for business narrative and risk factors, could apply to climate change. See this PubCo post.) The press release indicated that the Task Force would “develop initiatives to proactively identify ESG-related misconduct,” and “coordinate the effective use of Division resources, including through the use of sophisticated data analysis to mine and assess information across registrants, to identify potential violations.” In addition, the Task Force would “evaluate and pursue tips, referrals, and whistleblower complaints on ESG-related issues, and provide expertise and insight to teams working on ESG-related matters across the Division.” (See this PubCo post.) According to the article, the Task Force has recently had a major hand in at least three enforcement actions, including one against Brazilian mining company Vale S.A. (See this PubCo post.) According to Bloomberg, the Task Force’s recent actions “are likely just the beginning, with more cases expected soon.”

The FT also observes that, in some states, these bills have met resistance, receiving enough pushback to be defeated in at least one case. And, as discussed in a business journal article from the Wharton School, academic research looked at the financial impact in one state of legislation aimed at prohibiting local jurisdictions from contracting with banks that had adopted policies against guns and fossil fuels. It turned out that the legislation may not necessarily have worked in the state’s economic best interest. As a result of the legislation, a number of major underwriters exited the state. By decreasing competition, the legislation increased the costs of borrowing, the research found. The research estimated that, for the “first eight months following effectiveness of the legislation, the cities in that state will pay an additional $303 million to $532 million in interest on $32 billion in bonds.” In this case, as it turned out, the law had “so many loopholes and exceptions” that, when the state began to ask financial institutions to describe their climate policies, several banks attempting to re-enter the market were able to say that their policies were in compliance. For example, one loophole noted by NPR allowed companies that wanted to continue to work in that state to “still avoid investing in fossil fuels as long as they are doing so for strictly financial, rather than ethical or environmental, reasons.”

As noted in the Wharton article, businesses will “have to consider whether leaving a state over ESG regulation is worth the trade-off.” However, according to analysts cited by the FT, these state restrictions do not yet rise to the level of posing “a significant revenue risk but that could change if the efforts to freeze banks out of state business become more widespread.” Similarly, Bloomberg reports that few expect these actions “to vaporize the industry. As of now, roughly $3.4 trillion of public retirement money is invested in line with ESG strategies of some sort, according to the sustainable-investing industry group US SIF.”  In addition, some pro-ESG states are taking the opposite tack, “pushing for more restrictive ESG screens for state funds, not less. What’s more, many of the world’s biggest financial institutions have their own goals to cut emissions, which include reducing the amount of business they do with heavy polluters—whether they bill it as ESG or not. Many also have set targets for workforce diversity and elevating women in management….”

According to a commentator from Forrester, a market research firm, quoted in Bloomberg, “CEOs and corporate directors must decide how to balance the risks of alienating customers, employees, investors, and lawmakers.” Needless to say, that’s not always an easy exercise, and many companies may feel caught in the sociopolitical crossfire. To be sure, there may be instances where the company’s business in that state may not be seriously imperiled or countervailing regulatory or financial interests outweigh or counteract the impact of the state action, or where a loophole or “neutralized” workaround is available that still accomplishes the company’s goals and conforms to its values. And in many cases, company values will simply dictate the result. As the commentator observed, a “CEO has to imagine he or she is moving a slider on a control board to find the position that provides the least damage to the company.” And, as discussed by NPR, some commentators are skeptical about this type of legislation altogether, viewing these actions by states as largely symbolic and unlikely to succeed. For example, with regard to the ESG legislation aimed at financial firms, they point to “gaping loopholes in the legislation. They say that the climate risks to the financial system are so huge that there’s no real way to stop financial firms from pricing them in—and going greener in the process.” According to a mutual fund manager quoted by NPR, “for her firm, being listed as a boycotted entity might not be such a bad thing. ‘I don’t think this is going to affect demand at all,’ she says. ‘In fact it might spur more people to realize that they can invest fossil fuel free.’”

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