ESG and the State Coffers: An Emerging Political Battleground

October 11, 2022
25:21 minutes

In this Ropes & Gray podcast, Michael Littenberg, global head of the ESG, CSR and business and human rights practice, and Josh Lichtenstein, a benefits partner and head of the ERISA fiduciary practice, speak with Reagan Haas, an ERISA and benefits associate, about the increasing activity at the state level dictating what role, if any, ESG factors should play in managing public retirement plan assets, and other related developments. Later in the episode, Chong Park, an antitrust partner, joins the conversation to discuss assertions that some states are making that managers’ ESG commitments violate antitrust laws.


Reagan Haas: Hello, and welcome to today’s podcast where we will be discussing the latest emerging battleground over ESG—that is, what role ESG considerations should play in the day-to-day activities of state treasuries. I’m Reagan Haas, a member of our ERISA and benefits practice based in San Francisco, and I am joined by Josh Lichtenstein, benefits partner and head of the ERISA fiduciary practice, and Michael Littenberg, partner and global head of our ESG, CSR and business and human rights practice, both of whom are based in New York, and finally, Chong Park, an antitrust partner who is based in our Washington, D.C. office. Welcome, Chong, Josh and Michael.

ESG has taken on an especially prominent place in the workings of state treasuries over the last year—whether we are talking about selecting asset managers and investments for the state retirement system or contracting with banks to underwrite bond issuances. Politicians on both sides of the aisle have become especially vocal of late—as we have seen a proliferation of new legislation and other rules being proposed and enacted in many states, as well as proclamations and memoranda from state treasurers and attorneys general articulating the contours of ESG and its role in public finance. These initiatives have taken on several forms, including: (1) those intended to promote the integration of ESG considerations in investment decisions; (2) those intended to restrict the use of ESG considerations in investment decisions; (3) those meant to promote divestment from certain industries, such as fossil fuel or firearms; and (4) those targeting entities that boycott the fossil fuel or firearms sectors.

Ropes & Gray has been helping clients to understand and navigate these and other state ESG developments since they very first began to arise. Over a year ago, as part of our ESG center of excellence, we started formally and methodically tracking developments in this space. From what began with just a handful of bills, we are now tracking and advising on how to navigate initiatives in over thirty states, some of which have been signed into law and already taken effect. These contradictory state laws and approaches present real challenges to asset managers as they work to comply with their own fiduciary duties to state retirement plan clients, especially where restrictions may prohibit a manager from considering investment factors it would otherwise view as significant for purposes of prudently investing state pension assets. Layered on top of that is the DOL’s forthcoming (at least as they keep telling us) final ESG rule, which would provide a framework for ERISA plan fiduciaries for considering ESG factors when evaluating and selecting plan investments. All of this translates into an intricate regulatory web that an asset manager has to work through if it is going to manage money of both public and private sector retirement plans.

Josh, you’ve been tracking these bills closely for a long time now. Could you give us a brief overview of what you’re seeing?

Josh Lichtenstein: I’d be happy to, Reagan. As you mentioned, we have seen ESG-related legislation and regulatory guidance in the majority of states now. Some of these bills and initiatives are focusing on whether state pension plans should or should not take ESG considerations into account when making investment decisions, while others are more narrowly focused on only specific ESG issues. A couple of recent examples we’ve been tracking include: Arizona and Florida—both of which have recently revised their investment policy statements (for Arizona, it was the IPS for the State Treasurer’s Office, and for Florida, it was the IPS for the board that oversees the state retirement plan) to require that all investment decisions will be made based on “pecuniary factors,” and that expressly does not include environmental, social, and other related factors. On the flipside, Illinois enacted a law in 2020 that directs state and local government entities that manage public funds to consider materially relevant sustainability factors, including corporate governance and leadership, environmental, social capital, human capital, and business model and innovation factors when they’re making their investment decisions.

In other states, we have seen initiatives that have been more focused on one or more specific ESG issues, such as discouraging investments in energy (or in certain segments of the energy industry), or in firearms industries—or conversely, protecting industries, such as the energy industry, as you noted earlier. The adopted legislation that has arguably received the most attention from the public and other parties has been SB13, a Texas law that took effect in September 2021. The law prohibits Texas public entities, including state pension plans, from entering into contracts with financial companies that boycott energy companies. This summer, the Texas State Comptroller’s office published a list of ten financial institutions that the state of Texas considers to be “boycotters” of the Texas fossil fuel industry, and they’re no longer allowed to do business with Texas pension funds and other public entities—that includes investments in certain funds, and that also includes just more general, contracting. The Comptroller’s office has also flagged 348 funds that they are calling “ESG-focused funds,” which they believe also boycott the Texas energy sector (but note that this list does not apply more broadly to the managers themselves if they’re not on the boycott list—so, being on the restricted fund list relates to investments, but doesn’t relate to the ability to contract in the state). The Comptroller has indicated that this list is subject to change, so we expect to see things added to it over time, potentially on both the restricted parties or boycotters list, and also the restricted funds list. We have also seen recent action in Louisiana, where the treasurer announced on October 5 that the Louisiana treasury will liquidate all of its investments with a large asset manager by the end of 2022, citing the need to protect the state from alleged harm to the state’s energy sector based on the manager’s support for ESG investing and a theory that focusing on ESG is unacceptable under Louisiana state fiduciary law. This is noteworthy because Louisiana has actually unsuccessfully attempted to pass restrictions on ESG investing earlier this year, and now we see the treasurer effectively sidestepping that process and acting to divest on his own. On the opposite end of the spectrum, we have Maine, which signed a law in June 2021 that prohibits the Maine Public Employees Retirement System from investing in the 200 largest publicly traded fossil fuel companies.

Interestingly, even within states, it’s not always clear exactly how they’re aligned on ESG. For example, shortly before SB13 took effect in Texas, the Teacher Retirement System of Texas incorporated an ESG statement into its investment policy, which said that the board of trustees of the Texas Teachers Retirement Plan should consider ESG factors as it makes decisions consistent with its fiduciary duties to control risk and achieve a long-term rate of return for the plan. This policy appears to conflict with the requirements of SB13. In addition, while Florida has recently prohibited ESG-based investing for its public retirement plans, they have a strong history of supporting ESG-type proxy proposals with the securities that are holding their plans.

Reagan Haas: I know we’re lawyers and not political commentators, but it sounds like this is fundamentally becoming a red state versus blue state issue. Are we seeing coalitions form between states on these issues?

Josh Lichtenstein: It’s a good question, Reagan. As you said, states have been splitting along party lines on ESG pretty broadly, and as of this summer, we have seen states starting to form coalitions. In August, the attorneys general of nineteen states, including Georgia, Ohio, Texas, and Utah, sent a letter to a major asset manager regarding its use of ESG factors in managing state investments (including retirement assets). Among other things, their letter accused the asset manager of making decisions based on its climate agenda at the expense of the welfare of the state pensions that were invested. Soon thereafter, state treasurers from thirteen different states, plus the New York City Comptroller, published a letter through a trade group, For the Long Term, which asserted that the anti-ESG states are focused on the short-term and are actually using these blacklists to obstruct the free market. We can expect that this will continue to become more of a central issue as we enter election season, and only time will tell whether “ESG” will become a new mainstream political issue like “CRT” has.

Reagan Haas: Thanks, Josh. Michael, why do you think there has been this groundswell of activity on the state level lately?

Michael Littenberg: Reagan, as Josh noted, the split has been largely along party lines. I don’t want to get into the merits of the positions, but I think the state ESG/anti-ESG debate has largely become another front in the culture wars, so that is a significant driver of the groundswell in activity that we’re seeing. Underscoring that driver, the battle lines are largely being drawn by politicians, not by dispassionate bean counters or ivory tower academics, if you will. But in fairness to the politicians on both sides of the aisle, they’re deploying economic and legal arguments in support of their positions.

I think part of the fault here—and why ESG is being weaponized—is the fuzziness around exactly what ESG is. There’s no single accepted definition or construct of ESG, so that means that the term means different things to different people—it’s also often thrown about loosely. On a related point, ESG arguably also has strayed from its initial purpose of just being another lens through which to evaluate financial risk and opportunity. Instead, in many quarters, ESG is being equated with impact investing, corporate responsibility, or business and human rights—which are all related, but they are somewhat different topics.

Unfortunately, I don’t see the red state/blue state ESG dichotomy moderating any time soon. If anything, I think it’s going to intensify, as both the red and blue state constituencies continue to mobilize. So, that begs the question of what “State ESG 2.0” is going to look like. My prediction is that, over the next year, we are going to see more formal and informal ESG-related inquiries from state authorities. I also predict that we are going to see more blacklists, both from investment mandates and also more broadly, for diversified financial services firms that are seeking to do business with states. I think we’re also going to see continuing evolution of state investment-related statutes, policies and side letter provisions that seek to address ESG more comprehensively— in other words, the Florida approach, or the anti-Florida approach on the other side. In addition, I expect we also will start to see some ESG-related litigation, whether that’s on antitrust grounds, fiduciary duty or securities fraud or other investor protection grounds. I think that, at least initially, litigation is going to be primarily red state-driven. Litigation, of course, would not necessarily be tied to managing state pension fund assets.

One last point that I want to make: it’s very important to keep in mind that state ESG developments are just really one part of a very rapidly evolving ESG landscape that asset managers not only need to navigate, but they also need to holistically manage. And, here, I really want to put a double or triple underline or emphasis on holistic management. On the regulatory side, it includes regulation at the federal level; it includes regulation in Europe at the EU level, among other jurisdictions. The regulations include, for example, the expected Department of Labor rules in the United States that Josh mentioned earlier, as well as SFDR in Europe. But it’s not just legislation—we’re seeing prudential and other regulators also increasing their focus on climate risk. It still remains to be seen how that ultimately will influence ESG. Then there’s, of course, many other factors at play beyond regulation that will influence State ESG 2.0, but I think we’ll leave those for another time, perhaps another podcast.

Reagan Haas: Thanks, Michael. It’s helpful to see how the state ESG issues fit into the larger ESG picture and that this reaches beyond state pension plans. You noted antitrust. Chong, how does antitrust fit in here?

Chong Park: Sure thing, Reagan. As Michael said, the regulation of ESG is becoming highly politicized, and we are seeing that in the form of politicians suggesting that ESG commitments might violate the federal antitrust laws. Frankly, in my view, when you drill down on the substance, the antitrust theories don’t appear to hold any water—but they sound good, and they are easy enough for politicians to invoke, so they get media attention.

To understand why I believe the current antitrust theories here are weak, let’s step back a moment to understand why politicians might think that antitrust makes sense. They argue that you have firms that notionally control vast amounts of investments—so they see “market power,” the critical ingredient for many antitrust claims—and then you also have horizontal firms agreeing, or allegedly agreeing, not to take some action, and that action allegedly raises energy prices. So that sounds vaguely like a harm to competition, but that misunderstands the relevant antitrust principles here, as well as the actual facts about ESG investing.

As a starting point, the antitrust law that is most relevant here is Section 1 of the Sherman Act. Section 1 prohibits unreasonable agreements that restrain trade. Reasonableness is usually judged under what’s called the “rule of reason,” a balancing test that weighs the competitive harms against benefits of a given agreement. Now, that test in practice is pretty defendant friendly, but regardless, any antitrust case is no fun if you are a defendant or the target of an investigation.

Now, in certain narrow categories, courts will presume that agreements are unreasonable, and thus, unlawful. These are what are called “per se offenses”—for example, agreements between competitors to fix prices, rig bids, or allocate markets—anything where two competitors get together to agree not to compete or to harm competition. These are what are called so-called “hard-core” antitrust violations that individuals can actually go to jail for. But the biggest significance of per se or hard-core offenses is that a plaintiff or prosecutor only needs to prove that a defendant had the agreement itself—they don’t have to offer proof that the agreement actually hurt anyone, or that there were no benefits, etc.

So what is the relevance of all the background? The relevance of this is that there’s one type of agreement—a “group boycott”—that is sometimes a per se offense (although the exact contours of when a boycott claim is per se is confusing, even for the courts). But recognizing what an advantage it would be to have a per se antitrust claim, ESG critics, including some politicians, have suggested that investment firms committed to ESG principles might now be engaged in such an unlawful “group boycott.”

Michael Littenberg: Chong, it sounds as if the theory here is that investment managers that represent a significant share of investment assets are depriving energy firms of capital, thereby raising prices and hurting consumers. All of that sounds bad—all big competitors are doing the same thing, hurting consumers—and so if it’s a per se claim, ESG critics think they have a hook. Is that the right way to be thinking about this?

Chong Park: That’s correct, Michael. But this theory falls apart once you go beyond the surface. For one, a group boycott is only a per se offense when it involves horizontal competitors agreeing to not deal with some third party as a means of harming their competitor.

With investment firms that use ESG principles, you don’t have that same scenario: Even if those investment firms were boycotting energy firms that don’t follow ESG practices, these investment firms aren’t competitors to those oil and gas companies. They don’t benefit from directly harming non-ESG companies, so whatever “boycott” there is, it’s not about boycotting to gain a competitive advantage.

So the group boycott theory doesn’t make conceptual sense. To add to that, it also does not appear to be factually accurate. For one, many ESG efforts taken by investment firms concern voting for disclosure and transparency at the companies that they are invested in—they are not prohibitions on investing in particular companies. In addition, ESG commitments like the Climate 100+ pledge are also explicitly not binding firms to any particular investment choices. And to add to that, most of the major investment managers out there are still investing in non-ESG companies with their non-ESG funds. So this hardly seems to be a boycott in the first place.

So, that’s the main antitrust theory that’s been the focus of ESG critics. Notably, they haven’t provided too much in the way of actual details for their case against investment firms that take ESG considerations into account. But even taking what they’ve said in the best light possible, I think the antitrust claims raised so far are pretty weak.

Reagan Haas: What about companies that do follow ESG principles, do they face antitrust risk?

Chong Park: Companies that choose to adhere to ESG principles could, in theory, face a viable antitrust claim. The obvious basis for such a claim might be if companies use purported quality standards like ESG compliance as a cover for per se activity like price fixing. For example, competitors could agree potentially that they will not make cheaper alternatives to their products, and that they will all adhere to some high quality that takes into account ESG. In theory, that might be good, but the antitrust laws generally prohibit firms from entering into horizontal agreements to limit competition on price or the quality of products.

Indeed, during the Trump Administration, the DOJ briefly investigated car manufacturers for publicly declaring that they would follow California’s state auto emission standards, even though the Trump Administration had scrapped them at the federal level. Now, that was briefly investigated—controversially, I might add—by the DOJ, and many people saw that as a politically motivated investigation.

But beyond the DOJ case, no one has plausibly alleged that any pro-ESG company or firm is actually engaged in a cover for price fixing. It’s possible, I guess, but so far we haven’t seen it.

Reagan Haas: Thanks so much for sharing all of those insights, Chong. It’ll be really interesting to see how all of this continues to play out.

We’ve covered a lot of ground today on what the current ESG landscape is and what the antitrust concerns are, but coming full circle, how should asset managers be navigating this rapidly evolving area? What if anything should they be doing now?

Michael Littenberg: The first step is they should be calling Ropes & Gray for help navigating these challenges! But seriously, as I noted earlier, it’s critical for asset managers to take a holistic approach to ESG. That means an internally coordinated and thoughtful approach to addressing not only regulatory requirements and challenges, but also more broadly across policies, procedures and contractual undertakings, as well as also fund-level and voluntary disclosures and communications. In most cases, that’s still very much a work in process, especially the larger the firm and its geographic footprint. A holistic approach to ESG is also going to become increasingly important as regulatory approaches, and also stakeholder views on ESG more broadly, further evolve, and in many cases, also diverge or contradict each other. A holistic approach certainly is going to be important for ensuring regulatory compliance, but more generally, a holistic approach to ESG also is going to be increasingly important as a commercial imperative and as part of effective enterprise risk management.

Josh Lichtenstein: Those are great points, Michael. It’s also important for us to remember that for asset managers, navigating contradictory regulatory mandates is nothing new. For example, until the DOL issued its non-enforcement policy of the Trump Administration’s ESG rule in March 2021, we saw asset managers working to come to terms with how they’d have to change marketing approaches and even investment decision-making processes around the use of ESG. The rule posed particular challenges to managers who were also subject to the EU’s pro-ESG rules, including SFDR. We have helped countless managers to thread these needles, and are helping clients to do the same as the state ESG landscape continues to evolve and will see more competing requirements and concerns developing.

The bottom line is, to the extent that they are accepting money from different investors subject to conflicting regulatory schemes, asset managers will have to be extremely precise, organized and diligent when it comes to their documentation, marketing materials, and operations. Furthermore, it would be wise for asset managers to pay close attention to state activity over the coming months to see how this story continues to unfold. Until the dust finally settles, we think managers are going to want to avoid going too far in one direction in order to appease a single group, for example, making big changes to appease the anti-ESG states could mean losing out on other institutional shareholders, including pension funds from states that are pro-ESG, increasingly ERISA plans, and other major institutional investors.

Reagan Haas: Chong, Michael and Josh, thanks so much. This is a dynamic area of law and practice, and it seems like there will be much to monitor in the weeks, months and years ahead. Finally, as Josh mentioned, we also have the sleeping giant of the DOL’s final ESG rule, which is expected to come out before the end of this year.

As part of being at the forefront of ESG and our commitment to ESG thought leadership, we have a significant team that continues to monitor these developments. To stay up to date, we encourage you to subscribe to our state ESG tracker, which you can do by signing up for our dedicated mailing list, the “State Retirement Plan ESG Updates,” which you can find on this transcript and on the Ropes & Gray website. You also can sign up for our ESG and other mailing lists at In addition, stay tuned for our forthcoming microsite where you will be able to see these developments organized by state and category. And of course, if we can help you navigate any of the topics we covered, please don't hesitate to reach out to today’s commentators or your usual Ropes & Gray contact.

You can also subscribe and listen to our podcasts on ESG and other matters wherever you regularly listen to podcasts, including on Apple and Spotify. Thank you for listening.

Subscribe to RopesTalk Podcast