State lawmakers are imposing Texas-style business penalties against ESG

Republican lawmakers in several state houses are pushing to limit access to government contracts and pension funds for businesses with ESG investments and policies, forcing many firms to navigate the changing regulatory landscape.

Bills proposed in about a dozen states this year would penalize companies for considering environmental, social and governance factors — such as climate change or diversity issues — over financial returns. The activity adds to a growing backlash against companies with ESG investment policies from doing business in states like Texas and Florida, where GOP officials have launched high-level battles against BlackRock Inc. and other asset managers. There are also anti-ESG proposals from Republicans in the US House of Representatives.

“It’s definitely crescendoed recently,” said Lance Dial, a partner at Morgan, Lewis & Bockius LLP, whose clients include asset managers, mutual fund managers and pension fund managers.

The state’s proposals are part of a larger political debate about ESG that includes disagreement over its overall definition and whether those factors align with a company’s fiduciary duties. Firms were torn between shareholders who pressured them to be better corporate citizens and government officials who could sanction them for complying with ESG commitments, said Khalil Williams, a partner at Ballard Spahr and co-chair of the firm’s ESG task force .

“There are more risks and costs when you actually do what you say you’re going to do,” Williams said.

The action comes as Texas and more than 20 other states last week sued the Biden administration to stop a Labor Department rule that prioritized ESG concepts in ERISA regulations.

Conversely, Democratic lawmakers in states like New York and Massachusetts are pushing back against GOP proposals with bills to require new ESG considerations for public pension funds, potentially adding to an increasingly complex mix of rules for firms to navigate .

Boycott bills

State legislative proposals vary in their approaches to limiting ESG considerations, but most fall into several categories, Dial said. Pending bills in Arkansas, Oklahoma, Wyoming and other states would allow contracts with state governments only for companies that certify they do not boycott or discriminate against certain industries, such as oil and gas or firearms.

Lawmakers in states including Mississippi and South Carolina have authored bills that would prohibit public pension investment decisions from being based on any factor other than maximizing returns. The Missouri legislation would prohibit states from discriminating against or favoring potential suppliers or contractors based on ESG factors, including environmental policies and employee wages.

Many of the boycott and pension bills reflect model legislation pushed by conservative-backed groups, including Heritage Action for America and the American Legislative Exchange Council. Heritage Action’s state legislative campaign argues that ESG harms specific industries for politically motivated reasons.

ALEC’s model pension bill would remove politics from pension investment decisions to better protect retirees’ financial returns, said Jonathan Williams, the council’s chief economist and executive vice president for policy. It’s too early to say which state legislatures will ultimately pass laws this year to address ESG “weaponization,” but most center-right states will try, he said.

“There’s a lot of interest in this concept,” Williams said.

Required Disclosures

Of course, the bills will be rejected in the state institutions. North Dakota Representative Anna Novak (R) has introduced a bill (HB 1429) that would require government contractors to certify that they are not boycotting energy or production agriculture. Novak told a legislative committee that government money should not go to companies “that want to see the death of our critical government sectors.”

The proposal would complicate contract negotiations and increase litigation costs, Sherry Neas, representing the state Office of Management and Budget, told lawmakers. She questioned whether the measure would achieve the desired result and asked whether businesses would be willing to agree to the written verification required under the bill.

“Many would be hesitant to sign this vague provision,” Neas said.

‘In the middle’

Using ESG factors solely for financial reasons, rather than a mission-related purpose, is one approach companies can consider if they’re trying to operate in different states, Dial said. State boycott bills, for example, allow companies to restrict work with certain industries if there is a business purpose, such as a bank trying to limit its credit risks.

“You can find that middle ground,” Dial said, noting that there is a business trade-off because some investors are looking for “ethical” ESG products that go beyond financial considerations.

Most pending laws generally leave state officials to decide what counts as a boycott or other violation, complicating the debate.

“These are judgments,” said Dial.

Companies dealing with regulatory and reputational risks must consider what is important to their business and shareholders, as ESG considerations vary depending on the circumstances, said Williams with Morgan Lewis. They also need to solidify their own definitions of ESG, make clear disclosures about their business products and consider how to manage the downstream impacts, Dial said.

“You have to let the truth determine what these revelations are,” he said.

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