In litigation over its ESG disclosure rules, Missouri admits that ESG investing targets financial returns

The Missouri Securities Division recently adopted new rules that went into effect on July 30, requiring an investment adviser or broker-dealer to disclose to clients if it “incorporates a social objective or other nonfinancial objective” in its investment advice. Clients must in turn sign a specified form of acknowledgement and consent to the incorporation of any social or other nonfinancial objective in the investment of their accounts.

In August, the Securities Industry and Financial Markets Association (SIFMA) filed a federal lawsuit challenging Missouri’s rules on behalf of its members. SIFMA asserts that the rules are not only preempted by federal law (including ERISA), but also that the rules violate the First Amendment to the U.S. Constitution by compelling firms to adopt and express the government’s controversial position on the “nonfinancial” nature of ESG investing. The First Amendment allegations put Missouri in a difficult spot – how could the state credibly tell the court that the disclosure rules do not have the effect of compelling firms to endorse the government’s viewpoint, if they would be required to tell clients that ESG investing is “nonfinancial” even if the firm didn’t believe that to be true?

The answer to this question was revealed in Missouri’s motion to dismiss filed on October 2, where the state made an important concession. In arguing why the rules do not run afoul of the First Amendment, Missouri stated that no disclosure is required where “non-financial criteria” are considered in pursuit of financial returns. “This is a safe harbor,” the state told the court. The brief argued that the rules’ application turns on an adviser’s purpose in incorporating ESG considerations. If the purpose is something other than maximizing financial returns, this must be disclosed to clients; if instead the purpose is maximizing returns, the use of ESG factors falls within the “safe harbor” and doesn’t trigger the rules.

According to Missouri, “what triggers the disclosure is financial professionals’ own judgment” as to their purpose in considering ESG factors. “Merely choosing what appears to others to be a non-financial criterion is not enough to trigger disclosure. If the professional lacked a non-financial ‘purpose’ in using the non-financial criterion, there is no disclosure to make.”

Of course, to industry participants engaged in ESG investing, this assertion is hardly earth-shattering. It is a bedrock principle that ESG considerations reflect risks and opportunities that are incorporated in pursuit of financial returns.

What is noteworthy about Missouri’s statements is that much of the ongoing anti-ESG sentiment (in which Missouri participates) is founded on the opposite premise: that any consideration of ESG factors is necessarily in pursuit of non-financial social or political objectives, in violation of an adviser’s fiduciary duties.

Such a high-profile acknowledgement that fiduciary investment advisers may legitimately use ESG investing in pursuit of maximizing financial returns could open an important pathway for asset managers in navigating red state demands and challenges – including responding to statutory requirements that managers certify whether they are investing state pension funds with a “non-pecuniary” purpose.

The Missouri litigation bears close attention, as the state's concession could be made even more powerful if it finds its way into the court’s holding. Such a holding would join at least one other holding that has recognized the “pecuniary” nature of ESG investing (as discussed here), perhaps contributing to significant momentum in judicial recognition of this foundational premise.

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