State AGs Challenge Proxy Advisors for Promoting ESG and DEI Policies
Commentary by Steven Lofchie
Twenty-one State Attorneys General (the "AGs") criticized two proxy advisors, asserting that their commitments to promoting environmental, social and governance ("ESG") and diversity, equity and inclusion ("DEI") policies may be in violation of state and federal laws.
In a letter to the two proxy advisors, the AGs said that the entities are effectively investment advisers, and under the Investment Advisers Act, owe investors a fiduciary duty of care and loyalty. The AGs asserted that these duties are centered around an obligation to act with reasonable diligence in maximizing economic value. The AGs said that the proxy advisors may be failing to uphold their fiduciary duty in at least two respects, their recommendations as to votes on (i) net-zero emission standards and (ii) diversity, equity and inclusion policies.
As to the environmental recommendations of the proxy advisors, the AGs highlighted several potential issues. First, the AGs noted that the proxy advisors often recommend votes against board members and company plans that fail to adequately address reductions in greenhouse gas emissions. The AGs questioned how these recommendations may be tied to investors' financial interests. Second, the AGs pointed out the difficulty of reaching net-zero emissions on a global-level. "The IEA describes the pathway to net zero as 'perhaps the greatest challenge humankind has ever faced,'" the AGs said. In noting the impracticality of implementing net-zero emissions, the AGs questioned the advisors on how a rational company, acting in the best interests of shareholders, could voluntarily incur the expenses associated with trying to achieve a potentially out-of-reach goal.
Separately, the AGs suggested that the proxy advisors' practices regarding diversity, equity and inclusion may present violations of anti-discrimination laws. The AGs noted that the proxy advisors have advocated voting against boards they deem to have "insufficient racial, ethnic or sex-based diversity." The AGs concluded that these recommendations amount to the promotion of diversity quotas. Further, the AGs criticized these policies, stating that the proxy advisors' determinations of adequate diversity were based on arbitrary and vague measures.
The AGs concluded by requesting that the proxy advisors address several questions, including (i) whether they believe they have undertaken fiduciary duties of care and loyalty, (ii) whether their sole goal should be maximizing economic interests, (iii) the materiality of emissions reduction targets, (iv) how they determine the "appropriate" emissions reduction targets for each company, and the financial basis for that determination and (v) how they have determined that recommendations regarding diversity, equity and inclusion do not violate anti-discrimination laws.
The AGs asked the proxy advisors to provide written responses no later than January 31, 2023, and to uphold their legal obligations as proxy advisors.
Commentary
When a regulated firm is the subject of an inquiry from a governmental entity that is not the firm's direct regulator, the regulated firm can often ignore the inquiry, on the view that there is no effective authority behind it. That may not be a workable strategy here. The allegations of the state AGs raise the potential for claims under state securities law, antidiscrimination laws, and, with respect to advice given to state pension plans, under any fiduciary laws that may resemble ERISA, as well as potential contractual claims. In short, it is not obvious that the inquiries of the state AGs can simply be ignored.
There is also an SEC-sidecar element to this story. One of the SEC's notable actions in 2022 was rescinding regulations that would have imposed stricter requirements on proxy advisers (see SEC Proposal to Deregulate Proxy Voting Advice). These actions were notable both because they were procedurally unusual, rescinding rules that had not yet come into effect, and because the SEC has of late been seeking to substantially extend its regulatory authority, with the single exception of regulation of proxy advisors.
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