The National Association of Attorneys General Has a Unique Opportunity to Demystify ESG Investing

This piece is part of our Student Blog Series, featuring posts on climate, clean energy, and environmental issues from the State Impact Center’s legal interns and other students working with the Center.

Across the country, attorneys general are responsible for investigating and prosecuting environmental, social, and governance related misconduct. For example, in February 2022, Texas Attorney General Ken Paxton issued two civil demand letters to Tiktok to investigate the platform’s possible facilitation of human trafficking and child exploitation. This month, 42 states, including Idaho and Utah, announced a million-dollar settlement with a maker of a drug to treat opioid addiction resulting from the company’s unlawful anticompetitive efforts that increased prices for consumers. Lately though “ESG” has become a controversial three-letter acronym driving division among state attorneys general. This issue has recently sown division within the National Association of Attorneys General (NAAG), a nonpartisan forum that promotes bipartisan collaboration and relationship-building among attorneys general, with a new lawsuit filed against NAAG this month by the attorney general of Montana. In this moment, NAAG has a unique opportunity to reframe the dialogue in a much more concrete and productive manner by educating its membership about ESG in a technical manner.

ESG, which stands for “environmental, social, and governance,” refers to investment practices that consider not only financial information but also environmental, social, and governance data to pursue short- and long-term value. While ESG is often discussed in abstract terms, ESG-based business decisions are grounded in concrete Key Performance Indicators (KPIs) that help companies manage risk. The Harvard Law School Forum on Corporate Governance published an Introduction to ESG that helps explain the fundamentals of ESG investing, including ESG categories, related metrics and best practices. For example, so-called “ESG” data includes indicators of good governance (the “G” in ESG) such as the ratio of CEO-to-median employee pay, board composition, and bribery and corruption indicators. Many factors are considered, depending on the industry. For example, as noted by the Harvard Law School-published explainer, “[w]hile climate figures prominently in ESG discussions,” it is not the main focus of every ESG discussion. Instead, relevant ESG KPIs differ across industries, but provide a method for quantifying long-term risk and reputational risk. While the use of ESG data largely originated with socially responsible investing (known as “impact investing”) and strategic divestment, traditional asset managers increasingly use ESG data to account for risk that is overlooked in other financial valuations. Impact investors target beneficial social and environment impacts alongside financial returns, whereas traditional investors seek to maximize financial returns. Despite the tangible nature of ESG data, ESG-informed business practices have faced increasing criticism in the last year, particularly from several different coalitions of attorneys general.

Numerous attorneys general are scrutinizing the use of ESG information for decision-making. In August of 2022, for example, a coalition of attorneys general sent a letter to BlackRock’s CEO questioning the investment company’s practices and compliance with its fiduciary duties. In October 2022, nineteen attorneys general sent investigative demand letters to major financial institutions seeking information on their ESG practices and commitments to emissions-related UN alliances. In spring 2023, attorneys general targeted new industries with similar letters. A coalition of twenty-one attorneys general co-signed a letter to asset managers in March 2023. The letter was reportedly sent to dozens of asset managers. Subsequently, twenty-three attorneys general authored a similar letter to insurers in May. The letters made allegations of possible breach of fiduciary duty and antitrust violations.

Several attorneys general also sent letters to NAAG requesting disclosures of NAAG’s investments and financial positions. Kansas Attorney General Kris Kobach sent a letter to NAAG in January 2023; Idaho Attorney General Raúl Labrador sent a letter a few days later echoing Kobach’s concerns. In response, NAAG’s leadership addressed these concerns by clarifying the organization’s financial positions, according to reporting by Politico. Utah Attorney General Sean D. Reyes also filed a lawsuit against NAAG in Utah state court in March 2023, seeking an accounting of Utah’s funds held by NAAG and expressing concerns about investments with “ESG-oriented entities.” No answer to the complaint has yet been filed, according to the docket as of June 13, 2023. Reportedly, Montana Attorney General Austin Knudsen filed a similar lawsuit on June 7, 2023. The complaint similarly expressed concerns about a lack of oversight over NAAG’s financial management and requested an accounting of Montanan public funds held by NAAG. Even while these actions continue, many attorneys general across the political spectrum are continuing to conduct investigations into corporate behavior, focused on consumer protection, fighting corruption, and proactive environmental stewardship, and many other issues that are important to their constituents. For example, the Texas Attorney General’s Office recently announced a large settlement with Audi and Volkswagen for installing technology that evaded emissions tests, which resulted in air pollution and violated Texas environmental laws. The scandal resulted in a significant downgrade in Volkswagen’s ESG ratings from an ESG data provider in September 2015. Specifically, MSCI (formerly, Morgan Stanley Capital International) ESG Ratings downgraded Volkswagen from BBB to CCC, and MSCI the MSCI ESG Impact Monitor downgraded Volkswagen from receiving a “Yellow Flag” to a “Red Flag.” The data provider noted that traditional financial valuation models failed to capture the underlying risk, but various governance metrics such as corporate governance practices and elevated warranty expenses began to raise red flags before the misconduct became public.

NAAG is well suited to using its network and educational resources to address ESG concerns. In December 2022, NAAG hosted a panel discussion titled “ESG Investment Decisions — Understanding the Legal and Fiduciary Requirements.” The panel featured several voices from across the political spectrum, including Republican presidential candidate Vivek Ramaswamy, Tennessee Attorney General Jonathan Skrmetti, District of Columbia Attorney General Karl A. Racine, and the Yale Senior Associate Dean Jeffrey A. Sonnenfeld.

NAAG has an excellent opportunity to help depoliticize ESG now and enable attorneys general to engage thoughtfully with each other to protect their constituents. Hosting additional bipartisan discussions on ESG, emphasizing technical and nuanced aspects of ESG investing practices, would allow proponents and opponents to address key concerns such as consumer protection issues, “greenwashing,” and fiduciary duties. For example, NAAG programming could discuss critical best practices including vetting ESG disclosures for accuracy and qualifying forward-looking aspirational statements appropriately.

Additionally, discussion of technical ESG data inputs (or KPIs) could demystify ESG investing. NAAG could consider engaging leaders in the space focused specifically on creating uniform and defensible ESG standards. For instance, the Sustainability Accounting Standards Board (SASB) created industry-based standards that allow companies to provide disclosures about the sustainability risks and opportunities that are most salient to enterprise value. SASB’s standard-setting process is subject to oversight by a standards-setting board and its metrics are developed using evidence-based research and industry input. Moreover, the framework specifically connects ESG-related topics to relevant accounting metrics, where applicable. The SASB standards are measurable and industry specific (SASB makes its standards available for download by industry). For example, data privacy related metrics are highly relevant in the internet media & services category. On the other hand, quantitative measures of greenhouse gas emissions are relevant ESG-metrics for the airline industry. Investors use the SASB Standards for a variety of purposes, including comparing possible investments and managing portfolio risk allocation. Other uses for the SASB Standards depend on the type of investor. For example, public equity investors have used the data to build ESG-focused indexes, whereas private equity firms use the SASB Standards to identify areas for enhanced due diligence. NAAG could invite SASB leadership, many of whom are also business-leaders, to engage in panels and other educational programming. A panel of SASB standards-setting board members could provide insight to how ESG metrics differ across industries. This type of presentation could also discuss best practices for ESG metrics’ measurement and proper disclosure.

Further, this type of balanced discussion of examples of ESG KPIs could reveal areas where attorneys general from both sides of the aisle can analyze how to address related company risk that is ultimately borne by shareholders and citizens. For instance, in May 2022, all fifty states and the District of Columbia achieved a large settlement with the publicly-traded company Intuit. The settlement will provide $141 million in restitution to consumers who were tricked into paying for free services by the Intuit-owned company TurboTax. The underlying misconduct informed the IRS’s May 2023 announcement that it intends to pilot a government-provided tax filing service. Intuit stock fell prior to the report, according to analysis by Kiplinger. Separately, in April 2023, eighteen attorneys general authored a letter calling for a federal recall of Hyundai and Kia vehicles lacking anti-theft safety features, leading to an uptick in vehicle thefts and public safety problems.

In fact, it could be useful to discuss how the investigations related to ESG practices themselves should be addressed in investment decisions. Litigation risk is also considered an ESG KPI, according to a report by the European Federation of Financial Analysts Societies. Litigation risk indicators include metrics such as litigation payments, fines, and lawsuits related to anti-competitive behavior. For example, the SASB recommends a metric of “total amount of monetary losses as a result of legal proceedings associated with corruption and bribery” to measure corruption and bribery risks in the medical supplies industry. SASB also recommends measurement of the amounts of monetary losses resulting from legal proceedings associated with user privacy and with anti-competitive behavior for internet media and services businesses. State attorney general initiated investigations, including the actions that some coalitions of attorneys general have brought to learn more about ESG-related investing, could themselves be considered a material ESG metric in these standards. Ignoring this class of ESG data might breach duties of care and loyalty, if such data is available to identify repeat corporate wrongdoers whose shareholders bear many of the costs of reputational damage and litigation, by way of negative impact on their investments’ market value.

By fostering informed dialogue, NAAG has an opportunity to facilitate a more nuanced and productive understanding of ESG data, whether ultimately used for asset management or impact investing. Through educational initiatives and discussions, the association can navigate the complexities of ESG, promote transparency, and empower attorneys general to make informed decisions that protect their constituents’ interests.