Last Friday, a federal judge in Texas ruled that American Airlines violated federal law by allowing funds in its 401(k) plan from investment companies (mainly Blackrock), by “investing—or relying on others to invest—their employees’ retirement assets towards environmental, social, and governance (“ESG”) objectives.”
I will let someone else more well-versed on the law opine on the merits of the suit itself. Instead I want to highlight some of the judge’s commentary, which shows how fundamentally misunderstood ESG is (emphasis my own):
Because ESG investing plays a prominent role in this case, it is important to be clear about what ESG investing actually is. The evidence and expert testimony revealed that an investment strategy assumes an ESG label when it is aimed at, in whole or in part, bringing about certain types of societal change. Generally, three criteria inform ESG investing.
First, environmental factors examine a company’s carbon footprint, and whether any toxic chemicals are involved in its manufacturing processes and sustainability efforts that make up the supply chain.
Second, social factors capture how a company addresses LGBTQ+ interests, promotes racial and gender diversity, equity, and inclusion (“DEI”) programs and hiring practices, and engages in other forms of social advocacy.
Third, governance factors capture issues surrounding executive pay, diversity in senior leadership, and how well leadership responds to and interacts with shareholders’ socio-political concerns.
Investing that aims to reduce material risks or increase return for the exclusive purpose of obtaining a financial benefit is not ESG investing. Consideration of material risk-and-return factors is no different than the standard investing process when both are focused on financial ends.
As Bloomberg’s Matt Levine says, “I think that virtually 100% of ESG investors would disagree with this: ESG investing is, in the standard formulation, consideration of ESG factors because you think that they are material to long-term risk-adjusted financial returns.”
The judge seems to think ESG investing is okay as long as you don’t call it that and you really believe you the information considered is financially material:
Consider a company that does not meet certain diversity metrics because its executive leadership has too few female or diverse members.
When selecting its executives, the company selected the most qualified individuals from the applicant pool without considering ascriptive characteristics like race or gender. This lack of diversity in leadership positions notwithstanding, the company performs well and even generates record-level returns for its shareholders. In response, an investment manager decides to divest shares in the company despite the financial benefits of continuing to invest.
If the reason for divesting is due to the lack of diversity, this is a social and/or governance factor that is not grounded in an assessment of the best financial interest, making this strategy a form of ESG investing. But if the reason is because the investment manager reasonably believes the company’s lack of diversity materially risks financial harm to shareholders based on sound analysis, this is not ESG investing given the sole focus on this ESG factor’s economic relevance.
Our vision for PeopleReturn has always been to empower stakeholders with objective, timely, decision-useful data and insights to help them evaluate companies’ human capital and diversity efforts—to identify opportunities and mitigate risks.
Many of our clients are investors who engage with corporations to push them to improve in areas like disclosure, policies, governance structure, etc. or integrate human capital data into their investment process—not because they want to effect societal change, but because they believe it’s in the best interests of the company and its shareholders.
Last year, we heard from a lot of stakeholders that they were having a hard time evaluating risks—whether reputational, regulatory, operational or financial—related to how public companies manage their workforce.
Consider some recent events:
- Earlier this week, Mastercard agreed to pay $26 million to settle a class action lawsuit accusing it of underpaying female, Black and Hispanic employees compared with their male and white counterparts.
- Disney settled 2 suits related to pay inequity last year, both originally filed in 2019— one for $43 million related to gender pay equity and another for $233 million for wage theft
- Dollar General was fined $12 million for a history of health and safety violations
- 104 people got sick, 34 were hospitalized, and 1 person died from an e. coli outbreak caused by contaminated sliced onions on McDonald’s quarter pounders
We have been developing a new product we are calling ‘Risk Monitor,’ enabling stakeholders to get a much more timely, comprehensive view of human capital risks. Here are some highlights of what we are building:
- Litigation tracking, covering open and settled lawsuits (state, federal and private) on issues like discrimination, pay, and sexual harassment
- Health and safety, inspection and violation benchmarking, providing the first of its kind company-level KPIs of injury, illness and fatality data from regulatory agencies including OSHA, FRA, and MSHA
- Recall and adverse event tracking from the FDA and CDC
We will be highlighting some interesting findings over the next few months, but here is a quick one – a look at Dollar General’s health and safety improvement since the settlement with OSHA 6 months ago:
What we’re reading:
- Human capital is growing focus for investors, ISSB staff say (Investments & Pensions)
- Rollback, hushing or reform: Investors on US corporates and DE&I pushback (Responsible Investor)
- US Companies Face Pressure Around Global ESG Disclosure Mandates (Bloomberg Law)
- Deere & Co’s DEI showdown (Reuters) and Walmart is facing backlash from investors after cutting DEI programs (Fast Company)
- The financial materiality of human capital: How employee knowledge, skills and engagement can drive long-term growth and efficiencies (JPMorgan Asset Management)
- Thriving workplaces: How employers can improve productivity and change lives (McKinsey Health Institute)
- The Progress of Board Diversity: Slow Advancement Amid Waves of Change (Egon Zehnder)
- Three DEI Legal Issues Employers Should Keep Tabs on in 2025 (Bloomberg Law)