The Muddled Attack on ESG

Ever on the lookout for threats to the American way of life, the Right has begun pointing its finger at a surprising set of adversaries: BlackRock, Vanguard Group, State Street Corporation and other leading asset managers.

According to a chorus that includes former Vice President Mike Pence and Florida Governor Ron DeSantis, the three firms are part of a “woke Left” that is seeking to impose a radical environmental, social and governance agenda on big business. The allegations are part of an effort to make ESG into a bogeyman for investors similar to the way critical race theory, or CRT, has been used to scare parents of school-age children.

To some extent, the attack on ESG is simply another way to attack Democrats. One of its proponents, Vivek Ramaswamy, published an op-ed in the Wall Street Journal, the favorite soapbox of the movement, headlined “Biden’s ESG Tax on Your Retirement Fund.” The target of the piece was a proposal by the Labor Department to allow pension funds to consider climate-change-related financial risks in making investment decisions.

Ramaswamy has a vested interest in the anti-ESG effort. He wrote a book titled Woke Inc. that is regarded as the bible of the campaign, and he created an investment management firm called Strive to cash in on the backlash to ethical investing. Strive has a fund called DRLL that enthusiastically invests in fossil fuel companies and urges firms of all kinds to resist ESG pressures.

The problem for the rightwingers is that their issue is far from new. There has been a debate going on for decades over the proper role of large corporations when it comes to environmental and social issues. Ramaswamy and his ilk are parroting the arguments made half a century ago by economist Milton Friedman, one of the leading proponents of free market fundamentalism. His 1970 article entitled “The Social Responsibility of Business is to Increase its Profits” is the most famous expression of the idea that corporations should concern themselves with nothing other than making money for their shareholders.

That notion has remained popular in some circles, but most of big business has come to realize that it is simply not practical. Some companies such as Patagonia have made environmental and social engagement part of their brand. Some such as Exxon Mobil resisted change for many years but eventually began to make concessions. And some such as Koch Industries are engaged, but with a rightwing slant.

Modern-day ESG is largely a response by large companies to various external pressures, especially those coming from environmental groups and other corporate accountability activists. These days they also need to deal with the fact that many consumers are unwilling to do business with firms seen as contributing to the destruction of the planet.

Far from being radical, ESG often serves as a form of greenwashing, allowing companies to give the impression they are taking bold steps when their actions are actually quite limited. Much of the purported progress toward ESG goals is based on company self-reporting with limited verification.

The anti-ESG crowd is particularly upset at the role asset managers are playing in encouraging companies to set goals for net-zero greenhouse gas emissions. Yet many companies are planning to meet those goals through the purchase of dubious carbon offsets rather than major changes in their own operations.

When ESG initiatives lead to real changes in corporate practices, that is usually a reflection of changes in market dynamics. Companies such as General Motors are not putting more emphasis on electric vehicles as part of some secret leftist agenda, but rather because that is what its customers are demanding.

Oddly, the rightwing critics seem to pay little attention to the fact that several major ESG investment managers, including Goldman Sachs, are reported to be under investigation by the SEC, which is also seeking to adopt tighter rules on which firms can use the ESG label. Inquiries into whether ESG investment advisers engage in deceptive practices are also underway in Germany, where the offices of Deutsche Bank’s ESG arm were raided by investigators earlier this year.

Instead, the Right’s anti-ESG crusaders are promoting the moves by red-state attorneys general to do their own investigations, focusing on the influence of giants such as BlackRock. Those investigations, however, start out with exaggerated assumptions about the power of ESG, while the SEC seems to be concerned that those impacts are actually less significant than the advisors are leading investors to believe.

In an editorial celebrating the anti-ESG backlash, the Wall Street Journal warned that the changes being promoted by BlackRock could lead to new regulations. This betrays a fundamental misunderstanding of ESG. One of its primary aims is to use voluntary corporate initiatives to make the case that government mandates are unnecessary.

Although they go about it in very different ways, ESG proponents and rightwing critics are both seeking to limit the role of government in overseeing corporate behavior. That is where both groups fall short.

Whether large corporations are claiming to save the world or are simply maximizing profits, they cannot be left to their own devices. The same goes for the big investment managers.

Take the example of State Street Corporation, one of the big firms the Right is trying to make into a major ESG villain. Last year, State Street paid a $115 million criminal penalty to resolve federal charges that it engaged in a scheme to defraud a number of the bank’s clients by secretly overcharging for expenses related to the bank’s custody of client assets.

The problem with State Street and many other large companies is not that they are too focused on promoting virtue but rather that they may be lacking in virtue themselves.

Note: My colleagues and I are seeking a research analyst to work on Violation Tracker. Details are here.

ESG Besieged

Things have been rough lately for those high-minded asset management services promoting ESG investment practices. The Right is dragging ethical investment into its culture war, accusing the ESG world of promoting “woke capitalism.” In a recent op-ed in the Wall Street Journal, former Vice President Mike Pence went so far as to state that “the next Republican president and GOP Congress should work to end the use of ESG principles nationwide.”

Unfortunately, the ESG world has left itself vulnerable to such attacks. Its criteria for deciding which corporations deserve a seal of approval are often less than rigorous and may be based on unverified data produced by the companies themselves.

The problems of ESG have reached the point that the Securities and Exchange Commission recently proposed rules that would impose stricter disclosure standards on ethical investment funds and require them to meet somewhat stricter criteria in order to use ESG or related terms in the name of the fund.

Yet perhaps the biggest embarrassment for the ESG world just occurred in Germany, where dozens of agents from the Frankfurt public prosecutor’s office and the financial regulatory agency BaFin raided the offices of Deutsche Bank and its asset management subsidiary DWS. In the wake of that action, the chief executive of DWS resigned.

The investigators were reported to be seeking evidence that DWS defrauded clients by exaggerating the extent to which its green investment products were actually based on sustainable practices. In other words, the Deutsche Bank subsidiary appears to be under criminal investigation for engaging in greenwashing. The case is said to be related to a probe that the SEC has reportedly been conducting of the matter—though without any dramatic raids.

Without pre-judging the outcome of the investigation, I find it difficult to believe that DWS is innocent. After all, it is part of a corporation with a long history of engaging in misconduct. As shown in Violation Tracker, it has racked up more than $18 billion in fines and settlements for cases involving the sale of toxic securities, manipulation of interest rate benchmarks, promotion of fraudulent tax shelters, violations of anti-money-laundering laws, foreign bribery, and more. This is all on top of Deutsche Bank’s questionable business dealings with Donald Trump and Jeffrey Epstein.

I’ve always found it odd that a bank with a reputation such as this could put itself forth as a practitioner of ethical investing. Yet that is a big part of the problem with ESG. Rap sheets such as that of Deutsche Bank are often ignored, and companies are deemed worthy based on some specific practice that is far from representative of its overall behavior.

The Deutsche Bank case is not the only example of an ESG investment adviser being held to account. Recently, the SEC charged BNY Mellon Investment Adviser for misstatements and omissions concerning the ESG criteria used in some of its mutual funds. The company agreed to pay $1.5 million to resolve the matter.

Cases such as these signal that the ethical investing world is going to have to get a lot more ethical—and rigorous—if it is going to survive.

The Dubious Rehabilitation of the Arms Industry

War always creates business opportunities, and the brutal Russian invasion of Ukraine is no different. Some of those opportunities are direct: producers of military hardware stand to benefit from increased orders from the Pentagon to replenish stockpiles of weapons being shipped to help the Kyiv government survive. Some are indirect: petroleum companies are profiting from the rise in world oil prices brought on by the war.

We are now seeing another kind of boon: corporations previously regarded as pariahs are now being viewed by some in a new light. Chief among these are the weapons producers. In addition to the new orders, these corporations are enjoying the fact that some investment advisors and analysts who previously shunned their shares are now arguing for their rehabilitation.

After the war began, two analysts at Citigroup led the way with the claim that “defending the values of liberal democracies and creating a deterrent” meant that weapons makers should be included in funds with the ESG—environmental, social and governance—label. Sweden’s Skandinaviska Enskilda Banken is allowing some of its funds to buy shares of military companies, reversing a position it adopted just a year ago.

Many ESG advocates are pushing back on this effort, but the fact that it is happening is an indication of the inconsistency in the motivations for ethical investing. Some ESG investors simply want to dissociate themselves from companies they find objectionable. Others hope that companies denied ESG approval will feel pressured to change their practices. A third category believe that firms such as fossil fuel producers are susceptible to legal risks that will undermine the value of their shares. And yet others may hope that disinvesting in odious companies will ultimately put them out of business.

These different categories are further complicated by the distinction between companies that are shunned because of their own practices and those which are part of an industry that is problematic.

One thing made clear by the war in Ukraine is that big military contractors are not headed for oblivion, as some hoped after the end of the Cold War. That applies not only to producers of conventional weapons that are now in great demand. Russia’s claims that it just tested a new intercontinental ballistic missile could spark a new nuclear arms race.

All this is not to say that we should be pinning a halo on the likes of Northrop Grumman and Raytheon Technologies. Even if some of their products are currently needed for the legitimate cause of helping Ukraine, much of what that do is still inherently objectionable. A long-term, large-scale build-up of weapons spending is not what we need.

Moreover, the major military contractors have long rap sheets involving repeated violations of the False Claims Act in their dealings with the Pentagon as well as bribery, export control transgressions and other offenses. None of them are model corporate citizens.

The sad truth is that the decisions of ethical investors will make little difference in the future of the military contractors. With or without an ESG seal of approval, they are riding high and will continue to prosper as international conflicts intensify. We can only hope that the world calms down, and we can go back to treating weapons producers with the same disdain we direct toward coal and tobacco companies.