By Jeremy Kritt
Over the course of 2023, a legislative battle began to take shape in state legislatures regarding what’s known as ESG investing, with one of the key disagreements being over the use of ESG factors in investing public funds.
ESG is an acronym that stands for “environmental, social and governance.” ESG investing refers to the use of those factors to inform investment decisions, and more broadly, refers to an investment strategy that incorporates societal and environmental considerations in making investment decisions.
Pension fund managers have a duty to the beneficiaries of those funds to act in the best interests of those beneficiaries when managing the fund’s assets and making investment decisions.
Republican lawmakers do not see ESG considerations as being consistent with a fund managers’ fiduciary duties. In fact, according to the office of Florida Governor Ron DeSantis, ESG is “a worldwide effort to inject woke political ideology across the financial sector, placing politics above the fiduciary duty to make the best financial decisions for beneficiaries.”
This statement by Gov. DeSantis’ office came after the enactment of sweeping legislation aimed at restricting the consideration of ESG factors in a variety of contexts. As part of Florida’s new law, all investment decisions made by investment advisers or managers on behalf of Florida public pensions, public educational institutions, and other state retirement funds must be based only on “pecuniary factors,” which the law defines as a factor that the state official or authorized agent “prudently determines is expected to have a material effect on the risk or returns of an investment based on appropriate investment horizons consistent with applicable investment objectives and funding policy. The definition also makes clear that “pecuniary factors” “does not include the consideration of the furtherance of any social, political, or ideological interests.” The law then also requires state retirement systems and plans to biennially file a comprehensive report that includes detailing and reviewing its adherence to this fiduciary standard.
In contrast, Democratic lawmakers do not see ESG considerations as being inconsistent with a fund managers’ fiduciary duties. According to Illinois State Treasurer Michael Frerich, ESG is “simply additional information that investment professionals use to assess risk and return prospects.”
Illinois is one of the few states that has enacted legislation that promotes the consideration of ESG factors in state investment strategies.
The Illinois Sustainable Investing Act, which became effective on January 1, 2020, requires governments and government agencies managing public funds in Illinois to (1) develop, publish and implement sustainable investment policies applicable to the management of all public funds under their control, which policies should include material, relevant, and decision-useful sustainability factors to be considered by the agency as one component of its overall evaluation of investment decisions; and (2) prudently integrate sustainability factors into its investment decision-making, investment analysis, portfolio construction, due diligence, and investment ownership in order to maximize anticipated financial returns, minimize projected risk, and more effectively execute its fiduciary duty. The Act then lists various sustainability factors that may be included.
Additionally, this summer, an amendment to the Illinois Sustainable Investing Act was passed that will also require investment managers to disclose, prior to their selection as a fiduciary of public funds, including pension funds, how they integrate sustainability factors into their investment decisions in order to maximize anticipated risk-adjusted financial returns, identify projected risk, and execute the manager's fiduciary duties
While these two laws have distinctly different provisions, the tangible impact that they will have on investment decisions remains to be seen.
Ultimately, both laws require that investment managers make prudent decisions based on factors designed to maximize financial returns and minimize risk. The Florida law provides a broad definition of what factors are not relevant in doing so – namely, the furtherance of any social, political, or ideological interests. However, the Illinois law does not allow fiduciaries to further social, political or ideological interests in their investment decisions. Instead, it focuses on creating a transparent process for incorporating ESG-related factors into decisions that maximize financial returns while minimizing risk.
Marc Lane’s book, Profitable Socially Responsible Investing? (published by Institutional Investor), was written to de-mystify socially responsible investing. His research established that when investors actively select “virtuous” companies, they can successfully align their investment decisions with their values without jeopardizing their financial returns.
If you would like to explore how Marc J. Lane & Company, our investment affiliate, can help you manage your investments in a way that reflects your principles, please reach out to Marc in confidence at mlane@marcjlane.com or 312/800-372-1040.
Jeremy Kritt is an Associate Attorney with The Law Offices of Marc J. Lane, P. C.