The United States Department of Labor (DOL) spent the summer declaring war on socially responsible investing. Under current Labor Secretary Eugene Scalia, DOL took two huge steps to crush so-called “ESG” — environmental, social, and governance investing. The first, smaller, mostly procedural step took place in June with a move that would sharply increase the paperwork and regulatory burdens on ESG investors. The second, more brazen step took place just before Labor Day, when DOL proposed a rule change designed to get pension investors to stop voting in annual corporate elections. Though these attempts pose a significant threat to ESG, particularly if the Trump administration wins a second term and has a chance to enforce them for the next four years, we think this effort will ultimately fail. The reason is that the law is often weak in the face of powerful social and economic forces. And the overwhelming force driving ESG is the economic rise of the millennials.
Millennials — raised in the shadow of the threat of climate change — came of age during the 2008 global financial crisis and are now raising their young children amid a pandemic punctuated by social upheaval. Substantial research shows that, more than the Gen Xers or Baby Boomers, they integrate their social values into their economic life as employees, customers, and now investors. Unsurprisingly, millennials care far more about environmental issues than do their parents and grandparents. Large asset managers have taken notice and have begun to act on issues of importance to this rising generation.
As Blackrock CEO Larry Fink recently observed, U.S. society is already undergoing “the largest transfer of wealth in history: $24 trillion from baby boomers to millennials.” Millennials have also now entered the workplace, comprising 50 percent of the workforce within the next two years, and 75 percent by 2030. If they are fortunate to work for an employer that offers a retirement plan, they are making their initial retirement allocations now, choices that may prove sticky for decades. The current focus on ESG reflects market competition among asset managers to manage Millennial wealth.
Now, the United States Department of Labor, which regulates the nation’s retirement plans, is attempting to thwart ESG.
The new rules, if adopted, would serve not the interests of investors but the managers of oil and gas giants chafing under ESG scrutiny from their own shareholders. The first proposed rule would categorize any investment choices that deviate from maximizing shareholder returns as, in effect, illegal for trustees overseeing the $10 trillion in retirement plans under the Department’s jurisdiction. While many ESG investors argue that ESG factors are consistent with long term value, the rule requires plans to justify including options that consider ESG with extensive documentation requirements that will be bait for plaintiffs’ attorneys.
The second, even more aggressive step would scare many pension plans off voting their shares at all. Under current law, pension plans are required to vote in annual director elections for companies they own, but DOL’s proposed new rule would shift the burden against voting, requiring pensions to first undertake a costly legal and economic analysis to justify their voting, while explicitly permitting nonvoting.
These rules are a transparent attempt to silence the voices of small investors. They amount to economic voter suppression. And they are also attempts to thwart investors from responding to the new market reality.
To an unprecedented degree, corporations face pressure to react quickly and decisively to issues that were once considered political. The environment and diversity have become particularly salient not just to electoral politics but to the market. The corporate space is increasingly being reshaped in the Millennial image, one in which investment, employment, consumer, environmental, and political decisions do not operate in distinct spheres but are ever-present in all spheres. In this context, consideration of ESG factors isn’t just about blunting the sharper edges of capitalism: Being attuned to a company’s reputational and social risks is just smart investing.
As much as $30 trillion is at stake in the fight to manage Millennial wealth, and ESG is the proven path to winning it. Investment managers and companies that fail to get on board risk significant market penalties from Millennial employees, consumers, and investors. In standing athwart this social movement, DOL is fighting, not fiduciary breaches, but market forces set in motion by deep social currents.
There is a debate to be had over the role of ESG factors in investing, but that debate shouldn’t be settled by the Department of Labor or an increasingly shaky view of what it means to maximize value. It also shouldn’t shift the default presumption towards silence and away from voting. DOL should withdraw both rules and let investors decide for themselves how to get the most out of their retirement portfolios.
Michal Barzuza is professor of law at the University of Virginia, specializing in corporate law, corporate governance and corporate finance.
Quinn Curtis is professor of law at the University of Virginia, specializing in corporate law, securities and venture capital. He is a charter board member of the Society of Investment Law.
David H. Webber is associate dean for intellectual life and professor of law at Boston University. He is author of The Rise of the Working-Class Shareholder: Labor’s Last Best Weapon (Harvard University Press 2018)