ESG, DEI, and What to Do About Them

Special Report Progressivism

ESG, DEI, and What to Do About Them

December 31, 2024 Over an hour read Download Report
David R. Burton
Senior Fellow in Economic Policy, Thomas A. Roe Institute
David focuses on securities law, tax matters, financial privacy, regulatory and administrative law issues and entrepreneurship.

Summary

ESG and DEI have become ubiquitous in government, corporations, and universities. ESG and DEI harm U.S. workers, consumers, and investors and are immoral. Federal and state policymakers need to protect the public from these pernicious progressive efforts. Reforms to a wide range of complex laws and regulations are required to adequately address the problem. Policymakers should particularly focus on ensuring that fiduciaries meet their fiduciary duties. Furthermore, if firms enjoy oligopolistic market power, their refusal to engage in commerce is highly disruptive to ordinary personal, commercial, or civic life, and there is little practical alternative for the targeted persons, firms, or organizations, then Congress should consider legislation to ensure these firms do not discriminate against customers.

Key Takeaways

ESG and DEI harm U.S. workers, consumers, and investors and are immoral.

Reforms to a wide range of complex laws and regulations are required to adequately address the problem.

Policymakers should ensure that fiduciaries discharge their fiduciary duty and that firms with oligopolistic market power do not discriminate against customers.

ESG stands for environmental, social, and corporate governance factors, criteria, goals, or objectives. This Special Report describes ESG and its ideological cousin Diversity, Equity, and Inclusion (DEI) and why they are a problem.REF Its primary focus, however, is how to appropriately address the ESG and DEI problems at both the federal and state level. There is no one policy solution that will address the problem because ESG and DEI are now ubiquitous throughout all levels of government (in administration, regulation, and procurement), in corporate America, and in universities.

Addressing ESG and DEI requires a multipronged approach. This Special Report makes 40 specific recommendations for reform or action by the 119th Congress and the new Administration at the federal level and 13 specific recommendations for reform or action at the state level. These recommendations are summarized at the end of the Special Report. Implementing these recommendations would be an important starting point, but there are undoubtedly many other steps that will need to be taken to finally end these destructive policies.

Introduction

In a free society, investors and business owners have the right to make their own decisions about how to invest or operate their business. They can invest their money or operate their business to maximize their return on investment or to minimize their risk, but they may also invest or make business decisions for charitable, social, ideological, or political objectives that result in lower financial returns.REF There are two main limits to this principle. The first relates to fiduciaries, broadly defined, who invest or steward others’ funds. The second imposes non-discrimination requirements on private firms with unusual economic power.

Fiduciaries have a legal obligation to act in the best interest of another person (usually called a principal or beneficiary). Examples of fiduciaries in an investment context would include most investment fund or endowment fund managers or advisers, pension fund managers, endowment fund trustees and directors, and officers of publicly traded companies or private firms with a large number of shareholders where there is a separation of ownership and control.REF

The two most important duties that fiduciaries have are the duty of loyalty and the duty of care.REF

  1. The duty of loyalty means that the fiduciary must place the interest of the principal or beneficiary ahead of their own and act exclusively in the interest of the principal or beneficiary.
  2. The duty of care means that the fiduciary must exercise the care, skill, prudence and diligence of a prudent person familiar with the matter that the fiduciary has undertaken.REF

Fiduciaries do not have a right to pursue the fiduciaries’ preferred charitable, social, ideological, or political objectives with other people’s money without their consent. In other words, fiduciaries cannot, without the consent of investors or beneficiaries, decide to reduce the return on an investment or increase investment risk in furtherance of non-financial objectives chosen by the fiduciary. Blatant violation of fiduciary duties has now become commonplace in the name of ESG or ESG’s ideological cousin DEI.

The second general limitation on the freedom of private businesses to conduct their business affairs with non-financial or non-economic considerations in mind involves common carriers,REF public utilities,REF monopolies, and companies deemed public accommodations.REF These limitations, long recognized in Anglo-American law, effectively impose broad non-discrimination requirements on these private companies with respect to customers. A phone company or electric utility, for example, cannot refuse to provide service to people because it dislikes their politics or the color of their skin. Although skepticism by policymakers about broadening these non-discrimination requirements is warranted, the scope and limits of these non-discrimination requirements should carefully evolve as markets and society develop.

A non-discrimination or non-exclusion requirement with respect to customers is appropriate in the case of firms that meet three tests.

  1. The firm enjoys monopolistic or oligopolistic market power.
  2. The firm’s refusal to engage in commerce is highly disruptive to ordinary personal, commercial, or civic life.
  3. There is little practical alternative for the excluded person, firm, or organization.

In modern society, this may well be the case with respect to certain large tech companies,REF large health insurers or property and casualty insurers in some markets,REF hospital systems in some markets,REF and some large financial services companies (dominant registered investment advisers, dominant proxy advisory firms, and dominant credit card or payment processing companies).REF Limitations on the ability of such firms to discriminate against private parties for political, social, or ideological purposes unrelated to an ordinary business purpose would be analogous to, but not identical to, the long-standing limits placed on common carriers, public utilities, monopolies, and companies deemed public accommodations.

What Is ESG?

ESG stands for environmental, social, and corporate governance (ESG) criteria, standards or factors. Although the term “ESG” has come into prominence over the past dozen years,REF it is substantially similar to other progressive concepts used in a business or investing context, such as socially responsible investing, stakeholder capitalism, social justice, corporate social responsibility, sustainability, diversity, equity and inclusion (DEI),REF fair trade, progressive “business ethics,” and other terms.REF ESG, as a term, may have hit its peak.REF Undoubtedly, some other term will come to represent the core idea of substituting progressive politics for the traditional purpose of business.

All of these terms have two characteristics. First, they are designed to remake the purpose of business. Second, they are never clearly defined and are like chameleons, changing to fit the latest left-wing cause du jour or the prejudices of a particular author or organization.REF This fundamental amorphousness and lack of rigor has been empirically demonstrated by many studies that show very large differencesREF among the ESG ratings or ESG scores of particular firms by different ESG rating organizations.REF What is different about ESG is the aggressiveness with which the federal government and woke investment advisers, proxy advisors, and corporate managers are pursuing ESG objectives at the expense of taxpayers, investors, retirees, beneficiaries, customers, and others.

Fiduciaries

Widespread violations of fiduciary duties are now commonplace. This is sometimes accomplished by simply ignoring fiduciary duties—usually without consequences. Often, however, it is done more surreptitiously by using ESG factors as a “tie-breaker” after purposefully creating ties or by asserting that ESG factors increase returns or reduce risks. The Biden Administration actively encouraged this behavior despite majority opposition in both the House and Senate.REF This evasion is aggressively supported by the multi-billion-dollar “climate-industrial complex”REF and the DEI industryREF which employ vast numbers of people at corporations; universities;REF tax-exempt organizations; and law, lobbying, accounting, and consulting firmsREF that profit from climate change requirements and from DEI or “human capital management” racial preference requirements.REF These requirements will have a disproportionately adverse impact on small businesses and are a regulatory barrier to entry and competition. They will lead to further concentration in key industries since regulatory costs do not increase linearly with size.

Institutional DEI

DEI policies are often overtly racist and sexist in that they mandate that government or firms establish quotas or otherwise discriminate based on sex, skin color, ethnicity, or sexual orientation rather than making determinations based on individual achievement, talent, experience, or competence. DEI defines diversity entirely in terms of these immutable characteristicsREF and assigns them to a hierarchy of privilege and deprivation, oppressor and oppressed. This scheme is hostile to the myriad of other kinds of diversity such as achievement, expertise, experience, approach to business or business philosophy, educational background, socio-economic background, ethical views, political views, integrity, geographic location, and so on.

Morally, DEI represents a marked step backwards. It is rejection of the principle that people should be judged on the content of their character and their individual achievement rather than their sex, race, national origin, ethnicity, or sexual orientation. It judges people as members of a racial or sexual group rather than as individuals. It is a rejection of the principle of equal protection under the law (or, often, regulations promulgated with questionable basis in law). It is a rejection of the principle that all are created equal. Discrimination or quotas on the basis of race, ethnicity, or sex should be a relic of the past—and most Americans agree.REF

Asset Managers and Proxy Advisory Firms. Extreme concentration in the financial sector is one of the reasons that ESG has become particularly problematic now.REF Just six firms—the investment management firms BlackRock,REF The Vanguard Group,REF Fidelity Investments,REF and State Street,REF and the proxy advisory firms Institutional Shareholder Services (ISS)REF and Glass LewisREF (both foreign-owned)—effectively control most public corporations in the United States.REF

Globally, the four largest asset managers controlled about 21 percent of total assets under management as of 2021.REF The top 20 firms control approximately 45 percent of total assets under management globally.REF Proxy advisory firms provide recommendations to pension, investment, and endowment fund managers regarding how to vote the shares owned by the funds. Their recommendations are usually followed. ISSREF and Glass Lewis control an estimated 97 percent of the proxy advisory business.REF Although estimates vary due to methodological differences or the type of votes analyzed, ISS and Glass Lewis together can move 10 percent to 38 percent of shares voted.REF

As these six firms become increasingly “woke,” seeking to use their voting power to impose ESG and DEI principlesREF on most public companies at the expense of investor returns, corporations are becoming an effective means of imprinting progressive values on everyday life throughout the United States. Until recently, the large investment managers were forthright that they are doing this.REF Now, having received widespread criticism and legislative pushback at the state level, they are a bit more circumspect.REF Nevertheless, they are still aggressively promoting ESG and DEI, although this promotion is now being relabeled from ESG to “responsible business”REF or “sustainability” in some corporations.REF Rebranding the idea makes it no less pernicious.

Banking. A similar concentration is occurring in banking. As of 2022, the top five banks controlled 51 percent of U.S. deposits and the top 10 banks controlled 66 percent of U.S. deposits.REF As these banks and their regulators become more aggressively progressive in their political orientation, problems with “debanking” for political reasons and the allocation of credit to achieve political aims will presumably become more common.REF For now, however, the significant number of banking alternatives makes this a lesser problem than the effective control of most public companies by just six firms.REF

Congress needs to prevent the evasion of fiduciary duties imposed on registered investment advisersREF (fund managers) and their associated investment companies;REF proxy advisory firms (retained by fund managers, retirement plan managers or trustees and broker-dealers); retirement plan sponsors and managers (regulated pursuant to the Employee Retirement Income Security Act of 1974 (ERISA)); and others. It also needs to prevent the evasion of fiduciary or other heightened dutiesREF to investors by corporate directors and managementREF or broker-dealersREF to the extent that federal law governs those duties. The next conservative administration needs to launch enforcement actions against registered investment advisers, proxy advisory firms, and ERISA fiduciaries that are violating their fiduciary duties. Congress also needs to prevent banking regulators and so-called self-regulatory organizations (SROs)REF from allocating credit, financial services, and investment opportunities on the basis of ESG factors. Finally, it needs to keep ESG out of the federal procurement process.

State legislatures, attorneys general, treasurers, and other financial officers have an important role as well. State law governing state-sponsored pension plans, state contracting and procurement, the provision of financial services, and trusts and endowments can play an important role in protecting retirees, consumers, and taxpayers from the detrimental effects of ESG. State corporate, securities, banking, pension, and trust laws should be reformed to strengthen the protection of investors, depositors, and beneficiaries.REF State attorneys general or treasurers can launch enforcement actions against investment advisers, retirement plan fiduciaries, and others with a fiduciary duty who violate this duty—and should investigate the proxy advisory firm duopoly.

Common Carriers, Public Utilities, Monopolies, and Other Large Firms

It is well-established that common carriers, public utilities, monopolies, and companies deemed public accommodations cannot generally decline to do business with customers because they do not like their race or ethnicity, their environmental views, their politics, and so on—or even for more benign reasons. The central question facing policymakers at the federal and state level is the degree to which these types of requirements should be broadened to encompass other firms that enjoy oligopolistic market power.

Candidates for such regulation would include:

  • Certain large tech companies that own or control dominant operating systems, dominant search engines, dominant social media platforms, and cell phone manufacturing and software, among others;
  • Large health insurers, property and casualty insurers, and hospital systems in certain markets; and
  • Some large financial services companies (notably dominant registered investment advisers, dominant proxy advisory firms, and dominant credit card and payment processing companies).

Such limitations on the ability of firms to discriminate against private parties for political, social, or ideological purposes unrelated to an ordinary business purpose would be analogous to, but not identical to, the long-standing limits placed on common carriers, public utilities, monopolies, and companies deemed public accommodations. Such limitations, to the extent they are imposed, should simply require that firms must do business with customers on the same basis as other customers notwithstanding, for example, their lawful environmental practices (using fossil fuels, for example); the industry they are in (fossil fuel production, timber, agriculture, mining, firearms production, or distribution); their environmental views; their political views; or their race, religion, ethnicity, national origin, or sex. Specific proposals are discussed below.

Why ESG Matters

Traditionally, the purpose of a business has been to earn a return for its owners by cost-effectively combining the capital and entrepreneurial spirit of its owners with the labor and talent of its employees in a competitive environment to satisfy the wants and needs of its customers. Any well-run business must show due regard for its employees (otherwise their morale and productivity will decline, or they will leave to work elsewhere); its customers (otherwise revenues will collapse); its suppliers (otherwise the business will be unable to operate); and its community (otherwise its public reputation and its relationship with local officials will suffer).

Nevertheless, the primary reason that most companies are formed and that investors put their capital at risk (either to launch a company or by purchasing company securities on secondary markets like a stock exchange) is to earn a return. The relationship between entrepreneur–founders, investors, management, workers, suppliers, and customers have been—subject to certain broad constraints imposed by law—privately decided and voluntary.

Particularly in smaller enterprises in which ownership and control are not separated, or substantially overlap, the owners (as discussed above) have the right to operate their business to achieve objectives other than a return. But in cases in which ownership and control are separated, in the absence of an affirmative vote to the contrary, the business should be managed primarily to achieve a return for its owners by satisfying the wants and needs of its customers.REF

ESG is an effort by government, investment advisers, proxy advisors, pension fiduciaries, and the management of large corporationsREF to redefine the purpose of business and investment as being to pursue environmental, “diversity,” and other political or social justice objectives rather than earning a return by satisfying customers while treating employees or suppliers fairly. Investors may, of course, choose to invest their own money in funds or companies that have a social purpose beyond earning a return. That is why benefit corporations and benefit limited liability companies exist.REF It is, however, illegitimate for government, corporate management, or advisers with a fiduciary duty to investors to reduce those investors’ return in order to achieve the preferred political or social objectives of politicians, management, or advisers without the investors’ permission. This is particularly true with respect to the beneficiaries of pension or other retirement plans.REF

Governments at the federal, state, and local levels are increasingly allowing or requiring progressive actors in capital markets to make decisions for political, ideological, or social reasons rather than for business or economic reasons, and permitting systematic violations by those actors’ of their fiduciary duties.REFPoliticians, regulators, and other advocates routinely argue that politicizing business decisions in the name of ESG is in the interest of shareholders, investors, retirees, workers, and customers. This is false and rapidly becoming obvious despite the massive regulatory and financial support from the federal government. The data shows it.REF

Moreover, if it were true, then there would be no need for ESG initiatives since the ordinary legal rules and the profit motive would do the job. In fact, as ESG becomes more commonplace and induces firms to make uneconomic decisions and misallocate scarce capital,REF it will raise prices, reduce the quality of goods and services, cost jobs, reduce wages,REF harm entrepreneurs seeking to raise capital, reduce investment returns,REF and make American business less efficient, less dynamic, and less competitive internationally. The pursuit of progressive ESG objectives will further politicize business and the daily life of most Americans. ESG will force more and more Americans to comply with progressive dictates.

Solutions to the ESG and Related DEI Problem

This section addresses specific steps that federal and state legislators and officials can take to address ESG and the related DEI problem.

Prohibit Fiduciaries and Broker-Dealers from Acting Contrary to Investors’ Financial Interest Unless They Secure Explicit Consent to Do So. As discussed above, investors have the legal and ethical right to invest their own funds for reasons other than a return. Fiduciaries, however, do not have the right to invest other people’s money to achieve the fiduciary’s social, political, or ideological objectives by lowering financial returns received by, or increasing financial risks borne by, those to whom they owe a fiduciary duty.

Congress should require that any ERISA fiduciary, registered investment adviser, or broker-dealerREF be required to secure individualized written consent from an investor or plan beneficiary before they invest or vote securities for any reason other than maximizing risk-adjusted financial return. Congress should amend the law so that investing for such reasons (without obtaining investor or plan beneficiary consent) is an explicit violation of § 10(b) of the Securities Exchange Act; § 206(4) of the Investment Advisers Act;REF § 17(j) of the Investment Company Act (which prohibits fraudulent, manipulative, or deceptive practices); ERISA fiduciary duties;REF § 36 of the Investment Company Act governing the fiduciary duties of Registered Investment Companies.REF A conservative administration should actually enforce existing fiduciary duty requirements rather than encouraging fiduciaries to evade their fiduciary duties.

State legislatures should require fiduciaries that are not regulated by the federal government to do the same and have similar robust penalties on the firms and individuals who ignore this requirement. Examples would include those that are trustees for state pension plans or investment advisers for those plans,REF trustees of state university endowments, or other government funds.REF Consistent with the principle that private persons should be free to invest their own funds for purposes other than maximizing risk-adjusted returns, if an endowment or other fund accepts a gift, then expressed donor intent to do so should generally be respected (even at, for example, public universities) or the gift returned. No private institution should generally be required to invest in enterprises inconsistent with their purpose or values. State executive branch officials should consider a more aggressive enforcement posture ensuring that fiduciaries may not blithely ignore their fiduciary duties to further their own political, social, or ideological aims.

In addition, state corporate laws merit careful review and possible revision.

  • First, the state corporate business judgment rule (usually judicially created), should be clarified, if required, to ensure that director duties to the corporation and shareholders exclude the pursuit of political, social, and ideological aims unrelated or detrimental to the financial performance of the firm.
  • Second, the rules governing shareholder derivative lawsuits may need to be modified to ensure that when directors violate their fiduciary duties to the corporation and its shareholders that there are actual consequences.
  • Third, the rules governing director or officer indemnification for purposeful or negligent violation of director or officer duties to the corporation may need to be narrowed so that director or officer liability for violating fiduciary duty is more likely.

There is an active competition for corporate charters. Managements tend to prefer jurisdictions that, via the business judgment rule, effectively enshrine board primacy rather than shareholder primacy. Jurisdictions that clearly require boards and management to act in shareholders’ interest may be able to start effectively competing for corporate charters from outside their state. A full discussion of these corporate governance issues is beyond the scope of this Special Report.

Define Materiality for Purposes of Securities Law. The concept of materiality has been described as “the cornerstone” of the disclosure system established by federal securities laws.REF The Supreme Court has held that information or facts (or omitted information or facts) are material if there is a substantial likelihood that a reasonable investor would consider the information important in deciding how to vote or make an investment decision.REF The Court has also indicated that information is material if there is a substantial likelihood that disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information available.REF

There is no definition of material or materiality in the Securities Act or the Securities Exchange Act, although the term “material” is used in both many times. The Securities and Exchange Commission (SEC) has defined the term “material” in its regulations and changed its definition over years, often to conform to Supreme Court holdings. The current definition found in 17 Code of Federal Regulations § 240.12b–2 is:

Material. The term “material,” when used to qualify a requirement for the furnishing of information as to any subject, limits the information required to those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to buy or sell the securities registered.

These definitions are fine as far as they go but they are quite general and provide little practical guidance to issuers. There is a spirited debate about whether “principles-based” or more “prescriptive” bright-line rules should govern disclosure by issuers of material information. The Securities and Exchange Commission’s rules presently balance these two approaches.

There is also a major effort to effectively redefine what is material to include information that is really directed at achieving various social or political objectives. In other words, the information would be deemed material if a woke fund investment adviser or proxy advisory firm deems it “important” or would like to see the information—whether or not the information has any bearing on the financial results of the issuer.REF The European Union (EU) has already gone down this path, calling it “double materiality.”REF

Instead, the focus of the materiality standard in the United States should remain on what actual investors need to know to meet their financial, economic, or pecuniary objectives—not the preferred political or social objectives of investment advisers, corporate managers, or regulators. The vast majority of underlying beneficial owners in investment funds and the vast majority of direct shareholders care about the returns earned in their retirement and other accounts, not whether their advisers’ or corporate management’s political objectives are being met. While investors are free to invest in funds or corporations that explicitly sacrifice returns to achieve political objectives, few do so.REF

Congress should statutorily define materiality in terms generally consonant with Supreme Court holdings on the issue, making it clear that the term “material” refers to financial returns and financial risks. It should also specifically exclude social and political objectives unrelated to investors’ financial, economic, or pecuniary objectives.REF Investors would remain free to invest in funds or corporations that explicitly state that they are seeking to achieve political or social objectives by sacrificing return. But the funds, investment advisers, and issuers would no longer be able to misrepresent what they are doing.

Prohibit Retirement Account Fiduciaries from Acting to the Detriment of Beneficiaries. With proper enforcement by the Department of Labor (DOL), the current ERISA statute would be adequate. It does, after all, provide that ERISA fiduciaries operate the plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of providing benefits to participants and their beneficiaries or defraying the reasonable expenses of administering the plan.REF

However, the DOL under both the Biden and Obama Administrations has permitted ERISA fiduciaries to purposefully create “ties” among investment alternatives and to resolve those ties using ESG criteria.REF Ties are exceedingly rare in actual practice unless the fiduciary purposefully adopts a methodology that creates a large number of ties so that the fiduciary can then break the ties using criteria designed to further the fiduciary’s social, political, or ideological purposes. For example, a fiduciary could divide all of the public operating company investment alternatives into five categories. Since there are about 5,000 possibilities,REF there would be about 1,000 in the “best” category—1,000 “ties” which could then be broken using ESG factors.REF

Congress should amend § 404 of ERISA explicitly prohibiting ERISA fiduciaries from considering any non-pecuniary, non-economic, or non-financial social, political, or ideological goals or objectives when choosing investments, voting proxies, or exercising other rights appurtenant to investments held by the plan unless the plan beneficiary has explicitly, in writing, consented to the use of these factors.

Congress should also require that any tie among investment alternatives be broken using a random methodology. Because actual ties among competing investment alternatives are exceedingly rare, this provision will rarely be used, but it is preferable to enabling woke fiduciaries to purposefully create ties to evade the existing underlying requirements imposed by ERISA. Since it would only apply to actual ties where the projected return is the same, such a provision would have no material effect on returns.REF

States should enact legislation to ensure that state retirement funds are invested solely to achieve a return for state employees who are pension-plan beneficiaries rather than to achieve the political or social objectives of those who manage the money.REF

Change the Rules that Give Proxy Advisory Firms Outsize Importance. A number of regulatory steps by the DOL’s Employee Benefits Security Administration and its predecessor agenciesREF and the SEC led to the dramatic rise in the power of proxy advisory firms.REF

SEC rule 206(4)REF provides that it is a fraudulent, deceptive, or manipulative act, practice, or course of business for an investment adviser to exercise voting authority with respect to client securities unless the investment adviser adopts and implements written policies and procedures that are reasonably designed to ensure that the investment adviser votes client securities in the best interest of clients.REF The policies and procedures must describe how the investment adviser addresses material conflicts that may arise between the adviser and its clients.REF In a 2004 no-action letter (withdrawn in 2018), the SEC opined that the use of proxy advisory firms could “cleanse” conflicts of interest between Registered Investment Advisers (RIAs) and investors.REF The DOL has generally required fiduciaries to vote shares held by ERISA plans since 1988 and permitted outsourcing this function to proxy advisory firms.REF

Congress should make various changes to rules that give proxy advisory firms such outsized importance in corporate governance. Congress should amend section 206 of the Investment Advisers ActREF to make it clear that RIAs must act in the best interest of their client, and in the absence of individualized written consent from a client, that “best interest” means maximizing risk-adjusted financial return. Investing or voting proxies for any other reason, without obtaining written investor or plan beneficiary consent, should be explicitly, statutorily deemed a violation of § 206(4) of the Investment Advisers Act (or the new subsection explicitly requiring that RIAs act in the best interest of their client). Congress should also require the Securities and Exchange Commission to revise Rule 206REF and Rule 14a–9.REF Congress should also adopt statutory language making it clear that the use of third-party proxy advisory firms does not in any way relieve RIAs of their fiduciary duty or shield them from liability for conflicts of interest.

In addition, Congress should amend § 206 of the Investment Advisers Act such that voting proxies in furtherance of political, social, or ideological objectives that RIAs have publicly endorsed raises a rebuttable presumption that a conflict of interest exists and that the RIA’s fiduciary duty has been violated. Evidence that should be explicitly admissible in court or administrative proceedings and considered by the Securities and Exchange Commission when considering enforcement actions should include:

  • Board members’ or management’s public statements;
  • The firm’s website; and
  • Corporate or manager membership in, commitments to, or endorsements of:
    • An association,
    • A coalition,
    • Another similar organization,REF or
    • Other publicly released information.

This presumption could be rebutted if the RIA then demonstrates with clear and convincing evidence that voting in favor of the RIA’s declared political, social, or ideological objective was in its clients’ best interest (defined as maximizing clients’ risk-adjusted financial return). This will make duplicity by RIAs much more difficult. They would no longer be able to claim to be exercising their power to achieve political objectives in some forums while simultaneously claiming that they are doing nothing of the sort in others. In other words, they will not be able to virtue signal to politicians and activists by saying they are voting their proxies to further political objectives—while claiming to regulators, clients, and others that they are voting those proxies to maximize investor returns.

Congress should revise § 14 of the Securities Exchange ActREF to increase proxy advisory firm transparency, to increase the ability of issuers to understand the basis of proxy advisory firm advice and to respond to their recommendations before shares are voted, to more aggressively police proxy advisory firm conflicts of interest, and to ensure that proxy advisory firms are acting in a manner consistent with the fiduciary duties of their clients rather to achieve the proxy advisory firm’s political goals. Many of the provisions in the proxy-voting advice rule adopted by the SEC in 2020, and now largely rescinded, deserve congressional consideration.REF

For necessary changes to ERISA, see the discussion below entitled Prohibit Retirement Account Fiduciaries from Acting to the Detriment of Beneficiaries.

Prohibit Racism in the Board Room and in Financial Services Regulation. Many, perhaps most, of the proponents of diversity, inclusion, social justice, critical race theory, multiculturism, and identity politics reject (in their words) “the very foundations of the liberal order, including equality theory, legal reasoning, Enlightenment rationalism, and neutral principles of constitutional law.”REF They are engaged in a systematic and sustained effort to effectively change the national ethos from E Pluribus Unum to De Uno, Multis.REF

They seek to alter the “narrative” and to make sex, race, ethnicity, sexual orientation, and self-declared gender identity central to law, public policy, and self-understanding instead of individual achievement, merit, talent, and the content of one’s character. They actively seek to discriminate on the basis of sex, race, ethnicity, or sexual orientation rather than achieve a society in which such discrimination is unlawful and rare. They seek a faux diversity measured by group identity, determined largely by immutable characteristics—rather than true diversity that accounts for the rich tapestry of human experience. They seek to subordinate individual merit to group identity. Financial regulators should not go down this path but have begun to do so.

The National Association of Securities Dealers Automated Quotations (Nasdaq) board diversity rule effectively imposes racial, ethnic, or sex-based quotas on board membership (otherwise the company must publicly explain why they did not meet the quotas) and relies on self-identification for board-diversity disclosures. Besides being immoral, the rule’s subjective self-reporting mechanism raises liability concerns with respect to misrepresentation under the anti-fraud and reporting provisions of the federal securities laws.REF A person who is a Caucasian male is objectively not a female Native American, whether he “self-identifies” as a female Native American or not. On December 11, 2024, the U. S. Court of Appeals for the Fifth Circuit (sitting en banc) ruled by a vote of 9-8 that the SEC’s approval of the Nasdaq board diversity rule was inconsistent with the Securities Exchange Act of 1934 and vacated the SEC’s order approving the rule.REF The Federal Deposit Insurance Corporation (FDIC) has proposed going down a similar route for bank boards.REF The FDIC, unlike Nasdaq,REF is clearly a state actor, and its rules will have to pass constitutional tests regarding racial discrimination.

The Civil Rights Act of 1964 makes it unlawful for an employer to discriminate in employment based on an individual’s race, color, religion, sex, or national origin.REF It also makes preferential treatment based on quotas or percentage targets unlawful.REF The securities and banking laws should incorporate Civil Rights Act principles to prevent regulators, including SROs, from adopting rules or practices that discriminate on the basis of race, color, religion, sex, or national origin. Certainly, racism and sexism should not be legally mandated by securities regulators—including SROs. Congress should prohibit intentional discrimination on the basis of race, ethnicity, national origin, religion, or sexREF by financial regulators and self-regulatory organizations.REF Although board members are not generally regarded as corporate employees and therefore not currently subject to the anti-discrimination provisions of the Civil Rights Act, Congress should amend the law so that paid board members are.REF

End Racism in or by the Federal Government. Overt racism under the rubric of DEI has now become ubiquitous in the federal government. Increasingly, the federal government is imposing racist requirements on those who deal with the federal government. This should end.

DEI-related Executive Orders 13985,REF 13988,REF 14020,REF 14031,REF 14035,REF14091,REF and National Security Memoranda NSM–03REF and NSM–04REF should be rescinded. Any programs or offices that carry out these executive orders or memoranda should be immediately closed, and the agency head should undertake an appropriate reduction in force and not transfer, reassign, or redesignate any employees or contractors whose positions or functions were eliminated. Congress should provide that no funds appropriated or otherwise made available by law shall be used to implement or comply with these executive orders or national security memoranda.

The Directors of the Office of Personnel Management (OPM), the Office of Management and Budget, and all agency heads should revise all regulations, policies, procedures, manuals, circulars, courses, training, and guidance such that they effectively rescind those that were promulgated, adopted, or implemented to comply with the executive orders and memoranda listed above. The OPM Director should close the Office of Diversity and Inclusion and the Chief Diversity Officers Executive Council and further undertake an appropriate reduction in force and not transfer, reassign, or redesignate any employees or contractors whose positions or functions are eliminated.

The federal government should enforce existing constitutional and statutory prohibitions on racism in the federal government. Moreover, Congress should specifically prohibit:

  • Discriminating for or against any person on the basis of race, color, ethnicity, national origin, or sex;
  • Conducting training, education, course work, or other pedagogy that that asserts that a particular race, color, ethnicity, biological sex, sexual orientation, gender identity, or national origin is inherently or systemically superior, inferior, oppressive, oppressed, privileged, or unprivileged; and
  • Requiring as a condition of employment; as a condition for promotion or advancement; or as a condition for speaking, making a presentation, or submitting written materials the signing of or assent to a statement, code of conduct, work program or plan, or similar device that requires assent by the employee that a particular race, color, ethnicity, biological sex, sexual orientation, gender identity, or national origin is inherently or systemically superior, inferior, oppressive, oppressed, privileged, or unprivileged.REF

Because the Biden Administration refused to comply with the law and engaged in discriminatory DEI programs, trainings, and preferences, Congress should prohibit spending on such programs or activities. Specifically, Congress should provide that no funds may be appropriated or otherwise made available by law for the purpose of maintaining in any federal agency

  • An Office of Diversity, Equity, Inclusion and Accessibility; an Office of Diversity, Equity, and Inclusion; an Office of Diversity and Inclusion; or an Office of Diversity; or
  • A Chief Diversity Officer or substantially similar officer.

Congress should also provide that no funds appropriated or otherwise made available by law shall be used for the purpose of developing, implementing, distributing, or publishing in any federal agency diversity, equity, inclusion, and accessibility plans, strategic plans, reports, surveys, or anything substantially similar or equity action plans, reports, surveys, or substantially similar plans, reports, or surveys. Statutory diversity offices, diversity requirements, and Chief Diversity Officers should be eliminated.REF

Conduct an Antitrust Investigation of Proxy Advisory Firm Duopoly. As discussed above, ISS and Glass Lewis control an estimated 97 percent of the proxy advisory business.REF Given the centrality of this duopoly to the governance of U.S. public corporations, an antitrust investigation is warranted to gather facts about whether an antitrust violation has occurred. It is not clear whether this should be conducted by the Federal Trade Commission (FTC) or the Antitrust Division of the Department of Justice, given their overlapping jurisdictions.REF The next Administration should make an explicit assignment to one agency. The FTC is governed by five commissioners, each serving a seven-year term. Given the governance structure of the FTC, it may be advisable to assign the investigation to the Antitrust Division.

State attorneys general should also undertake an investigation. They may bring federal antitrust suits on behalf of individuals residing within their states (parens patriae suits) or on behalf of the state as a purchaser. (Typically, that would be state pension plans or university endowments in the case of proxy advisory firms.) In addition, state attorneys general also may bring an action to enforce the state’s antitrust laws.

Appropriately Use the Civil Rights Laws Against Left-Wing Racism. The next conservative administration should appoint leaders who will direct the Civil Rights Division of the Department of Justice, the Equal Employment Opportunity Commission, the Office for Civil Rights in the Department of Education, the Office for Civil Rights at the Department of Health and Human Services, and the Office of Federal Contract Compliance Programs at the DOL to launch enforcement actions against DEI-motivated discrimination on the basis of race, ethnicity, national origin, or biological sex in employment, university admissions, and other areas.REF Moreover, the next conservative administration should enforce the Equal Credit Opportunity Act against DEI racism.REF

Banking. Congress should prohibit racism by financial regulators, including so-called self-regulatory organizations.REF Congress also needs to prevent banking regulators and SROs from politicizing the allocation of credit, financial services, and investment opportunities on the basis of ESG factors. Virtually every financial regulator has started down this path.REF

Congress should statutorily reverse the multitudinous climate change and DEI regulations in an ESG and DEI reversal bill. The bill should contain a separate section for each rule being rescinded, and in each section, Congress should take four steps.

  1. It should adopt language similar to that used in the Congressional Review Act (the indicated rule will have “no force or effect”).REF It should, however, contain language that would also preclude adoption or enforcement of any “substantially similar rule.”
  2. It should adopt a provision that “no funds appropriated or otherwise made available by law shall be used to implement or comply with” the rule.
  3. The statute should adopt a directive to the agency to amend the Code of Federal Regulations within 60 days to reflect the recission of the rule and explicitly waive Administrative Procedure Act notice-and-comment requirements with respect to those changes necessary to effect congressional recission of the rule.
  4. It should adopt a directive to the agency to conform within 120 days all guidance, interpretative bulletins, no-action letters, and similar documents to reflect congressional rescission of the rule and make it explicitly clear that all such guidance is of no force and effect on the date of enactment of the bill.

Procurement. Because the federal government has routinely ignored constitutional prohibitions on discrimination in contracting,REF Congress should prohibit discrimination on the basis of race, color, ethnicity, national origin, or sex in federal procurement, contracting, and grant-making and prohibit federal contracts or grants from mandating such discrimination or from mandating DEI training or offices. In addition, the Office of Federal Contract Compliance Programs at the DOL, among others, should launch enforcement actions against DEI racism in federal procurement.

Congress should make so-called climate change disclosure requirements in the procurement process unlawful.REF While such requirements do enrich the climate industrial complex considerably, they do virtually nothing for the climate, they increase taxpayer costs, and they reduce competition in the procurement process.REF

States may want to consider prohibiting, or seriously limiting, state contracts with companies that engage in economic boycotts based on ESG factors.REF This will be of particular interest to legislators in states that have important industries that are being targeted by ESG proponents. The objective of such legislation is to create a commercial downside for companies that attempt to virtue signal to progressives by inflicting economic harm on companies that progressives do not like. Companies that make business decisions for business reasons would have nothing to fear from such legislation.

In this context, a company would be deemed to be engaging in an economic boycott when that company, without an ordinary business purpose, refuses to deal with, terminates business activities with, or otherwise takes any commercial action that is intended to penalize, inflict economic harm on, limit commercial relations with, or change or limit the activities of another company because the company, without violating federal or state law, engages in activities with which progressives disagree.

That would potentially include the state government refusing to deal with, or limiting commerce with, companies that boycott other companies that:

  • Engage in the exploration, production, utilization, transportation, sale, or manufacturing of fossil fuel–based energy, timber, mining, agriculture, and firearms or ammunition;
  • Do not meet, are not expected to meet, or do not commit to meet environmental standards or disclosure criteria, in particular to eliminate, reduce, offset, or disclose greenhouse gas emissions;
  • Do not meet, are not expected to meet, or do not commit to meet corporate board or employment, composition, compensation, or disclosure criteria that incorporate characteristics protected under the state’s state civil rights statute; or
  • Do not facilitate, are not expected to facilitate, or do not commit to facilitate access to abortion, sex or gender change, or transgender surgery.

Require Corporate Neutrality in Limited Circumstances. As discussed above, policymakers should consider broadening non-discrimination or non-exclusion requirements in certain well-defined circumstances. Such limitations are a limit of the freedom of firms to act for non-financial reasons and therefore should be subject to serious skepticism by policymakers. Nevertheless, free societies have long considered such non-discrimination or non-exclusion requirements appropriate in some circumstances, and the limits to those requirements should carefully evolve as markets and society evolve.

If Congress finds that particular firms enjoy oligopolistic market power;REF that their refusal to engage in commerce is highly disruptive to ordinary personal, commercial, or civic life; and that there is little practical alternative for the targeted persons, firms, or organizations, then Congress should consider legislation to address the problem. Such legislation could prohibit such firms from discriminating against potential customers based on their race, ethnicity, national origin, sex, or their politics; the lawful businesses in which they engage;REF or their commitment, or lack thereof, to climate change policies or greenhouse gas emission targets beyond those required by law.

Better, probably, is an approach that simply requires these firms to offer their services to all potential customers on ordinary terms with good-cause exceptions.REF Although different common-carrier statutes and court cases use different language, the typical formulations prohibit “any unjust or unreasonable discrimination,” “any undue or unreasonable preference or advantage or any undue or unreasonable prejudice or disadvantage,” the “refusal of service without good cause,” or the “unreasonable refusal to deal.” Alternatively, some statutes or cases require “equal access,” require that firms “serve all comers,” or mandate that a firm “shall provide” the transportation or service upon “reasonable request” or unless there is “good cause” not to do so.REF In all of these formulations, the contours of what is deemed to constitute good cause or unreasonable refusal would be a critical decision for policymakers.REF

At the state level, in markets in which a very few large health insurers, property and casualty insurers, or hospital systems are dominant—and viable alternatives do not really exist—state legislators may want to review their laws and consider either modifying some existing common carrier or non-discrimination statute or enacting a new requirement to deal or to not discriminate on the basis of ESG factors.

State University Endowments. States should amend the Uniform Prudent Management of Institutional Funds ActREF which has been enacted in every state except Pennsylvania, to ensure that funds managed and invested by state universities and government institutions for charitable or educational purposes are not diverted to lower-return investments to achieve the desired political or ideological objectives of fund managers.REF

State 529 Plans. Internal Revenue Code § 529 establishes qualified tuition programs that enable parents and others to save for their children’s education on a tax-deferred basis or to prepay tuition. Every state except Wyoming offers such plans. State legislators should ensure that these plan investment options maximize returns for parents saving for their children rather than to further ESG objectives.

Power Grid. State legislators play a critical role in ensuring that consumers obtain the lowest-cost reliable energy and that ESG objectives do not harm consumers. State laws should provide that utilities must generate electricity at the lowest monetary cost consistent with achieving reasonable reliability goals and prohibit having so much intermittently generated electricity (wind and solar) that they are unable to cost-effectively meet continuous operating requirements for summer and winter peak loads. The Affordable and Reliable Electricity Act provides model language.REF

Analysis of Specific Federal Legislation

Guiding Uniform and Responsible Disclosure Requirements and Information Limits Act. The Guiding Uniform and Responsible Disclosure Requirements and Information Limits Act or GUARDRAIL Act, as reported out of committee,REF would require that the SEC, when engaged in rulemaking, may only require issuers to disclose information that the issuer has determined to be material with respect to a voting or investment decision and defines material as whether there “is a substantial likelihood that a reasonable investor would view the failure to disclose that information as having significantly altered the total mix of information made available to the investor.” While this is constructive and consonant with Supreme Court decisions on the meaning of “material,” it does not go far enough.

As discussed above, the Left is trying to redefine “material” for purposes of U.S. law as anything a woke investment adviser may care about, and the European Union is pushing the so-called “double materiality” concept to achieve the same result. Thus, to defend the traditional U.S. conception of materiality from this assault, any statutory definition in U.S. law must define “material” in terms of evaluating the potential financial return and financial risks of an existing or prospective investment, and explicitly “define out” non-pecuniary, non-economic, or non-financial social, political, or ideological goals or objectives.REF

The bill would require the SEC to study “the detrimental impact and potential detrimental impact” of two EU Directives. The first is entitled “Corporate Sustainability Due Diligence.”REF The second, “Corporate Sustainability Reporting,” will require firms to report according to European Sustainability Reporting Standards and is part of the “European green deal.”REF The bill authors are correct to identify these two EU Directives as a serious problem.

Expecting, however, anything bordering on an objective report on the subject from the SEC is highly unrealistic since the commission has itself proposed something very similar to these two EU directives with its highly destructive climate change rule.REF Any such report by the SEC will almost certainly jettison any objectivity, adhere to climate change activist orthodoxy, and find that, “yes, there are some costs, but the costs are worth the benefits.” A study by some less partisan, more objective agency or bodyREF may be of value, but a study by the SEC will have an utterly predictable outcome.

The GUARDRAIL Act would also establish a public company advisory committee. While it is probably useful to encourage reasoned discourse between commissioners, SEC staff, and those it regulates, large public companies generally have no shortage of lawyers and lobbyists. Thus, it is not clear that such a committee is necessary. Small public companies, however, often do not have a legion of lawyers and lobbyists and are disproportionately affected by the ever-increasing level of regulation. Were the bill to require that a substantial proportion of committee members be from smaller reporting companiesREF and emerging growth companies,REF then such a committee could potentially play an important role.

Protecting Americans’ Retirement Savings from Politics Act. The Protecting Americans’ Retirement Savings from Politics ActREF is a package of measures that would take important steps toward protecting investors by reining in ESG excesses by proxy advisory firms, registered investment advisers, broker-dealers, and institutional investment managers.

It would:

  • Make it easier for issuers to exclude shareholder proposals that have repeatedly been defeated or that relate to environmental, social, or political matters;
  • Require the registration of proxy advisory firms with the SEC;
  • Create liability for failure to disclose material information relating to proxy-voting advice;
  • Require institutional investment managers to make detailed reports regarding their proxy voting;
  • Require institutional investment managers to certify that the voting decisions of the institutional investment manager are based solely on the best economic interest of the shareholders on behalf of whom the institutional investment manager holds shares;
  • Prohibit “robovoting,” defined as the practice of automatically voting in a manner consistent with the recommendations of a proxy advisory firm;
  • Adopt a version of the INDEX Act;REF and
  • Provide that for purposes of the Investment Advisers Act standards of conduct, the “best interest” of a customer be determined using only pecuniary factors unless the customer provides informed written consent.

Title I would allow management to exclude a shareholder proposal that has been voted on and lost. It contains a sliding scale so that a proposal may be excluded if it has been voted on once during a five-year period and received less than 10 percent of the votes cast; twice during such five-year period and received less than 20 percent of the votes cast; or three or more times during such five-year periods and received less than 40 percent of the votes cast. These are more stringent thresholds than exist under current Securities and Exchange Commission rules.REF This would reduce costs incurred in connection with politically motivated shareholder proposals that have been repeatedly defeated.

Title II would codify existing commission rules, allowing management to exclude a shareholder proposal that has been substantially implemented by the issuerREF or where the “principal thrust or principal focus” duplicates another proposal previously submitted to the issuer by another proponent.REF This is desirable in that it would prevent a future commission from reversing these rules and thereby increasing costs.

Title III would allow management to exclude a shareholder proposal if the subject matter of the shareholder proposal is “environmental, social, or political (or a similar subject matter).” This is a very important restriction, but because there is no definition of these terms, the implementing regulations and guidance will be of tremendous importance. Congress should provide greater detail. Specifically, it should define the terms “environmental,” “social,” and “political,” and provide that the proposals can be excluded unless they are material to the financial results of the firm.

Title IV would effectively reverse SEC guidance, making it much more difficult for management to exclude shareholder proposals relating to a “significant social policy issue” as an intrusion on the “company’s ordinary business operations.”REF This is desirable in that it will reduce costs and reduce shareholder proposals that are not material to the financial results of the firm.

Title V mandates an SEC study on various aspects of the proxy-voting system.

Title VI requires the registration of proxy advisory firms and requires that registered proxy advisory firms report information about their practices, financial condition, and conflicts of interest. It also requires that proxy advisory firms certify that they will provide proxy-voting advice only in the “best economic interest” of shareholders and defines “best economic interest” as “decisions that seek to maximize investment returns over a time horizon consistent with the investment objectives and risk management profile of the fund in which the shareholders are invested.” Given the outsized role, discussed above, that proxy advisory firms have in the governance of public corporations, this title would have a highly salutary effect.

Title VII would create liability for making false or misleading statements relating to proxy-voting advice. Such liability attaches to most actors in the financial markets. Proxy-voting advisory firms should be no different.

Title VIII would require, among other things, that institutional investment managers file an annual report with the Securities and Exchange Commission explaining how the institutional investment manager voted with respect to each shareholder proposal and how such votes were reconciled with the fiduciary duty of the institutional investment manager to vote in the best economic interests of shareholders. The costs imposed by this title could be significant. Those costs ultimately will have to be recovered from fund shareholders in the form of higher fees. While in the abstract, having this information is likely to promote adherence to discharging fiduciary duties, it may or may not be a cost-effective means of achieving that objective.

Title IX would prohibit the automatic voting with a proxy advisory firms’ recommendations (i.e., robovoting). Requiring RIAs to actually evaluate how they vote, rather than blindly following proxy advisory firms’ recommendations, promotes adherence to discharging their fiduciary duty.

Title X is a version of the INDEX Act. (See discussion below.)

Title XI would ensure that the determination, under the Investment Advisers Act standards of conduct, of whether broker-dealers and investment advisers are acting in the best interest of a customer is made using pecuniary factors, which may not be subordinated to or limited by non-pecuniary factors unless the customer provides informed, written consent that such non-pecuniary factors be considered. This is a highly constructive provision.

Businesses Over Activists Act. The Businesses Over Activists ActREF would prohibit the SEC from compelling an issuer to include any shareholder proposals and prohibits the preemption of state regulation of shareholder proposals or proxy or consent solicitation materials.

Although the provision in this bill that prohibits preemption of state corporate law governing the proxy process is fine, the prohibition on requiring management to include shareholder proposals is a step too far. It would basically empower management to deny any shareholder proposal a vote—and is a move toward board and management supremacy rather than shareholder supremacy.

Retirement Proxy Protection Act. The Retirement Proxy Protection ActREF is constructive but, without amendment, fiduciaries would be able to evade its purpose, particularly with the complicity of a Department of Labor like the Biden DOL.

The bill provides that a fiduciary, when deciding whether to exercise a shareholder right and when exercising a shareholder right, must “act solely in accordance with the economic interest of the plan and its participants and beneficiaries.” This, as discussed above, is not significantly different than the existing requirements under § 404 of ERISA that fiduciaries act “solely in the interest of the participants and beneficiaries”…“for the exclusive purpose of providing benefits to participants and their beneficiaries.”REF The bill also requires that fiduciaries “shall not subordinate the interests of participants and beneficiaries in their retirement income or financial benefits under the plan to any non-pecuniary objective, or promote non-pecuniary benefits or goals unrelated to those financial interests of the plan’s participants and beneficiaries.”REF

All of this is constructive, but it does not adequately address the problem of fiduciaries purposefully employing a methodology that creates “ties” among investment alternatives and then resolving those ties with ESG factors. As discussed above, this is precisely what the Biden DOL has greenlighted under current law—and the bill would not adequately address the problem since choosing between two “equally” attractive alternatives using ESG factors would not constitute “subordinating the interests of participants and beneficiaries.”

The bill should be amended to explicitly prohibit ERISA fiduciaries from considering any non-pecuniary, non-economic, or non-financial social, political, or ideological goals or objectives when choosing investments, voting proxies, or exercising other rights appurtenant to investments held by the plan without the explicit written consent of plan beneficiaries. The bill should also require that any tie among investment alternatives be resolved using a random methodology.

The bill also provides a safe harbor allowing plans not to vote securities when doing so is not expected to have a material effect on the value of the plan investment or when the securities held are 5 percent (or less) of plan assets. This provision is positive, although the 5 percent threshold should probably be reduced to something more like 1 percent, since any significant change in the value of assets that constitutes 5 percent of plan assets can be expected to have a material impact on plan benefits.

Roll Back ESG To Increase Retirement Earnings Act. While well-intentioned, the Roll Back ESG To Increase Retirement Earnings (RETIRE) ActREF as drafted is a mistake. It explicitly provides that

if a fiduciary is unable to distinguish between or among investment alternatives or investment courses of action on the basis of pecuniary factors alone, the fiduciary may use non-pecuniary factors as the deciding factor if the fiduciary documents—
(i) why pecuniary factors were not sufficient to select a plan investment or investment course of action.

Other than the documentation requirements,REF this is not that different from the Biden DOL rule discussed above. It is an invitation to evasion by woke fiduciaries. As discussed above, fiduciaries that want to create ties that can then be resolved using ESG factors can easily do so. This bill effectively invites them to do so, as has the Biden DOL despite opposition from majorities in both the House and the Senate.

The bill should be amended to explicitly prohibit ERISA fiduciaries from considering any non-pecuniary, non-economic, or non-financial social, political, or ideological goals or objectives when choosing investments, voting proxies, or exercising other rights appurtenant to investments held by the plan without the explicit written consent of plan beneficiaries. The bill should also require that any tie among investment alternatives be resolved using a random methodology.

INvestor Democracy Is EXpected Act. The INvestor Democracy Is EXpected Act or INDEX ActREF and Title X of the Protecting Americans’ Retirement Savings from Politics Act are similar but have important differences. In general, Title X is simpler and would have a more pro-management effect. Both bills are designed to address the very real problem that perhaps one-fifth of the shares of Standard & Poor 500 issuersREF are held by passive funds and that these funds are in turn overwhelmingly controlled by a few registered investment advisers who routinely vote the shares to achieve political, rather the business, objectives.REF

Both pieces of legislation undoubtedly require refinement before they are actually enacted into law. They should not be rushed. There should be additional hearings. Public comments should be solicited by the two committees. Otherwise, there may be substantial unintended consequences and serious practical compliance difficulties. But serious reforms are indicated with respect to both passively managed and actively managed funds to alleviate the effective control of most public companies by a very few investment advisers and proxy advisory firms.

Both bills apply only to “passively managed funds” and define that term to mean a fund that is “designed to track, or is derived from, an index of securities or a portion of such an index.”REF In the case of the INDEX Act, a fund that allocates 40 percent to 100 percent of its assets to an investment strategy tracking an index or indexes would qualify. In the case of Title X, it is 60 percent to 100 percent.

Both bills change the voting requirements with respect to non-routine matters but have markedly different definitions of what is routine. Title X defines routine very broadly, far beyond what would normally be regarded as routine. (Votes on mergers, for example, are deemed routine.) The INDEX Act deems many votes that would be regarded as routine as non-routine (uncontested board elections, for example).

The INDEX Act only governs voting requirements when an investment adviser’s various funds have more than 1 percent of the voting authority of the outstanding securities of the registrant subject to the vote. Title X applies to all non-routine votes.

Title X requires that with respect to non-routine votes the shares be: (a) voted in accordance with the instructions of the beneficial owner of a voting security of the passively managed fund; (b) voted in accordance with the voting recommendations of the issuer; or (c) not voted. There is nothing in the bill about how the RIA is expected to get instructions, what to do if they do not receive timely instructions, mirror voting,REF the consequences of failing to even try to get instructions, and so on. The INDEX Act generally requires the investment adviser to vote the shares it controls proportionately to the instructions it receives from beneficial owners (provided the 1 percent threshold mentioned above has been met).

Dismantle DEI Act. The Dismantle DEI Act,REF introduced by Senator J. D. Vance (R–OH) and Representative Michael Cloud (R–TX), would go a long way toward excising racist DEI policies from the federal government.REF A slightly amended version of this bill was reported out of the House Oversight Committee on November 20, 2024.REF

The bill defines a “prohibited diversity, equity, or inclusion practice” to mean:

(1) discriminating for or against any person on the basis of race, color, ethnicity, religion, biological sex, or national origin; or
(2) requiring as a condition of employment, promotion, advancement, speaking, making a presentation, or submitting written materials that an employee (a) undergo training, education, or coursework that asserts that a particular race, color, ethnicity, religion, biological sex, or national origin is inherently or systemically superior or inferior, oppressive or oppressed, or privileged or unprivileged or (b) sign or assent to a statement, code of conduct, work program, or plan that requires assent by the employee that a particular race, color, ethnicity, religion, biological sex, or national origin is inherently or systemically superior or inferior, oppressive or oppressed, or privileged or unprivileged.REF

The federal government, including federal advisory committees, would be prohibited from engaging in prohibited DEI practices. A private cause of action would be created so that private litigants can sue to enforce these requirements. Various statutory DEI-oriented offices and chief diversity officers would be eliminated. The bill would rescind six of President Joe Biden’s executive orders and two Biden Administration national security memorandums implementing racist DEI policies.

The Cloud–Vance bill would also require the Office of Personnel Management and the Office of Management and Budget to revise all regulations, policies, procedures, manuals, circulars, courses, training, and guidance to comply with the act. It would require the closure of all DEI or similar offices throughout the federal government and would abolish the Chief Diversity Officers Executive Council. It would prohibit a wide range of DEI actions and personnel practices by federal officials and prohibit the use of DEI factors in the federal performance appraisal process.

Federal contractors and grant recipients would be prohibited from using federal funds to engage in prohibited DEI practices. Most federal contracts would be required to contain a provision specifying that no part of the services performed under the contract can be performed in buildings or surroundings, under working conditions or in a working environment, provided by or under the control or supervision of a contractor or any subcontractor who is subject to, or required to comply with, a prohibited diversity, equity, or inclusion practice.

Education accreditation organizations would be prohibited from requiring or coercing any institution of higher education to engage in prohibited diversity, equity, and inclusion practices. Financial regulators, including so-called self-regulatory organizations, would be barred from engaging in prohibited DEI practices or requiring that regulated entities or members do so.

Analysis of Specific State Legislation

State Pension Fiduciary Duty Act. A version of the State Pension Fiduciary DutyREF has been enacted in about 10 states.

The bill provides that fiduciaries for the state pension board must discharge their duties solely in the financial interest of the participants and beneficiaries for the exclusive purposes of providing financial benefits to participants and their beneficiaries and defraying reasonable expenses of administering the system. This is analogous to ERISA requirements imposed on private plans.

The bill further provides that a fiduciary may take into account only financial factors when discharging its duties with respect to a plan and that all shares held by a public retirement system be voted solely in the financial interest of plan participants and their beneficiaries. It prohibits state plans from engaging investment managers or granting proxy-voting authority to any firm unless the firm has a practice of acting solely upon financial factors and commits in writing to do so. It contains substantial evidentiary and enforcement provisions.

Eliminate Economic Boycotts Act. The Eliminate Economic Boycotts ActREF would generally require companies that contract with the state to certify that they do not boycott or discriminate against companies to achieve various political objectives. Specifically, states can require contractors to not discriminate against those engaged in conventional energy production, mining, agriculture, timber, or firearms industries.

The bill defines “economic boycott” to mean “without an ordinary business purpose, refusing to deal with, terminating business activities with, or otherwise taking any commercial action that is intended to penalize, inflict economic harm on, limit commercial relations with, or change or limit the activities of a company because the company, without violating controlling federal or state law” engages in various lines of business or fails to take various measures such as committing to DEI quotas or greenhouse gas emission targets.REF

Affordable and Reliable Electricity Act. The Affordable and Reliable Electricity ActREF would require electric utility regulatory agencies to develop rules and procedures promoting an affordable and reliable electric grid that meets estimated peak demand, including during extreme weather events.

The bill requires that

  • Any new power-generation resource is chosen and approved based solely on achieving the lowest total monetary cost;
  • Existing power-generation resources not be retired prior to the end of their potential useful lives unless retirement results in a lower total monetary cost;
  • The grid maintains a guaranteed power capacity of at least 115 percent of peak net load;
  • Power-generation sources serving the grid meet continuous operating requirements for summer and winter peaks; and
  • New intermittent power generation sourcesREF not be approved unless the source has the support of firming power up to the expected maximum output level of the source for 48 hours during periods of peak load on the grid, and the cost of constructing or contracting for that firming power be included in calculating the total monetary cost of the intermittent generation source.

An Amendment to the Prudent Management of Institutional Funds Act. The Prudent Management of Institutional Funds Act has been adopted in every state except Pennsylvania.REF State legislatures should amend the Prudent Management of Institutional Funds ActREF to protect the charitable purpose of institutional funds managed and invested by state universities and other government institutions holding funds for charitable purposes. The bill requires that those managing these funds invest for a return and not for political purposes and, with certain exceptions, that they engage only service providers that invest or vote proxies to achieve a return.

Summary of Recommendations

This section briefly summarizes the recommendations made throughout the Special Report.

Congress should:

  • Statutorily define materiality in terms generally consonant with Supreme Court holdings, making it clear that the term refers to financial returns and financial risk—and specifically excluding social and political objectives unrelated to investors’ financial, economic, or pecuniary objectives.
  • Require that any ERISA fiduciary, registered investment adviser, or broker-dealer be required to secure individualized written consent from an investor or plan beneficiary before they invest or vote securities for any reason other than maximizing risk-adjusted financial return. Investing or voting securities for such reasons, without obtaining investor or plan beneficiary consent, should be explicitly, statutorily deemed a violation of:
    • § 404 of ERISA,
    • § 10(b) of the Securities Exchange Act,
    • § 206(4) of the Investment Advisers Act, and
    • §§ 17(j) and 36 of the Investment Company Act.
  • Amend § 404 of ERISA to explicitly prohibit ERISA fiduciaries from considering any non-pecuniary, non-economic, or non-financial social, political, or ideological goals or objectives when choosing investments, voting proxies, or exercising other rights appurtenant to investments held by the plan, and require that any tie among investment alternatives be resolved using a random methodology.
  • Amend § 206 of the Investment Advisers Act to make it clear that: (1) registered investment advisers must act in the best interest of their client; and (2) in the absence of individualized written consent from a client, that “best interest” means maximizing risk-adjusted financial return—and that investing or voting proxies for any other reason, without obtaining written investor or plan beneficiary consent, is a violation of the adviser’s fiduciary duty.
  • Amend § 206 of the Investment Advisers Act such that voting proxies in furtherance of political, social, or ideological objectives that RIAs have publicly endorsed raises a rebuttable presumption that a conflict of interest exists and that the RIA’s fiduciary duty has been violated.
  • Revise § 14 of the Securities Exchange Act (a) to increase proxy advisory firm transparency; (b) to increase the ability of issuers to understand the basis of proxy advisory firm advice and to respond to their recommendations before shares are voted; (c) to more aggressively police proxy advisory firm conflicts of interest; and (d) to ensure that proxy advisory firms are acting in a manner consistent with the fiduciary duties of their clients rather than to achieve the proxy advisory firm’s political goals.
  • Require the Securities and Exchange Commission to revise Rule 206 and Rule 14a-9 so that proxy advisory firms do not have outsized importance in corporate governance.
  • Adopt statutory language, making it clear that the use of third-party proxy advisory firms does not in any way relieve RIAs of their fiduciary duty or shield them from liability for conflicts of interest.
  • Require that proxy advisory firms certify that they will provide proxy-voting advice only in the “best economic interest” of shareholders (absent explicit written consent to the contrary).
  • Require the registration of proxy advisory firms.
  • Create liability for failure to disclose material information relating to proxy-voting advice.
  • Prohibit “robovoting” by RIAs and other fiduciaries, defined as the practice of automatically voting in a manner consistent with the recommendations of a proxy advisory firm.
  • Make it easier for issuers to exclude shareholder proposals that have repeatedly been defeated.
  • Make it easier for issuers to exclude shareholder proposals that relate to environmental, social, or political matters.
  • Require institutional investment managers to certify that the voting decisions of the institutional investment manager are based solely on the best economic interest of the shareholders on behalf of whom the institutional investment manager holds shares.
  • Require institutional investment managers to make detailed public reports regarding their proxy voting.
  • Prohibit discrimination on the basis of race, ethnicity, national origin, religion, or biological sex by financial regulators and self-regulatory organizations in their capacity as regulators or otherwise.
  • Amend the Civil Rights Act so that paid board members are deemed employees for purposes of employment discrimination provisions in the act.
  • Statutorily reverse DEI-related Executive Orders 13985, 13988, 14020, 14031, 14035, and 14091 and National Security Memoranda NSM–03 and NSM–04 by providing (a) that they are of no force and effect; (b) that no funds appropriated or otherwise made available by law shall be used to implement or comply with them; (c) that all agencies within 120 days must conform all guidance, interpretative bulletins, no-action letters, and similar documents to reflect the rescission of the orders and memoranda; and (d) all such guidance be made explicitly of no force and effect on the date of enactment of the bill.
  • Statutorily reverse the multitudinous climate change and DEI regulations in an ESG and DEI reversal bill. The bill should (a) contain a separate section for each rule being rescinded; (b) provide that the indicated rule (or any substantially similar rule) has “no force or effect”; (c) provide that “no funds appropriated or otherwise made available by law shall be used to implement or comply with” the rule (or any substantially similar rule); (d) provide a directive to the agency to amend the Code of Federal Regulations within 60 days to reflect congressional rescission of the rule and explicitly waive Administrative Procedure Act notice and comment and other regulatory requirements with respect to those changes necessary to effect the congressional recission of the rule; (e) provide a directive to the agency to conform within 120 days all guidance, interpretative bulletins, no-action letters, and similar documents to reflect congressional rescission of the rule; and (f) make it explicitly clear that all such guidance is of no force and effect on the date of enactment of the bill.
  • Prohibit banking regulators and SROs from allocating credit, financial services, and investment opportunities on the basis of ESG factors.
  • Prohibit discrimination on the basis of race, color, ethnicity, national origin, or sex in federal procurement, contracting, and grant-making, and prohibit federal contracts or grants from mandating such discrimination or from mandating DEI training or offices.
  • Prohibit mandatory climate change disclosures in federal procurement, contracting, and grant-making, and prohibit federal contracts or grants from mandating such disclosures.
  • Prohibit racism in government. Congress should specifically prohibit: (1) discriminating for or against any person on the basis of race, color, ethnicity, national origin, or biological sex; (2) conducting training, education, course work, or other pedagogy that that asserts that a particular race, color, ethnicity, biological sex, sexual orientation, self-professed gender identity, or national origin is inherently or systemically superior, inferior, oppressive, oppressed, privileged, or unprivileged; and (3) requiring as a condition of employment, as a condition for promotion or advancement, or as a condition for speaking, making a presentation, or submitting written materials, the signing of or assent to a statement, code of conduct, work program or plan, or similar device that requires assent by the employee that a particular race, color, ethnicity, biological sex, sexual orientation, self-professed gender identity, or national origin is inherently or systemically superior, inferior, oppressive, oppressed, privileged, or unprivileged.
  • Provide that no funds may be appropriated or otherwise made available by law for the purpose of maintaining in any federal agency (a) an Office of Diversity, Equity, Inclusion and Accessibility; an Office of Diversity, Equity, and Inclusion; an Office of Diversity and Inclusion; an Office of Diversity; or substantially similar office; or (b) a Chief Diversity Officer or substantially similar officer.
  • Provide that no funds appropriated or otherwise made available by law shall be used for the purpose of developing, implementing, distributing, or publishing in any federal agency (a) diversity, equity, inclusion, and accessibility plans, strategic plans, reports, or surveys, or anything substantially similar; or (b) equity action plans, reports, or surveys, or substantially similar plans, reports, or surveys.
  • Eliminate all statutory diversity offices, diversity requirements, and chief diversity officers.
  • Evaluate private firms exercising unusual economic power to further ESG or DEI. If Congress finds: (a) that particular firms enjoy oligopolistic market power; (b) that their refusal to engage in commerce is highly disruptive to ordinary personal, commercial, or civic life; and (c) that there is little practical alternative for the targeted persons, firms, or organizations, then Congress should consider legislation to address the problem. Such legislation could prohibit such firms from discriminating against potential customers based on their race, ethnicity, national origin, sex, or politics; the lawful business in which they engage; or their commitment, or lack thereof, to climate change policies or greenhouse gas emission targets beyond those required by law. Alternatively, Congress could simply require them to offer their services to all potential customers on ordinary terms with good-cause exceptions.

The federal executive branch should:

  • Rescind Executive Orders 13985, 13988, 14020, 14031, 14035, and 14091 and National Security Memoranda NSM–03 and NSM–04. Any programs or offices that carry out these executive orders or memoranda should be immediately closed, and the agency head should undertake an appropriate reduction in force and not transfer, reassign, or redesignate any employees or contractors whose positions or functions were eliminated.
  • Revise all regulations, policies, procedures, manuals, circulars, courses, training, and guidance such that they effectively rescind those that were promulgated, adopted, or implemented to comply with the executive orders and memoranda listed above.
  • Close any Office of Diversity and Inclusion or similar office.
  • Terminate the employment of any chief diversity officer or similar position.
  • Close the Chief Diversity Officers Executive Council and further undertake an appropriate reduction in force and not transfer, reassign, or redesignate any employees or contractors whose positions or functions are eliminated.
  • Enforce existing fiduciary duty requirements, rather than encouraging fiduciaries to evade their fiduciary duties, by launching enforcement actions against registered investment advisers, proxy advisory firms, and ERISA fiduciaries that violate their fiduciary duties.
  • Reverse the Biden DOL rule entitled, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.”
  • Reverse the Nasdaq board diversity rule.
  • Direct the Civil Rights Division of the Department of Justice, the Equal Employment Opportunity Commission, and the Office for Civil Rights in the Department of Education to launch enforcement actions against discrimination on the basis of race, ethnicity, national origin, and biological sex in employment, university admissions, and other venues undertaken in the name of DEI.
  • Launch an antitrust investigation of the proxy advisory firm duopoly by either the Federal Trade Commission or the Antitrust Division of the Department of Justice. Given the governance structure of the FTC, it may be advisable to assign the investigation to the Antitrust Division.
  • Revise all regulations, policies, procedures, manuals, circulars, courses, training, and guidance that were adopted to further the Biden Administration’s climate change agenda.
  • Launch enforcement actions against investment advisers, retirement plan fiduciaries, and others with a fiduciary duty who violate that duty.

State legislatures should:

  • Enact legislation to ensure that state retirement funds are invested solely to achieve a return for state employees who are pension plan beneficiaries, rather than to achieve the political or social objectives of those who manage the money.
  • Consider prohibiting, or seriously limiting, state contracts with companies that engage in economic boycotts based on ESG factors.
  • Evaluate state corporate business judgment rule (usually judicially created), and clarify, if required, that director duties to the corporation and shareholders excludes the pursuit of political, social, and ideological aims unrelated or detrimental to the financial performance of the firm.
  • Consider modifying the rules governing shareholder derivative lawsuits so that when directors violate their fiduciary duties to the corporation and its shareholders there are actual consequences.
  • Evaluate whether the rules governing director or officer indemnification for purposeful or negligent violation of director or officer duties to the corporation may need to be revised.
  • Evaluate whether state corporate, securities, banking, pension, and trust laws should be reformed to strengthen the protection of investors, depositors, and beneficiaries.
  • Review the laws in markets in which a very few large health insurers, property and casualty insurers, or hospital systems are dominant and viable alternatives do not really exist. Consider either modifying some existing common-carrier or non-discrimination statute or enacting a new requirement to deal with discrimination on the basis of ESG factors.
  • Amend the Uniform Prudent Management of Institutional Funds Act to ensure that funds managed and invested by state universities and government institutions for charitable or educational purposes are not diverted to lower return investments to achieve the desired political or ideological objectives of fund managers.
  • Ensure that § 529 plan investment options maximize returns for parents saving for their children’s education.
  • Ensure that consumers obtain the lowest cost, most reliable energy and that ESG objectives do not harm consumers. State laws should provide that utilities must generate electricity at the lowest monetary cost consistent with achieving reasonable reliability goals and prohibit having so much intermittently generated electricity (wind and solar) that they are unable to cost effectively meet continuous operating requirements for summer and winter peak loads.

State executive branch officials should:

  • Launch enforcement actions against investment advisers, retirement plan fiduciaries, and others with a fiduciary duty who violate their fiduciary duty.
  • Undertake an investigation of proxy advisory firm duopoly. States may bring federal antitrust suits on behalf of individuals residing within their states (parens patriae suits) or on behalf of the state as a purchaser. In the case of proxy advisory firms, the purchaser would typically be state pension plans or university endowments. In addition, state attorneys general also may bring an action to enforce the state’s antitrust laws.
  • Ensure that 529 plan investment options maximize returns for parents saving for their children’s education.

Conclusion

ESG and DEI are serious problems harming workers, consumers, and investors throughout the county in numerous ways. ESG and DEI have become ubiquitous in government, corporations, and universities. Federal and state legislators need to protect the public from these pernicious progressive efforts. Unfortunately, there is no simple way to address the problem. Reforms to a wide range of complex laws and regulations are required to adequately address the problem.

David R. Burton is Senior Fellow in Economic Policy in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

Authors

David R. Burton
David Burton

Senior Fellow in Economic Policy, Thomas A. Roe Institute

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