In a recent speech to the American Enterprise Institute, SEC Commissioner Hester Peirce continued her rebuke of the practice of “public shaming” of companies that do not adequately satisfy environmental, social and governance (ESG) standards—hence the title of her speech, “Scarlet Letters.” According to Peirce, in today’s “modern, but no less flawed world,” there is “labeling based on incomplete information, public shaming, and shunning wrapped in moral rhetoric preached with cold-hearted, self-righteous oblivion to the consequences, which ultimately fall on real people. In our purportedly enlightened era, we pin scarlet letters on allegedly offending corporations without bothering much about facts and circumstances and seemingly without caring about the unwarranted harm such labeling can engender. After all, naming and shaming corporate villains is fun, trendy, and profitable.” Message delivered.

Peirce’s views should not come as a surprise. You might recall that, at the December meeting of the SEC’s Investor Advisory Committee, Peirce opined that the acronym “ESG” stands for “enabling shareholder graft.” (See this PubCo post.) She has also criticized institutional investors (and specifically CII) for advocating ESG disclosure regulation. She remarked that, notably, the SEC did not sign up to the recent statement on ESG investing issued in January by The International Organization of Securities Commissions, which “directed issuers to consider whether ESG factors—which are not defined—should be included in their disclosures, endorsed the use of private disclosure frameworks purportedly designed to get at these factors, and suggested that some disclosures now being made voluntarily under these frameworks should be incorporated into these disclosures.” Peirce objected to the statement because she viewed it as “an objectionable attempt to focus issuers’ on a favored subset of matters, as defined by private creators of ESG metrics, rather than more generally on material matters.” U.S. securities laws focus on “materiality,” and ESG disclosure requirements could well be outside the scope of that concept. In Peirce’s view, requiring “disclosures aimed at items identified by organizations that are not accountable to investors unproductively distracts issuers.” She believed that the SEC should focus its efforts on its core mission of “protecting investors, facilitating capital formation, and fostering fair, orderly, and efficient markets”; to do otherwise would be a distraction. (See this PubCo post.)

So while her views may sound distinctly, um, inhospitable to ESG, to put it mildly, at their core, they do reflect the view of a significant segment, which is that ESG should not be wielded as a tool to impose one’s “values” on companies where the impact may be detrimental to shareholders; rather it should be a driving force only to the extent that it is expected to have a positive effect on shareholder value.

In his opening statement at the Investor Advisory Committee, SEC Chair Jay Clayton observed that demands for ESG information have increased and, in response, many companies have voluntarily increased the amount of ESG information they disclose. In providing this information, Clayton advised, companies “should focus on providing material disclosure that a reasonable investor needs to make informed investment and voting decisions based on each company’s particular facts and circumstances.” Likewise investors—principally asset managers—should also focus on each company’s particular facts and circumstances. Importantly, he stressed that these advisers should not put their own interests in ESG or other matters before those of their clients. If investors integrate ESG into their strategies, they should make sure that the material facts about the strategy are disclosed. Although some market participants have called for companies to follow designated frameworks to increase comparability, “that does not mean that issuers should be required to follow these frameworks in order to comply with SEC rules.” The standard frameworks may not fit the circumstances of each company or industry, but that doesn’t mean that they don’t add value to the mix of information. Rather, Clayton suggests, their value is analogous to that provided by “appropriately presented non-GAAP financial measures and key performance indicators (KPIs).” (See this PubCo post.)

In Peirce’s view, the governance category of ESG has some recognizable “concrete markers, such as whether there are different share classes with different voting rights [or] the ease of proxy access,” but the environmental and social categories are “more nebulous. The environmental category can include, for example, water usage, carbon footprint, emissions, what industry the company is in, and the quantity of packing materials the company uses. The social category can include how well a company treats its workers, what a company’s diversity policy looks like, its customer privacy practices, whether there is community opposition to any of its operations, and whether the company sells guns or tobacco. Not only is it difficult to define what should be included in ESG, but, once you do, it is difficult to figure out how to measure success or failure.” To the extent that some ESG issues may have a material financial impact, there is little controversy that those issues should be disclosed, not because of ESG, she contends, but because they are financially material. However, she maintains, the “ESG tent seems to house a shifting set of trendy issues of the day, many of which are not material to investors, even if they are the subject of popular discourse.”

While there are a number malefactors at work here—Peirce names developers of ESG scorecards, proxy advisors, investment advisers, shareholder proponents, non-investor activists and governmental organizations—the primary instigators, she argues, are “non-shareholder activists—the so-called stakeholders—who identify the controversial issues du jour. Other people quickly heed their call to action.” Also substantially at fault are the “self-identified ESG experts that produce ESG ratings. ESG scorers come in many varieties, but it is a lucrative business for the successful ones. The business is a good one because the nature of ESG is so amorphous and the demand for metrics is so strong. ESG is broad enough to mean just about anything to anyone. The ambiguity and breadth of ESG allows ESG experts great latitude to impose their own judgments, which may be rooted in nothing at all other than their own preferences. Not surprisingly then, there are many different scorecards and standards out there, each of which embodies the maker’s judgments about any issues it chooses to classify as ESG.”

The proliferation of ESG scorecards, and the confusion they can create for investors, is also discussed in this WSJ article. While investors flock to companies that align with their values on ESG, according to the article, identifying those companies has become complicated—the many tools and raters available “may be obscuring, instead of illuminating, the path to righteous investing….The flurry of firms attempting to grade companies on ESG factors, and the dizzying array of techniques and methodologies used to arrive at those scores, has led to mixed signals in the marketplace.”

The results offered by ratings providers and companies can sometimes be erratic: “ESG-scoring firms often rely heavily on information that companies voluntarily disclose in annual sustainability reports, which can be inconsistent across sectors or even within a single company year to year. Scoring firms try to find uniformity across industries by supplementing company reports with information gleaned from analysts’ own surveys, interviews or online sources. From there analysts apply varying weight to factors they think are most relevant to a given industry. Each firm has its own formula, its own process. The result: a lot of different results.” According to one commentator, some of the assessments are deficient because they don’t take into account factors in the “workplace environment that can be difficult to ascertain from the outside.” To illustrate the problem, one commentator raised by analogy the confusion that would result if there were major disagreements among credit ratings agencies about a corporate bond. And, the article reports, there are at least 200 providers of ESG ratings. This issue is compounded by the wide diversity of methods that companies use to measure their own ESG performance.

The explosion of ratings providers and other players has led some to look to regulators to address inconsistencies. At a meeting in December of the SEC’s Investor Advisory Committee, the Committee members considered whether to recommend that ESG disclosure be required through regulation, continued as voluntary disclosure but under a particular framework advocated by the SEC or continued only to the extent of private ordering as is currently the case. (See this PubCo post. And see this PubCo post regarding a rulemaking petition advocating that the SEC mandate ESG disclosure under a standardized comprehensive framework.)

Notwithstanding the discord in standards, on balance, the article concludes, “reports on companies’ ESG performance still provide useful information, which is why experts recommend looking at multiple ratings for a given company and understanding the underlying methodologies. Following a ratings firm’s analysis of a single company over time also can provide useful insight.” One portfolio manager cited in the article advocated the use of “ESG scores as the first step in a broader analysis of the nonfinancial risks that could have a big impact on a company’s bottom line. ‘You look at various sources of data,’ he says, ‘and then you try to solve the puzzle.’”

Peirce points out that many ratings providers use the data from reports that companies post themselves, but the scoring can be arbitrary, even as the consequences can be serious. An example she gives of arbitrary scoring is that companies may not be credited for conduct that they characterize as a “practice” when the scorer credits only conduct characterized as a “policy.” And a bad rating, she says, “can mean investors shun your stock. When a company has engaged in actual misconduct, this may be the correct result; I am not arguing that any company should get a free pass. When ratings, however, are based on misinformation, the accountability mechanism does not work properly.”

ESG, she reports, is often used, not just in “determining where investment dollars go, but at what cost and on what terms.” Many times, she contends, investment advisers rely on these ESG scorecards to “make decisions about how to vote or what to buy or sell.” While “most investment advisers, in light of their fiduciary duty, want to focus primarily on maximizing the value of their investors’ portfolios, many are also “courting investors, a vocal subset of whom are demanding that their money be invested in accordance with ESG principles.”

Many of the large investment advisers and asset managers have developed their own internal ESG teams and are “elevating ESG in their decision-making.” In fact, she observes, asset managers, such as BlackRock, have advocated that companies recognize their responsibilities to stakeholders beyond just shareholders—to employees, customers and communities. (See this PubCo post.)

The government also fueled the problem, she contends, when it previously determined that investment advisers that followed a proxy advisor’s recommendations had fulfilled their fiduciary duties, thereby effectively entrenching the use of proxy advisors. (That position was subsequently withdrawn. See this PubCo post.) And proxy advisors, such as ISS and Glass Lewis, have expanded their focus beyond governance issues and “have recently made concerted efforts to expand into environmental and social issues.” To win their approval, companies pay attention to their policies and recommendations.

In addition, a number of shareholder proposals, many of which have been submitted by a small group of shareholders, “have pushed companies to focus on ESG issues. Even perennial favorites, such as executive pay, have received an overhaul and now shareholder proposals seek to tie compensation not to performance metrics such as share price, but to ESG metrics.” (See this PubCo post.) International, state and local regulators have also embraced ESG factors.


Of course, in her speech here to the AEI, Peirce is likely preaching to the choir. In prior remarks, former Senator Phil Gramm, now associated with the AEI, complained of organized special interest groups that, because they are unable to convince the legislature or the agencies to adopt laws or rules promoting their views, instead use “intimidation” to impose policies on corporate America that, in Gramm’s view, are not in the interests of shareholders. (See this PubCo post.) In his view, the index funds, a growing category of investment fund, advocated in favor of certain high-profile social issues that have gained public favor strictly as a marketing tool to promote their funds. When investment advisors vote against social issues and are identified as part of the “flat-earth society,” they will see an adverse effect on the marketability of their products. As index funds grow, he predicted, this problem would increase, with the result that we would “undo the Enlightenment” and return to the Middle Ages, where these “leeches” bled business and stopped growth. It’s one thing, he said, for a holder to vote its own shares on social issues, but when voting the shares of others, they should vote only to increase shareholder value. The problem as he saw it was the SEC’s position that allowed index and other investment funds to fulfill their fiduciary responsibilities by following the advice of proxy advisors. (See this PubCo post.)

As the interest in ESG grows, Peirce contends, there have been increasing questions about the impact of ESG on financial results. So far, she maintains, the results are mixed. At the end of the day, investors are “free to invest their money as they wish, but they can only do so if the peddlers of ESG products and philosophies are honest about the limitations of those products. The collection of issues that gets dropped into the ESG bucket is diverse, but many of them simply cannot be reduced to a single, standardizable score. As beautifully simple as it is, a stark letter A does not always serve to convey the truth. The moral authorities of today, like their puritanical forebears, are motivated by a dream of a better society, but methods matter and so do facts. We ought to be wary of shrill cries from a crowd of self-appointed, self-righteous authorities, even when all they are crying for is a label.”