Anti-ESG lawmakers in several states have enacted legislation aimed at restricting investors from considering ESG factors in their investment strategies and decisions. But, as Tara Giunta and Ruth Knox of law firm Paul Hastings explore, definitions of what’s allowed vary from state to state.
Daye S. Cho and Hunter Nagai contributed to this report.
In recent years, environmental, social and governance (ESG) considerations have assumed a distinctly pivotal role in shaping the decision-making processes of sponsors, investors and financial institutions. Proponents of ESG point to the interconnectedness and correlation between companies’ financial performance and its environmental sustainability and social impact. Conversely, the anti-ESG camp views ESG as social engineering or pushing “progressive ideas in society and business.”
State anti-ESG lawmakers have responded by introducing and enacting legislation aimed at restricting investors from considering ESG factors in their investment strategies and decisions, by requiring state financial institutions to account for only “pecuniary” factors in evaluating an investment opportunity and prohibiting or restricting the consideration of any “nonpecuniary” factors.
States have adopted several general approaches to delineating pecuniary and nonpecuniary factors: pecuniary factors defined to include certain ESG considerations; pecuniary factors defined to exclude any ESG considerations; and attribution of nonpecuniary characteristics to an investment decision based on a fiduciary’s statements or membership in ESG-related coalitions, initiatives, agreements or commitments. Notably, the final category raises potential constitutional concerns under the First Amendment, which we explore briefly here.
From an investor’s perspective, this pecuniary vs. nonpecuniary distinction tends to create more questions than answers. While there is a dearth of case law precedent clarifying what may constitute pecuniary or nonpecuniary factors in the context of an investment decision, here we review various state-level anti-ESG laws, federal-level definitions under the Department of Labor’s ERISA rule and legal challenges to some of those approaches, to provide considerations for investors in this dynamic and fraught area.
State approaches to pecuniary vs. nonpecuniary
Pecuniary factors defined to include ESG considerations
The least restrictive definitions of pecuniary and nonpecuniary factors are found in the anti-ESG laws adopted in Arkansas (HB 1253), Montana (HB 228) and North Carolina (HB 750). These three states define pecuniary factors relatively broadly, allowing for circumstances under which ESG considerations may be deemed pecuniary factors.
For example, Arkansas defines “pecuniary factor” as “a factor that has a material effect on the financial risk or financial return, or both, of an investment[.]” In Arkansas, a “pecuniary factor” is distinguished from any “nonpecuniary” factor, defined as “any action taken or factor considered by a fiduciary with any purpose to further environmental, social, political, or ideological goals.” Nevertheless, “an environmental, social, corporate governance, or other similarly oriented consideration” can be a pecuniary factor if it “presents an economic risk or opportunity” that is not primarily related to events “involving a high degree of uncertainty regarding what may occur in the long-term future” or events that are “systemic, general, or not investment-specific in nature.” Hence, an ESG factor may be considered “pecuniary” if it stands to cause an apparent economic impact on an investment decision.
(In the realm of damages, state laws use the term “pecuniary” to generally refer to “tangible, economic losses,” while “nonpecuniary” refers to other types of harms, such as emotional losses and reputational damage. Thus, like in the investment context, the distinction between pecuniary and nonpecuniary in non-investment contexts has been drawn around whether something is “of or pertaining to money.”)
Comparably, the law in North Carolina specifies that the weight given to pecuniary ESG factors “shall solely reflect a prudent assessment of their impact on risk and return.” Reference to terms like “material effect” and “prudent assessment” places the burden on investors to demonstrate the financial “hook” of their ESG considerations, with courts as the final arbiters as to whether investors have met those standards.
Meanwhile, Montana’s anti-ESG law, which contains similar definitions as those prescribed in the laws adopted by Arkansas and North Carolina, is less subtle in that it imposes a relatively more concrete evaluation standard. It adds, “[A]ny pecuniary consideration of environmental, social, governance … must necessarily include evaluating whether greater returns can be achieved through investments that rank poorly on these factors.” Montana law thus appears to impose a higher burden by requiring investors to assess whether greater returns can nonetheless be achieved through investments that underperform in ESG categories, even if other investments tend to rank higher on an ESG scale.
These laws have yet to be litigated. It is nonetheless clear that, while these laws are constructed as inclusive of ESG considerations, they impose at least some affirmative requirements on investors seeking to include ESG considerations in their investment evaluations.
Pecuniary factors defined to exclude ESG considerations
On the other hand, Florida (HB 3) prohibits ESG considerations as nonpecuniary in nature, without caveat. The law states that a “pecuniary factor” means a factor “expected to have a material effect on the risk or returns of an investment[,]” and does not include “the consideration of the furtherance of any social, political, or ideological interests.” Unlike the laws adopted in Arkansas, Montana and North Carolina, Florida does not separately acknowledge circumstances in which ESG considerations may nonetheless have an economic effect on an investment. The bright-line rule in Florida therefore prohibits investors from incorporating any ESG considerations into their investment decisions. As a result, Florida courts will likely expect any investor under scrutiny for violating this law to be able to present an entirely “pecuniary,” non-ESG line of reasoning to avoid liability.
Presumption of nonpecuniary factors
A number of states impose anti-ESG laws even more restrictive than Florida’s bright-line approach. Anti‑ESG laws adopted in Kentucky (HB 236), Kansas (HB 2100) and Indiana (HB 1008) not only identify ESG factors as nonpecuniary but also allow their courts to infer that a fiduciary has considered or acted on such nonpecuniary interest based on extrinsic evidence beyond the investment decision itself. This can come in the form of evaluations of the investment firm’s fiduciary’s statements, communications with portfolio companies and even membership in coalitions, initiatives, agreements or commitments.
Kentucky’s anti-ESG law, for instance, defines pecuniary factor as “a consideration having a direct and material connection to the financial risk or financial return of an investment.” The law states that a nonpecuniary interest includes “an environmental, social, political, or ideological interest.” Notably, evidence that a fiduciary has considered a nonpecuniary “interest” encompasses, among other things, the “coalitions, initiatives, agreements, or commitments to which the fiduciary is a participant, affiliate, or signatory.”
Kansas’s and Indiana’s anti-ESG laws employ the same “interest” language. In Kansas, a pecuniary or “financial” factor does not include “any action taken or factor considered by a fiduciary with any purpose whatsoever to further social, political, or ideological interests.” Indiana also specifies that the term “financial” does not include “an action taken or a factor considered by a fiduciary with the nonfinancial purpose to further social, political, or ideological interests.” However, both anti-ESG laws arguably elevate restrictions on ESG interests beyond that of Kentucky. The concern is that, since both states can use “any action taken or factor considered” as evidence that fiduciary has pursued social, political or ideological interests, any commitment or statement made in support of an environmental and social concern or goal, such as with respect to greenhouse gas emissions or board composition, can be used against them without limitation to infer a violation of this legislation. This expansive language likely grants courts sweeping powers under state law to penalize investors for aligning themselves with ESG initiatives, regardless of whether ESG factors are factually present in any one investment decision.
First Amendment challenges to state anti-ESG measures
While the varying definitions of pecuniary and nonpecuniary factors have not been directly challenged in court, lawsuits have been filed in recent years against other similar anti-ESG measures, signaling a backlash by investors against these restrictions.
For instance, in August 2023, a lawsuit was brought in the Western District of Missouri challenging Missouri’s anti-ESG rules requiring financial services professionals to disclose any use of ESG objectives in their investment decisions. In particular, the rules require any firm that incorporates a social or non‑financial objective into investment decisions to issue their clients a “state-authored” statement that their “investment advice ‘will result’ in advice that is not ‘solely focused on maximizing a financial return.’” The plaintiffs argued, among other things, that the Missouri rules constitute compelled speech in violation of the First Amendment. Namely, the rules force affected financial professionals to characterize their investment strategies as “not solely focused on maximizing a financial return[,] … even in situations where the financial professional does not believe that statement to be accurate.” The plaintiffs further noted that, when the rules were initially proposed as a bill, the bill did not pass at least in part due to First Amendment concerns.
Although voluntarily dismissed, a similar First Amendment challenge was filed in Oklahoma in December 2023, alleging that the state’s anti-boycott law requiring written certifications from financial institutions that they do not boycott energy companies “compel[led] speech, is viewpoint discriminatory, and content discriminatory.”
In light of these constitutional challenges, it remains to be seen whether some of the more restrictive approaches to the pecuniary and nonpecuniary distinction in state anti-ESG laws would survive any future lawsuits employing similar First Amendment arguments about investors’ rights to free speech and association.
Federal approaches to pecuniary vs. nonpecuniary
Beyond the realm of state anti-ESG laws, the distinction between pecuniary and nonpecuniary factors has been relevant in the context of the duties of plan fiduciaries under the Employee Retirement Income Security Act of 1974 (ERISA), under their duty of prudence, which requires plan fiduciaries to diversify plan investments to reduce the risk of substantial losses, unless it is demonstrably prudent not to do so. The statute further requires plan fiduciaries to act solely in the interests of plan participants and for the benefit of the plan beneficiaries.
The term “pecuniary” became a focus when the Trump Administration amended the Department of Labor (DOL) regulations relating to ERISA in 2020. The 2020 DOL rule explicitly required plan fiduciaries to consider exclusively “pecuniary” factors in making investment decisions and exercising shareholder rights. Under the 2020 DOL rule, a “pecuniary factor means a factor that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and funding policy[.]” The 2020 rule also included a so-called tie-breaker rule, which allowed plan fiduciaries to consider “a non-pecuniary factor” only when it could be demonstrated that, “after an evaluation, alternative investments appear economically indistinguishable.”
However, on March 10, 2021, only a few months after the 2020 rule took effect, the Biden Administration launched a reexamination of the rule in one of its first Executive Orders. In December 2022, the DOL released a new rule, which removed the “pecuniary” and “nonpecuniary” nomenclature of the 2020 rule. It explained that there was significant confusion among stakeholders concerning the “appropriate integration of climate change and other ESG factors in investment decisions.” As a result, the term “pecuniary factors” was replaced with the instruction that plan fiduciaries’ investment decisions “must be based on factors that the fiduciary reasonably determines are relevant to risk and return analysis.” Moreover, the 2022 DOL rule modified the language of the tie-breaker rule to replace the term “nonpecuniary” with “collateral benefits”: If a fiduciary “prudently concludes that competing investments … equally serve the financial interests of the plan,” the fiduciary is “not prohibited from selecting the investment … based on collateral benefits other than investment returns.”
Since the 2022 DOL rule came into effect Jan. 30, 2023, it has faced only one direct challenge in Utah v. Walsh, a Texas federal court case where the plaintiffs sued the DOL for forcing them “to expend additional time and resources monitoring … to assure the advisors are focusing only on pecuniary considerations and not collateral ESG factors … and that oil and gas companies will likely be further harmed by decreased interest from investment capital.” In particular, the plaintiffs argued that the plain text of ERISA forecloses consideration of non-pecuniary factors, and the 2022 DOL rule’s replacement of “pecuniary” language makes the rule arbitrary, capricious, and manifestly contrary to the statute.
The Walsh court rejected both arguments, noting that “an ESG factor could be worth consideration” as a pecuniary factor, “even under prior rules if it is expected to have material effect on the risk and/or return of an investment.” The court acknowledged that the 2022 DOL rule still requires that ESG factors must reflect “a reasonable assessment of its impact on risk-return,” and it concluded that the rule “provides that where a fiduciary reasonably determines that an investment strategy will maximize risk-adjusted returns, a fiduciary may pursue the strategy, whether pro-ESG, anti-ESG, or entirely unrelated to ESG.”
This back-and-forth regarding the use of the pecuniary vs. nonpecuniary distinction in the ERISA context is indicative of the larger ongoing debate regarding the general utility of these terms in assessing the legality of fiduciaries’ investment decisions. Should the courts apply the definitions for “pecuniary” and “non-pecuniary” similarly with respect to anti-ESG laws, it is conceivable that these definitions will likely evolve in tandem with shifts in the political landscape. Indeed, in March 2023, Biden issued his first veto on a congressional resolution seeking to override the 2022 DOL rule. The resolution was pushed heavily by then-House Speaker Kevin McCarthy, who had made clear that anti-ESG would remain a policy priority.
Outside of ERISA, there is pending federal legislation that aims to expand the pecuniary vs. nonpecuniary distinction beyond the fiduciaries of employee pension plans. In June 2023, Republican members of Congress introduced the Ensuring Sound Guidance Act, also known as the ESG Act. This bill first proposes to amend the Investment Advisers Act of 1940 (IAA) to extend the pecuniary and nonpecuniary distinction to brokers, dealers and investment advisers registered under the IAA, providing that such service providers can only consider “pecuniary factors” when giving advice or making decisions in the best interests of their clients, “unless the customer provides informed consent, in writing, that such non-pecuniary factors be so considered.” The bill additionally proposes to reinstate the 2020 DOL rule definition for “pecuniary factor” into ERISA and incorporate the term by reference into the IAA. While the ESG Act is the only bill of its kind pending in the House, it is clear from the bill’s construction that Republican lawmakers are looking to mirror the framework of definitions established in the Trump Administration’s 2020 DOL rule and apply it to fiduciaries in other contexts.
Conclusion & key takeaways
The past couple of years have seen momentous evolution in how business leaders and investors view ESG in the context of their corporate strategies and investment decisions. Parallel with this development, however, has been an upsurge in state anti-ESG bills and other related measures across the U.S., directed at counteracting the newfound prominence of ESG-forward investing.
These new anti-ESG laws employ the terms “pecuniary” and “non-pecuniary” factors to distinguish the considerations that investors are and are not legally allowed to factor into their investment decisions. Nevertheless, these terms are not well-defined, and courts have yet to make determinations on the matter. Moreover, this terminology is deeply tied to the shifting political landscape. Thus, affected investors should assess how the current and upcoming administrations could affect the ways in which lawmakers and the courts perceive the role of ESG in the capital market system.
With respect to the ESG landscape, it is important for investors and investment advisers to understand the legal, regulatory and political developments taking place in the jurisdictions where they operate and attract investors. In light of the ongoing proliferation of anti-ESG laws, investors can safeguard themselves by aligning all investment decisions with a strictly financial — or pecuniary — purpose. Where does this leave ESG considerations? To this end, it is crucial that investors are attentive to the growing importance of identifying and assessing — in partnership with advisers and subject-matter experts — the pecuniary impact of ESG factors in their investment decisions.
This article was first published at Paul Hastings.com; it is republished here with permission.
Tara K. Giunta
Ruth Knox
