[co-author: Carson Cox]

Texas Attorney General (AG) Ken Paxton co-signed two letters to Morningstar, Inc. and its subsidiary Sustainalytics, joining multistate investigations into the credit ratings giant, as part of a growing trend among attorneys general and state legislatures to target the use of environmental, social, and governance (ESG) data in financial decision-making.

The lone star state’s AG recently joined an investigation into Morningstar, Inc., a financial services firm providing independent research, ratings, and tools for investment management. Texas AG Paxton states, in no uncertain terms, that companies and ratings agencies cannot violate state and federal laws when deploying ESG tools to the marketplace.

The investigation is led by Missouri AG Eric Schmitt, whose July 26 civil investigative demand opened an inquiry into whether the company’s ESG ratings reports constitute “deceptive, fraudulent, or unfair practices” under state consumer protection acts. Specifically, the letter expressed concern that Morningstar may have misrepresented or concealed material facts in violation of the Missouri Merchandising Practices Act when reporting credit ratings based on ESG metrics to consumers. Schmitt demanded Morningstar identify and produce numerous sets of documents, including “all solicitations or promotional materials … relating to ESG services” and “all policies and procedures … relating to ESG services.”

On August 23, Paxton also joined a Kentucky- and West Virginia-led inquiry into whether Morningstar’s ESG practices run afoul of state laws intended to prohibit state contracts with companies that further the boycott, divestment, or sanctioning (BDS) of goods or services from Israel. Sustainalytics — Morningstar’s ESG ratings and research firm — assigns ESG scores to companies based in part on whether they conduct business activities in regions connected to human rights violations. According to the AGs, the firm relied on biased data that resulted in Israeli companies operating in East Jerusalem, the West Bank, the Gaza Strip, and the Golan Heights being given similar ESG ratings as Chinese and Iranian companies and being placed on a human rights watchlist. The AGs allege this illegally furthered BDS objectives because the ratings influence public and private investment decisions. The letter demanded Morningstar submit a written response to their concerns.

The Morningstar investigations represent a trend among some AGs and lawmakers to scrutinize the use of ESG metrics in the financial services industry, claiming that the metrics violate state consumer protection laws, state and federal law governing the fiduciary duties of investors, antitrust laws, and, as noted above, even laws designed to protect the nation of Israel. Below are some recent examples of this rapidly growing trend:

• Multiple AGs have launched investigations into S&P Global for basing state and state subdivisions’ credit ratings in part on nonfinancial ESG factors;
• opinion that, under Indiana law, investment firms that manage public pension funds may not implement investment strategies that consider ESG metrics;

• Arizona AG Mark Brnovich is investigating whether membership in ESG-focused coalitions like Climate Action 100+ and GFNAZ violates federal antitrust laws;
• State treasurers have blocked firms from bond offerings, barred big banks from government contracts, and pulled investments from asset managers over their ESG plans;
• State legislatures have introduced bills, designating ESG plans disfavored state investments and redefining fiduciary duties to prevent the boycott of fossil fuel companies by prohibiting consideration of ESG investment strategies; and
• State AGs have combined forces to oppose any new SEC disclosure requirements concerning ESG.

There is mounting pressure for the federal government to respond to state efforts and clarify its position on ESG as a metric for investment decisions. A bill that would cement the materiality of ESG metrics to investment decisions and require publicly traded companies to disclose ESG-related data recently passed the House and has been referred to the Senate’s Committee on Banking, Housing, and Urban Affairs.

Our Take

Unless and until the federal government speaks on the issue, the AG inquiries and state legislative activities demonstrate that financial services companies, especially those publishing ratings or managing funds, should cautiously approach the decision of whether to integrate ESG metrics into their financial decision-making. Such companies with ESG plans already in place should familiarize themselves with state laws governing fiduciaries and thoroughly review their data collection and reporting practices to spot any potential claims of bias or misrepresentation.