A new report from Life:Powered, a national initiative of the Texas Public Policy Foundation, finds that state pension systems, while for the most part not actively promoting environmental, social, and governance (ESG) investing, are still being pushed into ESG trends by proxy voting advisory service firms like Glass Lewis and Institutional Shareholder Services (ISS).

ESG scores are essentially a risk assessment mechanism increasingly being used by investment firms and financial institutions that forces large and small companies to focus upon politically motivated, subjective goals that often run counter to their financial interests and the interests of their customers. Companies are graded on these mandated commitments to promote, for example, climate or social justice objectives. Those that score poorly are punished by divestment and reduced access to credit and capital.

“Proxy voting” refers to the process by which shareholders in a corporation can vote on company matters such as the election of directors, executive compensation, mergers and acquisitions, corporate governance policies, and shareholder proposals such as on environmental policy or “sustainability” practices without attending a shareholding meeting in person. Shareholders can appoint a proxy—often a person or entity—to cast their votes according to their instructions.

However, the report notes, “in recent years, environmental activists have taken advantage of this process to insert their politics into corporate decision-making. They do this by purchasing stock in public companies and forming coalitions with other shareholders to introduce shareholder resolutions and nominate new board members, copying the decades-old practices of activist hedge funds. But unlike the hedge funds of old, these activists are operating not under a financial rationale but under a political rationale, attempting to influence companies to support progressive policies on issues ranging from climate change to abortion. It is rational for companies to weigh in on policies and regulations that directly affect their finances and their ability to do business. But, while the activists usually claim there is a financial rationale for their actions, forcing actions on issues that are so far removed from a company’s balance sheet detracts from the ability of executives to make decisions that will produce the highest financial returns for their shareholders.”

Glass Lewis and ISS hold more than 90 percent of the market share for proxy voting advisory services and, according to the report, “have become major ESG promoters because the increasing number and complexity of shareholder resolutions from ESG activists increases the demand for proxy advising and related services.”

While some state public pension systems like the California State Employees’ Retirement System (also known as CalPERS) and California State Teachers’ Retirement System (CalSTRS) have rushed headlong into ESG investing, most have not. Still, many have been passively advancing these ESG investing trends due to proxy advisers like Glass Lewis and ISS. This is concerning because public pension systems are some of the largest institutional investors in the world, with assets north of $5.8 trillion.

The report lists five ways legislators can push back against ESG and activist investing, starting with “clearly [defining] in statute that ESG investment strategies and ESG shareholder resolutions run counter to the fiduciary duty of state pensions and should be avoided in all forms.”

Legislators should also look to “revoke all proxy voting authority that has been given to outside investment managers and third-party firms, unless those managers offer voting policies that enable state pensions to vote against ESG shareholder proposals” and “require state officials and outside managers to vote any shares held by state pensions solely in the financial interest of the beneficiaries of such funds.”

Lastly, legislators should “determine a process for auditing and overseeing the proxy voting practices of state and local pensions and outside managers, with a focus on examining board elections and proxy votes that run counter to management recommendations,” and also task “a review board or auditing committee with regularly surveying and reporting on the proxy votes of state and local pensions and provide reporting tools that enable the attorney general to quickly investigate and prosecute fiduciary violations in investments and proxy voting.”

“In addition to ensuring that state pensions are not supporting ESG activism through their proxy voting and investment practices,” the report concludes, “states need to develop other tools to mitigate the potential harm ESG practices can create for their taxpayers, pensioners, and businesses. Numerous industries, from energy to firearms to private prisons to agriculture, are being targeted by ESG activists and should be incorporated within the framework of legislation that prohibits state entities from doing business with firms that engage in such boycotting and sanctioning practices. Coordinated boycotts by insurance companies, ratings agencies, and other financial services providers should be investigated under existing antitrust laws.”

By clarifying the fiduciary duties of their state’s pension fund managers, and by insisting that maximizing the return on investment for clients be their only guiding principle, legislators can help ensure the long-term fiscal health of their state’s pension systems and make sure that promises proffered to state pensioners will be kept.

Heartland Impact can send an expert to your state to testify or brief your caucus; host an event in your state; or send you further information on a topic. Please don’t hesitate to contact us if we can be of assistance! If you have any questions or comments, contact Cameron Sholty, at csholty@heartlandimpact.org or 312/377-4000.