!is paper defends the validity of ESG Investing (Environmental, Social, Governance Investing) as an advisor’s "duciary responsibility.# !e "nancial industry is increasingly including ESG considerations when calculating the intrinsic value of a stock. In opposition to this valuation trend, nineteen state attorney generals (the Nineteen) have attacked ESG, challenging its legality by claiming that it violates state and federal law and the "duciary responsibilities that hold investment advisors accountable to their clients.# A$er identifying key elements of "duciary responsibility that are being ignored by the Nineteen’s position, several key and relevant United States statutes are reviewed and applied to their argument.# In doing so, it becomes evident that the Nineteen do not have the best interest of investors in mind not only because they violate key "duciary elements but also because their position would prevent investors the opportunity to bene"t from higher yielding Return on Equity portfolios. Aisthesis Volume 14, 202333 Defending ESG Fiduciary Duty by Katherine Held 1. Introduction Environmental, Social, Governance (ESG) investing is a method of investment screening that factors in sustainability and the societal impacts of a business. !e “E” captures factors of natural resources; “S” includes management of human capital, treatment of non-human animals, and the impact on external stakeholders; and “G” pertains to stakeholder well-being and how well a business follows local, national, and international laws. Although the term “ESG” is relatively new, valuing how a company impacts stakeholders traces back several centuries ago. Starting with religious groups to now in%uencing mass audiences, this buildup of ethical investing has carved ESG into what it is today. Despite this build, nineteen Attorney Generals are arguing against ESG. In 2022, these “Nineteen”1have argued that ESG hinders the best possible return and is acting against a client’s best interests. !rough evaluating the Investment Advisers Act of 1940, the Employee Retirement Income Securities Act (ERISA) of 1974, and the Dodd Frank Wall Street Reform and Securities Act, these laws specify who an investment adviser is and how an investor ful"lls "duciary duty. 1 Alabama, Arizona, Arkansas, Georgia, Idaho, Indiana, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Mon- tana, Nebraska, Ohio, Oklahoma, South Carolina, Texas, Utah, and West Virginia Many other papers have focused on the environmental, social, governance impacts of a business. ESG has the potential to mitigate several staggering outlooks. !e World Economic Forum anticipates that the top 5 risks to the global community are 1) climate action failure, 2) weapons of mass destruction, 3) biodiversity loss, 4) extreme weather, and 5) water crises.2 !e “E” in ESG reduces 1,3,4, and 5. For the “S,” ESG can incentivize companies to humanely source their labor. Globally, there are an estimated 168 million people involved in child labor, and over half of the 168 billion are engaged in hazardous work that puts their health and safety at risk. !rough global supply chains, these business risks are attributed to 12 million deaths every year.3 For “G,” the McKinsey & Company found that large portions of Earnings (EBITDA) are at risk for the following sectors: banks (50%), automotive, aerospace and defense, tech (50%), transport, logistics, infrastructure (45%), telecom and media (40%), energy and materials (35%), 2 World Economic Forum, “!e Global Risks Report 2020,”www.weforum.org/reports/the-global-risks- report-2020. 3 Charter for Compassion, “Human Rights in Supply Chains (Human Rights Watch),” 2022, charterforcompas- sion.org/human-rights-in-supply-chains-human-rights- watch-cci. Defending ESG Fiduciary Duty Aisthesis Volume 14, 202334 resources (30%), and consumer goods (25%).4 Other papers have dived deeper and have demonstrated the environmental, societal, and governmental necessity for ESG. Nevertheless, this paper does not revisit a more comprehensive rationale for pursuing ESG investments but focuses on rebutting the claims of the Nineteen. Speci"cally, ESG aids investors by mitigating risk and diversifying investment portfolios. !e discussion of ESG with clients does not con%ict with the "duciary duties of investment advisers. Most importantly, by analyzing data from the S&P 500 index, this paper shows how ESG not only bolsters a portfolio for long-term success but does not produce lower returns than a standard5 portfolio. Rather, a portfolio that includes ESG criteria has the potential to earn higher returns. !e rest of the paper is organized as follows. Section 2 discusses the Anti-ESG coalition and the actions of the Nineteen in greater detail. Section 3 discusses how ESG coheres with an investment adviser’s "duciary duty. Section 4 then examines how stocks scoring highly on an ‘ESG’ index perform in terms of their Returns on Equity, showing that they generally do not perform worse and o$en perform better. A conclusion follows. 2. Anti-ESG Coalition In 2022, the Nineteen publicly criticized ESG Investing on multiple occasions. In May 2022, Kentucky Attorney General Daniel Cameron’s o&ce published the Opinion of the Attorney General OAG- 22-05. !e document states, “!ere is an increasing trend (ESG Investing) among some investment management "rms to use money in public and state employee pension plans— that is, other people’s money—to push their own political agendas and force social change.”6 !e article then questions 4 Witold Henisz, et al., “Five Ways !at ESG Creates Value,” McKinsey & Company, June 23, 2021, www.mckinsey. com/capabilities/strategy-and-corporate-finance/our- insights/"ve-ways-that-esg-creates-value?cid=soc-web. 5 Standard indicates that ESG criteria is not included 6 Kentucky Attorney General O&ce, OAG, and Daniel Cameron, “Opinion of the Attorney General,” accessed June 23, 2022, www.ag.ky.gov/Resources/Opinions/Opin- ions/OAG%2022-05.pdf. if ESG is consistent with Kentucky and federal law. Referring to ESG mitigating climate change, Kentucky speculates that it could violate the law. Kentucky then joined forces with the other Attorney Generals to form a coalition against ESG. In August 2022, the Nineteen sent a letter to Larry Fink, the CEO of BlackRock Inc. !is was in response to a letter that BlackRock sent to various chief executives. BlackRock is the world’s largest investment management company overseeing $10 trillion in assets. In the letter sent to executives, Fink stated that BlackRock will increase ESG considerations when evaluating and recommending investments. !is increase in ESG aligns with BlackRock’s goal to operate under the targets of the Paris Agreement. One of the targets is to limit global warming to less than two degrees Celsius.7 In the Nineteen’s letter, they articulate, “Based on the facts currently available to us, BlackRock appears to use the hard-earned money of our states’ citizens to circumvent the best possible return on investment, as well as their vote.”8 !ey voice that BlackRock is exploiting citizens’ assets to pressure companies to comply with international agreements like the Paris Agreement. !e Nineteen write that they believe the Paris Agreement will phase out fossil fuels, increase energy prices, drive in%ations, and weaken the United States’ national security. !e Nineteen believe that by aiming for the targets set by the Paris Agreement, investment "rms breach neutrality, their duty of loyalty, and their duty of care. !e Nineteen speculate that "duciary duty is not satis"ed since BlackRock is circumventing the best possible return on investment and not discharging their duties in the interests of the bene"ciaries. In the same month, the Nineteen started legal proceeding against ESG by serving a Civil Investigate Demand against seven banks.9 !ey subpoenaed information speculating a breach of "duciary duty through ESG implementation. !e Missouri Attorney General states, “We are leading a coalition 7 CFA Society United Kingdom, ESG Investing, 2022, pp. 1–312. 8 Ken Paxton, “BlackRock Letter,” received by Laurence Fink CEO, Aug. 4, 2022. 9 Bank of America, Citigroup, Goldman Sachs, JP Mor- gan Chase, Morgan Stanley, and Wells Fargo Defending ESG Fiduciary Duty Aisthesis Volume 14, 202335 investigating banks for ceding authority to the U.N., which will only result in the killing of American companies that don’t subscribe to the woke, climate agenda.”10 !e seven banks are members of the Net- Zero Banking Alliance. !e initiative accelerates and supports the implementation of decarbonizing strategies. Each of the seven banks signed a Commitment Statement agreeing to “transition all operational and attributable GHG (greenhouse gases) from our lending and investment portfolios to align with pathways to net-zero.”11 !e Nineteen are citing a breach of "duciary duty for implementing ESG. !is coalition believes that ESG can only earn lower returns and that ESG investing violates "duciary duty. 3. ESG, Risk, and Fiduciary Duty A. ESG and Risk Investors utilize ESG to correctly identify, evaluate, and price companies. For example, if an investor determines that two companies have roughly the same expected return, the investor could turn to ESG to determine the risk of a company. If a company heavily pollutes, has high employee turnover, or does not follow regulations, the risk of that company increases. Since the investor is anticipated to earn the same return with a lower risk, they would opt for the less risky, more ESG stock. !e higher the risk, the more likely the stock will encounter large dips in stock price. Larger dips require more return to make it back to the “initial stock price.” In a case where a client cares solely about return, and not about the environment or the impact on people, they would still bene"t from the less-risky, more ESG stock. Asset managers attempt to mitigate risk and build their clients’ portfolio for long-term success. ESG has revolutionized the landscape of the investment world. ESG recognizes the direct relationship that adequate natural resources, healthy human capital, and law 10 Yudi Sherman, “19 Attorneys General Launch Investigation into Banks Pushing ESG,” America's Frontline News, Oct. 2022, americasfrontlinenews.com/ post/19-attorneys-general-launch-investigation-into- banks-pushing-esg. 11 United Nations Environment Programme Finance Initiative, “Net-Zero Banking,” www.unep".org/ wordpress/wp-content/uploads/2021/04/UNEP-FI- NZBA-Commitment-Statement.pdf. designed for the betterment of communities have on the viability of business. Before this recognition, many investors only considered direct and short- term "nancial results. Now, however, investors are still looking at "nancial returns (short and long- term) while also evaluating how a business builds itself to be sustainable and viable for the long-run. In 2019, the Global Impact Investing Network (GIIN) published “Sizing the Impact Investing Market.” !eir report estimated that there is $502 billion in the global impact investing market. In the annual GIIN survey, they discovered that 66% of investment "rms are pursuing ESG while simultaneously earning competitive, market rate returns.12 From ESG’s roots to a multi-billion-dollar industry, ESG is anticipated to expand even more because of increased demands of clients. It is essential for an investor to understand how committing to the laws governing "duciary duty interplay with ESG. B. Fiduciary Duty Fiduciary duty is de"ned as “a person or organization that acts on behalf of another person, putting their clients’ interests ahead of their own.”13 !eir duty preserves good faith and trust. A person in the role of a "duciary is bound legally and ethically to serve in the best interest of their client. Of the many elements encompassed in "duciary duty, the following three are particularly relevant to this paper’s analysis: 1) Recognition that every investor is di'erent, with their own set of goals, values, and desired outcomes. Investment should be done in concert with the client’s goals, not despite them. 2) Investment should be done in good faith with the hope that the businesses or industries invested in will be on-going concerns in one year, "ve years, ten years, and "$y years. If this is not factored into the investment decision, it 12 Global Impact Investing Network, “Annual Impact Investor Survey 2019,” US AID, thegiin.org/assets/ GIIN_2019%20Annual%20Impact%20Investor%20Sur- vey_ExecSumm_web"le.pdf. 13 Julia Kagan, “Fiduciary De"nition: Examples and Why !ey Are Important,” Investopedia, accessed Jan. 17, 2023, https://www.investopedia.com/terms/f/"duciary.asp. Defending ESG Fiduciary Duty Aisthesis Volume 14, 202336 puts into question the abilities of the businesses’ management and their ability to think long-term for the good of the company and its shareholders. 3) It is critical to use the most accurate data for investment decision. Once the goals of the client are understood, the most accurate data for investment decision should be utilized. If the data does not include a full cost accounting of doing business, it over-in%ates all Net Revenue and Equity calculations thereby falsely raising an investment’s return. Leading the "nancial investment world is the Chartered Financial Analyst (CFA) Institute. !e CFA is the most highly respected designation in the "eld. Standard III.A. of the CFA Institute Code of Ethics requires that “Members and Candidates must act for the bene"t of their clients and place their clients’ interests before their employer’s or their own interests.”14 Albeit broad, the CFA Institute alludes to three US laws that investors must follow. !ese laws include the Investment Advisers Act of 1940, the Employee Retirement Income Security Act of 1974 (ERISA), and the Dodd-Frank Wall Street Reform and Consumer Protection Act. !e Investment Advisers Act of 1940 de"ned who an investor is and their required standard of conduct. Under the act, “‘Investment adviser’ means any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.”15 !e Investment Advisers Act elaborates the role of an adviser by de"ning the Standard of Conduct: “!e Commission may promulgate rules to provide that the standard of conduct for all brokers, dealers, and 14 CFA Institute, “Fiduciary Duty: Fiduciary Standard & Regulations,” www.cfainstitute.org/en/advocacy/issues/ "duciary-duty#sort=%40pubbrowsedate%20descending. 15 US Government Publishing O&ce, “Investment Advisers Act of 1940,” Gov Info, www.govinfo.gov/ content/pkg/COMPS-1878/pdf/COMPS-1878.pdf. investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the "nancial or other interest of the broker, dealer, or investment adviser providing the advice.”16 !e act further speci"es that client consent is needed on all "nancial transactions. !e Investment Advisers Act de"nes an investment adviser as one who manages the assets of their client. !eir role is to provide the best level of care possible. !e client must be made aware of all actions within their portfolio. !e second law that the CFA refers to is the Employee Retirement Income Security Act (ERISA) of 1974 housed under the Department of Labor (DOL). Under ERISA, a "duciary investor must “act prudently and must diversify the plan’s investments in order to minimize the risk of large losses.”17 !e DOL states that "duciaries that do not follow these principles of conduct are personally liable to recover any of the clients’ losses. Under ERISA, investors must plan into the future for a successful portfolio while simultaneously diversifying the portfolio and mitigating risks. Another law created in the wake of a "nancial crisis is the Dodd-Frank Wall Street Reform and Consumer Protection Act. !e act seeks to ensure the "nancial safety of Americans by increasing the "nancial stability of major "rms, establishing the Consumer Financial Protection Bureau, and integrating credit ratings. Dodd-Frank built upon the Investment Advisers Act by making more stringent requirements on "nancial disclosures. While Dodd- Frank radically changed the "nancial sector, the subcategory, “Study and Rulemaking Regarding Obligations of Brokers, Dealers, and Investment Advisers,” is under review. In this section, Dodd- Frank states, “Nothing in this section shall require a broker or dealer or registered representative to have a continuing duty of care or loyalty to the customer a$er providing personalized investment advice 16 US Government Publishing O&ce, “Investment Advis- ers Act of 1940.” 17 United States Department of Labor, “Fiduciary Responsibilities,” www.dol.gov/general/topic/health- plans/"duciaryresp. Defending ESG Fiduciary Duty Aisthesis Volume 14, 202337 about securities.”18 !e CFA rebuts that this ruling is unworkable, and that the SEC would revise the extent of "duciary duty in the summer of 2017. Since the summer of 2017, advocates for “full-term” "duciary duty have been met with persistent opposition. Debates about the role of a "duciary a$er the initial transaction is still ongoing. !e CFA states that they had hoped the situation would have been resolved but support the underlying objective of the DOL which is to serve the client in their best interest.19 !e Nineteen fail the Investment Advisers Act of 1940 and ERISA if investors are no longer allowed to implement ESG. Under the Advisers Act, a client must be made aware of all actions in the portfolio and must give their consent to investment advisers to make any decisions in the portfolio. Investment advisers are therefore required to disclose if ESG is part of their valuation. Clients, with their own money, should have the right to decide whether their portfolio should include ESG. By taking away that choice, the Nineteen are grossly overreaching their governmental authority. It is not the investment adviser who makes the "nal decision in absence of their client, but rather, it should be a joint decision made in concert with the clients’ goals and values. ERISA states that an investor must act prudently and diversify their client’s portfolio. To act prudently means to show thought for the future. To diversify a portfolio means to mitigate risk and protect the assets in the portfolio. ESG measures a company by their risk potential. Companies with a lower ESG score have higher risk for the client’s assets. By investing in ESG companies, investors are mitigating the risks their clients could encounter if they do not include ESG considerations. Avoidance of these risks diminish the likelihood of various crises from happening to the client. 4. ESG Returns !e largest component of the Nineteen’s points of contention is that ESG Portfolios have lower returns than a standard portfolio. In this section, a company’s ESG score is compared to its Return on Equity (ROE). If the claims of the Nineteen ring 18 US Government Publishing O&ce, “Dodd-Frank Wall Street Reform and Consumer Protection Act,” Gov Info, https://www.govinfo.gov/content/pkg/COMPS-9515/ uslm/COMPS-9515.xml 19 CFA Institute, “Fiduciary Duty: Fiduciary Standard & Regulations.” true, then companies with higher ESG scores should have had lower ROEs. Instead, results will show that ESG portfolios do not underperform standard portfolios. Rather, ESG portfolios can experience higher returns than a standard portfolio. To come to this conclusion, S&P 500 companies’ annual Return on Equity (ROE) ratios are compared to their respective Bloomberg ESG Score from 2009 to 2021. !e S&P 500 was chosen because it is the most watched sector "lled with many recognizable company names. !e ROE ratio was selected because this ratio measures how pro"table a company is and how e&ciently the company makes those pro"ts. Essentially it measures the amount of pro"t per each dollar of shareholder’s stock. Bloomberg ESG Scores were chosen because this ESG score represents how transparent a company is regarding ESG criteria. While Bloomberg scores are not a true re%ection of how eco-friendly, socially responsible, or law abiding a corporation is, the sectors that typically are known for pollution and human rights violations in supply chains do not have high ESG scores because they are more resistant to share their disclosure scores. !ere are also many third-party, independent ESG rating companies. Since there is not one universal standard for ESG currently, Bloomberg ESG scores represent the most standardized of the rating systems. Bloomberg arrives to their "nal score through metric measurements and a yes/no system. “E,” “S,” and “G” are weighted equally. For example, for every “yes,” the company receives a point. Under Environmental, a company’s air disclosure score includes Nitrogen Oxide Emissions, VOC Emissions, Carbon Monoxide Emissions, Particulate Emissions, and Sulphur Dioxide/Sulphur Oxide Emissions (see the appendix for a complete scoring list). Based on emissions metrics, the company receives a score. !e Air Quality score represents 4.78% of the overall ESG Score amongst the other 95.22% weighting. We also collect data on ROE scores when reported.20A$er excluding companies without a ROE ratio and/or a Bloomberg ESG Score, 5,968 points of data were analyzed. Next, the S&P 500 was subdivided into eleven sectors to account for industry di'erences in ROEs 20 Some companies within the S&P 500 companies did not have reportable ROE scores, such as McDonalds in 2016, as its shareholder’s equity is a negative number due to share buybacks (McDonalds 2016 10K Report), thereby creating a negative ROE. Defending ESG Fiduciary Duty Aisthesis Volume 14, 202338 following MSCI’s Global Industry Classi"cation System (GICS).21 Table 1 shows the relationship between ROE on the ESG score for a particular sector. !e coe&cient estimates show when the regression between ESG and ROE is positive or negative. Most entries show a positive, albeit weak, association between the ESG score of a stock and its ROE. An example is the Consumer Discretionary sector as seen below. !e only sectors with negative slopes are communication services, energy, and materials. No negative correlation generally arises. Moreover, many observations lie well o' the regression line, showing that other factors besides ESG meaningfully contribute to the stock’s ROE. In summary, no general evidence arises that stocks with high ESG scores underperform. While the Nineteen claim that incorporating ESG into a client’s portfolio hurts the return, ESG does not lower returns but could increase returns. Figure 1 and 222 21 Communication Services, Consumer Discretionary, Consumer Staples, Energy, Financials, Industrials, Info Tech, Health Care, Materials, Real Estate, and Utilities 22 Bloomberg, "Annualized Return on Equity and Bloomberg ESG Disclosure Score for S&P 500 December 31, 2009-December 31, 2021," accessed October 2022. Table 123 Conclusion !e Nineteen’s position that ESG is against the "duciary duties of an investment advisor is built on false premises. It makes several key assumptions that %y in the face of "duciary duties and sound advice. First, it assumes that all investors are the same and that it is the advisor’s money to invest, not the investor’s money. Second, if they are successful in making it illegal to invest in higher ESG companies, it is a gross over-reach of government interfering with that should be a free-market system that would allow choice. !ird, if their de"nition of "duciary duty is simply to get the highest return for the client, their calculations are based on incomplete information since the "nancial ratios do not consider a full accounting of the costs of doing business. ESG plans for long-term success, mitigates risk, and outperforms portfolios without ESG considerations. For an investor to ful"ll "duciary duty, an investor must consider ESG. ESG guidelines are in the best interest of a client and therefore should play an active role in "duciary duty. ESG bene"ts the environment, stakeholders within the supply chain, employees, the clients and yes, even the Nineteen. 23 Bloomberg, "Annualized Return on Equity and Bloomberg ESG Disclosure Score for S&P 500 December 31, 2009-December 31, 2021." Defending ESG Fiduciary Duty Aisthesis Volume 14, 2023 Appendix Bibliography Bloomberg. "Annualized Return on Equity and Bloomberg ESG Disclosure Score for S&P 500 December 31, 2009-December 31, 2021." Bloomberg LP. Accessed October 2022. CFA Institute. “Fiduciary Duty: Fiduciary Standard & Regulations.” www.cfainstitute.org/en/advoca- cy/issues/"duciary-duty#sort=%40pubbrowse- date%20descending. CFA Society United Kingdom. ESG Investing. 2022, pp. 1–312. Charter for Compassion. “Human Rights in Supply Chains (Human Rights Watch).” 2022. charterforcompassion.org/human-rights-in- supply-chains-human-rights-watch-cci. Global Impact Investing Network. “Annual Impact Investor Survey 2019.” US AID. thegiin.org/ assets/GIIN_2019%20Annual%20Impact%20 Investor%20Survey_ExecSumm_web"le.pdf. Henisz, Witold, et al. “Five Ways !at ESG Creates Value.” McKinsey & Company. June 23, 2021. www.mckinsey.com/capabilities/strategy-and- corporate-"nance/our-insights/"ve-ways-that- esg-creates-value?cid=soc-web. Kagan, Julia. “Fiduciary De"nition: Examples and Why !ey Are Important.” Investopedia. Accessed Jan. 17, 2023. https://www.investopedia. com/terms/f/"duciary.asp. Kentucky Attorney General O&ce, OAG, and Daniel Cameron. “Opinion of the Attorney General.” Accessed June 23, 2022. www.ag.ky.gov/ Resources/Opinions/Opinions/OAG%2022-05. pdf. Paxton, Ken. “BlackRock Letter.” Received by Laurence Fink CEO, 4 Aug. 2022. Sherman, Yudi. “19 Attorneys General Launch Investigation into Banks Pushing ESG.” America's Frontline News, Oct. 2022. americasfrontlinenews.com/post/19-attorneys- general-launch-investigation-into-banks- pushing-esg. United Nations Environment Programme Finance Initiative. “Net-Zero Banking.” www.unep".org/ wordpress/wp-content/uploads/2021/04/UNEP- FI-NZBA-Commitment-Statement.pdf. United States Department of Labor. “Fiduciary Responsibilities.” www.dol.gov/general/topic/ health-plans/"duciaryresp. US Government Publishing O&ce. “Dodd-Frank Wall Street Reform and Consumer Protection Act.” Gov Info. https://www.govinfo.gov/ content/pkg/COMPS-9515/uslm/COMPS-9515. xml US Government Publishing O&ce. “Investment Advisers Act of 1940.” Gov Info. www. govinfo.gov/content/pkg/COMPS-1878/pdf/ COMPS-1878.pdf. World Economic Forum. “!e Global Risks Report 2020.” www.weforum.org/reports/the-global- risks-report-2020. 39 Defending ESG Fiduciary Duty Aisthesis Volume 14, 2023 Bloomberg ESG Scoring Criteria 40 Defending ESG Fiduciary Duty Aisthesis Volume 14, 2023 Source: Bloomberg, "Annualized Return on Equity and Bloomberg ESG Disclosure Score for S&P 500 December 31, 2009-December 31, 2021," accessed October 2022. 41