The Increasing Legal Complexity Surrounding ESG in the US

Kramer Levin Partner Andrew Otis highlights sharp differences between US states on the role of ESG factors in business and investment.

Whether in response to stakeholders, market pressures or legal requirements, many companies are choosing to incorporate ESG factors into their company missions, policies, and governance and management structures. In response to similar pressures, private equity funds and money managers are incorporating ESG factors into investment decisions. While responding to customer or limited partner demand for ESG investments, funds are also looking to ESG-screened investments to outperform other investments because they have identified and better managed macro risks such as climate change and social unrest. Indeed, more than US$500 billion poured into ESG‑oriented investment funds in 2021.[1] And analysts expect global ESG‑oriented assets to exceed US$41 trillion by 2022 and $50 trillion by 2025 — representing one‑third of total assets under management globally.[2]

ESG-aligned states

Consistent with this increased demand, a collection of states have used their resources to promote environmental policies while also seeking to capture the potential benefits of ESG-screened investments. At the same time, however, other states have identified ESG factors as sources of discrimination against their local industry and as a substitution of policy objectives for maximising financial return for investors. As a result, companies, funds and investment managers developing and implementing ESG policies and programmes must understand and navigate this increasingly complex legal landscape.

In particular, many states have enacted laws or other policies requiring state entities to integrate sustainability factors into their investment policies, processes and decisions. For instance, Illinois enacted the Illinois Sustainable Investing Act in 2019. That law required each “public agency or governmental unit” to “develop, publish, and implement sustainable investment policies” that incorporate “material, relevant, and decision-useful sustainability factors”. Those “sustainability factors” include “(1) corporate governance and leadership factors; (2) environmental factors; (3) social capital factors; (4) human capital factors; and (5) business model and innovation factors.” The state pension funds in CaliforniaNew JerseyNew York and Oregon follow similar policies. These funds incorporate ESG factors into their investment decisions.

To take one example, New Jersey’s policy requires that fund managers undertake “an ESG analysis to identify and consider ESG factors that present material business risks or opportunities,” while “giving weight to such factors as is appropriate to the relative level of risk and return involved compared to other relevant economic factors”. These factors include “carbon gas emissions; fossil fuel dependence; climate change; water issues; clean and renewable energy; workforce diversity; fair trade; human rights; fair wages and benefits; working conditions; reporting transparency; executive compensation; equitability of compensation; board accountability and composition; director independence; shareholder rights; auditor independence; voting practices; and accounting practices and policies”.[3]

Other states have passed or introduced legislation designed to divest from industries like fossil fuels. A Maine law precludes state investment in fossil fuel companies altogether. Legislators in New Jersey have introduced a similar bill. Furthermore, companies and funds based or operating in Europe could be compelled under applicable local law to consider ESG factors in investment and/or development and implement ESG policies.

Anti‑ESG states

However, another group of states has developed anti-ESG policies, arguing that pro-ESG policies “discriminate” against fossil fuels and substitute policy objectives for financial return. One group of anti‑ESG states precludes fund managers who invest state money from considering ESG factors. In North Dakota, for example, the law bars investing state funds “for the purpose of social investment”, which “means the consideration of socially responsible criteria in the investment or commitment of public funds for the purpose of obtaining an effect other than a maximised return to the state.” Indiana’s attorney general issued an advisory opinion concluding that existing Indiana law likewise prohibits the state pension fund from basing investment decisions on ESG considerations.

The Florida State Board of Administration, controlled by Gov. Ron DeSantis, recently enacted a resolution directing state fund managers to consider only “pecuniary factors” when making investment decisions, stating that those factors “do not include” — and thus fund managers may not consider — “the furtherance of social, political, or ideological interests”. And Arizona’s state treasurer adopted a similar investment policy requiring managers to consider “pecuniary factors” only, while ignoring “any factor that is intended to further, or is branded, advertised or otherwise publicly described by the offeror as furthering … [i]nternational, domestic, or industry agreements relating to environmental or social goals”, “[c]orporate governance structures based on social characteristics,” or “[s]ocial or environmental goals”.

A second group of anti‑ESG states has passed or introduced laws requiring divestment from companies that “boycott” the fossil fuel industry. Texas enacted the first such law last year. Texas’ first list of companies qualifying for divestment under the law, released in August, included 10 major international financial companies. Three other states — KentuckyOklahoma and West Virginia — have enacted comparable laws.

In five other states – IndianaIdahoLouisianaMinnesota and South Carolina — similar laws are pending. North Dakota has commissioned a study to explore this form of divestiture. And the American Legislative Exchange Council has developed and promoted legislation modeled after Texas’ divestment law.[4] Thus far, only Texas has identified specific companies in which state funds cannot be invested.

States are also attempting to use their law enforcement authority to oppose ESG programmes. In an August 2022 letter (Attorneys General Letter) attorneys general from 19 states accused a well-known investment advisor of appearing “to use the hard-earned money of our states’ citizens to circumvent the best possible return on investment” by using “citizen’s assets to pressure companies to comply with international agreements such as the Paris Agreement that force the phase-out of fossil fuels ….”

These laws and policies create a complicated legal landscape for companies pursuing ESG policies, programmes or investment strategies, especially those that are required to do so by domestic or foreign laws.

A quickly changing legal landscape

As an initial matter, firms should become familiar with the quickly changing legal landscape and understand the extent to which that landscape could impact their business. They should understand the extent to which they do business within or with “anti-ESG states”. They should assess the extent to which their programmes and policies may or may not be subject to the restrictions in the applicable anti-ESG regulations.

As an example, consider Texas’ divestiture law. It applies to companies that “boycott energy companies”. Under the law, to “boycott” an “energy company” means “refusing to deal with, terminating business activities with, or otherwise taking any action that is intended to penalise, inflict economic harm on, or limit commercial relations with a company because the company: (A) invests in or assists in the exploration, production, utilisation, transportation, sale, or manufacturing of fossil fuel-based energy; or (B) does business with a company described by [subpart] (A).”

But — crucially — that action amounts to a boycott only if it was done “without an ordinary business purpose”. That limitation may be key. An ordinary business purpose underlies virtually every decision that an investment company makes. So long as a company had an ordinary business purpose for not investing in a fossil fuel company, it could argue that Texas would lack statutory authority to divest that company. Indeed, investment advisors have pressed that argument in response to the Attorneys General Letter, explaining, for example, that “investors and companies that take a forward-looking position with respect to climate risk and its implications for the energy transition will generate better long-term financial outcomes”. They defended their climate‑risk policies as efforts to “realise the best long-term financial results consistent with each client’s investment guidelines”.

The divestiture regimes in other states have similar provisions. The divestiture statutes enacted in Kentucky, Oklahoma and West Virginia, and proposed in Indiana, Idaho and South Carolina, all contain a comparable ordinary business purpose limitation.

Florida takes a similar but slightly different approach. The Florida State Board of Administration’s resolution requires that investment decisions be based on “pecuniary factors”. The resolution does not specify which “pecuniary factors” investors must consider or over which time frames such factors must be considered. The language implies that investment decisions that were based on maximising return over the long run by excluding fossil fuel companies would not be subject to the resolution’s investment restrictions.

Companies that are implementing ESG programmes — whether in response to stakeholder requests or to comply with legal requirements — and are doing business with or in any of the states that have promulgated or are considering anti-ESG legislation, rules or guidance should consult competent counsel to determine the nature and extent of their legal and business risk and develop effective strategies to mitigate that risk.

[1] ESG outlook 2022: The future of ESG investing, J.P. Morgan Asset Management (Jan. 2, 2022),

[2] ESG May Surpass $41 Trillion Assets in 2022, But Not Without Challenges, Finds Bloomberg Intelligence, Bloomberg (Jan. 24, 2022),

[3] Common Pension Funds Environmental, Social and Governance Policy, State of New Jersey Department of the Treasury, Division of Investment (May 29, 2019), p.3.

[4] Model legislation targets banks that divest from fossil fuel companies, ABC News (Dec. 22, 2021),

This article was co-authored by Alan R. Friedman, Partner, Jason A. Shaffer, Associate, at Kramer Levin.

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