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The pushback against socially conscious investing

Elon Musk has called ESG investing a “scam.” Does he have a point?

We have written previously about the enormous inflows of capital into so-called ESG (“Environmental, Social and Governance”) investing over the past ten years and the challenges ESG investing poses for investors. Over the past two years, we have begun to see pushback against ESG investing on several fronts. The critiques merit a closer look because they further complicate the challenges investors face when trying to decide whether or how to employ ESG criteria in their investment portfolios.

First, let’s revisit what we mean by ESG investing. The conventional approach to investing focuses on maximizing the expected return. For stocks, this approach considers a host of economic and financial factors relevant to a particular company with the aim of determining the intrinsic value of the company’s stock. Stocks whose market price is low, or at least fairly priced with respect to its intrinsic value, should have a high, or at least reasonable, expected return. Stocks whose market price is too high relative to its intrinsic value would have a lower expected return and therefore may not be a good investment.

ESG uses a more expansive notion of value than the expected return. ESG ascribes value to certain moral or ethical principles or policy objectives and then tries to identify “good” companies that align with those values or eliminate the “bad” companies which do not.

The conventional approach to investing aims to maximize the returns to shareholders. The ESG approach aims to maximize the good or benefit for a set of stakeholders broader than the shareholders. Investing to promote the interests of an expansive set of stakeholders as opposed to a narrow set of shareholders is a radically different concept. Some ESG proponents view society as whole as the stakeholders of any company.

Regulatory scrutiny. Recent pushback against ESG investing has come from several directions, one of which is regulatory: The SEC has been scrutinizing the manner in which some ESG funds are packaged and promoted. Several prominent banks are reportedly under investigation or have been fined for what is being called “greenwashing.” Greenwashing refers to providing misleading information about environmental or other ESG-friendly attributes of a fund wherein the investments are not, in fact, consistent with those objectives.

In 2021, the SEC issued its ESG Risk Alert bulletin, which did not attack the merits of ESG investing itself but highlighted some concerns: First, some ESG funds may not be practicing what they preach. The SEC stated: “Actual portfolio management practices of investment advisers and funds should be consistent with their disclosed ESG investing processes or investment goals.”

Second, the SEC highlighted the risk to investors arising from the lack of standardized and precise ESG definitions: “(t)he variability and imprecision of industry ESG definitions and terms can create confusion among investors if investment advisers and funds have not clearly and consistently articulated how they define ESG and how they use ESG-related terms, especially when offering products or services to retail investors.”

Does ESG investing perform well for investors? The implicit promise with ESG investing is that investors can do well (achieve market like investment performance or better) while doing good (advancing ESG goals). The data so far is limited and inconclusive.

In some years (i.e., 2016-2020) ESG funds have done well relative to the broad market largely because they were heavily allocated to tech stocks and tech stocks have done better. More recently, ESG funds have lagged as tech stock have faltered and energy stocks have outperformed. This limited performance history may have more to do with the natural ebb and flow of performance across economic sectors than with the long-term investment merits of the more virtuous ESG stocks. Keep in mind that most ESG funds have a relatively short performance history.

Moreover, there are reasons to be skeptical of the ability of ESG funds to deliver better returns over the long-term. Princeton economist Burton Malkiel has argued that an increase in the demand for ESG funds may cause their share prices to rise and enhance their returns in the short-term. Over the long-term, however, elevated valuations for such funds would mean lower expected returns. ESG funds also typically cost several times more than comparable index funds, creating another hurdle for future performance. According to Malkiel, informed ESG investors should be willing to accept lower, not higher, long-term returns.

Does ESG investing promote “good” outcomes? Does ESG investing change corporate behavior? That is the point after all. Does it advance the objectives it promotes? A study published in 2021, “Do ESG Funds Make Shareholder-Friendly Investments,” examined whether ESG funds in fact selected stocks whose companies had better track records advancing ESG-friendly objectives. The study, published in the Harvard Law School Forum on Corporate Governance, found no evidence that they do.

“We find no evidence that ESG funds’ portfolio firms outperform non-ESG funds’ portfolio firms with respect to most of the measures of stakeholder-centric behavior that we consider in this paper.” The study considered a range of corporate behaviors, including compliance with environmental, labor or consumer laws, and carbon emissions, board composition and other aspects of corporate governance.

The authors concluded that “socially responsible funds do not appear to follow through on proclamations of concerns for stakeholders.” They wrote: “We find that ESG funds’ portfolio firms have significantly more violations of labor and environmental laws and pay more in fines for these violations, relative to non-ESG funds issued by the same financial institutions in the same year. Moreover, we find that ESG funds’ portfolio firms, on average, exhibit worse performance with respect to carbon emissions.”

In an op-ed piece appearing in USA Today, BlackRock’s former Chief Investment Officer for Sustainable Investing, Tariq Fancy, had this to say: “… our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that’s all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community.”

We don’t know whether the authors of the Harvard study or the USA Today op-ed have an ideological or other axes to grind, but their concerns are shared by other prominent figures, including the SEC.

ESG investing has been around for decades but the ESG segment of the markets was a financial backwater for most of its history. At an estimated $40 trillion worldwide, that is no longer the case. You can color this author skeptical that $40 trillion of equity investments are wonderfully ESG compliant.

The critiques presented here are not a conclusive indictment against the idea of ESG investing. Proponents believe that ESG investing is a noble idea; but critics believe that ESG investing is a pernicious attack on shareholder capitalism. As is so often the case, the truth may lie somewhere between the extremes.

Intelligent investing in general demands that investors be informed and careful. In this case, ESG investing calls for an even higher degree of scrutiny and due diligence.

David Peartree JD, CFP® is an investment advisor with Brighton Securities Capital Management. This column is a collaborative work by David Peartree and Patricia Foster, Esq. Patricia Foster is a securities law attorney with substantial experience advising members of the financial services industry. The information in this article is provided for educational purposes and does not constitute legal or investment advice.

IRS, SEC, other regulatory changes may affect your business

If you think accounting firms are simply the closers of books, you may want to think again – more often than not, they are fountains of information. The COVID-19 pandemic showed consumers just how important accounting firms can be in navigating new government regulations and programs – like Paycheck Protection Program loans and the Employee Retention Credit – quickly and adeptly.

Mark Kovaleski, managing partner of the Rochester-based Mengel Metzger Barr & Co. LLP

“There’s been a shift in clients looking to us to provide proactive services, rather than just compliance,” said Mark Kovaleski, managing partner of the Rochester-based Mengel Metzger Barr & Co. LLP a public accounting firm, where he has been a team member for almost twenty-five years. “There’s more of a focus now on being business advisors and providing a business advisory relationship.”

Nancy Catarisano, managing partner of Insero & Co. CPAs, LLP a public accounting firm with locations in Rochester and Ithaca has seen the same trend, noting “Since the pandemic we are doing a lot more advising of companies.”

Nancy Catarisano, managing partner of Insero & Co. CPAs, LLP

With that mind shift, the Rochester Business Journal asked Kovaleski, Catarisano, and other leaders of accounting firms in western New York what new and emerging issues and regulations should be front of mind for businesses right now.

One of the timeliest of these issues, Kovaleski said, was an announcement of failure to file penalty relief by the Internal Revenue Service (IRS) on August 24, 2022, for businesses and individuals who did not file their tax returns on time during the pandemic.

According to, nearly 1.6 million taxpayers will automatically receive more than $1.2 billion in refunds or credits for late filing. The refunds are automatic and most will be completed by the end of September. To qualify for the relief, any eligible income tax return from 2019 or 2020 must be filed on or before September 30, 2022.

The action is designed not only to provide relief to businesses and individuals but to help the agency focus its resources on the handling of backlogged tax returns and taxpayer correspondence with an endpoint of a return to normal operations for the 2023 filing season.

“The IRS is extremely overburdened and overwhelmed right now,” Kovaleski said. “They have millions of tax returns that haven’t been processed yet and this move will help them catch up. It’s a little bit of a reset and opportunity to get the ship righted.”

Another timely issue business owners should be aware of is a new accounting rule from the Financial Accounting Standards Board (FASB) called the Accounting Standards Update (ASU) 2016-02 – Leases or Accounting Standards Codification (ASC) Section 842 – that went into widespread effect on the first of this year.

The FASB is an independent nonprofit organization that serves as the standard-setting body for generally accepted accounting principles in the United States. This new rule requires businesses to record almost all leases longer than 12 months as liabilities. Formerly, operating lease payments were expensed as incurred.

This rule, which is a significant change in the accounting processes realm, was put into effect for public companies several years ago, but private companies did not have to comply until this year, partly due to an extension from the pandemic.

“Anyone who needs a financial statement should be aware of this change,” said Catarisano, who recommends that private business owners talk to their accountant about the lease accounting changes if they haven’t done so already. “While public companies had to do this already, it’s a new rule for private companies and adds another layer of complexity for small business owners.”

An emerging accounting issue business owners will want to keep an eye on are ESG regulations, which are requirements placed on a business by federal, state, or other entities to publicly disclose information about their environmental, social, or governance practices and performance.

In March 2022 the U.S. Securities and Exchange Commission (SEC) proposed rules that would require public companies to share specific greenhouse gas emissions metrics and climate-related financial data in public disclosures. These companies would not only have to share emissions they are responsible for but also (depending on the company’s size) from the upstream and downstream activities of vendors and other third parties connected to the company’s operations.

The comment period for the proposal drew such a heavy response it was extended from its original date in May 2022 to June 17, 2022, instead. No decision has been made by the SEC on the proposed rules yet.

David Hansen, director of risk advisory services for Freed Maxick CPA’s, which has offices in Batavia, Buffalo and Rochester, does not believe the proposed regulations are likely to stand as originally written, but will go forth in some variation and are important to get ahead of now.

David Hansen, director of risk advisory services for Freed Maxick CPA’s

“There is a tremendous amount going on in the ESG area right now and it’s not going to slow down,” Hansen said. “The proposal shows that the investor community is interested in whether companies are following through with ESG practices.”

Freed Maxick’s ESG practice is rapidly developing as several other notable changes and proposals have percolated in the past few years, like New York State’s Climate Leadership and Community Protection Act which was signed into law in 2019 and requires New York to reduce economy-wide greenhouse gas emissions 40 percent by 2030.

And earlier this year the state proposed ESG requirements for the fashion industry via the Fashion Sustainability and Social Accountability Act that would require large fashion retailers and manufacturers doing business in New York to make significant public disclosures about theirs and those in their supply chain’s ESG footprints.

The fashion industry proposal is just another indicator of what may be coming down the pike for other industries. For instance, if your company needs to invest in a new fleet of vehicles soon, you will want to consider the implications when choosing between gas or electric models.

Chad D. Ernisse, a senior manager at Freed Maxick

“The unknown is always scary,” said Chad D. Ernisse, a senior manager at Freed Maxick, who encourages his business clients of all sizes and industries to be proactive and not wait for regulations to start thinking about and incorporating ESG best practices. “A lot of time regulation is viewed as a cost, but it’s also an opportunity.”

Ernisse and Hansen note that there are many doors through which ESG practices can enter a business – regulation being one of them, but another way is customer-driven and customers are increasingly interested and influenced by a business’s ESG choices and how they share them publicly.

“As the laws change it’s going to be important for companies to think upstream and downstream how ESG programs will affect their clients, vendors and the investment community,” Hansen said. “We’re here to help them assess their different programs and how they’re documenting them so that their customers can better understand what they’re doing with ESG.”

Caurie Putnam is a Rochester-area freelance writer.