Best Practices for Boards to Approach ESG Strategies

The politicalization of environmental, social, and governance (ESG) investing has increased dramatically in both the public and private sectors, according to the Harvard Advanced Leadership Initiative Social Impact Review article, “The Politicization of ESG Investing.”

As a result, the board’s role in a company’s ESG efforts has become even more critical: It should balance the company’s business goals with its ESG strategies and also ensure that it meets its fiduciary duty to shareholders. Failure to discharge theses duties properly may subject the company to unnecessary litigation and board members to lawsuits for breach of fiduciary duty. 

On Dec. 11, 2024, the US Court of Appeals for the Fifth Circuit held that the Nasdaq marketplace rules for listed companies requiring disclosure of the racial, gender, and sexual characteristics of their directors exceeded the US Securities and Exchange Commission’s (SEC) authority to approve under the Securities Exchange Act of 1934, as amended. This ruling, effective immediately, removes the requirement that listed companies provide information in its proxy disclosure and information statements as to the above characteristics.

On Nov. 27, 2024, Texas and several other Republican-led states sued investment management companies, including BlackRock and State Street Corp. In the suits, these states allege that large asset managers have violated antitrust laws through climate activism that has resulted in higher energy prices and curtailed coal production which Texas Attorney General Ken Paxton has described “as part of a destructive, politicized environmental agenda.” 

SEC rulemaking and proposed rulemaking on ESG issues have hit snags as state legislation is on the rise. In addition, state officials and commentators claim that some ESG-driven policies have not only lowered investor returns but may also constitute a breach of fiduciary duty. This has created uncertainty regarding the direction of ESG efforts and how boards should approach their own companies’ ESG strategies. 

The lack of standardized measures to assess ESG initiatives is also partly to blame. In March 2024, the SEC adopted rules mandating the disclosure of climate-related risks to a company’s business and board oversight of climate-related risks, as well as the disclosure of greenhouse gas emissions, which would have created a baseline across publicly listed companies. However, those rules were promptly challenged and the SEC has stayed the rules while these challenges make their way through the courts.

As a result of these many factors, investors have started to question the necessity and validity of ESG measures, and certain companies are now dialing back their public ESG commitments. For example, in June 2024, Tractor Supply Co. announced that it was eliminating all positions within the company related to diversity, equity, and inclusion (DE&I) matters, as well as its carbon emissions goals. This came just two years after the organization touted plans to increase the representation of people of color in managerial positions by 50 percent and set a goal of achieving net-zero carbon emissions by 2040. Canada’s six largest oil sands companies eliminated their carbon emissions goals. Nike eliminated dozens of sustainability manager positions, and Shell, Crocs, Google, The Coca Cola Co., and Nestlé scaled back their DE&I and ESG commitments.

Earlier this year, The Vanguard Group, which has more than $10 trillion in assets, announced that it voted against every ESG proposal on shareholder ballots in 2024. More recently, Vanguard announced in November that it will give shareholders the option to put “profits above politics” in 2025 proxy votes. John Galloway, Vanguard’s global investment stewardship officer, said this is being done as “a response to feedback from investors.”

Despite this unsettling pattern, ESG and DE&I issues remain significant risks for many companies, regardless of their specific commitments or initiatives. Many public companies now include ESG or DE&I vulnerabilities in their risk factor disclosures. The reality is that walking back commitments does not reduce the risks, but it may reduce the capital that companies deploy for those matters. 

Still, ESG activities are relevant to many constituencies, including investors, supply chain members, employees, and certain states. There is a generational component to ESG initiatives, with Generation X, millennials, and Generation Z placing greater importance on these efforts than older generations. This suggests that these initiatives are unlikely to disappear entirely. Likewise, insurers are now required to manage the risks of both weather-related disasters that may be the result of climate change and the possibility of claims being brought forth by activist shareholders for regulatory violations, such as the Nasdaq diversity disclosure ruling.

What Is a Board To Do?

In jurisdictions where fiduciary duty is extended only to shareholders, the justification of diminishing profits for ESG priorities becomes difficult. In a 2015 paper, Leo E. Strine, Jr., a former Delaware Supreme Court chief justice, stated, “a clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end.”

Both for those jurisdictions where fiduciary duty is extended only to shareholders and those where it extends beyond this group, it may be time for boards to consider whether current ESG initiatives might be scaled back or at least modified to allow for differing interests, including those of shareholders.

In fact, in recent years, several claims and shareholder proposals alleged that a company either ignored its duty to maximize shareholder value or did not balance the need to maximize shareholder value with its expressed ESG commitments.  As an example, in 2022, the Florida legislature passed a bill restricting instruction of sexual orientation and gender identity in classrooms.  The Walt Disney Company, after initially remaining silent, publicly came out in opposition to the bill following criticism by its employees.  As a result, Florida Governor Ron De Santis threatened to eliminate a special district from which Disney benefitted financially.  Shortly thereafter, a longtime shareholder of Disney made a records request against Disney asserting that the directors breached their fiduciary duty to shareholders by failing to oppose the bill and therefore risking loss of the financial benefits of the special district.  As the court summarized, the shareholder contended that the directors “either put their own beliefs ahead of their obligations to stockholders or flouted the risk of losing rights associated with the special district.”  The suit was ultimately dismissed on other grounds but illustrates the conflicts that boards may be facing. 

It may be possible to scale back the public commitment to ESG efforts and examine each issue as it arises before determining how much emphasis to place on related initiatives. For instance, if a company is considering launching a new product line that promises to be highly profitable but does not necessarily advance its ESG commitments, the board could approve the action as a potentially high-return investment and, at the same time, acknowledge that other efforts outside the proposed initiative may be pursued to advance the company’s ESG commitment, balanced with what is in the best interest of the company.

To address and responsibly react to questions and concerns regarding a company’s ESG and DE&I goals, boards should consider taking the following actions:

• Determine whether state law applicable to the company extends directors’ fiduciary duty only to shareholders or also to other constituencies and analyze what significance or limitations that may create.
• Assess whether there are any activist shareholders that have expressed dissatisfaction with the company’s current policies.

o   If so, consider communicating with the shareholders directly to understand the nature of their discontent before making any decisions. This can include a public statement that the company has communicated with certain shareholders directly and is considering what actions to take as a result.

• Discuss the matters at the next scheduled board meeting and determine whether the company remains committed to its current position.

o   If so, consider making it clear to the public that this commitment is part of the company’s mission and that the company remains committed to the positions it has previously taken.

o   If not, consider carefully how to react. There is a broad spectrum of options from Tractor Supply’s reaction to, for example, a statement that the company is reevaluating its position on these initiatives in light of expressed shareholder concerns.

• Investigate whether the company’s directors and officers liability insurance policy premium is impacted by any ESG initiatives or positions.
• Formulate a plan of action and articulate it clearly to investors and the public. 

o   If the company is changing its prior position, explain why and make it clear that the company is committed to the new direction. If not, reaffirm the company’s positions, but make it clear that the board has thoroughly analyzed and considered new information when arriving at the conclusion to stay the course.

We’ve witnessed an increasing number of challenges to ESG initiatives over the past few years, and directors are being challenged. As Jonathan A. McGowan explains in a 2022 article, “The ambiguity of ESG, and lack of any clear legal definitions or regulatory standards in reporting, is more than just a problem for advocates. It places corporate directors and fund managers in the precarious position where the utilization of ESG and ESG investing is a breach of fiduciary duty, leaving them liable to civil action.” The pushback against ESG and DE&I initiatives has changed the business landscape. Boards should be both nimble and thoughtful in their responses to avoid potential backlash while remaining committed to their strategic goals and initiatives.

Geoffrey R. Morgan is a founding partner of Croke Fairchild Duarte & Beres and serves as head of the firm's securities group. He regularly represents public companies and boards in SEC compliance matters and advises on best practices for corporate governance.