SIFMA, Missouri make their cases in lawsuit over anti-ESG rules

The Securities Industry and Financial Markets Association and the state of Missouri laid out their arguments in court Tuesday in a lawsuit over the state’s year-old environmental, social and governance investment rules.  

Judge Stephen Bough of the U.S. District Court for the Western District of Missouri peppered the parties with questions, often based on his personal investing experience, to illustrate the arguments. Each side has filed summary judgement bids urging the judge to rule in their favor and end the case.

“We’ve spent a lot of time talking about politics in the case,” including about guns and abortion, said Bough, who was the judge in the high-profile class action claim between home sellers and the National Association of Realtors. “I’m worried about how all that kind of plays out when you don’t have enough definition on some of these environmental or social goals.”

SIFMA sued the Show Me State last August over a pair of anti-ESG securities rules that took effect in July 2023. The measures require advisors and broker-dealers to disclose and obtain written consent from customers to buy or sell an investment product based on social or other non-financial objectives.

The annual disclosure requirement includes language that says incorporating ESG considerations “will result” in investments and advice “that are not solely focused on maximizing a financial return for the client.” Client consent in the form of a signature is required every three years.

The rules opened a new front in the national Republican-led anti-ESG battle by attempting to directly regulate asset managers. Previous bills passed to date have regulated state funds or contracts.

Missouri Secretary of State John R. Ashcroft enacted the rules after lawmakers failed to pass a bill with the same goals. SIFMA’s complaint named Ashcroft and Missouri’s Securities Commissioner Douglas Jacoby as defendants. Bough in January rejected Missouri’s request that he toss the lawsuit.

During the Tuesday hearing, SIFMA outlined its argument that the rules are preempted by two federal laws, the National Securities Markets Improvement Act, and the Employment Retirement Income Security Act. The association also claimed the rules violate the First Amendment by requiring firms to adopt and express the state’s position on the “nonfinancial” nature of ESG investing, and are unconstitutionally vague.

“This is a direct and clear First Amendment violation forcing individuals to make political statements that the Missouri [Secretary of State] wants made,” said William Ray Price, with Armstrong Teasdale LLP, on behalf of SIFMA.

These are statements that “the Legislature itself did not want made,” Price added. “This is a rule by one office holder.”

The state’s attorney, Edward Dean Greim of Graves Garrett Greim, argued that broker-dealers and investment advisors are already required to disclose if they use ESG criteria to make investment decisions and that if they do not, the state has the authority to investigate them for what boils down to fraud and deceit.

“If a broker-dealer or an investment advisor is actually using nonfinancial criteria in making recommendations, and that isn’t disclosed to the customer, we would say that is fraudulent and deceitful,” Greim said. “If we have that power, at the very least, we’ve got to be able to inform the public here’s what you can do to avoid fraud and deceit,” he said, referring to the rules.

Bough questioned whether the rule would be triggered if a customer asked the advisor to invest in a pro-gun mutual fund or buy Tesla stock.

If a customer and advisor want to buy those positions because they believe it would enhance financial returns, the rules would not be triggered, Greim said.

“Is the investment advisor recommending these stocks to the client with the purpose of seeking to obtain an effect other than the maximizing of financial returns?” Greim asked. “The whole thing we’re regulating is the intent.”

After the nearly three-hour hearing, Bough thanked the attorneys for their “fascinating” presentations and said he would “get you an order out as soon as we can.”