In Texas, ESG Virtue-Signaling Is a Risky Investment

A s the old saying goes, it would take a heart of stone not to laugh. Large financial corporations are now being skewered in the Lone Star State as the anti-oil-and-gun virtue signaling they undertook to attract approval from liberals on Wall Street runs afoul of the pro-oil-and-gun commitments they made to gain access to state contracts in Texas. While the conflict might seem comical, the results will likely mean significant legal headaches for big players like Citigroup in the near future and greater skepticism of environmental, social, and governance (ESG) investing going forward.

Reuters reported recently that officials in the Fort Worth, Texas, field office of the Securities and Exchange Commission (SEC) have been sending inquiry letters to banks doing business in that state. The letters are part of their process of verifying that firms are living up to the ESG virtue tests that they have set up for themselves. Some of those firms have publicly announced that they will not engage in business ventures anywhere that promote fossil-fuel development or the sales of firearms — popular institutional orientations for the politically correct business crowd. The problem is that the state of Texas won’t let such firms do things like underwrite state and local bond issues unless they publicly promise not to boycott oil and firearm companies.

This obviously puts such firms in an awkward position. Less obviously, it also puts the SEC, now led by Biden appointee Gary Gensler, in new territory as well. Rather than merely cheerlead the adoption of ever more woke corporate policies (of which Commissioner Allison Herren Lee has been an especially enthusiastic supporter), they’re now policing — and potentially punishing —those firms that make the most strident ESG claims. That shifts the regulatory dynamic significantly.

Last year, for example, the SEC created a new task force within its enforcement division to “proactively identify ESG-related misconduct.” This includes policies and statements that are considered “greenwashing,” i.e., that mislead investors by making a firm appear more environmentally aligned than it really is. The agency even went so far as to solicit “tips, referrals, and whistleblower complaints” related to potential ESG chicanery. Many ESG claims, such as a company being “responsible” and “proactive” on climate change, are essentially non-falsifiable. Public declarations like those required to do business in Texas, in contrast, are more specific and potentially actionable by the SEC, especially given how broadly the agency has been reimagining its enforcement powers over the last year.

I wrote about this dynamic for Fortune last May, making (what I assumed was) a rather obvious point: While the SEC’s enforcement task force was considered a “pro-ESG” policy move that took the policies seriously, it was likely to have a chilling effect on the adoption of such policies moving forward. Just as supply-side economists like to remind us that taxing something ends up producing less of it, so responding to bold corporate ESG claims with investigations and potential enforcement actions will likely result in fewer of those pledges. For years, advocates of politicized investing have claimed that the progressive approach was all about reducing and mitigating investment risk. But what we have now is a corporate counsel’s worst nightmare — a scenario in which the trendiest business practices of the day are directly amplifying a firm’s reputational and legal risk.

That the chance of this happening has substantially increased because of regulations originating in Texas is especially interesting. The home of the Alamo is such a large market that, like its evil twin California, it can set de facto rules for the rest of the country. Educational policy experts, for example, have complained for decades that state officials in Texas have unfairly skewed the market for public-school textbooks. The author of a 2020 article in the Washington Post went so far as to claim that “conservative activists in Texas have shaped the history all American children learn”. This may have been an exaggeration, but it was certainly not a compliment. Exaggeration or not, we can expect that state laws targeted at woke investing in places like Texas and Florida will likely have a much larger impact than those in, say, Mississippi and Wyoming, will all due respect to the patriotic legislators of Jackson and Cheyenne.

But while conservative political operatives may be licking their chops at the prospect of sticking it to left-wing financiers based in New York City (especially given the forecasts for the 2022 midterm elections), we would all be better off without having to engage in such a conflict in the first place. If large financial institutions would adopt a “back to neutral” stance on divisive and controversial political campaigns — such as attempting to starve U.S. energy and firearms companies of capital — defensive policies like those in Texas would never have been necessary.

Also, the SEC is not wrong to police ESG claims that are actually misleading and fraudulent, as even Republican commissioner Elad Roisman suggested in a 2020 speech. But we wouldn’t need to send politically motivated ESG claims through the clunky federal government fact-checking process if CEOs stopped acting like woke social-media influencers, eager to stake their firm’s reputation on the latest activist demand.

Not every firm is going to end up being caught between a rock and a Texas-style hard place. But over the coming year, it is almost certain that more companies are going to end up being subjected to “Were you lying then or are you lying now?”–type inquisitions. Progressive commitments, adopted in haste amid fawning news coverage, will be repented amid uncomfortable questions about whether the company has lived up to its lofty public rhetoric. If any of these firms had listened to the many free-market advocates who warned them about getting into this mess in the first place, I might even feel bad for them.