Law firms in Indiana and across the globe are seeing increasing demand for legal advice on initiatives that measure corporate responsibility in the areas of environmental impact, social concerns and corporate governance.
Known as ESG, these measurements—combined with more conventional data, such as profit margins and debt load—are used by some investors and investment funds to determine (among other factors) if a company is worthy of investment or acquisition.
“We were seeing more and more companies that were trying to measure their impact, not just through financial returns, but through other sorts of reporting, such as their environmental or social impact,” said Russell Menyhart, partner at Taft Stettinius & Hollister.
According to a survey of American and European lawyers by the Dutch information services firm Wolters Kluwer, demand for such services is on the rise.
For instance, 45% of surveyed firms said demand from their corporate clients for ESG guidance increased over the past year. About 59% expect it to continue to increase over the next three years, despite rising political opposition from some conservative Republicans who call the ESG concept “woke.”
“To get some idea of the scope of the opportunity, take a look at some of the massive investments being made by global professional firms such as Deloitte, which is investing $1 billion in its climate and sustainability practice, and PwC, which said it expects ESG revenue to grow 10 times over the next few years,” said Mark Segal, founder of the news site ESG Today.
“Like any other professional service with a high level of expertise, companies will likely need to use external legal advice to deal with ESG-related issues, as most companies won’t have the internal capabilities to deal with many of the complexities in this new, emerging area,” Segal said.
Menyhart said ESG work at his firm first received a bump in 2016 when Indiana became the 30th state to enact a benefit corporation statute.
Benefit corporations are for-profit entities that are also structured to provide some specific public benefit that creates a “material positive impact on society and the environment.” This created a rather obvious opening for law firms engaged in facilitating ESG work.
“Five or six years ago, we set up our own group, the Responsible Business and Impact Investing Group,” Menyhart said. “One of the reasons that caused us to found that here in the Indiana office was the benefit corporation legislation.”
The questions his clients come to him with are endless. What are the recognized standards for ESG reporting? Are there environmental certificates they should acquire? How is reporting on various ESG issues accomplished? On and on.
“Everything from individual companies to investment funds want to have ESG policies drafted,” he said. “So we help them with their internal compliance policy. Companies have such policies in other realms already, such as health and safety. We help them put together internal compliance policies for ESG.”
Stacia Buechler, also a partner at Taft and chair of its Commercial Transactions Practice Group, said ESG has implications across many areas of law.
“This started to become something that became appropriate for us to really start thinking about across all different kinds of practice areas—to have every lawyer in the firm be adept at spotting these kinds of issues for clients. Because it’s really just helping our clients solve problems and become more sustainable,” Buechler said.
While ESG investing has never been hotter, it’s also never been more controversial. Lauded by some as a concrete way to invest ethically, it’s seen by others as a pointless, potentially damaging distraction that has no place in sound business calculations.
“Simply identifying what ESG means is one of the key issues facing this area, and it has been since its inception,” said Bruce White, a partner at Barnes & Thornburg who works intensively in the ESG area.
“The definition problem has become one of our larger problems, because it seems to constantly expand,” he added. “Some people are making a significant effort to focus and redirect the definition in order to create a more meaningful, workable framework. On the other hand, a lot of folks are bringing in numerous other factors that expand the perceived definition far beyond what it was originally.”
In the past, most individual investors, financial services corporations and pension fund managers parked their cash in businesses based solely on the likelihood of their offering a solid return. But the concept of “responsible investing” has been growing in popularity for 20 years, with many eschewing investments in businesses such as arms manufacturers or tobacco companies.
The idea also has expanded hugely and can take in everything from diversity strategies to whether a firm maintains an ethical supply chain to what it’s doing to fight global warming. The list can seem literally endless.
“There are actually opposing forces now who want to kind of trim it down, and there are other people who just want to keep making it bigger, and [the two sides are] just kind of at loggerheads,” White said.
Charles Baldwin, managing director of Ogletree Deakins, said ESG arose from the financial industry.
“They started saying, ‘We think if you focus on certain things, like environmental concerns, it will add shareholder value.’ And then they started saying, ‘What about better governance, in terms of how the corporate board is set up and things like that?’”
Baldwin said that, in the case of his law firm, ESG really took off a couple of years ago, when the Biden administration changed SEC guidelines to force companies to respond in a more substantive way to shareholder proposals that addressed sensitive issues. Companies had to defend a rejection with hard data, and that required outside legal expertise to help those companies gather the relevant metrics.
“Shareholders with a certain interest could make proposals,” Baldwin said. “For instance, if it seems like you’re having too many harassment cases, they could advocate that the company do an audit of the issue and perhaps look at all kinds of other human-capital-type issues. The companies could no longer just say, ‘Nah, you’re micromanaging the management team. That’s not our job.’ They had to offer a plan or take the question to a vote, and some of the big companies lost some of those votes.”
Indiana, Baldwin said, was somewhat slow to the ESG party—in part because the state doesn’t host all that many corporate headquarters. Now, however, even private Hoosier companies are asking for legal guidance for their own ESG programs. The main reason, of course, is money—or rather, the ability to lay hands on it.
“Banks are starting to ask for your ESG ratings,” Baldwin said. “I think you saw it a little later here, just because you can count the big, publicly traded companies with Indiana headquarters on one hand, or maybe two. We’re a labor and employment firm, so we focus on the human capital piece. We’ll be told that they have to report something in their annual report about diversity, equity or inclusion. They want us to help analyze that data and prepare for it.”
The firm also helps companies respond to shareholder proposals, including such issues as benefits, executive compensation, pay transparency, equal pay and labor relations. The 2022 Dobbs decision by the U.S. Supreme Court, which did away with Roe v. Wade and kicked the responsibility for abortion laws back to the states, also generated many quandaries.
“A lot of issues came up over the question of whether you can offer benefits that allow employees to go out of state to get health care treatment,” Baldwin said. “A lot of it came up in these shareholder proposals or in other ways that fell into the ESG bucket.”
Companies planning to purchase another company (or those seeking buyers), along with pension funds looking to invest, are also calling for ESG documentation as part of due diligence before signing off on a deal. And the government is turning the screws by requiring companies to offer data on their supply chains.
“A lot of the laws that have been passed in the last 10 or 20 years increasingly push companies to adopt a sort of ESG perspective on their supply chain,” said Menyhart, the Taft partner. “They can’t just turn a blind eye to where goods are coming from anymore.”
For instance, the recently passed Uyghur Forced Labor Prevention Act is designed to keep goods made by forced labor in China’s Xinjiang Uyghur Autonomous Region from making it into the United States, or into the supply chains of U.S. companies.
“U.S. Customs and Border Protection is actually detaining a lot of shipments at the port of entry,” Menyhart said. “They’re telling U.S. companies, ‘You need to give us documentation to show that you are not impacted by forced labor.’ And that’s a hard thing to do. It means that companies have to start thinking about this in advance. How do we make sure we have a responsible supply chain, so we know where our products come from? They can’t just say, ‘We’re buying it from an import-export company in Shanghai,’ and not worry about what’s happening further down the chain.”
Compliance on issues like these can sometimes leave businesses between a rock and a hard place.
Political opposition to ESG also continues to rise.
The Republican supermajority at the Indiana Statehouse last April passed a bill aimed at preventing the managers of the state’s government employee pension funds ($45 billion) from placing money with firms that factor ESG into their investment decisions.
“Our concern is when these large asset managers on Wall Street are using their outsized market power to force decisions on companies when it’s not best for them,” Republican Rep. Ethan Manning, the bill’s sponsor, told the Associated Press.
According to the environmental consulting firm Pleiades Investing, Republican lawmakers in 37 states (so far) have introduced 165 bills designed to prevent government pension funds and contracts from going to entities that make decisions based on ESG.
States joining Indiana in passing anti-ESG laws are Texas, Utah, Florida, West Virginia and Kentucky. Utah has passed multiple laws that prevent state and local governments from contracting with financial firms that boycott such industries as fossil fuels and firearms.
The critics’ case against ESG was bolstered this year as rising oil prices hurt the financial performance of many ESG funds that eschewed energy companies tied to rising carbon emissions.
Menyhart sees the controversy over ESG as something of a non-issue, at least among the companies he serves.
“I don’t see a lot of clients saying that they’re having to choose between being a profitable business and having ESG,” he said.
According to international statistics compiled by NAVEX Global, 88% of publicly traded firms and roughly two-thirds of private companies have put ESG initiatives in place. Furthermore, according to statistics from the asset management firm Capital Group, 89% of investors consider ESG at some level when making investment choices.
White said that while the United States quibbles about whether ESG should even be a “thing,” Europe is moving to more comprehensive guidelines. He said American companies, if they wish to acquire overseas investment, will have to follow suit.
“I’ve spent a fair amount of time writing about the program that we have in Europe, and the program that is in place in the United States,” White said. “Europe is 10 to 15 years ahead of the U.S. on ESG and sustainability. We’ve always wanted to lead in the capital markets area, but right now the rest of the world’s moving on, and we’re trying to catch up.”
The ongoing debate has led to an interesting case of rebranding. A survey of transcripts of S&P 500 companies’ earnings-conference calls from March 15 to June 9 of this year revealed that only 74 actually used the term ESG. In the fourth quarter of 2021, the number of references peaked at 156. However, while saying “ESG” might be falling out of favor, the actual practice continues apace.
“There’s a growing sense that ESG is a terrible term because it covers way too much,” David Meadvin, CEO of corporate strategy firm Day One, told the online news site Axios. “What you’ll see is a lot of companies and CEOs try to unpack that term with more focus on specific, highly defensible, highly beneficial efforts that they’re continuing to roll out.”
This isn’t the first time the term for this sort of thing has evolved, noted Buechler, the Taft partner, pointed out.
“You probably remember the days when companies talked about corporate social responsibility,” Buechler said. “But you don’t really hear about CSR today. Instead, it’s ESG. And that will evolve into something else.”•