SEC Commissioner: Big Asset Managers’ ESG Practices May Violate Exchange Act Section 13(d)
On November 17, 2022, in public remarks delivered in Washington, D.C., SEC Commissioner Mark T. Uyeda argued that the ESG activities of large asset management firms may be in breach of Section 13(d) of the Securities Exchange Act of 1934, an important federal securities law requiring disclosure of certain material information that American shareholders and investors have a right to know. While Commissioner Uyeda did not reach a definitive conclusion and carefully stated that he was speaking for himself, not the Commission, his arguments are, in our opinion, convincing.
Overview of Section 13(d)
Section 13(d) of the Exchange Act requires anyone who acquires more than a five percent share of a publicly held company to file a report with the Securities and Exchange Commission. 15 U.S.C. § 78m(d). The acquiror must disclose not only the acquisition itself, but also all trades in the relevant securities made in the previous sixty days, 17 C.F.R. § 240.13d-101, item 5(c), as well as the acquiror’s intentions with respect to the company, including any plans relating to, or participation in any transactions relating to, a change in the company’s directors, a material sale of company assets, or any “other material change in the issuer’s business.” Id. § 240.13d-101, item 4. An updated 13(d) disclosure must be filed every time the acquiror’s holdings change by more than one percent of the acquired company’s stock. Id. §240.13d-2(a).
Asset management firms are covered by Section 13(d), and their ownership percentage in any given company is not measured on a fund-by-fund basis, but rather is totaled across all their funds and portfolios. Thus under Section 13(d), a large asset management firm such as BlackRock—which owns more than 5% of more than half of all publicly held companies in the United States, including more than 95% of companies on the S&P 500—is in principle required to file disclosures with respect to thousands of companies, disclosing any plans they may have to effect material changes in a company’s business, for example through ESG-related proxy voting or through closed-door communications with company executives—communications that asset managers engage in frequently but the details of which they do not typically disclose.
However, large asset managers such as BlackRock do not comply with Section 13(d). Instead they report their 5% ownership interests on Schedule 13G, an alternative and much less onerous disclosure form first created in 1977, which does not require reporting of prior trades or of the acquiror’s intentions, and needs to be updated only once a year.
But Schedule 13G is limited in its applicability. Acquirors of more than 5% of a company can take advantage of the less-demanding Schedule 13G if and only if their shareholding has neither “the purpose nor the effect of changing or influencing the control of the issuer.” 17 C.F.R. § 240.13d-101.
In other words, by reporting their over-5% holdings on Schedule 13G, rather than complying with Section 13(d), large asset manager firms such as BlackRock, State Street, and Vanguard claim that: (a) they have no intent to change or influence control of the companies at issue; and (b) their exercise of their shareholder prerogatives does not have the effect of changing or influencing control of the companies at issue. But these firms’ efforts—often successful—to push the ESG agenda on corporate America belie such claims. Through their ESG-promoting activities, including proxy voting and so-called corporate “engagement,” firms such as BlackRock appear clearly to have both the purpose and effect of influencing control of companies within the meaning of Section 13(d).
Definition of “Control”
As defined by SEC regulations, with specific reference to the disclosure requirements set forth in Section 13, “control” means “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a [company], whether through the ownership of voting securities, by contract, or otherwise.” 17 C.F.R. § 240.12b-2 (emphasis added). Under this definition, the pro-ESG activities of asset management firms such as BlackRock almost certainly have both the purpose and the effect of changing or influencing control.
Asset Management Firms’ ESG Activities Violate Section 13(d)
Many may assume that the ESG activities pursued by large asset management firms such as BlackRock, Vanguard, and State Street consist simply of offering ESG investment funds to investors interested in promoting ESG objectives. That is not the case.
All of the Big Three asset managers have made “firmwide commitments” to ESG. See, e.g., BlackRock 2020 Sustainability Disclosure, at 6, https://perma.cc/4HE5-6DXH (disclosing BlackRock’s “firmwide commitment to integrate ESG information into investment processes across . . . all of [its] investment divisions and investments teams”). Such “firmwide” ESG commitments extend not merely to offering ESG-themed products to interested investors, but also to advancing the ESG agenda throughout all of these firms’ investment platforms and portfolios, including—significantly—in their so-called “passive” index funds.
In the case of index funds, asset management firms like the Big Three promote the ESG agenda through two primary mechanisms: (1) shareholder proxy voting and (2) corporate “engagement,” defined by Vanguard as “[d]irect contact with companies to discourage undesirable corporate behavior.” These “direct contact[s]”—typically high-level in-person conversations or phone calls with corporate officers—often take place behind closed doors, and the specifics of these communications are typically undisclosed to outsiders.
Through both mechanisms, ESG-promoting asset managers use their power as “shareholders in an attempt to . . . promote what they consider to be the right public policy. This takes place through dialogue with officers and proxy voting.” Again, asset managers who engage in these ESG-promoting practices—such as BlackRock, Vanguard, and State Street—admit that they do so throughout all their investment portfolios, including their nominally “passive” index funds. With their roughly $20 trillion in assets under management, the Big Three control a staggering sum of investment capital—the “equivalent of more than half of the combined value of all shares for companies in the S&P 500.” Due to this extraordinary economic power, ESG-promotion by firms like BlackRock can and does have a profound impact on company management and policy all across America, often at odds with the best financial interests of the company and its shareholders.
For example, in 2021, an environmental activist group holding a minuscule number of Exxon shares nominated a slate of new Exxon directors committed to reducing oil production. While some may believe that eradicating fossil fuel consumption is a noble goal, it is hard to see how reducing oil production is in the best financial interests of an oil company. Nevertheless, the Big Three asset management firms voted their proxies in favor of the activist directors, and as a result the activists won, causing Exxon subsequently to cut oil production, thereby reducing the company’s revenues and probably contributing to the eventual significant nationwide increase in gas prices.
This result is disturbing not only because it is a prime example of ESG-promotion by BlackRock and other major asset management serving to further social or political goals at the expense of shareholders and investors. It is also concerning because oil projects abandoned by Exxon can be picked up by rival companies like PetroChina, the Chinese national energy company—one of whose largest private shareholders happens to be BlackRock. There is no record evidence that BlackRock notified any shareholders or any of its investor-clients of this serious potential conflict of interest—i.e., that Exxon’s loss could be BlackRock’s gain.
In other examples of ESG initiatives seemingly at odds with the best interests of shareholders and other investors, the Big Three voted their proxies to cause Chevron to adopt Scope 3 emissions rules and to cause Apple to engage in a company-wide “racial audit.” But as with Exxon’s environmental activist directors, the Big Three never publicly disclosed their plans to bring about these material changes in the companies’ management and business policies, because they never filed disclosure reports under Section 13(d).
In addition to proxy voting, the Big Three also use corporate engagement to bring about ESG outcomes—and often they use a combination of corporate engagement and proxy voting. Commissioner Uyeda’s description is accurate and detailed:
In reviewing any large asset manager’s stewardship website, mentions of ESG seem ubiquitous, from voting guidelines to engagements statistics. The information on these websites often document how an asset manager (1) establishes its expectations for ESG matters, (2) engages with companies that aren’t meeting its expectations, and (3) may vote against one or more incumbent directors if those companies do not continue to meet expectations. For example, an asset manager publicly disclosed a case study where, following multi-year engagements, it voted against a director of a public company, who also chaired the board committee overseeing ESG matters, because the company had failed to disclose its forward-looking GHG reduction targets. This is one of many instances in which an asset manager did not support the election of a director on the basis of climate-related issues.
Such pro-ESG initiatives at a particular company, involving a contested election of directors and/or significant business policy decisions, would appear clearly to be intended to influence “the direction of the management and policies of a [company], whether through the ownership of voting securities, by contract, or otherwise,” 17 C.F.R. § 240.12b-2, and hence to qualify as an effort to influence “control” of the company within the meaning of Section 13(d).
SEC Staff Guidance Is Not to the Contrary
In an informal 2016 question-and-answer guidance document, the SEC’s corporate finance division opined that “[g]enerally, engagement with an issuer’s management on executive compensation and social or public interest issues (such as environmental policies), without more, would not preclude a shareholder from filing on Schedule 13G so long as such engagement is not undertaken with the purpose or effect of changing or influencing control of the issuer.” But this staff guidance, as Commissioner Uyeda notes, “does not answer the question. The guidance merely reiterates that the asset manager cannot take any action with the purpose or effect of changing or influencing control” (without subjecting itself to Section 13(d)’s disclosure requirements). Moreover, the guidance says that engagement “without more” does not preclude filing a Schedule 13G. But when asset management firms like BlackRock combine “multi-year engagement” with proxy voting against directors deemed insufficiently committed to the ESG agenda, those firms are doing much more than engagement. They are attempting to influence the company’s “management and policies,” and hence are acting with the purpose or effect of influencing control as SEC regulations define that term, thus requiring compliance with Section 13(d).
Private and State Attorney General Causes of Action
Courts have long recognized that “private parties ha[ve] a private cause of action under Section 13(d).” Jacobs v. Pabst Brewing Co., 549 F. Supp. 1050, 1060 (D. Del. 1982); see, e.g., General Aircraft Corp. v. Lampert, 556 F.2d 90, 94, 96 (1st Cir. 1977); Missouri Portland Cement Co. v. H.K. Porter Co., 535 F.2d 388, 398 (8th Cir. 1976).
In addition, state attorney generals can sue—and have sued—to enforce federal securities laws, either on behalf of their state or a state pension fund. See 15 U.S.C. § 78bb-f(1), -f(3)(B)(1) (disallowing private class actions but preserving the right of “a State or political subdivision thereof or a State pension plan [to] bring an action involving a covered security on its own behalf, or as a member of a class comprised solely of other States, political subdivisions, or State pension plans that are named plaintiffs”). For example, after the financial crisis of 2008, Ohio’s Attorney General filed suit against the Bank of America, leading a coalition of state pension funds in an attempt to recover investment losses from their holdings in Bank of America stock. See also, e.g., Demings v. Nationwide Life Ins. Co., 593 F.3d 486, 493 (6th Cir. 2010) (rejecting individual’s class action securities suit because the individual was not “a state, political subdivision thereof, or state pension plan [suing] on its own behalf”).
In matters involving securities, state Attorneys General may investigate and sue either on federal law grounds—to “enforce federal securities law”—or on state law grounds, for example to enforce state consumer protection or fraud laws. See 15 U.S.C. § 78bb-f(4) (“The securities commission (or any agency or office performing like functions) of any State shall retain jurisdiction under the laws of such State to investigate and bring enforcement actions.”). “In securities fraud litigation,” “any state [may] sue pursuant to its own laws so long as one of its citizens purchased the implicated securities.” A well-known example is New York’s groundbreaking 2008 campaign against Wall Street, in which former Attorney General Eliot Spitzer relied on a state anti-fraud statute to launch a successful, wide-ranging investigation into the relationship between investment banks and stock analysts.
For the foregoing reasons, we believe that the Section 13(d) argument raised by SEC Commissioner Uyeda is correct. ESG-promoting proxy voting and corporate engagement activities by large asset management firms such as BlackRock, State Street, and Vanguard are manifestly designed to significantly affect a company’s “management and policies,” and hence would seem clearly to be undertaken with the purpose and/or effect of influencing “control” as that term is defined under Section 13(d) of the Exchange Act. Moreover, these firms have admitted that their “firmwide” commitments to ESG involve pressing the ESG agenda not only on companies in their explicitly ESG-themed investment portfolios, but on all companies whose shares they own, including shares held in supposedly “passive” index funds. Accordingly, firms such as BlackRock, State Street, and Vanguard are in violation of their Section 13(d) disclosure obligations with respect to every company in which they own an over 5% share, and state Attorneys General may bring suit to remedy this breach.
 U.S. Securities & Exchange Comm., Nov. 17, 2022, https://www.sec.gov/news/speech/uyeda-remarks-cato-summit-financial-regulation-111722 (remarks of Comm. Uyeda at Cato Summit on Financial Regulation).
 See John Morley, Too Big To Be Activist, 92 S. Cal. L. Rev. 1407, 1424 (2019).
 See id. at 1425.
 See, e.g., Bismarck Brief, BlackRock’s Close Relationship with the U.S. Government, Nov. 2, 2022, https://brief.bismarckanalysis.com/p/blackrocks-close-relationship-with. And BlackRock is not even the largest shareholder of the greatest number of S&P 500 firms. Vanguard is. See Investor’s Business Daily, One Investor Is The Largest Owner Of Two-Thirds Of U.S. Companies, Aug. 15, 2022, https://www.investors.com/etfs-and-funds/sectors/sp500-one-investor-is-the-largest-owner-of-two-thirds-of-u-s-companies (“Vanguard is now the No. 1 owner of 330 stocks in the S&P 500”).
 Vanguard, ESG, SRI, and Impact Investing: A Primer for Decision-Making, Aug. 2018, at 4, https://perma.cc/42T2-K35T.
 Javier Al-Hage, Fixing ESG: Are Mandatory ESG Disclosures The Solution To Misleading ESG Ratings?, 26 Fordham J. Corp. & Fin. L. 359, 366 (2021).
 See, e.g.,BlackRock, BlackRock ESG Integration Statement, May 19, 2022, at 2, https://www.blackrock.com/corporate/literature/publication/blk-esg-investment-statement-web.pdf (“In index portfolios where the objective is to replicate a predetermined market benchmark, we engage with investee companies on ESG issues”).
 Farhad Manjoo, What BlackRock, Vanguard and State Street Are Doing to the Economy, New York Times (May 12, 2022), https://www.nytimes.com/2022/05/12/opinion/vanguard-power-blackrock-state-street.html.
 See Fintel, BlackRock Inc. ownership in PTR / PetroChina Co., Ltd., Feb. 3, 2022 (reporting that BlackRock owns over 1 trillion shares—or 5.7%—of PetroChina).
 U.S. Securities & Exchange Comm., supra note 1 (citing “BlackRock, available at https://www.blackrock.com/corporate/about-us/investment-stewardship; Fidelity, available at https://www.fidelity.com/mutual-funds/investing-ideas/sustainable-investing/stewardship-report; State Street Global Advisors, available at https://www.ssga.com/us/en/institutional/ic/insights/asset-stewardship-report; and Vanguard, available at https://corporate.vanguard.com/content/corporatesite/us/en/corp/how-we-advocate/investment-stewardship/index.html.”).
 Exchange Act Sections 13(d) and 13(g) and Regulation 13D-G Beneficial Ownership Reporting, quest. 103.11, July 14, 2016, https://www.sec.gov/corpfin/divisionscorpfinguidancereg13d-interphtm.
 For a description of Ohio Attorney General Cordray’s suit, see Margaret H. Lemos, State Enforcement of Federal Law, 86 N.Y.L. Rev. 700, 731 n.149 (2011).
 Lemos, supra, at 731.
 Amanda M. Rose, The Multienforcer Approach to Securities Fraud Deterrence: A Critical Analysis, 158 U. Pa. L. Rev. 2173, 2175 n.7 (2010); see also Michael A. Perino, Fraud and Federalism: Preempting Private State Securities Fraud Causes of Action, 50 Stan. L. Rev. 273, 326 (1998) (“As a practical matter, because issuers cannot prevent the residents of particular states from buying their securities on impersonal national exchanges, corporations will have no choice but to subject themselves to the laws of all states.”).
 See Lemos, supra, at 725.