A new rule requiring investment funds to disclose their environmental, social and governance proxy votes survived a legal challenge by four Republican-led states alleging the US Securities and Exchange Commission mandates would hurt investors and their oil and natural gas industries.
In a May 10 ruling, the US Court of Appeals for the 5th Circuit rejected the states' claims, saying there was no evidence that disclosure of the funds' votes on environmental, social and governance (ESG) issues would have economic impacts.
Unless held up on a possible appeal to the US Supreme Court, the rule known as "Enhanced Reporting of Proxy Votes by Registered Management Investment Companies" will go into effect July 1.
Louisiana, Texas, Utah and West Virginia had argued that funds would pass through costs for the ESG disclosures to investors. The appeals court disagreed.
"[T]here's a difference between theory and practice," the per curiam ruling by three 5th Circuit judges said. "As the states conceded during oral argument, there is no guarantee that regulated parties will always pass costs on to their consumers. Some costs may be too small to warrant a cost pass-through."
The states also argued that the SEC rule violated their "quasi-sovereign" right to protect the economic interest of their citizens, which the court rejected on the same grounds.
The litigation is over an SEC proposal first made in 2021 to amend a form that investment funds must file annually with the agency detailing their proxy voting record, known as N-PX. The new form would require them to categorize their votes by subject matter, five of which included ESG matters.
The final SEC proposal adopted in late 2022 included fewer categories and only four concerning ESG.
Critics had warned that including ESG topics in funds' annual reporting requirements would only serve activists who could pressure funds into voting for ESG measures with little value to investors. That, in turn, would cause fund managers to violate their fiduciary duties to investors, Utah said in comments to the SEC.
The office of Louisiana Attorney General Liz Murrill referred questions about the case to Utah officials; no other states responded to requests for comment. The four states have been vocal opponents and frequent litigants over ESG criteria companies use to assess investment risk and opportunities.
The SEC said the fund proxy vote disclosures would bring more consistency and transparency for investors, part of an ongoing effort by the SEC under President Joe Biden. Another, more high-profile rule, the agency's sweeping climate risk disclosure rule for many publicly traded companies, has been temporarily suspended amid litigation in the 8th Circuit appeals court.
The ruling in Texas v. SEC (No. 23-60079) was handed down by Judges James Dennis, James Ho and Leslie Southwick.