Since June of last year, Missouri state rules have required broker-dealers to issue scripts stating that investment strategies involving social or environmental objectives “will result” in investments “that are not solely focused on maximizing a financial return.”

Those scripts then had to be acknowledged, approved and signed by their customers.

The Missouri state rules were promulgated by the Missouri Securities Division, a part of the Secretary of State’s office. Penalties for not following the rules could include the loss of registration, a civil fine of up to $25,000 for each violation, and even criminal penalties if the violation was willful.

The Securities Industry and Financial Markets Association (SIFMA) filed suit, arguing that the rules violated the First Amendment because the mandatory scripts would constitute government-compelled speech. It also asserted that the rules were vague, overbroad and preempted by federal securities legislature.

Missouri’s motion to dismiss was denied in January.

Legal arguments in summary

In a 23-page broadside opinion published earlier this month, federal judge Stephen R Bough affirmed all of SIFMA’s complaints, and issued a permanent injunction against the rules.

Let’s look into the legal arguments SIFMA levelled against Missouri.

First Amendment challenge

Commercial speech generally has lesser protections than private expression under the First Amendment. The government can usually require private entities to include disclaimers and qualifications in statements.

However, when compelled commercial speech moves into the realm of controversy and arbitrary preference without solid factual backing, it is reviewed under an “intermediate scrutiny” standard.

Judge Bough found that the rules failed to meet this standard because the use of “will result” created a controversial suggestion that ESG investing is a zero-sum game, where profits are sacrificed for perceived social benefits. He also ruled that the Missouri rules go beyond the minimum requirements needed to prevent fraud or deceit.

This is an increasingly prevalent opinion: prudent ESG investing has been endorsed by some of the financial world’s biggest players as a hedge against social and environmental market entropy caused by unsustainable practices. Under this view, ESG considerations can be incorporated into investment strategies for clients who are interested in long-term security.

Federal preemption

The judge found that the rules were superfluous in intent because federal laws already prohibit financial institutions from placing their own interests ahead of their customers.

He also ruled that ERISA and NSMIA specifically preempt Missouri’s ability to require the scripts, because those laws extensively cover recordkeeping requirements at the federal level and the Missouri rules created new ones.

He further found that ERISA preempts the state rules by comprehensively “mandating what investments may be selected” in a way that conflicts with Missouri’s rules.

Unconstitutional vagueness

The Missouri rules state that “nonfinancial objectives” mean strategies that “obtain an effect other than the maximization of financial return to the customer.”

The judge agreed with SIFMA that this definition was unconstitutionally broad, and could be interpreted to proscribe merely conservative or risk-averse strategies.

Future of anti-ESG policy

Missouri is part of a coalition of Republican-led states that have passed or considered a plethora of laws and rules in the last few years addressing what they consider “woke” hijacking of institutions that create excessive risk for consumers.

But the drive to institute these policies has received significant resistance even from conservative lawmakers who consider it an intrusion into the free marketplace, and anti-ESG legislation has slowed down in 2024. Now that this case has affirmed broad concerns about federal preemption and unconstitutionality in state control of securities law, the status of similar future and pending anti-ESG policies in other states has grown even more tenuous.

And with their emphasis on vitiating “liberal priorities” in fiduciary strategy, anti-ESG legislation often seems more concerned with engaging in hot-button cultural melees than protecting investors.