BlackRock and Vanguard have temporarily withdrawn plans to hold stewardship meetings that include ESG considerations due to recent SEC interpretation on beneficial ownership reporting.

The guidance suggests shareholders might have to file a comprehensive Schedule 13D form if they use pressure to influence ESG outcomes at companies they hold stakes in. That guidance replaces an earlier interpretation which stated that ESG discussions would largely be exempt from that onerous requirement.

Both institutional investors prioritize passive engagement with companies, although they have been accused of using their influence to achieve ESG-related goals. In 2022, SEC commissioner Mark Uyeda noted that the rules as then-applied might not be capturing the ways in which shareholders could influence ESG outcomes.

BlackRock since announced that it is resuming engagement, but it will highlight its role as a passive investor at the start of each meeting. Both investment firms have scaled back their interest in effectuating ESG-related change in recent years.

Schedule 13D and 13G

The SEC requires beneficial ownership reports to be filed within 10 days of an investor crossing 5% ownership threshold in a registered voting entity. Expensive and onerous Schedule 13D forms are required of shareholders that indicate the possibility that they seek to exert activist pressure on a board.

Alternatively, a scaled-back Schedule 13G form is required if a shareholder does not commit to activist practices. Shareholders typically prefer to fill out a 13G to avoid perceptions of a takeover attempt, and to reduce the time and cost associated with a 13D form.

Soft or hard influence?

According to updated SEC interpretation of SEA Sections 13(d) and 13(g) issued on February 11th, shareholders must file a Schedule 13D form if they plan to “pressure” companies into ESG policy shifts.

“Pressure” contrasts with mere discussions about how a shareholder views a certain topic and how it might affect its future voting decisions, which would only require a 13G form.  

But the SEC noted that recommendations on ESG policy could be considered a “means of pressuring the issuer to adopt [a] recommendation” if it’s used to “explicitly or implicitly” condition support for a director nominee in an election, or “discusses with management its voting policy… and how the issuer fails to meet the shareholder’s expectations.”

ESG under fire

Both BlackRock and Vanguard have come under legal fire over their ESG-conscious investing strategy. While the investment firms argue this is a sound way of staving off long-term investment insecurity, critics say it is merely an attempt to effectuate a purely political and nonpecuniary outcome.

In a recent lawsuit, a Texas federal judge sided with plaintiffs who accused JetBlue of abdicating its fiduciary duty when it failed to oversee BlackRock’s management of its pension fund, which he contended included indefensibly political investment decisions. BlackRock itself was not a party to that suit.

In that case, Judge Reed O’Connor claimed that massive investment managers functioned as a “cartel” that made it difficult or impossible for companies to say no to their demands.

That outcome, which was met with surprise from legal experts, will likely be appealed.