District Court Holds Missouri’s “Anti-ESG Rules” are Preempted By Federal Law, Violate First Amendment and are Unconstitutionally Vagabond[1]

On the 14th of August 2024, the U.S. District Court for Western District of Missouri (“the District Court”) issued a ruling ordering a permanent restraining order against The District Court ruled that the Rules were preempted both by the National Securities Markets Improvement Act of 1996 (NSMIA) and the Employment Retirement Income Security Act of 1974 (ERISA). The District Court also found that the Rules violated First Amendment protections against compelled speeches and were unconstitutionally unclear. The decision highlights the limits of U.S. state power in policing the social objectives broker dealers and investment advisers incorporate into their practice and, if not overturned on appeal, suggests that broker dealers and investment advisers may face less legislative pushback, at least at the state level, in pursuing environmental, social, and governance (“ESG”) objectives in the future.[]Background

The Rules, which took effect in July 2023, had two core components. First, the Rules mandated that broker dealers and investment advisers disclose to their customers if they “incorporate

a social objective or other nonfinancial objective” into their investment decisions or advice.[d] Second, if their decisions or advice did incorporate such social or other nonfinancial objectives, the Rules required that broker dealers and investment advisers obtain written consent from customers in a form “substantially similar” to language prescribed by the statute (and keep record of that consent).[2] The Rules in turn imposed stiff penalties for failure to comply, “including the loss of registration, a civil penalty of up to $25,000 for each violation, and–if the violation was willful–criminal penalties.”[3] The Securities Industry and Financial Markets Association (SIFMA) sued to enjoin the Rules in August 2023, arguing the Rules were preempted by NSMIA and ERISA, violated the First Amendment’s protection against compelled speech, and were unconstitutionally vague.[4]District of Missouri’s Decision[5]

On summary judgment, the District Court sided with SIFMA, holding the Rules were invalid under the four independent bases expounded by SIFMA and issuing a permanent injunction barring their enforcement.

NSMIA

The District Court first held the Rules were expressly preempted by NSMIA because they required broker dealers and investment advisers to make and keep records that “differ

from” and were “in addition to” NSMIA’s requirements.[ed] The District Court reasoned NSMIA, which was enacted “to alleviate the ‘redundant, costly, and ineffective dual federal/state regulatory’ securities system” by “‘designat[6] the federal government to oversee nation-wide securities offerings,'” prevented Missouri from requiring dealers and advisers “to make and keep a new document that is not required by federal law.”[ing] The District Court also held NISMA’s savings clause did not salvage the Rules because the clause did not authorize a state to engage in its own rulemaking.[7]ERISA[8]

The District Court also held that the Rules were preempted by ERISA, which establishes “standards of conduct, responsibility, and obligation for fiduciaries of employee benefit plans” and displaces state regulation of such plans.

Specifically, the Court held the Rules interfered with ERISA because they “restrict[9] what investments may be recommended or selected” and “mandat[ed] disclosure and recordkeeping requirements not required by ERISA.”[ed] Further, and similar to its holding regarding that of NISMA, the Court held ERISA’s savings clause was inapplicable where the Rules undermined ERISA’s exclusive enforcement scheme.[10]First Amendment[11]

In addition, the District Court held the Rules violated the First Amendment. For one, the District Court held the Rules were subject to intermediate scrutiny because their written consent provision compelled speech of more than “purely factual and uncontroversial information.”

Applying that standard, the District Court held the Rules did not survive because they were more extensive than necessary and could have been more narrowly tailored to achieve Missouri’s unarticulated but possible interests in “preventing fraud and deceit” or of “addressing a policy debate.”[12]Vagueness[13]

Finally, the District Court held that the Rules were unconstitutionally vague. The District Court noted that under the “void-for-vagueness” doctrine, a law is unconstitutional where it “fails to provide a person of ordinary intelligence fair notice of what is prohibited, or is so standardless that it authorizes or encourages seriously discriminatory enforcement.”

Block quoting SIFMA’s opening brief, the District Court held that Rules were unconstitutionally vague because they left “many concepts in [14] definition [the] unexplained” and had failed to provide written guidance more generally on how to interpret the Rules.[of ‘nonfinancial objective’] The District Court remarked this vagueness was especially troublesome in light of the hefty penalties, both civil and criminal, the Rules imposed.[15]Permanent Injunction[16]

After deciding the Rules were invalid on these grounds, the District Court opted to strike out the Rules in their entirety.

Ticking through the test for a permanent injunction, the District Court held SIFMA had shown irreparable harm where the Rules violated SIFMA’s First Amendment rights, that that significant harmed weighed in favor of a permanent injunction, and that other members of the public were likely to suffer similar harm in the future were the Rules allowed to remain intact.[17]Key Takeaways[18]

The District Court’s decision suggests that laws similar to those of Missouri’s will be subject to the same challenges as those raised by SIFMA. States that are considering this approach to regulate dealers and advisers might now think twice about enacting it. Broker dealers and investment advisers may find some comfort in the fact that they will likely not be subject to similar disclosure and consent regimes in other U.S. jurisdictions.

More broadly, the District Court’s decision may mark a turning point in anti-ESG public sentiment and general backlash against the investing strategy, given that many aspects of the court’s reasoning would likely be applicable to other similar “anti-ESG” investing rules. The District Court’s decision limits the actions that states can take to regulate broker dealers and investment advisers in relation to ESG.

However, the District Court’s ruling will not likely stop all efforts to limit ESG consideration in investment decisions. Anti-ESG advocates could shift their resources from state legislation to federal legislation to combat the investment strategy or modify their proposed rules to increase their chances of surviving a challenge.

For the time being, Missouri has thirty days to decide if it will appeal the District Court’s decision. The State has yet to issue a statement regarding the decision.

Securities Industry and Financial Markets Association v. Ashcroft et al. 23-cv-04154-SRB (W.D. Mo. Mo. District of Missouri Opinion, p. 2-3 (quoting from 15 C.S.R. SS 30-51.170 (the Rules for Broker Dealers); 15 C.S.R. SS 30-51.172 is the rules for investment advisers. SS 30-51.172(3)).

[1] District of Missouri Opinion at 4-5 (quoting 15 C.S.R. SS 30-51.172(3)).[hereinafter District of Missouri Opinion] District of Missouri Opinion at 5, 20.

[2] District of Missouri Opinion at 5.

[3] District of Missouri Opinion at 8, 10.

[4] District of Missouri Opinion at 7-9 (quoting Lindeen v. SEC, 825 F.3d 646, 650 (D.C. Cir. District of Missouri Opinion, 9-10 (citing the 15 U.S.C. SS 77r (c)(1).

[5] District of Missouri opinion at 12-13. 1997); 29 U.S.C. SS 1001(b).

[6] Opinion of the District of Missouri at 13.

[7] Opinion of the District of Missouri at 14.

[8] Opinion of District of Missouri at Hudson Gas & Elec. Corp. v. Pub. Serv. Serv. Dev., LLC, 414 F. Supp. 3d 1205, 1239 (W.D. Mo. Mo.

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