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Navigating DEI in an Uncertain Environment

By Theresa Hamacher

May 6, 2024

For many investment advisers, diversity, equity, and inclusion (DEI) has been an important area of focus over the past few years, from both an employment and an investment perspective. But increasingly vocal opposition has generated concerns about DEI programs.

At the 2024 IAA Investment Adviser Compliance Conference, held in Washington, D.C., in March, Ranah Esmaili of Sidley Austin, Sofia Martos of Kirkland & Ellis, and Seth Waxman of WilmerHale brought attendees up to date on the latest developments. They spoke in a panel titled “DEI in the Investment Management Industry – Developments and Next Steps,” which was moderated by Lewis Collins of GW&K Investment Management.

Here’s what has – and what has not – changed when it comes to DEI and investment advisers:

There has been no change in the laws affecting employment decisions.

The session opened with a review of the legal landscape. In brief, despite all of the attention being paid to the Students for Fair Admissions v. Harvard case (SFFA) that was decided by the Supreme Court last June, the laws governing employment decisions by private companies have not changed.

DEI in the Investment Management Industry – Developments and Next Steps general session at the 2024 IAA Compliance Conference.

Waxman, who argued SFFA for Harvard before the Court, explained that the decision – which withdrew a special exception that the Court had previously granted to universities – had “zero relevance” for private employers. Instead, private companies must continue to comply with Title VII of the Civil Rights Act, which prohibits discrimination in employment, and Section 1981 of Title 42, which prohibits discrimination in contracting. As Martos later explained, these laws make quotas or set-asides illegal.

“If you are taking race into account expressly, that was illegal before SFFA was decided, and it’s still illegal,” stressed Waxman.

Anti-DEI voices have grown louder.

However, Martos noted, while the law governing private employers hasn’t changed, SFFA has “emboldened anti-DEI activists.” In addition to creating reputational risk for firms with DEI programs, these activists are looking to remake the legal landscape through litigation.

Martos highlighted three employment-related practices that have been the subject of recent litigation:

  • Establishing demographic targets, especially if these targets are numeric. Opponents of these targets argue that they can only be achieved through pursuit of an illegal quota.
  • Basing employment decisions on criteria that opponents contend are proxies for protected attributes, such as race.
  • Sponsoring programs that are exclusive to certain groups, such as professional development or mentorship programs that are available only to members of underrepresented groups.

Waxman added that anti-DEI litigants have also sought to deter the use of ESG criteria – which often includes DEI criteria – in investment decision-making. For example, a class action lawsuit against American Airlines argues that it inappropriately favored investment options with an ESG tilt in the 401(k) plan that it sponsored.

State legislation is making the landscape increasingly difficult to navigate.

Esmaili explained how legislative initiatives at the state level are creating contradictory requirements for investment advisers. While these initiatives address ESG investing more broadly, some have an explicitly DEI component.

Some of these initiatives create reporting obligations. For example, California now requires that venture capital funds disclose the demographics of the leadership of their portfolio companies.

Other bills create prohibitions on investments that consider DEI, such as a bill in Kansas, which requires that investments be solely in the financial interest of participants. An initiative in Arizona would prohibit the government from engaging in contracts with companies that participate in DEI programs, which would apply to investment advisers seeking to manage state funds.

This landscape becomes even harder to navigate when SEC regulatory initiatives – which tend to focus on greenwashing – are factored in, Esmaili added.

Investors still demand transparency.

At the same time, Martos noted, many investors are still demanding transparency. Clients are still including questions about DEI efforts in due diligence questionnaires, for example.

For advisers that may be concerned about collecting the demographic information needed to respond to the questions, Martos explained that data collection is “perfectly legal and quite critical.” In her view, providing this type of information is low risk.

The rationale for DEI initiatives remains intact.

Perhaps most importantly, advisers continue to have good reason for pursuing DEI initiatives, in both their employment practices and in their portfolios. As Waxman explained, having diverse and inclusive workplaces “has been shown over and over and over again to be a pro-competitive good for businesses.”

Moving forward.

The panelists had tips for advisers that want to continue to move forward on DEI.

  • DEI risk assessment. Martos recommended that advisers take an inventory of their current DEI activities and public statements and assess the risk of the activities. She noted that there are many activities that are low risk, such as de-biasing initiatives (often applied to resume screening), increasing inclusivity, and creating programs that are universal and benefit everyone. At the same time, advisers should think about the risk of withdrawing from DEI efforts, including the reputational risk.
  • Focus on fiduciary duty. When it comes to incorporating DEI into the investment process, Esmaili stressed that “your fiduciary duty should be your guiding light.” DEI should be one element in a multifaceted risk-based assessment of potential returns.
  • Involve legal and compliance. The panelists agreed that successfully implementing a DEI program while limiting litigation risk requires a multifunctional team. Compliance needs a seat at the table, while advisers should consult with counsel and stay on top of legal developments.

To view a recording of the session and more resources on fostering diversity, visit the IAA website.

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