Facing heat over ESG ratings, Morningstar tapped this lawyer to put out the fire

5 minute read

The White & Case offices in Washington, D.C., U.S. REUTERS/Andrew Kelly

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June 28 - When companies face allegations of misconduct, it’s practically standard operating procedure to hire a prestigious law firm to conduct an internal investigation.

But the assignment that Morningstar Inc gave a team from White & Case led by partner Tara Lee to dig into potential anti-Israel bias in its environmental, social and governance (ESG) ratings was unique.

“How was it different? It was harder,” Lee told me of the independent probe, which culminated in a 117-page report that Morningstar made public earlier this month. “There was no real template.”

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Morningstar pledged to adopt all of the White & Case team’s recommendations “in full,” a spokesperson said. In doing so, the financial services and investment research firm last week avoided adverse action by an Illinois board that oversees the state employee pension funds that would have barred investments.

"The investigation has been closed by a unanimous decision," Illinois Investment Policy Board chairman Michael Mahoney said via email, adding that the board "appreciates Morningstar's openness and transparency on the issue."

Score one for an effective internal investigation.

The undertaking points to wider issues with ESG ratings, which ostensibly provide a way for investors concerned about, say, climate change, diversity or human rights to direct their money to companies that share their social values.

The question is how such ratings are crafted. As the White & Case report points out, there’s “a vacuum of governmental guidance or regulation” for coming up with scores. Instead, they’re more like barbecue sauce – everyone has their own recipe.

Did Morningstar have a rancid ingredient?

In April 2020, JLens—which describes itself as an “investor network that explores a Jewish lens on impact investing”— zeroed in on perceived “research bias against Israel” in ESG ratings by Morningstar’s Sustainalytics unit, which the Chicago-based company had recently acquired.

JLens later alleged that Sustainalytics’ ratings “actively support” the Boycott Divestment Sanctions movement that seeks to isolate Israel over its treatment of the Palestinians.

For Morningstar, the potential fall-out was significant. Thirty-five states including Illinois have laws that bar investments in companies that boycott (a broadly defined term) Israel, and in March 2021, the Illinois Investment Policy Board moved to inform Morningstar that its activities “appear to violate the Illinois statute,” according to board meeting minutes.

When Morningstar first got wind of the concerns, it conducted its own apparently lackluster in-house investigation – an effort that in retrospect Morningstar executive chairman Joe Mansueto and CEO Kunal Kapoor in an open letter said “was overly dismissive of the serious bias concerns raised by the organization JLens, the Illinois Investment Policy Board (IIPB), and other entities.”

It was time to bring in the big guns.

Lee, who joined White & Case in 2020 from Quinn Emanuel Urquhart & Sullivan, where she was co-chair of the national trial practice, has a long track record of leading investigations. Earlier in her career, she worked alongside former senator and U.S. Special Envoy for Middle East Peace George Mitchell at DLA Piper as co-chair of the firm’s global investigations practice.

Lee told me White & Case pitched for the work in a “beauty contest,” beating out several rivals for the job. The firm had never previously represented Morningstar or its subsidiaries, nor did it accept any other business from the company during the course of the investigation.

Lee and her roughly 15-member team interviewed more than 40 employees and external parties while reviewing around 140,000 Sustainalytics documents, client-facing reports and other materials.

The investigators were given complete freedom to decide to who interview and what to look at, Lee said – something that’s not necessarily a given in an internal investigation

A Morningstar spokesperson in an email called the effort “quite thorough” and the resulting report “a fair, detailed and balanced evaluation of the Sustainalytics organization, products, and services.”

The report found that there was no evidence Sustainalytics products “recommend or encourage divestment” from Israel, nor did the White & Case team find pervasive or systemic bias against the country.

However, investigators did conclude that one standalone product, the Human Rights Radar, had an anti-Israel bias.

The product provided information about companies operating in regions of the world where serious human rights violations allegedly occur. But the White & Case report found it focused "disproportionately on the Israeli/Palestinian conflict areas relative to other 'high-risk' countries."

It also sometimes used "inflammatory language," failed to clearly and consistently provide sourcing attribution, and lacked any formal checks and balances to ensure its work was accurate, the report found.

Morningstar subsequently announced it would discontinue Human Rights Radar.

The company also pledged to make changes including greater transparency in Sustainalytics’ research sources and ratings methodology, adopting a style guide to ensure all research products are free from biased terminology, and discontinuing bespoke research on behalf of clients.

JLens CEO Julie Hammerman in a statement said, “This is a victory in the fight against the anti-Israel" Boycott Divestment Sanctions movement.

Still she added via email that “transparency and clarity on the implementation of the report's recommendations are required to assess whether Morningstar has truly ceased supporting" the anti-Israel campaign.

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Jenna Greene writes about legal business and culture, taking a broad look at trends in the profession, faces behind the cases, and quirky courtroom dramas. A longtime chronicler of the legal industry and high-profile litigation, she lives in Northern California. Reach Greene at jenna.greene@thomsonreuters.com