SEC Reminds Advisers About ESG Practices

SEC Reminds Advisers About ESG Practices

In recent years, investor awareness regarding environmental, social and governance issues (“ESG”) has grown and investors increasingly look for investments that advance their personal goals. As a result, the number of investment options claiming to consider ESG factors has also grown. There is a range of approaches with respect to the influence of ESG factors on an investment decision.

The U.S. Securities and Exchange Commission’s (“SEC”) Division of Examinations (“DOE”) has observed a variety of practices followed by investment advisers, including instances in which advisers fail to clearly represent their actual investing behavior. As a result, on April 9, 2021, the DOE issued a Risk Alert[1] to highlight their observations from recent exams of investment advisers, registered investment companies and private funds offering ESG products and services (collectively, “Firms”).

Following the issuance of the Risk Alert, SEC Commissioner Hester Peirce issued a statement regarding the Risk Alert[2]. She stressed that the SEC’s role is not to second-guess investment decisions, but to understand whether a Firm acts consistently with its claims. She also stressed that the topics discussed within the Risk Alert are not necessarily unique to an ESG strategy compared to other strategies.

What to expect in an exam

The DOE will evaluate the accuracy of ESG related disclosures as well as a Firm’s policies and procedures. Specifically, examinations will focus on reviewing portfolio management processes to ensure that investment decisions and proxy voting decision making is consistent with ESG disclosures and marketing; reviewing a Firm’s regulatory filings, marketing materials (including websites and RFP responses) and reports to sponsors of global ESG frameworks, such as the UN Principles for Responsible Investment (“UNPRI”); and examining the effectiveness of compliance programs, in particular written policies and procedures, their implementation and compliance oversight and reviews.

Do this, not that

The Risk Alert also highlighted good and bad practices observed by the DOE staff during recent examinations.

GoodBad
Simple and precise disclosures regarding Firm’s approach to ESG investing, which are aligned to actual practicesPortfolio management practices were inconsistent with disclosures
Clear disclosure regarding level of reliance on unaffiliated advisers, such as mutual fund sponsorsInadequate controls to monitor ESG guidelines
Precise disclosure about role of ESG factors, especially if such factors could be considered alongside other factorsProxy voting inconsistent with ESG claims
Explain how investments are evaluated using goals established by global ESG frameworks, such as UNPRIUnsubstantiated or potentially misleading claims about ESG approach
Policies and procedures addressing ESG investing and covering relevant practicesInadequate controls to ensure disclosures and marketing are consistent with practice
Knowledgeable and engaged compliance staff who are integrated into ESG-related processesCompliance program did not adequately address ESG issues
Compliance staff actively reviewing disclosures, marketing and other reportingCompliance staff has limited knowledge of investment process or marketing disclosures

Takeaway

As Commissioner Peirce said in her statement, there are no specific rules that apply with respect to offering ESG influenced investment strategies. The Advertising Rule and anti-fraud provisions of the Investment Advisers Act of 1940 still apply. Marketing, disclosures and other communications should accurately reflect the Firm’s approach and not attempt to mislead their intended audience. The Compliance personnel should understand the Firm’s business and be active participants in communications activities. In short, the old rules still apply and Firms should ensure that their words match their actions.

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[1] “The Division of Examinations’ Review of ESG Investing”, https://www.sec.gov/files/esg-risk-alert.pdf, April 9, 2021.

[2] Statement on the Staff ESG Risk Alert, Hester M. Peirce, https://www.sec.gov/news/public-statement/peirce-statement-staff-esg-risk-alert, April 12, 2021