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.
| Good | Bad |
| Simple and precise disclosures regarding Firm’s approach to ESG investing, which are aligned to actual practices | Portfolio management practices were inconsistent with disclosures |
| Clear disclosure regarding level of reliance on unaffiliated advisers, such as mutual fund sponsors | Inadequate controls to monitor ESG guidelines |
| Precise disclosure about role of ESG factors, especially if such factors could be considered alongside other factors | Proxy voting inconsistent with ESG claims |
| Explain how investments are evaluated using goals established by global ESG frameworks, such as UNPRI | Unsubstantiated or potentially misleading claims about ESG approach |
| Policies and procedures addressing ESG investing and covering relevant practices | Inadequate controls to ensure disclosures and marketing are consistent with practice |
| Knowledgeable and engaged compliance staff who are integrated into ESG-related processes | Compliance program did not adequately address ESG issues |
| Compliance staff actively reviewing disclosures, marketing and other reporting | Compliance 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.
To speak with one of our regulatory or ESG experts, email us at: info@cssregtech.com.
[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