During examinations of investment advisers, registered investment companies and private funds engaged in ESG investing, SEC staff have observed instances of potentially misleading statements, according to an April 9 SEC Risk Alert.
Citing a response to investor demand, the SEC notes that investment advisers and funds have expanded their various approaches to ESG investing and increased the number of product offerings, but this has presented certain risks, particularly given a lack of standardized and precise ESG definitions.
For instance, the Risk Alert notes that the variability and imprecision of industry ESG definitions and terms can create confusion among investors if investment advisers and funds have not clearly and consistently articulated how they define ESG and how they use ESG-related terms.
To highlight risk areas and assist firms in developing their compliance practices, following are some of the specific observations of deficiencies and internal control weaknesses from examinations of investment advisers and funds.
Portfolio management practices were inconsistent with disclosures about ESG approaches. The staff observed portfolio management practices that differed from client disclosures in required disclosure documents (e.g., Form ADV Part 2A) and other client/investor-facing documents.
Controls were inadequate to maintain, monitor and update clients’ ESG-related investing guidelines, mandates and restrictions. The staff noted weaknesses in policies and procedures governing implementation and monitoring of the advisers’ clients’ or funds’ ESG-related directives.
Proxy voting may have been inconsistent with advisers’ stated approaches. The staff observed inconsistencies between public ESG-related proxy voting claims and internal proxy voting policies and practices. The staff also noted public claims regarding clients’ ability to vote separately on ESG-related proxy proposals, but clients were never provided such opportunities and no policies concerning these practices existed.
Unsubstantiated or otherwise potentially misleading claims regarding ESG approaches. The staff observed unsubstantiated or otherwise potentially misleading claims regarding ESG investing in a variety of contexts. For instance, the staff noted marketing materials for some ESG-oriented funds that touted favorable risk, return, and correlation metrics related to ESG investing without disclosing material facts regarding the significant expense reimbursement they received from the fund sponsor, which inflated returns for those ESG-oriented funds.
Inadequate controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices. The staff observed inconsistencies between actual firm practices and ESG-related disclosures and marketing materials because of a weakness in controls over public disclosures and client/investor-facing statements.
Compliance programs did not adequately address relevant ESG issues. The staff observed that some firms substantially engaged in ESG investing lacked policies and procedures addressing their ESG investing analyses, decision-making processes, or compliance review and oversight. For instance, the staff identified compliance programs that did not address adherence to global ESG frameworks to which the firms claimed to be adhering.
Not all was bad, however. The Risk Alert also provides examples of disclosures and procedures that some investment advisers and funds had in place that accurately conveyed material aspects of firms’ approaches to ESG investing.
The Risk Alert further advises that the staff will continue to examine firms to evaluate whether they are accurately disclosing their ESG investing approaches and have adopted and implemented policies and practices that accord with their ESG-related disclosures.
The SEC has been intensifying its focus on climate risk and ESG factors lately. The Commission recently released a request for comment about whether current disclosures adequately inform investors. It also announced recently that its 2021 examination priorities will include a greater focus on climate and ESG-related risks by examining proxy voting policies and practices to ensure voting aligns with investors’ best interests and expectations.
