In the US Securities and Exchange Commission staff’s most recent guidance addressing environmental, social, and governance (ESG) investing, the staff of the Division of Examinations released an April 9 Risk Alert noting observations made during recent examinations of investment advisers and funds (both registered and private) engaged in ESG investing.
The Risk Alert highlights certain deficiencies and internal control weaknesses observed by the staff, as well as observations regarding what the staff viewed as effective practices related to the management and oversight of ESG investing activities. The Risk Alert also summarizes certain ESG-related areas on which the Division of Examinations (Examinations) intends to continue to focus in its examinations of investment advisers and funds. In an April 12, 2021, statement, US Securities and Exchange Commission (SEC) Commissioner Hester M. Peirce offered her thoughts on the Risk Alert and cautioned that the Risk Alert should be considered with some additional context, discussed below.
Although ESG investing has been around for decades, it has gained considerable momentum in recent years. In response to the growing investor appetite for ESG funds, and associated investment product innovation and growth from advisers and sponsors, Examinations has included ESG investing in its published examination priorities for the last two years. In the Risk Alert, Examinations provides insight into its ESG examination focus areas and observations of both deficient (or weak) and effective practices surrounding advisers’ and funds’ ESG activities.
In the Risk Alert, Examinations acknowledges the challenges presented by the ESG investing landscape. It notes that funds and advisers employ a wide variety of ESG investment strategies without the benefit of standardization in terminology, investing approaches, issuer disclosures, and data. The Risk Alert highlights that this combination of variability and imprecision has the potential to mislead investors or cause investor confusion.
It is important to note that, as of the date of the Risk Alert, the SEC has not released any formal rules or guidance regarding ESG investing or the marketing of ESG strategies. Additionally, Examinations does not take a position on the relative merits of any ESG investment approaches or of any global ESG reporting frameworks. The Risk Alert does, however, mention adherence to global ESG frameworks multiple times—focusing on the importance of adhering to a global ESG framework if a fund has committed to do so in its disclosures.
Division of Examinations’ Focus Areas
According to the Risk Alert, Examinations staff will continue to focus on ESG disclosure and compliance practices, including the following:
Deficient Practices Observed
The staff observed a number of practices surrounding ESG investing, some of which, in its view, presented risks of misleading and/or confusing investors. These observations included the following:
Several Effective Practices Observed
The staff also highlighted several categories of practices that they characterized as “effective” related to ESG investing, disclosures, and compliance policies and procedures. The staff included a sampling of these practices in the Risk Alert, which is not intended to be a comprehensive list:
In light of the staff’s noted observations in the Risk Alert, advisers and fund sponsors should consider reviewing their ESG-related disclosures, procedures, and investment practices. This review should also encompass the ESG practices of any unaffiliated advisers or other third parties, as applicable. In general, SEC staff will expect that funds and advisers are actually following the ESG investment practices that they are disclosing to investors and prospective investors.
Examinations’ approach to ESG investing is consistent with how the SEC Division of Enforcement (Enforcement) is probing ESG issues as well. In a recent interview, Acting Deputy Director of Enforcement and head of the new SEC Climate and ESG Task Force Kelly L. Gibson confirmed that the Task Force would be approaching its work in the context of existing rules and guidance, focusing on disclosures being accurate and not misleading and on advisers adhering to their fiduciary duties. Ms. Gibson said that the Task Force would be utilizing data analytics—focusing on all publicly available information such as Forms 10-K, public statements, and website information, as well as prospectuses and marketing materials—and fielding tips and complaints from potential whistleblowers.
On April 12, 2021, Commissioner Peirce issued her own statement in response to the April 9, Risk Alert. In her statement, she commended Examinations staff for their efforts and also expressed her view that the Risk Alert requires context. It merits mention that the current SEC commissioners are not all aligned in their views of the SEC’s role in ESG investing oversight and regulation. Three commissioners released statements earlier this year reflecting their differing views.
Commissioner Peirce cautioned that ESG is not unique as compared to other investment strategies or approaches and noted that none of the observations included in the Risk Alert are ESG-specific. For example, funds should ensure that all statements and claims about investment strategies in public and client disclosure documents are consistent with a firm’s actual practices. She also emphasized the point made in the Risk Alert that neither the SEC nor the staff take any view on the relative merits of one ESG investment approach over another, or on ESG investing generally.
Commissioner Peirce also cautioned that Examinations’ discussion regarding proxy voting should be considered along with existing SEC proxy voting guidance. Specific to certain effective practices noted by Examinations staff, and the potential to imply otherwise, Commissioner Peirce noted that firms are not required to have in place ESG-specific policies and procedures, nor are firms required to designate ESG-specialized compliance personnel. A firm’s compliance personnel should be sufficiently knowledgeable in all aspects of a firm’s business in order to oversee an effective compliance program. On April 14, Commissioner Peirce issued a separate statement eschewing the concept of a universal standard of ESG metrics, which she believes would “constrain decision making and impede creative thinking.” This statement stands in opposition of Acting Director of Corporation Finance John Coates’ recent statements that the SEC “can and should” lead the way in developing a standardized global framework for ESG.
The Risk Alert and Commissioner Peirce’s statement are the most recent of a number of cross-agency actions taken by the SEC in response to the recent rapid growth and expansion of the ESG investing landscape, in an effort to become more informed on ESG investing practices and to enable effective oversight of ESG activities, where needed. Other actions have included the following:
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 The Division of Examinations’ Review of ESG Investing (April 9, 2021) (Risk Alert).
 ESG used in this LawFlash, as well as in the Risk Alert, is intended to encompass other related and similar investment strategies including, but not limited to, “sustainable,” “socially responsible,” and “impact” investing.
 The Division of Examinations was formerly known as the Office of Compliance Inspections and Examinations (OCIE).
 The Risk Alert provides Examinations’ observations of ESG investing practices in the context of well-established principles under the Federal Securities Laws, including the Investment Company Act of 1940, the Investment Advisers Act of 1940, and the rules adopted thereunder.
 E.g., the United Nations–sponsored Principles for Responsible Investment (UNPRI) and Sustainable Development Goals (SDGs).
 Risk Alert at 6.
 Statement on the Review of Climate-Related Disclosure, statement from Acting Chair Allison Herren Lee (Feb. 24, 2021), and Enhancing Focus on the SEC’s Enhanced Climate Change Efforts, joint statement from Commissioners Hester M. Peirce and Elad L. Roisman (Mar. 4, 2021).
 See Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Release No. IA-5325 (Aug. 21, 2019), 84 Fed. Reg. 47420 (Sept. 10, 2019), and Supplement to Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Release No. IA-5547 (July 22, 2020).
 The SEC has also established a dedicated website to house all of their ESG-related work.
 Environmental, Social and Governance (ESG) Funds – Investor Bulletin (Feb. 26, 2021).
 Public Input Welcomed on Climate Change Disclosures, statement from Acting Chair Allison Herren Lee, (Mar. 15, 2021). Public comments submitted in response to the request will be available online.