ESG Investing: Is Your Firm Ready for SEC Examination?

This blog was coauthored by Randa Abdelhamid.

In March 2021, the US Securities and Exchange Commission (SEC) again signaled its focus on oversight of companies’ response to climate and environmental, social, and governance (ESG) risks and opportunities. It launched a new webpage dedicated to all the agency’s efforts and actions on ESG issues. On April 9, 2021, the SEC’s Division of Examinations issued a risk alert detailing observations from recent exams of investment advisers, registered investment companies, and private funds offering ESG products and services.

What Do Examiners Look For?

The short answer? Do what you say you are doing. The risk alert sets forth the factors on which examiners base their evaluation of firms claiming to engage in ESG investing, including:

• Portfolio management: Review of the firm’s policies, procedures, and practices related to ESG; due diligence and other processes for selecting, investing in, and monitoring investments.
• Performance advertising and marketing: Review of the firm’s regulatory filings, websites, reports to sponsors of global ESG frameworks, and client presentations, as well as responses to due diligence questionnaires, requests for proposals, and client/investor-facing documents, including marketing materials.
• Compliance programs: Review of the firm’s written policies and procedures and implementation, compliance oversight, and review of ESG investing practices, and disclosures.

ESG Investing Has Shortcomings

The alert indicates examinations identified some instances of potentially misleading statements regarding ESG investing processes and representations regarding the adherence to global ESG frameworks. Some of these observations include:

• Inconsistent portfolio management practices that do not align with disclosures about ESG approaches.
• Inadequate controls to maintain, monitor, and update clients’ ESG-related investing guidelines, mandates, and restrictions.
• Unsubstantiated or potentially misleading claims regarding ESG approaches.
• Inadequate controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices.
• Compliance programs that did not adequately address relevant ESG issues and lacked policies and procedures addressing ESG investing analyses, decision-making processes, or compliance review and oversight.

With the Biden administration’s focus on the environment and other ESG issues, and heightened attention to ESG matters from the SEC, this risk alert provides valuable insight to firms looking to make sure their ESG investing practices will withstand SEC scrutiny in the future. Funds that make false or misleading disclosures or omissions about their ESG investing, and those that do not implement proper governance of ESG issues, will be low hanging fruit for an enforcement referral.