Socially responsible funds—also known as environmental, social, and governance (“ESG”) investments—have become increasingly popular with investors in recent years. In 2020, a record $51 billion flooded into sustainable U.S. funds. This growing market has become the focus of regulators concerned that guidelines and disclosures have not kept pace with current trends and may not adequately protect investors.
Last month, the U.S. Securities and Exchange Commission (“SEC”) issued a Risk Alert related to “potentially misleading” claims about and inadequate controls for ESG investment options offered by investment advisers, registered investment companies, and private funds.
With rising demand for ESG products, investment advisers and funds have expanded their various approaches to ESG investing and increased the number of product offerings across multiple asset classes. However, these investments present certain risks because there is a lack of standardized and precise ESG definitions. For example, some advisers consider ESG factors alongside other investment-related factors, such as macroeconomic trends; others look to whether ESG investments would, on their own, “provide higher returns or result in better ESG-related outcomes.”
The alert warned that variable and imprecise terms can create confusion among investors if investment advisers and funds have not clearly and consistently articulated how they define ESG and use ESG-related terms. While specific firms were not identified by the SEC, the alert described problem areas that include:
(1) potentially misleading statements of advisers and funds claiming to have formal processes in place for ESG investing when they do not;
(2) policies and procedures that are not reasonably designed to prevent violations of law or are not implemented;
(3) documentation of ESG investment decisions that are weak or unclear; and
(4) compliance programs that are not reasonably designed to guard against inaccurate ESG-related disclosures and marketing materials.
The SEC encouraged market participants promoting ESG investing to clients, prospective clients, investors, and prospective investors to evaluate their ESG investment options to ensure that the policies, procedures, and practices are reasonably designed and accurately conveyed.
This is the latest action that the SEC has taken this year reflecting the agency’s focus on ESG investing. On March 4, 2021, the SEC announced that it was launching the Climate and ESG Task Force to “develop initiatives to proactively identify ESG-related misconduct,” including identifying any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.
Soon thereafter, on March 15, 2021, the agency invited investors, registrants, and other market participants to provide input on whether current disclosures adequately inform investors. The SEC is seeking public input in order to update its 2010 guidance on climate change disclosure requirements. Former Acting SEC Chair Allison Herren Lee explained at a virtual conference held by the Center for American Progress that the updated disclosures will seek to provide investors with the ESG-related information they are demanding to make more informed investment decisions.
The request for comments includes 15 questions aimed at gathering data to help create a “consistent, comparable and reliable” framework to bring the agency in line with what Lee referred to as a “shift in investor focus … over the last decade toward the analysis and use of climate and other ESG risks and impacts in investment decision-making.” Submissions can be made by email or webform and are due by June 13, 2021 (within 90 days of the SEC’s March 15, 2021 statement). The public has started to weigh in, including those who are critical of the entire endeavor. The West Virginia Attorney General’s March 25, 2021 submission raises concerns about the SEC overstepping its mandate: “the Commission should stick to its core mission of requiring statements on matters that are material to future financial performance – not statements on issues that drive a political agenda.” The Attorney General Patrick Morrisey voiced additional concerns, stating that “[i]f the Commission proceeds down this pathway, States and other interested stakeholders will not hesitate to go to court to oppose a federal regulation compelling speech in violation of the First Amendment.” The public comments made to date can be viewed here.