SEC, NASAA Issue Alerts on ESG Investing

The growing popularity of investments that focus on environmental, social and governance factors, coupled with the lack of global standards for ESG investing, has led federal and state securities regulators to issue alerts about these investments.

The SEC’s Division of Examinations has issued a Risk Alert to highlight findings from recent exams of investment advisors, registered investment companies, and private funds offering ESG products and services. The agency had announced in March that the division would enhance its focus on climate- and ESG-related risks as part of its 2021 priorities.

The North American Securities Administrators Association (NASAA) has issued an advisory for investors.

“The financial services sector is now claiming to offer more ESG funds, and further claim to have thoroughly researched companies that incorporate these values,” the advisory stated.  “However, all ESG funds may not be created equal, and investors should be aware if an investment is right for them, and their risk tolerance.”

The Forum for Sustainable and Responsible Investment estimated in its 2020 annual report that sustainable investing accounted for $17.1 trillion in assets at the start of 2020, or one-third of professionally managed assets.

What SEC Examiners Found

The SEC agrees, noting in its Risk Alert that some advisors and funds consider ESG factors along with many other factors, while others focus just on investments that have more favorable ESG profiles, and still others simply do negative screening to exclude certain issuers or include companies that pledge to improve their ESG-related practices.

In addition, according to the SEC: “The variability and imprecision of industry ESG definitions and terms can create confusion among investors if investment advisors and funds have not clearly and consistently articulated how they define ESG and how they use ESG-related terms. Actual portfolio management practices of investment advisors and funds should be consistent with the disclosed ESG investing processes or investment goals.”

But portfolio management for ESG investing often didn’t match client disclosures or expectations, according to the SEC Division of Examinations.

Other findings of the division’s examination of ESG practices included:

• Weaknesses in policies and procedures governing implementation and monitoring of the advisors’ clients’ or funds’ ESG-related directives. Some ESG funds were dominated by issuers with low ESG scores.
• Inadequate controls to monitor and update clients’ ESG-related investing guidelines, mandates and restrictions, especially if client directives about ESG investments were ill-defined, vague or inconsistent.
• Deficiencies in proxy voting practices. SEC staff saw claims that clients could vote separately on ESG-related proxy proposals when no such opportunities were provided.
• Unsubstantiated or potentially misleading claims regarding ESG approaches. Staff saw marketing materials from some ESG-oriented funds that touted favorable risk, return and correlation metrics without disclosing material facts regarding significant expense reimbursement the funds received from their sponsor.
• Inadequate controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices. The staff said some funds failed to adhere to global ESG frameworks despite claims to the contrary.
• Inadequate compliance programs, which lacked policies and procedures addressing ESG investing analyses, decision-making processes, or compliance review and oversight. The staff found compliance programs that claimed to adhere to global ESG frameworks when they didn’t.
• Lack of policies and procedures to ensure reasonable support for ESG-related marketing claims oversight of ESG-focused subadvisors.
• Lack of knowledge of ESG investing among compliance staff, which led to less effective oversight of ESG-related disclosures and marketing decisions.

Recommendations From the SEC and NASAA

The SEC alert concludes with a recommendation that all market participants promoting ESG investing evaluate their disclosures, marketing claims and other public statements about ESG investing and consistently implement its approach to ESG investing throughout their firms, with  oversight by knowledgeable compliance personnel. It also suggests that firms consider  documenting and maintaining records related to important stages of the ESG investing process.

The NASAA report recommends that investors conduct a thorough check on the ESG fund or investment they’re considering, understand what they’re investing in, check with a local securities regulator if they’re concerned about an investment or individual selling an investment, and consider consulting with a financial services professional or advisor familiar with ESG investing to get insights on into what to look for in an ESG investment.

(Image: Shutterstock)