As investors have piled into ESG-friendly mutual funds over the past several years, the SEC has begun ratcheting up scrutiny of the representations made by the advisers of those ESG investment funds.  This week, the SEC announced a $1.5 million fine against an investment adviser relating to “misstatements and omissions” with respect to certain ESG funds. 

Specifically, the SEC’s order found that the adviser represented in various disclosures that an affiliated sub-adviser to the at-issue mutual funds had performed “an ESG quality review” of all investments in the funds even though “numerous investments” did not have any ESG quality review score at the time of investment.

Notably, the charge was spearheaded by SEC Enforcement’s Climate and ESG Task Force, which was formed last year to analyze investment disclosures relating to ESG strategies.  The charges in this case represent one of the first high-profile actions brought by the Task Force for misleading ESG investment disclosures.[1]

The action against this firm, however, is not the only ESG investigation relating to investment funds.  The Wall Street Journal reports that another large financial institution’s asset management division is also under investigation on suspicion of overstating ESG efforts.

The marketplace is likely ripe for additional ESG-related SEC investigations.  ESG has been a revenue driving marketing device for numerous investment funds and firms, and in the rush to bring financial products to market, there are likely to be discrepancies in disclosures.  Significantly, this case demonstrates that investment advisers and funds need to accurately disclose not only what ESG-related efforts or investments they are making directly, but also those of all sub-advisers to their funds.  As the SEC and industry groups begin to catch-up and scrutinize past disclosures and measure those disclosures against the investments actually made, we would anticipate seeing a significant increase in SEC investigations. 

This action comes at a tumultuous time in the development of the ESG legal framework.  The SEC has proposed new regulations that would require companies to make extensive ESG disclosures.  These new regulations are garnering substantial public comments, and the SEC has scheduled an open meeting on its proposals for May 25. In addition, the S&P’s ESG ratings have come under intense criticism by states and industry groups for overtly “politicizing” ESG rankings.  As several state treasurers recently noted, S&P had ranked Russian-controlled Gazprom and Rosneft ahead of Exxon and Chevron, and had ranked Russia’s Sberbank, which was sanctioned by the US and EU in response to Russia’s Crimea annexation, ahead of J.P. Morgan.  Finally, greenwashing litigation—lawsuits aimed at misrepresentations of the environmental credentials of a product or the company itself—is beginning to explode as consumers and government agencies begin to question the truth of environmental-friendliness claims.[2]

The United Kingdom has sought to position itself as being at the forefront of the transition to net-zero with a raft of new legal and regulatory obligations imposed or set to be imposed on financial institutions and asset managers and the UK’s largest companies. Despite this, UK regulators have yet to bring any enforcement actions for inadequate climate related disclosures and/or greenwashing although both the Financial Conduct Authority and the Financial Reporting Council have identified failings in both climate related reporting and the marketing and distribution of sustainable products. Enforcement action is therefore simply a matter of time. While litigation is yet to gather momentum, there are now a number of court actions in their early stages and the environment is ripe for a significant upswing in climate related litigation in the UK as well. 

Despite the challenges, it is therefore imperative for businesses operating in the financial services sector to make sure they are fully abreast of the changing regulatory and legal environment, the guidance and information published by regulators and that they are complying with it. Crucially companies must be able to justify any green or sustainable claims they make about the products they offer or about their own business.

The rapid developments in the ESG environment are leading to opportunities for companies as the demand for sustainable investments grows. However with those opportunities comes considerable risk and complexity for companies trying to navigate the uncertainty particularly across jurisdictions with differing ESG laws and regulations.

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