Regulators Ramp Up Scrutiny of ESG Funds

Beveridge & Diamond PC

Beveridge & Diamond PC

The environmental, social, and governance (ESG) oversight train continues to gain momentum with recent efforts aimed at “greenwashing” in investment funds. Several actions reflect a confluence of global efforts to ensure that ESG-related actions, regardless of sector, are consistent, comparable, and transparent. Entities participating in the ESG investment sector should remain attuned to these emerging regulatory and enforcement trends, both in the United States and elsewhere.

U.S. Developments

On May 25, 2022, the U.S. Securities Exchange Commission (SEC) proposed amendments to rules and reporting forms to provide investors with information concerning funds’ and advisers’ incorporation of ESG factors. The proposed rules would require funds and advisers that consider ESG factors in their investment process to provide more detailed disclosures in fund prospectuses, annual reports, and adviser brochures regarding the ESG strategies they use. The SEC proposed a “layered framework” for these additional disclosures, where the level of detail required for the disclosure depends on how central the ESG factors are to a fund’s strategy. The proposed rules would also require ESG-Focused Funds to disclose additional information regarding the greenhouse gas (GHG) emissions associated with their investment, such as the carbon footprint and the weighted average carbon intensity of their portfolio.

As part of its increased focus on ESG matters, the SEC Division of Enforcement’s Climate and ESG Task Force recently charged BNY Mellon Investment Advisor, Inc. (BNY Mellon) “for misstatements and omissions about ESG considerations in making investment decisions for certain mutual funds that it managed.” In its order, the SEC alleged that BNY Mellon represented or implied that it conducted ESG quality reviews of its funds when it allegedly only conducted this review of some funds. The SEC found that many investment funds did not have an ESG quality review score. BNY Mellon settled the case with the SEC and agreed to pay a $1.5 million penalty.

These actions by the SEC build on rulemaking and enforcement initiatives first launched in 2021, which we discussed here. Notably, the SEC has sent letters to numerous publicly traded companies seeking additional information related to their GHG risk reporting and has proposed new rules to govern GHG risk reporting while creating new requirements for GHG and ESG disclosures, with comments on those rules due by June 17, 2022. The SEC’s expansion of its ESG focus to the financial sector is perhaps unsurprising, but represents a new area of focus for the SEC and a new source of risk for investment companies developing or marketing ESG funds.

Global Developments

Entities abroad also face increased scrutiny of ESG claims related to investment funds. German law enforcement officers recently searched the offices of Deutsche Bank and its subsidiary, DWS, based on allegations of fraudulent advertising of sustainable investment funds. Prosecutors stated that they found evidence that DWS only applied ESG standards to a few investments, contrary to statements made in the company’s sales prospectus, and further enforcement by German authorities is anticipated.

Broad Impacts

Regulators around the world—particularly in the U.S. and Europe—will continue to increase their focus on the use and implementation of ESG factors as countries seek to enforce and regulate ESG-related claims. Entities making ESG-related claims, whether concerning their operations or investment platforms, need to ensure that these claims are appropriately supported and comply with relevant laws to minimize the risk of enforcement or allegations of “greenwashing.” As part of that effort, it is important to assess ESG-related claims and strategies across all media as well as other public statements and regulatory filings to ensure consistency and accuracy.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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