On April 9, 2021, the U.S. Securities and Exchange Commission (“SEC”) Division of Examinations (the “Division”) issued a Risk Alert regarding the Division’s review of ESG investing. The Risk Alert provides insight into the SEC’s perspective on the “potential violations” referred to in the SEC’s announcement, released on March 4, 2021, of a Climate and Environmental, Social, and Governance (“ESG”) Task Force in the Division of Enforcement. The Division’s Risk Alert focuses on the accuracy and consistency of disclosures, marketing claims, and other public statements; the application of ESG approaches throughout firms; the adequacy of ESG policies and procedures; compliance oversight; and the sufficiency of ESG-related documentation.

The Risk Alert describes a number of problematic practices the Division has observed in recent examinations of investment advisers, registered investment companies, and private funds offering ESG products and services. The document also lays out several effective practices that these firms should consider.

PROBLEMATIC PRACTICES

The Risk Alert warns firms that the Division has observed practices that could mislead investors into believing that they invested in companies pursuing ESG strategies that actually were not, including:

• Inaccurate or inconsistent disclosure of ESG strategies in Form ADV Part 2A, advisory agreements, offering materials, responses to requests for proposal, and due diligence questionnaires.
• Proxy voting inconsistent with disclosed ESG strategies.
• Policies and procedures that:
  • Were not reasonably designed to prevent violations.
  • Were inconsistent with actual portfolio management practices.
  • Lacked coverage of ESG investing analyses, decision-making processes, or compliance reviews and oversight.
  • Did not provide adequate oversight of ESG-focused sub-advisors.
• Compliance weaknesses, including:
  • Compliance programs that were not reasonably designed to guard against inaccurate ESG disclosures and marketing materials.
  • Failure to update marketing materials to maintain accuracy.
  • Inadequate controls with respect to specific investor requests, e.g., negative screens.
• Weak or unclear documentation of investment decisions, and unsubstantiated or otherwise potentially misleading claims regarding ESG approaches, including adherence to global ESG frameworks.
• Lack of substantiation for support of claims of high component (as opposed to composite) ESG scores provided by a sub-advisor.

EFFECTIVE PRACTICES

The Division also recommends several effective practices that firms should adopt to avoid ESG violations, including:

• Simple and clear disclosures that accurately reflect ESG practices and client choices.
• As appropriate, clear and prominent disclosures regarding consideration of ESG factors alongside many other factors and engagement in seemingly contrary investment strategies.
• Explanation of investment evaluation, including quantitative information on the local impacts of investments.
• Detailed, comprehensive policies and procedures that address specific documentation to be completed at various stages of the investment process and related written procedures.
• The involvement of integrated compliance personnel knowledgeable about firms’ ESG practices, including specialized personnel when multiple ESG approaches are taken simultaneously.
• Compliance tasks that include meaningful review of public disclosures and marketing materials, testing of existing policies and procedures, and assessment of whether additional policies and procedures are necessary.
• Evaluation of portfolio management processes for alignment with stated ESG investing approaches.
• Adequacy testing of documentation of ESG-related investment decisions and adherence to clients’ investment preferences.