The Division of Examinations of the US Securities and Exchange Commission has issued a Risk Alert describing the agency’s observations of environmental, social and governance investment options offered by investment advisers, registered investment companies, and private funds. In particular, the Risk Alert offers observations of deficiencies and internal control weaknesses in the area of ESG investing.
The Division noted, firstly, that the plethora of new ESG products and services, and the lack of standardization of terms used in the industry, could engender confusion among investors, absent clear and consistent articulation by investment advisers and funds. The Division added that the portfolio management practices of industry players should be consistent with disclosed ESG investing processes and goals, and that the Division’s examinations of these practices will focus on portfolio management, performance advertising and marketing, and compliance programs.
While praising the clear and precise ESG disclosures and well-designed practices of some firms, the Division staff listed areas of concern observed in others:
- Potentially misleading statements – The Division found that portfolio management practices were inconsistent with client disclosures. In particular, some firms failed to adhere to global ESG frameworks despite claiming to do so.
- Inadequate controls over ESG-related guidelines and disclosures – The staff found weaknesses in policies and procedures for monitoring and implementing ESG-related directives such as client-tailored prohibitions on investments in certain industries. The staff also found vague directives, and inadequate tracking mechanisms to ensure compliance with such prohibitions.
- Unsubstantiated or potentially misleading ESG claims – Issues identified by the Division included marketing materials that failed to disclose material facts about expense reimbursement received from ESG-oriented fund sponsors, which led to inflated returns. Some advisers were found to have made unsubstantiated claims about their roles in the development of ESG products.
- Lack of policies and procedures for ESG issues – The Division found that compliance programs in some firms did not address the ESG frameworks to which they claimed adherence, and some firms were unable to substantiate their ESG-marketing claims about specific elements of their ESG investing program or their oversight of ESG-focused sub-advisers.
The Risk Alert outlines the staff’s observations of good ESG-related practices and procedures, in order to guide market participants that promote ESG investing.
Risk Alerts have no legal force or effect, and merely express the views of the staff of the Division of Examinations (formerly known as the Office of Compliance Inspections and Examinations, or OCIE).