SEC Risk Alert: ESG offerings

The United States' SEC releases its 2021 examination priorities

On April 9 2021, the Division of Examinations for the U.S. Securities and Exchange Commission (SEC) released guidance for firms offering environmental, social and governance (ESG) investment options, as investor demand increases for ESG-related products and services.

The Division of Examinations (the “Division”) acknowledged that firms approach ESG investing in various ways while emphasizing that the industry currently lacks standard ESG definitions and terms, which the Division believes in certain instances is creating confusion among investors. Accordingly, the Division highlighted that firms should clearly and consistently articulate how they define ESG and how it applies to their investment approach. The Division also noted that its interest in the accuracy and adequacy of disclosures by firms offering ESG investment strategies is the same as it would be for firms offering any other type of investment strategy.

Exam priorities

The Division identified focus areas for future exams of firms providing ESG products and services, noting that exams will primarily focus on the accuracy and adequacy of disclosures and any applicable policies and procedures used by the firm related thereto. Additionally, the Division emphasized that any disclosure documents must be consistent and match any global framework that the firm is advertising.

Accordingly, exams will include a review of a firm’s:

  • Processes regarding: (i) use of ESG-related terminology; (ii) selecting, investing in and monitoring investments in view of its disclosed ESG approaches; and (iii) proxy voting
  • Advertising and marketing materials in view of the firm’s disclosed ESG strategies
  • All other written disclosures, policies and procedures concerning ESG investing practices

Key deficiencies

The Division also identified specific risk areas where they have noted deficiencies in recent exams.

Those key deficiency areas included:

  • Inconsistent disclosures – Firm disclosure documents (e.g. the Form ADV Part 2A Brochure) that were inconsistent with other client-facing communications
  • Weaknesses in implementing and monitoring ESG directives – Firms did not have adequate controls for implementing or monitoring the strategies that it represented to clients or investors
  • Inconsistent proxy voting approaches – Internal proxy voting policies were inconsistent with the policies represented to clients or investors
  • Unsubstantiated or misleading claims regarding ESG approaches – Firms did not include appropriate disclaimers as applicable to their particular ESG strategy
  • Inconsistent marketing materials – Client-facing communications were inconsistent with actual internal practices
  • Inadequate compliance programs tailored to relevant ESG issues – Firms did not have compliance programs that addressed adherence to the global ESG frameworks that the firms claimed to be adhering
  • Limited knowledge of compliance personnel – Personnel lacked knowledge of relevant ESG frameworks

Successful programs

The Division also noted several areas where firms had successful compliance programs that included accurate disclosures and policies that appropriately conveyed material aspects of the firm’s ESG strategy.

Those programs included:

  • Disclosures that were simple, clear, and precise, as well as tailored to the firm’s specific ESG strategy – These disclosures provided transparency and clarity to clients and investors
  • Policies that required specific documentation for various stages of the investment process – These policies strengthened the implementation and monitoring of ESG directives
  • Knowledgeable personnel – Firms with knowledgeable personnel were less likely to have materially misleading marketing materials or disclosures

Taking action

In reviewing the above summary, firms should:

  • Clearly and consistently articulate how it defines ESG for the firm’s strategy
  • Evaluate the firm’s disclosure documents and ensure consistency with marketing materials
  • Tailor policies and procedures to account for ESG directives
  • Train employees on applicable ESG frameworks
  • Consider engaging additional resources for assistance in addressing ESG-related risks, such as IQ-EQ Compass

IQ-EQ Compass offers a full suite of ESG services including:

  • ESG Health Check – A gap analysis that enables firms to understand their current position on the ESG spectrum
  • ESG Reputational Assessment – Comprehensive ESG reputational reports on funds, portfolio companies and their leadership teams
  • ESG Foundations – Assistance in drafting ESG policies, frameworks, and procedures
  • ESG Reporting – Collecting and compiling ESG data and drafting ESG and Impact performance reports
  • ESG Dashboard – Enables firms and investors to navigate, monitor and benchmark their ESG objectives on an ongoing basis

For more information on this risk alert please contact us, or click here to find out more about IQ-EQ Compass.