The SEC’s Division of Examinations (EXAMS) issued a key Risk Alert (the “Alert”) that tackles the thorny compliance issues surrounding ESG (Environmental, Social, and Governance) investment themes. EXAMS has conducted reviews of RIAs and funds that follow ESG strategies and compiled a list of both positive and negative findings from those examinations. RICS (Registered Investment Companies), private funds, and SMAs (Separately Managed Accounts) were all included in the ESG targeted examinations conducted over the last few years.
The Alert issued this month includes Staff observations from both a positive and negative perspective. Some common deficiencies found were:
- Portfolio management practices that did not match client disclosures
- Lack of monitoring on ESG-related investing guidelines and restrictions in client accounts
- Inconsistent proxy voting on ESG matters
- Misleading claims in marketing materials on ESG investing
- Poor internal controls around ESG disclosures in marketing v. actual practices
- Compliance programs that did not cover ESG compliance controls, especially in relation to ESG frameworks such as the Principles for Responsible Investment (“UNPRI”) or sub-adviser compliance
- Lack of knowledge by compliance personnel of ESG strategies and risks
Effective practices were also discovered during the targeted examinations. These successful approaches included:
- Clear, precise, and customized ESG disclosures that met actual firm practices and offered:
- Simple and clear disclosure language
- Balanced disclosure on the use of global ESG frameworks and use of contrary investments
- Disclosures on how a firm met global ESG frameworks such as UNPRI that included quantitative information on local impact
- Written policies and procedures that covered ESG investing oversight and monitoring
- Knowledgeable compliance personnel that were integrated into the ESG processes
EXAMS will continue reviewing firms that specialize in ESG investing to look for the issues found above or whether the firm or fund utilizes effective practices. Since the Biden Administration has made it clear that ESG matters are important to our country’s future, expect the SEC to serve as conduit to that goal.
FrontLine Compliance will continue to monitor ESG developments in 2021 and keep you informed of any updates.