Compared with that of his predecessor, President Biden’s administration has taken a markedly different direction on a number of issues, and that certainly includes oversight of the financial industry. Of course, early in any presidency, it is difficult to foresee the full effect of four-years’ worth of executive influence. But last Friday, the U.S. Securities and Exchange Commission flashed its teeth in a preview of at least one area of renewed focus.
In recent years, so-called socially responsible funds have become increasingly popular with investors, in spite of efforts by the Trump administration to curtail their growth. In 2020 alone, despite the lingering effects of a pandemic, a record $51 billion flowed into U.S. sustainable funds, according to Morningstar. With that much money at stake, it comes as little surprise that some funds have been accused of overinflating their progressive credentials to attract a bigger piece of the pie.
On Friday, the SEC announced the preliminary results of a review of investment advisors and funds that focused on investing ESG issues. Regulators said they had found advisers and funds making “potentially misleading” claims. The SEC also said it had uncovered inadequate controls around ESG issues.
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The SEC explicitly warned that it was looking into mismatches between funds’ stated approaches and the actual actions of advisors and fund managers in the real world. This included informational failures, with some advisers accused of promoting investment strategies as socially responsible despite lacking tools to screen for or reasonably track investments in relevant industries. But the SEC also complained of procedural inadequacies, citing instances in which investors were not allowed to separately vote on ESG-related proposals despite being promised a chance to do so. The SEC’s exam staff intends to continue this review into ESG investing.
These latest efforts are in line with earlier climate risk and social governance initiatives the SEC has taken on since Joe Biden was inaugurated. The acting chair of the SEC, Allison Herren Lee, has been especially active on ESG issues.
No pending enforcement actions were announced on Friday in conjunction with the SEC’s latest ESG review. Even so, this is just the latest shot across the bow: The SEC has issued notice after notice that ESG disclosures will be a priority for 2021. Funds that do not pay heed could reap the consequences in the coming months.
Some ways to stay out of the SEC’s crosshairs in an ESG review are rather obvious. While recognizing that advisors and funds want to attract investors rather than scare them away, it is still best not to overstate the sustainability or social justice bona fides of any given option. Not all areas SEC regulators are likely to focus on are quite so straightforward, though. Political spending disclosures, for example, have been directly tied to ESG disclosures by Lee. A company that makes a climate or racial justice pledge, and subsequently offers campaign contributions to lawmakers whose voting records contradict the pledge, could find itself facing an uncomfortable level of regulatory scrutiny, according to recent public comments from Lee.
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In addition to taking steps to get one’s own house in order, industry insiders also stand to play a role in forming the SEC’s final ESG regulatory scheme. In late March, the SEC held a virtual panel focused on the SEC’s ESG subcommittee’s recommended new standards for disclosure of material ESG risks. Panelists included both agency staff and industry leaders, and each panelist was individually given the opportunity to express a viewpoint on the recommended ESG standards. While panelists seemed to fall into two distinct camps (with little clear room for compromise), those in the industry to be regulated have nothing to lose and at least the potential to gain by having a seat at the table.
ESG issues are going to be at the forefront of the SEC’s agenda under President Biden and chair nominee Gary Gensler, who has made clear that ESG disclosures will be a focus for the agency. For funds and advisors that are proactive, this change in focus does not have to be especially painful, and there may even be opportunities in actively discussing the form of new ESG regulations directly with the SEC.
Jonathan Wolf is a civil litigator and author of Your Debt-Free JD (affiliate link). He has taught legal writing, written for a wide variety of publications, and made it both his business and his pleasure to be financially and scientifically literate. Any views he expresses are probably pure gold, but are nonetheless solely his own and should not be attributed to any organization with which he is affiliated. He wouldn’t want to share the credit anyway. He can be reached at [email protected].