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Bates Research  |  12-13-22

SEC to IAs: Take ESG Compliance Very Seriously

Image © [Vitalii Vodolazskyi] /Adobe Stock

The SEC recently held a National Seminar on compliance for investment advisers and investment company senior officers. Of the many important panels in the day-long program, one was devoted to the SEC’s expectations on investment adviser compliance with ESG requirements. The panel included representatives from the Divisions of Examinations, Investment Management and Enforcement, as well as a Chief Compliance Officer of a sustainable investing asset management company. A week later on November 22, 2022, the SEC announced a $4 million dollar settlement with a large investment adviser for ESG-related compliance failures. In the Order, the SEC found that the firm (i) failed to timely “adopt written policies and procedures governing how … [they]… evaluated ESG factors as part of the investment process until some time after the strategy was introduced;” and (ii) failed to consistently follow its own written policies and procedures once adopted prior to February 2020.  

Here we look at the takeaways from the seminar, which covered SEC exam concerns, an ESG disclosure proposal update, recent enforcement activity, and a CCO’s advice on ESG compliance.

SEC Seminar on ESG Compliance Obligations

Moderator Cindy Eson, Associate Regional Director for the Division of Examinations, began the panel discussion by describing the state of the ESG investment adviser market. She said that advisers are responding to increasing demand from investors by offering products and services that incorporate ESG strategies in their investment decisions. She highlighted current estimates on the size of the market saying that over 800 ESG funds with three trillion dollars in investable assets are currently in play. But she also underscored the many political controversies permeating every aspect of the field and the uncertainty that follows. By example, she shared that a significant number of Senators have written to law firms that handle ESG matters notifying them that they should prepare for congressional investigations. In another instance, she pointed to a lawmaker who issued requests for information from six investor research firms about how they calculate issuers’ ESG scores.

Examination Observations

Andy Sohrn, Manager, SEC Division of Examinations, highlighted several observations on ESG compliance raised in recent examinations. He acknowledged the compliance challenges that result from the lack of a standard definition for ESG but focused on the practical steps advisers should be considering as they incorporate ESG factors (negative screening or filtering, positive screening, socially responsible investing strategies, integration of ESG into traditional analysis, issuer engagement, impact investing and proxy voting) into their policies, processes and practices. In anticipation of exams, Mr. Sohrn focused on three recommendations.

1 - Specificity in Disclosure and Marketing

First, he highlighted the importance of specificity in disclosures and marketing. He said the lack of a definition of ESG makes the need for specificity in disclosure critical and described how a simple ESG claim like“we exclude fossil fuel companies from our portfolio” can run afoul of an examination without greater specificity; (e.g., did the disclosure specify traditional oil and gas companies only? companies that may have subsidiaries in the industry? companies that are also consumers of fossil fuels?) He said that examinations revealed examples of the use of negative screens for ESG that were based on a politically divisive issue which should have been a material consideration but was not disclosed; and an instance where an adviser told fund investors that a company scored highly on each ESG rating, but failed reveal that the scores were provided by a third party which blended composite scores and contained no breakdowns for how the companies scored in each of the categories. 

2 - Reliance on Third-Party Data Providers

Second, Mr. Sohrn highlighted the added risk to ESG investment advisers from reliance on third-party data providers. He suggested that advisers understand fully the information a third-party data provider can give, what the advisers need from such a data provider to actually implement their ESG strategy, and what the adviser must disclose to its investors about that reliance. He reminded advisers that different data providers can come to different conclusions and recommendations regarding companies and, also, that there can be gaps in the data which can affect their recommendations and their disclosure obligations.

3 – Branding and ESG Strategy

Third, Mr. Sohrn highlighted that firms that rebrand existing funds or strategies into ESG funds or strategies ensure that the new name fairly and accurately represents the funders ESG strategy. He cautioned that sometimes “the marketing people get ahead of the portfolio management people and compliance people.” He concluded with a general warning that the more that ESG is integral to a firm’s business—the more it is advertised or marketed as part of the firm’s strategy—the more risk there is, and the more likely it is that examiners would expect a firm to have policies and procedures to address that risk.

Status Update on SEC ESG Disclosure Proposal

Sara Cortes, Senior Special Counsel, SEC Division of Investment Management, offered the latest on the SEC’s proposal to require “registered investment advisers, certain advisers exempt from registration, registered investment companies, and business development companies” to disclose information on ESG investment practices and strategies in fund registration statements, prospectuses, annual reports, and adviser brochures. (See previous Bates post). Ms. Cortes described the rulemaking as clarifying how much disclosure is necessary in various categories. She said that concerns raised in received comments include: (i) that some of the categories intended for regulatory purposes could be used by firms for marketing purposes, (ii) that a number of the rules were highly prescriptive, and (iii) that smaller advisers could be asked to bear unacceptably high compliance costs. In closing, she said that the proposed ESG rules reaffirmed existing obligations under the Compliance rule.

Enforcement Observations

Kimberly Frederick, Assistant Director, SEC Division of Enforcement (Asset Management Unit) emphasized that ESG compliance enforcement remain focused on broader regulatory requirements of materiality and disclosure. She described how the SEC built a special climate and ESG Task Force in March 2021, which currently has two dozen staff selected for their experience in financial reporting, issuer disclosure, investment adviser matters. She said the Task Force “proactively” works to identify ESG compliance and related misconduct and uses big data and other tools to analyze disclosure and compliance matters relating to investment advisers’ and funds’ ESG strategies.

Ms. Frederick described notable SEC ESG cases, including (i) a 2020 action against Fiat Chrysler for making materially misleading statements about the emissions from their vehicles which resulted in a $9.5 million fine; (ii) a 2022 case involving a NY robo-adviser that marketed itself as providing services that complied with Sharia law (The firm did not have written policies and procedures setting forth how it would do so and agreed to pay a $300,000 penalty and to hire an independent compliance consultant.); and (iii) an enforcement action against an adviser for representing that all holdings in a mutual fund had undergone an ESG review, even though that was not the case, resulting in a $1.5 million penalty.

Ms. Frederick reiterated that these cases were all about materiality and disclosure and said the takeaway is simple: “Say what you mean, and mean what you say.” She concluded that “if an adviser is marketing itself as having an ESG-driven or influenced investment process, it must make sure its marketing materials are not misleading, and it has to adopt policies and procedures reasonably designed to match its investing.”

A CCO Point of View: Consistency Matters

Several direct observations came from John Boese, Chief Compliance Officer at Impax Asset Management LLC. He remarked that an exam covering ESG was like a “routine exam on steroids,” and that his recent experience was that the exam was “as much of a fact-finding mission as it was an exam.” He asserted that the SEC is looking to see whether “you’re saying it,” and if you are, then “if you are doing it,” and further, “if you are consistent in all your filings and marketing and disclosures.” On ESG best practices, he suggested: “don’t create compliance traps in your prospectuses; don’t say things that you are not going to be able to do. You have to make sure that your prospectus is consistent with your website which is consistent with your ADVs and with your marketing.”

He also recommended (i) that compliance be an ad hoc member of every department in your organization; (ii) that firms create specific policies and procedures around ESG; and that (iii) compliance professionals be able to test those procedures, “not only for a firm’s own protection, but for compliance’s as well.”  

Policies and Procedures: Recent ESG Settlement

These observations were on display in a matter announced a week after the seminar. The SEC Order stated that the investment adviser “had several policies and procedures failures involving the ESG research its investment teams used to select and monitor securities.” Specifically, the SEC found that, for a time, “the company failed to have any written policies and procedures for ESG research in one product,” and “failed to follow its own policies and procedures” once they were established. These alleged failures included internal requirements for employees to complete questionnaires on companies to be included in ESG investment portfolios prior to their selection. In its settlement, the adviser agreed to a cease-and-desist order, a censure, and a $4 million penalty.


As the market for ESG investing grows, attention to compliance around related materiality and disclosure will intensify. Meanwhile, the SEC’s ESG disclosure proposal keeps winding its way through the rulemaking process. Notwithstanding the controversies surrounding ESG investing, and the political uncertainties hovering over it, the SEC has organized itself for sustained attention to investment adviser compliance. Both the panelists and the recent enforcement settlement make that clear. Bates will keep you apprised.  

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