SEC Issues Risk Alert on ESG Investing

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April 14, 2021

Client Alert
On April 9, 2021, the Securities and Exchange Commission (the “SEC”) Division of Examinations (the “Division”) issued a Risk Alert highlighting observations made by the Division from recent examinations of investment advisers, registered investment companies, and private funds (collectively, “firms”) offering products and services that incorporate environmental, social, and governance (“ESG”) factors. According to the Division, the rapid growth in demand for ESG products and services and the lack of standardized and precise ESG definitions present certain risks, and the Risk Alert is intended to highlight risk areas and assist firms in developing and enhancing their compliance practices.

The Risk Alert is available here. The following is a summary of what is discussed in the Risk Alert.

Examination Priorities

ESG investing and its related risks were an Examination Priority for the Division in 2020, and as noted in this Chapman Client Alert and in a recent edition of Chapman Insights, the Division previously announced that its Examination Priorities for 2021 will continue to include ESG investing and related risks. The Division has examined, and will continue to examine, whether firms are accurately disclosing their ESG investing approaches and whether they have adopted and implemented policies and procedures that align with their ESG-related disclosures. During an examination of firms who offer ESG-related products, the Division focuses on:

Compliance Deficiencies

During examinations of firms engaged in ESG investing, the Division noted instances of firms making potentially misleading statements regarding their ESG investing processes and representations regarding adherence to global ESG frameworks. For example, for some firms that claimed to have formal processes in place for ESG investing, the Division observed a lack of policies and procedures related to ESG investing, policies and procedures that did not appear to be reasonably designed to monitor and prevent violations of law, and weak or unclear documentation of ESG-related investment decisions.

Additional observations by the Division included:

Effective Practices

The Division also noted certain effective compliance practices they observed that may assist firms in developing and enhancing their compliance practices regarding ESG investing. Examples of these practices are listed below.

Going Forward

The Division recommends investment advisers, registered investment companies, and private funds evaluate whether their disclosures, marketing materials, and other public statements related to ESG investing are accurate and consistent with their internal practices. Specifically, firms should ensure that their approaches to ESG investing are implemented consistently, are adequately addressed in relevant policies and procedures, and are subject to appropriate oversight by knowledgeable compliance personnel. The Division further noted that those offering ESG-related products should consider documenting and maintaining records relating to important stages of the ESG investing process.

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