The Securities and Exchange Commission (SEC) threw down the gauntlet after President Biden's election and asserted its interest in greater regulation and policing of environmental, social, and governance (ESG) issues. One aspect of this initiative-the possibility of mandatory disclosure rules for all issuers-has reignited significant debate about the SEC's role and the nature of the potential disclosures, including whether the SEC has the authority to mandate such disclosures if ESG issues are not material to a specific issuer.1 These debates have received significant attention and will likely take time to resolve.

This client alert addresses the SEC's focus on the burgeoning sector of investment products focused specifically on their ESG attributes-a sector estimated to include 800 registered investment companies with more than $3 trillion in assets. Simply put, this is an area where we expect enforcement attention from the SEC in the near term. Policing ESG investment products is likely to be an SEC priority under the umbrella of its mandate to police disclosure, given the sector's substantial growth and the priority the SEC has announced it will place on ESG issues generally.

In July alone, multiple top SEC officials sent messages that they are focused on ESG disclosures made by investment advisers and funds. For example, on July 28, 2021, SEC Chairman Gary Gensler stated that he had instructed the SEC staff to consider recommendations on whether fund managers should disclose the ESG criteria and related data that are used to determine what investments qualify, noting that "[l]abels like 'green' or 'sustainable' say a lot to investors."2 And on July 13, 2021, then Acting SEC Director of Enforcement Melissa Hodgman stated that funds advertising ESG investments will be subject to increased scrutiny and should anticipate potential disclosure-related enforcement actions.3 These are only the most recent statements warning the industry of the SEC's increased focus on these issues; for example:

  • In March 2021, the SEC established a Climate and ESG Task Force in the Division of Enforcement (ESG Task Force). The announcement cited disclosure and compliance related to ESG strategies of investment advisers and funds as an area of focus for the ESG Task Force.
  • Soon after, in April 2021, the Head of the ESG Task Force publicly emphasized that existing legal provisions can be applied to enforcement actions for fraudulent marketing of ESG products and insufficient controls around those products.
  • In April 2021, the SEC's Division of Examinations published a Risk Alert based on its examination of investment advisers, registered investment companies and private funds offering ESG products and services and highlighted six areas of weakness.
  • Earlier in July 2021, SEC Chairman Gensler explained that he was concerned about truth in advertising with ESG products, and he explained that he had asked the SEC staff to consider both mandatory disclosure obligations for ESG funds and possible revisions to the "Names Rule" applicable to ESG funds.4
  • The SEC's Asset Management Advisory Committee (AMAC), made up of outside experts and industry participants, established a subcommittee at the beginning of 2020 to review ESG issues and to make related recommendations to the SEC. On July 7, 2021, AMAC recommended, in part, that the SEC suggest best practices for ESG investment product disclosures.

This client alert reviews the SEC's statements on these issues, the application of the SEC's potential legal theories to ESG investment products, and the questions asset managers and fund advisers should ask to best protect themselves. Whatever views asset managers and fund advisers may have concerning this SEC initiative, those who are participating in this growing sector should take steps to ensure that ESG-related investment products are accurately described to investors, that reasonable policies and procedures have been established to adhere to funds' ESG-related criteria, and that those policies and procedures are applied as intended.

Read the full alert.

Footnotes

1. Compare Letter from Senator Toomey et al. to Chair Gary Gensler and Commissioner Allison Herren Lee (June 13, 2021), with Commissioner Lee's May 24, 2021, Speech, Living in a Material World: Myths and Misconceptions about "Materiality"; see also Hester Peirce, Commissioner, Speech by Commissioner Peirce on ESG Disclosure (July 21, 2021).

2. Gary Gensler, Chairman, Prepared Remarks Before the Principles for Responsible Investment "Climate and Global Financial Markets" Webinar (July 28, 2021).

3. Al Barbarino, Top SEC Official Suggests More ESG Enforcement Is Coming, Law360 (July 13, 2021).

4. Gary Gensler, Chairman, Prepared Remarks Before the Asset Management Advisory Committee (July 7, 2021). As currently framed, Rule 35d-1 under the Investment Company Act of 1940 (the Names Rule) requires a registered investment company with a name suggesting that it focuses on a particular type of investment to invest at least 80% of its assets in the type of investment suggested by its name.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.