SEC Exam Observations: ESG Investing Risks

ESG-Specific Examination Practices

• During an examination of your firm’s ESG practices, examiners will review ESG-related policies and procedures, due diligence practices for selecting new investments, and proxy voting processes.
• Marketing materials and performance advertising will be assessed to determine whether advisers employ proper disclosures and follow global ESG frameworks, if applicable. These materials may include due diligence questionnaires, regulatory filings, websites, and other public-facing documentation.
• Advisers’ compliance policies and procedures and the execution of proper ESG practices and disclosures will be reviewed during these exams.

Observations from Recent Exams

• Some of the examined advisers’ portfolio management practices were inconsistent with the ESG disclosures provided to clients, including those reported in Form ADV.
• Inadequate controls for upholding clients’ ESG-related directives were found. For example, some advisers were found not to have proper mechanisms in place to track clients’ negative screens or prohibitions on investments, like those including alcohol, tobacco, or firearms.
• Inconsistencies between advisers’ proxy voting practices and stated ESG approaches were observed. These included advisers publicly stating clients’ ability to vote on ESG-related items with no follow-through or policies to support these claims.
• Misleading claims about ESG approaches were made by some of the examined advisers. These sometimes included marketing materials with inflated risk and return metrics or unsubstantiated statements regarding adviser contributions to ESG development.
• Insufficient controls were in place to confirm ESG-related disclosures and marketing matched firms’ actual practices.
• Advisers’ policies and procedures did not appropriately address ESG practices. For example, some advisers claimed to follow global ESG frameworks but did not have policies and procedures in place to support these programs.
• Exam staff noted that firms with compliance staff who had less ESG-specific knowledge also had less effective compliance programs overall.

Positive Exam Observations and Effective Compliance Practices

• Some of the examined firms had clear, concise, and accurate ESG disclosures. These included tailored disclosures regarding how some investments may be inconsistent with ESG requirements, but still fit into the use of a global ESG framework, for example.
• Comprehensive and complete policies and procedures for handling ESG investing were observed among some advisers. These practices included firms completing documentation throughout the investment process at various stages, like research, due diligence, selection, and monitoring.
• Firms with compliance personnel who were more knowledgeable and well-informed about ESG investing had stronger compliance programs and more meaningful ESG oversight than other firms.