RIA Compliance and Practice Management Blog

SEC Issues RIA Risk Alert for ESG Investments

Posted by RIA in a Box

Apr 29, 2021 8:31:24 PM

www.riainabox.comhubfsSEC Risk Alert-1-Dec-14-2020-09-53-33-74-PM

On April 9th, 2021, the Securities and Exchange Commission (“SEC”) Division of Examinations’ released a new risk alert summarizing the findings from recent examinations of registered investment adviser ("RIA") firms and private funds offering environmental, social, and governance “ESG” products and services.

This risk alert follows the SEC’s focus on ESG-related investing highlighted in the list of 2021 examination priorities as well as the launch of the Climate and ESG Task Force within the Division of Enforcement.

In this release, the Division states it has observed firm’s different approaches to ESG investing and discusses the risks associated with a lack of standardized ESG definitions.

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Some of the key takeaways for RIAs regarding compliance considerations with ESG investing include:

Examinations of Investment Advisers and Funds:

  • Portfolio Management: RIA firms can expect the Division to assess the consistency between their disclosures and their portfolio management practices and polices related to ESG investing. Additionally, Division staff will evaluate the use of ESG terminology in the disclosures and the firm’s due diligence for the ESG investing approaches. Proxy voting decision-making processes will be assessed for consistency with ESG disclosures and marketing materials.
  • Performance Advertising and Marketing: Examinations will include a focus on reviewing firm’s regulatory filings, websites, communications with clients and prospective clients, marketing materials, and due diligence questionnaires for consistency with the firm’s claims related to ESG investing.
  • Compliance Programs: The Division will evaluate firm’s written policies and procedures related to ESG as well as assess the implementation and compliance supervision of the policies in place.

Staff Observations of Deficiencies

Following recent examinations of RIA firms and private funds, the Division staff reported numerous deficiencies related to ESG investing. Advisors can take items from the list below into consideration while reviewing and updating their policies and procedures in their compliance programs for preparation of future examinations.

  • Portfolio management practices were inconsistent with disclosures about ESG approaches: The Division found weaknesses in firm’s portfolio management practices and client disclosures, specifically the form ADV Part 2A, and other client communications related to ESG approaches. There were unsubstantiated claims regarding ESG-related investment practices and lack of documentation on the decisions and issuer engagement efforts.
  • Controls were inadequate to maintain, monitor, and update clients’ ESG-related investing guidelines, mandates, and restrictions: Firms were noted to have weak policies and procedures with respect to the implementation, supervision, and notification process for clients or funds for ESG-related directives.
  • Proxy voting may have been inconsistent with advisers’ stated approaches: Staff discovered cases where firms were not internally evaluating proxy proposals on a case-by-case basis to maximize value as promised in public ESG-related policies. Firms also did not follow through with claims to provide separate ESG-related proxy voting opportunities.
  • Unsubstantiated or otherwise potentially misleading claims regarding ESG approaches: Cases of unsubstantiated or potentially misleading claims found in recent exams included marketing materials for ESG-related funds that suggested favorable risk and return, without disclosures for the material facts regarding substantial expense reimbursement from the fund-sponsor, therefore inflating the returns for those funds.
  • Inadequate controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices: Division staff discovered weaknesses in controls over public disclosures and client-facing statements along with a lack of adherence to the global ESG frameworks claimed to be followed. Instances of marketing efforts not updated in a timely manner were noted, specifically when ESG services were being advertised after no longer being offered.
  • Compliance programs did not adequately address relevant ESG issues: Observations of ESG-related inadequacies in compliances programs included lack of information on analyses, decision-making processes, or general compliance oversight. Firms were found to have difficulties substantiating claims involved with favorable scoring of ESG fund investments.

Staff Observations of Effective Practices

The Division staff also published some compliance best practices for ESG investments. RIA firms and private fund managers can use these examples as a guide on best practices related to ESG investments:

  • Disclosures: Clear, precise, and tailored disclosures were designed for the specific approaches to ESG investing that align with the actual practices. Disclosures included explanations as to how investments were evaluated using goals established under global ESG frameworks.
  • Policies and procedures that addressed ESG investing and covered key aspects of the firms’ relevant practices. The Division staff noted firms satisfied compliance requirements with policies and procedures comprised of specific documentation related to the research, due diligence, selection, and monitoring of ESG related investments.
  • Compliance personnel that are knowledgeable about the firms’ specific ESG-related practices: The Division found that the firms with compliance personnel who were well-informed on the ESG-related practices were less likely to make materially misleading claims by providing meaningful reviews and properly assessing the policies and portfolio management processes in place.

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The Division concludes the risk alert by emphasizing on the importance for firms to implement proper compliance measures and continue consistency within their practices.

Topics: RIA Operations, RIA Compliance, RIA Technology

RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

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