SEC Keeps ESG Momentum with Release of Risk Alert

Publish Date


Compliance Alert


  • ESG
  • Compliance
  • SEC

On Friday, April 8, 2021, the SEC’s Division of Examinations issued a Risk Alert for ESG Investing, putting an exclamation point on ESG being a top priority for the Commission. The Risk Alert comes directly on the heels of a flurry of activity from the Commission including an “enhanced focus on climate-related risks” in its 2021 examination priorities, the creation of a Climate and ESG Task Force in the Division of Enforcement, an ESG Funds Investor Alert, and the launch of a SEC webpage dedicated to climate and ESG risks and opportunities.

The Risk Alert highlights observations from recent exams of investment advisers, registered investment companies, and private funds offering ESG products and services and is intended to highlight risk areas to assist firms in developing and enhancing their compliance practices. While ESG investing is not a new concept, the explosive growth in this area has led to inconsistent definitions of ESG investment strategies that vary greatly from firm to firm, leading to increased focus from the SEC to ensure investors are not misled.

The Risk Alert can be summarized with two simple themes:

  1. Do what you say you do, and
  2. Have formal processes in place for ESG investing from implementation to oversight and testing.

Do what you say you do

The staff noted inconsistencies between ESG portfolio management processes and how the approach is disclosed to clients and investors, as well as proxy voting claims and actual voting policies and practices. It was also discovered that some firms were unable to substantiate claims of positive ESG contribution to returns and risk metrics. To avoid these issues, firms should have clear, concise disclosures regarding the firm’s approach to ESG investing and view them in the same way they would disclosures for any other investment strategy. Having a clearly defined, repeatable, and documented investment process that has adequate and proper compliance oversight built in is a key element to ensure alignment between what is being disclosed and what is taking place.

Have formal processes in place for ESG investing

Inadequate controls were another common observation by the examiners. Specifically, controls around maintaining, monitoring, and updating client directed negative screening were weak, leading to an increased risk that prohibited securities could be included in client portfolios. Similar issues were noted with positive screening where, despite claiming to have the ability to implement client-directed positive screens, the screen was not implemented due to challenges around implementation and monitoring. Weaknesses in controls around ensuring ESG-related disclosures and marketing materials are consistent with the firm’s practices were also identified. Having detailed, comprehensive investment policies and procedures that address ESG investing are critical aspects of a firm’s successful ESG program, as they serve as the basis from which the disclosures are built. Beyond just having good policies and procedures, firms need to have adequate controls in place to effectively execute them throughout the investment lifecycle.

Additional observations

Throughout the Risk Alert, lack of adherence to global ESG frameworks was mentioned multiple times, indicating that the SEC is arming itself with enough knowledge of these additional frameworks to know when a firm’s actions do not match its claim of alignment with a given ESG framework. Having supportive frameworks within its purview is not new for the SEC and as additional frameworks evolve and come on-line, we can expect the SEC to become savvier in this area to support ESG investing compliance.

It is particularly interesting that the Risk Alert specifically calls out lacking oversight (of disclosures and marketing decisions) and poor ESG knowledge amongst compliance personnel as factors contributing to inadequate compliance programs. The statements made by the staff indicate the need for firms to build adequate ESG skills and capacities – it is difficult for a firm to determine if it is in compliance with ESG standards (or indeed whether they are implementing proper ESG practices in general) if professionals don’t understand what they are looking at. Given the evolution of ESG investing and the clear shift from ESG as a function of the investment decision making process to ESG as a function of compliance, this point comes as little surprise. Ensuring adequate ESG capacities amongst the compliance function is an important consideration for firms developing ESG program oversight, as it has been historically common for ESG to sit outside of compliance.

Commissioner comments

In an uncommon move, Commissioner Hester Peirce issued comments on the SEC’s Risk Alert almost immediately following the release. Commissioner Peirce acknowledged the importance of accountability in the ESG space and the need for asset managers to explain what they mean by ESG and then do what they say they do, echoing the general premise of the Risk Alert. However, the Commissioner was quick to point out that ESG should not be viewed as a unique concept requiring separate policies and procedures or that it would be viewed differently in the eyes of the examiners. Rather firms should bolster existing policies, procedures, and practices to incorporate ESG and consider it like any other investment strategy. In an effort to debunk some myths and confusion about the SEC’s role around ESG, Commissioner Peirce also pointed out that SEC examiners will not be merit regulators; rather, their role is to ascertain whether firms are adhering to their own ESG claims.

What’s next?

The SEC will continue to examine firms to determine they are accurately disclosing their ESG investing approaches and have adopted and implemented policies and practices that align with ESG-related disclosures. Firm’s claiming to engage in ESG investing can generally expect an examination to focus on the following areas as they relate to ESG:

  1. Portfolio Management: Policies and procedures, including ESG-related terminology and the investment process (selection, investment, monitoring) must be consistent with disclosed ESG investment approaches. Additionally, examiners will be looking to see that the proxy voting decision-making process is consistent with ESG disclosures.
  2. Performance Advertising and Marketing: Regulatory filings, websites, RFPs, client reporting and presentations, due diligence responses, and other client/investor facing documents will be reviewed for false or misleading information. If a firm has committed to an ESG framework, such as UNPRI, and communicated that commitment to clients, any reporting to those frameworks will also be reviewed.
  3. Compliance Programs: Documented policies and procedures will be reviewed and include a review of the implementation, compliance oversight (including testing and supporting materials), and review of ESG investing practices and disclosures.

How ACA can help

As ESG continues to evolve and expand at an accelerated rate, it can be difficult to keep pace with the ever-changing landscape. ACA has uniquely designed services to not just keep pace with all the changes but keep you one step ahead. Our compliance-rich heritage and expertise in the financial services industry put ACA in a unique position to guide firms through their ESG journeys, always keeping regulatory obligations in sight.

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