Tip for Updating Your Compliance Program: ESG

As we wrap up Form ADV season, we are reminded that compliance officers face the thankless task each year of reviewing their policies and procedures to determine their adequacy and effectiveness, as required by Advisers Act Rule 206(4)-7. This review entails updating the firm's compliance program to reflect changes to relevant regulations and new regulatory guidance, and confirming the program is appropriately followed by the firm.  

We’ve compiled a series of tips to help you focus on the U.S. Securities and Exchange Commission (SEC) focus areas for 2023. You can read our previous tips here:  

• Get ready for SEC focus on hedge clauses in advisory agreements 
• Keep tabs on Continuing Education requirements 
• Update your compliance program to address the SEC Risk Alert about MNPI compliance issues 
• Prepare for an SEC examination focused on Marketing Rule compliance
• Update Your Compliance Program to Prevent Identity Theft Under Regulation S-ID 

Tip #6 – Environmental, Social, and Governance (ESG)

As the SEC noted in its 2021 risk alert, the Division of Examinations’ Review of ESG Investing, investor demand has been increasing for funds that incorporate ESG factors as part of their investment process. Firms have been eager to fill this need, setting up sustainable funds with ESG investment objectives. But some investment advisers have overstated their commitment to sustainability or lagged in implementing policies and procedures for selecting, investing, and monitoring investments using ESG factors. In recognition of the potential for misleading investors, the SEC launched the Climate and ESG Task Force within the Division of Examinations (EXAMS) to “proactively identify ESG-related misconduct consistent with increased investor reliance on climate and ESG-related disclosure and investment.”   

EXAMS promised to target firms touting ESG-related advisory services and investment products as part of its 2023 Examination Priorities Report. And in 2022, the SEC brought two significant cases against advisers for failing to live up to their marketing hype for ESG investing. You can read about them here and here. Both of these cases involved advisers that represented they were following certain procedures for evaluating potential investments using ESG factors, but fell short of living up to those representations.  

For firms claiming to use ESG factors as part of their investment process, EXAMS will be looking at the following:  

• Whether the adviser accurately discloses its ESG investing approach (or approaches) 
• Whether the adviser has adopted and implemented policies, procedures, and practices consistent with its Form ADV and other disclosures to investors, such as a prospectus or private placement memorandum 
• Whether a firm with proxy voting responsibility votes client securities following proxy voting policies and procedures and whether the votes align with its ESG-related disclosures and mandates 
• Whether the firm overstates or misrepresents the ESG factors considered or incorporated into portfolio selection (e.g., greenwashing), such as in their performance advertising and marketing 

Our guidance

• Review Form ADV disclosures about the firm’s approach to ESG and compare them to marketing materials and investor documents, such as a prospectus or private placement memorandum, to ensure they consistently and accurately represent the investment process.   
• Review Form ADV and other disclosures about the firm’s approach to ESG to ensure that they adequately explain how investments are evaluated.  
• Adopt detailed, comprehensive investment policies and procedures that include contemporaneous documentation of the ESG factors considered in specific investment decisions at all stages in the process (e.g., research, due diligence, selection, and monitoring). 
• Integrate compliance personnel into the ESG-related processes to provide meaningful reviews of firms’ public disclosures and marketing materials.  
• Test the adequacy and specificity of existing ESG-related policies and procedures and the adequacy of documentation of ESG-related investment decisions and adherence to clients' investment preferences. 
• Test the proxy voting process to ensure that proxies are being voted as the proxy voting policy dictates and evaluate whether that policy is consistent with the firm's ESG-related disclosures and investment guidelines.  

How we help  

The ESG landscape is evolving at a rapid pace and requires additional resources to meet investor and regulatory expectations.  

For firms that need basic ESG programs to answer to their investors, to firms that need to report to external frameworks, to those that want to be on the leading edge of best practices, ACA's Program Management offers a suite of services for every ESG program maturity level. We go beyond implementation and provide support and maintenance while ensuring our clients stay one step ahead of the ever-changing ESG landscape. 

Through our acquisition of Ethos ESG, ACA’s new ESG platform integrates in-depth, transparent ESG data into your portfolio construction. Ethos aggregates 2,000,000+ data points to provide impact profiles on 17,000+ companies and funds. Ethos offers ratings, screens, controversies, scenarios, and 300+ ESG metrics related to carbon emissions, governmental fines, diversity, employee satisfaction, pay equity, tax payments, innovation, business models, and more.  

ACA’s ESG platform can help firms easily conduct ESG risk and impact diagnostics and benchmarks to understand how investments map to widely accepted sustainability frameworks, such as the United Nations Sustainable Development Goals and the Paris Climate Accord. Feel prepared to address inquiries related to evolving concerns over environmental, social, and governance issues.  

Contact us to learn more about our integrated tech and advisory ESG practice, including our robust approach to ESG reviews. 

Contact us

Listen to our 2023 Regulatory Outlook webcast on demand 

We recently hosted a webcast to review the regulatory changes that will likely have implications on compliance programs in 2023, and provide recommendations to prepare for these changes. Our experts discussed rule proposals and adoption, examination and enforcement trends, and regulatory guidance. Watch our webcast for more insights to help you prepare your compliance program for this year’s focus areas. 

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