IA Fined for Misstatements on ESG ETFs
Commentary by Andrew Lom
An investment adviser settled SEC charges for misstatements related to ESG Fund portfolios, which were marketed as excluding companies involved in fossil fuels and tobacco.
According to the Order, the adviser misrepresented to the ESG Funds' Board, and in the Funds' prospectuses, that the Funds would screen out companies involved in these activities. The SEC found that during the relevant period, the Funds held investments in "coal mining and the transportation of coal, natural gas extraction and distribution, and the retail sale of tobacco products." The SEC found that the adviser was aware that its third-party screening process was flawed, but did not disclose the limitations of the data used for the screening nor did it revise the fund disclosures in a timely manner. In addition, the adviser did not adopt sufficient written policies and procedures to ensure compliance with the ESG investment process, leading to ongoing discrepancies between its stated ESG criteria and actual investments.
The SEC determined that the adviser violated Advisers Act Section 206(4) and 206(2) ("Prohibited transactions by investment advisers") and Advisers Act Rule 206(4)-7 ("Compliance procedures and practices").
To settle the charges, the adviser agreed to (i) cease and desist, (ii) a censure and (iii) pay a $4 million civil penalty.
Commentary
The SEC has taken various approaches to advance its agenda on greenwashing and other types of ESG disclosures and compliance, including, for example, the fund names rule, the proposed rules for ESG funds and strategies, the currently stayed rules for public company reporting and enforcement actions such as this.
This enforcement is interesting because the fund manager tried to use relevant ESG screens from a third party provider, but the screens did not match the funds' prospectus and other disclosures. It appears that the SEC would not have objected to certain assets slipping through the screens and into the fund portfolios if the fund manager had simply disclosed the limitations of the screens. As the Acting Director of the SEC's Division of Enforcement stated about this enforcement, fund managers must "do what they say and say what they do," even if it means a less than perfect ESG portfolio. At the end of the day, the SEC's current regulation for ESG matters still comes down to disclosure.
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SEC Director of Enforcement, Gurbir S. Grewal highlighted the challenge of ensuring that companies and investment firms make truthful ESG disclosures, and the tendency of some entities to exaggerate positive ESG activities or downplay negative ESG-related information.
