ESG compliance insights for registered investment companies

A strong emphasis from the SEC raises the stakes

Keeping up with compliance requirements is always a critical imperative in the highly regulated registered investment company (RIC) sector. An often overlooked and increasingly important compliance function is environmental, social and governance (ESG) compliance.

Since announcing its Climate and ESG Task Force in early 2021, the SEC’s Division of Examination (“The Division”) has continued to bolster its attention to ESG reporting within the RIC sector.

Several firms across multiple sectors have faced enforcement actions from the SEC regarding their ESG reporting, including companies in sectors such as asset management, health insurance and agriculture, among others. This focus will continue. When the SEC highlighted six areas of focus among its 2023 examination priorities, ESG was among them.

What the SEC addressed

Within its examination priorities release in February, the SEC stated, “The Division will continue its focus on ESG-related advisory services and fund offerings, including whether funds are operating in the manner set forth in their disclosures." The SEC also announced that it would "… assess whether ESG products are appropriately labeled and whether recommendations of such products for retail investors are made in the investors’ best interests.” This is a new area of focus that the SEC did not mention in its 2022 examination priorities and may be a signal that the SEC could be shifting its ESG monitoring to prioritize retail investor well-being.

In the past, SEC examinations typically focused on whether registered investment advisors (RIAs) and registered funds were accurately disclosing their ESG investing approaches. They also focused on whether RIAs and registered funds had adopted and implemented policies, procedures and practices designed to prevent violations of the federal securities laws in connection with their ESG-related disclosures, including a review of their portfolio management processes and practices.

ESG disclosure best practices

The Division has encouraged market participants promoting ESG investing to clients, prospective clients, investors and prospective investors to evaluate whether their disclosures, marketing claims and other public statements related to ESG investing are accurate and consistent with internal firm practices. The Division has also noted that firms should consider taking steps to document and maintain records relating to important stages of the ESG investing process. Both of these recommendations are underpinned by strong, robust internal controls.

Key takeaways

1. The Division is placing a new emphasis on ESG, reviewing whether products are appropriately labeled and whether recommendations of such products for retail investors are made in the investors' best interests.
2. The Division advises funds and their advisers to evaluate whether their disclosures, marketing claims, and other public statements related to ESG investing are accurate and consistent with internal firm practices.
3. The Division encourages funds and their advisers to consider taking steps to document and maintain records relating to important stages of the ESG investing process.