On September 17, 2020, SEC Commissioner Hester Peirce gave a speech that focused on potential issues raised by investment advisers that—while purporting to follow environmental, social and governance (“ESG”)-labeled investment strategies—did not, in Commissioner Peirce’s words, “walk the ESG walk.” Her comments are the latest reminder that, while the SEC has continued to struggle with whether to mandate specific ESG disclosures, there seems to be consensus behind the SEC’s focus on determining whether advisers’ disclosures concerning ESG are sufficiently accurate and understandable. Thus, asset managers would be well served to review and, where warranted, enhance their ESG-related disclosures and compliance policies in an area where the SEC’s Enforcement Division may well be looking to bring cases.
Commissioner Statements on ESG Investing
In her September 17, 2020 speech, Commissioner Peirce discussed the importance of ESG funds clearly disclosing their investment strategies and being specific about the meanings of terms of art in this space. She focused on investors’ ability to determine whether the fund actually pursues what the investor considers an ESG strategy and understand any related risks, such as whether the fund prioritizes non‑pecuniary ESG goals over investor returns. According to Peirce, not having to explain what they mean by terms like ESG and “sustainable” can allow advisers to be less than precise with the terms. This is made more confusing considering the multitude of different metrics that an investment adviser could use to assess commitment to ESG. However, she went on to explain why she wouldn’t support standardizing ESG disclosures or criteria. Put simply, Peirce indicated that there is no clear set of metrics for an ESG strategy—different people can hold contrary views on what one considers ecofriendly, for example—and she sees no reason to insert the SEC into the middle of such debates. According to Peirce, a prescriptive framework would be inconsistent with the current “tried and true principles-based framework”, based on materiality, that currently applies to ESG disclosure and is the hallmark of the SEC’s disclosure regime.
Commissioner Peirce’s speech echoed many of the points raised by Commissioner Elad Roisman in his recent June 7, 2020 speech. Both argued that investment advisers following ESG strategies should ensure they provide clear disclosure, but that the SEC should not mandate specific ESG disclosure requirements.
Like Peirce, Roisman stated that investment advisers that purport to use ESG investing strategies should—under the currently existing disclosure regime—be required to provide clear and accurate ESG disclosure because they are material to their investors. He noted that there is growing demand for investment products that use terms like “ESG”, “green” or “sustainable” but there is no universal definition for any of these words. Accordingly, advisers should be careful to disclose what ESG metrics mean to their investment strategies and how they are weighed in decision-making.
Roisman also addressed other potential risks he has seen, such as whether advisers (1) adequately disclose whether or how they prioritize non-pecuniary ESG goals above investor returns or (2) “greenwash” an investment by giving investors a false impression that it is environmentally friendly and burying clarifying information in the fine print.
There is not universal assent, however, among the Commissioners to the adequacy of the current system that requires disclosures to be materially accurate without mandating any specific ESG disclosures. Commissioner Allison Herren Lee, a Democratic appointee, for example, has argued that the SEC should mandate and set ESG disclosure standards. According to Lee, the continued emphasis by investors and asset managers to push public companies for ESG disclosure and studies linking ESG directives to company success show that investors consider ESG disclosures material.
Despite these disagreements, however, the SEC appears aligned in a focus on whether ESG-related disclosures are accurate. For example, although OCIE has requested ESG-related information during exams since at least 2018—including how ESG terminology is defined in disclosures and marketing materials and policies and procedures governing how an investment qualifies as an ESG investment—this year was the first time it specifically added ESG disclosures as an exam priority.
Commissioner Peirce’s recent statements—combined with OCIE’s ongoing focus on and prioritization of the topic—serve as a reminder that, for all the policy debates surrounding whether to mandate ESG disclosures, advisers need to pay close attention to the accuracy of their disclosures, particularly where terms are not subject to a universally understood definition. The absence of regulatory guidance in this area makes accurate and precise disclosure more challenging as other advisers may—quite reasonably—take a different view as to the meaning of ESG terminology and the relevant metrics. The current split between the Commissioners also makes it unlikely that advisers will receive authoritative guidance on the subject from the SEC itself. Rather, “guidance” will come in the form of examinations, Risk Alerts and potential enforcement investigations by SEC staff meant to influence behavior and disclosure practices.
However, there are some practical points that can be gleaned from recent Commissioner statements and OCIE priorities. Advisers to ESG funds should consider the following:
- Disclosures should clearly describe what “ESG”, “green” or “sustainable” mean for the adviser or the particular fund, and how these terms relate to the fund’s objectives, constraints, strategies and the characteristics of its holdings.
- Disclosure should address how an adviser weighs individual elements of ESG (e.g., environmental, social, and green) in selecting portfolio companies or investments.
- Advisers should consider whether disclosures concerning prioritizing between returns and non‑pecuniary ESG goals are sufficiently robust.
- Advisers should be careful not to create a misleading impression that a given investment is ESG‑compliant—for example, is environmentally friendly (e.g., “greenwashing”)—by burying information in footnotes, disclaimer pages or obscure disclosures.
- If an adviser relies upon an ESG standard set by an independent body, disclosure should include what the ESG standard is, the standard’s methodology and how the adviser weighs the standard in making investment decisions.
- Policies and procedures should clearly set forth how an adviser determines an investment is ESG or appropriate for the ESG strategy (including any ESG scoring methodologies used).
- Advisers should consider ESG-related disclosures by peer firms when evaluating whether they are properly evaluating their business and disclosures, including how other market participants use and define ESG terminology.
 Hester M. Peirce, Lucy’s Human: Remarks at Virtual Roundtable on The Role of Asset Management in ESG Investing Hosted By Harvard Law School and the Program on International Financial Systems (Sept. 17, 2020).
 Elad L. Roisman, Keynote Speech at the Society for Corporate Governance National Conference (June 7, 2020).
Roisman provided an example of a bond fund that marketed itself as having a significant environmental impact, but clarified in fine print describing its methodology that its figures included the total impact of an investment’s project or issuer, rather than the amount represented by the fund’s share.
 She unsuccessfully argued for including mandated ESG disclosure in the recent amendments to Regulation S-K and pointed to the “thousands” of comments in support of including mandated ESG disclosure as further evidence of its materiality. Allison Herren Lee, Regulation S-K and ESG Disclosures: An Unsustainable Silence (Aug. 26, 2020).