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As companies increasingly encounter conversations about environmental, social, and governance (ESG) factors, they, their investors, and other stakeholders find themselves navigating the web of sometimes contradictory regulations that govern the world of ESG investing. We are faced with the challenge of surviving.
In the United States, ESG-related regulatory risks primarily arise from three major sources: the U.S. Securities and Exchange Commission (SEC), the U.S. Department of Labor (DOL), and state legislatures and government agencies. This article provides an overview of the regulatory framework that affects his ESG investments in these three areas.
SEC Examinations and Enforcement
In recent years, ESG has evolved into an area of focus for the SEC due to investor demand for investment products and strategies that advance investors’ ESG goals. As a result, even informal ESG-related disclosures made by companies to investors and customers may be considered “material” in the SEC’s view.
One of the SEC’s main concerns is that asset managers overstate the scope and importance of ESG considerations, practices, or strategies, resulting in portfolios and practices that are out of step with disclosures to investors and clients. It’s possible. Therefore, the SEC scrutinizes a company’s internal policies, procedures, and investment practices in light of a company’s external disclosures.
The SEC examines disclosures in required filings as well as marketing materials, websites, investor documents and client presentations to identify potential misstatements or misrepresentations. This approach is consistent with SEC practice in other situations. The SEC has long undertaken similar efforts under the principles of fiduciary duty and disclosure.
Late last year, the SEC accused an investment adviser of making materially misleading statements about its management of incorporating ESG factors into research and investment recommendations for ESG-integrated products, including certain actively managed mutual funds and separately managed accounts. In response, a fine of $19 million was imposed. . The SEC also alleged that the advisor promoted itself as an ESG leader adhering to certain policies for integrating ESG considerations into its investments. However, for several years, the advisors failed to implement certain provisions of that policy.
Another recent SEC enforcement case involved an investment adviser’s policy and procedural deficiencies regarding two mutual funds and one separately managed account strategy marketed as ESG investments. The SEC alleged that the advisor failed to implement and consistently adhere to reasonable policies and protocols for ESG research regarding its products. The SEC fined the advisor $4 million.
Given the foregoing, investment advisers and sub-advisors expect that their ESG-related statements and claims will be investigated and will seek to substantiate such statements and claims, including in connection with their use of third-party service providers. It turns out that you have to be in a position. This means that every team, department, and business unit within your organization, from investment management to marketing to compliance to legal, must be informed and on the same page. Additionally, internal policies and procedures and investor statements and documents must be consistent, consistent, and verifiable. Finally, practices, statements and policies in this area need to be constantly re-evaluated in light of changes in business and practice.
ERISA and the DOL
As the overseer of the Employee Retirement Income Security Act (ERISA), the DOL seeks to regulate fiduciaries regarding how ESG is or is not allowed in private retirement plan investment decisions. The DOL has been considering this issue for more than 20 years, but its efforts accelerated in 2020. In 2020, the DOL introduced rules that many consider “anti-ESG.”
This 2020 rule was followed by additional rulemaking at the DOL and accelerated activity by state legislatures and the U.S. Congress to regulate ESG investing. In essence, the 2020 DOL ESG Rule was a precursor to the broader ESG investment discussion that has exploded in recent years.
ERISA regulates investment decisions made by private retirement plans. That rule applies directly to ERISA fiduciaries and also to certain service providers of these plans, such as investment consultants for these plans and certain asset managers of the products in which the retirement plans invest. . As a result, the DOL’s ESG rulemaking could have far-reaching implications for the financial services industry.
The DOL considers the question of whether ESG factors are considered from an economic perspective or as an effort to advance societal goals to be critical in ESG-related rulemaking and guidance. In its 2020 ESG Rule, the DOL ignored consideration of ESG factors by fiduciaries as having economic relevance.
However, under the Biden administration, the DOL reversed course and deemed ESG an acceptable factor to consider when conducted in the context of a risk/return analysis. There are currently pending lawsuits challenging the rule, including a 2023 lawsuit against the nation’s largest airlines. We note that related legislation has been introduced by Republicans in Congress that would prohibit any ESG considerations from US private retirement plans.
situation
Since March 2021, 41 states have proposed or enacted ESG investment laws. Eight states have enacted “pro-ESG” laws, which essentially state that ESG factors should or must be taken into consideration, or that restrict certain controversial industries or sectors (such as the fossil fuel industry). ) have enacted laws that obstruct investment.
Conversely, 20 states have enacted “anti-ESG” laws that seek to disincentivize ESG investments using state assets and prohibit consideration of ESG for reasons other than normal business or financial purposes. ing. In fact, the biggest potential pitfall for asset managers and their investors appears to lie within these anti-ESG regimes.
Some anti-ESG legislation requires investment decisions to focus solely on maximizing investment returns. Many of these laws also include provisions that address proxy voting practices, requiring third parties to focus solely on financial factors when considering how to vote. Other anti-ESG legislation completely prohibits public entities or companies operating in the relevant state from discriminating against individuals or other companies on the basis of ESG factors. Still other bills would blacklist or prohibit state agencies from contracting with companies or financial services companies deemed to be “boycotting” certain industries (such as the fossil fuel industry). .
Despite the diversity of state legislative environments, companies that make it clear that investment decisions are made first and foremost by considering monetary or financial factors related to the investment involved, even if disadvantageous. It seems possible to avoid most of the anti-ESG minefields even if you are exposed to ESG-related investments. Companies must ensure that they document their investment intentions by making explicit statements and disclosures about their investment intentions.
conclusion
The regulatory risks associated with ESG investing are constantly evolving, and so are the regulatory frameworks under the SEC, DOL, and states. Companies and other stakeholders should continue to monitor SEC, DOL, and state-level developments and work with their legal counsel to avoid risks as they address the regulations governing the world of ESG investing.
If you have any questions or would like more information about the issues discussed in this insight, please contact the author or your Morgan Lewis representative.
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