The SEC Sets Its Sights on ESG

Isaac Mamaysky is a Partner at Potomac Law Group PLLC. This post is based on his Potomac Law piece. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita; How Much Do Investors Care about Social Responsibility? (discussed on the Forum here) by Scott Hirst, Kobi Kastiel, and Tamar Kricheli-Katz; Does Enlightened Shareholder Value add Value (discussed on the Forum here) by Lucian Bebchuk, Kobi Kastiel, Roberto Tallarita; and Companies Should Maximize Shareholder Welfare Not Market Value (discussed on the Forum here) by Oliver D. Hart and Luigi Zingales.

As more investors seek to align their portfolios with their values, asset managers and financial advisers are increasingly offering environmental, social, and governance (ESG) products and strategies. While investors certainly gravitate towards ESG options, the resulting market demand has created a financial incentive for advisers to brand strategies and investments as ESG even when the categorization may be a stretch.

The SEC has thus been focused on the issue of false ESG claims. For example, at the end of November it announced a $4 million settlement with Goldman Sachs for alleged failures to follow its own ESG policies and procedures when choosing investments for two mutual funds and one separately managed account strategy.

“In response to investor demand,” the SEC explained, “[advisers] are increasingly branding and marketing their funds and strategies as ESG.” [1] But when they do so, “they must establish reasonable policies and procedures governing how the ESG factors will be evaluated as part of the investment process, and then follow those policies and procedures, to avoid providing investors with information about these products that differs from their practices.” [2]

With this theme as context, and following other recent enforcement actions, SEC Commissioner Mark Uyeda delivered remarks about ESG concerns in late January to the California ‘40 Acts Group, a nonprofit forum that facilitates discussions regarding matters that impact the investment management industry. [3] The commissioner’s remarks include numerous words of caution for any asset manager or adviser offering ESG options.

Mr. Uyeda explained that demand for ESG investments has been rapidly growing, with such investments garnering higher fees than traditional alternatives. “Touting a product as being ‘ESG’ is good for business,” Mr. Uyeda concluded. [4] “Although ESG investing is wildly popular, it is difficult to ascertain exactly what ESG means, so it is challenging to identify when an ESG investment strategy is properly labeled as such.” [5]

Beyond the risk of mislabeling a strategy, Mr. Uyeda observed another compliance challenge with ESG strategies: namely, they’re sometimes not fully and fairly disclosed to clients. The commissioner notes that asset managers and advisers have a fiduciary duty to their clients to provide full disclosure of strategy details. As Mr. Uyeda explained, “an adviser can only pursue an ESG investment strategy if the client expresses a desire to pursue such a strategy after receiving full and fair disclosure regarding the salient features of the strategy, including the strategy’s risk and return profile.” [6]

In this context, Mr. Uyeda cautioned against implementing specific ESG regulations to govern the growing space, arguing instead that the current regulatory framework is sufficient to address ESG concerns. [7] Under existing federal securities laws, asset managers and advisers must ensure that their investment strategies align with client objectives—including non-financial objectives, in the case of ESG—which requires full and adequate disclosure, and client approval, prior to implementing an ESG strategy. [8] Moreover, asset managers and advisers have a fiduciary duty to their clients that prohibits them from mislabeling or misrepresenting a strategy as ESG to make the strategy more desirable to the marketplace. [9]

Arguing for the adequacy or existing securities laws, Mr. Uyeda is skeptical of implementing a new ESG regulatory framework for three reasons:

First, in the commissioner’s view, we lack a uniform, objective definition of ESG and must recognize the “fundamental reality that standardized ESG measures are doomed to fail.” [10] Rather, each adviser engaging in an ESG strategy must clearly inform investors of what that particular adviser means when using the term ESG. [11]

Second, Mr. Uyeda believes that regulators have a “temptation to place [their] fingers on the scale in favor of specific ESG goals or objectives,” which may force companies to further politically-motivated ESG agendas. [12] While the goal is to prevent greenwashing, the potential outcome is for political considerations to govern business decisions. [13]

Third, Mr. Uyeda observes that asset managers have a “desire . . . to pursue ESG-related goals without obtaining a mandate from clients,” thus prioritizing social and political ends over client financial outcomes. [14] According to Mr. Uyeda’s example, when asset managers who intend to track indices use their proxy voting rights to further non-financial ESG goals, those advisers may not be acting in accordance with their fiduciary duty to clients, who are invested in an index, rather than an ESG strategy, and never agreed to compromise financial outcomes for political and social goals. [15]

While some may argue with Mr. Uyeda’s pessimistic assessment of an ESG-specific regulatory framework—indeed, the SEC has proposed multiple rules regarding ESG investing [16]—the commissioner’s remarks make clear that the SEC is focused on full disclosure and transparency in regards to ESG claims.

So where does this leave us? The SEC is closely watching the rapid growth of ESG strategies and investments. The commission is concerned that market demand for ESG products has created a financial incentive for asset managers to identify products as ESG, even when the definition is not entirely fitting. The SEC is also concerned about investment advisers implementing ESG strategies for client accounts without full disclosure and approval, potentially in violation of advisers’ fiduciary duty.

Based on these related concerns, the commission has set its sights on ESG. Whether the SEC will move forward with an ESG-specific regulatory framework, despite the commissioner’s concerns, or will continue to rely on the existing obligations of the federal securities laws, advisers and asset managers can continue to expect enforcement actions, both when purported ESG products are mislabeled, and when ESG strategies are implemented without full and proper client disclosure and approval.

Taking this all together, asset managers and financial advisers would be well-served to confirm that they have a good justification for labeling a strategy as ESG. Likewise, they should have a good reason to implement ESG products or strategies for particular client accounts—namely, the client has requested such a product or strategy, or approved it following full disclosure of its risk and return profile by the adviser. By taking these steps while staying conscious of the SEC’s new ESG focus, asset managers and advisers may keep themselves out of the regulatory crosshairs.


1SEC Charges Goldman Sachs Asset Management for Failing to Follow its Policies and Procedures Involving ESG Investments, Securities and Exchange Commission, Nov. 22, 2022, back)

3Mark Uyeda, Commissioner of Securities and Exchange Commission, Address before California ’40 Acts Group, ESG: Everything Everywhere All at Once (Jan. 27, 2023), available at back)

16See, e.g., SEC Proposes to Enhance Disclosures by Certain Investment Advisers and Investment Companies About ESG Investment Practices, Securities and Exchange Commission, May 25, 2022, back)

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