SEC Inspections and ESG Investing: The Key is the Basics

ESG has been the topic de jure for some time at the Commission. Now that Gary Gensler has been confirmed as Chairman, it is reasonable to expect that these topics will be high on agenda for the agency.

The Division of Examinations has, in recognition of investor trends in these area, added metrics tied to ESG into its exam process. Based on its experiences, the Division issued Risk Alert, detailing observations on the manner in which registrants are implementing ESG investments and areas where improvements are required. Risk Alert, The Division of Examinations’ Review of ESG Investing, April 9, 2021 (here).

The Alert

A number of investment advisers have adopted investment programs keyed to ESG metrics in view of the significant investor interest. The focus of each program varies. Some, for example, concentrate on ESG factors while others adopt specific global frameworks. This provides investors with a variety of options. In assessing these programs it is important to consider the basics — actual portfolio management practices in view of the disclosed investing process or goals. Appropriate internal controls and transparency are, as always, critical.


In conducting exams, the Division assesses the overall portfolio approach and management. Three points were key: Management; performance advertising and marketing; and compliance programs.

· Management: The Division assesses the advisory’s policies and procedures and use of ESG terminology together with the related due diligence and other processes for selecting, investing and monitoring investments in view of the disclosed objectives. This included an assessment of proxy voting and if it is consistent with the ESG disclosures.

· Performance advertising and marketing: The Division also made an assessment of the advisory’s filings and marketing. This included the websites, reports to sponsors of global ESG frameworks, client presentations and similar matters.

· Compliance: The Division reviews the compliance written policies and procedures and their implementation. Oversight is examined.

Observations – deficiencies

During the examinations the Division observed situations in which the advisory failed to have processes in place as to ESG investing that were reasonably designed and/or implemented to assure compliance. Frequently these deficiencies were present despite claims that the advisory had in place the proper controls. Examples include:

· Portfolio management: In certain instances, the management practices were inconsistent with the disclosures made by the firm. This occurred, for example, in situations where the advisory claimed that it was implementing a global ESG framework when in fact a failure to adhere to those standards and/or inconsistencies with them were observed.

· Controls: In a number of instances the Division observed “weaknesses in policies and procedures governing implementation and monitoring of the advisers’ clients’ or funds’ ESG-related directives,” according to the Alert. This occurred, for example, in connection with so-called negative screens – investing in securities that were prohibited such as those involving alcohol, tobacco or firearms. In other instances, client preferences were not adequately effectuated. These situations typically arose from challenges with the implementation and monitoring of the practices despite marketing claims to the contrary.

· Proxy voting: The Division observed situations in which the firm advertised and made certain representations regarding proxy voting. In some instances, there were inconsistencies between those representations and the actual internal controls monitoring them. For example, in some situations there were public statements that ESG related proxy proposals would be independently evaluated internally in each case. Yet internal guidelines did not provide for the type of monitoring discussed in public statements.

· Inconsistent statements: Inconsistent statements and/or materially incomplete statements regarding ESG investing were observed in a variety of areas. Claims that the ESG focused funds had favorable risk and return metrics were made in some instances where the related expenses and reimbursements received from a fund-sponsor were not disclosed creating inconsistencies. In other situations, there were claims that the adviser made substantial contributions to the development of ESG products when in fact the role was minimal.

· Controls and compliance: In a number of instances the firm had inadequate controls to ensure that ESG related disclosures and marketing practices were consistent with the firm’s performance. In other instances, compliance programs were not adequate to address the relevant ESG metrics. The former occurred, for example, in situations were the firm claimed to be adhering to a global ESG framework but lacked the internal policies and procedures to either effectively implement those metrics or reasonably assure compliance. The latter occurred, for example, where those at the firm implementing the program had inadequate training and knowledge of the ESG metrics to properly implement policies and procedures.

Observations – Effective Practices

In many instances firms established effective practices that accurately informed investors about the firm’s approaches to ESG investing. Examples include:

· Clear, tailored disclosures: A number of firms crafted clear and precise disclosures that informed investors about its ESG investment practices. These included, for example, situations in which the approach adopted by the advisory to ESG investing was properly presented in various communications and was implemented internally through the necessary policies, procedures and controls. In other instances where, for example, the firm made investments that were inconsistent with the adoption of a global ESG framework, the firm provided investors with clear disclosure of this fact with side-by-side presentations.

· Policies and Procedures: The firm adopted reasonable policies and procedures that were designed to cover each key aspect of the ESG investing program. This included detailed investment policies and procedures implemented by specific documentation to be completed as to the investment process and factors considered.

· Compliance Staff: Effective ESG investing programs integrated the compliance personnel into their related processes and were knowledgeable about the firms practices in the area.


Investor enthusiasm for ESG continues to grow, creating increasing demand for investing programs. As a result, ESG investment programs are expanding rapidly. This demand and growth has spawned a variety of frameworks, metrics and concepts tied to ESG investing. While the ideas here may be new, the nuts and bolts of creating an ESG program are not. The successful programs are built on clear, precise disclosures for investors, the creation of effective and properly implement internal controls and the education of compliance staff on the key metrics of the program.

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