US: SEC brings “greenwashing” enforcement action against investment adviser of mutual funds

On May 23, 2022, the U.S. Securities and Exchange Commission settled charges against an investment adviser for misstatements and omissions relating to the use of ESG considerations in making investment decisions for certain mutual funds it managed (the “Overlay Funds”). As part of the settlement, the investment adviser agreed to a cease-and-desist order, a censure, and payment of a penalty of USD 1.5 million.

The SEC alleged that the investment advisor committed violations of various provisions of the Investment Advisers Act and Investment Company Act, based on the following:

• From July 2018 to September 2021, the investment adviser represented that its affiliated sub-adviser to the Overlay Funds (“Sub-Adviser”) implemented ESG principles by conducting proprietary ESG quality reviews as part the investment research process for all investments made by the Overlay Funds. The adviser made such representations to investors in mutual fund prospectuses, to those funds’ boards and in written responses to RFPs from other investment firms considering investments on behalf of their own clients.
• According to the SEC, in fact, while the Sub-Adviser maintained a Responsible Investment Team that researched ESG issues and produced ESG quality reviews, the Sub-Adviser only mandated ESG quality reviews for investments made by a separate category of funds – the “Sustainable Funds.”
• By contrast, for the Overlay Funds, the Sub-Adviser’s staff were permitted to, and in some cases did, select investments that were not researched by the Responsible Investment Team and which did not undergo the ESG quality review.
• The investment adviser’s compliance personnel were unaware during the relevant period that ESG quality reviews had not been prepared for all investments selected for the Overlay Funds.
• The adviser lacked written policies and procedures reasonably designed to prevent inaccurate or materially incomplete statements regarding the Sub-Adviser’s use of ESG quality reviews when selecting investments for the Overlay Funds.

A senior SEC official noted that investors are increasingly focused on ESG considerations in investing, and that this enforcement action consequently demonstrates that “the Commission will hold investment advisers accountable when they do not accurately describe their incorporation of ESG factors into their investment selection process.” 

As part of its rulemaking agenda, the SEC has also issued new proposed rules relating to the labeling of funds (including ESG funds), and disclosures regarding funds’ and advisers’ incorporation of ESG factors into the investment selection process (see here).

Given the SEC’s continued focus on “greenwashing” (see here), including in relation to ESG funds, advisers and funds should look to strengthen their ESG governance, including by implementing appropriate policies and procedures that ensure oversight over, verification of, and consistency across, ESG disclosures and communications throughout their business.