ESG Funds Are Finding It's Not Easy Being Green

David Schultz. So today's another e s G episode. It's a topic we love talking about, and according to our analytics, you also love hearing about for those not in the know. E s G stands for Environmental, Social and governance. It's a tag that a lot of Wall Street funds have been adopting recently, touting that they only invest in companies that are good for the environment, have a positive social impact,

and or have humane corporate government structures. But as we've talked about in the past, those are all pretty subjective metrics, and both investors and activists have started to worry that just because the mutual fund calls itself e s G doesn't mean it actually is. These worries have risen in tandem with the rise of e s G investing itself.

Blomberg Intelligence estimates that by the end of this year, forty one trillion dollars will be managed by a fund that advertises itself as e s G. So clearly there are a lot of people who want to invest this way and they want to get what they're paying for. That's where the SEC steps in. In recent weeks, the agency has proposed regulations that would require e s G funds to report the carbon footprints of the companies they

invest in. Also, possibly more significantly, the SEC settled an enforcement claim against B and Y Melonto the tune of one point five million dollars over allegations to the bank misled investors on some of its E s G products. It's a tricky time to be in the green investing business,

and the tricky times lawyers become really important. We're gonna be hearing from two lawyers who represent the financial services folks trying to give investors what they want without running a foul of the SEC, George Rain and Robert Skinner with the firm Ropes and Gray, and they spoke with Bloomberg Laws Andrew Bonis about what this new aggressive stance from the SEC means for their clients. Or started off by talking about what he and his colleagues are telling

nervous E SG fund managers right now. I think the main message we're giving to clients these days is that the fears and concerns they had previously based on SEC examinations and public statements are now all the more present and all the more important. That the expected actions that the SEC was going to make are now being made. So we've seen the first watershed enforcement case on an E s G disclosure matter, and we're seeing real rulemaking that's coming out that has teeth both as two names

of funds as well as specific disclosures. And all the expectations are that this will be fast tracked and some variation on the rules will make their way into the position of being final rules over the coming months. But I've be interested rob your perspective on the You know, there are to two points there. One is there the immediate response to a worsement action, which is which is

the flag that's up. Obviously, the rules are proposed and rule proposals required comment um, so that and we'll have a fair fair period of time for implementation before the compliance is required. So I think first and foremost were saying talk to people like Rob Skinner about why they should be could be concerned in the very present moment, but long before we have final rules. The timing of the enforcement action against a mutual fund advisor you can't

have been coincidental, right. It preceded the issuance that they proposed rule in thement by two days um and strikes us as a pretty vivid prelude UM as to the enforcement agenda that's going to accompany the implementation of the rules, whatever those rules might be. UM and And frankly, it's the approach taken in that enforcement action UH causes us some real concern about UM how aggressive the staff intends

to pursue UM what it deems to be greenwashing. I'll start with the premise that I feel like the claims of of widespread greenwashing that we see in a lot of the SEC's rhetoric recently UH to be pretty overblown. But if the SEC UM is prepared to UM enforce rules and read fund disclosures through a lens UH that is affected by their view of how E s G and sustainable and green funds ought to be run rather than through the traditional lens of let's see whether or

not the disclosures fairly describe how they are being run. UM. It may open up a lot of uh, you know, enforcement exposure UM based upon you know, the staff's views regarding what funds should look like. You know what I what I went again too, is do you do you think the b N Y Melan case could have a chilling effect on funds that are thinking about employing E s G strategies. Well, let me say, I certainly hope not.

At the end of the day. Uh, the law requires that a supposed misrepresentation or omission in fund disclosures be material in order to make out a violation of the securities laws. And that means that you know that there is a substantial likelihood that it would affect the decision of a reasonable investor um in light of all of the information available, the total mix of information. Frankly, the

recent enforcement action strikes us as a reach. If the staff is prepared to pursue those kinds of theories consistently and aggressively, it is certainly a possibility this this will be chilling. Building on that the b N Y Melan case was certainly selected not just for timing but also for content, the fact that it was hitting only the primary advisor to a fund, and they didn't hit the subadvisor and only hit the advisor as they were organizing their complex um the fact that it was really about

ambiguous language rather than actively misleading language. It was more sort of sloppiness as to the to the delineation of which funded with what aspect of of E s G incorporation into the process, that that was the focus here than it was any notion that there was active greenwashing or someone uh intentionally misrepresenting. But but that's sort of

the point of this shot across the bow. Ultimately, the content of this enforcement action is consistent with what we've been seeing, and we've an advising clients in the day to day examination process with the SEC Division of Examinations, where the questions they're getting on the E s G fund are very much focused on do you have a process in place to make sure you've ticked and tied every single statement with an E s G activity that's

being overseen and documented. Every time you're saying you you have any kind of involvement of E s G, how do you know that you're actually doing it? It's this sort of be very clear of say what you do, do what you say, but really tying it in almost with compliance policies and procedures, and so it's it's very much what the examination staff has been pushing for quite some time and which frankly a lot of our clients are spending a lot of time trying to be responsive to.

So before before you saw, before this case came out, you saw your clients for seeing an uptick of interest from examinations and and E s G. So this was sort of you saw you saw something like this could be coming U. How aggressive has those like hamination has been and what can you talk a little bit about that The examinations have been ongoing for several years and we've been tracking kind of tweaks to the standard request list.

Uh that that the that the exam staff has been out with UM it's been a very technical, rigorous process. Anytime they see anything that's E s G related that you'll get a set of specific questions. Uh. And and there's a focus on really getting to a compliance oversight role with respect to what previously and frankly reasonably was or could be seen as a a part of the

investment process. You don't have compliance officers going through with a compliance policy to tell whether someone is thinks that something will grow quickly or slowly, or has a value tilt or some sort of you know, these aspects of the process s they can't get inside the heads of the portfolio managers. With E s G. It's in a

different category almost. Um. It's the The expectation on exam has been that you have to have a process that links any statement about E s G to what's actually happening on the ground and have some kind of oversight over it. It hasn't helped from the regulatory side of things that a number of managers have taken existing funds and rebranded them with an E s G tilt, which

immediately gets to the word of the day, which is greenwashing. Um. And I will also note that in the SEC proposing release for the new advisor and fund disclosures where greenwashing comes up in the second paragraph, So it's there right at the front. And I take it this is not going to be a one off case for the SEC. This d N Y mel and one that they're they're just likely more more to come. But what what do

you expect future litigation to look like in this area? Well, I mean, one thing that is remarkable about the settlement order is the staff ultimately concludes that investors could have been misled by what the fund disclosures implied or suggested. Two extrapolate from that conclusion to something being materially misleading. Um, it's pretty extraordinary and we think not in keeping with with um, you know, the traditional legal standards of materiality

when when enforcing the securities laws. So if you overlay that approach, UM, if the staff is going to be you know, using a screen about about what somebody could have found misleading in isolation, rather than looking at the entirements of information available to the to the to the investor, and and apply that screen to all of the new rules that are about to issue. There are a lot of judgment calls that are going to be required under

those rules. And if the staff is prepared to second guess them this aggressively based on what somebody quote could have been misled by from what a prospectives might suggest or imply, it could be very fertile ground if that's where the staff wants to go. And of course, um, as we know from history, the plaintiffs bar happily lines up behind the staff and comes in with securities class actions.

It's kind of a recipe for a big fat open door for the plaintiff's bar to follow in behind the staff and and wreak a lot of havoc and frankly, um bring a lot of expensive and distracting litigation. UM that is going to ultimately, I'm afraid, you know, undermine that the ultimate purpose of the of the of the E s G movement, which is to put you know, values into action in their investments. All right, let's get back to our discussion of SEC enforcement of E s

G funds. Here is Andrew Ramonis. Now I want to get a little bit into the uh the E s G fund proposals that that also came out with. With these proposals, the SEC has been receiving significant pushback from some quarters of the finance industry, with the leader of a funds trade group saying the proposal on emissions reporting is unworkable because some emissions information from companies is not accessible to funds. Do you agree on the miss sans

reporting piece. I see that as being on the shopping block when the industry comes in. This has happened time and time again that the SEC comes out with a set of standards and then some specific may potentially cherry picked requirement that everyone just can't get over. It happened the first time they tried swing pricing. It was to be mandatory, just became optional and then no one adopted it,

So it may be a first swing it is. It is absolutely a blunt instrument because it it picks up one attribute on greenhouse gas emissions with some kind of fuzzy trigger as to whether you need to put this in your in your disclosures, and does not give any real away for you to to to distinguish between which

whether it's E or s ORG that you're doing. Yet you have to be putting in a whole bunch of disclosure about one particular subset of the poor of the E, S and G. It's it's unworkable, there's arbitrary and no. This was also pillaried by Commissioner Purse in her in her comments when the when the proposal was coming out.

I don't I don't see that one surviving. But the the other parts of the rule, I think aspects of those are gonna are absolutely going to be there, and they're going to be wooden, and they're going to be difficult to deal with, and they're going to have I think, the effect in the case of the disclosures, of pushing the industry to fit their funds into particular boxes because they're being driven by a category that is designed today by the SEC based on current practices and isn't really

designed or built to expand and develop over time as the concept of E s G investing develops, and that different today's episode of Parts Bervillion. If you want more environmental news, check us out on Twitter. These are pretty easy to remember handle. It's at Environment, just that at Environment. Today's EPP. The Parts of the Billing is produced by myself, David Schult's Parts of Him was graded by Jessica Combs and Rachel Dagle and is edited by Zach Sherwood and

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