SEC Issues Risk Alert on ESG Investing

SEC Issues Risk Alert on ESG Investing

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On April 9, 2021, the Securities and Exchange’s Division of Examinations (the “Division”) issued a Risk Alert related to firms’ practices on environmental, social and governance (“ESG”) investing. This follows the formation of an ESG task force within the Division of Enforcement. Investor demand has increased in recent years, including: (1) seeking to invest in ESG strategies and/or (2) expecting managers to have internal ESG policies (for example, diversity in hiring, selecting service providers, community involvement and the like). The challenge for managers is that ESG investing means different things to different clients or fund investors. While it is natural to want to meet that demand, firms should not attempt to be all things to all people. Indeed, it would be impossible to account for every ESG-related metric. Rather firms should consider the issues that matter most to them, whether they are building out internal policies and procedures, launching an ESG strategy or both.

Unsurprisingly, the SEC is seeking to understand the landscape of ESG investing and assessing firms’ policies and procedures in core compliance areas. The Risk Alert highlights deficiencies and weaknesses from examinations of investment advisers, as well as areas in which firms have been effective in complying with regulatory expectations. The Division will focus on the following when examining firms with ESG strategies:

  • Portfolio Management: Examinations will include review of ESG policies, terminologies used, due diligence for selecting and monitoring investments, and how firms handle proxy voting in ESG investments.
  • Performance Advertising and Marketing: All disclosures in offering documents, regulatory filings, websites/social media and other marketing materials will be under scrutiny.
  • Compliance Programs: The Division will focus on firms’ internal policies related to ESG initiatives.

In particular, the Division has observed the following deficiencies:

  • Portfolio management practices were inconsistent with disclosures about ESG approaches. One example is when the Division noticed a lack of adherence to certain global ESG frameworks, despite disclosing such adherence in client-facing documents.
  • Controls were inadequate to maintain, monitor and update clients’ ESG-related investing guidelines, mandates and restrictions. The Division noticed weaknesses in implementing or monitoring ESG investments, or a total lack of an ESG program, despite marketing one to clients.
  • Proxy voting may have been inconsistent with advisers’ stated approaches. ESG policies should exist and be adequately implemented. Firms should consider disclosing that policy to investors separately from policies related to other investments.
  • Unsubstantiated or other potentially misleading claims regarding ESG approaches. Performance is subject to a high level of scrutiny for being potentially misleading or inaccurate. All marketing related to the benefits of ESG investing must be substantiated. Firms should ensure that any benchmarks they use are relevant and periodically reviewed to ensure continued relevance and usefulness.
  • Inadequate controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices. Policies should have controls over content related to ESG investing, updating documents for material changes, and ensuring that content aligns with investment decisions.
  • Compliance programs did not adequately address relevant ESG issues. The Division observed that some firms lacked policies and procedures related to an ESG program at all. Firms should establish and periodically review their policies and procedures with respect to their ESG programs and strategies.
  • The staff observed that compliance programs were less effective when compliance personnel had limited knowledge of relevant ESG-investment analyses or oversight over ESG-related disclosures and marketing decisions. Firm compliance professionals did not know how to respond to client requests and due diligence questionnaires, and how to substantiate ESG-related claims.

The Division also noted some aspects of ESG-related compliance programs that worked:

  • Disclosures that were clear, precise and tailored to firms’ specific approaches to ESG investing, and which aligned with the firms’ actual practices. Division staff observed that there were clear disclosures in client-facing materials related to portfolio or separately managed account offerings. Additionally, some firms were able to satisfy the requirements of certain global ESG frameworks while not necessarily engaging in ESG investing. In such cases, disclosures should state that adherence to these frameworks does not necessarily alter contrary investment strategies. The Division also noted that some firms had detailed explanations on how they followed global ESG frameworks in client-facing materials.
  • Policies and procedures that addressed ESG investing and key aspects of relevant practices. Adequate policies and procedures required documentation at various stages of the ESG investment process, particularly when multiple ESG investing approaches were employed at the same time.
  • Compliance personnel that were knowledgeable about the firms’ specific ESG-related practices. The Division noted that firms were better able to manage ESG compliance programs if their compliance personnel were knowledgeable about the program and could answer due diligence questions.

From a regulatory perspective, managing an ESG strategy is actually nothing new. Firms should consider the core compliance areas of marketing and adherence to stated investment strategies as they relate to their particular business and strategies.  This includes documentation of processes, investment decisions and disclosures to investors. Though not required, firms that manage ESG strategies should consider establishing internal ESG initiatives, particularly those that align with their strategies.  Ultimately, both investors and regulators will expect firms to mean what they say when it comes to ESG.  The Greyline team is happy to discuss the Risk Alert, other ESG matters and/or assist with developing or reviewing existing policies and procedures.

The full Risk Alert can be viewed at SEC.gov.

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JP Gonzalez

Partner
JP Gonzalez is a Partner at Greyline and heads the company’s technology and sales initiatives globally. He is also a member of gVue’s steering committee. Prior to joining Greyline, JP spent six years designing and evangelizing Compliance Regulatory Technology for broker-dealers, investment advisors and fund managers, where he assisted clients with all aspects of complying with FINRA, SEC and state rules and regulations related to a firm’s code of ethics. His technology background includes five years as a software developer and program manager at Microsoft, with his last two years at Microsoft as the UX/UI usability and accessibility program manager for Internet Explorer. He has a B.S. in Computer Science from Rose-Hulman Institute of Technology.

Nick Thomas

Partner
Nick Thomas is a Partner at Greyline and oversees the London office, which provides compliance support to U.K.-based hedge funds, private equity firms and other alternative asset managers. Prior to joining Greyline, Nick spent 13 years at the Financial Conduct Authority, the U.K. regulator, followed by three years at a well-known international compliance consultancy. During this time, he gained a broad and deep understanding of the U.K. regulatory environment applicable to alternative asset managers – both from the perspective of the regulator and the firms being regulated. His time at the FCA included working as a supervisor on the alternative investments team, with responsibility for supervising some of the largest and most prominent hedge funds in the U.K., and undertaking firm examinations across a broader population of alternative asset managers. Prior to this, he worked extensively on AIFMD implementation from the FCA’s perspective, as well as assessing applications from investment firms seeking to obtain FCA authorization. Nick obtained a BSc in Mathematics from Imperial College London. In addition, he holds the Investment Management Certificate (IMC), the Fundamentals of Alternative Investments Certificate and the Financial Planning Certificate (FPC). He also speaks Japanese.

Tim Goodwin

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Tim Goodwin is a Partner at Greyline and the head of the Fort Worth office. Prior to joining Greyline, Tim spent two years providing ongoing compliance and consulting services to alternative asset managers, including private equity funds, venture capital funds, real estate funds and hedge funds. He worked at TPG Capital for seven years in compliance and internal audit positions. As a director in the risk management and internal audit department, Tim was responsible for documenting and testing TPG’s allocation of fees and expenses, as well as preparing the firm for possible public listing, by leading TPG’s efforts in Sarbanes Oxley testing and compliance. Before joining the internal audit team, he spent five years running TPG’s compliance testing efforts across all of TPG’s businesses, including the private equity funds, credit platform, hedge funds, a 40 Act fund and a registered broker dealer. Prior to joining TPG Capital and moving to Texas, Tim spent more than six years with UBS Wealth Management (New York and New Jersey) in various compliance roles, touching on investment company, investment adviser and broker dealer compliance. He was most recently the chief compliance officer to UBS’s unit investment trusts and a compliance director for advisory products, including the separately managed account, financial advisor discretionary and mutual fund wrap programs. He assisted UBS in its first ever required annual reviews conducted pursuant to the compliance program rule, helped design and implement compliance policies and procedures for UBS’s advisory programs, and routinely assisted in updating required disclosure documents, including the Form ADV.

Jennifer Dickinson

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Jennifer Dickinson is a Partner at Greyline and heads the firm’s Chicago office, as well as its CFTC/NFA practice. Her clients include private fund managers (hedge, private equity, venture capital and real estate), traditional RIAs, CPOs, CTAs and Swap Dealers. Jennifer advises on a range of compliance matters, including code of ethics/insider trading issues, risk management, compliance training, conflicts of interest and regulatory examinations. Prior to joining Greyline, Jennifer was the managing director of Sansome Strategies, a boutique compliance consulting firm specializing in alternative asset managers. Her other consulting experience includes serving as chief compliance officer for three prominent, SEC-registered investment advisers. Jennifer has also worked at noted law firms in the financial services space, including Cole-Frieman & Mallon LLP and Pillsbury Winthrop Shaw Pittman LLP. Jennifer began her career as the legal and compliance administrator at Standard Pacific Capital LLC, a SEC-registered, multi-strategy hedge fund manager based in San Francisco. Jennifer has an undergraduate degree from DePauw University and a law degree from Golden Gate University School of Law, where she was the editor–in–chief of the Law Review.

Sean Wilke

Partner & Head of Strategic Growth
Sean Wilke is a Partner, and the Head of Strategic Growth at Greyline and its affiliate GCM Advisory, which specialize in compliance consulting and outsourced finance, accounting and operations. He has extensive experience advising various types of investment managers, including hedge funds, private equity/credit funds, wealth managers, registered investment companies, institutional allocators and family offices, on a range of regulatory, compliance, operational and management matters. Before joining Greyline, Sean was a director within the governance, risk, investigations and disputes group at Duff & Phelps, where he focused on compliance and regulatory consulting for the alternative investment space. Prior to that, he was the general counsel and chief compliance officer of Bramshill Investments, a $4 billion, multi-strategy investment manager, where he oversaw all legal and compliance affairs. Sean also spent four years as a corporate and securities attorney at a law firm, as well as three years as a compliance associate at Bear Stearns & Co., where he performed surveillance for the investment and merchant banking groups. Sean has a B.A. in Political Science from Rutgers University and a J.D. from New York Law School.

Kathy Malone

Partner & Head of Consulting
Kathy Malone is a Partner at Greyline and co-head of the firm’s New York office. Before joining Greyline, she was an examiner with the U.S. Securities and Exchange Commission’s Office of Compliance Inspections and Examinations in the Boston and New York offices, where she participated in numerous investment adviser and broker-dealer examinations. Prior to her time with the SEC, she was an examiner with FINRA, completing many examinations of broker-dealers and enforcement referrals. Most recently, Kathy worked for a consulting firm where she assisted broker-dealers, investment advisers and investment companies with the registration process, examination support and ongoing compliance needs. She has a B.S. in Finance from Villanova University and a Juris Doctor from Seton Hall Law.

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Talia Brandt is a Partner at Greyline, and a member of gVue’s steering committee. Her team from Vista Compliance, LLC joined Greyline in May 2017. Talia founded Vista Compliance — a compliance consulting firm servicing broker-dealers, registered investment advisors and private fund managers — in April 2008. In her role with Greyline, Talia works closely with firms to ensure compliance with FINRA, state and SEC regulations. She has developed and implemented compliance and financial policies and procedures to ensure solid internal controls are in place for varying financial services firms. In addition to her compliance consulting work, Talia has served internally to firms as chief compliance officer and holds FINRA Series 7, 24, 66 and 79 registrations. Prior to forming Vista Compliance, Talia worked at Goldman Sachs in the investment management division in Salt Lake City. She then moved to the Bay area, where she went to work with smaller startup, boutique financial services firms.

Matt Okolita

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Matt Okolita is Managing Partner of Greyline, and a member of gVue’s steering committee. He has extensive SEC, FINRA and CFTC experience, having worked for and with premier hedge funds, private equity and venture capital firms, CLO and other debt managers, business development companies and mutual fund managers in both legal and compliance roles. Matt’s background includes undertaking a variety of legal and compliance functions, serving as counsel and chief compliance officer for startup managers, as well as international asset managers managing more than $30 billion. Matt has a Bachelor of Arts in Political Science and Economics from Bucknell University and a Juris Doctor from Suffolk University Law School, with distinction in Business Law and Financial Services.