Recent SEC ESG-Related Actions Impacting Investment Advisers and Investment Funds
At the end of May 2022, the U.S. Securities and Exchange Commission (“SEC”) proposed two new rules concerning Environmental, Social, and Governance (“ESG”) considerations of certain investment advisers and registered funds and brought an ESG-related enforcement action against an SEC-registered investment adviser. Investment advisers and fund sponsors that consider ESG factors will need to pay attention to these recent developments. The following is an executive summary of each.
Proposed Standardized Disclosures by Investment Advisers and Registered Funds
On May 25, 2022, the SEC proposed amendments to certain rules and forms under the Investment Advisers Act of 1940 (the “Advisers Act”) and the Investment Company Act of 1940 (the “Company Act”) to require specific disclosures by (i) SEC-registered advisers and certain exempt reporting advisers (the “Advisers”) as well as (ii) registered investment companies and business development companies (the “Funds”) with respect to their incorporation of ESG factors in their investment processes (the “Disclosure Proposal”). According to the SEC, the Disclosure Proposal aims to promote consistent, comparable and reliable ESG disclosures to clients and investors. The Disclosure Proposal:
- defines three types of ESG funds and ESG-related advisory services, namely “integration”, “ESG-focused” and “ESG-impact”, and aims to implement a layered, tabular disclosure approach by imposing more disclosure obligations on ESG-focused funds and ESG-impact funds;
- enumerates various methods that Funds and Advisers may utilize to implement their ESG strategies, such as tracking an index, inclusionary screen, exclusionary screen, seeking impact, proxy voting, and engagement with issuers, with additional disclosure requirements regarding impact, proxy voting and issuer engagement;
- requires quantitative data for environmentally focused Funds, namely the “carbon footprint” and the “weighted average carbon intensity” of such Funds’ portfolios in the Funds’ annual reports;
- proposes to amend disclosure requirements on Form ADV Part 2A (including its Appendix 1) as well as regulatory report on Form ADV Part 1A with respect to Advisers; and
- proposes to amend disclosure requirements on Forms N-1A, N-2, N-8B-2, N-CSR, S-6 and annual reports as well as regulatory report on Form N-CEN for Funds.
The Disclosure Proposal is now open for public comment and will remain open for 60 days after publication in the Federal Register. Once adopted, there would be an 18-month compliance period for Funds’ annual report disclosure obligations and a one-year compliance period for all other disclosure obligations by Funds and Advisers.
Proposed “Names Rule” for Registered Funds
On the same day, the SEC proposed to amend Rule 35d-1 under the Company Act applicable to registered investment companies or business development companies (the “Names Proposal”). According to the SEC, the Names Proposal aims to help ensure that a Fund’s name accurately reflects the Fund’s investments and risks. The Names Proposal:
- requires any Fund with a name that suggests it focuses on (i) a particular type of investment, (ii) a particular industry, or (iii) a particular country or geographic region, to invest at least 80% of its assets in such type of investment, industry, country, or geographic region, as suggested by its name (the “80% Requirement”);
- prohibits an “integration fund” from using ESG or similar terminology in its name;
- requires Fund prospectus disclosure that defines the terms used in a Fund’s name;
- proposes to amend Form N-PORT to require greater transparency on how a Fund’s investments match the Fund’s investment focus;
- requires a Fund that temporarily departs from the 80% Requirement to come back into compliance with the 80% Requirement within 30 consecutive days, with limited exceptions; and
- imposes shareholder vote and notice requirements on changes to a Fund’s 80% investment policy.
The Names Proposal is now open for public comment and will remain open for 60 days after publication in the Federal Register. Once adopted, there would be a one-year compliance period for Funds.
ESG-Related Charge against an Investment Adviser
On May 23, 2022, the SEC charged BNY Mellon Investment Adviser, Inc., an SEC-registered investment adviser (“BNY”), for misstatements and omissions about ESG considerations in making investment decisions for certain mutual funds that it managed (the “ESG Order”).
In the ESG Order, the SEC found that BNY represented or implied to its investors that all investments in the relevant BNY funds had undergone an ESG quality review; however, numerous investments held by certain funds did not have an ESG quality review score as of the time of investment. Therefore, the ESG Order charged that BNY violated Sections 206(2) and 206(4) of the Advisers Act and Rules 206(4)-7 and 206(4)-8, and Section 34(b) of the Company Act. To settle the charges, BNY agreed to pay a $1.5 million penalty.
Taken together, the Disclosure Proposal, the Names Proposal and the ESG Order signals the SEC’s increased regulatory focus on ESG-related investments. As SEC Chair Gary Gensler mentioned on May 25, 2022 and many previous occasions, investors are entitled to consistent and comparable disclosures about ESG strategies, just like consumers are entitled to information on the nutrition label of fat-free milk. Although these recent moves targeted only SEC-registered advisers, certain exempt reporting advisers and registered funds, they may have sweeping impacts on all advisers and investment funds. All advisers and fund sponsors that consider ESG factors should be following these developments closely and taking steps to ensure their disclosure practices and investment methodologies appropriately track current SEC regulation and guidance.
For more information on the topic discussed, contact:
- Wayne H. Davis | email@example.com | 212-508-6705
- Michele Gibbs Itri | firstname.lastname@example.org | 212-508-6732
- Haylie Gordon | email@example.com | 212-508-6745
- Karen Liu | firstname.lastname@example.org | 212-508-6775
- Jason M. Rimland | email@example.com | 212-702-3142
- Beth Smigel | firstname.lastname@example.org | 212-702-3176
- Michael G. Tannenbaum | email@example.com | 212-508-6701
BulletPoint® is a newsletter of Tannenbaum Helpern Syracuse & Hirschtritt LLP’s Investment Management practice. It is an alert covering recent regulatory and tax developments impacting the financial services industry. To subscribe for the newsletter, send email to firstname.lastname@example.org.
06.10.2022 | PUBLICATION: BulletPoint | TOPICS: Investment Management | INDUSTRIES: Private Investment Funds