SEC Charges Investment Advisor with ESG Disclosure Violations in Latest Action by ESG Task Force

BNYMIA is an investment advisor with over $380 billion in regulatory assets under management as of March 31, 2022, including over $350 billion in mutual funds or other investment companies. The disclosures at issue in the SEC’s case were related to one of its mutual funds, Overlay Funds, and the ESG review process of BNYMIA’s sub-adviser (the “Sub-Adviser”).

BNYMIA represented to investors, mutual fund boards, other investment firms, and in prospectuses that its Sub-Adviser took ESG considerations into account for all of Overlay Fund’s investments. The SEC found that BNYMIA’s representations were misleading or incomplete because the Sub-Adviser could and did select portfolio investments that were not subject to ESG quality review processes. Some of the specific disclosure violations described in the SEC’s Order include:

• in Overlay Fund prospectuses, BNYMIA represented that the Sub-Adviser conducted proprietary ESG quality reviews “in an effort to ensure that any material ESG issues are considered;”
• in July and August 2018, BNYMIA represented to the board members of Overlay Funds that the Sub-Adviser assigns ESG quality review ratings prior to making an investment; and
• in response to numerous inquiries from other investment firms evaluating Overlay Funds for their own clients, BNYMIA included language describing Sub-Adviser’s ESG quality reviews and at times promised that “ahead of investing, each security being considered for investment… must have an ESG quality review conducted” by its team.

The SEC found that these disclosures were either incorrect or misleading because “a reasonable investor reading [the prospectuses] could mistakenly conclude that all portfolio holdings selected by the Sub-Adviser were subject to an ESG quality review.” The SEC found that between January 1, 2019, and March 31, 2021, 67 out of 185 investments made by Overlay Funds did not undergo ESG quality review at the time of the investment.

Beyond the alleged material misstatements and omissions, the SEC also faulted BNYMIA for failing to adopt and implement policies and procedures designed to prevent these inaccurate or incomplete statements. BNYMIA compliance personnel were unaware before mid-March 2020 that quality reviews were not prepared for all Overlay Fund investments.

BNYMIA consented to the entry of the SEC’s order finding that BNYMIA violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 ( “Advisers Act”) and Rules 206(4)-7 and 206(4)-8 thereunder, as well as violating Section 34(b) of the Investment Company Act of 1940 (“Investment Company Act”).

Takeaways From This Latest ESG Action

First and foremost, don’t make any promises, particularly ESG-related promises, you can’t keep. The SEC is taking a close look at ESG disclosures and fact-checking the claims companies make to investors and to the market, even where the company itself does not directly impact the environment. Here, for example, the SEC is not charging a company promising to go carbon neutral; rather, it is subjecting a mutual fund investment advisor to Climate and ESG Task Force scrutiny. Adam S. Aderton, Co-Chief of the SEC Enforcement Division’s Asset Management Unit and a member of the SEC’s Climate and ESG Task Force, stated in the SEC’s press release that “[i]nvestors are increasingly focused on ESG considerations when making investment decisions. As this action illustrates, the Commission will hold investment advisers accountable when they do not accurately describe their incorporation of ESG factors into their investment selection process.”

Second, fraudulent intent is not required. Here, BNYMIA was charged with violations of Section 206(2) and 206(4) of the Advisers Act, as well as Section 34(b) of the Investment Company Act. None of these charges require scienter and may rest on a finding of simple negligence. So, even if an entity intends to fulfill promises related to ESG and is unaware that these promises are not being fulfilled, that entity can still be held liable under certain charges. To ensure your company is not unknowingly or recklessly breaching ESG promises, regularly confirm that your policies and procedures are designed to prevent inaccurate or incomplete statements.

Third, cooperation can be key. Here, the SEC considered cooperation and remedial act was promptly undertaken by BNYMIA. The SEC highlighted that BNYMIA provided detailed factual summaries, made presentations to the SEC on key topics, revised disclosure language, and modified relevant processes, policies, and procedures. Even with an active SEC focused on ESG-related violations, cooperation and remediation can make a material difference in resolving a matter.

More Expected From the SEC on ESG Rules

On a related note, the SEC just released another set of draft rules relating to ESG investing. The draft rules target potentially exaggerated ESG claims in investment products. Stay tuned for more insights into the new proposed rules and what they could mean for the industry and our clients.