On May 23, 2022, the Securities and Exchange Commission (SEC) charged BNY Mellon Investment Adviser, Inc., for misstatements about and omissions of environmental, social, and governance (ESG) considerations in making investment decisions for certain mutual funds that it managed. BNY agreed to a cease-and-desist order and a censure and to pay a $1.5 million penalty without admitting or denying the SEC findings.
“The SEC’s order finds that, from July 2018 to September 2021, BNY Mellon Investment Adviser represented or implied in various statements that all investments in the funds had undergone an ESG quality review, even though that was not always the case,” states an SEC press release. “The order finds that numerous investments held by certain funds did not have an ESG quality review score as of the time of investment.”
“Registered investment advisers and funds are increasingly offering and evaluating investments that employ ESG strategies or incorporate certain ESG criteria, in part to meet investor demand for such strategies and investments,” says Sanjay Wadhwa, deputy director of the SEC’s Division of Enforcement and head of its Climate and ESG Task Force. “Here, our order finds that BNY Mellon Investment Adviser did not always perform the ESG quality review that it disclosed using as part of its investment selection process for certain mutual funds it advised.”
“Investors are increasingly focused on ESG considerations when making investment decisions,” says Adam S. Aderton, co-chief of the SEC Enforcement Division’s Asset Management Unit and a member of the Task Force. “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.”
SEC Climate and ESG Task Force
On March 4, 2021, the SEC announced the formation of a 22-person task force focused on climate and ESG issues. This team was also tasked with policing “public companies that fail to disclose material business risks stemming from climate change, such as the potential depreciation of fossil fuel assets or supply chain disruption caused by flooding or wildfires,” according to a Reuters article published in Insurance Journal.
ESG funds are also known as “sustainable investing, socially responsible investing, and impact investing,” according to the SEC. ESG practices include “strategies that select companies based on their stated commitment to one or more ESG factors —for example, companies with policies aimed at minimizing their negative impact on the environment or companies that focus on governance principles and transparency. ESG practices may also entail screening out companies in certain sectors or that, in the view of the fund manager, have shown poor performance with regard to management of ESG risks and opportunities. Furthermore, some fund managers may focus on companies that they view as having room for improvement on ESG matters, with a view to helping those companies improve through actively engaging with the companies.”
Adding ESG regulations that will stand the test of time
In a speech given at the National Investor Relations Institute 2021 Virtual Conference, then-SEC Commissioner Elad L. Roisman identified three questions that need to be addressed for the SEC to promulgate sustainable ESG rules:
- What precise items of “E,” “S,” and “G” information are investors not getting that are material to making informed investment decisions?
- If we were able to identify the information investors need, how would the SEC come up with “E” and “S” disclosure requirements, both now and on an ongoing basis? What expertise do we need?
- If the SEC were to incorporate the work of external standard-setters with respect to new ESG disclosure requirements, how would the agency oversee them—in terms of governance, funding, and substantive work product—on an ongoing basis? And what kind of new infrastructure would be required inside the SEC and at the standard-setters themselves?
“It is tempting to think that the Commission could provide one list of ESG disclosures for companies to make that would satisfy all demands for information,” Roisman said. “But I am not sure that is a role we can play at this time. First, I suspect there is a reason for the differences among ESG disclosure requests. This variation likely reflects the requestors’ different objectives and uses for the information. Also, it is not clear to me that investors have yet settled on an agreed list of information that they want from companies. Instead, it sounds like there is evolution in this area and in companies’ practices for providing ESG information to investors.
“I worry that by stepping in to promulgate a static list of ESG disclosure requirements, the SEC would displace a good amount of this private sector engagement and freeze disclosures in place prematurely. In the area of climate-related disclosures in particular, we have continuing development in scientists’ projections of what physical risks we can expect climate change to present to companies and their assets on various time horizons. There’s potentially even more rapid development in which benchmarks people believe companies should consider when they disclose their so-called ‘transition risk,’ or their ability to compete in a low-carbon economy.
“SEC rule-writing is slow by design. When we enshrine new disclosure requirements in our rules, we want to feel confident that they will be appropriate and relevant for many years to come, since the Commission normally does not revisit them for some time,” Roisman continued.
Recently proposed rules
1. Enhanced and standardized climate risk reporting
On March 21, 2022, the SEC proposed rule changes that will require U.S.-listed companies to provide investors with detailed climate change risk information, including some climate-related financial statement metrics and the disclosure of registrants’ greenhouse gas (GHG) emissions.
The proposed rule will require the following information disclosures:
- The registrant’s governance of climate-related risks and relevant risk management processes;
- How any climate-related risks identified by the registrant have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short, medium, or long term;
- How any identified climate-related risks have affected or are likely to affect the registrant’s strategy, business model, and outlook;
- The impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of a registrant’s consolidated financial statements, as well as on the financial estimates and assumptions used in the financial statements;
- Direct GHG emissions (Scope 1);
- Indirect emissions from purchased electricity or other forms of energy (Scope 2); and
- GHG emissions from upstream and downstream activities in its value chain (Scope 3), if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.
The comment period for this proposed rule has been extended to June 17, 2022. For more information, see the SEC Fact Sheet “Enhancement and Standardization of Climate-Related Disclosures.”
2. Names Rule
On May 25, 2022, the SEC proposed changes to its Names Rule. The current Names Rule requires registered investment companies with business names suggesting a focus on particular types of investments to adopt a policy to invest at least 80 percent of the value of their assets in those investments (an “80 percent investment policy”).
“A fund’s name is an important marketing tool and can have a significant impact on investors’ decisions when selecting investments, and the Names Rule addresses fund names that are likely to mislead investors about a fund’s investments and risks,” adds the SEC press release. “The proposal follows a request for comment the SEC issued to gather public feedback on potential reforms to the rule in March 2020.”
“A lot has happened in our capital markets in the past two decades. As the fund industry has developed, gaps in the current Names Rule may undermine investor protection,” said SEC Chair Gary Gensler. “In particular, some funds have claimed that the rule does not apply to them — even though their name suggests that investments are selected based on specific criteria or characteristics. Today’s proposal would modernize the Names Rule for today’s markets.”
The proposed changes to the Names Rule would require more investment companies to adopt the “80 percent investment policy.”
“Specifically, the proposed amendments would extend the requirement to any fund name with terms suggesting that the fund focuses in investments that have (or whose issuers have) particular characteristics,” continues the press release. “This would include fund names with terms such as ‘growth’ or ‘value’ or terms indicating that the fund’s investment decisions incorporate one or more environmental, social, or governance factors. The amendments also would limit temporary departures from the 80 percent investment requirement and clarify the rule’s treatment of derivative investments.”
Upon publication in the Federal Register, public comments will be accepted for 60 days.
For more information on these changes, see the SEC Fact Sheet “Amendments to the Fund ‘Names Rule.’”
3. ESG investment practices
The SEC also announced a second proposed rules change on May 25, 2022, that “proposed amendments to rules and reporting forms to promote consistent, comparable, and reliable information for investors concerning funds’ and advisers’ incorporation of environmental, social, and governance (ESG) factors. The proposed changes would apply to certain registered investment advisers, advisers exempt from registration, registered investment companies, and business development companies.”
“I am pleased to support this proposal because, if adopted, it would establish disclosure requirements for funds and advisers that market themselves as having an ESG focus,” added Gensler. “ESG encompasses a wide variety of investments and strategies. I think investors should be able to drill down to see what’s under the hood of these strategies. This gets to the heart of the SEC’s mission to protect investors, allowing them to allocate their capital efficiently and meet their needs.”
The amendments seek to broadly categorize certain types of ESG strategies and require more specific disclosures in fund prospectuses, annual reports, and advisor brochures based upon the category of ESG investment strategy.
- Funds focused on the consideration of environmental factors generally would be required to disclose the GHG emissions associated with their portfolio investments.
- Funds claiming to achieve a specific ESG impact would be required to describe the specific impact(s) they seek to achieve and summarize their progress on achieving that impact.
- Funds that use proxy voting or other engagement with issuers as a significant means of implementing their ESG strategy would be required to disclose information regarding their voting of proxies on particular ESG-related voting matters and information concerning their ESG engagement meetings.
To compliment the proposed specific disclosures, certain ESG reporting would require the use of Forms N-CEN and ADV Part 1A, “which are forms on which funds and advisers, respectively, report census-type data that inform the Commission’s regulatory, enforcement, examination, disclosure review, and policymaking roles,” notes the press release.
The proposed ESG investment practices disclosure changes will be published in the Federal Register under File # S7-17-22. Upon publication, public comments will be accepted for 60 days.
For more information on these proposed changes, see the SEC Fact Sheet “ESG Disclosures for Investment Advisers and Investment Companies.”
BNY Mellon Investment Adviser’s $1.5 million penalty brings home the fact that the SEC is not playing around regarding ESG investment disclosures. Additionally, the recently proposed rules changes are a signal to industry that ESG and climate change reporting will become increasingly more detailed.