Climate Change Emerges as a Compliance Focus for SEC

Securities regulators are sharpening their focus on whether asset managers that tout funds as socially responsible are picking stocks that align with that cause, and whether the firms support environmentally-friendly policies at companies they have invested in.

Source: WSJ | Published on March 4, 2021

insurance industry combating climate change

The Securities and Exchange Commission said Wednesday that it plans to boost examinations of such fund managers this year, showing how an area long seen as a niche is crucial for many investors. The SEC’s move is its latest step to seize a bigger role in the corporate debate over issues such as climate change, which big investors such as BlackRock Inc. have helped advance.

Climate change is one of the hottest considerations for investors who give priority to environmental, social and governance risks at companies whose shares they own. Funds with an ESG focus attracted a record $51.1 billion of new money in 2020, according to Morningstar. The rise of ESG funds also has become a partisan lightning rod in Washington, with Republicans questioning their performance record and Democrats looking for ways to give the segment a boost, including through pension funds and retirement portfolios.

The SEC polices disclosures that investment managers make to their shareholders, including whether those statements align with their strategies. Significant gaps, such as a fund that touts an ESG focus but invests mostly in polluting industries, could run afoul of SEC rules.

“Investors really care about this, and advisers make a big deal of it,” said Jeremiah Williams, a partner at Ropes & Gray LLP and a former SEC enforcement attorney. “So just like you have to be careful with how you present performance, you have to be accurate when you talk about ESG.”

The regulator also is checking how ESG-oriented funds vote on environmental matters that appear on annual shareholder ballots, the SEC said in a report issued Wednesday. SEC examiners don’t fine firms but can order them to fix compliance deficiencies or refer their findings to the SEC’s enforcement division, which is how many investigations are started.

“It does raise questions about how the SEC will approach proxy voting by mutual funds and other investment advisers,” said Betty Moy Huber, co-head of Davis, Polk & Wardwell LLP’s ESG group. “The SEC recognizes the asset-management industry can wield enormous influence here, so [these exams] are a gigantic tool in their arsenal.”

Mutual fund managers and other investment advisers vote on thousands of shareholder resolutions every year, including many related to topics such as climate change and board diversity. Advisers must disclose the policies they follow when casting votes, and the SEC plans to scrutinize those policies “to assess whether they align with the strategies,” according to the report.

One of the SEC’s core jobs is examining how financial firms such as asset managers and brokerage firms follow investor-protection laws. The SEC conducted 2,950 exams last year, a 4.4% drop from 2019, it disclosed Wednesday.

The SEC began examining how ESG funds work in 2019, sending letters to firms that asked for a list of stocks they had recommended to clients, models for judging which companies are environmentally or socially responsible, and the best- and worst-performing ESG investments. Wednesday’s announcement signals the regulator is now approaching the subject in a more systematic way.

The SEC last week opened a review of how public companies have complied with climate-change disclosure requirements. The agency has long told companies to report material environmental risks, but regulators are now working on new guidelines tailored to how companies discuss climate-change-related risks.

“Through these and other efforts, we are integrating climate and ESG considerations into the agency’s broader regulatory framework,” Acting SEC Chair Allison Herren Lee said in a written statement Wednesday.

The Biden administration has nominated Gary Gensler as the agency’s permanent chairman. At his Senate nomination hearing on Tuesday, Mr. Gensler said he would enforce disclosure of material climate-related risks and signaled many investors want to see more information.

“In 2021, there’s tens of trillions of dollars of invested assets that are looking for more information about climate risk, and I think then the SEC has a role to play to help bring some consistency and comparability to those guidelines,” Mr. Gensler told members of the Senate Banking Committee.

SEC examiners this year also will review whether online brokerage firms are adequately handling customer orders when they sell them to high-speed trading firms to execute, the agency said. That practice, known as payment for order flow, became a flashpoint in the debate over the role of individual investors in the trading in January that caused GameStop Corp. shares to rise from $20 to nearly $500.

Many of the online brokers, including Robinhood Financial LLC, don’t charge trading commissions but earn money through the payments provided by the high-speed traders, which trade with its clients’ orders.