Loyola University Chicago School of Law, JD 2024
The Securities and Exchange Commission (SEC) established the Environmental, Social, and Governance (“ESG”) Task Force in 2021. In March and May of 2022, the SEC proposed a disclosure rule “forcing publicly traded companies to disclose how climate change could threaten their businesses and describe their contributions to global warming.” The rule further accentuates the SEC’s mission “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” However, the proposal has faced substantial opposition, as some believe the proposal exceeds the SEC’s authority.
ESG Task Force
Companies ESG implementation in their investment strategies has been of increasing interest to investors in their decision-making process. As shown in 2021, there was an increase in investor demand for ESG-related/driven portfolios correlated with the global attention on greenwashing. This increase, without regulation, leaves investors to be easily misled without criteria to measure ESG investment. Within the SEC Division of Enforcement, the ESG Task Force was created to investigate ESG-related violations to protect investors, making it easier for them to compare companies. It was designed to promote disclosure between advisors and investors to ensure investors aren’t being misled.
One of the ESG Task Force’s cases was against BNT Mellon Investment Advisor, Inc. (Mellon). The complaint alleged Mellon presented fraudulent information to investors regarding the investment decisions for certain mutual funds that it managed. The ESG Task Force settled with Mellon for $1.5 million, fining them for misleading clients by representing that their fund investments were vetted for ESG factors when no such vetting had taken place.
SEC disclosure proposal
In continuance of the SEC’s goal to promote disclosure between advisors and investors; the SEC has proposed “the Enhancement and Standardization of Climate-Related Disclosures for Investors” rule. The rule broadens the scope of certain ESG strategies and requires more specific disclosures based on the ESG strategies they pursue. The rule also requires “funds that use proxy voting or other engagement with issuers as a significant means of implanting 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.” The rule would apply to certain registered investment advisors, advisors exempt from registration, registered investment companies, and business development companies.
Additionally, the proposal creates more transparency between companies and investors, giving them more information on business spending in order to make better investment decisions and avoid fraudulent representation. The proposal also requires changes to ESG forms N-CEN and ADV Part 1A, which funds and advisors use to report census-type data that inform the SEC’s regulatory, enforcement, examination, disclosure review, and policymaking roles. In the SEC summary of the proposed release they state, “the proposed rules and form amendments are designed to create a consistent, comparable, and decision-useful regulatory framework for ESG advisor services and investment companies to inform and protect investors while facilitating further innovation in this evolving area of the asset management industry.”
Proponents and opposition to the proposal
The proposal has received its fair share of criticism. Those in opposition believe that the proposal exceeds the regulatory powers that the SEC has and its implementation would be used in “…asserting many new powers in extra-statutory ways.” They further believe that the commission is trying to use “back-door financial regulatory actions” to implement rules that they have failed to implement through regulation directly. When Congress created the SEC it gave the regulator quasi-judicial power, giving it broad authority over all aspects of the securities industry. Twenty-four GOP attorneys wrote a letter to the SEC stating the rule promotes “policy preferences far afield of the Commission’s market-focused domain.” The attorneys further argued that “[f]reed from any pretense of constraint, the Commission can work to mold the market to its will.”
However, those in support of the proposal, such as environmental activists Lena Moffitt, say it is “an important first step to fulfill its mandate to protect investors and capital markets.” The proposal has also found support from SEC Chairman Gary Gensler and Commissioners Allison Lee and Caroline Crenshaw. Gensler believes the proposal “gets to the heart of the SEC’s mission.” He stated, “I think investors should be able to drill down to see what’s under the hood of these funds…[t]hese disclosures would enable investors to dig into the details of a fund’s strategy.”
Although this proposal would increase how much advisors are disclosing to investors in general, the proposal doesn’t seem to create a burden on advisors to provide ESG investment information. As a company’s records show how much they’ve invested in ESG related funds, this information is easily accessible for them to retrieve. In the long term it will be interesting to see what type of data companies can use to show their ESG investment measurements. Whether the SEC would also make companies tally their ESG investments separately instead of as a whole would be something to think about. However, that could lead to challenges as some factors are intertwined and can be hard to assign to one particular category.
As the proposal hasn’t been made official, time will tell whether the proposal oversteps the SEC’s rulemaking authority. The potential increase in the availability of information for investors will seemingly boost confidence and protection. As the SEC has already enhanced the quality of information being provided to investors with the new marketing rule going into effect on November 4, 2022. It seems the SEC will continue that trend with this proposal as well.