Insight Analytical Note

Read

ESG Implementation Failure

Summary:

  • On September 25, 2023, the Securities and Exchange Commission charged a fund manager1 under Section 206(2) of the Advisers Act with making material misstatements and failing to adopt and implement policies and procedures to ensure that disclosed Environmental, Social and Governance (“ESG”) factors were incorporated into the adviser’s research and investment process.
  • The manager was ordered to pay an unusually high penalty of $19,000,000.

Key Facts and Allegations:

  • ESG Policies Not Implemented:
    • Marketing: The manager marketed itself to investors as a leader in ESG.
      • Marketing included ESG Integrated Products.
      • The manager marketed an “ESG Engine” which assists in analyzing responsible investing.
      • The manager posted its ESG policy on its website, making the policy itself a marketing document.
    • Policy: The manager created an ESG policy and shared it with investors through its public website.
      • The policy required that investment personnel restricted their investment activities to holdings within an ESG compliant investment universe.
      • The policy stated that the goal of the ESG Integration Policy was to set out minimum standards for assessing investment risks and opportunities by incorporating “ESG factors into [our investment professionals’] investment process, analysis and decisions.”
    • Implementation Failure:
      • The manager conducted internal testing which revealed that its policy had not been followed. However, the policy remained on its website.
      • The manager appeared to lack a surveillance mechanism to detect whether the policy was being followed or whether the ESG engine was used.
      • Employees had an inconsistent understanding of their ESG responsibilities with some research analysts actively pushing back against ESG responsibilities.

Takeaways:

  • This was a failure of culture: There appears to have been a compliance culture breakdown at this investment manager. The compliance department created appropriate policies and procedures and executed compliance testing identifying deficiencies but many investment professionals and investment analysts did not comply. Compliance culture is difficult to change once it’s ingrained and senior management must be involved in any attempt at a cultural shift.
  • ESG and regulation: While ESG did not appear on the 2024 SEC Exam Priorities and the Investment Adviser ESG rule appears to be moving slowly, investors continue to be interested in and continue to ask questions about ESG factors. Continued investor interest raises the possibility of inadvertent ESG misstatements and increases regulatory risk.

1 DWS Investment Management Americas, Inc.; Administrative Proceeding File No. 3-21709. In a related action (3-21707), the SEC also charged the same adviser with failure to implement a reasonable AML program. ia-6432.pdf (sec.gov)