US SEC settlement demonstrates the risks to investment advisers of using ESG investment decision-making metrics

The US Securities and Exchange Commission (SEC) has been increasingly vocal about its view that environmental, social and governance (ESG) disclosures can be material to investors. To help combat ESG disclosure violations, the SEC created a Climate and Risk Task Force within the Division of Enforcement. As a result of the Task Force’s efforts, on May 23, 2022, the SEC charged BNY Mellon Investment Adviser, Inc. (BNYMIA) for material misstatements and omissions about a sub-adviser’s ESG quality reviews. Without admitting or denying the allegations, BNYMIA settled the matter by agreeing to pay a US$1.5 million penalty.

According to the settlement, between July 2018 and September 2021, the SEC claimed that BNYMIA made material misrepresentations in mutual fund prospectuses in responses to requests for proposals, and in statements to the boards of directors of the relevant mutual funds suggesting that an affiliated sub-adviser had conducted proprietary “ESG quality reviews” for all investments with BNYMIA’s “Overlay Funds.” Specifically, the order explained that BNYMIA’s affiliated sub-adviser’s “Responsible Investment Team” prepared written ESG quality reviews as part of its research process for investment recommendations in connection with equity securities and corporate bonds. These reviews scored a company on a scale of one to 10, measuring the degree to which ESG challenges were well-managed within the business strategy of an issuer in which a mutual fund was considering an investment.

The SEC alleged that representations about the use of these ESG quality reviews in the investment approach of BNYMIA’s Overlay Funds were materially incomplete because they did not fully state that the sub-adviser could and did select portfolio investments that were not subject to a full ESG quality review at the time of investment. In one example, the SEC noted that 67 out of 185 investments made by one Overlay Fund between January 1, 2019 and March 31, 2021 did not have an ESG quality review at the time of investment.

The SEC credited BNYMIA with providing detailed factual summaries and substantive presentations on key topics, which advanced the quality and efficiency of the task force’s investigation. Both BNY Mellon and the SEC noted that the fund materials had been updated as part of BNYMIA’s remediation efforts. 

This settlement is significant as it is directly attributed to the findings of the SEC’s ESG Task Force. It also comes on the heels of another recent SEC enforcement action concerning a public company making alleged misstatements in publicly available corporate sustainability reports. Created in March 2021, the ESG Task Force is responsible for identifying false or misleading ESG disclosures. These recent matters are likely just the beginning of enforcement actions emerging from the Task Force’s work.

This settlement further reveals how closely the ESG Task Force is examining ESG-related statements, including the implied use of ESG metrics by investment advisers. Investment advisers that claim to use ESG metrics as part of their investment decision-making process need to have clear and effective policies, procedures and controls regarding how those metrics are used, and need to ensure that the usage is consistent with the representations made to investors.