SEC Proposes Amendments to Rules to Regulate ESG Disclosures for Investment Advisers & Investment Companies | White & Case LLP
On May 25, 2022, the US Securities and Exchange Commission (the “SEC”) proposed two form and rule amendments seeking to enhance and standardize disclosures related to environmental, social and governance (“ESG”) factors considered by funds and advisers, and to also expand the regulation of the naming of funds with an ESG focus.1 These proposed rules follow the landmark SEC proposal announced on March 21, 2022 requiring public companies to disclose extensive climate-related information in their SEC filings.2
These proposals trail a recent settled enforcement action against a mutual fund adviser regarding misleading ESG disclosures and a complaint filed against an issuer for misleading investors in its ESG disclosure.3 Taken together with the recent formation of the SEC’s Climate and ESG Task Force in the Division of Enforcement, it is clear that the SEC Staff is increasingly focused on reviewing disclosure with respect to ESG issues.4
The proposals are subject to public comment, which will be open for 60 days following publication of the proposing releases in the Federal Registrar.
ESG Disclosures for Investment Advisers & Investment Companies Proposal
The SEC proposal would impact registered investment companies, business development companies (referred together as “funds”) and registered investment advisers and certain exempt reporting advisers5 (referred together as “advisers”). To summarize, the proposed changes would augment the existing disclosures by amending the rules and forms to:
- Require specific disclosures on ESG strategies in fund prospectuses, annual reports, and adviser brochures;
- Introduce a standard table for ESG funds to disclose information allowing investors to compare ESG funds quickly; and
- Require certain environmentally focused funds to disclose greenhouse gas (GHG) emissions of their portfolio investments; funds that disclose they do not consider GHG emissions as part of their ESG strategy would not be expected to report this metric.
The amount of disclosure required under the proposed rule depends on the degree to which ESG factors are core to a fund’s strategy. The proposal identifies the following three categories of ESG funds: Integration Funds, ESG-Focused Funds, and Impact Funds.
- Integration Funds integrate both ESG factors and non-ESG factors in their investment decisions such that ESG factors are not considered dispositive. Integration Funds would be required to disclose how ESG factors guide their investment process. The disclosure would be brief to avoid overstating the role of ESG factors. Integration Funds that consider GHG emissions would be required to disclose how the fund considers GHG emissions, including the methodology and data sources consulted by the fund.
- ESG-Focused Funds significantly center or focus on ESG factors and would be required to submit detailed disclosures, including in the form of an ESG strategy overview table. The proposal would also obligate certain ESG-Focused Funds to provide about their ESG strategies, including any inclusionary or exclusionary screens, and information about the impacts they are pursuing. ESG-Focused Funds that utilize proxy voting or engagement with issuers to implement its ESG strategy would also be required to disclose how it voted proxies relating to portfolio securities on particular ESG-related voting matters and information regarding its ESG engagement meetings. ESG-Focused Funds that have environmentally focused investment strategies would be required to disclose additional information on the GHG emissions associated with their investments, including the carbon footprint and the weighted average carbon intensity of their portfolio.
- Impact Funds are a subset of ESG-Focused Funds pursuing a specific ESG impact (e.g., financing the construction of affordable housing, or improving availability of clean water). Impact Funds would be required to disclose how it measures progress (in qualitative and quantitative terms) and summarize achievements towards its stated ESG goal.
Under the proposal, advisers would be obligated to make similar disclosures in their brochures (Form ADV Part 2) regarding the consideration of ESG factors in investment strategies, the methods of analysis employed considering any ESG factors, and would be required to disclose certain ESG information in annual SEC filings.
Amendments to the “Names Rule” Proposal
The SEC also proposed amendments to Rule 35d-1 under the Investment Company Act of 1940 (the “Names Rule”). The Names Rule currently requires funds with certain names to adopt a policy to invest 80% of their assets in investments that are aligned with the fund name. The proposed amendments would extend the Names Rule to apply to any fund name with terms suggesting the fund focuses on investments that have—or investments whose issuers have—particular characteristics. ESG related fund names would be subject to the 80% requirement because their names suggest that they are invested in issuers or investments with particular ESG characteristics. The funds would have to define the terms used in their names in the fund prospectus. Under the proposal, a fund that considers ESG factors together with—but not more centrally than—other non-ESG factors in its investment decisions would not be permitted to use “ESG” or similar terminology in the fund name. Funds that violate the rule would be considered to be misleading or materially deceptive in the use of ESG terminology.
The proposal would also enhance prospectus disclosures on how the fund’s investments align with the fund’s name and investment focus, and require funds to maintain records.
1 The proposed rules are available here (ESG Disclosures for Investment Advisers and Investment Companies) and here (Amendments to the Fund “Names Rule”). The corresponding fact sheets are available here and here. See also, SEC Press Releases (SEC Proposes to Enhance Disclosures by Certain Investment Advisers and Investment Companies about ESG Investment Practices; SEC Proposes Rule Changes to Prevent Misleading or Deceptive Fund Names); SEC Chair Gary Gensler’s statements on the proposed rules here and here.
2 See White & Case LLP alert (SEC Proposes Long-Awaited Climate Change Disclosure Rules).
3 SEC Press Releases (SEC Charges BNY Mellon Investment Advisor for Misstatements and Omissions Concerning ESG Considerations; SEC Charges Brazilian Mining Company with Misleading Investors about Safety Prior to Deadly Dam Collapse).
4 See SEC website on the Spotlight on Enforcement Task Force Focused on Climate and ESG Issues.
5 Although the proposed rules do not apply in their entirety to exempt reporting advisers, the proposal includes potential additional disclosure and reporting requirements for these advisers.