Securities and Exchange Commission, SEC, Building in Washington DC

Three recent enforcement actions highlight the risks of failing to adhere to representations made to investors regarding ESG and biblically responsible investing strategies.

The upcoming change in US administration is expected to bring about significant priority shifts by the federal government, including at the US Securities and Exchange Commission (SEC). One area of potential overlap that the investment community should be prepared for, however, is in the realm of thematic investing. Citing its core mission to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation, the SEC has recently focused on the investment decision-making processes and disclosures of registered investment advisers (IAs) and registered investment companies (RICs or funds).1

The SEC’s Division of Examination (the Division) has not only listed IAs and RICs first in its annual examination priorities for 2025 (2025 Priorities), but also published on November 4, 2024, a Risk Alert specifically for RICs, (“Registered Investment Companies: Review of Certain Core Focus Areas and Associated Documents Requested”) (the Risk Alert). It highlights certain common deficiencies and weaknesses that Division staff observed among such funds’ compliance, disclosure, and governance practices over the last four years.

The themes of the Risk Alert align with enforcement trends, as the SEC has settled enforcement actions against three separate IAs in the past three months for alleged misstatements and compliance failures relating to the IAs’ investment processes and procedures. All three of these enforcement actions relate to some level of thematic investing considerations.

Misleading Statements Relating to “ESG Integrated” Assets

On November 8, 2024, the SEC charged an IA with making misleading statements about the percentage of company-wide assets under management that were “ESG integrated”, a term that the IA used to indicate the incorporation of environmental, social, and governance (ESG) factors into its investment decision-making process, in violation of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 (Advisers Act) and Rules 206(4)-1(a)(5), 206(4)-7, and 206(4)-8 thereunder.2

According to the SEC’s order, from April 2020 until July 2022, the IA made misleading statements to the boards of directors of funds it advised, in proposals to prospective clients, and in certain marketing materials, by asserting that the majority of the firm’s assets under management (AUM) were “ESG integrated.”3 However, the SEC noted that — despite public disclosures of “broad and systematic ESG integration” in these AUM — the IA (a) did not adopt and implement comprehensive written policies and procedures to define “ESG integration” or assess ESG integration in its AUM, and (b) overstated the percentage of its AUM that was “ESG-integrated” by including various ETFs which, as passive strategies that selected investments without reference to an ESG-related index, could not, in the SEC’s view, be said to integrate ESG factors in investment decisions.

The IA consented to the entry of the SEC’s order without admitting or denying the findings and agreed to to pay a $17.5 million civil penalty, along with a censure and cease-and-desist order.

Misstatements and Compliance Failures Relating to ESG-marketed ETFs

On October 21, 2024, the SEC charged another IA with making misstatements and for compliance failures relating to the execution of an investment strategy that was marketed as incorporating ESG factors, in violation of Sections 206(2) and 206(4) of the Advisers Act and Rules 206(4)-7 and 206(4)-8 thereunder4 and Section 34(b) of the Investment Company Act of 1940 (Investment Company Act).5

According to the SEC’s order, from March 2020 until November 2022, the IA represented that three ESG-marketed ETFs would not invest in companies involved to any degree in certain “controversial” products or activities (including fossil fuels and tobacco). These representations were made in prospectuses for the funds (and to the board of trustees overseeing the funds).

The IA represented that it had developed a model using data from third-party vendors to screen out companies that had “any involvement” in fossil fuels and tobacco. However, the data it initially obtained and later supplemented did not achieve a perfect screening, resulting in certain investments that appeared to contravene these exclusions. The SEC emphasized that the IA was allegedly aware of some of these defects by 2020 but did not update the board or prospectus materials until late 2022, following an examination by the Division. These revisions included changes to the scope of “fossil fuels-related activities,” removal of claims that companies involved with fossil fuels or tobacco were screened out regardless of revenue, and updates to risk factor language.

The IA consented to the entry of the SEC’s order without admitting or denying the findings and agreed to pay a $4 million civil penalty, along with a censure and cease-and-desist order.

Misleading Statements and Compliance Failures in “Biblically Responsible Investing” Strategy

On September 19, 2024, the SEC charged a third IA with making misleading statements and for compliance failures related to the execution of its “biblically responsible investing” strategy (BRI), in violation of Sections 206(2) and 206(4) of the Advisers Act and Rules 206(4)-7 and 206(4)-8 thereunder Act6 and Section 34(b) of the Investment Company Act.7

According to the SEC’s order, from at least 2019 to March 2024, the IA represented in its Form ADV Part 2A Brochure (brochure) and ETF prospectuses that it used an objective, data-driven methodology to evaluate companies. It also represented that it did not invest in companies that participated in certain practices that it determined were not aligned with biblical values.

However, the SEC noted that the IA relied on a manual research process, primarily focused on assessing donor/sponsor lists of certain well-known organizations that it determined were associated with prohibited activities that would disqualify them under its stated investment criteria, and did not typically conduct research on individual companies. For example, the SEC flagged that the IA had excluded certain companies from its investment universe for sponsoring or donating to certain organizations/events but invested in multiple companies that contributed to the same or similar events. As a result, the IA’s approach appeared to not only fail to “introduc[e] best-practice disciplines of data science,” as it had represented, but also to apply its investment criteria inconsistently in the processes it established.

The IA consented to the entry of the SEC’s order without admitting or denying the findings and agreed to pay a $300,000 civil penalty and to retain an independent compliance consultant, along with a censure and cease-and-desist order.

What’s Next?

Although the incoming administration has yet to formalize the SEC’s priorities and makeup, scrutiny may continue on thematic investing disclosures and alleged misrepresentations on the degree to which ESG matters are incorporated into decision-making processes.

Unlike the above enforcement actions, many of these criticisms stem not from concerns of overstatement, but instead of understatement. Many of the fundamental considerations from an SEC compliance perspective are similar. However, when paired with the scrutiny and legal theories surrounding antitrust and fiduciary duty (among others) that various federal and state governmental authorities, policymakers, and activists have nurtured over the past years, the investment community may be subject to scrutiny on thematic investing efforts from both sides.

Conclusion and Key Takeaways

As Sanjay Wadhwa, Acting Director of the SEC’s Division of Enforcement, stated upon the release of one of the enforcement orders: “At a fundamental level, the federal securities laws enforce a straightforward proposition: investment advisers must do what they say and say what they do.” However, particularly in the realm of thematic investing, IAs and RICs must be cognizant not only of the alignment between their disclosures and practices but also how those disclosures/practices may be construed by the incoming administration.

Below are several key takeaways for the investment community to consider in relation to these developments:

  • The SEC is examining IAs and RICs for clarity and consistency of investment processes and procedures, whether focused on ESG or alignment to a particular thematic investment strategy.
  • IAs and RICs should have written policies and procedures that explain how their actions are consistent with disclosures concerning their investment focus, criteria, and processes, and should ensure that there is no mischaracterization of their use of ESG or other factors in their investment processes.
  • IAs and RICs should appropriately disclose any limitations or exceptions to stated investment criteria or screening mechanisms.
  • Greenwashing may encompass not just the marketing of a particular fund, but also the marketing of an IA’s entire business or investment process.
  • Although the 2024 and 2025 Exam Priorities did not specifically identify ESG as a topic of focus for registrant reviews, the omission should not be taken to mean that ESG is not an ongoing SEC concern. However, the particular aspects of the broad umbrella of topics that fit under the acronym “ESG” in focus will likely shift with the incoming administration.
  • As such, IAs and RICs should carefully review their investment vehicle documentation and practices to confirm consistency throughout, while also strategically considering risks that may emerge from the likely change in perspective with the incoming administration.

If you have questions about this topic, please contact a lawyer in Latham’s Environmental, Social & Governance (ESG), Investment Funds – Regulatory Strategy, and Financial Regulatory practices, or the Latham lawyer with whom you normally consult.

  1. RICS encompass mutual funds (structured as open-end funds), closed-end funds, unit investment trusts, and exchange-traded funds (ETFs). ↩︎
  2. Section 206(2) prohibits an IA, directly or indirectly, from engaging “in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” Section 206(4) and Rule 206(4)-1(a)(5) make it a fraudulent, deceptive, or manipulative act, practice, or course of business to, among other things, directly or indirectly publish, circulate or distribute an advertisement which contains any untrue statement of material fact, or which is otherwise false or misleading. (Rule 206(4)-1(a)(5) was amended effective November 2022, after the conduct at issue in the settlement occurred. However, we note that amended Rule 206(4)-1 contains similar prohibitions.) Section 206 and Rule 206(4)-7 require an IA to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder. Section 206 and Rule 206(4)-8 prohibit any IA to a pooled investment vehicle from “mak[ing] any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading, to any investor or prospective investor in the pooled investment vehicle.” ↩︎
  3. The claimed percentage of AUM that was “ESG integrated” varied from 70% to 94% during the relevant period. ↩︎
  4. See supra note 2 for a discussion of Sections 206(2) and 206(4) of the Advisers Act and Rules 206(4)-7 and 206(4)-8 thereunder. ↩︎
  5. Section 34(b) makes it unlawful for any person to make any untrue statement of material fact in any registration statement or other document filed with the SEC under the Investment Company Act, or for any person so filing or transmitting to omit to state therein any fact necessary in order to prevent the statements made therein, in light of the circumstances under which they were made, from being materially misleading. ↩︎
  6. See supra note 2 for a discussion of Sections 206(2) and 206(4) of the Advisers Act and Rules 206(4)-7 and 206(4)-8 thereunder. ↩︎
  7. See supra note 5. ↩︎