On September 25, the U.S. Securities and Exchange Commission (SEC) announced a US$19 million settlement with the investment adviser DWS Investment Management Americas Inc. (DIMA) for material misstatements and shortcomings in its policies and procedures related to Environmental, Social and Governance (ESG) investing.[1] TheOrder resolves a longstanding investigation by the SEC into “greenwashing” allegations against Deutsche Bank AG’s asset-management arm, DWS Group (DWS), which we discussed in our September 20, 2021 Advisory.

The order provides a roadmap of areas for compliance that the SEC may scrutinize in future ESG investigations. The SEC focused on lack of: (1) training, (2) testing, (3) controls, (4) standards for management, (5) consistency in approach, and (6) remediation once it recognized the inconsistencies. To settle charges brought under the Investment Advisers Act and the SEC’s rules promulgated thereunder, DIMA agreed, without admitting or denying the SEC’s findings, to pay a US$19 million penalty, and accept a censure and cease and desist order.

This Advisory spotlights both the SEC’s continuing focus on “greenwashing” statements and related policy and procedure deficiencies, as well as the importance of robust whistleblower and internal investigation procedures.

Findings Against DIMA

In the order, the SEC found that DIMA marketed itself to current and prospective fund clients and investors as a leader in ESG. DIMA marketed certain mutual funds as “ESG integrated” because they were subject to the Global ESG Integration Policy of its parent company (DWS). Under that policy, which was published on DIMA’s public website, DIMA investment professionals advising these mutual funds were expected to consider material ESG aspects as part of their investment decision. In particular, the published policy stated that DWS applied an ESG screening and integration strategy to all of its actively managed holdings.

Additionally, from at least 2019 through 2021, DIMA regularly marketed the use of a proprietary ESG quality review, which aggregated data from multiple ESG third-party vendors to provide a letter rating from A to F for thousands of issuers according to six rating categories, such as overall ESG quality, carbon and water risk, and controversial business conduct. In an article in an investment industry magazine titled “When ESG is in your DNA,” DIMA stated that every DWS investment team used the ESG quality review system to make investment decisions for their portfolio.

The SEC found, however, that from August 2018 to late 2021, DIMA failed to adequately implement the ESG Integration Policy’s requirements as it had led clients and investors to believe it would. The SEC further found that DIMA did not adopt and implement reasonable policies and procedures to ensure that its public representations about the ESG Integration Policy were not misleading. The SEC found that the ESG Integration Policy remained published on DIMA’s website even though DIMA knew or should have known that it lacked adequate procedures to ensure that employees were following the policy. In fact, quality checks conducted by the ESG Integration Team on a sample of research notes written between January and November 2020 showed that of the research notes sampled, only about 54% of active equity research notes and 21% of fixed income research notes mentioned ESG criteria. Moreover, the SEC found that the ESG Integration Team received pushback from research analysts and their supervisors regarding monitoring and documenting compliance with the ESG Integration Policy, such that monitoring for ESG integration in models and recommendations was not achieved consistently across the organization.

In determining the penalty in this matter, the SEC credited DIMA’s remedial acts and cooperation, including that DIMA modified relevant processes, policies, procedures, and controls.

Key Takeaways

In light of the DIMA case and the focus by the SEC on climate and ESG-related issues, fund sponsors, companies, and financial institutions should consider the following key takeaways:

• Bold statements will draw regulatory attention. In the press release announcing the order, Sanjay Wadhwa, the head of the SEC’s Climate and ESG Task Force and Deputy Director of Enforcement, pointed to DIMA’s claim that “ESG was in its ‘DNA,’” saying, “whether advertising how they incorporate ESG factors into investment recommendations or making any other representation that is material to investors, investment advisers must ensure that their actions conform to their words.” The message from the SEC on this point is clear: if you are going to make bold and material statements about how your company incorporates ESG principles into its research and investment recommendations and decisions, or in any other representation material to investors, you need to ensure that such statements are supported in practice.[2]

• The SEC is also focused on policies and procedures intended to prevent ESG-related misstatements. The SEC criticized not only DIMA’s misstatements, but also the lack of reasonable policies and procedures to ensure compliance with DWS’s Global ESG Integration Policy. Some of the cited policy deficiencies might seem overly detail-oriented; for example, the SEC found that, while the ESG Integration Policy required supervisors to monitor compliance with the policy by monitoring ESG comments in research notes, the policy did not specify how supervisors should monitor the notes. The takeaway here is that the SEC, and other government agencies, are likely to be particularly critical about internal controls when they believe the firm has made egregious ESG-related misstatements. In addition, policies, procedures, and controls — particularly individual roles and responsibilities — should be well-defined upfront, providing clear expectations to analysts and enabling supervisors and compliance teams to tell whether analysts are adhering to guidance, both of which broke down for DIMA.

• Firms must ensure adequate controls around public statements. The SEC noted that DWS’s Marketing Review Group flagged a statement by a senior DIMA leader that “Every DWS investment team uses [DWS’s ESG quality review] to make investment decisions for their portfolio,” and even changed “every” to “most.” However, the revision did not appear in the final published version of the statement. Firms should ensure that public statements are adequately checked and verified and that edits are implemented where necessary. Like the SEC’s prior action against BNY Mellon Investment Adviser Inc. (BNYMIA), the SEC again focused on responses to requests for proposals (RFPs), which, while not unprecedented, is an area of concern since RFP responses are not typically subject to the same level of internal scrutiny as prospectuses and other filings.

• Compliance teams should be adequately staffed and have appropriate authority. The DIMA matter is particularly instructive on the resourcing of compliance departments. The SEC found that, in 2018 and 2019, the ESG Integration Team consisted of one employee based in Frankfurt, who conducted occasional ad hoc quality checks for ESG integration in research reports, and that this review process was not widespread, formalized, or documented. Even after additional personnel were added to the ESG Integration Team, the SEC found that there were limitations on the time the team could devote to monitoring and documenting compliance with the ESG Integration Policy. The SEC also found that the ESG Integration Team received pushback on their efforts from research analysts and their supervisors. Firms should ensure that compliance teams have adequate resources and authority to conduct their reviews and are involved in developing policies and procedures that safeguard the accuracy and consistency of disclosures.

• Ensure adequate controls around internal whistleblower reports and investigations. It has been widely reported in the media that the former Head of Sustainability of DIMA raised concerns about the firm’s ESG strategy both internally and then externally. Companies should ensure that all internal reports, whether verbal or in writing, including those made by senior executives, are required to be triaged and investigated. When a senior executive is making the report, consider whether the investigation should be overseen by the Board of Directors and conducted by external, independent counsel. Consider an internal report as the first important step in investigating, building the record, and remediating, if appropriate. Following up on every internal report will put the company in a better position to have a defensible position in the event of regulatory inquiry, just as allowing an internal report to go uninvestigated can have an equally negative impact.

• The SEC ESG Task Force is focused on “greenwashing” statements. Following the SEC’s settlements with BNYMIA and Goldman Sachs Asset Management LP (GSAM) last year, this action represents the third investment firm-related action by the SEC’s Climate and ESG Task Force since its formation in March 2021. As explained in our prior Advisory on the BNYMIA action and our prior Advisory on the GSAM action, the allegations in these orders feature “greenwashing” statements and policy and procedure failures that have become the focus of the task force. We anticipate a continuing focus by the SEC on these types of statements, as well as the procedure and controls surrounding them.

ENDNOTES

[1] The SEC also issued a separate order charging DIMA for failing to implement a reasonably designed anti-money laundering (AML) compliance program; according to the SEC, DIMA adopted its ultimate parent company’s AML program used for all U.S. operations without tailoring the program to meet AML compliance requirements specific to mutual funds. As part of the settlement, DIMA agreed to pay a US$6 million penalty and accept a cease and desist order.

[2] The order comes on the heels of the SEC’s Final Rule on Investment Company Names (September 20, 2023), which (1) applies its 80% investment policy requirement to any fund name with terms suggesting that the fund focuses in investments that have, or investments whose issuers have, particular characteristics, such as ESG, and (2) requires such fund to define the terms used in its name, including the criteria the fund uses to select the investments such terms describe. Taken together with this rule, the order compounds the notion that the SEC is deeply concerned with the substance behind any kind of marketing statement made by funds and/or investment advisers.

This post comes to us from Arnold & Porter Kaye Scholer LLP. It is based on the firm’s memorandum, “ESG, Whistleblowing, and Compliance Programs: Key Takeaways from a Recent ESG Misstatement Case,” dated October 12, 2023, and available here.  Arthur Luk and Paul Nabhan contributed to the memorandum.