As readers of this blog well know, ESG is one of the hot topics in the investment and financial world these days. ESG is also very much on the mind of regulators as well, as two recent developments show. First, on November 22, 2022, the U.S. Department of Labor issued updated rules expressly allowing plan fiduciaries to consider ESG factors when they select retirement fund investments and exercise shareholder rights, such as proxy voting. Second, the SEC, acting through its Division of Enforcement’s Climate and ESG Task Force, brought a settled enforcement action against Goldman Sachs Asset Management for policies and procedures shortcomings at funds marketed as ESG investments. These developments underscore the challenges companies, investment funds, and others face as they navigate the complex ESG landscape.

The Department of Labor’s November 22, 2022 press release about the plan investment ESG guidelines can be found here. The guidelines themselves can be found here. The SEC’s November 22, 2022 press release about the Goldman Sachs action can be found here. The SEC’s Order in the Goldman Sachs matter can be found here.

The New Plan Fiduciary ESG Investment Guidelines

The Department of Labor’s press release describing the new investment guidelines is very explicit that the reason for issuing to guidelines was to address “two rules issued in 2020 during the prior administration” which, the press release states, “unnecessarily restrained plan fiduciaries’ ability to weigh environmental, social, and governance factors when choosing investments, even when those factors would benefit plan participants financially.” The press release quotes an agency official as saying that it will make workers savings “more resilient” by removing “needless barriers, and ending the chilling effect created by the prior administration.”

The new guidelines, according to the DOL press release, clarify “that retirement plan fiduciaries can take into account the potential financial benefits of investing in companies committed to positive environmental, social and governance actions as they help plan participants make the most of their retirement benefits.”

The Goldman Sachs SEC Enforcement Action

The kind of investments that plan fiduciaries might well invest in under the new DOL guidelines are exemplified by the Goldman Sachs funds that are the subject of the SEC’s recent enforcement action. The investments involved were two Goldman Sachs mutual funds and one separately managed account strategy. These investments, according to the SEC’s press release “marketed themselves as Environmental, Social, and Governance (ESG) investments.”

As summarized in the SEC’s press release, during the period April 2017 through February 2020, Goldman Sachs had “several policies and procedures failures” in connection with its staff ESG research used to select and monitor securities. Among other things, the SEC alleges that initially the company failed to have policies and procedures for ESG research in place, and then, once the procedures were in place, failed to follow the procedures consistently.

For example, under the procedures, personnel were to complete a questionnaire for each company that was to be included in the product’s investment portfolio; however, the agency alleged, in many instances, personnel completed the questionnaire only after the securities were already selected for inclusion. Goldman Sachs agreed to the entry of a cease-and-desist order without admitting or denying the allegations, and agreed to pay a $4 million penalty.

The SEC’s press release quotes an Enforcement Division official as saying that advisers “are increasingly branding and marketing their funds and strategies as ‘ESG.’ When they do, the must establish reasonable policies and procedures governing how ESG factors will be evaluated,” and then must follow those policies and procedures.

Discussion

From my perspective these two regulatory actions seem like two sides of the same coin. On the one hand, under the DOL guidelines, plan fiduciaries may properly take ESG considerations into account in connection with plan investments. On the other hand, investment funds that want to try to position their products as “ESG” qualified must match their marketing with practices to ensure that the products live up to their branding.

The SEC action reinforces a point I have made here that companies that seek to  project their ESG virtues increasingly are subject to scrutiny; if there is one consistent message, it is that ESG initiatives cannot merely be marketing vehicles or PR efforts; the initiatives have to be backed up with substance. As numerous recent cases have shown, ESG initiatives potentially are subject to execution error and may be, as was the case here, subject to scrutiny as well.

The DOL’s new guidelines may well have been intended to give fiduciaries comfort in making ESG investments, but it cannot be entirely reassuring that the guidelines issuance were simply an effort to change guidelines put in place under the prior administration. The obvious implication is that the guidelines could be changed again by a future administration. In any event, the change highlights the extent to which ESG itself has become a political issue; anyone making an ESG-related decision, even with the benefit of the new guidelines, will have to be aware of and take into account the growing
“ESG backlash” (discussed at length here).

Some observers may say that the Goldman Sachs miscues were relatively innocuous process errors, and that the penalty itself is relatively modest as well. The magnitude of the enforcement action is not the message here; the message is that the SEC is on the beat, attentive, and actively seeking to ensure that there is substance behind ESG claims. The agency’s ESG task force is clearly targeting efforts at “greenwashing” and generally committed to policing firms’ efforts to try to proclaim their ESG virtues.

Perhaps the thing that is most clear is that regulators have set their sights on ESG issues. For better or worse ESG is going to be a much-exercised topic in the months ahead.