SEC Considering ESG Disclosure Mandates for Advisory Firms

An advisory group for the U.S. Securities and Exchange Commission (SEC) comprising financial industry officials, academicians, and other experts recommends the SEC add and expand social responsibility disclosure requirements for U.S. businesses.

The group recommends increasing required disclosures on environmental, social, and governance (ESG) information for all investment products and public companies. It also advises the implementation of diversity disclosures for registered investment advisors and funds.

The Asset Management Advisory Committee approved both proposals by unanimous vote, Investment News reports.

The stated purpose of the rules is to provide investors with more information about funds related to environmental, social, and governance. The group says it wants investors to have a clearer picture of what a firm means when it claims to be “green” or sustainable,” because of the current lack of detailed criteria.

“I think investors should be able to drill down to see what’s under the hood of these funds,” said SEC Chairman Gary Gensler in his remarks during a recent meeting of the commission’s Asset Management Advisory Committee. “As there’s not a standardized meaning of these sustainability-related terms, I’ve asked staff to consider recommendations about whether fund managers should disclose the criteria and underlying data they use.”

Gensler says he also wants to force improvements in diversity in fund companies and within the ranks of investment personnel. He says he is interested in ways to improve transparency.

“For example,” Gensler said, “This could include requiring disclosure of aggregated demographic information about an adviser’s employees and owners. It also could include information about an adviser’s diversity and inclusion practices in its selection of other advisers.”

Such disclosures will require reporting to the SEC during the recruitment, selection, and hiring of workers. By placing diversity as a priority, the requirement would limit a firm’s freedom to select  advisors. It would also require the release of information typically considered confidential.

At the same meeting, Republican SEC Commissioner Hester Peirce disagreed with Gensler and said diversity should not be the focus of investment professionals.

“Would such classifications disempower, rather than empower, people?” Peirce said. “What if, for example, an African American woman who owns an asset management firm prefers to be identified by her Wharton finance degree and her deep knowledge of fixed-income markets rather than her ethnicity or gender, the characteristics the recommended SEC disclosure mandate might emphasize?”

The U.S. House of Representatives has already passed a bill that would support the disclosure requirements, Environment and Climate News reports.

“Under bill H.R. 1187, the Corporate Governance Improvement and Investor Protection Act, the SEC would issue rules within two years requiring every public company to disclose climate-specific metrics in financial statements, requiring metrics tied to greenhouse gas emissions, fossil-fuel-related assets and other risks posed by the changing climate,” Environment & Climate News reports.

The bill now moves to the Senate, where it will probably fail. This will not preclude the SEC from moving forward with rulemaking related to ESG funds, disclosures, and other diversity and inclusion efforts.

As the bull market continues, ESG investing has grown, even increasing during the pandemic, Global Investment Daily reports.

“During the first quarter of 2020, a good 10-out-of-12 ESG-focused index funds that were surveyed outperformed the S&P 500, while all 11-out-of-11 foreign-based ESG funds have trounced their respective international benchmarks,” Anis Alic writes.

The fact that sectors included in ESG stocks have done well have resulted in a positive trend for ESG-focused investors. If ESG-focused portfolios begin to suffer, investors may lose some of their current interest in the environment and diversity, says Mark Hoaglin, CFP, an industry executive.

“It is not the advisor’s duty or responsibility to guide the client toward ESG investing unless it is the most suitable choice,” said Hoaglin. “The fiduciary duty lies in educating the client regarding the most suitable investment alternatives” from a solely financial perspective.

Hoaglin said he can foresee the rise of situations “where a client blames the advisor for not talking them out of an ESG portfolio when the advisor knew the returns would be less than a traditional portfolio.”

“Clients may say they want to use their money to do what feels right,” an anonymous wealth advisor told Budget & Tax News. “Then it all goes out the door once they are not making any more money. Virtue goes out the door when they are not making as much money as their friends are.”