Yes, Governance Matters. – ESG: Adherence to internal policy and procedures

INTRODUCTION:

The Securities and Exchange Commission (“SEC”) recently charged Goldman Sachs Asset Management, L.P. (“GS”) for policies and procedures failures involving two mutual funds and one separately managed account strategy marketed as Environmental, Social, and Governance (ESG) investments. GS agreed to pay a $4 million penalty to settle¹ the charges.

FACTS:

According to the SEC, GS had several policies and procedures failures involving the ESG research its investment teams used to select and monitor securities from April 2017 until February 2020.

This included failure to have any written policies and procedures for ESG research as well as a failure to follow them consistently, once policies and procedures were established.

Interestingly, the SEC took cognisance of the fact that while GS own policies and procedures required its personnel to complete a questionnaire for every company it planned to include in each product’s investment portfolio prior to the selection, the fact was that personnel completed many of the ESG questionnaires (i) after securities were already selected for inclusion; and (ii) relied on previous ESG research, which was often conducted in a different manner than what was required in its policies and procedures.

Further, GS shared information about its policies and procedures, which it failed to follow consistently, with third parties, including intermediaries and the funds’ board of trustees.

THE REGULATOR’S VIEW:

Noting that in response to investor demand, advisers like GS are increasingly branding and marketing their funds and strategies as ‘ESG’, the SEC went on to state that “When they do, they must establish reasonable policies and procedures governing how the ESG factors will be evaluated as part of the investment process, and then follow those policies and procedures, to avoid providing investors with information about these products that differs from their practices.”²

DISCUSSION:

The order against GS reinforces the fact that ESG is the flavour of the season and is being used increasingly to brand and market funds and investment strategies. Investment decisions are, consequently, driven by the existence of ESG-based branding and strategies.

To that end, any policies and procedures that are so developed over investment processes, including ESG research, must be adhered to. This is to ensure that investors receive the advisory services they would expect to receive from an ESG investment.

Whilst ESG may well be the flavour of the season globally, its reporting and adherence to polices and procedures in India requires significant attention and improvement. ESG regulations in India are set out under several different legislations. Moreover, the ESG reporting is largely still being done more as a ‘check-the-box’ item rather than being followed in its true nature and spirit. In India, the Securities and Exchange Board of India (“SEBI”) has also been conducting random inspections of alternative investment funds registered with it, to supervise inter-alia whether these funds are adhering to policies and procedures set out by them in the fund documents. While SEBI is unlikely to take any action against fund managers without a grievance expressed by investors, considering that SEBI takes cues from the SEC, it is all the more imperative now for Indian fund managers to take their policy and procedures, including ESG covenants, seriously.

With ESG-based branding and strategies driving investment decisions, it may well be the time for us, in India, to learn from evolving global best practices and see how best to, amongst other things (i) consolidate the ESG reporting; (ii) apply standards to ensure its completeness and accuracy; (iii) develop a regulator-based checking system whereby the policies and procedures are developed and strictly adhered to.

¹ https://www.sec.gov/litigation/admin/2022/ia-6189.pdf

² Sanjay Wadhwa, Deputy Director of the SEC’s Division of Enforcement and head of its Climate and ESG Task Force