More than milk: ESG investing given SEC’s rulemaking, enforcement agenda

June 24, 2022

By Amy Roy, Robert Skinner, and Brooke Cohen, Ropes & Gray

The massive flow of assets into ESG-focused funds reflects the intense and growing demand for investment products that enable investors to put their values into action while pursuing strong financial returns. The dramatic growth of the ESG funds sector has predictably attracted the attention of regulators, commentators, and the private plaintiffs’ bar, some members of which allege that many of the offered “sustainable” or “green” funds are not living up to their names and promises because their portfolio holdings are not sufficiently aligned with that critic’s particular standards for addressing climate change.


Notably, the Securities & Exchange Commission has begun to take forceful action against so-called “greenwashing” in recent weeks, announcing proposed rule amendments relating to fund naming conventions and ESG disclosures, and settling enforcement action charges against an investment adviser accused of overstating its ESG considerations.


The proposed rule amendments and recent enforcement action reflect the SEC’s overly simplistic understanding of ESG investing in registered funds. SEC Chair Gary Gensler has repeatedly lumped ESG funds into a single category, treating them all as synonymous with “green,” “sustainable,” or “carbon-neutral” funds.[1] He suggests that selecting an ESG fund should be more like selecting “fat-free” milk at a grocery store, where the grams of fat—an objective measurement—can easily be ascertained by looking at the nutrition facts on the carton. He concludes: “It is easy to tell if milk is fat-free, it might be time to make it easier to tell whether a fund is really what they say they are.”


The SEC’s recent proposed rule amendments, along with ongoing assertions of greenwashing among regulators and the public, attempt to apply one-size-fits-all metrics to funds that fail to account for the full breadth of the sector’s varied investment approaches. These assertions are often based on a flawed premise: They grade how “green” a fund’s holdings are, as measured by the grader’s selected yardstick, rather than assess whether the fund is managed consistent with the manner described in its prospectus and other disclosures—the appropriate metric under the federal securities laws. The SEC’s aggressive posture towards ESG disclosures threatens novel risk to funds that even consider ESG factors in their investment decisions, requiring fund boards to carefully reassess the enforcement and litigation exposure of their ESG-related offerings.


While colorful, Chair Gensler’s milk analogy ignores the many different ways that ESG funds can pursue their goals and the range of investor values these products seek to represent. Unlike fat-free milk, where the product’s fat content can be ascertained by looking at one line on a nutrition label, ESG funds cannot be evaluated or compared based on a single, graduated metric. Just as grocery customers select differing baskets of goods based on their various tastes and dietary needs (not just on fat content), so too ESG fund investors come to the market with widely varying values and financial goals they wish to see represented in their investment baskets. Allowing for a variety of different ESG products that pursue ESG objectives in different ways provides investors with numerous options to meet their distinct goals. This is no different from how the fund sector has long offered funds with widely varying investment objectives and strategies to meet the varying financial goals and risk tolerances of the investing public.


Recent SEC ‘Greenwashing’ Initiatives

Proposed Fund Names Rule: On May 25, 2022, the SEC issued proposed changes to Rule 35d-1 under the 1940 Act, commonly know as the “Names Rule.” Notably, the proposal would extend the existing 80% investment policy requirement—which requires registered investment companies with names that suggest a particular investment type to have at least 80% of their assets invested in that type of issuer—to fund names containing the terms “growth,” “value,” or those suggesting a focus on one or more ESG factors. The 80% threshold is triggered when the terms in the name could be construed as referring to an investment strategy—an amorphous standard at best.


The proposal would further require funds to specifically disclose the circumstances under which they may not meet the 80% threshold and the time frame by which this would be remedied; to define the terms used in its names and disclose the criteria used to select investments under those definitions; and to use a derivative instrument’s notional amount, rather than its market value, when calculating compliance with the 80% threshold. Finally, the proposal prohibits the use of “ESG” or similar terms in a fund’s name if ESG factors are not “central” to the fund’s strategy, thus effectively prohibiting funds that seek to integrate ESG concerns into their holistic portfolio design considerations from communicating this objective in their names.


Proposed ESG Disclosure Rule: In tandem, the SEC also released proposed amendments to the 1940 Act and the Investment Advisers Act that would require registered funds and their investment advisers to make additional ESG-related disclosures in their prospectuses, Forms N-CEN and ADV Part 1A. Funds and advisers would be required to classify each ESG-related offering into one of three strategy buckets:


  • ESG Focused: Considers one or more ESG factors as a significant or primary consideration in making investment decisions (e.g., engages with portfolio companies on diversity issues or screens companies based on carbon emissions).
  • ESG Impact: Pursues the achievement of a specific ESG impact or benefit through its investment decisions (e.g., funding companies that provide clean water or access to affordable housing).
  • ESG Integration: Considers one or more ESG factors but does not weigh ESG factors more significantly than non-ESG factors.


The proposal does not define “ESG,” but instead would require funds to describe and disclose how ESG factors are incorporated into their investment strategies and investment selection processes.


ESG Integration funds would face fewer disclosure requirements than the other categories but would be prohibited from using “ESG” or similar terms in their names under the proposed fund name amendments. ESG Focused and Impact Funds face more exacting disclosure requirements, including a detailed “ESG Strategy Overview table” in their prospectuses with key information about their ESG analysis. Impact Funds must provide still further disclosures, outlining how they will assess and measure progress toward their stated goals, the time frame by which progress will be evaluated, and how the impact correlates to financial returns. Additional disclosures are also required in annual reports, including Impact Fund disclosures, ESG proxy voting disclosures, ESG engagement disclosures, and GHG emissions disclosures.


The proposing release also discusses perceived deficiencies in the compliance practices of funds purporting to consider ESG factors. The release expresses the SEC’s expectation that advisers’ and funds’ compliance policies and procedures should address ESG disclosures and related portfolio management processes, offering exemplar disclosures, policies, and practices for reference.


ESG Enforcement Settlement: The SEC’s proposed tripartite classification of ESG funds threatens to impose an unhelpful oversimplification on a diverse investment ecosystem. The dangers of this approach are evident in a recent SEC enforcement action, announced a few days before the proposed rules were released, where the SEC announced settled charges and a $1.5 million penalty against a mutual fund adviser for alleged misstatements and omissions in fund disclosures regarding ESG considerations.[2] Although the adviser sponsored a suite of funds identified as “sustainable,” for which the prospectuses stated all investments were required to be subject to a proprietary ESG quality review, those funds were not the subject of the SEC’s action. Rather, the funds at issue were not represented to be ESG-specific or green funds and did not have an ESG-focused mandate; the funds’ prospectus merely indicated that the sub-adviser managing the funds at issue “integrated” its proprietary ESG ranking system.


The SEC’s attempt to shoehorn the ESG investing movement into a discrete roster of arbitrary categories, and to adopt rules and pursue enforcement actions to further this effort, poses an alarming threat to this growing market. While the rules are still open to comment and revision, the recent enforcement action reveals that the SEC is not waiting for rules to formally change before beginning to impose its new theory of ESG disclosures on the market.


What’s Next for Boards

As the SEC continues to develop and enforce its ESG agenda, fund boards will need to analyze how the proposed amendments, should they be adopted, alongside the staff’s aggressive enforcement posture will affect the board’s role and the risks their funds will face. At bottom, the proposed rules should not change the fundamental role played by boards made up of fiduciaries who already understand the importance of providing proper naming, disclosures, and oversight to the funds under their purview. Boards must continue to work, as they always have, to make sure that the fund disclosures reasonably describe what the fund actually does and not assume that the breakdown is as simple as the proposed rule and comments from Chair Gensler might suggest.


While disclosures will continue to be evaluated against the “total mix of information” standard that is a hallmark of the securities laws, the attention given to ESG-specific language is likely to intensify. Boards should bear in mind that this language will be subject to close review by cynical staff attorneys (and plaintiffs’ lawyers thereafter) looking to tease out arguable ambiguities in the language—including by construing ESG-related statements and definitions in isolation, as the SEC’s recent enforcement action reflects. Thus, boards will want to conduct close reviews of prospectus language and confirm that adequate policies and procedures are in place to ensure greenwashing is not taking place. Boards may also wish to emphasize ESG-specific risk areas that are keyed to the proposed rules and enforcement action in their upcoming meetings.


With respect to fund names, boards might consider taking inventory of any ESG-labeled funds and confirm they will be in compliance with an 80% investment policy if adopted. Boards may also consider asking their advisers to explain how they are defining the “ESG”-related term in the fund name. Similarly, boards should evaluate whether there are currently ESG-labeled funds that might fall within the SEC’s defined “integration fund” bucket such that the name and/or fund strategy would need to be changed.


Boards might also consider working with their advisers to answer the following questions in light of the proposed disclosure amendments:


  1. How is the adviser identifying which of the three “buckets” identified by the SEC its ESG-related funds fall in? 
  2. What compliance policies and procedures are in place to ensure any ESG-related funds continue to be managed in the way the disclosures state they will be managed?
  3. How do the policies and procedures compare to those exemplars given by the SEC in the proposing release?
  4. What is the nature of the collaboration among compliance, marketing, and the portfolio management team on ESG-related issues and disclosures?
  5. If using sub-advisers, how are the board and adviser monitoring the sub-adviser’s adherence to its ESG disclosures?
  6. How could a cynical regulator or plaintiffs’ lawyer attempt to read ambiguities or misstatements into the disclosures?


The ESG investing space continues to be fertile ground for funds and boards to add value to their clients’ portfolios by providing a diverse array of options that marry ESG values with financial returns. Boards must adapt to the SEC’s rulemaking and enforcement agenda as they endeavor to continue meeting the demands of the marketplace without subjecting themselves to avoidable enforcement and litigation risk.

Amy Roy (top) is a partner in the securities litigation group of Ropes & Gray, where she represents financial services firms, including investment advisers and mutual funds, and other clients in securities litigation and other complex business disputes in courts and against government regulators around the country. 


Robert Skinner (middle) is a partner in Ropes & Gray’s litigation and enforcement practice group, where he represents investment advisers and other financial services firms in securities litigation and other complex business disputes. In addition to handling active litigation matters, he frequently advises investment managers and other clients in their dealings with state and federal regulators.


Brooke Cohen (bottom) joined Ropes & Gray in 2021 as an associate in the litigation and enforcement practice group. During law school, Brooke was a submissions editor for the Harvard International Law Journal and a peer advisor at the Office of Career Services.

[1] Gary Gensler, Office Hours with Gary Gensler, Twitter (Mar. 1, 2022),


[2] In the Matter of BNY Mellon Inv. Adviser, Inc. Respondent, Release No. 6032 (May 23, 2022),




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