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SEC Greenwashing Rule Gives Funds Chills Over Emission Reporting

May 27, 2022, 10:00 AM

A new SEC proposal for investment funds to disclose their portfolio companies’ greenhouse gas emissions is forcing them to think twice about pursuing environmentally friendly strategies.

The plan, which the Securities and Exchange Commission released May 25, would require funds focused on environmental factors to report the carbon footprint and intensity of the companies they invest in. But funds could avoid the obligation, if they say emissions don’t play a role in their approaches to environmental, social and governance investing.

The proposal comes as the SEC is stepping up work to combat greenwashing and other bogus ESG claims by funds and companies that purportedly espouse sustainability. Bank of New York Mellon Corp. on May 23 agreed to pay $1.5 million to settle SEC allegations it gave the false impression some of its mutual funds underwent an ESG quality review.

The proposal will bring new due diligence reviews and compliance costs that could be unpalatable to some funds, said Kenya Davis, a Boies Schiller Flexner LLP partner, who focuses on ESG issues.

“I do think that this will be helpful for all of us because we all benefit from a cleaner planet,” she said. “But my fear of course, is that there will be less funds that will choose to go through that door.”

Funds already are coming out against the proposal.

The plan is “unworkable,” with some emissions information from companies not accessible to funds, said Eric Pan, CEO of fund trade group Investment Company Institute.

Pan on Thursday pushed SEC Chair Gary Gensler about the fairness of directing funds to disclose Scope 3 emissions, which result from activities like business travel and customer use of a company’s products.

The proposal would require funds to disclose Scope 3 emissions, along with Scope 1 and 2 emissions, which come from companies’ direct operations and power usage. Many companies report Scope 1 and 2 emissions, but fewer disclose Scope 3 information. A proposal the SEC released earlier this year would require large companies to make Scope 3 disclosures, if the emissions are part of their climate goals.

“You might be setting up for a future lawsuit, so I’m not going to comment,” Gensler told Pan at an ICI conference in Washington.

ESG Deterrent?

The SEC may adopt the proposal as it is in the coming months. But the agency often alters its plans after hearing feedback.

The public will have 60 days to comment on the proposal once it’s published in the Federal Register, which will happen in the coming days or weeks.

The SEC may end up deterring growth and innovation in ESG investing that it hoped to nurture, if it doesn’t change the proposal, said Amy McDonald, a Morgan, Lewis & Bockius LLP associate, who advises funds.

“We all know those metrics are not necessarily super reliable and accurate,” McDonald said.

But the proposal might not be bad for some funds and the companies they invest in.

The SEC plan doesn’t dictate what constitutes an ESG fund. It only requires companies to report greenhouse gas emissions and make other ESG disclosures.

Tesla Experience

Tesla Inc. still could be part of a green fund due to its environmental record, despite losing its place on the S&P 500 ESG Index, Davis said. S&P Dow Jones Indices booted the electric carmaker led by Elon Musk from the index earlier this month after concerns about its working conditions and how it handled a probe into deaths and injuries tied to its driver-assistance systems.

Musk has been critical of sustainable investing, calling ESG “an outrageous scam.” But not all sustainable funds may be on board with the approach used by the S&P 500 ESG Index and can point to ESG-focused indexes by MSCI Inc. and others that retain Tesla.

In a similar fashion, ESG funds will have varied approaches in how they assess and give weight to a company’s various environmental, social and governance actions, Davis said.

“There are some doors you may just not be able to walk through,” she said. “And there are certain investors who really don’t care about the E, the S and the G. Some may only care about the E.”

Funds are unlikely to leave ESG investing en masse due to the SEC proposal, especially with strong investor interest bringing in billions of dollars in assets, lawyers said.

Some funds may be hesitant to start new green funds, but many existing ones will continue to operate, said Keri Riemer, a K&L Gates LLP of counsel, who advises funds.

“I don’t think that this is going to cause funds to close up shop,” Riemer said.

To contact the reporter on this story: Andrew Ramonas in Washington at aramonas@bloomberglaw.com

To contact the editors responsible for this story: Michael Ferullo at mferullo@bloomberglaw.com; Roger Yu at ryu@bloomberglaw.com