SEC said to be cracking down on standards for so-called sustainable assets

U.S. regulators have long said they’re dubious about the green and socially conscious labels that Wall Street applies to $35 trillion in socalled sustainable assets.

Now, the watchdogs are hunting for proof that they’re right.

For several months, Securities and Exchange Commission examiners have been demanding that money managers explain the standards they use for classifying funds as environmental, social and governance-focused, said people familiar with the matter. The review is the SEC’s second into possible ESG mislabeling since last year — showing the issue is a priority for the agency and a reason for the industry to worry about a rash of enforcement actions.

“It is a real area of scrutiny, particularly as it relates to disclosures,” said Morgan Miller, a partner at law firm Paul Hastings in Washington and a former SEC enforcement attorney.

The SEC is following the money: Few businesses are booming in high finance like sustainable investing as governments, pension plans and corporations all seek to lower their carbon footprints and be better public citizens. Amid the rush for dollars, more and more ESG insiders have started sounding alarms that a lot of the marketing is hype, a term known in the industry as greenwashing.

For instance, German and U.S. authorities, including the SEC, launched investigations into Deutsche Bank AG’s asset-management arm DWS Group after a former senior executive alleged the firm exaggerated the environmental credentials of some investment products.

While DWS rejected the claims, its shares slid the most in almost 18 months last week on news of the probes.

The sell-off was a warning to other fund managers of what’s at stake if they end up in regulators’ crosshairs. Some European firms responded by checking whether they might have to reclassify assets and setting up internal teams to review ESG products.

Letters that the SEC sent out earlier this year point to some of the agency’s top concerns, said the people who asked not to be named because the correspondence isn’t public.

Investment advisers were asked to describe in painstaking detail the screening processes they use to ensure assets are worthy of ESG designations, one of the people said. The SEC also wants to know how firms are grappling with different jurisdictions’ requirements. For instance, Europe has specific standards that money managers must adhere to in making sure assets are green or sustainable. But in the U.S., it’s much murkier.

Another SEC query sought

information about ESG compliance programs, policies and procedures, a different person said. The SEC additionally asked about statements made by managers in their marketing materials or regulatory filings.

The review is being conducted by the SEC examinations division, whose findings can trigger policy changes. If it spots signs of misconduct — like that fund managers are misleading customers — it would typically alert the SEC’s enforcement unit for further investigation and potential fines.

The SEC has shown it’s keen to bring cases, forming a task force of enforcement lawyers in March whose focus includes fund managers’ ESG disclosures.

An SEC spokesman declined to comment.

Climate change and social issues like boosting workforce diversity are high priorities for the Biden administration, and SEC Chair Gary Gensler has talked often about the regulator’s focus on ESG.

Appearing before the European Parliament this week, he reiterated that the SEC may force fund managers to reveal the criteria and data they use to market themselves as environmentally and socially conscious. The agency is also working on a rule that would make public companies disclose how a warming planet could impact profits.

“Funds that say they’re sustainable and green and the like — what stands beneath that right now?” Mr. Gensler told European Union lawmakers last week. “It could be appropriate to say you’ve got to say an awful lot more.”