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    Oct. 13, 2022

Money or Ethics: The ESG Investing Debate

Environmental, social and governance (ESG) investing has been a focus for investors over the past several years, not to mention a growth opportunity for asset managers. As with any growth opportunity, ESG investing has attracted the attention of global regulators, which sought to pass regulations to ensure truth in advertising when it came to ESG. The E.U. was first with the Sustainable Finance Disclosure Regulation, followed by the U.S., with the SEC proposing new disclosure requirements for ESG funds. ESG has also captured political attention, and now there is a new wave of state-level regulation, with 18 states proposing or adopting laws or regulations limiting investing based on ESG factors. History teaches, however, that these battles over ESG investing are nothing new. The state-level debate over the relevance and materiality of ESG factors is actually a new chapter of the debate that has been going on at the U.S. Department of Labor about whether it is appropriate for fiduciaries of employer-sponsored retirement plans to consider non-traditional factors such as ESG factors. In a guest article, Morgan Lewis attorneys Lance C. Dial and Rachel Mann review the history of ESG investing; discuss the intersection of federal retirement plan regulations and ESG investing; assess the state-level debate over ESG investing; and posit the next steps in this area. For more from Dial, see our two-part series on the Net Zero Asset Managers Initiative: “What It Is and What It Requires” (Feb. 3, 2022); and “How to Make the Commitment” (Feb. 10, 2022).

AI Compliance Playbook: Understanding Algorithm Audits

The European Commission and the Federal Trade Commission have both made major pronouncements about artificial intelligence (AI) enforcement, highlighting the need to prevent troubling outcomes from algorithm use. The auditing of AI algorithms is a developing practice addressing this need, with Twitter earlier this year buying one of the few specialist firms. This third article in a series examines two recently completed audits of widely used AI services and presents insights from algorithm auditors and AI incident responders about the practical role of AI audits. The first article covered compliance essentials for AI/machine learning tools, and the second article supplied questions to guide AI oversight. See “Managing the Machine: How Hedge Fund Managers Can Monitor and Review Their Automated Trading Strategies (Part Two of Two)” (Jan. 14, 2016).

Ignoring Investment Mandate Results in SEC Fraud Charges for Portfolio Manager

The adage, “Say what you do and do what you say,” is especially apt with respect to a fund’s investment mandate; when a manager strays from its disclosed investment strategy, it risks investor claims and SEC enforcement action. The SEC recently filed a civil enforcement complaint against a portfolio manager who was a principal of an investment adviser. Unbeknownst to investors or the adviser’s other principals, the portfolio manager allegedly began making risky trades in violation of the fund’s mandate to make conservative investments in industrial equities – and those trades resulted in the loss of all of the fund’s capital. This action may reflect the SEC’s continuing focus on individual accountability and risks to individual and retail investors. This article explores the SEC’s allegations and the portfolio manager’s settlement with the SEC. See “Adviser Faces Significant Fines and Disgorgement for Misrepresentations Concerning Investment Concentration and Risk Controls” (Jun. 11, 2020); and “Investors Sue Hedge Fund Manager Harbinger Capital and Philip A. Falcone for Alleged Style Drift” (May 31, 2012).

FCA Identifies Regulatory Priorities for Alternative Investment Managers

The U.K. Financial Conduct Authority (FCA) recently issued a portfolio letter (Letter) to firms in its alternatives portfolio that sets out its supervisory strategy and priorities for alternative investment managers. The Letter is also noteworthy because it portends more vigorous enforcement activity by the FCA, according to Leonard Ng, partner at Sidley Austin. This article details the key takeaways from the letter, with additional commentary from Ng. See “FCA Alert Reminds Custodians and Fund Service Firms of Safeguarding, Servicing and Oversight Duties” (Jul. 14, 2022); and “FCA Details Shortcomings of ‘Host’ Authorized Fund Managers” (August 26, 2021).

SEC Penalizes Adviser With Lax Policies for Monitoring Wrap Fee Accounts

It is axiomatic that an investment adviser must always act in the best interests of its clients, including as their circumstances change. The SEC expects advisers to adopt policies and procedures reasonably designed to satisfy that obligation. The SEC’s recently settled enforcement proceeding against an investment adviser is a reminder that advisers must periodically review their clients’ accounts to ensure that they are not overcharging the clients – and have policies and procedures for doing so. The adviser offered wrap fee accounts to clients but, contrary to its disclosures, allegedly failed to review those accounts periodically to ensure that they remained suitable for the clients. Moreover, certain wrap fee clients also incurred transaction costs that should have been included in the wrap fee. This article outlines the alleged compliance failures and the terms of the SEC settlement order. See “Pair of Risk Alerts Focuses on Issues Associated With Cross Trades, Principal Transactions and Wrap Fees” (Aug. 19, 2021); and “Pay to Play, Revenue Sharing and Wrap Fees Remain on the SEC’s Radar” (Apr. 20, 2017).

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