What the SEC’s Actions on Greenwashing Mean for Investors

The Securities and Exchange Commission made strides in its fight against greenwashing, settling a two-year probe of DWS Investments into misstatements about its environmental, social, and governance investing, as well as making changes to its Names Rule.

On Sept. 25, money manager DWS Investments agreed to pay $25 million for overstating how it used ESG factors in its funds. Meanwhile, DWS settled SEC allegations that it violated anti-money-laundering rules for its mutual funds. DWS, which is controlled by Deutsche Bank DB, didn’t admit or deny the charges but agreed to cease and desist orders related to the anti-money-laundering violations and the ESG misstatements. “DWS advertised that ESG was in its ‘DNA,’ but, as the SEC’s order finds, its investment professionals failed to follow the ESG investment processes that it marketed,” Sanjay Wadhwa, deputing director of enforcement for the SEC, said in a statement.

Separately, on Sept. 20, the SEC adopted amendments to the Names Rule. The fund’s name is the first thing that investors encounter, and according to the Names Rule, which was originally adopted in 2001, funds must invest 80% of their assets in the investments the name suggests. The amendments now expand that requirement to fund names with “particular characteristics,” such as “growth” and “value,” or names that say it incorporates ESG. These are broad new requirements that will also require greater disclosures in the prospectus.

How Do These Combat Greenwashing?

Fund names are important signals for investors. For example, Andrew Behar, CEO of the investor advocacy organization As You Sow, points out that when investors buy an ESG or “fossil-fuel-free” fund, they expect not to own oil or coal. But today, “we see funds with ESG in their names holding dozens of fossil fuel extraction companies and coal-fired utilities. The plain English meaning of ‘fossil free’ should rule out these holdings,” Behar said in a statement.

“In my mind, we’re in the second half” of the battle against greenwashing, “and half-time adjustments have been made,” said Adam Fleck, director of research, ratings, and ESG at Morningstar. “It’s clear what direction the coaches want to go. The SEC wants to tamp down anything that could mislead investors.”

“The final [Names] rule from the SEC succeeds in combating misleading fund names and provides additional transparency for investors and important guidance for funds,” said Maria Lettini, CEO of US SIF, the trade group for the sustainable-investment industry, in a statement.

Why Are These Rules Needed?

ESG investing has grown significantly over the past few years. Many more investors have become concerned about the world’s sustainability challenges. A wave of sustainable funds were launched to meet that demand, and many conventional funds adopted ESG criteria in a more limited way. The funds use similar terms in their names, which may imply to investors and advisors that they are all alike. But as we have shown in our Sustainable-Investing Framework, there are numerous ways to address sustainability issues in an investment strategy.

Greenwashing Fears Put ESG Funds Under Greater Scrutiny

But the past 18 months brought political backlash and greater scrutiny. Money managers like BlackRock and State Street have closed dozens of funds this year, Bloomberg reported, citing Morningstar data. “It’s because of the scrutiny,” says Adam Bernstein, ESG analyst for Gitterman Wealth Management.

For individual investors, this wave of activity means that the securities regulator is addressing any fears about greenwashing, or companies making deceptive claims about the funds they offer. This has been a major critique of sustainable investing. For example, the SEC considered, then dropped, a proposal that funds that consider ESG metrics in their investment process but don’t regard them as any more important than other factors should be banned from using the term “ESG” in the name. Ultimately, the SEC decided not to adopt the provision because of “mixed feedback,” writes Sara Mahaffy, ESG strategist at RBC Capital Markets.

“What is your fund? What is it meant to do? Do the names and holdings match the intent? It’s a lot easier to get information about funds now than in the early 2000s,” says Fleck of Morningstar. “But words matter, names are important, and time is something few of us have in abundance.”

To be sure, it may still be confusing to pick a fund. Consider the iShares Climate Conscious & Transition MSCI USA ETF USCL. What is the industry standard for a portfolio invested in carbon transition economy stocks? There isn’t one.

Are There Such Things as ‘ESG Stocks?’ No.

Many investors will also be perplexed about whether there are such things as “ESG stocks.” This term appears numerous times in fund names, suggesting there’s a list of ESG-compliant stocks. Here’s the reality: There isn’t. Some companies score well on ESG risk ratings (Morningstar owns one such rating agency—Sustainalytics). Some companies provide solutions to climate change. But the variety of what constitutes ESG investing is pretty wide.

What’s Next in Sustainable-Investing Regulation

More efforts are still to come. One is the expected release of the SEC’s so-called ESG Disclosure rule, which aims to enhance and standardize sustainable fund disclosures and was the subject of an array of comments before adoption.

The Big Daddy is the proposed climate disclosure rule, which the SEC released in 2022 and invited comment. These include disclosures about the so-called scope 1, 2, and 3 greenhouse gas emissions, as well as climate-related risks and their impacts on business and the company’s outlook. Greenhouse gas emissions cause global warming.

Already, California lawmakers have passed two new measures requiring big companies that do business in California to disclose greenhouse gas emissions and climate-related financial risk.

The California laws, as well as the coming SEC climate disclosure rule, will surely be challenged in court. “The SEC is spending its time writing as airtight of a rule as it can come up with,” says Jon Hale, the longtime Morningstar analyst who is now an independent consultant on sustainable investing. Investors want companies to disclose material risks, including those that people didn’t know about when the SEC was founded in 1934, such as climate change. Still, Hale says the rule “will probably go to the Supreme Court.” There, it might encounter opposition. In 2022, the Supreme Court limited the Environmental Protection Agency’s ability to regulate carbon emissions.

For now, the United States still lags Europe in terms of ESG disclosures. For example, Europe’s Sustainable Finance Disclosures Regulation poses mandatory ESG disclosure obligations for asset managers and others. Fund managers must provide precise, standardized disclosures on how they integrate ESG factors. The rule also categorizes the different kinds of funds and their impacts.

“The direction of travel is Europe,” says Bernstein of Gitterman Wealth. “This Names Rule is just one small step.”