More penalties in ‘eight-figure range’ likely for ESG violations, says former SEC lawyer

The US Securities and Exchange Commission (SEC) has been one of the most active regulators when it comes to ESG enforcement, with headline-grabbing fines levied last year against US financial heavyweights including the asset management arm of Goldman Sachs ($4 million) and BNY Mellon Investment Adviser ($1.5 million).  

With reports that another ESG enforcement sweep is underway at the SEC, Responsible Investor spoke with Kurt Gottschall, who spent 22 years at the regulator – most recently as head of its Denver office – before returning to private practice in July 2022. 

Gottschall, now a partner at law firm Haynes Boone, describes the penalties seen so far for ESG violations as “very significant” given that many of the SEC’s ESG-related cases “did not allege intentional misconduct or recklessness”. 

Typically, compliance violations would result in fines for asset managers “in the low hundreds of thousands”, he says.  

He is convinced that the cost of ESG-related infringements will keep rising, with more penalties in the eight-figure range likely in the US.  

“I think penalties will be higher. This leadership team at the SEC, particularly in the enforcement division, has been very public about their desire to ratchet up penalties.” 

Gottschall does not appear to be alone in this expectation. In July, Bloomberg reported that Deutsche Bank, which is being investigated by the SEC among others, has set aside €27 million to pay fines for alleged greenwashing. 

One of the theories behind ratcheting up penalties, according to Gottschall, is the “efficient breach”.  

The idea behind this concept is that, if regulators repeatedly see the same types of misconduct, it means potential lawbreakers are “evaluating past penalties, factoring that into their calculus, and determining that there is more to be gained by violating the law”. 

Gottschall does not necessarily subscribe to the theory.

“People just don’t think that way,” he says. “Asset managers and companies pay attention to SEC penalties, and some may even make corresponding adjustments to their legal and compliance budgets. But in my experience, those engaging in violations have little to no idea what financial or other sanctions might be.”  

The fact that three of the SEC’s seven ESG taskforce cases have been against asset managers speaks to the “complexity asset managers face when constructing ESG portfolios”, Gottschall tells RI.  

Managers have also been “hampered” by a lack of standards when trying to create ESG strategies and position them in the market, he adds. At the same time, he says: “Once you have made disclosures – either directly to investors in your prospectus or to financial intermediaries – it’s not rocket science to conform to those disclosures.” 

A paper tiger? 

The SEC rolled out its ESG taskforce in March 2021, less than two months after President Joe Biden took office, and a year before the release of its proposed climate rule and the arrival of current chair Gary Gensler.  

Gottschall says the timing and launch of the taskforce was a “robust statement” on how concerned the regulator was about the greenwashing. “Typically, the SEC doesn’t want to be accused of rulemaking by enforcement ,” he says. “So the timing of the taskforce raised a lot of eyebrows, both inside and outside the agency.”     

Members of the ESG taskforce were drawn from the SEC’s existing staff. Gottschall notes that such groups are “dependent upon their resources and staffing levels”. He adds that, as far as he is aware, the SEC has not updated publicly available information on taskforce staffing beyond the original 22 members.

“So, it may be more of a paper tiger,” he says.  

The SEC typically brings more than 700 enforcement actions per year but since the ESG taskforce was established, it has brought just seven cases. “That includes a couple that appear to have already been in the pipeline when the taskforce was launched,” says Gottschall.     

He adds that the cases against Goldman Sachs AM and BNY Investment Advisor were “procedural cases” and did not necessarily require expertise by an ESG taskforce “to compare how those firms represented that they were constructing ESG portfolios versus the reality of what was or was not done”.  

For example, BNY Mellon Investment Adviser was found by the SEC not to always have undertaken an ESG quality review despite representation that it would.  

Gottschall thinks there will be more of these type of cases – “lapses in exclusionary screens or other tools used for the selection of underlying investments in ESG portfolios” – as opposed to rulings by the SEC on the quality of ESG assessments by managers.    

“I think for the asset management industry, it’s going to be very hard for the SEC to wade into those kinds of qualitative judgements,” he says. 

It could be a different story for companies.  Gottschall points to the $55.9 million fine that Brazilian miner Vale agreed to pay the SEC in March in response to allegedly false and misleading disclosures the company made about the safety of its dams prior to the 2019 Brumadinho disaster. 

He describes that penalty as a “real eye-opener for multinational companies that access US capital markets”. 

“If you have some sort of environmental catastrophe, this SEC likely will scrutinise any prior public disclosures to find some sort of jurisdictional hook. I believe that we’ll see more of those types of cases under Gary Gensler.”    

Latest sweep  

Rumours of a new sweep by the SEC’s ESG taskforce surfaced last month, with reports of subpoenas being sent to a number of asset managers.

Gottschall tells RI that this approach to enforcement is being used by the SEC for the asset management industry because of the similarities in business models between firms.  

“If the SEC finds misconduct in one asset manager, they’re likely to find it recurring,” he says. “And finding those violations quickly allows the SEC to amplify its enforcement footprint.”  

As to what a manager should do if it thinks it may have transgressed, Gottschall’s advice is “make sure that whatever you have represented has been done – even if it was done belatedly”.