Saturday, March 26, 2022
Climate Change and Wahed Invest
Not long ago, the SEC filed an enforcement action against robo-advisor Wahed Invest. Wahed Invest assured clients that it only selected investments that were compliant with a Shari’ah law. In fact, according to the SEC, in addition to many other fraudulent practices (it claimed to have funds it didn’t have; it claimed to rebalance and didn’t), it also failed to adopt policies and procedures to assure Shari’ah compliance. As the SEC put it:
While Wahed Invest advertised its adherence to Shari’ah compliant investing, Wahed Invest failed to adopt and implement written policies and procedures reasonably designed to address its Shari’ah advisory decision-making processes and compliance reviews and oversight.
On the Wahed Invest Website, in its marketing materials, and in interviews, Wahed Invest extensively discussed the importance of its income purification process. For example, the Wahed Invest Website stated that Wahed Invest “go[es] the extra mile to ensure your wealth is pure” by creating a “unique annual purification report” for each robo-advisory client, which were provided to clients.
Despite these representations to clients and prospective clients, Wahed Invest had no written policies and procedures addressing how it would assure Shari’ah compliance on an ongoing basis or how it would calculate and report the purification of unpure income. Wahed Invest also failed to adopt policies and procedures to ensure Wahed obtained reasonable support for its Shari’ah-related marketing claims.
I am unaware of any other enforcement action by the SEC based on nonfinancial information provided to investors. I.e., there is no argument that the investors’ interest in Shari’ah compliant securities was traceable to any financial motive or expectation that Shari’ah investments would perform better; it arose because of investors’ religious preferences. I suppose in the long history of the securities laws and creative forms of fraud there must be other examples of enforcement actions like this, but I personally don’t know what they are.
Why am I mentioning this now?
Because on Monday, the SEC dropped 500-odd pages of proposed rules regarding climate change disclosures. And though (obviously aware of the likelihood of litigation), the release is chock full of references to the financial/business impacts of climate change, there is also this nugget:
several large institutional investors and financial institutions, which collectively have trillions of dollars in assets under management, have formed initiatives and made commitments to achieve a net-zero economy by 2050, with interim targets set for 2030. These initiatives further support the notion that investors currently need and use GHG emissions data to make informed investment decisions. These investors and financial institutions are working to reduce the GHG emissions of companies in their portfolios or of their counterparties and need GHG emissions data to evaluate the progress made regarding their net-zero commitments and to assess any associated potential asset devaluation or loan default risks. A company’s GHG emissions footprint also may be relevant to investment or voting decisions because it could impact the company’s access to financing or signal potential changes in its financial planning as governments, financial institutions, and other investors make demands to reduce GHG emissions
Notice that especially in the first part of the paragraph, the SEC appears to be taking into account the constraints of institutional investors to achieve their own climate-related goals (help achieve a net-zero economy), which may or may not be strictly about those investors’ ability to maximize their financial returns for investors. I mean, it’s hard to articulate – climate change is so disastrous that it obviously will have economic impacts, and so at a very high level any climate change regulation is investment regulation – but in more concrete terms, the SEC seems to be recognizing these investors’ own contributions to transitioning to a net-zero economy as investment goals.
I’m pointing this out because the idea that the SEC should respect investors’ nonfinancial tastes – not merely when prohibiting lies, as in Wahed Invest, but in required disclosures – is contestable. At the same time, though, some institutional investors may operate under regulatory mandates – including mandates from other countries – to work to achieve climate-related goals, and there would be something perverse about the SEC ignoring that mandate when determining the kind of information investors need.
So. I have no doubt these issues will be hashed out in great detail when the lawsuits begin, and maybe by then I’ll have finished reading all 500-odd pages.
Ah, the whole qualitative materiality thing! Even then, though, I kind of assumed the SEC was not viewing it from the lens of "investors want to invest in moral companies" but more like "management character matters for investment returns/risk/etc"
Posted by: Ann Lipton | Mar 27, 2022 3:35:19 PM
I thought that would be your answer, Ann. Thanks for sharing it. I would want to go back and read the cases and any materials filed by the SEC to see what the rationale might have been. Could be an interesting research excursion . . . .
Posted by: joanheminway | Mar 27, 2022 6:48:59 PM
I have not read anything other than this post yet, Ann, but in terms of non-financial enforcement proceedings by the SEC, what about In re Franchard, 42 SEC 163 (1964)? But maybe you wouldn't count that since there were some putative/possible financial effects. Just curious as to your take . . . .
Posted by: joanheminway | Mar 27, 2022 3:33:40 PM