The Securities and Exchange Commission (SEC) this week fired a shot over the bow at Wall Street companies that promise to help investors avoid putting their money into fossil fuels and tobacco — but steer funds towards those companies anyway.

In a little-noticed settlement, the SEC fined investment adviser WisdomTree $4 million for claiming that three of its investment funds were fossil- and tobacco-free — when in reality, they were loaded up with investments in oil, natural gas, and tobacco companies. The three funds combined managed roughly $119 million worth of investors’ assets.

The WisdomTree settlement marks the first time the SEC penalized a U.S.-based fund simply for falsely marketing itself as fossil-free. It comes on the heels of a European Union Deutsche Bank “greenwashing” criminal scandal that led to a German police raid of the bank’s headquarters in 2022, the resignation of a top executive, and a $19 million SEC settlement last year — but the range of allegations was broader in that case.

“At a fundamental level, the federal securities laws enforce a straightforward proposition,” Sanjay Wadhwa, acting director of the SEC’s Division of Enforcement, said in a statement announcing the settlement, “investment advisers must do what they say and say what they do.”

WisdomTree did not respond to a request for comment from DeSmog. The investment advisory firm consented to the SEC order, the $4 million penalty, and an SEC censure and cease-and-desist without admitting or denying the agency’s findings, the SEC noted.

The SEC’s complaint faults WisdomTree for promising to make fossil-free investments — but then steering investors’ money into a wide array of fossil fuel companies. Those investments included companies involved in fracking, natural gas distributors, a natural gas pipeline builder, and the part-owner of an oil refinery. Investments were also made in a freight company that hauls coal, fracking sand, and crude oil and a company that makes chemicals used for pipelines and oil and gas drilling, the SEC said. The WisdomTree ESG funds had also invested in dozens of companies that made retail tobacco sales, the SEC added.

WisdomTree is hardly alone. Investigative reporting into so-called “environmental, social and governance” or ESG funds has repeatedly found that many funds — even those claiming to be fossil-free — have actually driven investors’ money into fossil fuel stocks.

“A total of 82.8% of sustainable funds contain at least some exposure to companies producing fossil fuels,” EnergyMonitor reported last year.

Often, the fine print on “sustainable” investments leaves room for investment in fossil fuel companies, with many ESG-themed funds promising only to steer clear of companies whose fossil fuel revenues represent more than a given percentage of their total revenues. Using those definitions can mean many companies that actively drill for oil, mine coal, or run natural gas pipelines can slip by.

And sometimes, as with the three WisdomTree ESG funds, the fine print specifically promises no fossil investments — but the fund invests in companies involved in fossil fuels anyway.

On Wall Street, industry insiders say ESG promises are viewed as toothless — in part because it’s easy to make a promise that’s too vague to be meaningful or enforced and also because, even when violations are clear-cut, the SEC remained on the sidelines.

This week’s move against WisdomTree, however, suggests the agency might be taking enforcement more seriously.

Divestment Demand

As the climate crisis has continued to escalate, investment advisers like WisdomTree have found themselves on the horns of a dilemma.

On the one hand, investors today are clamoring for ESG investment options — many people and organizations want to keep their money out of fossil fuels. 

On the other hand, there’s been political pushback from the fossil fuel industry’s backers. In the first half of 2023, 16 states adopted laws designed to undermine ESG investing.

Despite that backlash, demand for climate-conscious investment options is off the charts, and not just among European investors. A stunning 84 percent of American individual investors are interested in “sustainable” investing, according to a survey earlier this year by Morgan Stanley, with most citing “new climate science findings” as the top reason for their growing interest.

Fossil fuel stocks are particularly unpopular. Worldwide, 21 percent of individual investors said they would outright refuse to invest in oil, gas, or coal companies because of climate change, Morgan Stanley’s survey found. Another 51 percent said they would only be willing to invest in energy companies if the company has made “robust plans” to cut their climate-altering pollution.

ESG investing isn’t only a matter of morality or climate concerns — it also affects returns. “In terms of performance, sustainable funds outperformed and generated better returns than traditional funds in 2023, with a median return of 12.6% versus 8.6% for traditional funds,” a report from the Institute for Energy Economics and Financial Analysis this summer concluded. “This is not an anomaly as sustainable funds have outperformed traditional funds’ returns every year from 2019, except in 2022.”

Adding to the surge in demand from individual investors, a growing number of organizations and institutions have sought to divest from fossil fuels. Over 1,600 institutions worldwide — including major universities, religious organizations, and pension funds — have made fossil fuel divestment commitments, representing over $40 trillion in assets under management.

With that much money looking for a home, a flood of investment plans marketed as “sustainable” or “fossil-free” has swept Wall Street in recent years.

That included, until recently, WisdomTree’s three ESG offerings. WisdomTree shut down all three of its “fossil-free” funds at the start of 2024.

Though it’s not clear from public disclosures which investors held interests in WisdomTree’s three funds, there are some potential signs that nonprofits or universities could have been among those who bought in.

For instance, one of the major holders of WisdomTree’s ESG funds was Disciplina Capital Management, according to a review of SEC filings and disclosures, which show Disciplina at one point held over $60 million in one ESG fund (more than half of the valuation for all three funds combined). Disciplina offers to act as an “outsourced chief investment officer” for clients, a service the company says “is exclusively geared to institutional investors.” It specifically lists “university endowments and charitable foundations” among its clients.

Outsourcing Research — But Not Liability

Like many ESG investment advisors, WisdomTree relied on subcontractors to help screen out fossil fuel companies from its ESG funds. The SEC’s complaint suggests that, in this case at least, the fault for misleading investors lies with WisdomTree, the investment advisor, and not the data vendors.

“WisdomTree used data from third-party vendors that did not screen out all companies involved in fossil fuel and tobacco-related activities,” the SEC wrote. Even though WisdomTree was aware of those gaps, it failed to add its own “policies and procedures over the screening process to exclude such companies,” the SEC added.

WisdomTree promised its ESG funds would screen out fossil fuel companies “regardless of revenue measures” — but it bought data sets designed to make exceptions for companies based on revenue percentages.

WisdomTree also didn’t actually buy the full collection of lists of fossil fuel companies offered by its primary data vendor, the SEC alleged, saying the company failed to subscribe to lists that identified “Shale Energy” and “Oil and Gas” companies for funds to avoid.

Strikingly, the SEC also took a broad view of what it means to be “involved” in fossil fuel production, including not just oil and gas drillers or coal miners but also companies involved all along the fossil fuel production and distribution supply chain, like chemical suppliers and freight haulers.

Some of the largest ESG data vendors do not make it clear if they are equipped to offer comprehensive “fossil-free” screenings.

Morningstar Sustainalytics, one of the largest providers of ESG data worldwide, declined to say whether the company currently offers any “fossil fuel” data sets that could be used to screen out companies involved in fossil fuels comprehensively — or whether it would consider offering that sort of data set in the future.

The wide range of faults the SEC identified could signal trouble for any other ESG funds that, for example, define “involvement” more narrowly than might be implied in their marketing.

And there’s a huge amount of money on the line. This year, about seven percent of the world’s total assets under management were held in sustainable funds, according to Morgan Stanley’s Institute for Sustainable Investing — meaning that over one out of every 15 dollars invested worldwide was in a fund marketed in its prospectus or regulatory filings as “focusing on sustainability, impact investing, or environmental, social, and governance (ESG) factors.”

ESG Task Force Disbanded — But Leader Promoted

The timing of the WisdomTree settlement could suggest the SEC plans to continue its interest in ESG fraud — even though the agency recently disbanded its Climate and ESG enforcement task force, a move Bloomberg first reported last month.

That task force, launched in March 2021, was just a few years old.

“The strategy has been effective, and the expertise developed by the task force now resides across the Division,” the SEC told Bloomberg at the time.

The chief of the ESG task force was Wadwha, who was promoted to acting director of the Division of Enforcement this month after Gurbir Grewal, known for extracting relatively large penalties from corporations, left the SEC.

Outside observers had predicted that the SEC’s interest in ESG themes could grow on Wadwha’s watch. “With Sanjay Wadhwa and Sam Waldon at the helm, the Division is well-positioned to continue its rigorous enforcement efforts and maintain its focus on emerging issues, such as digital assets and ESG disclosures, while building on the strong foundation laid by Mr. Grewal,” the law firm Anderson, P.C., which defends corporate clients, noted in an advisory to clients.

The WisdomTree enforcement action comes after the investment firm changed the prospectus for its ESG funds in November 2022, which the SEC alleged was in response to the Commission’s questioning.When investment advisors say they’ll follow certain criteria, they have to follow through, Wadhwa said in the SEC’s announcement statement. “By contrast,” he said, “the funds at issue in today’s enforcement action made precisely the types of investments that investors would not have expected them to based on WisdomTree’s disclosures.”