Proposed Department of Labor regulations on ESG investing (environmental, social, and governance) by retirement plans have drawn criticism from thirteen members of the US Senate. In a comment letter dated July 15, 2020, Independent party member, Senator Bernie Sanders, along with 12 Democratic Senators*, expressed “deep concern” over the DOL’s proposal “discouraging retirement plan fiduciaries from considering environmental, social, or governance (ESG) criteria in their investment decisions relating to ERISA-governed** retirement plans.”
The rule proposed last month by the Employee Benefits Security Administration, EBSA, (a part of the Department of Labor) would establish that retirement plan fiduciaries can only cite pecuniary reasons for choosing ESG funds to be represented on their menu of plans.
“The Department is concerned that the growing emphasis on ESG investing may be prompting ERISA plan fiduciaries to make investment decisions for purposes distinct from providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. … The Department is also concerned that some investment products may be marketed to ERISA fiduciaries on the basis of purported benefits and goals unrelated to financial performance.”
The positions expressed in the rule generally are in keeping with the previous position of the DOL regarding ESG investments. Past guidance has permitted environmental, social, and governance benefits to be used in tie-breaker circumstances when investment performance and cost are effectively identical for ESG and non-ESG funds.
Given that much of the DOL’s concerns seem cautionary not revolutionary, why have these US Senators along with some other financial industry professionals voiced opinions against the proposed regulations?
A PLANSPONSOR article published July 15, 2020, (DOL’s Proposed ESG Restrictions Criticized by Senate Democrats) quoted Lisa Woll, CEO U.S. Forum for Sustainable and Responsible Investment (US SIF) in Washington, D.C., who said, “The proposed rule suggests, but without evidence, that the growing emphasis on ESG investing may be prompting plan fiduciaries to make investment decisions for purposes distinct from providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. However, the DOL proposal is out of step with professional investment managers, who increasingly analyze ESG factors precisely because of risk, return and fiduciary considerations.”
The Senators authoring the comment letter voicing concerns against the regulation speak out even more decisively, drawing a direct line from the proposed regulation to issues of racism. The letter states:
“We are at (a) pivotal moment in the fight against systemic racism in our country. Yet, while people across the country demand accountability and reach for available tools to fight for racial and economic equity—from advocating for sweeping federal reforms to address systemic racism to taking smaller personal steps like supporting Black-owned businesses—the Department is moving in the opposite direction. ESG investing allows retirement savers to support long-term change by building a system that rewards and values inclusion and diversity in corporate culture from the board to the workforce. By restricting ESG investing, the Department’s proposal would undermine a powerful tool that leverages trillions of dollars a year to drive positive social change.”
ESG Investing Regulations are More than Guidance
Over the years, ESG investing has shifted from a motivation to avoid supporting companies (and thereby funds) with negative associations to proactively aligning with companies and funds for their positive policies and initiatives. However, plan sponsors cannot be permitted to use their employee’s retirement plans to support a political agenda, even if that agenda is a noble one.
Secretary of Labor Eugene Scalia pointed out, “…ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers.”
Below are the additions to the regulation, as explained in the DOL’s news release of June 23, 2020.
5 Core Additions to the Regulation:
- New regulatory text to codify the Department’s longstanding position that ERISA requires plan fiduciaries to select investments and investment courses of action based on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.
- An express regulatory provision stating that compliance with the exclusive-purpose (i.e., loyalty) duty in ERISA section 404(a)(1)(A) prohibits fiduciaries from subordinating the interests of plan participants and beneficiaries in retirement income and financial benefits under the plan to non-pecuniary goals.
- A new provision that requires fiduciaries to consider other available investments to meet their prudence and loyalty duties under ERISA.
- The proposal acknowledges that ESG factors can be pecuniary factors, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories. The proposal adds new regulatory text on required investment analysis and documentation requirements in the rare circumstances when fiduciaries are choosing among truly economically “indistinguishable” investments.
- A new provision on selecting designated investment alternatives for 401(k)-type plans. The proposal reiterates the Department’s view that the prudence and loyalty standards set forth in ERISA apply to a fiduciary’s selection of an investment alternative to be offered to plan participants and beneficiaries in an individual account plan (commonly referred to as a 401(k)-type plan). The proposal describes the requirements for selecting investment alternatives for such plans that purport to pursue one or more environmental, social, and corporate governance-oriented objectives in their investment mandates or that include such parameters in the fund name.
Footnotes:
*ERISA Employee Retirement Income Security Act of 1974
**The comment letter to the DOL was signed by Senators Tina Smith (Minnesota) and Patty Murray (Washington), authors of the letter, and Sherrod Brown (Ohio), Kirsten Gillibrand (New York), Tim Kaine (Virginia), Elizabeth Warren (Massachusetts), Bernard (Bernie) Sanders (Vermont), Tammy Baldwin (Wisconsin), Robert P Casey, Jr. (Pennsylvania), Dick Durbin (Illinois), Amy Klobuchar (Minnesota), Cory Booker(New Jersey), and Dianne Feinstein (California).
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