By Hank Boerner – Chair & Chief Strategist – G&A Institute
August 9 2020
In the early 1970s, Congressional hearings featured allegations of abuses by managers of corporate pension funds taking actions to systemically deny men and women approaching retirement age their promised benefits. A law was passed to protect plan beneficiaries: The Employee Retirement Income Security Act of 1974.
This was intended by the Congress of that day to create standards for private-sector plans to protect the financial and health of beneficiaries of corporate plans.
The U.S. Department of Labor was designated is the primary designated arm enforcing “ERISA”, charged with “protecting the interests of employee benefit plans participants (workers) and their beneficiaries”.
Other agencies have plan oversight responsibilities as well – the U.S. Treasury Department (the IRS) and the Pension Benefit Guaranty Corporation (PBGC).
PBGC is like the FDIC protection for bank customers’ money; when a corporate pension plan fails, the PBGC assumes responsibility for providing retirement benefits to retirees. When a company with a retirement plan goes belly up, filing bankruptcy, or giving up responsibility for the plan, the PBGC takes over to help the plan’s beneficiaries (they don’t get all that was promised by the plan when it was managed by the company they worked for).
Among other elements of the ERISA law and operating rules, there are standards set for fiduciaries and managers of worker retirement plans and welfare benefit plans.
ERISA has been updated since passage 40+ years back and the DOL rules have changed over time. So have related Internal Revenue Service rules. In 1978 the Internal Revenue Code was amended to allow taxpayers to have a tax-deferred, defined, voluntary retirement plan of their own – the familiar 401 (k) plan that millions participate in.
In the latest summary from the DOL’s Employee Benefits Security Administration of DOL (“EBSA“) for FY 2013(!) — ERISA rules [then] applied to 684,000 retirement plans, 2.4 million health plans and 2.4 million additional welfare benefits.
These plans covered 140 million workers and beneficiaries – at the time, that was about half of the American workforce – and assets under management of the plans exceeded US$7 trillion.
To simplify what follows here, the rules adopted by federal regulators are intended to explain and enforce the statute passed by Congress – in this case, protection of worker rights and oversight of fiduciaries managing workers’ assets in plans.
There is a structured process for creating the enforcing agency rules-of-the-road for those organizations being overseen (for ERISA, fiduciaries, plan managers) and these rules could be changed from time-to-time and also be “interpreted” by regulators through communications intended to clarify the rules.
ESG Investment and the Department of Labor Perspectives
As “sustainable” or “ESG” investing became a preferred approach for individuals in plans and managers of plans, many more institutions and individuals preferred those investments, alongside or instead of more traditional investments.
Investors want to be able to invest in an ESG-themed mutual fund or ETF along with or instead of a traditional version that may track a benchmark of the same type.
Example: There are many investment managers whose fund track the widely-used S&P 500 benchmark (from S&P Global) and investable products with an S&P 500 ESG benchmark.
State Street a few days ago launched an S&P 500 ESG Exchange Traded Fund (ETF) “to provide investors an opportunity to tap into ESG investing at the core of their portfolio” (with a very low expense ratio). This “EFIV” tracks the new S&P 500 ESG Index.
SSgA explains: “ESG investing is approaching a critical inflection point…the collective call for change is growing louder and investor increasingly taking a stand through their investment choices.”
How do the regulators of ERISA react to such progress? To the call for change? To respond to investors’ call for action?
By moving backward in rule-making with changes in rules to make it more difficult for plan managers and beneficiaries to invest in ESG vehicles.
To be sure, rules are subject to change. The DOL’s first guidance on ESG investment issues as issued back in 1994.
More recently, in 2008 (during the Administration of President George W. Bush) guidance appeared to be designed to restrict ESG investments by plan fiduciaries.
In 2015 (during the Administration of President Barack Obama) DOL guidance gave the green light to ESG investments…if the investment is appropriate based on economic considerations including those that may derive from ESG factors. (See our perspectives here from November 2015: http://ga-institute.com/Sustainability-Update/big-news-out-of-the-u-s-department-of-labor-for-fiduciaries-opportunity-to-utilize-esg-factors-in-investment-analysis-and-portfolio-management/)
And now in 2020, in June DOL’s EBSA proposed a “new investment duties rule” with “core additions” to the regulations. (“Financial Factors in Selecting Plan Investments” — this to address “recent trends involving ESG investing”).
Among the comments of DOL that really wrankled the ESG investor universe:
- New text was added to codify DOL’s “longstanding position” that plan fiduciaries must select investments based on financial considerations relevant to the risk-adjusted economic value of an investment (or “course of action”).
- The reminder that “Loyalty” duty prohibits fiduciaries from subordinating interests of plan participants and beneficiaries to “non-pecuniary goals”. ESG factors could be “pecuniary” factors — but only if they present economic risk/opportunity under generally-accepted investment theories.
- New text was added on required investment analysis and documentation for the “rare circumstance” when fiduciaries are choosing among “truly economically-indistinguishable” investments. (Huh?)
- A provision that fiduciaries must consider “other” available investments to meet prudence and loyalty duties.
- A new provision for selection of investment alternatives for 401-K plans describes what is required for “pursuing” one or more ESG-oriented objectives in the investment mandate (or include ESG “parameters” in the fund name).
DOL Comments On These:
“ERISA plan fiduciaries may not invest in ESG vehicles when they understand an underlying investment strategy…is to subordinate return or increase risk for the purpose of non-financial objectives.” And
“Private [Sector] employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives…not in the interest of the plan…ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers.”
After the rule changes were published, numerous investors pushed back – some summaries for you that were published on the 401K Specialist web platform of the responses of some fiduciaries who object to the proposed rule (“Commenters Hammer DOL of Proposed ESG Rule”).
More than 1,500 comments have been submitted so far to DOL, calling for changes in the proposed rule, withdrawal, and the very short comment period (just 30 days, ended August 3, vs. the usual 90 days).
T. Rowe Price: The proposed rule is attempting to solve a problem that does not exist. Worse, the proposed rule discourages fiduciaries from taking into account ESG factors that should be considered.
ICCR/Interfaith Center on Corporate Responsibility: The rule would impose significant analytical and documentation burdens on fiduciaries of benefit plans governed by ERISA wishing to select (or allow individual account holders to select) investments that use ESG factors in investment analysis, or that provide ESG benefits (signed by 138 member institutions).
ESG Global Advisors: The Proposal has misunderstood and/or mischaracterized the nature and purpose of ESG integration…this is likely to lead to confusion for ERISA fiduciaries and additional costs to plan savers. Plan fiduciaries will struggle to fulfill their obligation to integrate all financially-material ESG risk factors into their investment process.
Morningstar: The Department’s rule is out of step with the best practices asset managers and financial advisors use to integrate ESG considerations into their investment processes and selections. The proposed rule would…erect barriers to considering ESG factors that many financial professionals consider as a routine part of investment management…
Voya Financial Inc.: The Proposal is fundamentally flawed for two reasons…among the many qualitative factors an ERISA fiduciary may appropriately consider…the Proposal singles out ESG factors and subjects them to special tests…second, the Proposal fails to account for the positive effect on investment behavior that the availability of ESG-focused investment options can have…
American Retirement Association: …appropriate investments that include ESG factors should not be prohibited from qualifying as Qualified Default Investment Alternatives (“QDIAs”)…
The Wagner Law Group: The proposed amendment is inconsistent with existing law and guidance…it would require fiduciaries to only consider pecuniary factors instead of using their judgment and discretion to evaluate investments under the totality of circumstances…a narrow list of permissible factors is inconsistent with the notion that prudence is not determined by a checklist and is a fact-specific determination…
BlackRock: …the Proposal creates an overly prescriptive and burdensome standard that would interfere with plan fiduciaries’ ability and willingness to consider financially-material ESG factors…we urge DOL to engage with the industry to understand how investment options incorporating ESG factors are used in ERISA plans…
Members of Congress – the body that passed ERISA during its 93rd session in 1974 – reacted along partisan lines.
Republican members of the House Committee on Education and Labor submitted a letter of support of the DOL action.
Democrat Party members (41 of them) of the House and 20 members of the House Education and Labor Committee expressed opposition to the rule changes.
The Securities & Exchange Commission is looking at ESG investments as well – soliciting public comment “for the appropriate treatment for funds that use terms such as ESG in their name and whether the terms are likely to mislead investors” (also in the Federal Register post).
In May 2020 the SEC Investor Advisory Committee / Investor-as-Owner Subcommittee issued their perspectives on ESG disclosure: https://www.sec.gov/spotlight/investor-advisory-committee-2012/recommendation-of-the-investor-as-owner-subcommittee-on-esg-disclosure.pdf
There are more details for you here (the investor response summaries): https://401kspecialistmag.com/commenters-hammer-dol-on-proposed-esg-rule/
The Department of Labor’s EBSA proposal highlights are here as published in the Federal Register, June 30, 2020: http://ga-institute.com/Sustainability-Update/big-news-out-of-the-u-s-department-of-labor-for-fiduciaries-opportunity-to-utilize-esg-factors-in-investment-analysis-and-portfolio-management/
Notes: The Secretary of Labor is Eugene Scalia, a nominee of President Donald Trump.
Acting Assistant Secretary for EBSA is Jeanne Klinefelter Wilson (appointed in June 2020).
There is an ERISA Advisory Council with six members. Effective July 14, 2020:
- Glenn Butash is chair; he is managing counsel at Nokia Corp.
- David Kritz is vice-chair; he is deputy counsel at Norfolk Southern Corp.
- John Harney is partner at law firm O’Donoghue and O’Donoghue.
- Peter Wiedenbeck is Washington University School of Law professor.
- James Haubrock is CPA and shareholder, Clark Schaefer Hackett.
- Lisa Allen is compliance consultant, Altera Group.
Stay Tuned: We will update you when decisions are announced by the Department of Labor.