DOL Pulls Back on ESG Guidance

By Nevin Adams • April 25, 2018 • 0 Comments
While reiterating some long-standing positions on socially responsive investing, the Department of Labor (DOL) has some new cautions about an ESG emphasis in plan design and proxy voting.

It has done so in the form of Field Assistance Bulletin 2018-01, issued April 23, which is designed to provide guidance to the Employee Benefits Security Administration’s national and regional offices “to assist in addressing questions they may receive from plan fiduciaries and other interested stakeholders,” specifically about Interpretive Bulletin 2016-01 (relating to the exercise of shareholder rights and written statements of investment policy) and Interpretive Bulletin 2015-012 (relating to “economically targeted investments” (ETIs)).

Once termed SRI (for socially responsible investments, or socially responsive investments), these days such factors are often referred to as ESG — environmental, social, ethical and governance.

Fiduciary Acts

By way of background, the DOL restated what it termed its “longstanding position” that the fiduciary act of managing plan assets that involve shares of corporate stock includes making decisions about voting proxies and exercising shareholder rights, reminding of its previous effort to “assist plan fiduciaries in understanding their obligations under ERISA” in Interpretative Bulletin 2016-01. The DOL also called to mind its “similarly longstanding position” that ERISA fiduciaries may not sacrifice investment returns or assume greater investment risks as a means of promoting collateral social policy goals, citing IB 2015-01 as being its interpretation of ERISA Sections 403 and 404 as applied to employee benefit plan investments in economically targeted investments (“…investments selected for the economic benefits they create apart from their investment return to the employee benefit plan”).

In the latter, the DOL said it “reiterated its longstanding view that, because every investment necessarily causes a plan to forego other investment opportunities, plan fiduciaries are not permitted to sacrifice investment return or take on additional investment risk as a means of using plan investments to promote collateral social policy goals.” Moreover, that IB 2015-01 reiterated the view that when competing investments serve the plan’s economic interests equally well, plan fiduciaries can use such collateral considerations as tie-breakers for an investment choice.

More Than Mere Tie-Breakers

That said, in the new FAB, the DOL characterized that observation as one that “merely recognized” that there could be instances when otherwise collateral ESG issues present material business risk or opportunities to companies that company officers and directors need to manage as part of the company’s business plan and that qualified investment professionals would treat as economic considerations under generally accepted investment theories, and that these “ordinarily collateral issues” should be considered by a prudent fiduciary along with other relevant economic factors to evaluate the risk and return profiles of alternative investments. “In other words,” the FAB states, “in these instances, the factors are more than mere tie-breakers,” and that “the weight given to those factors should also be appropriate to the relative level of risk and return involved compared to other relevant economic factors.”

That said, the DOL cautions here that “fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision,” and that “it does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors.”

Rather, the FAB reminds us that ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits. “A fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives.”

As 2016 (and the Obama administration) wound to a close, the tone of the Labor Department’s Interpretive Bulletin (IB) expressed concern that fiduciaries had been reluctant to incorporate ESG considerations in proxy voting “or undertaking other shareholder engagement activities.” The current FAB acknowledged that in IB 2016-01, the DOL had noted that investment policy statements are permitted to include policies concerning the use of ESG factors to evaluate investments, or on integrating ESG-related tools, metrics, or analyses to evaluate an investment’s risk or return. However, the new FAB goes on to clarify that that former discussion “…does not reflect a view that investment policy statements must contain guidelines on ESG investments or integrating ESG-related tools to comply with ERISA,” nor does that IB “imply that if an investment policy statement contains such guidelines then fiduciaries managing plan assets, including appointed ERISA section 3(38) investment managers, must always adhere to them.” In other words, “if it is imprudent to comply with the investment policy statement in a particular instance, the manager must disregard it.”

ESG and Investment Menus

The FAB explains that in the case of an investment platform that allows participants and beneficiaries an opportunity to choose from a broad range of investment alternatives, adding one or more funds to a platform in response to participant requests for an investment alternative that reflects their personal values does not necessarily result in the plan forgoing the placement of one or more other non-ESG themed investment alternatives on the platform, and that “a prudently selected, well managed, and properly diversified ESG-themed investment alternative could be added to the available investment options on a 401(k) plan platform without requiring the plan to remove or forgo adding other non-ESG-themed investment options to the platform.”

It cautions, however, that in the case of a qualified default investment alternative (QDIA), “…selection of an investment fund is not analogous to merely offering participants an additional investment alternative…” The new FAB states that “nothing in the QDIA regulation suggests that fiduciaries should choose QDIAs based on collateral public policy goals,” and that in the QDIA context, “the decision to favor the fiduciary’s own policy preferences in selecting an ESG-themed investment option for a 401(k)-type plan without regard to possibly different or competing views of plan participants and beneficiaries would raise questions about the fiduciary’s compliance with ERISA’s duty of loyalty.”

Proxy Voting

As for proxy voting, the FAB notes that while in IB 2016-01, the DOL stated that an investment policy that contemplates engaging in shareholder activities that are intended to monitor or influence the management of corporations in which the plan owns stock can be consistent with a fiduciary’s obligations under ERISA, “if the responsible fiduciary concludes there is a reasonable expectation that such activities (by the plan alone or together with other shareholders) are likely to enhance the economic value of the plan’s investment in that corporation after taking into account the costs involved.” Indeed, the current FAB emphasizes the cost aspect, cautioning that the 2016 IB “was not intended to signal that it is appropriate for an individual plan investor to routinely incur significant expenses to engage in direct negotiations with the board or management of publicly held companies with respect to which the plan is just one of many investors,” nor was it “meant to imply that plan fiduciaries, including appointed investment managers, should routinely incur significant plan expenses to, for example, fund advocacy, press, or mailing campaigns on shareholder resolutions, call special shareholder meetings, or initiate or actively sponsor proxy fights on environmental or social issues relating to such companies.”

The FAB concludes that, “If a plan fiduciary is considering a routine or substantial expenditure of plan assets to actively engage with management on environmental or social factors,” either directly or through the plan’s investment manager, that may well constitute the type of “special circumstances” that the IB 2016-01 preamble described as warranting a documented analysis of the cost of the shareholder activity compared to the expected economic benefit (gain) over an appropriate investment horizon.