Fiduciary Standards for ESG Funds
Art by Jun KimOver the decades, Republican and Democrat administrations have engaged in
periodic tightening and loosening of the rules governing the extent to which
fiduciaries may take environmental, social and governance (ESG) factors into
account in making investment decisions. This puts fiduciaries in a difficult
position whenever the rules change, as they recently have in the Department of
Labor (DOL)’s publication of Interpretive Bulletin 2015-01, in October.
The classic example of ESG investing is a collectively bargained pension plan’s financing or acquisition of an interest in a real estate project constructed with union labor to create more jobs for union membership. An alternative version of this use of plan assets is an investment in affordable housing that is located in the same area as the union. However, consideration of ESG factors is by no means restricted to plans of unionized workers and could come into play if a plan sponsor adopts an investment policy favoring investment in companies meeting certain “green” criteria. A sponsor might like to invest plan assets in companies it sees as socially beneficial, such as those managed with the participation of their employees or companies perceived to negotiate fairly with their workers.
Through the early 1990s, the DOL issued a number of advisory opinions and information letters holding that economically targeted investments (ETIs) would not be prudent if they provided a plan with less return than comparable investments available to it with a commensurate level of risk. Conversely, ETI investments would be imprudent if they involved a greater risk to the security of plan assets than other investments offering a return similar to the ETI investments. Thus, a decision to make an ETI investment could not be influenced by non-economic ESG factors unless the investment, when judged solely on its economic value to the plan, would be equal or superior to available non-ETI investments. This is sometimes referred to as the “all-things-being-equal” test, because it permits ESG factors to be considered by a fiduciary as a tiebreaker once it has been determined that the economic factors are equivalent.
The Clinton administration strongly favored ETIs and issued Interpretive Bulletin 94-1 to promote them. While careful to preserve the all-things-being-equal test, this guidance concluded that if this requirement were met, “the selection of an ETI, or the engaging in an investment course of action intended to result in the selection of ETIs will not violate” the Employee Retirement Income Security Act (ERISA)’s prudence or exclusive benefit rules. Congressional testimony was given looking forward to the day when ETI investing would be an “unremarkable, ordinary investment practice.”
In the waning days of George W. Bush’s presidency, the DOL, acting on the Bush administration’s belief that the 1994 interpretive bulletin had gone too far, issued Interpretive Bulletin 2008-1. This emphasized that “fiduciaries who rely on factors outside the economic interest of the plan in making investment choices and subsequently find their decision challenged will rarely be able to demonstrate compliance with ERISA absent a written record demonstrating that a contemporaneous economic analysis showed that the investment alternatives were of equal value.” The 2008 bulletin also included five examples showing how various ETIs failed the all-things-being-equal test.
The political winds having again shifted, the Obama administration believes that the need for a written economic analysis “unduly discouraged fiduciaries from considering ETIs and ESG factors.” This has led to the replacement of the 2008 bulletin, as previously noted, with Interpretive Bulletin 2015-01. This latest guidance reinstates its 1994 predecessor more or less word for word.
The preamble to Interpretive Bulletin 2015-01, however, adds a new element to the ongoing policy debate by stating the DOL’s belief that ESG-related tools, metrics and analyses may be used to evaluate an investment’s risk or return or to choose among otherwise equivalent investments. Up to now, ESG factors have been treated as separate from the economic analysis of an investment. Taken to its logical conclusion, the thought expressed in the preamble could mean that a fiduciary may consider ESG factors.
Marcia S. Wagner is an expert in a variety of employee benefits and executive compensation issues, including qualified and non-qualified retirement plans, and welfare benefit arrangements. She is a summa cum laude graduate of Cornell University and Harvard Law School and has practiced law for 28 years. Wagner is a frequent lecturer and has authored numerous books and articles.