Socially responsible investing often sounds like an intriguing idea, but investing plan assets in a socially responsible manner is a notoriously tricky proposition. Earlier this year, the US Department of Labor issued additional guidance clarifying existing DOL guidance applicable to socially responsible investment of plan assets. However, the clarifications included in FAB 2018-01 may further limit the scenarios in which socially responsible investing could be considered prudent under the Employee Retirement Income Security Act of 1974, as amended (ERISA).
While socially responsible investing often sounds like an intriguing idea, investing plan assets in a socially responsible fashion is a notoriously tricky proposition. The US Department of Labor (DOL) issued additional guidance earlier this year (Field Assistance Bulletin (FAB) 2018-01) clarifying existing DOL guidance applicable to socially responsible investment of plan assets. However, the clarifications included in FAB 2018-01 may further limit the scenarios in which socially responsible investing could be considered prudent under the Employee Retirement Income Security Act of 1974, as amended (ERISA).
Interpretive Bulletin 2015-01 (IB 2015-01) and Interpretive Bulletin 2016-01 (IB 2016-01) set forth the DOL’s current position on socially responsible investment of ERISA plan assets. IB 2015-01 addresses “economically targeted investments” (ETIs), defined as “investments selected for the economic benefits they create apart from their investment return to the employee benefit plan.” The preamble to IB 2015-01 summarizes the DOL’s position on two ETI points. First, the preamble states that plan fiduciaries “should appropriately consider factors that potentially influence risk and return,” including environmental, social and governance (ESG) factors. According to the DOL, these factors “are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of competing investment choices.” Second, the preamble reiterates the DOL’s longstanding position that “plan fiduciaries may invest in ETIs based, in part, on their collateral benefits so long as the investment is economically equivalent, with respect to return and risk to beneficiaries in the appropriate time horizon, to investments without such collateral benefit.”
IB 2016-01 summarizes the DOL’s position on (1) the voting of proxies on securities held in ERISA plan investment portfolios and (2) statements of investment policy, including proxy voting polices. In IB 2016-01, the DOL notes that a plan investment policy may include rules regarding the use of ESG factors to evaluate ERISA plan investments.
FAB 2018-01 clarifies the application of IB 2015-01 to socially responsible investing in two primary respects. Both of these clarifications sound a warning bell for plan fiduciaries engaged in socially responsible investing.
Treatment of ESG Factors in Investment Review Process
The DOL cautions fiduciaries against “too readily” treating economic, social and governance (ESG) factors as economically relevant to a particular investment decision. FAB 2018-01 reiterates and elevates the long-standing DOL belief to “always put first the economic interests of the plan in providing retirement benefits.”
The DOL clarifies the application of ESG factors to a defined contribution plan’s qualified default investment alterative (QDIA). In FAB 2018-01, the DOL confirms that a plan fiduciary could add a “prudently selected, well managed, and properly diversified ESG-themed investment alternative” to a defined contribution plan’s investment lineup, but strongly cautions a plan fiduciary against adding such ESG investment option as the plan’s QDIA. The DOL believes that a fiduciary’s decision to favor its own ESG preferences in selecting an ESG-themed investment option would raise questions about the fiduciary’s compliance with ERISA’s duty of loyalty. According to FAB 2018-01, offering a socially responsible QDIA is still technically feasible, but only if the selection otherwise strictly complies with the guidelines set forth in IB 2015-01.
With respect to IB 2016-01, FAB 2018-01 clarifies that if a plan’s investment policy includes rules around the use of ESG factors to evaluate investment options, the plan fiduciary must disregard these ESG rules if following the rules would result in an imprudent investment decision. Prior to issuing FAB 2018-01, the DOL believed that some plan fiduciaries may have felt obligated to follow the plan investment policy’s ESG rules regardless of the outcome.
If your ERISA plan engages in socially responsible investing, please discuss FAB 2018-01 with your plan’s investment advisor or investment manager so that you fully understand the potential impact on your plan’s investment strategy. More specifically:
If you have a plan investment policy that includes ESG rules, consider revising this investment policy to specify that these ESG rules will be ignored if adhering to the rules would lead to an imprudent investment decision.
If your defined contribution plan’s QDIA could be viewed as a socially responsible QDIA, reevaluate this selection under a strict interpretation of IB 2015-01.