On April 23, 2018, the Department of Labor (DOL) issued new guidance for private sector employee benefit plans about fiduciary responsibility in the exercise of shareholder rights and in weighing environmental, social, and governance (ESG) factors in investment decision-making. At a time when public pension beneficiaries are expressing concerns about the prudence of retaining fossil fuel investments in their pension plans, Field Assistance Bulletin (FAB) 2018-01, though not legally binding on public plans, has provided some guidance about how plan fiduciaries can consider ESG factors.
Although it may appear that the guidance comes in response to the growing number of investment advisors contemplating ESG factors, this is not the first guidance about the prudent exercise of fiduciary duties while selecting investments for their collateral or social benefits. Ultimately, FAB 2018-01 does not rescind any part of previous guidance and instead preserves the rationale and conclusions of prior interpretive bulletins. The guidance acknowledges that fiduciaries with obligations under the Employee Retirement and Income Security Act of 1974 (ERISA) can weigh ESG factors and shareholder engagement considerations, but must always put the economic interests of beneficiaries first. Despite the cautionary tone of the guidance, a fiduciary may still consider ESG factors in investment decision-making while complying with the core fiduciary duties of loyalty and prudence.
Where does this come from and why now?
For the last 30 years, the Department of Labor has provided some form of guidance and clarification about how fiduciaries for private employer plans can consider ESG factors in their decision-making. As the first statement by the Trump Administration’s DOL, FAB 2018-01, although a “lower level” policy statement than previous interpretative bulletins (IB), reaffirms prior bulletins related to ESG and Shareholder Rights, IB 2015-01 and IB 2016-01, that respectively provide (in relevant part) that (1) fiduciaries cannot accept lower expected returns or greater risks but may take ESG benefits into account as “tiebreakers” when competing investments otherwise serve the economic interests of the plan equally and (2) fiduciaries may engage in shareholder activities intended to monitor or influence corporate management where the responsible fiduciary concludes, after taking into account expenses, that engagement with management is likely to enhance the value of the plan’s investment.
What are the bulletin’s messages about ESG factors and the selection of investment alternatives?
FAB 2018-01 elaborates on past guidance provided in IB 2015-01 and IB 2016-01 about how a fiduciary can consider ESG standards in prudent decision-making, while also cautioning fiduciaries against concluding too quickly that ESG factors are economically relevant.
Past guidance in IB 2015-01 clarified that under ERISA, fiduciaries can engage in economically targeted investing (ETI), where investments are selected both for their investment returns and for non-economic goals or outcomes that are beneficial to society. For example, a fiduciary could decide to select an investment for its favorable returns but that also furthers the health benefits of a low-carbon economy, so long as that investment has an expected rate of return that is equal to the rates of return of alternative investments with similar risk characteristics. This standard of decision-making is also referred to as the “all things being equal” test, and the DOL has consistently recognized that fiduciaries may consider non-economic or collateral goals as “tiebreakers” when choosing between investments that are otherwise equal with respect to return and risk over the appropriate time horizon.
FAB 2018-01 is seemingly more skeptical about the prudence of fiduciaries selecting ESG-themed investment options. The guidance makes a distinction between ESG-themed funds and the incorporation of ESG factors in non-ESG themed funds. According to the bulletin, the selection of an ESG-themed target date fund as a Qualified Default Investment Alternative (QDIA) may not be prudent if the fund would provide a lower than expected rate of return in comparison to an available non-ESG alternative target date fund. While there are concerns that this language somehow restricts or limits how or whether fiduciaries should weigh ESG factors in investment decision-making, nothing in FAB 2018-01 rescinds language from IB 2015-01 or IB 2016-01.
Conclusions
While FAB 2018-01 seems less supportive of fiduciaries considering ESG factors in investment decision-making, the same core principles stated in IB 2015-01 and IB 2016-01 still apply: ERISA fiduciaries must act solely in the interest of the plan’s participants and beneficiaries and for the exclusive purpose of providing benefits to their participants and beneficiaries.
Under this directive, fiduciaries under private employer plans would be prudent in ensuring that there is a robust record that demonstrates that the interests of beneficiaries were first and foremost in any investment decision-making process. At a time when global regulatory changes, the rise of competing technologies, a growing number of climate lawsuits, and changes in consumer demand, among other financial risks, will impact nearly every sector of the economy, FAB 2018-01 can be interpreted to encourage fiduciaries to engage in more due diligence to determine how the responses to climate change will impact the risk and rate of return for plan investments.
Additionally, we look forward to a new report expected later this month from the General Accounting Office, which will include further guidance on how fiduciaries should approach ESG factors in investment decision-making.
Originally posted May 8, 2018