DOL Affirms Fiduciary Standards for ‘Socially Responsible’ Funds

Economic value trumps social-justice concerns in selecting retirement plan funds

Stephen Miller, CEBS By Stephen Miller, CEBS May 7, 2018
DOL Affirms Fiduciary Standards for ‘Socially Responsible’ Funds

The U.S. Department of Labor (DOL) is cautioning retirement plan fiduciaries not to give too much weight to the social-justice mission of mutual funds when selecting investments for employee benefit plans.

The DOL's Field Assistance Bulletin (FAB) 2018-01, issued April 23, says that fiduciaries under the Employee Retirement Income Security Act (ERISA) "must not too readily treat ESG [environmental, social and governance] factors as economically relevant to the particular investment choices at issue when making a decision." Rather, ERISA fiduciaries "must always put first the economic interests of the plan in providing retirement benefits."

Financial services firms also refer to mutual funds that consider ESG factors as "socially responsible investments" or "sustainable and responsible investments" (SRI), while regulators have used the phrase "economically targeted investments." ESG funds, for instance, may exclude the stock of tobacco, fossil fuel, firearm and defense companies, and of firms that are opposed to union organizing or that pay excessive executive compensation. They may actively pursue the shares of companies with a commitment to gender equality, diversity, shareholder rights and community engagement.

The bulletin is a response to guidance issued by the Obama administration in 2015 and 2016 that said the DOL should not unduly discourage fiduciaries from considering ESG factors in selecting investment funds. The new guidance strikes a different tone, affirming that a decision to designate an investment alternative "may not be influenced by noneconomic factors unless the investment ultimately chosen for the plan, when judged solely on the basis of its economic value, would be equal to or superior to alternative available investments."

Not a Ban

The guidance is not a ban on ESG funds in employer-sponsored plans. "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" in keeping with a plan sponsor's fiduciary responsibilities, the bulletin states. While ESG factors can be "more than mere tie-breakers" when deciding between funds, the DOL cautions plan fiduciaries 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."

The bar for considering ESG factors when selecting an automatic-enrollment default investment is especially high. In the case of a qualified default investment alternative (QDIA), "the decision to favor the fiduciary's own policy preferences in selecting an ESG-themed investment option for a 401(k)-type plan … [could] raise questions about the fiduciary's compliance with ERISA's duty of loyalty," the bulletin states.

Meg Voorhes, director of research at Washington, D.C.-based US SIF, The Forum for Sustainable and Responsible Investment, noted that the bulletin differentiates between ESG-themed funds and funds that incorporate ESG factors, "which is different from the 2015 guidance." ESG-themed funds would include socially responsible index funds, religious-belief investment funds or environmental and sustainable investment funds.

The bulletin "says that plan sponsors may designate a fund for the QDIA that considers ESG factors, but only if this consideration is part of the economic analysis the fiduciaries undertake to ensure the QDIA will further the interests of plan participants and beneficiaries in their retirement income," Voorhes pointed out. "More explicitly themed religious, SRI or impact funds, it says, will not be appropriate for the QDIA, even when they are permissible as part of the overall menu of options an ERISA plan offers."

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

Shareholder Activism

The bulletin also addresses shareholder activism that might be undertaken by retirement plans. If a plan fiduciary "is considering a routine or substantial expenditure of plan assets to actively engage with management on environmental or social factors," then a documented analysis of the cost of the shareholder activity compared to the expected economic gain for plan participants would be warranted, the guidance says.

Taking a Cautious Approach

"The FAB reminds us that ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits," summed up Nevin Adams, chief of communications for the Retirement Association in Arlington, Va., which represents plan sponsors and service providers.

Plan sponsors may be sued by plan participants or could face penalties under ERISA if they violate their fiduciary responsibilities. "Fiduciaries who have started down the path of considering ESG factors in their investment decision-making, proxy voting or shareholder engagement"—based on prior guidance issued by the Obama administration seen as favorable toward ESG investments—"may wish to review their process and their policies in light of FAB 2018-01," advised benefits attorneys at law firm Morgan Lewis.

Officials at the Plan Sponsor Council of America, a Chicago-based employer group, said that the new guidance "will make it potentially more difficult" for plans to add ESG investment options to their lineups.

Voorhes, however, noted that a Field Bulletin is a lower-level policy statement than the Interpretive Bulletins issued by the Obama administration, and that the new guidance augments, rather than rescinds, the earlier guidance, limiting its impact.

Cheers and Jeers

Responses to the guidance fell along political lines. "It is crucial that every dollar American workers put away for retirement is invested with the goal of seeking to maximize return, not achieving a secondary goal," said Trey Kovacs, a policy analyst at the conservative American Enterprise Institute in Washington, D.C. "Workers who participate in an employer-sponsored retirement plan, 401(k) or defined benefit plan should feel confident that the exclusive goal plan fiduciaries pursue is securing workers' retirement."

Advocates of socially responsible investing were critical. "These guidelines unfortunately reflect an outdated view that understands the priority of the investor to be maximization of short-term shareholder profits over everything else," said Abhilash Mudaliar, research director of the New York City-based Global Impact Investing Network, which advocates for socially responsible investing worldwide. Long-term, sustainable investment success, he argued, is "reflected in the significant growth of various practices ranging from ESG investing to … corporate social responsibility to conscious capitalism."

The Society for Human Resource Management has not taken a position on the new guidance but believes that a bedrock of sound fiscal and savings policy is ensuring that every U.S. employee has the opportunity to save and plan for retirement, according to SHRM's 2018 Guide to Public Policy Issues.

ESG Funds in Defined Contribution Plans

Plan sponsors, at least in the private sector, remain skeptical about adding environmental, social and governance (ESG) funds to their plans. According to a 2017 study by Callan, an investment consulting firm:

  • 16 percent of defined contribution plans offered a dedicated ESG fund.
  • Only 5 percent of private-sector defined contribution plans offered an ESG fund while 43 percent of government and nonprofit plans did so.
  • An average of just 1.2 percent of plan assets were invested in an ESG fund when offered.

Related SHRM Articles:

DOL Gives an OK to 'Socially Responsible' Funds, SHRM Online Benefits, October 2015

Socially Responsible Funds Popular in Mission-Driven 401(k)s, SHRM Online Benefits, September 2011

Keep Your 401(k) Plan Out of Fiduciary Hot Water, SHRM Online Benefits, July 2016

A 401(k) Fiduciary ChecklistSHRM Online Benefits, July 2015

Supreme Court: Fiduciaries Have Ongoing Duty to Monitor Investments, SHRM Online Employment Law, May 2015

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