DOL Gives an OK to ‘Socially Responsible’ Funds

ERISA guidance on funds that promote environmental, social and governance goals

By Stephen Miller, CEBS October 28, 2015

The Department of Labor (DOL) has issued new guidance clarifying when it is acceptable for fiduciaries to invest pension plan assets in what many plan sponsors call “socially responsible investment” or “sustainable and responsible investment” (SRI) funds, but which the DOL refers to as “economically targeted investments” (ETIs). The rule, Interpretive Bulletin (IB) 2015-01, was published in the Federal Register on Oct. 26, 2015. The DOL also posted a related fact sheet.

Socially responsible or ETI funds favor corporate practices that are believed to promote environmental stewardship, consumer protection, human rights, social justice and diversity. Some, but not all, SRI or ETI funds avoid businesses involved in alcohol, tobacco, gambling, weapons and the military. These funds use various screening and ranking methods to select companies deemed suitable for their portfolios.

The DOL said that the new guidance confirms that plan fiduciaries may invest in ETIs based, in part, on their collateral benefits “so long as the investment is appropriate for the plan and economically and financially equivalent with respect to the plan's investment objectives, return, risk and other financial attributes as competing investment choices.”

The guidance also has implications for sponsors of 401(k) and similar plans, who have a fiduciary responsibility to act with “care, skill, prudence, and diligence” when selecting funds for their plans’ investment menus, in that IB 2015-01 presents criteria for weighing whether socially responsible funds may be deemed to be prudent investments.

ERISA Conflicts

The desire of some fiduciaries to invest in socially responsible funds has sometimes be seen as conflicting with the Employee Retirement Income Security Act (ERISA), which “requires plan fiduciaries to act solely in the interest of participants and beneficiaries, and for the exclusive purpose of providing benefits to participants and beneficiaries,” explained Sarah Lowe, a partner with law firm Kilpatrick Townsend in Atlanta. “ETIs have long been controversial because they may be viewed as inconsistent with ERISA fiduciary standards”—because their aims go beyond the financial-security goals of income, portfolio growth, risk reduction and asset diversification—and violating ERISA can make plan sponsors vulnerable to participant lawsuits and subject to DOL penalties.

These concerns were reinforced, for some, by prior DOL guidance. “The Labor Department previously addressed issues relating to ETIs in Interpretive Bulletin 94-1 (IB 94-1) and Interpretive Bulletin 2008-1 (IB 2008-1), according to a DOL news release. “However, the department has now concluded that in the seven years since its publication, IB 2008-01 has unduly discouraged fiduciaries from considering ETIs and environmental, social and governance (ESG) factors under appropriate circumstances.”

Under the new guidance, Lowe noted, the DOL clarifies that while plan sponsors and advisors acting as fiduciaries “are still prohibited from selecting investments for noneconomic reasons when they have lower expected returns than other investments with commensurate risk,” they should, however, “not be at greater risk for investing in funds that are constructed by noneconomic criteria when the fiduciary has determined the funds are prudent investments under economic criteria.”

Pensions, 401(k)s, and ESG Factors

According to a September 2015 survey by investment consulting firm Callen Associates, 29 percent of institutional investors have “incorporated ESG factors into decision making”—a broad statement whose meaning varies widely in terms of implementation by organization. Endowments and foundations were the highest adopters relative to other fund types.

Corporate funds had the lowest overall integration of ESG factors at 15 percent in 2015, but this figure was substantially different for corporate defined contribution plans (24 percent) and corporate defined benefit plans (7 percent).

Move Welcomed by Advocates

The guidance was welcomed by advocates of socially responsible investing.

"Clean oceans and clean air, full employment, living wages, a hospital that might serve plan participants—those are the primary goals of good government and the charitable sector, but they can be only a collateral goal for ERISA fiduciaries,” said Karen Friedman, executive vice president and policy director at the Washington, D.C.-based Pension Rights Center, in a released statement. “But when we can do well by doing good, we should do both. One might even say we have a non-ERISA fiduciary obligation to each other and to future generations to do so." The nonprofit group she heads advocates on behalf of retirement plan participants.

The nonprofit Forum for Sustainable and Responsible Investment, also Washington, D.C.-based, said in a post that IB 2015-01 “brings ERISA guidance in step with today's realities” and “clearly signals that ERISA-governed plans…may integrate critical environmental, social and governance issues into their investment decisions.”

Nonprofit advocates weren't the only ones to praise the move. “We believe that integrating ESG criteria into the investment process is a sound strategy as a growing body of research highlights the material impact that ESG factors have on a company’s long-term performance,” commented members of the investing committee at Boston-based pension fund manager NEPC. “For instance, a company with weak ESG policies and practices can carry additional headline risk or come under increased regulatory scrutiny, thus making it an unattractive investment prospect.”

Concerns Expressed

But some plan advisors are critical of the idea of fiduciaries selecting investments based on ideological considerations. “For 40 years we’ve managed to keep politics out of the U.S. retirement savings system,” Michael Barry, president of the Plan Advisory Services Group, a Chicago-based consultancy, commented in response to the DOL guidance. “Do we have to drag all these incredibly divisive issues into this area as well?”

Noting that the DOL stated that environmental, social, and governance considerations may be used as “tie-breakers” where “the ETI has an expected rate of return that is commensurate to rates of return of alternative investments with similar risk characteristics,” Barry remarked, “I love that word commensurate—it just sounds like it means something.”

Fiduciary Responsibilities

Meanwhile, attorneys at the Groom Law Group in Washington, D.C., offered this prudent advice: “Plan fiduciaries may wish to review and consider revision of their current investment policy statements to the extent they would like to explore new investment strategies” in socially responsible funds.

Similary, attorneys at Buck Consultants advised in their analysis of the new guidance:

[F]iduciaries should be mindful that, when considering ETIs, they cannot accept lower returns or take on greater risks in exchange for ETI-related benefits. They should also be aware that identifying an available alternative investment with commensurate risk and/or rate of return itself is an act involving the exercise of fiduciary judgment that can be subject to challenge.

It remains to be seen whether this guidance will result in an uptick of interest in ETI-related investments. While it may remove some hesitation, fiduciaries must still make investment decisions — with or without a social investment component — based on the same prudence and exclusive benefit requirements they have always considered.

“IB-2015-01’s suggestion that social responsibility considerations ‘are proper components of the fiduciary’s analysis … of investment choices’ is quite likely to raise more questions than it answers,” blogged attorney Todd Berghuis, senior vice president for ERISA compliance at Acensus.

Stephen Miller, CEBS, is an online editor/manager for SHRM. Follow me on Twitter.

Related SHRM Articles:

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

Supreme Court: Fiduciaries Have Ongoing Duty to Monitor Investments, SHRM Online Legal Issues, May 2015

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