by Jane Meacham, Contributing Editor

The Department of Labor (DOL)’s latest pronouncement on factoring in environmental, social, and governance (ESG) elements when making retirement plan investments was interpreted by many in the industry as another in a series of presidential administration swings on the extent to which plan fiduciaries can consider collateral benefits beyond investment returns.

The last two Democratic administrations took a more neutral stance toward ESG factors; the Trump administration and that of George W. Bush have indicated such considerations should rarely be taken into account.

“Arguably, the pronouncements over the years have made little substantive impact, more signaling minor gradations of emphasis than changes in interpretation. However, the area remains a politically charged one, and thus is constantly debated,” a May 8 client bulletin from Groom Law Group said.

Economically Targeted Investing

Field Assistance Bulletin No. 2018-01, issued April 23, instructs Employee Retirement Income Security Act (ERISA) plan fiduciaries on the regulatory framework to use when addressing Economically Targeted Investments (ETIs) and proxy voting.

ERISA requires fiduciaries to act with the care, skill, prudence, and diligence of a hypothetical prudent person. It also requires fiduciaries to act “solely” in the interest of a plan’s participants and beneficiaries and for the “exclusive purpose” of providing benefits and paying reasonable administrative expenses.

Consideration of ESG factors, or the “extra-financial” benefits of plan investments and proxy-voting decisions, historically has given fiduciaries pause as they seek to comply with ERISA’s basic fiduciary duty provisions.

The new FAB comments on Interpretive Bulletin 2015-01’s (IB-2015) ETI investing guidance. The 2018 FAB does not reverse its position but outlines limitations to the potentially more expansive interpretations of prior guidance that broadly permit or even require consideration of ESG factors when investing plan assets.

“The tone suggests a contrasting view by the Department of IB-2015 while simultaneously affirming that it is still the law of the land,” Groom attorneys observed in an April 27 client bulletin that analyzed the FAB.

“IB 2015-01 emphasized the notion that ESG factors can be economic factors,” according to an April 30 bulletin from Morgan Lewis. “FAB 2018-01 seeks to define when ESG factors are indeed economic factors and, if they are, what that should mean to fiduciaries.”

Adding ESG Lineup Alternatives

FAB 2018-01 offers up some helpful language regarding the addition of ESG-themed investment alternatives to a 401(k) plan’s investment lineup.

“[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 without requiring the plan to forgo adding other non-ESG-themed investment options to the platform,” the guidance counsels.

But DOL then goes on to discourage the use of ESG-themed options as qualified default investment alternatives (QDIAs) by stating: “Nothing in the QDIA regulation suggests that fiduciaries should choose QDIAs based on collateral public policy goals.”

The FAB also said that fiduciaries must “not too readily treat ESG factors as economically relevant.” To be more than tie-breakers, DOL suggested, ESG factors must “present material business risk or opportunities that company officers and directors need to manage as part of a business plan and that qualified investment professionals would treat as economic consideration under generally accepted investment theories.”

According to Groom, however, DOL also muddied its guidance by distinguishing in a footnote, without much explanation, between “non-ESG-themed investment funds” that incorporate ESG factors in investment selection and proxy voting and “ESG-themed funds” (such as socially responsible index funds, religious belief-based investment funds, and environmental and sustainable investment funds).

Role in IPS

The new guidance further mentions the use of ESG factors as part of a plan’s Investment Policy Statement (IPS). It reminds plan fiduciaries that while an IPS is part of the documents governing a plan, ERISA directs fiduciaries to follow plan documents only to the extent they are consistent with the act.

“In the ESG context, DOL states this means that [plan] managers may at times have to ‘disregard’ a plan’s IPS,” Groom said.

Shareholder Engagement Guidance

In addition, the FAB provides more detail on Interpretive Bulletin 2016-01 (IB 2016-01), used by DOL to indicate that proxy voting and shareholder engagement can be consistent with a fiduciary’s obligation under ERISA. However, the FAB said that the agency primarily characterized these activities as permissible because they “typically do not involve a significant expenditure of funds.”

In summary, “fiduciaries may wish to review their process for determining whether and to what extent ESG factors are economic factors affecting the plan’s investment choices,” Morgan Lewis ERISA attorneys advised in their bulletin. “Similarly, it may make sense for fiduciaries to review how they conduct the cost-benefit analysis for various types of shareholder activities.”