The Department of Labor is looking for a new federal regulation that may discourage retirement funds from making investments based on environmental, social and governance considerations.
The department said in a press release Tuesday night that it was taking action to “provide clear regulatory guidelines.” Labor Secretary Eugene Scalia, in an opinion piece published Wednesday in The Wall Street Journal, said the move “reminds plan providers that it is illegal to sacrifice returns or accept additional risks, through investments aimed at promoting a social or political purpose. “
Investments based on social objectives may consider, for example, a company’s efforts to reduce its carbon footprint or to promote racial and gender diversity among its directors and executives.
Such investments have grown tremendously in recent years, to about one in every four dollars under management, according to the US SIF Foundation. USA, a category-focused nonprofit. While little of that was in workplace retirement plans, some experts believe 401 (k) plans will play an increasingly important role in that investment.
But experts said the proposed rule would not significantly change employers’ obligations. And Morningstar found that funds based on environmental, social and governance objectives, known as ESG factors, outperformed conventional offerings during the first quarter of this year and also date back several years.
Under the Employee Retirement Income Security Act of 1974, known as ERISA, managers who oversee employee retirement plans, generally an employer’s financial or human resources officers, must act of the strict financial interests of the workers. That usually means they can add a mutual fund option that emphasizes social and environmental goals only if they expect it to work at least as well as an option that doesn’t focus on those factors and takes similar risk.
“The Labor Department has always taken the position that the plans may take into account other factors, such as social and environmental, as long as they do not increase the risk or sacrifice the return of the plan,” said Olena Lacy, who served as an assistant. . labor secretary in charge of the agency that oversees employee benefits during the Clinton administration.
Lacy said that the Democratic and Republican administrations had simply deferred over the years in formulating the obligations of employee plan managers.
“Democrats say the standard is that it’s okay for you to do this as long as it’s the same,” he said, referring to risk and returns. “Republicans say it’s illegal for you to do this unless it works the same way.”
Jon Hale, head of sustainability research at Morningstar, said the practical effect of the new framework could be to discourage plan managers from adding ESG options to 401 (k) plans for fear of breaking the law.
Even if the proposal is not approved, he said, employers could decide to avoid ESG investments because they see them as a possible political minefield.
The proposed rule says that environmental, social and governance concerns can be taken into account independently of factors such as risk and return only if they act as a kind of tie-break when investments are otherwise financially indistinguishable. In that case, the rule would require plan managers to document the investment analysis that led to the conclusion.
The department acknowledged that the provision could create additional burdens for employers, but said in a background document that it “does not expect this requirement to impose a significant cost since these situations are rare.”
In the Labor Department statement, Mr. Scalia said the proposed rule was intended to ensure that social goals were not seen at the expense of returns to participants in retirement plans, and the statement said that employers did not they may invest in ESG-focused funds seeking “subordinated return or increased risk for non-financial objective purposes.”
The department did not respond to a request seeking examples of employers who have followed such strategies.
Jerome Schlichter, an attorney who has successfully prosecuted numerous employers on behalf of workers for excessive fees on his 401 (k) plans, said he was unaware of employers who had tried to achieve ESG goals at the expense of financial returns.
“That was not something we’ve seen,” said Schlichter. “It has not been done extensively by fiduciaries, in part due to concerns about litigation exposure.”
Other attorneys said that while the growth in ESG’s investment options and its increasing popularity among workers may require additional regulation and enforcement, such action would generally be better targeted at investment companies that market such funds, rather than employers. and managers of their plans.
George Sepsakos, a lawyer who advises employers on their legal responsibilities plans, said the Securities and Exchange Commission had been reviewing ESG’s disclosure of funds to ensure that its marketing accurately reflected its investment strategies. “Right now, the definition can mean different things to different people,” said Sepsakos.
He said that if an investment company had misrepresented the possible returns or fees of an ESG-focused fund, the investment company instead of the employer would typically be liable. “The trust plan can only make investment decisions based on what they know or should have known at the time,” he said.
A 2015 academic article that examined decades of research and more than 2,000 other studies found that about 90 percent of the work did not show a negative connection between ESG principles and corporate financial performance. A great majority showed positive findings.
As a result, Mr. Hale of Morningstar said, the proposed rule could end up being counterproductive. “It’s not just investments that focus on the long-term sustainability of companies that lead to truly superior long-term performance because you’re choosing better quality companies,” he said. “But there is also the systems argument, that you are helping to create a financial system and an economy that will be more successful.”
