DOL cautions fiduciaries on use of plan assets to promote ESG goals

The Department of Labor has issued guidance that may effectively discourage fiduciaries from using plan assets to promote environmental, social, ethical, and governance (ESG) concerns or engage in shareholder activism. The new guidance, in the guise of clarifying prior issuances on proxy voting, shareholder engagement, and economically targeted investments, cautions fiduciaries that they must always prioritize the economic interests of the plan and avoid “too readily” treating ESG factors as being economically relevant to investment choices. While technically directed to EBSA national and regional offices, Field Assistance Bulletin (FAB) 2018-01 is clearly intended to send a message to plan fiduciaries.

Prior guidance

In DOL Interpretive Bulletin 2015-01, EBSA addressed the fiduciary standards applicable to economically targeted investments (ETIs), stating that if a fiduciary properly determined that an investment was appropriate based solely on economic considerations, including those that may derive from environmental, social, and governance factors, the investment could be made without regard to any collateral benefits the investment may also promote. In withdrawing restrictive guidance under DOL Interpretive Bulletin 2008-01, the DOL advised that plan fiduciaries may base an investment in ETIs, in part, on collateral benefits, as long as the investment was “economically equivalent,” with respect to return and risk to beneficiaries, to investments that did not consider collateral benefits.
Subsequently, in DOL Interpretive Bulletin 2016-01, the DOL reversed a policy expressed in DOL Interpretive Bulletin 2008-02 which effectively required fiduciaries to cast proxy votes only in accordance with a plan’s economic interests. In Interpretive Bulletin 2016-01, the DOL confirmed that a fiduciary, in voting proxies, is required to consider the factors that may affect the value of the plan’s investment and not subordinate the interest of plan participants and beneficiaries in their retirement income to unrelated objectives. However, fiduciaries were no longer required to perform a cost-benefit analysis prior to exercising a proxy vote. Moreover, plan fiduciaries were authorized to consider environmental, social, and governmental issued in connection with proxy voting.

ESG investments

In revisiting DOL Interpretive Bulletin 2015-01, the DOL now explains that, to the extent ESG factors involve business risk or opportunities that are properly treated as economic considerations in evaluating alternative investments, the weight given to the factors should be appropriate to the relative level of risk and return involved compared to other economic factors. Thus, the DOL stresses, fiduciaries may not “too readily treat ESG factors as economically relevant” to the particular investment choices when making a decision. While not prohibiting ESG investments, the DOL cautions, a fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a “material effect on the return and risks of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives.”

ESG guidelines in investment policy statements

Investment policy statements may continue to include policies governing the use of ESG factors in evaluating investments, or the integration of ESG-related tools, metrics, or analyses in assessing an investment’s risk or return. However, the DOL clarifies that compliance with ERISA does not require investment policy statements to contain guidelines on ESG investments or integrating ESG-related tools. Moreover, fiduciaries are not required to adhere to investment policy statements that do include such provisions, if compliance would be imprudent.

ESG investment options as plan investment alternatives

Plan fiduciaries may add a properly diversified ESG-themed investment alternative to the available investment options on a 401(k) platform without being required to remove (or forego the addition of) non-ESG themed investment options. However, the DOL advises, plan fiduciaries may not base a selection of a qualified default investment alternative (QDIA) on collateral public policy goals. In the QDIA context, the DOL emphasizes, the decision to favor the fiduciary’s own policy preferences in selecting an ESG-themed investment option for a 401(k) plan without regard to the possibly different or competing views of plan participants and beneficiaries would raise questions about the fiduciary’s compliance with ERISA’s duty of loyalty. Thus, the selection of an ESG-themed target date fund as a QDIA would not be prudent if the fund would provide a lower expected rate of return than available non-ESG alternative target date funds with commensurate degrees of risk, or if the fund would be riskier than non-ESG alternative available target date funds with commensurate rates of return.

Shareholder engagement activities

In DOL Interpretive Bulletin 2016-01, the DOL explained that an investment policy that contemplates engaging in shareholder activities that are intended to monitor or influence the management of corporations in which the plan owns stock can be consistent with a fiduciary’s obligations under ERISA, if the fiduciary concludes that there is a reasonable expectation that such activities are “likely to enhance the economic value of the plan’s investment in that corporation after taking into consideration the costs involved.” The DOL guidance was in large measure informed by the understanding that proxy voting and other shareholder engagement activities typically do not involve a significant expenditure of funds by individual plan investors, as such activities are generally undertaken by institutional investment managers. Reflecting a similar understanding, the DOL now clarifies that DOL Interpretive Bulletin 2016-01 was not meant to imply that plan fiduciaries, including appointed investment managers, should routinely incur significant plan expenses to, for example, fund advocacy, press, or mailing campaigns on shareholder resolutions, call special shareholder meetings, or initiate or actively sponsor proxy fights on environmental or social issues relating to such companies.
The DOL concedes that certain corporate governance reform and environmental issues may present significant operational risk and cost to a business, and, thus, may be clearly connected to long-term value creation for shareholders. Under such circumstances, a reasonable expenditure of plan assets to engage with company management may be a prudent means of protecting the plan’s investment. However, the DOL notes, if a plan fiduciary is considering a routine or substantial expenditure of plan assets to actively engage with management on environmental or social issues, the fiduciary may need to provide a documented analysis of the cost of such shareholder activity compared to the expected economic benefit over an appropriate investment horizon.

Source: Field Assistance Bulletin 2018-01, April 23, 2018.
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