Economy and Society: Labor Department rule makes ESG investing in 401(k) plans easier


Economy and Society is Ballotpedia’s weekly review of the developments in corporate activism; corporate political engagement; and the Environmental, Social, and Corporate Governance (ESG) trends and events that characterize the growing intersection between business and politics.

ESG Developments This Week

In Washington, D.C.

Labor Department rule makes ESG investing in 401(k) plans easier 

As was reported in previous issues of this newsletter, one of the Biden Administration’s first actson inauguration daywas to suspend a Trump Labor Department rule that, essentially, barred ESG investments from retirement plans. The Trump administration held that many, if not most, ESG-directed investments potentially violate investment fiduciaries’ responsibilities under ERISA (the Employee Retirement Security Act of 1974). In turn, it warned fiduciaries to be careful and judicious in their use of ESG investment criteria. On his first day in office, President Biden signed an executive order asking Labor to reconsider the rule. Labor simultaneously suspended enforcement of the Trump rule and began the process of creating a new regulatory proposal for dealing with retirement plans’ use of ESG. That proposal was released this past Wednesday, October 13.

The new proposed rule not only reverses the Trump rule but, in fact, makes ESG investing in ERISA-covered plans much easier than it had been previously. The Wall Street Journal provides the details:

“The Labor Department on Wednesday proposed a rule that would make it easier for investors to purchase funds focused on environmental, social and governance measures in their 401(k) plans….

The proposal would reverse a Trump administration rule making it harder for 401(k) plans to offer investments based on environmental, social and governance, or ESG, measures.

“ESG factors can be financially material, and when they are, considering them will inevitably lead to better long-term risk-adjusted returns, protecting the retirement savings of America’s workers,” said Ali Khawar, acting assistant secretary for the Employee Benefits Security Administration at the Labor Department….

A statement by the American Retirement Association, which represents retirement-plan professionals, expressed support for the proposal.

“We are pleased that the DOL has established a level playing field for ESG investment considerations in retirement programs,” the group said.”

Does the Labor rule establish a duty to consider ESG factors?

Tara Siegel Bernard, writing in The New York Times’ “Business Briefing,” noted an additional detail that was largely absent from most of the rest of the reporting on the story:

“The Labor Department proposed rule changes on Wednesday that would make it easier for retirement plans to add investment options based on environmental and social considerations — and make it possible for such options to be the default setting upon enrollment.

In a reversal of a Trump-era policy, the Biden administration’s proposal makes clear that not only are retirement plan administrators permitted to consider such factors, it may be their duty to do so — particularly as the economic consequences of climate change continue to emerge….

The new regulations would also make it possible for funds with environmental and other focuses to become the default investment option in retirement plans like 401(k)s, which the previous administration’s rules had prohibited.”

Response to the Labor rule 

In the June 10 issue of National Review, Patrick Pizzella, the Deputy Secretary of Labor (and briefly, the Acting Secretary) penned an article explaining why the Trump administration promulgated its rule and why he believes that reversing the rule is a significant mistake. He wrote:

“Asset managers often apply supposedly “socially conscious” ESG — environment, social, and (corporate) governance — criteria to screen potential investments. Pension funds are the deep pockets for woke capitalism. But ESG or “sustainable” investing is anything but a slam dunk for pension beneficiaries. There are real risks, and many financial professionals have begun to raise serious questions about them….

Since 1994, four different secretaries of labor — two from each party — have issued what’s known as an “interpretive bulletin” (IB), providing guidance for investing in ERISA-managed funds in compliance with the statute. I refer to this as “IB ping-pong” because it is relatively easy for one administration to respond to another administration’s IBs without soliciting formal stakeholder input. In 2020, however, Secretary Eugene Scalia decided that the De­partment of Labor (DOL) should undertake formal rulemaking under the Ad­ministrative Pro­cedures Act — which requires the solicitation of comments from the public — and provide more-enduring certainty to the regulated community and America’s retirees.

The department received over 1,500 comments and revised and tailored a final rule, published last November, that was in part based on them. The rule reminds plan providers that it is unlawful to sacrifice returns or to accept additional risk through investments intended to promote a social or political end. It allows for the inclusion of an ESG fund among other investment options, provided that it is selected based on pecuniary considerations. But ESG factors are often touted for nonpecuniary reasons, as addressing social welfare more broadly. That may appeal to some in­vestment advisers, but it is inappropriate for an ERISA fiduciary managing other people’s retirement funds….

Ironically, the department — without an assistant secretary for the Employment Benefits Security Administration, a solicitor, or a deputy secretary — maintains that it had heard from a wide variety of stake­holders, including asset managers, labor organizations, plan sponsors, and in­vestment advisers. But the rule that the DOL published last November, titled “Financial Factors in Selecting Plan Investments,” wasn’t written just for those stakeholders. It was primarily written for the plan participants and beneficiaries — the people depending on the income once they retire….

We should all keep in mind that annual expenses for so-called sustainable exchange-traded funds (ETFs) are more than ten times higher than those for the cheapest index funds, according to the financial-services firm Morning­star. As Jason Zweig, a well-respected financial analyst, recently wrote in the Wall Street Journal: “ESG is the last best hope for investment firms seeking to hang onto fat fees.”

The skeptics of ESG investing in­clude a growing list of distinguished financial experts, such as Alicia Munnell, executive director of the Center for Retirement Research at Boston College (“I really have no respect for ESG investing”); Tariq Fancy, former chief investment officer for sustainable investing at BlackRock, the largest asset manager in the world (“The financial services industry is duping the American public with its pro-environment, sustainable investing practices. This multitrillion dollar arena of socially conscious investing is being presented as something it’s not. . . . In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community”); and Securities and Exchange commissioner Hester Peirce (“The first issue is we don’t even know what ESG means”; “Not only is it difficult to define what should be included in ESG, but, once you do, it is difficult to figure out how to measure success or failure”)….

As for plan fiduciaries considering ESG factors when selecting investment options, they should curb their enthusiasm. The Biden administration’s ability to shield fiduciaries from legal exposure may be very limited without congressional action or a sudden change of heart by the Supreme Court, whose long-established ruling on the matter is that ERISA’s duty of loyalty requires fiduciaries to act for the exclusive purpose of providing financial benefits to participants. Fidu­ci­aries would be wise to act very prudently and document their decision-making processes.”

On Wall Street and in the private sector

Canada’s six largest banks join Net-Zero Banking Alliance

This past Friday, Canada’s six largest banks announced that they had entered into an agreement to align their lending and investment portfolios with a net-zero-carbon future. The banks all joined Mark Carneythe former governor of the Bank of England, former governor of the Bank of Canada, and one of the first global bankers to advocate using the banking system to fight climate changein his organization, Net-Zero Banking Alliance:

“The commitment by the banks, which include Bank of Montreal, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, Bank of Nova Scotia and TD Bank, comes ahead of the UN climate summit set to start in Glasgow at the end of the month and where a major focus will be on finding the finances to fund the climate promises.

The industry-led alliance commits signatory banks to aligning their lending and investment portfolios with net-zero emissions by 2050, as well as to setting intermediate reduction targets for 2030 or sooner….

Carney said in a statement that the financial systems needs to transform to ensure a “prosperous and just transition to net-zero” and that by joining the alliance, Canadian banks are “bringing their deep expertise and strong balance sheets to drive solutions for the sustainable economy.”

The alliance has, however, come under criticism for not going far enough, including ads published last week by more than 90 environmental groups that urged Carney to be more ambitious with membership requirements.

The groups want to see more immediate targets laid out to phase out fossil fuel funding, a prohibition on financing any new fossil fuel projects, and a goal of halving financed emissions by 2030.”

Response to Net-Zero Banking Alliance

Mark Carney, the brainchild of net-zero banking and originator of the idea that banking is not merely an available tool but a necessary tool in the fight against climate change was described by independent investment-market analyst Rusty Guinn of Epsilon Theory as, in his words, the “first mission-creep missionary” in the creation of the narrative that banks must do something about perceived climate change. In a note for clients, Guinn wrote:

“[W]hat interests us is Goldman alum Carney, the first mission creep missionary. From a June 2016 article in Canada’s Globe And Mail, he was already active establishing the idea that something must be done (emphasis in original) to create a connection between regulatory policy – more to the point, monetary policy – and climate change. And he did so in a way that was crafted for an audience of institutional investors….

Carney’s September 2016 speech in Berlin was a masterpiece in narrative construction, explicitly conflating climate change with terms of art in the world of financial risk management. He begins:

Your invitation to discuss climate change is a sign of the broadening of the responsibilities of central banks to include financial as well as monetary stability. It also demonstrates the changing nature of international financial diplomacy.

That is, I believe, what we call saying the quiet part out loud. Still, to really appreciate the skill being applied here, take note of the effective redefinition of climate change in the most well-known memes of financial risk….

[In Carney] we had a missionary – or perhaps a prophet – alone in the wilderness, shouting that something must be done to address the risks of climate change through monetary policy (emphasis in original).

In the spotlight

ESG goes royal

On October 12, the New York Times’ financial column “Dealbook” reported on the newest ESG royaltyliterally:   

“Prince Harry and Meghan, the Duchess of Sussex, are getting into the investment business. They are joining Ethic, a fintech asset manager in the fast-growing environmental, social and governance space, as “impact partners” and investors. Ethic has $1.3 billion under management and creates separately managed accounts to invest in social responsibility themes.

The couple could attract more attention to sustainable investing (emphasis in original). Harry and Meghan can make E.S.G. investing part of pop culture in a way that, say, BlackRock’s Larry Fink can’t. “From the world I come from, you don’t talk about investing, right?” Meghan told DealBook in a joint interview with Harry. “You don’t have the luxury to invest. That sounds so fancy.”