DOL Issues More Guidance Related to ESG Investing in DC Plans

The Department of Labor (DOL) has issued Field Assistance Bulletin (FAB) No. 2018-01, which provides guidance to the Employee Benefits Security Administration’s (EBSA) national and regional offices to assist in addressing questions they may receive from plan fiduciaries and other interested stakeholders about the exercise of shareholder rights and written statements of investment policy and Interpretive Bulletin (IB) 2015-01 (relating to “economically targeted investments” (ETIs)).

In 2015, the DOL issued Interpretive Bulletin 2015-01, a piece of guidance it said will significantly expand the use of environmental, social and governance (ESG) investing principles under the Employee Retirement Income Security Act (ERISA).

The Department had previously addressed issues relating to ETIs in Interpretative Bulletin 94-1. The publication “corrected a misperception that investments in ETIs are incompatible with ERISA’s fiduciary obligations” that existed beforehand, the Labor Secretary at the time said. The guidance also “contains much clearer discussion and explanation of how responsible fiduciaries should and should not use ESG/ETI factors while creating and managing portfolios under ERISA.”

Strictly speaking, under IB 94-1, as under the 2008 guidance, ESG investing factors can still only serve as a tiebreaker when considering economically similar investments. As the Secretary clearly reiterated, “Fiduciaries still may not accept lower expected returns or take on greater risks in order to secure collateral benefits.”

But under the 94-1 paradigm, unlike under 2008-1, the DOL directly acknowledged that ESG factors “may have a direct relationship to the economic and financial value of an investment. When they do, these factors are more than just tiebreakers, but rather are proper components of the fiduciary’s analysis of the economic and financial merits of competing investment choices.”

In the new FAB, the DOL says fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision. “It does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors. Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits. 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 risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives,” the FAB says.

Disregarding IPS policies if imprudent

In addition, the DOL explains that in IB 2016-01, it noted that investment policy statements (IPS) are permitted to include policies concerning the use of ESG factors to evaluate investments, or on integrating ESG-related tools, metrics, or analyses to evaluate an investment’s risk or return. It says that discussion in the IB does not reflect a view that investment policy statements must contain guidelines on ESG investments or integrating ESG-related tools to comply with ERISA. Moreover, the IB does not imply that if an investment policy statement contains such guidelines then fiduciaries managing plan assets, including appointed ERISA section 3(38) investment managers, must always adhere to them.

A statement of investment policy is part of the “documents and instruments governing the plan” within the meaning of ERISA section 404(a)(1)(D),5 and an investment manager or other plan fiduciary to whom such an investment policy applies is required to comply with the policy, but only insofar as the policy is consistent with Titles I and IV of ERISA (including the core fiduciary obligations of prudence and loyalty). Thus, if it is imprudent to comply with the investment policy statement in a particular instance, the manager must disregard it.

ESG investments in QDIAs

The Department explained in the preamble to IB 2015-01 that the standards set forth in sections 403 and 404 of ERISA apply to a fiduciary’s selection of an investment fund as a plan investment or, in the case of an ERISA section 404(c) plan or other individual account plan, a designated investment alternative under the plan. In the case of an investment platform that allows participants and beneficiaries an opportunity to choose from a broad range of investment alternatives, adding one or more funds to a platform in response to participant requests for an investment alternative that reflects their personal values does not necessarily result in the plan forgoing the placement of one or more other non-ESG themed investment alternatives on the platform. Rather, in such a case, a prudently selected, well managed, and properly diversified ESG-themed investment alternative could be added to the available investment options on a defined contribution (DC) plan platform without requiring the plan to remove or forgo adding other non-ESG-themed investment options to the platform.

In the case of a qualified default investment alternative (QDIA), however, selection of an investment fund is not analogous to merely offering participants an additional investment alternative as part of a prudently constructed lineup of investment alternatives from which participants may choose. Nothing in the QDIA regulation suggests that fiduciaries should choose QDIAs based on collateral public policy goals. In the QDIA context, the decision to favor the fiduciary’s own policy preferences in selecting an ESG-themed investment option for a 401(k)-type plan without regard to possibly different or competing views of plan participants and beneficiaries would raise questions about the fiduciary’s compliance with ERISA’s duty of loyalty.

Even if consideration of such factors could be shown to be appropriate in the selection of a QDIA for a particular plan population, however, the plan’s fiduciaries would have to ensure compliance with the guidance in IB 2015-01. For example, 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.