Compliance November 9, 2022

Senators Toomey and Cotton Write Warning Letters to ESG Industry

These warnings allege potential anti-trust violations and come in the wake of other such warnings and divestments on the state level.

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Senator Pat Toomey, R-Pennsylvania, wrote a follow-up letter to twelve ESG ratings and analytics providers on October 31 requesting that they keep documents related to the methodologies for their environmental, social and governance ratings.

Toomey is the ranking member on the Senate Banking, Housing and Urban Affairs Committee, and will retire before the next Congress is sworn in, and will likely be replaced by Senator-elect John Fetterman, D-Pennsylvania, this January.

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This letter follows an earlier letter sent September 20 to the same twelve firms asking for clarification on their ratings methodology.

He requested all non-proprietary methods for assigning ESG ratings. More specifically, he asked for how they engage with the companies they rate, if they employ analysts with sector specific expertise, if they have a revision process for errant ratings, if companies can dispute ratings, how they handle companies that do not provide requested information, how they evaluate data quality, if they consider political donations as a factor, and whether or not they use state-owned media as a data source in creating ESG ratings.

The letter also asked if involvement in fire arms, fossil fuels, or tobacco influences an ESG rating, and if so, how. These three industries, especially fossil fuels, are the most cited by Republicans when expressing skepticism or hostility to ESG strategy.

Six of the twelve provided responses. The other six either have not responded or provided responses that the Toomey considered “incomplete”. Institutional Shareholder Services, the parent company of ISS Media was one of the six that did not respond. The other five non-responsive ESG raters were Arabesque S-Ray, Carbon Disclosure Project, FactSet, RepRisk, and Sustainalytics

Senator Cotton, R-Arkansas, sent a more threatening letter to 51 law firms who counsel investors and other actors in the ESG sector.

Cotton’s letter was co-signed by four other Republican senators including Marsha Blackburn of Tennessee, Chuck Grassley of Iowa, Mike Lee of Utah, and Marco Rubio of Florida. Several of the law firms were contacted for comment and either declined to comment or did not respond to the request.

Cotton’s letter indicated that firms applying ESG investment principles The letter does not specify a specific industry such as investment advice or ESG ratings but suggests that the “ESG movement” is colluding “to restrict the supply of coal, oil, and gas, which is driving up energy costs across the globe and empowering America’s adversaries abroad.”

This alleged collusion could violate anti-trust laws according to the senators’ letter, and it says that there is no ESG exemption to federal anti-trust law. The letter advises the firms to store documents related to their communications with clients about ESG in anticipation of anti-trust investigations.

These letters follow similar warnings sent to Blackrock in August by 19 Republican attorney generals which alleged that Blackrock was privileging its “climate agenda” over its fiduciary duties. Another group of Republican attorney general last month sent civil investigative demands to the six largest banks in the U.S. to explore the AGs’ assertions that the banks’ ESG pledges have harmed the energy sector.

The Louisiana state pension fund also divested from Blackrock last month for their “blatantly anti-fossil fuel policies.” Other states, including Utah and Missouri, have divested from BlackRock with similar reasoning.

Compliance November 8, 2022

403(b) Plans May Apply for IRS Determination Letters Starting Next June

The IRS will provide determination and termination letters to 403(b) plans beginning next June.

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Starting in June 2023, the IRS will permit sponsors of individually designed 403(b) plans to request a determination letter for a new plan or for terminating a plan or as an initial review of a longstanding 403(b) plan using the same program currently used by 401(k) plans and other plans qualified under Section 401(a).

The announcement of Revenue Procedure 2022-40 expands one of the IRS and Treasury programs for approving retirement plans, allowing 403(b) plans—which are used by certain public schools, churches, and charities—to apply for the same tax-favored treatment as qualified retirement plans.

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The implementation of the new rule will be staggered by Employer Identification Number. Sponsors with an EIN ending in 1, 2, or 3 may begin requesting determination letters starting June 1, 2023. Those ending in 4, 5, 6, or 7 must wait until June 1, 2024; and those ending in 8, 9, or 0 must wait until June 1, 2025. Terminating 403(b) plans may request a plan termination letter without regard for EIN beginning June 1, 2023.

Determination letters are often used by qualified retirement plans to seek official approval from the IRS, according to Robert Abramowitz, an employee benefits attorney and partner at Morgan Lewis. Though these letters are not required by law, it is standard practice for larger plan sponsors of 401(a) qualified retirement plans.

These letters are essentially an insurance policy against IRS audits or legal flaws in the plan design because the sponsor can rely on previous IRS approval. It also permits a sponsor to catch an issue quickly by referring it to the IRS before they invest heavily in a flawed plan. Also, sometimes a third party, such as creditor, will ask a sponsor to obtain or share their determination letter as a condition of service, explains Abramowitz.

Under Revenue Procedure 2022-40, the determination letter process will now become available to 403(b) plans. Abramowitz describes it as “a big change” for 403(b) plans, and a change to their benefit. It will streamline the process of plan adoption and make it more similar to the process for qualified retirement plans, like 401(k) plans.

David Ashner, an employee benefits attorney at Groom Law Group, says that individually designed 403(b) plans could not get formal approval from the IRS prior to this change.

Abramowitz cautions however, that though this is “good news for many,” those sponsors of long-standing 403(b) plans that seek determination letters may have long-standing flaws revealed as part of the process. He explains that sponsors of older plans should “be careful what you ask for. The IRS looks at things carefully.”

He notes that sponsors normally seek determination as part of initial plan adoption to avoid having to correct issues down the road.

Ashner adds that many 403(b) sponsors are institutions such as universities which often have highly unique plans that go back decades. This change is something that 403(b) sponsors have wanted for a long time, and there should “be a lot of interest” in acquiring determination letters.

Ashner explains that the change also allows 403(b) sponsors to apply for determination letters when terminating a 403(b) plan. This allows them to get approval from the IRS to close out a plan properly. Though rare, Ashner says that if a plan is terminated and the IRS later determines that the plan was not qualified, then the sponsor as well as the participants could face onerous tax consequences because the plan would no longer be considered tax advantaged.

The full text of Revenue Procedure 2022-40 can be found here.

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