Social Investing and ERISA Plans: The Context Is Significant

The Department of Labor (DOL) recently issued Field Assistance Bulletin (FAB) 2018-01. This guidance is intended to explain how much importance the fiduciaries of Employee Retirement Income Security Act (ERISA)-covered retirement plans, when selecting investments for those plans, may or should ascribe to investments that promote social policy goals. It is important to note that this guidance does not cover all circumstances plans may face. Nor does it significantly inhibit, as some have warned, the investment in environmental, social and governance (ESG) funds, which are intended to promote social goals.

This article first examines ERISA’s investment regulatory regime. Then it considers the guidance provided under FAB 2018-01 as it applies to social investing in various benefit plan contexts.

By way of background, ERISA fiduciaries in selecting investments must act prudently and with the care, skill and diligence an expert would use. They must act solely for the benefit of plan participants. In addition, the examined investments must be consistent with the terms of the relevant plan documents unless compliance would be inappropriate under other statutory standards.

The DOL has promulgated regulations describing factors a prudent fiduciary must use in selecting investments. Among the factors identified were the diversification of the portfolio, liquidity of the assets relative to cash flow needs, the projected return of the investment relative to the plan’s funding objectives and the risk of loss associated with the investment. 

In the context of social investing, the department has had a long-standing position that ERISA fiduciaries may not sacrifice investment returns or assume greater investment risks as a means of promoting collateral social policy goals. Consequently, a question raised early on was, under what circumstances may a fiduciary consider noneconomic factors—i.e., social goals—in selecting investments. The DOL initially determined that social goals may be taken into account if economic considerations were equivalent between two alternative investments. In other words, noneconomic considerations are permitted to serve as a tiebreaker.

A fiduciary considering selecting any investment should ask the following two questions:

• Is the type of investment appropriate for my plan? To answer this question in regard to investment funds that take into account social objectives, the ERISA investment fiduciary needs to examine the particular characteristics of the plan and the investment alternatives permitted under its governing document.

• If the answer is yes, he should ask: Is the particular fund appropriate? This requires application of the investment guidance described above.

In the Field Assistance Bulletin, the DOL reminded us of its position: 

[B]ecause every investment necessarily causes a plan to forego other investment opportunities, plan fiduciaries are not permitted to sacrifice investment return or take on additional investment risk as a means of using plan investments to promote collateral social policy goals. IB 2015-01 also reiterated the view that when competing investments serve the plan’s economic interests equally well, plan fiduciaries can use such collateral considerations as tie-breakers for an investment choice.

The guidance later went on to state: 

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.

ESG factors may be relevant in evaluating an investment, but the department made clear that these considerations are not always material in evaluating a particular investment’s appropriateness. The structure and type of plan—for example, defined benefit (DB) vs. defined contribution (DC)—may be significant in determining the extent to which ESG factors may be taken into account when selecting investment opportunities.

The review that should occur before an investment is made in a fund that’s designed to provide collateral benefits depends on whether the investment decision will limit the ability of the plan to invest in another manner.

Investments in defined benefit (DB) plans should be made only after the two questions set out above can be answered in the affirmative. Investment decisions should be made based on economic criteria, and other concerns may be examined only if they are used to determine which among one or more equivalent investments is appropriate.

The analysis regarding defined contribution (DC) plans is varied depending on the nature of the investment account. Some of these plans vest all investment decisionmaking authority in one or more trustees or in another investment fiduciary. In these situations, the analysis and approach described for defined benefit plan investing should be followed.

Many DC plans afford a default investment, in the event a participant does not self-direct his account. The selection of a default option should comply with the foregoing analysis, and, in addition, the rules regarding default options should be addressed.

Often, the plans permit participants to choose from a menu of investment choices. In this situation, the fiduciary may select an ESG fund as one of the alternative investments. However, here the second question is critical and the fiduciary must determine that the particular fund is appropriate.

Finally, some DC plans permit participants to invest in a broad range of investments of the participant’s choosing. Here, the choices are not limited by a menu of alternatives. In this case, the plan fiduciaries need not address whether the participant’s decisions are appropriate under ERISA’s general fiduciary standards discussed in the recent department guidance.

ESG funds are growing in popularity. The ability of a plan to include these funds in its investment portfolio varies based on the type of plan and the extent to which plan fiduciaries, as contrasted with participants, make investment decisions.

Thomas M. White, a partner Rimon Law, specializes in benefits and executive compensation. He can be reached at Thomas.white@rimonlaw.com.