New DOL ERISA Bulletin Tempers ESG Focus Among Institutional Investors

By Randi Morrison posted 04-28-2018 03:22 PM

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Last week, the DOL released this substantive Field Assistance Bulletin that emphasizes principles from and clarifies previously-issued Interpretive Bulletins (IB) 2016-01 and 2015-01, and appears aimed at effectively tempering ESG activities and activism by asset managers and other ERISA fiduciaries in their management of plan assets involving corporate stock.

Key takeaways - including principles espoused in prior guidance and reiterated in the FAB - include:

Investment Considerations

- The fiduciary act of managing plan assets involving shares of corporate stock includes making decisions about voting proxies and exercising shareholder rights. However, ERISA fiduciaries are not permitted to sacrifice investment returns or assume greater investment risks to promote collateral social policy goals.

- ESG factors that themselves are economically relevant to an investment may be taken into account; however, "[f]iduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision...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."

- Investment policy statements are permitted but not required to include ESG-related guidelines. Regardless, investment managers and other plan fiduciaries are not permitted to comply with any such ESG-related guidelines in the event it would be imprudent to do so (i.e., in accordance with the overarching "economics first" investment principle).

- In the QDIA (qualified default investment alternative) context, the fiduciary's favoring its own policy preferences in selecting an ESG-themed investment option for a 401(k)-type plan w/o regard to possibly different or competing views of plan participants and beneficiaries may be inconsistent with the fiduciary’s duty of loyalty, e.g., selecting an ESG-themed target date fund as a QDIA wouldn't 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

- Plan fiduciaries are expected to engage in traditional and customary proxy voting activities (i.e., proxy voting and shareholder engagement) in discharging their fiduciary obligation to prudently manage plan investments, provided, however, that these activities don't typically involve a significant expenditure of funds by individual plan investors because the activities are generally undertaken by institutional investment managers that are appointed as the responsible plan fiduciary pursuant to ERISA.

- It isn't appropriate for individual plan investors to routinely incur significant expenses to engage in direct negotiations with public company boards or management of which the plan is just one of many investors. Similarly, appointed investment managers and other plan fiduciaries shouldn't routinely incur significant plan expenses to, e.g., 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.

- A "reasonable expenditure" of plan assets to actively engage with company management on ESG issues may be appropriate where the issues present significant business risks and costs and are "clearly connected to long-term value creation for shareholders" - as opposed to merely reflecting the fiduciary's public policy preferences; however, "[i]f a plan fiduciary is considering a routine or substantial expenditure of plan assets to actively engage with management on environmental or social factors, either directly or through the plan’s investment manager, that may well constitute the type of “special circumstances” that the IB 2016-01 preamble described as warranting a documented analysis of the cost of the shareholder activity compared to the expected economic benefit (gain) over an appropriate investment horizon."

See also the DOL's release; this Sullivan & Cromwell memo; these articles from the WSJ: "Don’t Choose Ethics Over Profits in Your 401(k), Government Warns" and Bloomberg: "Labor Department Says Do-Good Investments Are Not Always ‘Prudent’"; and our prior report on the 2016 IB: "DOL Issues New Proxy Voting & Shareholder Engagement Guidance."

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