On April 23, 2018, the U.S. Department of Labor (the "DOL") released Field Assistance Bulletin No. 2018-01 ("FAB 2018-01") which provides guidance regarding (1) the exercise of shareholder rights and written statements of investment policy (addressed in Interpretation Bulletin 2016-01); and (2) economically targeted investments ("ETIs"; addressed in Interpretation Bulletin 2015-01). I have previously discussed certain issues arising with respect to the exercise of shareholder rights. See my article "DOL Updates Guidance on Proxy Voting by Plan Fiduciaries", January 19, 2017. This article will review the Field Assistance Bulletin's consideration of issues relating to "economically targeted investments."
"Economically targeted investments" or "ETIs" are "generally defined as investments that are selected for economic benefits they create in addition to the investment return to the employee benefit plan investor." Factors present in ETIs may include socially responsible investing, sustainable and responsible investing, environmental, social and governance investing, and impact investing (hereinafter referred to as "ESG Factors").
Generally, Sections 403 and 404 of the Employee Retirement Income Security Act of 1974, as amended ("ERISA") require a plan fiduciary to act prudently, to act solely in the interest of the plan's participants and beneficiaries for the exclusive purpose of providing benefits, and to diversify plan investments so as to minimize the risk of large losses.
In Interpretation Bulletin 2015-01 ("IB 2015-01"), the DOL construed the solely in the interest of and the exclusive purpose requirements as "prohibiting a fiduciary from subordinating the interests of participants and beneficiaries in their retirement income to unrelated objectives". As such, the DOL stated that fiduciaries "may not sacrifice investment returns or assume greater investment risks as a means of promoting collateral social policy goals."
However, in IB 2015-01, the DOL recognized two situations which may support a fiduciary's selection of an ETI. First, "fiduciaries may consider such collateral goals as tie-breakers when choosing between investment alternatives that are otherwise equal with respect to return and risk over the appropriate time horizon." (i.e., the "all things being equal test"). Second, in situations where ESG Factors have a direct relationship to the economic value of the investment, "such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary's primary analysis of the economic merits of competing investment choices".
Unfortunately, the "all things being equal test" is difficult to apply because plan fiduciaries are rarely confronted with a choice between two investments (one of which is an ETI) with identical risk and reward characteristics. Likewise, it is difficult to identify and quantify the relationship between ESG Factors and the economic value of most ETIs. Based on the principles articulated in IB 2015-01, many plan fiduciaries have been reluctant to select ETIs as investment options in ERISA plans.
FAB 2018-01 supports a cautious interpretation of IB 2015-01. In FAB 2018-01, the DOL restates its "longstanding view that because 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".
While recognizing that ESG Factors may impact the value of an ETI, the DOL cautions that:
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.
This language suggests that the DOL may be concerned that some plan fiduciaries are inappropriately weighting ESG Factors in the selection of ETIs as plan investments.
In addition, FAB 2018-01 notes that, while a plan's investment policy statement may contain policies concerning the use of ESG Factors and/or ESG-related metrics to evaluate investments, such language in an investment policy statement does not modify the analysis as to whether an ETI is a prudent investment. The DOL states that a fiduciary is required to adhere to an investment policy statement only in so far as the document is consistent with the fiduciary's duty of loyalty and prudence. Significantly, the DOL states "if it is imprudent to comply with the investment policy statement in a particular instance, the manager must disregard it."
FAB 2018-01 also notes that the fiduciary analysis applicable to the selection of an ETI is the same in cases where the ETI is intended to be a non-core investment option under an ERISA Section 404(c) plan or a qualified default investment alternative (i.e., investment selected, when judged solely on basis of economic value, should be equal to or superior to alternative available investments).
In summary, FAB 2018-01 restates the DOL's view that ESG Factors have a very limited application to the selection of investments in ERISA plans. Further, FAB 2018-01 may be interpreted as a warning that the DOL has concerns that some fiduciaries may be misapplying ESG Factors in connection with the selection of ETIs as plan investments. Finally, FAB 2018-01 notes that language in an investment policy statement will not override the prudence analysis with respect to the selection of an ETI as a plan investment. As such, fiduciaries should carefully consider the principles articulated in IB 2015-01 and FAB 2018-01 in connection with the selection or retention of ETIs as investment options in ERISA plans.