The US Department of Labor (DOL) issued, on October 22 Interpretive Bulletin 2015-01, a new guidance that confirmed the legality and importance of economically targeted investments (ETIs) by pension funds under ERISA. Secretary of Labor Thomas Perez gave a remarkable speech on this change, surrounded by and joined by labor, SRI and mainstream bankers and investors who have been pushing hard for this change.
Since 1994, the Department has generally defined ETI investments as strategies that are selected for the economic benefits they create in addition to the investment return to the employee benefit plan investor. In addition to reversing a politically charged Bush Administration rule that clouded ETIs (in other words, they pressed “delete”), the new rule adopts an environmental, social and governance (ESG) approach, aligning the US fiduciary investment process with the modern global standard set by the UN-backed Principles of Responsible Investment (PRI).
The U.S. Department of Labor is, thankfully, both reconfirming the 1994 ETI Letter, and moving the responsible investing framework from ETIs to ESG. This change comes at a time when momentum is galvanizing around the financial and non-financial impacts of social inequality, climate change, weak corporate governance and gridlocked political structures. Responsible investments allow pension and other institutional funds to promote positive economic development, good employment and labor relations, and sustainable environmental practices among portfolio investments. This historic ruling makes it easier for pension funds to offer ESG options to plan participants.
Some of the following passages, taken from the upcoming Responsible Investor Guidebook, provide some historical references for this bumpy ride from ETIs to ESG.
Historical US Legal Framework for Economically Targeted Investments (ETIs)
Even in times when the capital markets are flooded with liquidity, market failures can result in capital gaps – a systemic lack of access to capital in isolated regions, inner cities and labor-intensive sectors. In particular, there have been large capital gaps in affordable housing, advanced manufacturing, infrastructure and the clean economy, and within the supply chains that feed these sectors. Smart capital stewards are aware that these market failures can yield significant investment opportunities. Competitive risk-adjusted financial returns and the provision of collateral benefits are not mutually exclusive. ETIs are uniquely positioned to find and fill these gaps.
Pension funds invariably turn to alternative investments and some fixed income products to diversify their asset allocation portfolio, which would otherwise be heavily represented by stocks and traditional bonds. These investments include private equity, venture capital, real estate, project finance vehicles, and others. ETIs in alternative investments can be used to generate specific collateral benefits, along with competitive financial returns.
In the 1980s, Robert Monks, a long-time corporate governance expert, became the head of the Office of Pension and Welfare Benefit Programs in the DOL. Appointed by President Reagan, Monks understood the role of pension funds as institutional investors and encouraged fiduciaries to make prudent investments that also achieved social objectives. During this time, the Lanoff Letter was issued to encourage targeted investing.
The Lanoff Letter
In 1980, DOL’s first ERISA Administrator, Ian Lanoff, stated in the letter that while ERISA “does not exclude the provision of incidental benefits to others, the protection of retirement income is, and should continue to be, the overriding social objective governing the investment of plan assets.”
In 1994, under President Bill Clinton, DOL Secretary Robert Reich issued Interpretive Bulletin 94-1 regarding ETIs. The bulletin provided the ETI rule within the framework of the Employee Retirement Income Security Act of 1974 (ERISA), which outlines the fiduciary duties of pension trustees and capital stewards. 94-1 explained that a pension plan may choose an investment that provides “collateral benefits” if the investment has a risk-adjusted market rate of return which is equal or superior to alternative investments.
The DOL’s 1994 bulletin stated that a fiduciary may invest plan assets in an ETI “if the ETI has an expected rate of return that is commensurate to rates of return of alternative investments with similar risk characteristics that are available to the plan, and if the ETI is otherwise an appropriate investment for the plan in terms of such factors as diversification and the investment policy of the plan.”
Reich, touting a “new ethic of stewardship,” stated that “ETIs provide pension funds with competitive, risk-adjusted rates of return plus ancillary benefits, such as affordable housing, infrastructure improvements and jobs… Significant successes, among them the housing construction program of the California Public Employees Retirement System (CalPERS), prove that ETIs are, overall, successful.”
According to another DOL report, “To the extent that capital markets are judged to be tradition-bound, rigid or incapable of funding all ‘worthy’ investments, making funds available from the pension investment pool is seen as addressing capital gaps that would otherwise impede local economic development.”
According to pension scholar and legal expert Jayne Zanglein, collateral benefits obtained through ETIs can be applied broadly and can “create new jobs, provide capital to replace loan funds no longer rolling through the bank pipelines, provide startup businesses with access to capital, finance low-cost housing and improve the infrastructure of the nation, all without sacrificing a return on investments or otherwise jeopardizing the pensions of future retirees.”
Organized labor has long encouraged pension trustees and other capital stewards to consider ETIs (particularly those that utilize union labor). As Reich claimed as well, ETIs can benefit not only retirees but the economy as a whole and thus, indirectly, the well-being of pensioners. He also said ETI investments would reward companies with high performance workplaces, which are associated with above-average returns. Funds adhering to such guidelines would do well by doing good.
When the owners of workers’ capital began investing in ETIs, they generally followed a strategy of investing in “worker-friendly” companies and projects. Also known as ‘high performance’ workplaces, such companies and projects are said to generate stable profits through increased labor and management productivity and higher levels of employee participation, including worker ownership. For example, in the construction industry, such companies choose to require the use of responsible contractors that respect workers’ rights to collectively bargain and employ highly skilled tradespersons.
Such strategies better allow investors to reduce the potential risks and liabilities which arise from bad outcomes, such as shabby construction, delayed project completion, or even dangerous worksites.
Thus, responsible investors can seek portfolio investments that:
Provide job security;
Adhere to responsible contractor policies and adopt ‘high-road’ workplace practices;
Follow responsible health, safety and environmental standards; and
Treat workers with respect and provide for neutrality in labor relations.
Unfortunately, there were political attacks against ETIs from the moment that the DOL 94-1 Interpretive Bulletin was issued. Representative Jim Saxton (R-NJ), then the vice chairman of the Joint Economic Committee, attacked the ETI Bulletin and killed a proposed ETI Clearinghouse claiming that these would open the door for political misuses of pension funds, sacrificing returns. Contrary to Saxton’s claim, the ETI Clearinghouse would have been a simple public information program, providing a voluntary market-matching service.
On October 16, 2008, the DOL, in the last weeks of the outgoing Bush administration and under prodding by the US Chamber of Commerce, published DOL Interpretative Bulletin 08-1 that modified and superseded the DOL’s prior guidance regarding ETIs. The revised bulletin stated that before a fiduciary selects an ETI (over another investment), it must first conclude that the investment alternatives under consideration are “economically indistinguishable,” that is, “truly equal, taking into account a quantitative and qualitative analysis of the economic impact on the plan.” This analysis must include consideration of an investment opportunity’s level of diversification, degree of liquidity and potential risk and return as compared to other investments that would fill a similar role in the plan’s portfolio.
However, it is generally held that, while the DOL’s 2008 ETI Bulletin contained cautionary language about ETIs, the bulletin did not reflect a substantive change in the law on this issue. James Beall, a partner at Willig, Williams & Davidson (a labor and employment law firm), suggests that pension trustees should “treat the law as your friend, not your enemy” in considering what constitutes an investment that satisfies ESG (responsible investment) principles. “That starts with the duties prescribed under ERISA. The DOL has given specific guidance on ETIs which appears hostile, but is actually empowering: with appropriate due diligence,” Beall reports. “It’s very important, therefore, to have a stack of due diligence with which to defend your investment.”
There were hundreds or maybe thousands successful ETI-type investments over the two decades since 1994 (some investors didn’t label their investments as such). But the 2008 Rule clouded the legality of ETIs. Innumerable pension fund managers, consultants and lawyers rejected the notion of investing responsibly, using the same old tired warnings and clichés, but also citing the 2008 ruling.
Back to the Future
Meanwhile, creative capital stewards and labor leaders in Canada, Australia, Europe and South Africa pushed the envelope by investing their pension assets utilizing the PRI-ESG responsible investment framework, launched in 2006. Over 1,400 asset owners and asset managers from across the globe, representing $59 trillion in assets, have now signed the UN-backed Principles for Responsible Investment (UN PRI). Investing in light of the opportunities and risks of ESG, or environmental, social, and governance concerns (ESG), the UN PRI is the modern global standard for intentional investment.
These innovative stewards have invested common pools of capital locally and across their borders with a focus on areas such as housing and infrastructure, clean energy and climate change. U.S. pension funds have increasingly co-invested in these initiatives, putting greater focus on ESG risks and opportunities rather than just ETIs. These can include prudent, profit-making investments to:
• Increase the availability of sustainably-built affordable and workforce housing;
• Invest in retrofitting and modernizing the residential, commercial and industrial built environment;
• Provide capital to stabilize and turn around domestic manufacturing industries and other economically vital sectors of the industrial commons;
• Provide growth capital to Small and Medium Enterprises (SMEs);
• Increase the availability of worker-friendly, community-scale, sustainable infrastructure investments; and
• Support new market-driven innovations such as renewable energy, efficient transportation, transit-oriented developments, downtown revitalization and smart growth in the clean economy.
In 2007, the Global Trade Unions endorsed the UN PRI. At the 2013 Constitutional Convention in Los Angeles, the AFL-CIO passed Resolution 11, defending retirement security and endorsing the responsible investment of workers’ capital. This is particularly important in terms of influencing the $4-5 trillion in pension funds partly trusteed by workers and manager partners, along with billions in non-ERISA funds managed by the labor movement. AFL-CIO President Richard Trumka is a champion of this initiative, and has concurrently pushed for pension fund investments in infrastructure and workforce housing, energy retrofits and renewable energy, and investments to turn around and revive critical industries.
There were other drivers influencing the DOL, not the least the persuasive arguments put forth by Pope Francis and his Encyclical on Climate, released at the end of the summer, 2015. The Pope issued an historic encyclical on combating climate change, blaming “relentless exploitation and destruction of the environment...the reckless pursuit of profits, excessive faith in technology and political shortsightedness.”
But the most formidable argument in the arsenal is the fact that responsible investment, well, makes money. There is an expanding archive of sustainability data and academic reports showcasing the financial advantages (or lack of financial disadvantages) of investing responsibly and of good corporate governance. Hundreds of reports and studies are pointing in this direction, and new reports are coming out by the day. The UN PRI has already borrowed the Guidebook’s helpful summary of those reports.
As Pensions and Investments Magazine put it:
"A 2008 interpretative bulletin from the Labor Department “unduly discouraged plan fiduciaries” from considering environmental, social and governance factors under appropriate circumstances, Mr. Perez said in a statement. 'Changes in the financial markets since that time, particularly improved metrics and tools allowing for better analyses of investments, make this the right time to clarify our position.'
Under the new guidance, Interpretive Bulletin 2015-01, fiduciaries cannot accept lower expected returns or greater risks, but may take ESG benefits into account as “tiebreakers” when investments are otherwise equal. When ESG factors have a direct relationship to the economic and financial value of an investment, 'these factors are more than just tiebreakers,' a DOL statement said."
This evolution from ETIs to ESG, a concept first coined by our fellow Heartland author and PRI Academic Network leader Tessa Hebb, has indeed been a long and bumpy ride. We needed DOL guidance that insisted that pension and institutional investors re-align their governance and investment strategies with the long-term interests of workers, citizens and retirees by incorporating these responsible practices into their investment decisions. Capital stewards can now more confidently invest in ways to renew our cities, revive our industrial commons, grow the clean economy and make the “boss” more accountable.
Smart investors have been reaping profits on responsible investments in the real economy for decades. The DOL needed to remove the barriers, real or perceived. On the other hand, it is also smart to remind investors, if they don’t already know, that they need to beware of undue or reckless risks. You don’t want to be the next real estate guy who invests in a Love Canal, or bank or investment house that blows the world up with sub-prime mortgages and other toxic securities (using and losing our savings and assets while doing so). We knew that Wall Street and the Chamber were wrong all along. Now we know that the law is on our side.
 Ian Lanoff, “The Social Investment of Private Pension Plan Assets: May it Be Done Lawfully Under ERISA?” 31 Labor Law Journal, vol. 387, 389 (1980).
 Robert B. Reich, “Pension Fund ‘Raid’ Just Ain't So,” Letter to the editor, Wall Street Journal, (October 26, 1994), A21.
 DOL Advisory Council (1992).
 Tessa Hebb, “Economically-Targeted Investing: Changing of the Guard,” (2014)
 Robert B. Reich, “A moral Workout for Big Money,” New York Times, Ec 3 (September 11, 2994), 9.
 Cassandra Chrones Moore, “Whose Pension Is It Anyway? Economically Targeted Investments and the Pension Funds,” Cato Policy Analysis No. 236, (Washington DC: Cato institute, September 1, 1995).
 Comments of James Beall, speaker at the Philadelphia Heartland Responsible Investment Forum, quoted in “AFL CIO’s Housing Investment Trust (HIT) Creating Competitive Returns and Thousands of Jobs,” by Marco Trbovich, www.heartlandnetwork.org, (April 13, 2012).