Background and Information on DOL Rulemaking (look for ou

Heartland Capital Network

Briefing Package on DOL Rulemaking on Financial Factors in Selecting Plan

Investments

Overview

The US Department of Labor has issued proposed new regulations implementing the Employee Retirement Income Security Act of 1974 (ERISA) that would discourage and, in some cases, effectively prohibit responsible investment in US retirement plans. The proposed rulemaking was issued on June 30, 2020, with a public comment period ending on July 30, 2020.

The proposed rulemaking, with the DOL’s commentary, is available at:

https://www.federalregister.gov/documents/2020/06/30/2020-13705/financial-factors-in-selecting-plan-investments

This briefing package provides background on the proposed rulemaking together with talking points and a sample letter to assist individuals and organizations in opposing the proposal through comments to the DOL and outreach to members of Congress.

The DOL must respond to every comment letter. Letters should be customized to reflect each sender’s experience and situation.

All recipients of this briefing package are urged to submit a customized letter to the DOL no later than July 30, 2020. In addition, recipients are urged to contact their senators and representatives to urge them to hold hearings on the proposed rulemaking and to communicate their opposition to the DOL.

Comment letters to the DOL should include the identifier “RIN 1210-AB95” and can be submitted electronically or by mail.

Federal e-Rulemaking Portal: www.regulations.gov

Mail: Office of Regulations and Interpretations

Employee Benefits Security Administration

US Department of Labor

Room N-5655

200 Constitution Avenue NW

Washington, DC 20210.

Background

ERISA was adopted to protect retirement savers by setting high standards for retirement plan fiduciaries, requiring them to act with due care, skill, prudence, and diligence and to avoid conflicts of interest. The ultimate goal of ERISA is to maximize retirement savings for plan participants.
Responsible investment - that is investment taking into consideration environmental, social, and/or governance (ESG) factors - has long been permitted in ERISA-regulated retirement plans provided that the use of ESG considerations does not result in a discounting of expected risk-adjusted financial returns relative to non-ESG investments.
The overwhelming majority of rigorous, peer-reviewed academic studies have concluded that ESG-guided investments have in general performed as well as or better than comparable conventional investments.[i] This is backed up in reports by leading industry analysts such as Morningstar.[ii]

The Proposed Rulemaking

The DOL is now proposing regulations that specifically target ESG-guided investments for burdensome requirements and intensified enforcement oversight.
The proposed regulations would require fiduciaries to demonstrate on a factor-by-factor basis the economic materiality of every ESG consideration involved in any investment decision – a requirement not applicable to non-ESG considerations and an extraordinary burden in an enforcement context.
If the new regulations are adopted, fiduciaries would be allowed to consider an ESG factor only if it could be demonstrated that it improved forecasted financial performance. This departs from decades of precedent that allowed fiduciaries to consider ESG factors so long as doing so did not discount expected financial performance. This change would tip the burden of proof that fiduciaries must meet sharply against ESG investments, deterring fiduciaries from considering them.
The new regulations would restrict ESG-guided investments under any circumstances as part of a qualified default investment alternative (QDIA) in 401(k)-type plans.

Suggested talking points:

ESG Factors Do Not Mean Sacrificing Returns

The ultimate purpose of ERISA is to help ensure that retirees achieve the best financial outcomes for their retirement savings. Given the overwhelming evidence that ESG-guided investments perform as well as or better than conventional investments, issuing onerous regulations that specifically target and burden this type of investment undermines the purpose and intent of ERISA.
It would be burdensome and impractical for the DOL to micro-manage through investigations and enforcement the myriad of individual factors considered by investment professionals. By proposing just this sort of micro-management for one specific type of investment – ESG-guided investment – the DOL is effectively declaring its intent to discourage and, in many cases, prohibit ESG-guided investments in retirement plans.
In these proposed regulations, the DOL is attacking a fictitious problem – the supposed trade-off between ESG considerations and investment performance. The overwhelming evidence from academic and industry sources is that no such trade-off exists. Consequently, by discouraging and deterring fiduciaries from investing in ESG-guided funds, the DOL would be forcing participants into potentially lower-performing investments resulting in lost, long-term retirement savings, in direct contravention of ERISA’s purpose.
The DOL’s proposal is out of step with the investment industry today. Major asset managers, including the world’s largest, BlackRock, have declared their commitment to considering ESG factors in selecting and managing investments. In his 2020 letter to CEOs, BlackRock’s Chairman and CEO, Larry Fink, stated bluntly: “We believe that sustainable investing is the strongest foundation for client portfolios going forward.”[iii]

DOL Proposes Essentially to Eliminate the Use of ESG Factors as Tiebreakers

For decades, the DOL has allowed fiduciaries to consider a non-financial factor as a tiebreaker in choosing among investments that are comparable from a risk/return perspective. The use of non-financial considerations as tie-breakers has been an essential part of ERISA practice, allowing fiduciaries to take into consideration factors, including some ESG factors, that cannot be conclusively shown on an individual basis to have a positive economic effect, but whose application does not diminish financial returns.
The proposed rule would require that fiduciaries document that investments are “economically indistinguishable” in order to be considered “comparable” in a tiebreaker analysis. Since all investments have distinguishable economic characteristics this change effectively eliminates the possible use of an ESG factor as a tiebreaker. There is no basis in real-world investment practice that supports the proposition that investments must be economically indistinguishable in order to be considered comparable.

So long as the fiduciaries exercise due care, skill, prudence, and diligence, any tools they use to distinguish among otherwise comparable investment options, including ESG factors, should be subject to the same fiduciary standards, not subject to a different level of oversight and documentation.

Take Politics Out of ERISA

ERISA fiduciaries must apply a high standard of care and loyalty in seeking to maximize participants’ financial outcomes, as specified in the statute. Once this burden is met by a fiduciary and the requirements of care and loyalty in maximizing financial outcomes have been satisfied, there is no justification for the DOL’s imposition of deliberately onerous regulatory treatment targeted against ESG considerations. The motivation appears political and responsive to corporate interests that have long opposed responsible investment.
Retirement savings represent capital that belongs directly or in trust to plan participants – not to the DOL and certainly not to outside political interests. Capital deployment decisions reflect and express values as well as economic interests. ESG investing has been an effective, free-market tool for producing needed change and its popularity with investors is growing rapidly. Interference in the investment preferences of retirement investors by the DOL on political grounds rather than to fulfill ERISA’s purposes would be arbitrary and capricious, a violation of the economic rights of those investors and a potential violation of their First Amendment rights.

[i] The US Government Accountability Office reviewed five years of relevant academic studies to conclude: “The vast majority (88 percent) of the scenarios in studies we reviewed … reported finding a neutral or positive relationship between the use of ESG information in investment management and financial returns in comparison to otherwise similar investments.” The GAO report also referenced meta-studies by other researchers surveying the relevant academic literature reaching the same conclusion. Government Accountability Office, Retirement Plan Investing: Clearer Information on Consideration of Environmental, Social, and Governance Factors Would be Helpful (May 2018), 7-8.

[ii] See Morningstar, Sustainable Funds U.S. Landscape Report: Record Flows and Strong Fund Performance in 2019 (February 2020). Morningstar reviewed 303 ESG-focused funds in all asset groups and found that 65% performed in the top half of their relevant peer fund groups in 2019 (67% on a three-year basis and 64% on a five-year basis). Only 14% performed in the bottom quartile in 2019 (12% on a three-year basis and 13% on a five-year basis).

[iii] Fink, Larry, “A Fundamental Reshaping of Finance” (2020 Letter to CEOs) available at: https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter