DOL Issues New Guidance on Economically Targeted Investments
The guidance clarifies that environmental, social, and governance factors may be relevant to a plan fiduciary’s evaluation of an investment’s economic merits.
The US Department of Labor (DOL) recently published an interpretive bulletin that provides updated guidance on fiduciaries’ duties under the Employee Retirement Income Security Act (ERISA) when making so-called “economically targeted investments” (ETIs). Interpretive Bulletin (IB) 2015-01 replaces its predecessor, IB 2008-01, and reinstates the language of IB 94-01.
Notably, the DOL has clarified that environmental, social, and governance (ESG) factors may be considered attributes relevant to evaluating an investment’s economic merits. The DOL also concluded that ETI investments are subject to the same recordkeeping and documentation requirements that generally apply to plan fiduciaries and that no special documentation is presumptively required—a change from interpretations of IB 2008-01.
ETIs, the term that the DOL adopted in 1994 to refer to what were also known as “socially responsible investments” or “sustainable and responsible investing,” are investments intended to produce benefits in addition to, and apart from, the financial return on the invested assets. They have become increasingly popular as investors look for opportunities to generate “double bottom line” returns that fulfill both financial and social objectives.
ERISA Fiduciary Standard
ERISA requires plan fiduciaries to act prudently and solely in the interest of a plan and its participants and beneficiaries. As such, plan fiduciaries are generally required to consider relevant investment factors, including the degree of risk, maximization of returns, mitigation of loss, and furtherance of a plan’s funding objectives. Thus, the DOL’s consistent view has been that ERISA’s fiduciary duty rules do not permit fiduciaries to sacrifice the economic interests of a plan to promote collateral goals.
ETIs and the Fiduciary Standard
The DOL has consistently stated that ERISA does not prevent plan fiduciaries from investing plan assets in ETIs with expected rates of return comparable to similarly situated investments but that the collateral benefits of a particular investment cannot supplant the fiduciary duty to evaluate the investment’s returns and risks. Thus, IB 94-01, which was issued during President Clinton’s administration as part of an effort to encourage these types of investments, set forth the “all things being equal” test. In this test, fiduciaries could evaluate collateral benefits as tie-breakers where investments were otherwise equal with respect to their economic and financial characteristics.
Although generally consistent with this view, IB 2008-01, which was released toward the end of President George W. Bush’s administration as a reaction to what was thought to be an overly permissive standard under IB 94-01, stated that collateral, noneconomic factors should rarely be considered in selecting plan investments. Further, this guidance noted that fiduciaries should contemporaneously document their economic analysis to show that the investments were of equal value. Some practitioners concluded that the guidance created an ETI compliance standard that was both difficult to meet and unclear.
In releasing the current guidance, the DOL indicated that “IB 2008-01 has unduly discouraged fiduciaries from considering ETIs and ESG factors. In particular, the Department is concerned that the 2008 guidance may be dissuading fiduciaries from (1) pursuing investment strategies that consider environmental, social, and governance factors, even where they are used solely to evaluate the economic benefits of investments and identify economically superior investments, and (2) investing in ETIs even when economically equivalent.”
To clarify its position, the DOL has withdrawn IB 2008-01 and replaced it with new guidance that reinstates the language of IB 94-01. The latest bulletin therefore marks a return to the “all things being equal” test, without the need for documentation or evaluation beyond what is necessary for plan investments generally. At the same time, however, the new guidance acknowledges that ESG factors may have a direct relationship to the economic value of a plan’s investment. As such, these factors may not be merely “collateral considerations” or “tie-breakers,” but rather “proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices.” The overarching message is that fiduciaries need not treat commercially reasonable investments that take ESG factors into account as inherently suspect or in need of special scrutiny as compared to any other investment. The DOL added that the same standards apply to selecting a “socially-responsible” mutual fund as a plan investment option, reaffirming previous guidance.
Practical Applications and Observations
IB 2015-01 reflects the DOL’s current thinking on the standards applicable to ETIs and ESG-based investments, highlighting that considering ESG factors can be part of an economics-based investment process. Importantly, it clarifies that no special documentation is presumptively required to demonstrate that ETIs or consideration of ESG factors complies with ERISA. That being said, the DOL guidance notes that fiduciaries responsible for plan investments should maintain records sufficient to demonstrate their compliance with ERISA’s fiduciary standards and that the appropriate level of documentation depends on individual facts and circumstances. Therefore, plan fiduciaries should consider and evaluate their procedures for documenting and maintaining records of all their plan investment decisions’ prudence, not just ETI/ESG investments. Finally, although not specifically subject to ERISA and this new guidance, governmental plan fiduciaries (often leaders in the ETI field) should consider how this pronouncement affects their investment programs.