DOL Liberalizes Views on Economically Targeted Investments
The U.S. Department of Labor (“DOL”) has changed its stance in reference to guidance it issued in 2008, with respect to retirement plans allocating funds to economically targeted investments (“ETIs”) that consider environmental, social and governance (“ESG”) factors. Due to this about-face by the DOL, plan sponsors should review their investment policies.
The DOL defines ETIs as “any investment that is selected, in part, for its collateral benefits, apart from the investment return to the employee benefit plan investor.” In issuing, Interpretive Bulletin (IB) 2015-01, the DOL intended to reassure retirement plan trustees that they have some latitude to invest in ETIs (or give plan participants the opportunity to do so) without violating their fiduciary obligations to participants. In essence, the DOL has backtracked to its original position that it had maintained since 1994 until changing it in 2008.
The original 1994 guidance stated that nothing in ERISA’s fiduciary standards prevented ETIs if their expected rate of return was “commensurate” with that expected from alternative investments with similar risk characteristics. Additionally, ETIs had to be appropriate investments for the plan in terms of diversification and the plan’s investment policy. The standard was nicknamed the “all things being equal test.”
IB 2008-1 clarified that fiduciary consideration of collateral, noneconomic factors in selecting plan investments should be rare. It also emphasized that sponsors should document their decision in a manner that demonstrated compliance with ERISA’s fiduciary standards. This guidance led many retirement plans to decide not to invest in ETIs.
The DOL now believes that its 2008 interpretation unduly discouraged fiduciaries from considering ETIs and ESG factors. IB 2015-1 goes beyond the “all things being equal” standard of IB 1994-1 for fiduciaries considering ETIs.
IB 2015-1, instructs plan fiduciaries to consider all factors that potentially influence risk and return. Environmental, social and governance issues are some examples of factors that may have a direct relationship to the economic value of the plan’s investment.
Theoretically, as an example, a public company that has strong governance systems in place and an active board of directors that doesn’t always vote according to the CEO’s wishes, might, in the long run, outperform another company with weak governance. According to the DOL, fiduciaries can be open to considering such an argument.
Another example, could be a company that might outperform a competitor with a long history of litigation and penalties for environmental violations because of the hard costs and adverse reputational impacts associated with poor environmental stewardship.
In fact, according to the 2015 guidance, ESG factors “are proper components of the fiduciary’s analysis of the economic merits of competing investment choices.”
Similarly, fiduciaries don’t have to treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they consider environmental, social or other such factors. At the same time, however, when a fiduciary prudently concludes that an investment is justified based solely on the investment’s economic merits, there’s no need to evaluate ETI goals as tie-breakers.
In conclusion, IB 2015-1 essentially annulled IB 2008-1’s implication that documentation of the justification for choosing an ETI need require additional documentation, or evaluation beyond that required by fiduciary standards applicable to plan investments generally.
Before you decide for or against investing in ETIs, make sure to consult with your benefits specialist and make the decision using the same fiduciary standards as you would for all other investment decisions.
For 401(k) plans, plan sponsors should weigh the decision to add ETI-based funds as investment options in light of plan fiduciaries’ general views regarding the merits, or lack thereof, of maximizing the number of participants’ investment choices. Plan fiduciaries must decide whether a particular fund or investment satisfies ERISA fiduciary requirements based on all the facts and circumstances of the individual situation.
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