Covered pension plans may use ESG investment strategies, including avoiding gun firms, provided that such investments are expected to perform on a par with other available choices, attorneys told Bloomberg BNA in recent interviews.
Fiduciary duty requirements under the Employee Retirement Income Security Act don't prohibit plans from considering environmental, social or governance factors in making investment decisions, Scott A. Webster, partner and ERISA specialist with Goodwin Procter LLP in Boston, told Bloomberg BNA July 29.
However, he said they can't be used unless plan fiduciaries show that such investments will produce equivalent expected returns without incurring more risk for plan participants.
Plan fiduciaries must subject ESG or other socially responsible investments to the same stringent standards that they apply to all potential plan investments, Thomas E. Clark Jr., of counsel with the Wagner Law Group in St. Louis, told Bloomberg BNA Aug. 1. Only ESG strategies that meet these standards are eligible for plan investment, he said.
Studies Show Positive Returns
Finding socially responsible investments with equivalent or superior expected risk-adjusted returns may not be so difficult. The Forum for Sustainable and Responsible Investment lists many studies showing the positive performance of such investments.
In fact, courts may someday expect plans to consider ESG factors when selecting investments as part of their ERISA fiduciary responsibility, Elizabeth Shea Fries, co-founder of Goodwin Proctor's impact and responsible investing practice group in Boston, told Bloomberg BNA July 29.
Labor Department Guidance
“All fiduciary decisions must be made in the best interests of plan participants,” Clark said. Over the years, there’s been a controversy as to how a plan picks a mutual fund to invest in or offer to plan participants that has other interests, such as, for example, supporting environmental issues, he said.
When a plan selects such investment it may be unclear whether the investment was picked because it was “good for participants or good for the environment,” Clark, who specializes in ERISA fiduciary law, said.
Last October, the Labor Department withdrew Interpretative Bulletin 08-01 and replaced it with IB 2015-01. The new guidance clarified that ERISA permits plans to make ESG-type investments. It also made clear that plan fiduciaries couldn’t “use plan assets to promote social, environmental, or other public policy causes at the expense of the financial interests of the plan’s participants and beneficiaries.”
The department explained that plan fiduciaries “may not accept lower expected returns or take on greater risks in order to secure collateral benefits.”
A pension plan fiduciary can’t deviate from its existing investment evaluation procedure when evaluating a socially responsible fund, Clark said.
For example, he explained that a plan’s prudent process for selecting mutual funds might show 20 funds have met the plan’s stringent investment eligibility requirements. If socially responsible funds are on the list of surviving funds, then a plan is free to select them, Clark said. ERISA won’t penalize the plan if the investment ultimately performs poorly, he added.
Plan investment fiduciaries, however, must continue to monitor all of their investments and usually have strict mechanical return criteria telling them when to remove an existing investment, Webster said. Socially responsible investments that fail to meet the plan's ongoing performance standards need to be removed, he added.
Practical Issues With ESG
Going down the path of socially responsible investing, while permissible, in practical terms may require a lot more work for plan fiduciaries, Clark said. Both the level of due diligence and the level of monitoring increases substantially, he said.
In addition, Clark said that a plan fiduciary may identify appropriate ESG funds to invest in and discover that they aren’t available on the plan record-keeper’s platform. If a plan wanted to change its record-keeper in response, it would need to consider whether the time and expense of doing so would benefit its participants, Clark said.
David B. Brandolph