SRIs Part One:DOL’s Reinterpretation of the Rules for Social Investing - An Opening for 401(k) Plans

There is a highly political aspect to Socially Responsible Investing (SRI) in retirement plans that gets reflected in the DOL rules depending on the party that is in the White House. Republicans tend to hate social investing and find ways to make it harder for plan fiduciaries to do it. Democrats tend to like it and conversely find ways to make it easier.

Last year this bouncing ball was swatted back toward restrictiveness, making the social investment path narrower but with a window of opportunity for 401(k) plan fiduciaries that want to add SRI funds to their investment lineups. This latest iteration of DOL views on the topic is in Field Assistance Bulletin 2018-01 (“FAB” or “2018-01”).

What is socially responsible investing?

In the context of 401(k) plans socially responsible investing is typically done through a mutual or collective investment fund whose stated prospectus objective is to invest in companies with sustainable business models without compromising investor returns.

SRI funds combine financial analysis with environmental, social, and corporate governance (ESG) screening. Although the screening varies across the SRI fund universe, these funds will generally avoid companies that are significantly involved in the manufacture of weapons, tobacco products, or are involved in gambling or engage in unethical business practices. SRI funds also screen for companies that have positive impacts on the environment, fair workplace practices, robust corporate governance, high product integrity, and positive community involvement.

When can a fiduciary take into account the “social” aspects of competing investments?

The core principles established by DOL for many years now are these:

• Plan fiduciaries cannot sacrifice investment returns to achieve social goals using environmental, social and governance or “ESG Factors” and

• It’s okay to use these ESG factors to break ties if the competing investments are otherwise equivalent.

FAB 2018-01 affirms these core principles but applies them more narrowly than in Obama era Interpretive Bulletin 2015-01 (“IB 2015-01”) when it declares that plan fiduciaries “do not need to treat commercially reasonable [SRIs] as inherently suspect or [consider them] in need of special scrutiny.” In addition, it goes on to say that while social factors can be used to break ties they can also be considered primary economic considerations in evaluating risk and return.

Specifically, though, 2018-01 cautions that:

"[Plan sponsors/fiduciaries] must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision. It does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors.”

What is clear is that DOL views SRI investing skeptically and is not encouraging it. Consequently, plans investing in SRI funds should be prepared to clearly demonstrate their due diligence process has not resulted in overstated conclusions about the benefits of ESG factors.

The key question for the plan fiduciary is “have I done all that I could have reasonably done to validate the prudence of the investment decision?” To answer this question, the fiduciary should assess whether they can make a prudent decision without the assistance of an expert investment adviser and whether they are confident in the thoroughness of their decision-making process.

FPG has prepared a checklist for decision makers to use in evaluating whether to add one or more SRI funds as an option. To request a copy, contact us directly at info@fiduciaryplangovernance.com

What does DOL mean when it says plan fiduciaries have a duty to follow ERISA?

FAB 2018-01 says that when an investment policy statement contains ESG factors and guidelines, plan fiduciaries must not follow them if it would be imprudent to do so. There is nothing remarkable or even new in this statement. This is the statutory requirement that applies to all fiduciary decision making, not just SRIs. What makes the statement worthy of comment is that DOL chose the area of SRI investments to point this out. Thus, it should be taken as warning to be careful.

In our next installment, we will briefly cover other aspects of the FAB, including investment policy statements and the DOL’s “permission” to use SRI in 401(K) lineups provided certain conditions are met.

Note

It is interesting and relevant to note that in a recent Charles Schwab piece, “Socially Responsible Investing Comes of Age, Can SRI funds hold their own?”, data from Morningstar “shows that, on average, SRI mutual funds have slightly outperformed their non-SRI counterparts in the short medium and long terms...” If that kind of advantage does exist, then data like this would be something a plan fiduciary could use to justify and would need to analyze in making an RSI investment decision. My colleague, Ed Lynch, has prepared a series on this very topic that will follow this two-part series.

Please contact info@fiduciaryplangovernance.com for information regarding this post, for inquiries about FPG services or for information on investment management and advisory services from our related company, Dietz & Lynch Capital.

Chuck Humphrey focuses his practice on employee benefits and is the principal of Law CGH Benefits Law Firm, Buffalo, New York, a consultant to Fiduciary Plan Governance, LLC, and the author of The Fiduciary Responsibility eSource, available at ERISApedia.com. He can be reached at chumphrey@cghbenefitslaw.com or 716-465-7505.