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A big wince as Trump's DOL presses efforts to erase Obama-era ESG guidance, with tough new rule to curb do-good funds in ERISA accounts; critics cry 'politics'

Lawyers see crackdown as 'a solution in search of a problem' in regard to Labor Dept. pleas in proposed rule of danger that meeting environmental and social justice goals could harm returns, hence retiree security.

Wednesday, July 1, 2020 – 8:18 PM by By Lisa Shidler
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Betsy Moszeter: It's not obvious why the DOL is proposing a rule specifically for ESG.

Brooke's Note: You might have thought that the ESG horse left the barn long ago, now that it's at about $12 trillion and companies like BlackRock claim to be all-in. See: Chafing under $4 trillion of passive assets, BlackRock CEO warns Fortune 500 CEOs he may bring other activist means to bear It seems to hit the sweet spot of good returns and good vibes. But environmental, social and governance funds are also the bane of gambling, whiskey, coal and heedless social media companies, none of which are lacking their own political constituency. So the Department of Labor (DOL) is determined to make a new fiduciary rule that understand the needs of brokers to make sales without inconveniences. It's also determined to keep retirement dollars flowing into shares of companies that pollute, addict and sell our privacy to high bidders. They say purging these "sin stocks" from portfolios puts the interests of asset managers ahead of investors. Pension lawyers doubt they have much of a case. And, BlackRock, already frowned on by the Sierra Club, declined a request for comment.

The Trump administration, as part of an effort to undercut Obama-era regulations--especially regarding the environment-- is targeting social justice funds with a tough new rule that will curtail, if not eliminate, their use in retirement accounts. 

Lisa Woll
Lisa Woll: 'Generating more hurdles to the incorporation of ESG criteria will have a chilling effect.'

The Department of Labor (DOL) released the proposed new rule Tuesday (June 23). It limits plan fiduciaries from investing in so-called ESG funds, claiming they could harm investment returns or take on additional risk.

"This should be viewed as a serious and material step to limit 401(k) plans from investing in ESG [environmental, social and governance ] funds. At the same time, it is hard to see this as anything but political," said Jason Roberts, ERISA attorney with Pension Resource Institute. 

If the current rule is passed, it could create a major pushback against advisors and plan sponsors even considering using these funds, he adds. "The DOL is increasing the burden associated with including these funds and increasing the risk associated with these funds. There are specific rules."  See: New 'anti-regulatory' DOL Fiduciary Rule figures to keep $10-trillion IRA market under the IRS, allow some conflicted advice; does Rule's revival from dead presage Joe Biden presidency?

The move is directly contrary to DOL guidance issued by the Obama administration in 2015 and 2016 that promoted the use of environmental, social and governance funds with one caveat.

The investments had to be "appropriate for the plan and economically and financially equivalent with respect to the plan's investment objectives, return, risk and other financial attributes as competing investment choices.”

Chilling effect

The proposed DOL rule doesn't take into account the thoughtful analysis completed by managers, says Lisa Woll, CEO of the Forum of Sustainable and Responsible Investment. 

Marcia Wagner
Marcia Wagner: 'On its face, the DOL has... a concern about the manner in which ESG products have been marketed.'

“The DOL proposal is out of step with professional investment managers, who increasingly analyze ESG factors precisely because of risk, return and fiduciary considerations," Woll said in a statement. 

Three-quarters of the 141 money managers who responded to a 2018 survey of U.S. sustainable investment firms showed a desire to improve returns and minimize risk over time. 

”Generating more hurdles to the incorporation of ESG criteria will have a chilling effect, leading to plan participants losing access to ESG options---many of which have outperformed their indices over time and especially during the market shock related to COVID 19," she said. 

“The proposal would put a substantial additional burden on fiduciaries who wish to utilize ESG investments."

Political end run

But Marcia Wagner, founder and attorney at Wagner Law Group, counters that the DOL has some legitimate concerns. 

Fred Reish
Fred Reish: 'The Republicans and Democrats have gone back and forth on this for years.'

"On its face, the DOL has... a concern about the manner in which ESG products have been marketed to ERISA plans and a concern that ERISA plan fiduciaries may be making investment decisions based upon non-pecuniary factors rather than focusing solely upon financial factors." 

Betsy Moszeter, chief operating officer of Green Alpha Advisors, questions why the DOL is so hell-bent on singling out socially conscious investments for such scrutiny.

"If that's not clear in current rules, the DOL should be making that clear across the board rather than targeting ESG investment options," she says. "ESG-oriented investment vehicles, evaluated in aggregate rather than separately, are not any more or less likely to reduce potential investment returns or increase potential investment risks. Given that, it's not obvious why the DOL is proposing a rule specifically for ESG."

The issue is simply that passion projects may not be prudent in retirement accounts, Wagner says.

"Their concern may be that a focus upon ESG factors is precluding plans from investing in entities that they would otherwise have been invested in because of issues such as the use of fossil fuel, global warming, etc. and these proposed regulations may alter the plan's investment decision process." 

Still, politics are playing a big role, says Fred Reish, an ERISA attorney with Faegre Drinker Biddle & Reath LLP in Philadelphia. See: Waving the flag of 'capital formation,' SEC promises to let the genie out of the bottle, allowing private funds in 401(k) plans; DOL silent

"The Republicans and Democrats have gone back and forth on this for years, with the Republicans trying to make it harder for fiduciaries to select ESG investments, and the Democrats trying to make it easier." 

Revised guidance

President Donald Trump signaled his plans to dismantle federal environmental safeguards in March 2017, three months after taking office. His first move was to begin the process of withdrawing from the historic Paris Agreement to limit global warming.

A month later, the Trump DOL revised the Obama-era guidance with Field Assistance Bulletin (FAB) 2018-01.  It said fiduciaries "must not too readily treat ESG [environmental, social and governance] factors as economically relevant to the particular investment choices at issue when making a decision."

Rather, ERISA fiduciaries were required to "always put first the economic interests of the plan in providing retirement benefits."

The DOL has always offered sub-regulatory guidance on this issue, which made it easier for the next administration to reverse the decision, Reish says. 

"In this case, though, it is being done through a proposed regulation, which would be harder for a Democratic administration to change," Reish adds.

Growing trend

The proposed rule would essentially elevate previous Trump DOL guidance to a binding formal regulation. 

Joshua Levin
Joshua Levin: 'I've been impressed how fast Trump's GOP latched onto ESG and made it a political football.' 

Fiduciaries would be required to select investments "based on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action," according to the DOL fact sheet. 

"This is a big deal and way outside of routine DOL rulemaking precedent. I think this is very much a solution in search of a problem,” says Roberts. 

It is unclear who lobbied for this new rule, but sources suspect that oil and gas interests were likely pushing it. 

Socially responsible funds--also known as SRI or ETI funds--favor corporate practices that promote environmental stewardship, consumer protection, human rights, social justice and diversity, according to business references. 

Some, but not all, funds avoid businesses involved in alcohol, tobacco, gambling, weapons and the military. Various screening and ranking methods are used to select companies deemed suitable for their portfolios.

At the moment, ESG funds are included in just 10% or so of all defined contribution plans, says Anastasia (Anya) Krymkowski, associate director of retirement with Boston-based Cerulli Associates.

Currently, more than $9 trillion in assets are part of DC plans, according to Cerulli. “They’re still not that common, but they’ve been more of a discussion topic lately,” Krymkowski says.

ESG funds, however, have been gaining in popularity and total more than $12 trillion today. A decade ago, they weren't as popular, says Joshua Levin, co-founder and chief strategy officer at OpenInvest. 

"I've been impressed how fast Trump's GOP latched onto ESG and made it a political football - from the Financial Choice Act of 2017 to the 2018 ERISA guidance, to today," he says.

"It's also a signal that ESG's growth is actually having an impact, as the GOP's corporate sponsors are increasingly feeling the pressure from ESG shareholder questions and activism," he adds. 

Unwavering focus

Secretary of Labor Eugene Scalia in a statement says that retirement funds need to be carefully selected and shouldn't be based on social goals. 

Eugene Scalia: 'Private employer-sponsored retirement plans are not vehicles for furthering social goals.'

“Private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan. 

Rather, ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers," he said. 

Dennis Clark, managing director at San Francisco-based Shelton Capital Management, a firm that manages a number of ESG funds, says they have performed well over time.   

"Perhaps, the DOL is worried about backlash if, and when, a fiduciary recommends an ESG strategy that is so poorly managed in terms of risk and return that savers get hurt badly.  

"I have actually seen research that properly managed strategies with an ESG overlay generates alpha because companies that make money in clean industries and that manage their businesses with an eye toward sustainability actually perform better financially over the long run," he adds.


What's particularly interesting, Krymkowski says, is a lack of statistics showing that these funds traditionally perform worse than other funds, or that they're more expensive.

Jon Hale
Jon Hale: 'Sustainable funds comfortably outperformed their peers in 2019.'

"I think the misconception is that ESG funds will be more expensive or sacrifice performance. But everything we've seen shows it's actually natural in both areas or positive. I haven't seen anything that shows ESG has worse performance."

Jon Hale, Ph.D., CFA, who is head of sustainability research for Chicago-based Morningstar, wrote in an April report that sustainable funds outperformed their conventional fund peers in 2019.

"Sustainable funds comfortably outperformed their peers in 2019," Hale wrote.

"The returns of 35% of sustainable funds placed in the top quartile of their respective categories, and nearly two-thirds finished in the top two quartiles. By contrast, the returns of only 14% of sustainable funds placed in the bottom quartile, and only about one third placed in the bottom half."

Ronnie Cox
Ronnie Cox: 'Environmental and social components bode well for strategies as well.'

The funds performed well in other years as well, the report notes.

"Focusing on the trailing annualized three-year returns through the end of 2019, we see a similar pattern. The returns of 40% of sustainable funds placed in the top quartile of their categories and two-thirds finished in the top half. Much of that outperformance was driven by sustainable equity funds." 

He added sustainable equity funds did even better. "With the returns of 41% ranking in the top quartile of their respective categories, and 68% in the top two quartiles. The returns of only 16% placed in the bottom quartile and 33% in the bottom half.

Hale adds that in the five-year trailing history, these funds have done well, but he acknowledges that few have existed longer than five years.

"We see a similar story over the trailing five years, even though only 90 sustainable funds have five-year records, compared with 154 sustainable funds that have three-year records." 

The DOL rule is actually headed in the wrong direction, says Aron Szapiro, Morningstar's head of policy research. "We should plan sponsors should have a study to consider long-term ESG risk, not to be scared to do so. This is not about preferences, it's about managing ESG risks. ...ESG-focused investments have performed well in recent years."

Ronnie Cox, senior vice president of investments at RIA Pensionmark Financial Group LLC based in Santa Barbara, agrees that ESG investments can outperform their peers. 

"Environmental and social components bode well for strategies as well, particularly in the case of how companies are addressing the impacts to their business around climate change," Cox says in an email. His firm has provided guidance on ESG funds in the past. 

Reality check

Reish is perplexed by the rule because he says, parts of it are confusing. For instance, the proposal does allow plans to invest in ESG funds, if the competing investments are otherwise economically the same. 

"Of course, that doesn’t make any sense either legally or practically. No two investments have the exact same economic profile or equivalence.  On a practical level, mutual funds and other investments are selected by applying 'screens' or criteria.  Those that satisfy the prudent criteria are all considered to be prudent selections.

"For example, if there were 100 funds of a particular type, 10 or 20 of those could potentially pass the screens and any one of those could be selected by plan fiduciaries, with the differentiator being ESG factors. That’s the real world."

He is fearful that plan sponsors may now shy away from ESG funds in their plans.

"Unfortunately, I think that this rule is likely to instill concern in many plan sponsors and advisors that they should not incorporate ESG investment options within their plan. In my view, this rule just adds an additional layer of documentation." 

Ultimately, ESG funds have similar-costs, he says.

"I believe that the cost and return and return characteristics are just as competitive as any other investment options and I don’t believe this rule precipitates the need to remove ESG funds from investment menus.

"But I do believe it will call for even more scrutiny and documentation of those funds to show the economic benefit (or remove them if it can’t be shown)."

In 401(k) plans that are trustee directed, Roberts says this hasn’t been in issue at all. But he says he has had some San Francisco-based plan sponsors who have sought out ESG funds, and he’s had to explain the importance of looking at all funds.

Roberts says rule-making involves a lot of give and take and suspects that the administration will receive a host of comments, and may end up lessening their tight reigns on ESG funds.

“I think there will be more of a middle-ground approach,” he says. “I feel like the DOL drew a line in the sand where they’re starting the conversation and now it’s incumbent on advisors to push that line back to the center.”


Mentioned in this article:

Pension Resource Institute, LLC
Compliance Expert
Top Executive: Jason C. Roberts

Retirement Law Group, PC

Top Executive: Jason C. Roberts

Marshall Smith

Marshall Smith

July 2, 2020 — 2:04 PM
Active managers have always used quantitative and qualitative factors to determine which investments will outperform. ESG is no different. Unless an ESG fund plans to underperform, I don't see how this ruling even applies.


July 2, 2020 — 5:22 PM
The DOL has flip flopped on the issue of SRI/ESG investments in qualified plans for decades. This is nothing new. And, to be fair, those of us who have been in the industry for 25 years or longer certainly remember sub-par performance in that category of investments. SRI/ESG investments have exploded in recent years And, yes, the performance in recent history has gotten much better; however, there are no industry standards as to exactly what qualifies as a legitimate SRI/ESG investment. Many, if not most, money managers refuse to identify their criteria of research and investment. It's a black box and, clearly, many money managers are attempting (successfully) to capitalize on this trend. In fact, most managers in the U.S. focus on governance criteria (in instances where they choose to divulge their criteria), not environmental or societal issues. Additionally, many use criteria that allows them to invest in the least bad oil companies (for example), rather than no fossil fuel companies at all. Consequently, many investors aren't ~really~ having their assets managed according to their values. Arguably, they're being hoodwinked. There isn't anyone auditing the process and calling "foul or fair ball". On the other hand, there truly are some fine managers who have very good reputations, good returns, and are forthright in their management process. And, shouldn't a religious institution (for example) be able to invest according to their convictions and principles? Bottom line is -- there are two sides to this story. Simply identifying political motivations of one party or the other doesn't address all of the history or concerns surrounding this issue.
Brooke Southall

Brooke Southall

July 2, 2020 — 6:15 PM
I appreciate both the above comments, each thoughtful and constructive. [The artful dig at the acronyms is appreciated, too.] ESG is a topic that can become religious, political, moral, legal, regulatory and economic all at once. To step aside from all of that for a minute, it does seem like the acronym-ed ESG/SRI world can mark this DOL scrutiny as an affirming coming of age event. The success of the category is now great enough that it has become a concern to federal regulators. People want economic gains but not if they have to feel like they are ill-gotten. That seems good. But whether or not that approach should be legal and what 'good' is for society ... we won't solve those questions in one article.

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