The Wall Street Journal just published an article entitled, "Don’t Choose Ethics Over Profits in Your 401(k), Government Warns." The article discussed the recent issuance of the Department of Labor of Field Assistance Service Bulletin No. 2018-01.  The field assistance provides guidance to the DOL's Employee Benefits Security Administration’s national and regional offices to assist in addressing questions they may receive from plan fiduciaries across the nation about, among other things, investment policy statements and  “economically targeted investments." 

The article and DOL guidance are timely and coincidental, as one of our partners just asked if we ERISA and government pension lawyers have any experience in the area of Environmental, Social, and Governance investing (or ESG Investing). 

Let us quickly note that we lawyers are not trained, nor should we be expected, to serve as investment professionals, evaluating the wisdom of any particular investment. But, yes, we have experience with ESG.  What once simply had been called “social investing” has become more prevalent in the qualified plan arena.  As counsel to plan fiduciaries, we have been asked to advise on a variety of legal questions that arise in the context of adding ESG funds to the investment evaluation process. 

ESG Investing is a phrase used in capital markets and by an increasing number of investors to evaluate corporate behavior and to predict the future financial performance of companies when determining whether a particular entity is a prudent investment option.  

With the growing presence of millennials as investors and as leaders in the investment community, men and women who have serious concerns about an entity’s impact on the environment and broader world communities, retirement plan fiduciaries have begun to explore the appropriateness of ESG funds as an investment option in defined contribution plan (such as a 401(k) or 403(b)) or as part of the overall investment strategy for a defined benefit plan.  

When it comes to investing qualified retirement plan funds, plan fiduciaries have one overarching objective: to do what is in the best interests of the plan, its participants, and beneficiaries.   Not long ago when fiduciaries were asked to invest qualified retirement plan funds in a “socially responsible manner,” politicians were hoping for investment of local pension money into the local economy.  Often, that was not in the best interests of the plan participants and beneficiaries. 

Another form socially responsible investing often took was the divestiture of or prohibition on investing in “sin” stocks -- alcohol, tobacco, defense, guns, etc. Occasionally, socially responsible investing was geopolitical, plans refusing to invest in companies that do business with international “bad” actors.   Occasionally, when stakes were high on the global political front, some states enacted divestiture laws governing their state and municipal pensions. 

In the past, when asked by clients if they should invest in a local project in City A or State B,  our response generally was “Does investment of plan assets in this local project meet the high standard of prudence, as required under ERISA?" 

If the local investment happens to stack up very favorably against other investment opportunities, great. If not, a plan fiduciary could be exposed for failing to invest the plan’s assets in a prudent manner, because “social responsibility” should not be the prime driver in determining whether a plan investment is prudent.  See aboveDOL Field Service Bulletin, citing Interpretive Bulletin 2015-01 ("the Department reiterated its longstanding view that, because every investment necessarily causes a plan to forego other investment opportunities, plan fiduciaries are not permitted to sacrifice investment return or take on additional investment risk as a means of using plan investments to promote collateral social policy goals").

A plan fiduciary is obligated to perform due diligence on each plan investment considered, and if the potential investment meets the plan’s investment criteria (typically set forth in the plan’s investment policy statement), without regard to some socially conscious purpose, then such an investment decision could be deemed prudent.  However, if the primary factor in selecting a particular investment is based upon outside pressures, a sense of socially responsible behavior, or the desire to invest in the local community (especially to appease a local politician), it will likely not be a proper discharge of fiduciary duty.  

In the 80’s and 90’s, when the concept of socially responsible investing began to gain traction, socially responsible decisions were not outwardly driving economic success. Ford Motor Company’s use of green agri-roofs on their factories did not result in a better, more cost-efficient automobile that consumers were flocking to buy, and it didn’t make Ford a better corporate investment than say Toyota or Honda. 

However, today, more and more investors across a broad spectrum are engaging in ESG Investing - making their investment decisions in public and private companies by considering a company’s environmental, societal, and governance conduct. One only has to look at the image Toyota projected throughout the Olympics, appealing to consumers with not only Toyota’s advanced forms of automobile transportation but also its seemingly socially conscious commitment to developing 22nd century energy- efficient, perhaps more autonomous, vehicles (including specialized “vehicles” for persons with mobility challenges). That huge marketing push may suggest Toyota’s belief that ESG will translate to greater total sales and thus greater shareholder value.

If a substantial body of investors are now taking ESG factors into account in making their investment decisions, it may now be prudent for investment fiduciaries to add to their investment evaluation template an analysis of the ESG plans and actions of potential investments. Fiduciaries should probably set aside sufficient time and resources to study the processes and actions of other fiduciaries in this area and perhaps to develop their own ESG investment policy and guidelines.