Field Assistance Bulletin 2018-1 – DOL clarifies guidance on economically targeted investments and proxy voting, again

On April 23, 2018, the Department of Labor published Field Assistance Bulletin (FAB) No. 2018-01 on Interpretive Bulletins (IBs) 2015-01 (economically targeted investments) and 2016-01 (proxy voting). The issue of economically targeted investments (ETIs) (particularly) has become “political,” with the Clinton, Bush, Obama and (now) Trump DOL’s all weighing in with (differing) guidance on it.

In what follows, we begin with a brief background. We then discuss the new FAB 2018-1 DOL ETI guidance. We conclude with a discussion of DOL’s new guidance on proxy voting.

Background

The Department of Labor has tweaked the rules for ETIs four different times – in 1994 the Clinton DOL issued Interpretive Bulletin (IB) 94–1 “correct[ing] a misperception that investments in ETIs are incompatible with ERISA’s fiduciary obligations.” In 2008, the Bush DOL produced a new IB 2008-1, modifying and superseding IB 94-1, stating that “the Department believes that fiduciaries who rely on factors outside the economic interests of the plan in making investment choices … will rarely be able to demonstrate compliance with ERISA absent a written record demonstrating that a contemporaneous economic analysis showed that the investment alternatives were of equal value.”

Then in 2015 the Obama DOL concluded that “IB 2008–01 had unduly discouraged fiduciaries from considering ETIs and environmental, social and governance (‘ESG’) factors under appropriate circumstances ….” And so it issued IB 2015-1, in which it stated:

[I]t has been the Department’s consistent view that sections 403 and 404 of ERISA do not permit fiduciaries to sacrifice the economic interests of plan participants in receiving their promised benefits in order to promote collateral goals.

At the same time, however, the Department has consistently recognized that fiduciaries may consider such collateral goals as tie-breakers when choosing between investment alternatives that are otherwise equal with respect to return and risk over the appropriate time horizon. ERISA does not direct an investment choice in circumstances where investment alternatives are equivalent, and the economic interests of the plan’s participants and beneficiaries are protected if the selected investment is in fact, economically equivalent to competing investments. (Emphasis added.)

DOL explained what it meant by “collateral goals” as follows: “As used in this interpretive bulletin … an economically targeted investment broadly refers to any investment that is selected, in part, for its collateral benefits, apart from the investment return to the employee benefit plan investor.” Thus, “collateral goals” in IB 2015-1 apparently means “not related to investment returns.”

FAB 2018-1 on ESG/ETI

In FAB 2018-1, however, the (Trump) DOL gives the language we just quoted a different spin:

In making that observation [that “collateral goals” may be used as “tie-breakers”], the Department merely recognized that there could be instances when otherwise collateral ESG issues present material business risk or opportunities to companies that company officers and directors need to manage as part of the company’s business plan and that qualified investment professionals would treat as economic considerations under generally accepted investment theories. In such situations, these ordinarily collateral issues are themselves appropriate economic considerations, and thus should be considered by a prudent fiduciary along with other relevant economic factors to evaluate the risk and return profiles of alternative investments. In other words, in these instances, the factors are more than mere tie-breakers. To the extent ESG factors, in fact, involve business risks or opportunities that are properly treated as economic considerations themselves in evaluating alternative investments, the weight given to those factors should also be appropriate to the relative level of risk and return involved compared to other relevant economic factors.

At this point – after the publication by DOL of four different interpretations, each one attempting to correct or at least clarify the last – it is becoming somewhat difficult to reconcile or in some cases even parse what DOL is saying. But it is at least arguable that:

IB 2015-1 stood for the principle that where, e.g., two technology companies presented similar economic/investment opportunities, a fiduciary could choose the one with a “better” environmental policy, even though that policy had no effect on investor returns, simply because it had that environmental policy.

FAB 2018-1 stands for the principle that a fiduciary could take into account environmental issues with respect to a company (including a company’s environmental policy) only where those issues, e.g., involve a business risk (such as the existence of possible litigation risk) that may have an economic effect on the company. A similar rule would apply to the selection of an ESG fund that made investment decisions on the basis of (among other things) ESG issues.

To be absolutely clear: these two interpretations, under IB 2015-1 and under FAB 2018-1, are not reconcilable with each other.

ESG in DC plans

That – at least until another administration takes over at DOL – is the general rule. In FAB 2018-1 DOL did, however, suggest that a different standard might apply to DC plans “where an investment platform … allows participants … an opportunity to choose from a broad range of investment alternatives.” In those sorts of plans, “a prudently selected, well managed, and properly diversified ESG-themed investment alternative could be added to the available investment options on a 401(k) plan platform without requiring the plan to forgo adding other non-ESG-themed investment options to the platform.”

This somewhat loser standard would not, however, apply with respect to the plan’s qualified default investment alternative (QDIA):

Nothing in the QDIA regulation suggests that fiduciaries should choose QDIAs based on collateral public policy goals. In the QDIA context, the decision to favor the fiduciary’s own policy preferences in selecting an ESG-themed investment option for a 401(k)-type plan without regard to possibly different or competing views of plan participants and beneficiaries would raise questions about the fiduciary’s compliance with ERISA’s duty of loyalty.

The distinction being that the plan fiduciary, rather than the participant, is choosing what funds will be in, e.g., a target date fund QDIA.

Investment policy statements

IB 2016-01 stated that “the Department does not believe ERISA prohibits a fiduciary from addressing ETIs or incorporating ESG factors in investment policy statements (IPSs) or integrating ESG-related tools, metrics and analyses to evaluate an investment’s risk or return or choose among otherwise equivalent investments.” In this regard, FAB 2018-1 states:

That discussion in the IB does not reflect a view that investment policy statements must contain guidelines on ESG investments or integrating ESG-related tools to comply with ERISA. Moreover, … an investment manager or other plan fiduciary to whom such an investment policy applies is required to comply with the policy, but only insofar as the policy is consistent with Titles I and IV of ERISA (including the core fiduciary obligations of prudence and loyalty). Thus, if it is imprudent to comply with the investment policy statement in a particular instance, the manager must disregard it.

A fiduciary’s obligation to follow ERISA rather than the terms of an IPS, where the two conflict, is accepted ERISA law, although how it would be applied to different IPS provisions would no doubt be the subject of many arguments.

Proxy voting

IB 2016-1 (issued by the Obama DOL) discussed the ERISA principles applicable to a plan’s exercise of proxy voting rights generally. It included a final paragraph that addressed (1) when it would be appropriate for plan fiduciaries to “monitor or influence the management of corporations in which the plan owns stock,” and (2) the issues (including ESG issues) that a plan fiduciary might, in that regard, raise with management. The latter is a fairly long list, including board of directors candidates, governance structures, merger policies, capital structure, long-term business plans (“including plans on climate change preparedness and sustainability”), workforce practices (“e.g., investment in training to develop its work force, diversity, equal employment opportunity”) and “policies and practices to address environmental or social factors that have an impact on shareholder value, and other financial and non-financial measures of corporate performance.”

With regard to this earlier guidance, FAB 2018-1 states:

All that language in the IB [i.e., the language we just summarized] should be read in the context of the Department’s observation that proxy voting and other shareholder engagement typically does not involve a significant expenditure of funds by individual plan investors because the activities are generally undertaken by institutional investment managers that are appointed as the responsible plan fiduciary …. The IB was not intended to signal that it is appropriate for an individual plan investor to routinely incur significant expenses to engage in direct negotiations with the board or management of publicly held companies with respect to which the plan is just one of many investors. Similarly, the IB was not meant to imply that plan fiduciaries, including appointed investment managers should routinely incur significant plan expenses to, for example, fund advocacy, press, or mailing campaigns on shareholder resolutions, call special shareholder meetings, or initiate or actively sponsor proxy fights on environmental or social issues relating to such companies.

The point here seems fairly clear. Fiduciaries engaging in this sort of activity (e.g., attempts to directly influence corporate policy) should be prepared to justify it on a cost-benefit basis. Thus: “If a plan fiduciary is considering a routine or substantial expenditure of plan assets to actively engage with management on environmental or social factors, either directly or through the plan’s investment manager, that may well … [warrant] a documented analysis of the cost of the shareholder activity compared to the expected economic benefit (gain) over an appropriate investment horizon.”

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Sponsor fiduciaries of plans with ETI/ESG policies will want to consider the implications of this new guidance. We will continue to follow this issue.