Is Socially Conscious Investing a Breach of Fiduciary Duty? - RMC Group

On June 23, 2020, the Department of Labor issued a proposed rule addressing the circumstances under which a fiduciary of a qualified retirement plan can base investment decisions on socially conscious factors.

What is Socially Conscious Investing?

Socially conscious investing, otherwise known by the acronym ESG, is a form of investing designed to promote social goals.  Under an ESG strategy, an investor screens potential investments based on environmental, social and governance criteria.  Environmental criteria consider how a company’s business practices treat the environment.  Social criteria consider how a company manages its relationship with its employees, customers and its community.  Governance criteria considers a company’s management practices, such as executive pay and shareholder rights.

Under What Circumstances is ESG Investing Allowed?

The proposed rule reiterates that the purpose of a qualified retirement plan is to maximize the retirement benefits of the plan participants.  To that end, investment decisions must be made with one goal in mind – maximizing investment performance.  Because ESG subordinates investment returns to non-financial objectives, it may run afoul of the fiduciary standard set forth in ERISA.

The proposed rule makes five points:

1. ERISA requires plan fiduciaries to make investment decisions based on financial considerations “relevant to the risk-adjusted economic value of a particular investment or investment course of action”.
2. ERISA’s “exclusive purpose” rule prohibits a fiduciary from subordinating the interests of plan participants in retirement income to non-pecuniary goals.
3. A fiduciary must consider all investments available to meet their duty of prudence and loyalty under ERISA.
4. ESG factors in investment decisions can be a valid pecuniary consideration if required economic analysis establishes that the ESG investment presents economic risks or opportunities that a qualified investment professional would find acceptable.
5. A 401(k) plan may provide designated investment alternatives.

In announcing the proposed rule, Secretary of Labor Eugene Scalia said that:

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.