Retail investors have enough to worry about amid a global health and economic crisis that has left millions out of work and roiled financial markets. But if the Department of Labor (DOL) gets its way, retirement investors may have something else to worry about.
In a move that was overwhelmingly condemned in the investment community, the DOL issued proposed rules in late June hindering a fiduciary’s use of environmental, social and governance (ESG) investment strategies in 401(k)s and other retirement plans.
As proposed, the DOL rules would impose significant burdens on fiduciaries and advisors selecting ESG investments, and they would effectively prohibit 401(k) plans from using an ESG fund as part of the default investment alternative—even if it was the best available investment. This flies in the face of a growing mountain of evidence suggesting that ESG strategies often lead to financial outperformance and risk mitigation.
Despite attempts to force through the changes with just 30 days for public comments, a near-unanimous groundswell of financial advisors, asset managers, industry associations, institutional investors and retail investors has risen in opposition to the changes. Among them, members of the U.S. Impact Investing Alliance have raised serious concerns with the DOL’s proposal.
For one, the proposed rule is arbitrarily burdensome for fiduciaries and carries serious anti-competitive implications. By increasing costs for plan sponsors to access the growing universe of ESG funds and products, the proposal will potentially result in lower returns for beneficiaries. And in burdening 401(k)s in particular with added red tape, the rule is especially harmful to individual retirement investors and their advisors who will be effectively sequestered from the ESG market.
The proposed rule is also based on the false premise that ESG factors are often financially immaterial and that considering them can lead to underperformance. In fact, an abundance of recent evidence suggests the exact opposite is true—ESG is often financially material, frequently leads to outperformance and helps to reduce risk and uncertainty over time.
In our public comments, the Alliance implores regulators to acknowledge that considering material ESG factors is in alignment with fiduciary duty, and that discouraging such considerations could have harmful effects on plan beneficiaries.
Moving forward with such a hastily constructed rule would have drastic implications for plan fiduciaries and beneficiaries in the middle of a global pandemic and economic crisis. In fact, the ongoing crises we face today only reinforce the importance of considering long-term material ESG factors when making investment decisions.
More hurdles on the way
Unfortunately, this DOL proposal is not the only regulatory move seemingly designed to curb ESG investing. And as the amount of assets invested in sustainable or ESG funds continues to grow—the latest estimate from the Forum for Sustainable and Responsible Investment is around $12 trillion—these actions are clearly out of tune with investors and the marketplace.
Earlier this summer, the SEC began finalizing rules that will restrict investors’ ability to engage corporate managers—even limiting their ability to seek timely advice on how to vote on complex shareholder resolutions.
Now the DOL is expected to enact similar rules restricting ERISA-regulated fiduciaries as part of a so-called “harmonization” of regulations. As is the case with the DOL’s proposed restrictions on investment selections, these efforts seem motivated by an ideological crusade to stymie growing investor interest in ESG strategies.
Shareholder resolutions have been used for decades by Franciscan nuns, climate activists, and corporate watchdogs alike to hold executives accountable on ESG issues. And as the evidence of financial materiality of those issues has accumulated, mainstream investors from Blackrock to the Japanese pension system have begun to take note. But the coming changes to Rule 14a-8 will significantly increase barriers for submitting new proposals and could particularly hamper efforts around ESG.
A coalition of shareholders recently presented evidence and case studies from 2020 proxy voting illustrating that the proposed changes would have a chilling effect on the filing of ESG-related shareholder-sponsored resolutions. They cited research from the Sustainable Investments Institute (Si2) which found that 27 percent of social and environmental shareholder proposals voted for in 2020 would be ineligible for consideration in 2021 if the rule changes go through
Unfortunately, in its recent and impending actions, the DOL is poised to join in the missteps of the SEC. Once again, the investment community must prepare to unite in opposition to these rule changes. Together, we must let Washington regulators know that ESG is a non-negotiable aspect of the modern investment landscape and that these burdensome rules will harm retirement investors.
Fran Seegull is the Executive Director of the U.S. Impact Investing Alliance.