Trump loses his link to your 401(k) in the Department of Labor ruling

On Tuesday, the Biden administration finalized a set of rules that will make it easier for employers to include so-called impact investment funds in their retirement plans. In particular, the Department of Labor will no longer prohibit employers and consultants from considering outside factors such as social impact when evaluating investment assets for an employer-sponsored retirement plan. This has been hailed as a victory for environmental and social movements, but employers may need to pay attention to a rule that could change hands with each new Washington administration.

Consider working with a financial advisor for help navigating how this will help your own retirement investment options.

What is the DOL ESG Rule?

The new rule is broadly written, meaning it allows employers to explore different asset classes. But it is specifically aimed at creating more opportunities for ESG investing, or “Environmental, Social and Governance.” Also known as impact investing, these are portfolios that invest around specific social and political causes. For example, a portfolio can explicitly choose not to invest in fossil fuels and dirty industries, or it can proactively invest in renewable energy companies.

ESG investing has grown significantly in recent years. A September Dow Jones study called this “the biggest growth opportunity for investment professionals,” and expected the industry to more than double between 2022 and 2025.

However, employer-sponsored pension funds have recently avoided this category of investing due to a rule passed by the Trump administration.

The Trump-era rule amended ERISA to specifically prohibit employers and advisors from considering factors other than risk, return and financial performance indicators when selecting assets for a retirement portfolio. In particular, the employer-sponsored retirement plan “required fiduciaries to select investments and investment behaviors based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.”

Employers who appeared to consider outside factors could be subject to legal scrutiny by the Department of Labor. Failure to comply with this rule was considered a breach of fiduciary duty, a serious charge that could warrant enforcement action, up to and including loss of license for involved financial professionals.

While these rules do not specifically mention ESG funds, the Trump administration has made it clear in external statements that they intended to cool down impact investing. It seems to have worked. While hard data is scarce, anecdotal reporting suggests that employers avoided ESG funds in their 401(k)s and related plans to avoid Trump Department of Labor investigations.

This rule was widely criticized not only by social activists, but also by the financial community as a whole. As MarketWatch reported in 2020, about 96% of all public commentary was against this change to ERISA, and professional investors noted that ESG funds actually outperformed the market as a whole in 2020. This rule not only forced employers to avoid funds that their employees might personally prefer, potentially hurting an employer’s ability to attract younger talent, but also what might have been the better investment at the time.

The Biden administration rule reverses these requirements in three specific ways.

First, employers are no longer required to consider only raw performance when considering a retirement investment. Instead, “a fiduciary’s duty of care should be based on factors that the fiduciary reasonably determines are relevant to risk and return analysis and [such] factors include the economic effects of climate change and other ESG considerations on the specific investment or investment practice.”

Second, an employer can use ESG funds as the default investment options of its retirement plan. They cannot subordinate financial performance to unrelated goals, which means they cannot select an underperforming impact fund. However, as long as fund returns are strong, an employer can make ESG funds their first choice.

Finally, employers can use impact issues as a “tie-breaker” when choosing between equally competitive funds. The Trump-era rule required competing investments to be “economically indistinguishable” before an employer could choose based on impact-related issues. Given the range of data available for any investment product, this was a functionally impossible standard to meet, and one that prompted scrutiny by an openly hostile regulatory body.

What does the Biden ESG rule mean for fiduciary duties and your investments?

The new rule reiterates “the long-standing principle that the fiduciary should not accept lower returns or greater risks in order to secure collateral benefits.” However, within that context, an employer can choose investments based on impact issues, as long as the fiduciary “can cautiously conclude that competing investments or investment actions equally serve the financial interests of the plan over the appropriate time horizon.” In other words, as long as competing investments are essentially similar, they need not be identical.

The result is a mixed one for employers seeking ESG investment opportunities. This is a field that can have both financial and employee culture benefits for many employers. Impact-related investments usually yield competitive outcomes and are very popular with younger workers. Employers who want to seek that return or those employees can do so now.

However, there is also a significant risk of whiplash in the future. Republican politicians have emerged as openly hostile to ESG, and many national figures have made opposition to impact investing a campaign theme. As a result, employers may have to anticipate rules that change every time a new party wins the presidency, a potential headache for plan administrators who prefer to think in terms of decades rather than presidential administrations.

It boils down

The Biden administration has reversed a Trump-era rule that restricted investment in funds that focus on environmental, social and governance issues. While employers can now freely pursue these investments, they must be wary of an issue that has become increasingly politicized in recent years.

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Photo credits: © Khirisutchalual, ©

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