Saturday, June 2, 2018


Institutional shareholders are increasingly using their “voice” in matters of corporate policy, and, in particular, are taking an interest in “environmental, social, governance” (ESG) performance measures at their portfolio companies.  Investments are selected, and shareholders engage with management, using a variety of ESG metrics, often concerning matters like climate change, gender and racial diversity, and similar issues.  Though it’s often argued that some ESG engagement reflects the investors’ personal policy preferences rather than a sincere attempt to improve corporate performance, it seems that at least some ESG factors are, in fact, wealth maximizing.  It’s also been argued that many institutional investors have already diversified away their vulnerability to idiosyncratic risks and, by engaging on ESG matters, are attempting to protect themselves against systemic risks

Nonetheless, the trend has met with some criticism.  One set of concerns pertains to protection of retail investors to whom the institutional investors owe fiduciary duties – fear that their money is being used to advance social causes favored by the investment manager, rather than to benefit investors in the fund.

A parallel set of concerns has less to do with protecting fund beneficiaries than with protecting portfolio companies.  In the most charitable account, the fear is that inexpert fund managers will improperly meddle in corporate affairs, harming both their own beneficiaries and other shareholders.  In a less charitable account, corporate managers hope to avoid accountability to a powerful shareholder base by squelching institutional participation in governance (this is the account described in detail in David Webber’s new book, The Rise of the Working Class Shareholder, which Ben Edwards blogged about here).

The battle plays out to a large extent via federal securities regulation, in everything from the process for bringing shareholder proposals under Rule 14a-8 to new attempts to regulate proxy advisors.

And it also plays out in regulation of the funds themselves, many of which are retirement plans governed by ERISA.  Even those retirement plans that do not formally fall within ERISA’s ambit – local government plans, for example – may very well look to ERISA for guidance or best practices, making ERISA regulation a critical battlefield.  (Hence Anita Krug’s characterization of the Department of Labor as “the other securities regulator”).

Essentially, the critical question under ERISA has been, to what extent may fund administrators select investments based on ESG factors, and involve themselves in the corporate governance of portfolio companies?

Over the years, the DoL has issued a series of guidelines interpreting fiduciaries’ obligations under ERISA.  All emphasize that plan administrators must act to advance the economic interests of the beneficiaries, and may not subordinate those interests to “social” objectives.  That said, the Bush, Obama, and now Trump administrations have each put their own stamp their interpretation of an ERISA fiduciary’s obligations.  The Bush Administration’s 2008 interpretation emphasized, for example, that when voting proxies, “the responsible fiduciary shall consider only those factors that relate to the economic value of  the plan's investment … If the responsible fiduciary reasonably determines that the cost of voting (including the cost of research, if necessary, to determine how to vote) is likely to exceed the expected economic benefits of voting, ... the fiduciary has an obligation to refrain from voting.”  The Obama Administration, by contrast, stated that to the extent the Bush bulletin was interpreted to require a cost-benefit analysis for every vote or governance action, this was incorrect; instead, fiduciaries should generally vote unless there is a reason to believe costs exceed benefits, because – it would be assumed – most costs associated with a vote would be minimal.

The Obama Adminstration’s guidance was also more tolerant towards the plan involvement in corporate governance, and consideration of ESG factors in the administration of plan assets, than was the Bush Administration.  The Obama guidance stated that the Bush guidance might be “misinterpreted” to require specific cost-benefit analyses with respect to ESG factors, when in fact, fiduciaries may “recogniz[e] the long term financial benefits that, although difficult to quantify, can result from thoughtful shareholder engagement when voting proxies … or otherwise exercising rights as shareholders.”  The Obama bulletin went on to emphasize the growing recognition of the importance of ESG factors when making investment decisions, and the benefits of shareholder engagement.

But now the pendulum has swung back hard, via the Trump administration.  Trump’s bulletin warns, “Fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision. It does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors. Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits.”  The new bulletin further states that the Obama bulletin:

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 [Obama bulletin] 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…. 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 constitute the type of “special circumstances” that … warrant[] a documented analysis of the cost of the shareholder activity compared to the expected economic benefit (gain) over an appropriate investment horizon.

The new bulletin goes even further, by discouraging the inclusion of ESG funds within ERISA plans that permit plan beneficiaries themselves to choose among a menu of options.  Though the bulletin admits that fiduciaries may include ESG funds if plan participants request such an option, it also includes a footnote that contains a heck of a qualification:

in deciding whether and to what extent to make a particular fund available as a designated investment alternative, a fiduciary must ordinarily consider only factors relating to the interests of plan participants and beneficiaries in their retirement income. A decision to designate an investment alternative may not be influenced by non-economic factors unless the investment ultimately chosen for the plan, when judged solely on the basis of its economic value, would be equal to or superior to alternative available investments

The bulletin also warns against making an ESG fund a “default” option based on “the fiduciary’s own policy preferences.”

So what does all this mean?

Well, if you want law firm guidance, here's some; there’s also a brief discussion in the Wall Street Journal.

As for me, I’ll start with the obvious: the back-and-forth makes clear that a larger debate about the proper role of shareholders in corporate governance is playing out across the stage of ERISA regulation, raising questions about the degree to which actual concern for plan beneficiaries is motivating the shifts (except, perhaps, in the very broadest sense that different administrations have different ideas about what balance of power will ultimately benefit shareholders generally).

Beyond that, the attempts to discourage the inclusion of ESG funds in ERISA plans strikes me as a peculiar elevation of legally constructed investor preferences over the, well, actual preferences of investors – what Daniel Greenwood dubbed “fictional shareholders.”

It’s all well and good to require that ERISA fiduciaries act solely in the economic interests of beneficiaries, on the assumption that this is what beneficiaries would likely want, and on the assumption that wealth maximization functions as “least common denominator” for beneficiaries’ otherwise conflicting interests. 

But this reductionistic approach to defining beneficiary interests, adopted for the purpose of making them more manageable, should not stifle opportunities to accommodate the actual preferences of beneficiaries, especially when it is feasible to allow beneficiaries to sort themselves – like, say, when ESG-focused funds can be made available to those beneficiaries who are willing to sacrifice some degree of financial return to advance social goals.  Providing these opportunities to beneficiaries who choose them inflicts no damage on the interests of beneficiaries solely interested in financial return, and, in fact, the principle that investors should be able to control their own retirement planning is (supposedly) the reason these types of ERISA platforms are offered in the first place. 

The new guidance, then, seems less about protecting beneficiaries from politically-motivated fiduciaries than it is about forcing beneficiaries to participate in the political goals of the Trump administration, namely, minimizing shareholder participation in corporate governance, particularly when those shareholders advance (what are usually) liberal policy priorities.

Ann Lipton | Permalink


If I remember correctly, this bounced back and forth with Clinton and Bush too. But, at bottom, I think the substantive differences aren't all that large. As I read the guidance, even under the democratic presidents, financial value was still primary and ESG factors could only be considered as a tie-breaker or to the extent that they improved expected financial return.

Posted by: Haskell Murray | Jun 2, 2018 11:03:00 AM

Hi, Haskell. I agree; a lot of the changes from administration to administration may not amount to much, but I don't think they're meaningless. I think the new bulletin may be the first to take aim at ESG funds included in a menu of options, and I also think there are subtle differences in essentially the burdens of proof; under the Obama administration, there's more of a suggestion that the consideration of ESG factors would by default be considered reasonable; under Bush and especially Trump, there's more of a suggestion that the consideration of ESG factors requires extensive documentation of cost-benefit analysis.

Posted by: Ann Lipton | Jun 2, 2018 12:59:51 PM

On the question of including an ESG fund as one in a range of alternatives among which participants can choose, I find the bulletin's text and that footnote a little hard to reconcile. Here's what I think they are saying. In choosing fund options, a fiduciary must focus on financial return. However, if participants request that an ESG fund be made available, the fiduciary may do so, so long as the fund it picks is prudently managed. How different is that from what you would like to see? It does put the onus on participants to request that an ESG fund be made available. But where there is real demand for such a fund, how big an obstacle is that?

Ultimately, as Haskell says, even the Democratic administration guidance focuses on financial return as the sole proper objective. That is because the statutory language is pretty explicit. That is probably not how I would choose to do things, but a really substantial change (rather than arguing over the margins) would require amending the statute.

Posted by: Brett McDonnell | Jun 4, 2018 9:05:47 AM

Hi Brett. Yeah, I agree the text and the footnote are a bit at war with each other. Without the footnote, I would agree with your interpretation but the footnote itself seems to mandate that ESG focused funds may only be an option if they are financially equivalent to other options.

I'll add, based solely on the bulletin, my instinct is to either think - this is sloppy drafting and maybe they did intend the flexibility that you see, and the footnote is an anomaly, or we've got more than one drafter and they are at war with each other.

Posted by: Ann Lipton | Jun 4, 2018 9:13:01 AM

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