Legal Battles Likely Over Trump’s ESG Crackdown, Advisers Say

The Trump administration’s proposal to require retirement plans to justify their investment in environmental, social, and corporate governance funds could lead to breach-of-fiduciary-duty cases piling up in courts.

A U.S. Chamber of Commerce representative called the proposed guidance “very problematic” and said the administration’s cure is worse than the supposed disease.

“The standards included will easily be challenged because there always could be an investment that performs better,” Chantel Sheaks, the Chamber’s retirement policy director, said. “In addition, the added documentation requirements are a road map for the plaintiffs’ bar.”

The new Labor Department guidance, released Tuesday, mandates that plan sponsors fully document their reasoning in pursuing those so-called do-good investment options. That means spelling out the “proper analysis and evaluation” involved, Kim Jones, a partner at Faegre Drinker, said.

“Fiduciaries are now on notice that ESG investments will be scrutinized if selected,” Jones said.

DOL: Don’t Sacrifice Returns

Officials from the Employee Benefits Security Administration, the Labor Department agency responsible for oversight of certain employee benefits, did not immediately respond to a request for comment on criticism of the proposal. In a Wall Street Journal op-ed published Tuesday, Labor Secretary Eugene Scalia touted the need to base investment decisions “solely on whether they enhance retirement savings.”

“The department’s proposed rule reminds plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end,” Scalia wrote.

And EBSA Acting Director Jeanne Wilson issued a press release stressing the importance of holding retirement security above all else.

Changing Times

Labor officials cite data from consulting firm NEPC’s July 2018 survey showing that approximately eight of the 69 plan sponsors surveyed had incorporated ESG funds into their investment portfolios. Per NEPC, approximately 70% of 401(k)-style plans featured an ESG fund, and 30% of traditional pension plans had adopted ESG funds.

Respondents said two things keep them from pursuing ESG investing: lack of data about the financial performance of ESG funds (34%) and fund vetting processes based solely on financial factors (27%). Overall, NEPC calculated that ESG funds account for $4.7 trillion in professional managed assets.

Ed Farrington, head of retirement and institutional sales at Natixis Investment Managers, estimated that less than 10% of 401(k)-style plans currently offer a sustainable investment option, such as an ESG-focused fund.

But times, and the core audience, are changing.

“Demand from plan participants is growing with 70% of millennials stating they want more sustainable investment options in their plan,” Farrington told Bloomberg Law. He attributes part of the uptick to investment returns that show “performance of sustainable funds is strong.”

Bloomberg Intelligence analyst Rob Du Boff said the Trump administration’s anti-ESG crusade might prompt cheers inside the White House, but it rings hollow elsewhere.

“I can’t think of a single ESG fund where returns are subordinated,” Du Boff said. “They live and die by their returns, same as every other fund.”

“This will likely put the burden of proof on ESG fund providers to show they have a rigorous process and are not just tree hugging, which may lead to challenges. That said, this could be a moot point come the elections in November,” he said.

Try Again

The Labor Department missed the mark on this one, in Sheaks’ opinion.

“The DOL has created more of a problem than what existed,” she said, poking holes in the administration’s projected compliance costs (about $57,000) and the time required (two hours) for the additional record keeping.

“Anyone who spends that little time likely would have breached their fiduciary duty with respect to a plan’s investment,” she said. “The DOL also ignores that plans will need to seek legal review of such documentation which will add significantly to the cost.”

George Michael Gerstein, co-chair of Stradley Ronon Stevens & Young LLP’s fiduciary governance practice, said the administrative screw tightening will hinder plan fiduciaries and ESG fund managers alike.

“ESG funds and products that have short track records, low assets under management, and/or are somewhat more expensive than similar non-ESG funds, will be particularly vulnerable under this proposal,” Gerstein wrote on his firm’s website.

Future Shock

Fiona Reynolds, CEO of the United Nations-backed Principles for Responsible Investment, blasted Labor Department officials for what she called their antiquated thinking. PRI maintains that ignoring climate change is a recipe for disaster—whether the Trump administration believes it or not.

“DOL has stepped in to prevent progress on ESG integration by American retirement savers,” Reynolds said in a press release. She called the proposed rule “a risk to the U.S. pension market” and “U.S. savers.”

“The Department must make clear that fiduciaries should be considering material ESG factors such as climate change risks as part of their investment processes,” she said.

Fighting the future is futile, Natixis’ Farrington said. He predicts that ESG funds “will be available in all plans within 10 years and will be chosen by the majority of plan participants by that time.”