Trillions at Stake as 401(k)s Become ESG Political Footballs

The stage is set for President Joe Biden’s first veto, which would halt an effort to block a new policy on socially conscious 401(k) investing as retirement plans play a larger role in forging a greener Wall Street.

Enormous amounts of executive and legislative political power in Washington are being spent in the clash over a whether private-sector retirement plans can even consider environmental or social impacts in the investments they choose. Regulators are facing at least two federal lawsuits in Texas and Wisconsin challenging their authority to promulgate that kind of rule in the first place while states crack down on public pensions that contract with environmentally friendly managers.

Some of that adversity came to a head late Wednesday when Senate Republicans convinced two moderate Democrats up for reelection next year to support passing a House resolution that would bar the US Labor Department from continuing to enforce its worker benefit rule. The president has pledged to veto it.

The pressure that seemingly benign DOL regulation faces on Capitol Hill and in the courts has the potential to shape the movement of nearly $30 trillion in investment capital and determine the returns of more than 140 million workplace savers. At issue is whether allowing the consideration of environmental, social, and corporate governance factors to seep into the closely guarded employer-driven retirement space amounts to “woke capitalism” or investment neutrality.

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“Trillions of dollars are on the line, and we’re counting on that money when we retire,” said Natalia Renta, senior policy counsel for corporate governance and power at the Americans for Financial Reform Education Fund. “If there’s ambiguity on what can or can’t be considered, that really puts our retirement savings at risk, because the issues we’re talking about are central to investing in the 21st century.”

Confusion and Hesitancy

Disagreement over the materiality of certain factors specific to the retirement space has introduced confusion among skittish plan decision makers and held back major Wall Street institutions from tailoring a new slate of products for 401(k) savers.

Animosity for ESG up-take in those private-sector retirement plans has drowned out what became seen as a commonplace strategy in the institutional and retail markets.

ESG investing was worth a $8.4 trillion last year, according to conservative US SIF Foundation estimates bound by proposed Securities and Exchange Commission regulations. Only about 14% of that represented pass-through assets under management, of which retirement plans are a slim minority.

“There is an arc of movement that has long been in favor of material ESG considerations,” said Steven Rothstein, managing director of the Ceres Accelerator for Sustainable Capital Markets. “Today, if you’re investing in a company out West, should you consider water bans and droughts? Of course, that is a real business risk.”

The Labor Department has said its rule was intended to untie the hands of financial advisers and their customers who have a fiduciary duty of prudence and loyalty to participants and beneficiaries.

The regulation undid a Trump-era policy that restricted plans to “pecuniary,” or financial factors only, so the Biden administration issued its loosened rule to clarify that ESG considerations can be relevant financial factors among many others. But, importantly, the rule doesn’t require ESG considerations. It only permits them, as part of a fiduciary’s risk-return analysis.

“If the unintended consequence of striking down language that says, ‘You may consider these factors for economic reasons’ is that you can no longer feel comfortable using a sustainable investment strategy, that indeed takes away a potential positive opportunity for participants,” said Matthew Eickman, national retirement plan practice leader at Prime Capital Investment Advisors LLC.

Dizzying Back-and-Forth

The legal battles in Texas and Wisconsin and the purported motive behind Wednesday’s Congressional Review Act resolution was to revert fiduciary guidance back to the Trump rule.

“For too long the intentionally obtuse investment strategy known as ESG has been used as a progressive weapon to reshape American culture and force partisan action in areas of life that have traditionally been free of political activism,” said Will Hild, executive director of Consumers’ Research, a nonprofit advocacy firm targeting corporate “wokeness.”

The Biden administration rule wasn’t a direct rebuke of Trump’s regulation, however. The administration had already issued a non-enforcement policy on the former rule, meaning the true effect of blocking the latest agency action would be to go back to Obama-era guidance emphasizing the financial materiality of ESG considerations.

That dizzying back-and-forth presents a real struggle for plan fiduciaries, said Dana Muir, a professor of business law at the University of Michigan Ross School of Business.

“The regulatory instability is entirely inconsistent with the need to have long-term investment strategies in defined-benefit plans and to have stable investment options in defined-contribution plans,” Muir said.

The true intent of litigation and legislation challenging the department’s rule is political gamesmanship, said Renta. The fate of a little-known rule for retirement savings could preview a renewed attack on future Biden actions.

“It is really frustrating that this particular rule is going to be the first veto of the administration, because it really is neutral,” she said. “But it’s part of a larger effort to imbue this E-S-G acronym with false meaning and legislate against it.”