Press Release
SIF Criticizes U.S. Department of Labor Employee Benefit Division for Ambiguous Recent Bulletins on Fiduciary Duty
CONTACT: Meg Voorhes, 202-872-5362 or mvoorhes@socialinvest.org
WASHINGTON, D.C. |
December 19, 2008 |
SIF CEO Lisa Woll and Chair Cheryl Smith write to the Department of Labor's Employee Benefit Security Administration, which administers ERISA, to criticize two recent bulletins that could discourage fiduciaries from considering environmental, social and governance factors in investment decisions. They say that while the basic foundation underlying fiduciary principles (of protecting the financial interests of the pension fund beneficiary) remains intact, the bulletins’ ambiguous language could discourage prudent decision making by trustees in the area of investment policies, proxy voting and shareholder engagement with companies.
Bradford P. Campbell, Assistant Secretary,
Employee Benefit Security Administration
United States Department of Labor
Dear Assistant Secretary Campbell,
In October, your office took the unfortunate step of making modifications to the Department of Labor's official view on fiduciary duties, 29 CFR 2509.08-1 and 29 CFR 2509.08-2. Arguably, these modifications sought to limit investment management discretion as well as the exercise of shareholder rights by pension fund fiduciaries. While it appears that the basic foundation underlying these principles remains intact, internal inconsistencies and ambiguous language in the bulletins could discourage prudent decision making by trustees in the area of investment policies, proxy voting and shareholder engagement with companies. We believe the current leadership at the Department may be misrepresenting the consensus understanding on fiduciary duties as it has evolved from legal and regulatory precedents as well as the steps taken by a number of leading pension funds. We also believe that now is the time for the new administration to restate the consensus view that fiduciary duty may compel fiduciaries to consider environmental, social and governance (ESG) factors.
The Labor Department’s guidance fails to support fiduciaries that undertake these activities in fulfillment of their fiduciary duties. As a result, many cautious fiduciaries may read this guidance as encouragement to “do nothing” rather than risk an enforcement action for taking steps to protect the long term value of plan assets. As discussed below, this cautious attitude may in fact be imprudent, exposing beneficiaries to severe risks that may have been avoided. The Labor Department’s most recent guidance places efficiency above all, suggesting that any activities that may impose costs in order to pursue an uncertain outcome violate fiduciary duties. This is a misconception, and a potentially dangerous one.
The Shareholder Rights Bulletin
As just one example of the confusion regrettably created by the bulletin regarding shareholder rights, 29 CFR 2509.08-2, it is unclear if the Assistant Secretary was seeking to change the standard for fiduciaries' activities intended to monitor or influence the management of a corporation whose shares their plan owns. On the one hand, the Bulletin amends the previous guidance from “likely to enhance the value of the plan's investment in the corporation” to “will enhance the economic value of the plan's investment in the corporation” (emphasis added). This standard is impossible to apply, as it is never possible to predict the outcome of shareholder activity with any certainty, just as it is impossible to predict stock price movement with any certainty. This standard, if applied literally, would appear to make shareholder engagement activities exceedingly more difficult, if not impossible, to justify.
Or perhaps there is no real change. This section of the Bulletin also refers to a “reasonable expectation” of enhanced value. In light of that language, it may signify that if fiduciaries have a reasonable basis for concluding that it will have a positive effect, they may have some discretion in exercising their rights to engage companies. If that is the case, then there may be an argument that little, if anything, has changed in the Department's position.
In addition, the Bulletin does not modify its favorable treatment of activities that seek to monitor or influence “the nature of long-term business plans, the corporation's investment in training to develop its work force, [and] other workplace practices.” This construction leaves us wondering whether the altered language was inadvertent rather than intentional, and not meant to amend the standard at all.
These various interpretations seem to have found proponents for their respective positions and demonstrate that observers and fiduciaries are uncertain as to its meaning. For example, there have been disparate readings of the significance of this Bulletin in the media. Compliance Week concluded that the Bulletin “makes it tougher for funds investing for the long term to consider environmental, social, and governance issues such as climate change, human capital and reputation.” On the other hand, Global Pensions reported that the Department was simply reiterating its stance against the taking of political action via pension fund investments.
Furthermore, it would appear that the Bulletin is not consistent with other Department regulations. Consider for example how 29 CFR 2550.404a-1, the Department's adoption of modern portfolio theory, relates to the Bulletin. Under 29 CFR 2550.404a-1, decisions respecting individual assets and courses of action must be evaluated not in isolation, but in the context of the portfolio as a whole and as part of an overall investment strategy. In other words, one cannot judge a particular proxy vote or engagement in isolation as a breach of fiduciary duty. Rather the question whether there is a breach of fiduciary duty depends on the full spectrum of fiduciary conduct, which taken as a whole is reasonably intended to "to further the purposes of the plan.” As a result, the Bulletin's focus on “the economic value of the plan's investment in the corporation” seems inconsistent with modern portfolio theory, prior and other Departmental guidance and common practice. Thus, it can only serve to create confusion for fiduciaries.
These examples illustrate the inherent problems with the Shareholder Rights Bulletin. In contrast, the 1994 Interpretive Bulletin and the so-called “Calvert Letter” provided fiduciaries with a clear understanding of the consensus surrounding fiduciary duties. For these reasons, we call on the new administration to discard the 2008 Interpretive Bulletin on Shareholder Rights.
The ETI Bulletin
The ETI Bulletin, 29 CFR 2950.08-1, also presents fiduciaries with more questions than answers. To begin, the Bulletin defines “Economically targeted investments” as “investments selected for the economic benefits they create apart from their investment return to the employee benefit plan.” It goes on to describe the conditions under which an ETI would and would not violate fiduciary duties.
By way of illustration, the Department also offered four examples of transactions that would violate the rule it described. Those examples include investments in (1) a competing company; (2) a large loan for a construction project to provide jobs; (3) an affordable housing bond; and, surprisingly, (4) environmental or “so-called 'green' companies”.
This illustration creates confusion and uncertainty because while examples 1 – 3 clearly fall within the definition of an ETI, example 4 does not. Why did the Department include an example that seems so out of place, arguably irrelevant, in a discussion of ETIs? Is it, as contemplated by one commentator, a suggestion of a broader intent behind the ETI bulletin? Or is it so far afield that it should be regarded as an error? And the question still remains whether the rule described in the ETI Bulletin applies to the selection of funds within a defined contribution plan subject to ERISA.
In short, the ETI Bulletin does not shed a clarifying light on the subject for fiduciaries. It only brings uncertainty and doubt to an otherwise rigorous and previously well understood area of fiduciary duties.
Going Forward – ESG factors and the Prudent Investor
We want to take this opportunity to do more than document some of the failings of the two Interpretive Bulletins. We also see this as the appropriate time to call for Department guidance to align with investment and management realities in the 21st Century. Specifically, that environmental, social and governance (ESG) considerations are consistent with fiduciary duties and can be justified – like any other factors that fiduciaries take into account – on an economic basis as likely to advance the financial performance of the plan’s portfolio.
Fiduciaries of some of the largest and most respected institutions in the world (with literally trillions of dollars under management) have long understood, with the support of academic and investment house research, that ESG issues such as climate change, water scarcity, executive compensation, corruption, sweatshop labor and other human rights issues have material impacts on corporate and portfolio performance and value. Company and portfolio value is the result of many factors, including how companies manage the risks presented by ESG challenges. It flies in the face of robust peer-reviewed research for the Department to argue that a fiduciary cannot conclude, for example, that a company’s environmental performance, or corporate governance, may have some material impact on its future financial prospects.
Quite the contrary is true – there is a substantial body of respected literature showing that ESG factors can be material to financial performance and/or that investing that incorporates ESG factors is capable of outperformance or performs no worse than so-called mainstream investing. See Demystifying Responsible Investment Performance, Fall 2007, a joint report by The Asset Management Working Group of the United Nations Environment Programme Finance Initiative and Mercer reviewing 20 academic studies. It is just as difficult, if not more difficult, to "prove" that any specific item on the balance sheet or income statement has materiality as it is to "prove" the materiality of any individual ESG factor; taken together, however, they are often sound indicators of good management. The law of fiduciary duty in at least nine jurisdictions, including the
Contrary to the views expressed in the Department’s Bulletin, activities such as proxy voting on a specific proposal can be undertaken at virtually no cost to the plan, which, according to prior Department guidance, already has a fiduciary duty to vote its proxies in the best interests of its beneficiaries. (Letter from the Department to Helmuth Fandl, Chairman of the Retirement Board of Avon Products, Inc. (Feb. 23, 1988) (“
Other engagement activities can be undertaken at relatively low cost. Such judgments should fall within the fiduciary’s broad discretion to make. We also observe that many funds are effectively universal owners, obliged by the size of their assets and prudent portfolio diversification to effectively own the market. For those shareowners, the only way to improve portfolio performance may be through shareholder engagement.
Now is the time to update these concepts for the 21st century. Once, stocks were considered imprudent. But as our understanding of prudent and efficient asset allocation developed a track record, fiduciary law evolved to reflect the realities of stock market investing. The current economic crisis is a reflection of many diverse factors. At least two factors are particularly relevant here: the behavior of public corporations and the behavior of investors. Fiduciaries need guidance and support if they are to evaluate these rapidly changing challenges and play an effective role monitoring the behavior of market actors.
According to economist Nicholas Stern, Chief Economist and Senior Vice-President of the World Bank from 2000 to 2003, in The Stern Review on the Economics of Climate Change, the global economy could shrink by 20 percent as a direct result of the massive effects of climate change over the next century. Extreme weather conditions alone would reduce global GDP by 1 percent. And depending on the degree to which global temperatures rise, global output could be reduced by up to 10 percent. Could prudent fiduciaries, considering ESG factors, have acted to help avert this crisis? Fiduciaries managing more than $6.4 trillion are now working to address that question under the auspices of the Investor Network on Climate Risk, the European Institutional Investors Group on Climate Change, and the Investors Group on Climate Change. What if they had acted 10 years ago, or 20, when the risks were coming to be known, but were not yet considered to be financially “material”? Did the concept of “materiality” force them to wait until catastrophic losses were too late to avoid? Could fiduciaries have helped to avert the housing crisis, and the ensuing economic crisis, by addressing the predatory lending practices of their portfolio holdings? These are but two examples of the danger of the Labor Department’s recent guidance. Fiduciaries must be protected in their efforts to understand and address these emergent risks.
In closing, it is important to note that these recent bulletins appear to have been prompted by a letter from the Chamber of Commerce seeking to curtail actions by the AFL-CIO. The Department has refrained from doing so. However, any objective reader of these releases must conclude that their apparent departures from prior guidance and established legal principles was motivated by political considerations. Beneficiaries deserve better. The wide discretion afforded to fiduciaries in managing plan assets must be protected from such influence.
We would welcome the opportunity discuss any of these matters further at your convenience.
Sincerely,
CEO
Cheryl Smith
Board Chair