Patrick Gilsenan
Associate Editor
Loyola University Chicago School of Law, Weekend JD 2023
In the last days of the Trump administration, the Trump Department of Labor (“DOL”) finalized a rule that made it more difficult for socially conscious investments to be included in retirement plans. The Trump-era rule discouraged employer 401(k) and other retirement plans from offering funds from managers that consider Environmental, Social and Governance (“ESG”) factors over investment returns or risk in their due diligence. Despite this, ESG funds continue to gain in popularity, and the new Biden administration has stated that it will not enforce the Trump-era rule as it considers reversing it.
Protecting vulnerable retirees or climate change denial?
Under the Employee Retirement Income Security Act (“ERISA”), employers that maintain retirement plans are subject to fiduciary responsibilities regarding the administration of the plan. These fiduciary duties were clarified under the Trump-era rule to stipulate that it’d be a breach of an employer’s fiduciary duties to select investments based on anything other than a fund’s risk and return. This effectively means that in comparing two retirement funds, if one performs better than the other, but the other prioritizes social and environmental good, employees should only be given the choice to invest in the first fund. Including the fund that prioritizes social and environmental good in its offerings would invite further legal scrutiny, with the reasoning that including such a fund could damage their employees’ financial outlook.
Eugene Scalia, Secretary of Labor under President Trump and son of late Supreme Court Justice Antonin Scalia, argued in an op-ed announcing the rule that “when investments are made to further a particular environmental or social cause, returns unsurprisingly suffer.” He further went on to state that under the ERISA plan “fiduciaries act with an ‘eye single’ to funding the retirements of plan participants and beneficiaries” and that “it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end.” Despite it often being untrue that ESG funds underperform their counterparts, with U.S. ESG Funds outperforming conventional funds in 2019 and 2020 according to Morningstar, the finalized rule went on to establish burdensome requirements for analysis and documentation of any ESG investment option.
The rule has proven unpopular, with 96% of more than 8,730 comments on the rule during its comment period negative, and opposition coming not only from environmental groups but large conventional asset managers including BlackRock, Fidelity, State Street, T. Rowe, and Vanguard. According to Mindy Lubber, president of sustainable investing advocate Ceres, the rule “is another harmful action by the Trump administration, at a time when the global climate crisis looms large as another systemic risk upending lives, livelihoods and causing deadly devastation and damage.” Additionally, on a global level, the rule stands in contrast with the European Union, which in 2019 adopted rules to integrate ESG factors into its investor duties instead of locking them out. Lacking support from the financial industry, environmental groups, and global markets, some have gone so far as to say that the rule looks like nothing more than “lame-duck hippie-punching… to throw a bone to climate-change deniers.”
The growth and promise of ESG funds
As the rule went into effect only eight days before President Joe Biden was sworn in, many observers rightfully expected the Biden administration to walk it back. Sure enough, on President Biden’s first day in office, he signed an executive order that called for an immediate review of federal regulations passed in the last four years that conflict with the national objective of confronting the climate crisis. On March 10, 2021, the now Biden DOL issued a statement indicating that it won’t enforce the Trump-era rule as it continues its review, and indicated the DOL intends to revisit it, which could lead to rescission or a rewrite.
Even with the chilling of retirement investments into ESG funds, ESG funds have become enormously popular. Net investment flows of $51 billion in 2020 into sustainable funds were more than double their total for 2019 and nearly 10 times more than in 2018, according to Morningstar. Should 401(k) and other employee sponsored retirement plans have more access to ESG funds, those investments could grow even faster. According to the Investment Company Institute, as of 2019 there were $6.4 trillion in assets in 401(k) plans, and $2.7 trillion in other defined-contribution plans such as 403(b) plans. Further, according to the Federal Reserve, in 2019 55% of non-retired adults have savings in a defined contribution plan such as a 401(k) or 403(b). The exclusion of this combined $9 trillion in wealth from a majority of Americans has been a major obstacle for ESG funds as they compete with conventional funds. However, if the Biden administration does reverse the rule, the floodgates could open as Americans have more control over their investments and choose to invest sustainably.