The Department of Labor Carpet Bombs Investor Protection

The Department of Labor (DOL) has launched a major attack on investor protection and shareholder rights in the last three months. In three successive strikes against long-standing practices of ERISA fiduciaries, the DOL has created disorder and confusion.  Its actions have included threatening managers of Employee Retirement Income Security Act (ERISA) assets with sanctions if they try to advance the inclusion and factoring of ESG considerations into the investment process, blocking such fiduciaries from using proxy advisers or voting on proxy matters unless they are certain such votes would benefit the pecuniary interests of the underlying beneficiaries. Most alarming, DOL has attempted to dismantle investor protections  and neuter fiduciary duties owed to ERISA plan beneficiaries.  CFA Institute [1] has directed its commentary in strong opposition to all three of these ill-advised efforts.

Discouraging ESG-Related Products and Services in the Investment of ERISA Assets 

DOL starts with an assault on current investment analysis conventions, advancing a not-so-hidden agenda to block consideration of anything climate-related in the investment management process.  It takes the form of placing strict limits on what we call ESG factoring in the management of ERISA funds.  The stated reason for these limits is to protect beneficiaries from an ERISA manager who might interject her own social or political views into the ERISA portfolio management process.  Moreover, DOL claims that ESG factoring potentially compromises the ERISA manager’s primary obligation to deliver best risk-adjusted returns, presumably as a result of being distracted by some financially irrelevant, social or climate change agenda.

As we detail in our comment letter to the DOL even professional investment managers are still trying to determine the best methods for measuring ESG performance, but they are fully confident that companies that manage financially material ESG issues most effectively are focused on best, long-term financial results. The consideration of various ESG factors, particularly climate impacts on the company receiving the investment, has become an increasingly important aspect of assessing the risk profiles of individual companies and overall portfolios.

CFA Institute generally concurs with the Securities and Exchange Commission (SEC) and DOL that materiality should determine the relevance of a factor to investment decisions.  Accordingly, more and more professional investors and analysts must use some form of ESG factoring as part of advanced risk management, alpha generation, and an ever-evolving skillset for active management. There is no evidence, empirical or otherwise, that supports the notion that material ESG considerations are not increasingly important to a complete risk-return analysis or that such factoring somehow violates investment fiduciary norms.

The example of negative screening for companies with excessive carbon footprints is instructive.  It is but one ESG factoring tool investors may use in performing rigorous fundamental analysis of a company’s regulatory, financial, and investor-sentiment risks.  To be most useful, greater detail and consistency in company ESG disclosures are needed, together with increased standardization of the sustainability reporting methods. Rather than banning the use of such information, DOL should be encouraging principles that will help make material information more available and useful for investors, thereby reducing their costs of collection and analysis.  Even with informational shortcomings, ESG factors have become important economic considerations and their use a significant analytical tool for pursuing a best risk-adjusted return strategy.

In the context of the investment marketplace in 2020, the concerns and interests of the underlying beneficiaries of ERISA funds are neither monolithic nor different from those of  the rest of the investing public.  Investment strategies and products and approaches to retirement saving are evolving rapidly, and the ERISA fiduciary must have the flexibility to adapt.  Government-mandated limits on proper analysis, new tactics, or emerging investment products in ERISA accounts is inconsistent with fiduciary duties. Ultimately, it will be detrimental to keeping young savers focused on developing proper retirement-savings habits.  ERISA and its mandated investment practices must stay as current and relevant as the rest of the investment industry.

We agree that an ERISA fiduciary should never confuse investing for best risk-adjusted return with seeking purely social outcomes. But neither should fiduciaries be threatened with sanctions for considering new and evolving factors that are material to proper financial analysis. Likewise, including ESG-focused strategies or products as investment options for ERISA beneficiaries should be embraced rather than deemed to run afoul of DOL thinking.  As long as any ESG product has been through a documented due diligence review by the ERISA fiduciary and full disclosures have been made about any risks, costs, or performance issues related to it, the product  should meet ERISA fiduciary requirements.

Proxy Voting – Don’t Bother If It’s Too Expensive or ESG Related

The second target of the DOL is shareholder rights and  the proxy voting responsibilities of ERISA fiduciaries.  Corporate governance stakeholders have seldom witnessed a more blatant government intervention that advances corporate interests to the great detriment of shareholder rights.

This latest DOL proposal, announced in late August, seeks to undo a landmark of fiduciary duty for proxy voting. That landmark was set by the so-called Avon Letter, written in 1988, and stemming from a proposition raised by renowned shareholder rights warrior Robert Monks when he served at the DOL. In the letter, DOL said that fiduciaries that oversee retirement plans regulated by ERISA must treat proxy voting as another of the fund’s assets. Importantly, they must do so with diligence and care when analyzing and voting proxies in the best interests of beneficiaries.

The Avon letter has stood the test of time and serves market integrity admirably. It has led to a much more consistent and accountable proxy voting process by fund managers.  Importantly, the industry has moved away from treating proxy voting as an afterthought.  It was Avon that prompted not just ERISA funds but many public pension funds to pay attention, review the proxy issues, and submit votes that reflect the interests of investors.  Proxy voting was not meant to be just a rubber-stamp for management’s views, but rather the key to shareholder rights and better corporate accountability.

This proposed rule not only shelves the Avon Letter, it tries to diminish proxy voting to the point where the fiduciary “prudently determines that the matters being voted upon would have an economic impact on the plan.” The department has gone from a regime of it is part of your fiduciary duty to vote proxies to a misguided directive to skip votes deemed non-pecuniary.  It is no secret that the current DOL sees ESG issues in the “skip” category. It specifically warns that ERISA plan votes are not “to be used to support or pursue proxy proposals for environmental, social or public policy agendas that have no connection to increasing the value of investments used for the payment of benefits or plan administrative expenses.”

The Labor Department says this is to “ensure that individuals responsible for the retirement savings of millions of American workers are voting proxies only where it is financially in the interest of the plan to do so.”  It warns that if a fiduciary cannot establish the direct connection of such votes to a positive effect on financial returns for underlying beneficiaries, such fiduciary risks violate the new ERISA duties. At the same time, DOL proposes a safe harbor under “permitted practices” for fiduciaries voting with management. Though it is unclear how DOL would monitor, enforce, and penalize such violations, the message is that shareholder activism and voting for ESG matters is out.

Clearly this proxy voting gyration, and its companion DOL effort to limit the use of ESG investment strategies, are twins in a last-minute and calculated effort to reject climate change, investor activism, and shareholder rights wherever they can be rolled back.

Fiduciary Duty Rollback

The most potentially damaging attack on retirement investor protection is the DOL’s efforts to recast ERISA fiduciary duties.  DOL contends that such efforts ensure that the interests of retirement investors are always foremost and ahead of the interests of the investment firms and sales agents who advise retirement savers.  Similarly, DOL claims to support enhancing the investment options available to retirement savers without placing undue burdens on retirement sales agents.

The truth is that many of DOL’s proposals weaken the fiduciary regime that has long-been the foundation of ERISA. Of particular concern is the proposal’s new and broad-based exemption for ERISA fiduciaries, which allows financial institutions and their agents to act in direct conflict with the obligation to put investors first by simply disclosing that such conflicts exist.  That approach comes as a result of synching ERISA with the SEC’s new Regulation Best Interest (Reg BI).

Synching Reg BI Means Sinking Investor Protections. The justification DOL gives is that it needs to clean up and make more consistent investment-advice practices and rules across all types of retirement and investment accounts.  It is mischaracterized as merely a step to clarify and coordinate ERISA duties with the standard of care modeled after the SEC’s Reg BI.

The move would actually undermine the demanding ERISA fiduciary duties in favor of the untested and confusing standard of Reg BI.  The ERISA duty is a true fiduciary duty requiring the financial adviser to act with loyalty and care and to avoid or mitigate conflicts.  Conversely, much of Reg BI was left undefined by the SEC and is merely a sales agent standard based on disclosure of conflicts.

Like investors now dealing with Reg BI, we are concerned that ERISA investors will not understand the distinction between fiduciary and best interest advice nor fully comprehend what the difference may mean for the quality and independence of the advice they receive. In effect now for only two months, Reg BI has not been operational long enough for anyone to assess whether it can adequately replace ERISA’s existing fiduciary standards. Despite the attraction of regulatory harmonization, any conclusions are premature.

Resurrecting the Five-Part Test. The department’s official reinstatement of the so-called five-part test from 1975, which determines what constitutes investment advice and thereby who counts as a fiduciary, is outdated. DOL recognized the test’s shortcomings  in 2016, including its failure to meet the statutory intent of defining who qualifies as an ERISA fiduciary.

A Two-Pronged Assault on Fiduciary Duty. We are concerned about the combined effects of the five-part test and the new, broad-based exemptive framework that has been proposed.  The test is susceptible to regulatory circumvention, allowing sales agents as well as investment advice fiduciaries to skirt ERISA’s fiduciary obligations. The new proposal provides another escape by allowing those who still qualify as investment advice fiduciaries under the test to qualify for exemptive relief.  It is a lethal combination for investor protection and, if successful, makes thousands of ERISA practitioners eligible to receive a wide variety of payments from brokers and investment product providers whose interests may conflict with those of the underlying ERISA beneficiaries.

CFA Institute has long advocated for a fiduciary duty standard that applies to all who provide personalized investment advice to retail investors. Our Code of Ethics and Standards of Professional Conduct, to which all members must annually attest, requires members and candidates to “act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests.” We believe it is more important than ever to provide retirement savers with appropriately tailored investment-advice protections while preserving investment options and encouraging greater financial literacy and education.

The Big Jam Through 

Finally, it comes as no surprise that many are protesting the DOL’s 30-day comment period for each of these efforts to change the nature of ERISA fiduciary responsibilities, claiming it is too short for interested parties to provide proper feedback. None of the proposals has been the subject of meaningful public testimony or hearings. ERISA fiduciary duties, investment advice issues, and proxy voting duties are complicated, as is their interplay with similar SEC initiatives.  For DOL to abbreviate the typical  90-day or longer comment period seems to  reflect regulatory capture by the same commercial investment management interests that surfaced in Reg BI debates.  The rush to unwind the long-standing fiduciary obligations of ERISA practitioners and well-established norms for thorough investment analysis and proxy voting practices is deeply misguided.


[1] CFA Institute membership includes more than 185,400 investment analysts, advisers, portfolio managers, and other investment professionals in 163 countries, of whom more than 178,500 hold the Chartered Financial Analyst® (CFA®) designation. CFA Institute membership also includes 160 member societies in 77 countries and territories.

This post comes to us from Kurt N. Schacht, the head of policy at CFA Institute and former chair of the SEC Investor Advisory Committee, and Karina Karakulova, a policy director in the Washington, D.C., office of CFA Institute.