Field Notes: ERISA Guideline Reform

Field Notes

This primer offers a quick guide to the Department of Labor's 2015 clarification on the fiduciary framework for impact investing by retirement funds.

Photo by Jeff Sheldon

Forty years ago President Gerald Ford signed the landmark legislation the Employee Retirement Income Security Act of 1974, known as ERISA. The government's guidance on how pension funds can comply with the bill has been adjusted several times over the years and is now at a turning point, as a recent repeal of the 2008 ERISA guidance ushers in a new era in socially-conscious pension fund investments.

What is ERISA's purpose?

ERISA was established to safeguard the pension and health funds of the millions American working in the private sector. Signing the bill on Labor Day of 1974, President Ford stated its intention to protect workers from losing benefits when they leave jobs, or when employers close down without sufficient funds to pay out pension benefits. In his address Ford declared that the "men and women of our labor force will have much more clearly defined rights to pension funds and greater assurances that retirement dollars will be there when they are needed."

What does ERISA do? 

Until the day recipients begin to receive their pension funds, ERISA ensures that portfolio managers oversee and prioritize the growth of assets. Oversight of ERISA is divided between three federal agencies: the Department of Labor (DOL), the Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corp (PBGC). They ensure that pension plan fiduciaries act prudently, diversifying their investments to minimize the risk of large losses. Additionally, ERISA requires pension funds to provide participants with information about their plans, outlines the fiduciary responsibilities of those who manage and control plan assets, and requires plans to establish grievance and appeals process for participants. It also establishes that participants have the right to sue for benefits and breaches of fiduciary duties.

How has ERISA changed over time? 

In 1994, updated guidance from the Department of Labor [PDF, pp. 4-5] permitted pension plans to consider environmental, social, and governance (ESG) factors, when “choosing between investment alternatives that are otherwise equal with respect to return and risk over the appropriate time horizon”. In short, ESG factors could be used as tie-breakers between comparable investments, opening up trillions in assets to socially-conscious investing. Four years later, in a letter to Calvert Investments that became known as the "Calvert Letter," the DOL maintained that making "economically targeted investments" or ETIs, which are expected to create "economic benefit" as well as return to the investor, was consistent with the fiduciary duties of portfolio managers

In 2008, however, the Department of Labor superceded their 1994 guidance with Interpretive Bulletin 2008-1 [PDF], which underscored ERISA's requirements to put financial return first, stating that "fiduciaries who rely on factors outside the economic interests of the plan in making investment choices and subsequently find their decision challenged will rarely be able to demonstrate compliance with ERISA absent a written record demonstrating that a contemporaneous economic analysis showed that the investment alternatives were of equal value.” Coming about in the midst of the financial crisis, "Many plan sponsors viewed that 2008 guidance as a disincentive to offering responsible investing elections," according to Calvert's Lynne Ford.

What is the latest change and what brought it about? 

In October of 2015, Labor Secretary Thomas Perez announced a big change, the withdrawal of the 2008 guidance, because it had "unduly discouraged plan fiduciaries" from considering ESG factors. The new guidance allows pension fund fiduciaries to consider ESG factors, remain compliant with ERISA’s fiduciary obligations, and have fewer concerns over repercussions from the Department of Labor for insufficient documentation. At the announcement Perez remarked

In the wake of that 2008 guidance, that train [of ESG investing] has continued to barrel down the tracks, largely leaving behind some $8.4 trillion worth of assets in ERISA-covered defined benefit and defined contribution plans. The marketplace has experienced explosive, exponential growth, but ERISA fiduciaries face artificial barriers from making these investments — not because they aren't sound investments, but, perversely, because they also promote the public good.

For seven years, while we've effectively discouraged and dissuaded ERISA fiduciaries from pursuing these kinds of investments, the business community and the non-ERISA investment communities didn't just stand still — they've charged full steam ahead on that train... the trajectory is truly staggering: $202 billion in 2007, then soaring to $4.3 trillion in 2014. But ERISA plans are on the outside looking in at that stratospheric growth.

With that growth has come improved metrics, which were unavailable seven years ago, allowing us to more precisely evaluate the performance of a given investment. Some of the biggest fund managers out there are employing these tools and making decisions about their entire portfolio accordingly.

And what those analytics often tell us, in fact, is that these so-called "collateral" benefits aren't necessarily collateral at all. In fact, the social impact can be intrinsic to the marketplace value of an investment. In other words, ETIs can be the place where doing well also means doing good.

What does this mean for impact investing? 

Under the new guidance, known as Interpretive Bulletin 2015-01 [PDF], pension plan fiduciaries can invest in organizations with whom they share a social mission when presented two equally financially viable alternatives: “In these instances, such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices." The guidance opens up countless socially-conscious investment opportunities to one of the market's largest pools of assets under management, representing a major step forward for the investing community's ability to channel assets for positive financial and social return. 

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