End of Week Notes
Biden order on climate risk supports ESG in retirement plans
But congressional effort to rescind SEC rule on shareholder proposals looks dead
Mostly good news on the regulatory front this week. Yesterday, President Biden issued an Executive Order on Climate-Related Financial Risk, which, among other things, included a provision asking the Department of Labor (DOL) to “suspend, revise, or rescind” the last-minute Trump-era rules limiting the use of ESG funds in retirement plans regulated under the Employee Retirement Income Security Act (ERISA) of 1974 and discouraging retirement plans from proxy voting. The EO asks for notice of proposed rulemakings to happen by September.
The EO also asks DOL to assess how the Federal Retirement Thrift Investment Board, which oversees the giant federal employee defined-contribution plan, has taken ESG factors, including climate-related financial risk, into account. That’s a way of prodding the board to add ESG options to the plan.
From the Fact Sheet accompanying the order:
Bolster the Resilience of Life Savings and Pensions. The Executive Order directs the Labor Secretary to consider suspending, revising, or rescinding any rules from the prior administration that would have barred investment firms from considering environmental, social and governance factors, including climate-related risks, in their investment decisions related to workers’ pensions. The order also asks the Department to report on other measures that can be implemented to protect the life savings and pensions of U.S. workers and families from climate-related financial risk, and to assess how the Federal Retirement Thrift Investment Board has taken environmental, social, and governance factors, including climate-related risk, into account.
If these both come to fruition, millions more American workers could save and invest for their retirements using investment options that consider material ESG risks, like climate-risk, and that encourage public companies to better serve workers and other stakeholders alongside shareholders.
So that’s good news. Given the extensive public comments the DOL received last year in response to the current rules, nearly unanimous in opposition, and past positions the DOL has taken, it already has a roadmap to crafting a straightforward approach.
However, what one Administration giveth, the next could taketh away. That’s how it has been with ESG since the first guidance related to SRI funds was issued in 1994. Under Democratic administrations, the DOL has generally made it easier to include ESG funds — or their forebears —in retirement plans, while Republican administrations have made it harder.
When the Trump DOL got hold of the issue last year, it was the first time any changes had been contemplated since ESG investing had become part of the investment mainstream. Far more investors, from individuals to institutions to professional asset managers, now care about ESG, and climate-risk, in particular, and this was reflected in public comments and the overall negative reaction to the final rule.
And a “rule” it is. The Trump DOL pushed through an actual federal rule last year, which carries more weight than interpretive bulletins. The latter only provide guidance on issues that aren’t addressed directly in the governing statute, in this case, ERISA. From 1994 to 2015, all the back-and-forth on ESG took place in interpretive bulletins.
It was much easier to swing from one interpretation to another when no rule was involved. Changing the rule requires going through another federal rulemaking process so it will take longer. But, as the EO directs, we should see a new proposed rule open for public comment by September, if not before.
ESG bill introduced in the Senate
One way to end the back-and-forth would be for Congress to take action. Yesterday, Sen. Tina Smith (D-MN) introduced legislation that would settle the issue. Her bill, The Financial Factors in Selecting Retirement Plan Investment Act, would provide legal certainty to plans that choose to consider ESG factors in their investment decisions or offer ESG investment options to plan participants.
The bill would formally repeal the current DOL rule and obviate the need for others, thereby limiting any future regulatory actions that erect barriers to discourage ESG investing by ERISA plans.
The bill would amend ERISA in three ways:
First, it makes clear that plans may consider ESG factors in their investment decisions when they are expected to have an impact on investment outcomes, provided plans consider them in a prudent manner consistent with their fiduciary obligations. This is the same legal standard that ERISA already applies to non-ESG investment factors a plan would typically consider.
Second, it allows plans to consider ESG factors as tie-breakers when deciding between otherwise comparable options. The tie-breaker rule existed in DOL guidance for decades, but was rendered very difficult to apply in the rule passed last year.
Third, it makes the selection process for default investments in plans the same as it is for other plan options. The existing DOL rule bans ESG funds from being selected as default options.
Morningstar has endorsed the bill, along with US-SIF, the American Retirement Association, SIFMA, CFA Institute, State Street Global Advisors, and Smart USA.
Chances of passage? Well, there’s this thing called the filibuster that will require 60 votes in the Senate. Maybe there’s hope: Helping American workers take climate- and other ESG risks into consideration and hold corporations accountable for more-responsible behavior in their retirement accounts need not be a partisan issue.
In fact, it isn’t if you look at surveys like those conducted by JUST Capital, which consistently find widespread support across the political spectrum for stakeholder capitalism. When JUST Capital asked Americans in October whether the pandemic is an opportunity for large companies to hit “reset” and focus on doing right by their workers, customers, communities and the environment, 89% said yes.
So perhaps 10 of 50 Republican Senators can be convinced to support the bill (OK, I admit I’m not holding my breath).
However, the bill likely foreshadows what the DOL will propose in its upcoming rulemaking.
Democrats appear unwilling to invoke CRA to support shareholder democracy
Meanwhile, you may recall last year’s controversial SEC rule that raised the ownership thresholds for shareholders to be able to propose resolutions at company annual general meetings and raised the vote thresholds that allow a proposal to be re-filed in subsequent years.
Democrats in Congress are trying to undo the rule by invoking the Congressional Review Act. The CRA allows Congress to pass a joint resolution disapproving of an agency’s final rule, which requires only a simple majority of both chambers to pass, along with the president’s signature. Congress must invoke the CRA within 60 days of a finalized rule. For rules that go final within 60 legislative days of the end of one Congress, the new Congress gets a new 60-day period to invoke the CRA.
That period is up next week and what I’m hearing is that Democrats don’t have the votes. Bloomberg Law reported on May 7 that Senate Democratic leadership had not yet backed the resolution, which may be just another way of saying the votes aren’t there. Why not?
One possible reason is that, once a rule is rescinded under the CRA, an agency is permanently banned from enacting a “substantially similar” rule, and what exactly that means has never been tested in court. That idea may sit well with Members of Congress who have a deregulatory bent, but for others, invoking the CRA means that any future action on the issue in question would have to occur in Congress rather than in the agency rule-making process. Democrats in Congress have plenty of issues on their plate already. Without taking action on the CRA resolution, the SEC, which Democrats now control, remains free to rescind or modify the rule. Given the makeup of the Commission and the heightened awareness and effectiveness of proxy voting, it would not be surprising to see the SEC revisit the issue.
Also of note this week — honored to share the virtual stage with Karina Funk of Brown Advisory and Katherine Collins of Putnam:
The Wall Street Journal applies a false-equivalence approach here:
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