At the end of last month the Department of Labor published a new notice of proposed rulemaking on the investment choices that private pension fund managers are allowed to make on behalf of their beneficiaries. Since 1974, the Employee Retirement Income Security Act (ERISA) has governed how pension funds are managed, and since then the Department of Labor has issued multiple rules and sub-regulatory guidance documents laying out the requirements. The most recent proposed rule would further clarify when it is possible to use environmental, social, and governance (ESG) considerations when investing on behalf of pension fund beneficiaries.
The short version is that fund managers are required by ERISA to invest with only the long-term financial benefit of plan beneficiaries as a goal. Putting money in ESG-themed investment vehicles because of their ostensible environmental or social benefits rather than their expected return is a misuse of funds and not allowed under the law. The current proposed rule seeks to reinforce and clarify that requirement.
While there is an army of advocates that will insist that ESG-compliant companies are on average at least as profitable as their counterparts, there’s no way to make that assertion in any meaningful way. As Secretary Scalia writes, “standards for ESG investing are often unclear and sometimes contradictory.” There is no standard for what even counts as an ESG “concern,” much less which specific policy must be adopted to address such a concern, any more than there is an objective standard for which laws are good or which candidates are fit for office.
That lack of clear definitions isn’t the only problem that the proposed rule addresses, but it’s a big one. In accordance with the usual procedure, the Department of Labor has opened a public comment period on the proposed rule which has already generated almost 500 comments. My own comment is available here and will eventually be available at the Federal Register page listing all of the submitted comments. In it, I emphasize four points that, as it proceeds, the Department of Labor should:
- Beware of political priorities masquerading as materiality concerns
- Beware of claims of mainstream validation
- Avoid increasing compliance burdens arising from documenting investment decisions
- Avoid meaningless distinctions between “left-wing” and “right-wing” ESG Concerns
The first two points address fund managers who might claim that their positions in ESG-themed investment are not violating the department’s proposed rule because their decisions are based (as the rule allows under certain circumstances) on real financial considerations rather than political or altruistic motives. In the first case, some ESG fans claim that future law and regulation will retroactively legitimate their current investment choices. In the second they often claim that ESG investing is a “mainstream investing theory” that already complies with the relevant guidance. Both are means to evade the plain-language requirements of ERISA and the department’s clear policy goals, and should be specifically addressed in the final published rule.
The third point reiterates the Competitive Enterprise Institute’s long-standing emphasis on regulatory cost and compliance burdens and urges the department to use the least burdensome means to accomplish its current salutary ends. Decades’ worth of research by my colleague Wayne Crews and our friends at the Mercatus Center, among others, demonstrates how even the best-intentioned interventions can create massive drags on innovation and prosperity.
The final point addresses the current ideological assumptions about ESG investments, and how shifting definitions of “left” and “right” could lead to confusion in the future. Many of the policy preferences most frequently cited as being ESG concerns, such as climate change and hiring diversity, are more frequently characterized as priorities of left-leaning political groups, but there are plenty of populist or nationalist policy advocates who would be happy to use ESG-style investing and activism to accomplish their own goals. Whether it is a focus on national security, human rights, or outsourcing, right-leaning activists have been pressuring fund managers (sometimes of public, rather than ERISA-covered private, pension funds) to make ESG-style investing decisions. The current rule should emphasize that politically themed fund management is not allowed under ERISA, regardless of the political orientation or the ostensible value of the goal being advanced.