Protecting Pensions from Politicized Mismanagement

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Recently the American Legislative Exchange Council (ALEC), an organization of state legislators from across the country, unveiled model legislation aimed at protecting the retirement savings of government employees. The proposed bill requires that investment managers at pension funds focus only on providing returns to beneficiaries rather than try to advance unrelated environmental and social goals. This proposal is part of a widening debate in finance and government over the role of environment, social, and governance (ESG) investing. The key part of the model legislation reads:

A fiduciary’s evaluation of an investment must be focused only on pecuniary factors. Plan fiduciaries are not permitted to sacrifice investment return or take on additional investment risk to promote non-pecuniary benefits or any other non-pecuniary goals. Environmental, social, corporate governance, or other similarly oriented considerations are pecuniary factors only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.

Focusing exclusively on returns rather than so-called “non-pecuniary” factors has traditionally been the standard for pension fund managers in general, including those who administer private pension funds and are regulated by the Employee Retirement Income Security Act of 1974 (ERISA). At the federal level, former Secretary of Labor Eugene Scalia attempted to clarify and reinforce this standard with a new rule toward the end of the last administration called “Financial Factors in Selecting Plan Investments.” I submitted a comment letter in support of the rule as part of that proceeding that noted the activist campaigns behind politicized investing:

Recent years have seen a significant increase in “use of the term ESG among institutional asset managers” and “in the array of ESG-focused investment vehicles available.” Proponents of an environmental, social, and governance (ESG) framework for investment and finance analysis have not just celebrated its growing popularity, but have actually warned observers that the movement behind it is propelled by sufficient force that they would be foolish to ignore or oppose it. If the carrot of being perceived as an ethical investment firm is not sufficient to motivate fund managers, ESG advocates have suggested that the stick of future financial losses and legal punishment awaits managers who decline to embrace it.

Unfortunately, the current leadership at the Department of Labor is attempting to repeal the Scalia-era rule, and another one related to proxy voting by investment managers, in hopes of encouraging more ESG-themed investment decisions. I also submitted comments for the record on this proposed replacement rule at the end of last year:

The motivation for policymakers to greenlight greater ESG integration into pension fund management is more understandable when one realizes that many ESG proponents in the U.S. are policy advocates who have been frustrated by their inability to pass legislation through Congress. ESG activism is often an outlet for promoting a pre-existing agenda that has been grafted onto existing institutions and covered with a fig leaf of legal justification, rather a prudent way to discharge sound fiduciary responsibilities, as ESG advocates often claim.

The ALEC model bill and the individual state legislators endorsing it are attempting to accomplish, at the state level, a similar goal as the federal pension rules published in 2020 that the Biden administration is currently trying to repeal. America’s retirees will be more prosperous and secure if they succeed.