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Labor Dept. Seeks to Restrict Social Goals in Retirement Investing


The Labor Department is seeking a new federal regulation that could discourage retirement funds from making investments based on environmental, social and governance considerations.

The department said in a news release Tuesday evening that it was taking the action to “provide clear regulatory guideposts.” Labor Secretary Eugene Scalia, in an opinion article Wednesday in The Wall Street Journal, said the move “reminds plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end.”

Investments based on social goals can consider, for example, a company’s efforts to reduce its carbon footprint or to promote racial and gender diversity among its directors and executives.

Such investments have grown immensely in recent years, to roughly one of every four dollars under management, according to the US SIF Foundation, a nonprofit focused on the category. While little of that was in workplace retirement plans, some experts think 401(k) plans will play an increasing role in such investing.

But experts said the proposed rule would not meaningfully change employers’ obligations. And Morningstar has found that funds based on environmental, social and governance goals — known as E.S.G. factors — outperformed conventional offerings during the first quarter of this year and going back several years as well.

Under the Employee Retirement Income Security Act of 1974, known as ERISA, administrators overseeing employee retirement plans — usually an employer’s financial or human resources officials — are required to act in the strict financial interests of workers. That typically means they can add a mutual fund option that emphasizes social and environmental goals only if they expect it to perform at least as well as an option that does not focus on those factors while taking similar risk.

“The Department of Labor has always taken the position that plans can take into account other factors, such as social and environmental, as long as they don’t increase risk or sacrifice return for the plan,” said Olena Lacy, who served as assistant labor secretary in charge of the agency overseeing employee benefits during the Clinton administration.

Ms. Lacy said Democratic and Republican administrations had simply differed over the years in framing the obligations of employee plan administrators.

“Democrats say the standard is that it’s OK for you do to this as long as it comes out the same,” she said, referring to risk and returns. “Republicans say it’s illegal for you to do this unless it comes out the same.”

Jon Hale, the head of sustainability research at Morningstar, said the practical effect of the new framing could be to deter plan administrators from adding E.S.G. options to 401(k) plans for fear of violating the law.

Even if the proposal does not come to pass, he said, employers might decide to avoid E.S.G. investments because they see them as a potential political minefield.

The proposed rule says that environmental, social and governance concerns can be taken into account independent of factors like risk and return only if they act as a kind of tiebreaker when investments are otherwise financially indistinguishable. In that case, the rule would require plan administrators to document the investment analysis that led to the conclusion.

The department acknowledged that the provision might create additional burdens for employers, but said in a background document that it “does not expect this requirement to impose a significant cost as these situations are rare.”

In the Labor Department release, Mr. Scalia said the proposed rule was meant to ensure that social goals would not come at the expense of returns to participants in retirement plans, and the release says employers cannot invest in E.S.G.-focused funds that seek to “subordinate return or increase risk for the purpose of nonfinancial objectives.”

The department did not respond to a request seeking examples of employers that have pursued such strategies.

Jerome Schlichter, a lawyer who has successfully pursued numerous employers on behalf of workers over excessive fees in their 401(k) plans, said he was not aware of employers who had sought to pursue E.S.G. goals at the expense of financial returns.

“That has not been something that we’ve seen,” Mr. Schlichter said. “It hasn’t been done by fiduciaries in any broad way, in part due to concerns about exposure for litigation.”

Other lawyers said that while the growth in E.S.G. investment options and their rising popularity among workers could require additional regulation and enforcement, such action would typically be better aimed at investment companies marketing such funds, rather than employers and their plan administrators.

George Sepsakos, a lawyer who advises employer plans about their legal responsibilities, said the Securities and Exchange Commission had been reviewing disclosure from E.S.G. funds to make sure their marketing accurately reflected their investing strategies. “Right now the definition can mean different things to different people,” Mr. Sepsakos said.

He said that if an investment company had misrepresented potential returns or fees from an E.S.G.-focused fund, the investment company rather than the employer would typically be liable. “The plan fiduciary can only make investment decisions based on what they know or should have known at the time,” he said.

A 2015 academic paper examining decades of research and over 2,000 other studies found that about 90 percent of the work showed no negative connection between E.S.G. principles and corporate financial performance. A large majority showed positive findings.

As a result, said Mr. Hale of Morningstar, the proposed rule could end up being counterproductive. “Not only could investments that focus on the long-term sustainability of companies lead to truly long-term outperformance because you’re picking better quality companies,” he said. “But there is also the systems argument, that you’re helping to create a financial system and economy that will be more successful.”

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