Joe Biden’s first use of his presidential veto was — for reasons that Willie Sutton could have explained — entirely predictable. It was also wrong. In short, the president vetoed a measure (which enjoyed some bipartisan support) that would have overturned Department of Labor rules governing 401(k) and certain other retirement plans. These rules themselves were an amendment of Department of Labor rules introduced during the Trump administration by then–labor secretary Eugene Scalia.
The Scalia rules were designed to govern the extent to which ESG principles could be used by those responsible for managing retirement funds governed by ERISA. ESG is an investment “discipline,” under which actual or potential portfolio companies are measured against various and varying environmental (the “E”), social (the “S”), and governmental (the “G”) benchmarks. How such scores are derived, and how the E, the S, and the G are weighed against each other, will depend on whom you ask. There is rather more agreement that ESG investment products carry higher fees, and that the underlying ethos of ESG aligns to the left. The more money intended for retirees invested according to ESG guidelines, the more money there will be to advance a broadly progressive agenda. Put another way, ESG allows investment managers to play politics with other people’s money, and without the inconvenience of asking the electorate what it thinks.
To oversimplify somewhat, the Scalia rules were designed to push back against this. They were intended to reinforce the principle that fiduciaries must base their decision on which investments to pick “only on pecuniary factors.” And a pecuniary factor was defined as something “that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment.”
That did not mean that such investments had to be intended to maximize return. For one thing, fiduciaries could take risk into account. Moreover, they could take into account non-pecuniary considerations if they presented “economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.”
Where two investment vehicles were “financially equivalent” (a notion that the Labor Department treated with some skepticism), then ESG factors, including non-pecuniary factors, could be used as a tiebreaker.
Another provision was that prudently selected ESG-oriented investments could be included as an investment option under a defined-contribution plan, so long as the fiduciaries included only pecuniary factors in coming to that conclusion and such investments were not default options.
After President Biden was elected, these protections were pushed to one side before being replaced by language that, while it preserved fiduciaries’ overall obligation to focus on return, widened the definition of risk in ways that will skew that focus. Specifically, it provided that among the considerations that a fiduciary may consider in selecting an investment are the economic effects of climate change and other ESG issues, something that, as was almost certainly intended, opens a very wide door indeed. As with the changes discussed below, it’s not hard to guess why.
There is a strong case that, given typical investment horizons, climate change is irrelevant for investment purposes. To be fair, legal and regulatory challenges resulting from the fear of climate change (a different matter altogether) may not be. But those wishing to throw climate-change considerations into the investment mix (and there are plenty of them) may not be satisfied with considering just that. Furthermore, while there is no compelling argument that, in general terms, ESG will deliver an investment advantage, it will not be difficult to find plenty of well-paid “consultants” of one sort or another only too keen to argue the opposite.
Making matters worse, the strict requirement that a fiduciary should consider only pecuniary factors has gone, to be replaced by a requirement that the fiduciary makes its decision based on factors that it “reasonably determines” are “relevant” to a risk-return analysis. That’s a far lower standard than the requirement that such factors must have “a material effect” on risk or return. This is another change that means that issues only remotely connected (if that) to economic return will be able to be brought into consideration when weighing an investment. Once again, it’s not hard to guess why.
Other changes include a relaxation of the tiebreaker rules and the removal of the prohibition against default options including investment options that included an ESG element but satisfied the prudence test.
At a time of increasing doubts about the long-term viability of our retirement system, the last thing that anyone should be doing is conscripting people’s savings to advance a set of policies that owe far more to politics than to science.
The silver lining in a very dark cloud is that the president’s veto has once again highlighted the profoundly political nature of ESG and the need, in our share-owning democracy, for our elected representatives to join the growing resistance to it.