Trump-era DOL rule for ESG arises in model bill for pensions

A proposal from a group that supports conservative initiatives targets ESG in state pension plans.

A conservative group that drafts model legislation for state congresses is focusing on the use of ESG in public pensions – and it is taking cues from the Trump-era Department of Labor in its tactics.

Last Wednesday, the American Legislative Exchange Council published the model for legislators, which could be introduced with little modification in various states. The proposal seeks to “[protect] retirees from politically motivated investment schemes,” the group stated in an announcement.

The document borrows heavily from a set of DOL rules finalized during the Trump administration that were widely seen as having a chilling effect on the use of ESG within retirement plans. Under the Biden administration, those rules are not being enforced and are in the process of being replaced by a proposal that would expressly allow the use of ESG. The Trump-era rules focused on financial materiality and pecuniary factors in investment decisions and proxy voting by pensions, and they prohibited ESG-specific default investment options in 401(k)s and other plans.

The model bill put forth by ALEC notes that ESG 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”.

While that does not necessarily preclude pensions from using ESG, it would likely make investment fiduciaries think twice, said Bryan McGannon, director of policy at US SIF.

“It’s an attempt to take the authority out of the hands of investment professionals,” McGannon said. “It’s put forward by partisans who have a very specific policy agenda. It is intended to have a chilling effect on those pension fiduciaries – to look over their shoulder and worry that if this bill is on the books in any of these states, that they will have to steer clear of any investment that has any environmental, social or governance consideration.”

Some Republican-heavy states, such as Texas, have started campaigns that could penalize investment managers that avoid fossil fuel holdings or have net-zero goals. Recently, for example, BlackRock took steps to assure Texas that it will continue investing in fossil fuels.

Such states could be easy targets for the model legislation.

“In those red states that have the conservative legislatures and conservative governors, these are easy-to-pass bills,” McGannon said. “In certain circles, ESG is a bad word now, to the determinant of the plan beneficiaries. These are things that a prudent fiduciary should be looking at and considering.”

POLICY TRACK RECORD

By bringing a version of the Trump-era ESG rule to the states, ALEC would be following a playbook made by former Labor Secretary Eugene Scalia, whose short time leading the agency included several major reforms being passed, including the DOL’s current fiduciary rule.

ALEC, which did not respond to a request for comment, bills itself a nonpartisan organization but has a member base of Republican members of state congresses. The group says it has issued more than 900 model policies over 49 years. And citing a report from news sources, ALEC states that its models have been employed in state bills in 2,900 instances between 2010 and 2018, with those bills being passed 21% of the time.

A 2013 analysis by the Brookings Institution found that the organization’s model bills have been introduced verbatim in states “at a non-trivial rate” and that the bills at the time had a better chance of becoming law than most legislation. However, “the bills that pass are most often linked to controversial social and economic issues”, the Brookings piece read.

MATERIALITY IS KEY

When it comes to political debates about ESG, the word “materiality” is used by both sides in either arguing for ESG or against it. Increasingly, though, investment managers view ESG as a material factor.

“The final [DOL] rule was leaning on ‘pecuniary.’ It was a weird way of talking about it,” McGannon said. “Nearly all asset managers and investment professionals realize that climate risk is a pecuniary risk to the companies in their portfolios.”

Further, the argument for limiting ESG in public pensions will be more difficult to make in blue states.

“As pension fund trustees we take our fiduciary duty and obligation to act for the sole and exclusive benefit of the funds’ members and beneficiaries seriously,” New York City Comptroller Brad Lander said in a statement to ESG Clarity. “The American Legislative Exchange Council’s proposal restricts the ability of fiduciaries to take prudent action in the best interests of the funds. It is widely accepted among investment professionals that consideration of ESG factors in investment decision-making addresses financial risks that help determine whether investments will generate superior long-term risk-adjusted returns.”

Decisions on how to invest should be left to fiduciaries of pensions, Lander said.

“Removing this tool from the investment toolbox is as misguided as removing any other risk analysis tool,” he said. “Legislatures are not fiduciaries to the funds, and every pension trustee should have the ability to take all investment considerations into account when making prudent decisions, unrestricted by the biases of these legislators.”