VEA Vice Chair Nell Minow writes on the Harvard Law School Forum on Corporate Governance and Financial Regulation about the Labor Department’s review of ERISA fiduciaries and ESG under the Executive Order issued last month by President Trump. She wrote:
ERISA, the 1974 law that governs pension funds, recognizes that the third parties who manage those funds might be tempted to make decisions that were more in their interests than the interests of the people who were depending on them to make good decisions about their investments. And so the law makes it clear that all decisions are to be made “for the exclusive benefit of plan participants.” But it was not until the “Avon letter” of February 23, 1988 that the Labor Department made it clear that the “exclusive benefit” standard applied not just to buy/sell/hold decisions about stock, but about proxy voting as well.
Until the takeover era of the 80’s promoted abuses of shareholders by both corporate raiders and entrenched management, proxy issues had been routine votes to re-elect board members and approve auditors. But once more complex and controversial issues were turning up on proxy cards, and a study by the Investor Responsibility Research Center showed that fund managers were voting with an eye toward getting business from corporate clients and not “for the exclusive benefit” of the plan participants, DOL had to make it clear that all actions with regard to a security were covered by that standard.
That issue was raised again in an Executive Order on Energy Infrastructure issued on April 10, 2019 by President Trump. It calls on the Department of Labor to consider the role that funds governed by ERISA play in this critical element of our economy and national security. The Executive Order states in part:
To advance the principles of objective materiality and fiduciary duty, and to achieve the policies set forth in subsections 2(c), (d), and (f) of this order, the Secretary of Labor shall, within 180 days of the date of this order, complete a review of available data filed with the Department of Labor by retirement plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) in order to identify whether there are discernible trends with respect to such plans’ investments in the energy sector. Within 180 days of the date of this order, the Secretary shall provide an update to the Assistant to the President for Economic Policy on any discernable trends in energy investments by such plans. The Secretary of Labor shall also, within 180 days of the date of this order, complete a review of existing Department of Labor guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.
Representatives of the pension fund community and other institutional investors as well have been making the case for many years that the Department should continue to support the obligation of fiduciaries to consider all elements of investment risk and return “for the exclusive benefit of plan participants,” as the statute requires.
For example, over the past few years, the market has become much more sensitive to the impact of climate change on both risks and opportunities for portfolio companies. This is reflected by the fastest growing sector in the investment world, ESG (environment, social, governance, sometimes also known as sustainability), a market-driven response from every major financial institution, not just in the US but throughout the world.
There is a great deal of evidence about the increasing sophistication of the assessments investors, insurers, and others use in applying ESG indicators to evaluate risk and return. For example, just in the last month:
1. The Environmental Protection Agency published a 150-page document about coping with the debris from natural disasters across the country: Start planning for the fact that climate change is going to make these catastrophes worse. This is an essential issue for every element of corporate strategy, from supply chain issues to core operations and risk management. (April 27, 2019)
2. A study published in Sustainability Accounting, Management and Policy Journal by Michael Magnan and Hani Tadros found that better disclosure of environmental performance correlated with better performance at the 78 companies in environmentally sensitive industries that they examined.
Note: Since July 2017, following the release of the Task Force on Climate Related Disclosure (TCFD) guidelines, more than 500 large businesses, investors and industry groups have signed on to provide this type of forward-looking financial disclosure. Companies in the financial services industry are leading the way in their support of the TCFD recommendations, including BlackRock, State Street and S&P Global, along with the Association of Chartered Certified Accountants.
It’s not limited to the financial services industry. Other sectors are signing on, including Statoil and Shell in the energy sector, consumer product companies such as H&M and Nestlé, materials companies such as BASF and DowDuPont, as well as industrial companies such as Saint-Gobain and Ingersoll Rand.
3. The Bank of England takes note of climate risk:
[A] speech by Sarah Breeden, head of international banks supervision, suggests a degree of sympathy with the points being made by the protesters: that time is running out to prevent catastrophic climate change and previous efforts to combat the problem have been nowhere near vigorous enough.
Breeden’s message to the financial sector was that they need to incorporate climate change into their corporate governance, their risk management analysis, their forward planning and their disclosure policies or face the prospect of losing a heck of a lot of money.
The financial markets have a term for a sudden drop in assets prices known as a Minsky moment (after the economist Hyman Minsky). Breeden said a climate Minsky moment was possible, in which losses could be as high as $20tn (£15.3tn).
If the Bank of England is calling on companies to address the risks of climate change, then the Department of Labor should recognize that pension fund managers’ similar assessment of risk is consistent with their obligation as fiduciaries. (“Avoiding the storm: Climate change and the financial system,” speech by Sarah Breeden April 15, 2019)
4. Legendary investor Warren Buffett announced that Berkshire Hathaway is putting “a lot of money” into renewable energy. (“Buffett says Berkshire plans to ‘put a lot of money’ into energy,” Marketwatch, May 4, 2019)
5. Reuters reports, “After historic floods devastated midwestern agricultural states this spring, some fund managers are evaluating how climate change will affect the long-term value of companies that make or sell products ranging from tractors to fertilizer.” One commented: “If weather conditions continue to have a more unforeseeable impact on agro business the best way to model this would be … to increase the beta-factor within the discounted cash flow model used by me.” He admits he has not yet done so, which again shows the importance of a robust market response from investors. (“Climate change has U.S. fund managers adjusting agriculture investments,” May 1, 2019)
6. The New York Times reports that an individual trader so vastly exceeded his borrowing limits that it put the entire global system of central counterparties at risk. How could a once-successful investor, so successful that he achieved the very rare distinction of being given counterparty status as an individual, make such a bad bet? In large part it was because failed to consider the risk of regulatory changes addressing climate change and of the impact of climate change itself on weather conditions. This is further proof of the direct, vital importance of factoring in climate change risk, including regulatory risk. (“How a Lone Norwegian Trader Shook the World’s Financial System,” New York Times, May 3, 2019)
7. A coalition of groups led by Majority Action has delivered over 129,000 petition signatures to BlackRock, Vanguard, and Fidelity, calling for the world’s largest asset managers to use their voting powers to force companies to act responsibly on climate, by supporting key climate-related shareholder resolutions and voting against directors who are not serving long-term investors’ best interests at nine major upcoming shareholder meetings.
8. There is evidence that the energy companies will be shown to have same kind of disconnect between internal memoranda and public statements (including SEC filings) that we saw in the tobacco companies, which were a significant contributor to the $27.5 Master Settlement. (InsideClimate’s report on this issue covered in a May 14, 2019 article on Gizmodo).
The Department of Labor policies for investment professionals have always been about process, the only substantive requirement being the statutory obligation of diversification. We encourage the Department to continue with this approach. It would be a mistake to substitute its own judgment for that of the professional money managers who are in the best position to make those decisions. The Department’s job is to ensure the independence and freedom from conflicts of interest of those professionals, and that includes not allowing the insiders at their portfolio companies to tell them what to do.
We expect the Department to conduct wide-ranging research to prepare their response to the directive in the Executive Order, reaching out to institutional investors to better understand how they are incorporating their assessment of climate change and other environment-related investment and liability risk in their proxy votes and other shareholder rights, including litigation and nomination of dissident candidates for the board.