ESG Doesn’t Trump Fiduciary Principles

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ESG Doesn’t Trump Fiduciary Principles

For plan sponsors, ESG investing is a hot topic of discussion. However, like #BlackLivesMatter and #MeToo, ESG can be seen as a highly politicized buzzword that often means different things to different people. Retirement plan fiduciaries should dig below the surface.

Lawmakers on Capitol Hill have introduced legislation that would amend ERISA and allow for the offering of ESG options, and for the consideration of ESG factors within retirement plans. Importantly, the proposed statutory language offers that while ESG considerations maybe taken into account, traditional fiduciary principles (such as, prudence, acting solely in the interest of plan participants, exclusive purpose of providing benefits, defraying expenses, and diversification) still apply.

In other words, fiduciary principles can’t be sacrificed in favor of a push towards ESG investing, simply because ESG is a hot topic

However, we maintain that best practices concerning ESG are not at odds with fiduciary principles but promote and advance fiduciary obligations. ESG factors can be included in the investment analysis process – but should not be the purpose of it.

It was just over 15 years ago when the term ESG Investing entered the collective consciousness of investors. Fast forward to today, and we still don’t have a universal framework for its implementation. It can feel like a gray area for investors, so it’s worth defining what we are actually talking about when we use the term ESG. Basically, it involves incorporating Environmental, Social and Governance factors in the analysis of investments because they are relevant to an investment’s expected performance.

ESG however, is not to be confused with “Socially Responsible Investing” (SRI) which often seeks to screen out investments that derive revenues from morally or ethically questionable activities or countries. SRI came first and was more widely adopted by even the largest institutional investors from the beginning. Many public pension plans, often prompted by state legislatures, avoided and eliminated investments with ties to Iran or Sudan for instance. Some, like CalPERS, decided in 2000 that they would divest from all tobacco stocks which, according to the Wall Street Journal, cost them about $3.5 billion over the course of the next 16 years. (https://www.wsj.com/articles/calpers-dilemma-save-the-world-or-make-money-11560684601)

The presumption here, is that directing investments away from politically or socially objectionable entities, will move society towards a better place. Maybe, maybe not. But at the end of the day, SRI investing isn’t necessarily about assessing risk and return.

ESG, on the other hand, most certainly can be implemented with the intent of improving risk and return. For retirement plan fiduciaries, that puts incorporating ESG factors into investment decisions, squarely into play. But there are boundaries that they must adhere to in order to stay out of the hot seat of ERISA litigation. So how should a retirement plan fiduciary proceed when it comes to including ESG options in a plan? Stick to your knitting and ensure that investments incorporate ESG factors with the goal of increasing returns and reducing risk.

In order to do this, plan fiduciaries need to understand how an investment manager assesses ESG related risks and how they determine what impact, if any, these risks have on an investment’s enterprise value going forward. What are the factors they are using in scoring investments and how do they integrate those scores into the process? For example, when looking at two similar companies in the energy sector, if Company A relies solely on fossil fuels in its business, and Company B has started to phase in green and renewable sources of energy, Company A will likely have the higher ESG risk. That higher risk can affect the value of the company and that valuation analysis can inform a risk/return assessment. What the investment manager shouldn’t be doing, is eliminating Company A because they aren’t adhering to a preconceived notion of what a portfolio should and should not hold.

As ESG considerations are becoming more and more commonplace in markets today, assessing and understanding how various factors can add or detract from an investment’s overall growth potential, should always be the objective of a retirement plan. Notwithstanding the proposed statutory language, fiduciaries cannot forget that first and foremost, they remain subject to traditional fiduciary duties at all times. The legislation may provide a safe harbor for implementing ESG factors, but it doesn’t otherwise take fiduciaries off the fiduciary hook. And that is a good thing. 

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Our Retirement System Isn’t Working the Way It Once Did

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Our Retirement System Isn’t Working the Way It Once Did

The retirement system in America presents real challenges to both plan participants and plan sponsors. It’s probably time that we talked about it.

Years ago, people could rely on their company’s pension plan to provide a comfortable retirement, but those days are long gone. The newer defined contribution system shifted the burden of planning for, and funding retirement, away from corporations and placed it squarely on the shoulders of American workers. You could argue that it’s not enough, but you can’t argue that there aren’t plenty of investment options to help retirement savers reach their goals. These options, however, can only be accessed through a complicated maze of a system that is difficult to navigate for both plan sponsors and plan participants. And I would argue that the current state of affairs isn’t serving either of them very well.

I have worked in the investment industry for over two decades and during that time I have absorbed a solid understanding of how the system works. And I still found myself getting short end of the stick when, as the result of a merger, a former employer changed their 401(k) plan administrator. I had my entire balance in an S&P 500 index fund, which was my choice. I received a letter from the plan telling me that I needed to make an investment election for the new platform and as I thought I had done that already, I put it aside with the intention of getting back to it. But I never did.

That notice came in March of 2020, just a few days before I abruptly left my home in New York City in the midst of the Covid-19 pandemic. It was left behind, and subsequent notices sat for weeks in an overflowing mailbox. By the time I realized the new plan administrator had divested me from my index fund, and placed me in their default option, a target date fund with a much higher fee, I had missed out on much of the stock market run up in April of 2020. My 401(k) balance was a lot less than it should have been. I was furious. I felt it shouldn’t have happened.

While I caught it relatively quickly and shifted my allocation back, it got me thinking about the teachers, doctors, construction workers, lawyers and plumbers. All of these hard-working Americans, who often aren’t savvy in the realities of the investment industry. Would they have caught this as quickly as I did? Would they have been paying as much attention as I was? They probably wouldn’t have. The retirement system has become so overwhelmingly complex and  too often, the overwhelm can lead investors to avoidance. And that can lead to bad outcomes.

But plan participants aren’t the only ones who can be overwhelmed by the retirement system. Plan Sponsors have an awful lot to contend with as well. Consider this scenario: One firm gets acquired by another and as a result, the retirement plans are merged. The individuals serving on the retirement committee (often the named plan fiduciaries) are likely a mixture of internal executives with great skill in their fields. Perhaps an HR professional, a General Counsel, a CFO and maybe a CEO. These are busy people trying to run a business and they have an awful lot on their plates. Then consider that they also have to oversee the retirement plan for their employees, and they are personally liable for the decisions they make in that capacity.

Overseeing a retirement plan is a business unto itself that can siphon company resources away from managing the underlying business. It’s not hard to see how important things could get overlooked. But when it comes to the stewardship of participant retirement savings, nothing should be getting overlooked.

If you sit on your company’s retirement committee and you are a named fiduciary for a plan, there is a long list of things that you need to not just be familiar with, but that you need to be expert in. First and foremost, ERISA and all its very specific and not so specific requirements. Then there is the increasingly complex investment landscape that you’ll need to navigate, including understanding and analyzing fee structures and expenses for investment options and for every vendor. Throw some Target Date Funds into the mix and you’ve got yourself a full-time job on top of the one you already have. And there’s more; retirement plan cybersecurity is a dangerous landmine that threatens retirement plans and it’s only getting trickier. Also, do you understand the implications of adding alternative investment options to a plan and do you possess the skills to dive into that adequately? If you don’t you need to get them. How about cryptocurrencies like Bitcoin? Should they have a place in your plan? And if not, do you understand why? And have you documented it adequately?

This sounds like an awful lot, because it is. As a committee member, you may be comforted by the team of advisors and consultants that your plan has engaged to help you. While that’s a bonus, have you asked them where their fiduciary responsibility starts and stops? Unless you’ve appointed a third-party independent fiduciary, the buck continues on past all of them and stops with you. So you’ll want to know what they are doing and understand it. While you’re at it, familiarize yourself with any conflicts of interest they may have. Those could come back to bite you.

Once you are comfortable that all of your ducks are in a row with the plan that you are personally responsible for, then you can go back to your day job and make sure that company is running as it should. Or do you do that first?

Plan sponsors who are overseeing their retirement plans internally are often doing so because that’s model that we’ve all become accustomed to. But the landscape looks different today than when defined contribution plans first became the norm. ERISA class-action lawsuits against plan sponsors have risen exponentially, and the increasingly complex investment landscape makes the waters much more difficult to navigate.

I wanted to share my story because the vast majority of people in 401K plans aren’t paying nearly as much attention as I was. Until the system evolves to adequately address prudent retirement plan fiduciary oversight, participants need to pay much more attention.  

And given how quickly the landscape has changed, and is changing, perhaps we will start to see plan sponsors realizing that status quo of managing their retirement plans internally, isn’t really working as well as it once did.

 

 

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Supreme Court Wades Into Battle Over Fee Litigation

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Supreme Court Wades Into Battle Over Fee Litigation

The Supreme Court will decide the fate of “excessive fee” litigation against defined contribution plans, as it has agreed to hear the case of Hughes v. Northwestern University.

This form of litigation has been a scourge of corporate America over the past years. Legions of plaintiff’s lawyers have filed suits alleging that plan sponsors have breached their fiduciary duties by causing plans to pay fees that substantially exceed fees for alternative, available investment products or services. There is a thriving and complex cottage industry that supports this litigation deluge. Other than the plaintiff’s lawyers, no one likes this litigation, least of all corporate officers and directors.

ERISA is quite clear: fees paid by plans must be reasonable and plan fiduciaries must act as prudent experts in their decision-making processes with respect to the retirement plans that they oversee.

In order to protect the $35.4 trillion held by U.S. retirement plans (ICI, June 16, 2021), ERISA imposes the highest standard of care on plan fiduciaries. Absent these high standards, retirement plans would quickly devolve into an unlimited feeding trough for a wide range of financial service providers. In effect, the fiduciary standards protect America’s pool of retirement assets.

ERISA does not dictate specific behaviors or actions on behalf of plan sponsors. Instead, they are given a wide berth in how they meet the standards of prudence and reasonableness. ERISA reflects a free market, capitalist spirit in that it allows plan sponsors the agency and creativity for meeting these standards. But, meet the standards, they must.

In our American system, the courts are uniquely capable of determining whether the standards are met: whether actions are prudent or reasonable.  

As much as they may protest, plan sponsors are not helplessly left to the vagaries of litigation. Instead, there are scores of lawyers, consultants and independent fiduciaries who possess expertise in guiding plan sponsors with respect to best practices. Since plaintiff’s lawyers must invest their own time and resources in their litigation, once they catch wind that a plan sponsor has adopted its own rigorous fiduciary processes, they will likely lose interest in a particular defendant and move on to one who has been less diligent. Plan sponsors are not unwitting victims here.

Of course, litigation is an unpleasant nuisance to corporate America. However, this type of fee litigation effectively helps preserve the assets accumulated by hard-working Americans. After all, every dollar paid to service providers, is one less dollar funding someone’s retirement. 

 

 

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ERISA Settlement Mandates Fees and Independent Fiduciary Oversight

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ERISA Settlement Mandates Fees and Independent Fiduciary Oversight

 

 

In a recent ERISA class action settlement, a 401(k) Plan sponsor with close to $2 billion in assets was forced to pay millions of dollars in damages and appoint an independent third-party fiduciary to oversee aspects of their plan. For all plan sponsors, this introduces the real possibility they could be forced to engage independent oversight for their retirement plan.

It makes sense. Managing retirement plans is much more complicated than it used to be. There is a field of landmines that didn’t exist in years past. And litigation is on the rise, having already forced plan sponsors to pay more than $1 billion in recent years.

Experts say there’s more trouble on the way. The next wave of litigation is expected to focus on Target Date Funds and their increasing use as default investment options. And it won’t just affect the larger plans. Recent trends have shown that plans with $100 million or less can be targets.  Plan sponsors argue that they’re capable of their own retirement plan management, but the courts increasingly disagree.

While most lawsuits contest the high fees of investment offerings, court decisions really come down to whether the sponsor has fulfilled its fiduciary duty to the plan participants. Since this falls ultimately on the shoulders of retirement plan fiduciaries, it’s an easy call for courts to mandate the involvement of an independent third party.

Progressive sponsors will look to get ahead of the change. To avoid the combined costs of legal fees, management time, and reputational damage, they will look for their independent fiduciary oversight on their terms.

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John Hancock ERISA Settlement Includes Appointment of Independent Consultant

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John Hancock ERISA Settlement Includes Appointment of Independent Consultant

 

 

For years, ERISA experts (lawyers and fiduciaries) have acknowledged the added value of appointing independent expert fiduciaries to run and monitor retirement plans. Corporate America has been slow to take up this opportunity. Senior executives try to manage their plans internally until they confront litigation, which drains their resources and reputation.

The Department of Labor, and now increasingly the courts, are recognizing that independent expertise is the best model for prudent management of retirement funds. The word is getting out. In fact, the wave is building that independent oversight is best industry practice.

Given the old adage, “pay me now, or pay me later”, corporate executives have a choice: Get ahead of the wave and turn to an independent fiduciary now or continue the status quo until the uglier wave of ERISA litigation knocks you over. As any beach-lover knows, once you are caught in the tumult of a churning wave, turned upside down, gasping for breath, it’s too late to seek the protections of calmer waters.

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Bitcoin – Irrational Exuberance 2.

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Bitcoin – Irrational Exuberance 2.0

By Mitchell Shames

The other day I received a survey in my inbox to the effect of: “should institutional investors start thinking about Bitcoin?”

The question is so preposterous in my mind that I both deleted the survey and couldn’t help but wonder if markets have crossed the threshold into another era of Irrational Exuberance – Alan Greenspan’s characterization of the dot.com boom… and, bust.  

Every day there are articles and postings about potential new “investments” – Bitcoin, NFT’s, and SPAC’s. Each is touted as either the next great investment opportunity OR the next tulip mania. To be fair, at this point, we simply don’t know. New technologies are always enticing and alluring. But for retirement plan fiduciaries, the unknowns should always temper unbridled enthusiasm.

Fiduciaries hold discretion, with respect to investment decisions, over other people’s retirement assets. Vast numbers of employees are relying on these assets to fund their retirement. Given the magnitude and the implications of this responsibility, fiduciaries are charged with acting prudently. Each investment decision is judged against this standard of prudence.

Over the past decades (it’s almost 50 years since ERISA was enacted) norms of investment decision-making have developed around the investment of plan assets. Whether assessing a manager or a strategy, analysis of past performance is a central principle in making investment decisions. Legions of consultants stand ready to assist plan fiduciaries in determining whether a manager or strategy fits within an asset allocation plan or within investment guidelines. Most of these analytics include a detailed review of investment performance.

When it comes to most of these new investment opportunities, however, there simply is no performance history. There should be no need for a survey. Right out of the box, these assets should not be eligible for ERISA qualified plans. But, yet, they are quite enticing.

The pandemic has stretched on long enough. Corporate earnings took a significant hit in 2020.  As we begin to come out of the global quarantine there are glimmers of revived economic output. The pent-up demand is staggering; so is the urge to make up for the lost time and the lost earnings. Bitcoin, NFT’s and SPAC’s play into the zeitgeist of the moment.

Retirement plan fiduciaries must stick to tried and true, prudent methodologies. Certainly, they must assess the performance of the plan investments through the pandemic. But, while annual performance is important, performance also must be viewed over longer periods; three, five, and ten years. If a review indicates that changes to a portfolio might be warranted, they must start with the investment guidelines for the plan and the assumptions underlying the guidelines. By necessity, this needs to be a deliberative, careful, and yes, a prudent process.

Bitcoin, NFT’s, and SPAC’s are the glittery new objects in the investment universe. The allure of outsized investment returns is powerful. Fiduciaries, however, should know better. They must exercise prudence before committing retirement funds to these assets.

Yes, I am skeptical. However, I also know that as a fiduciary, I must keep my eye on these new investments, as well as others that come onto the horizon. While they might not be prudent today, who knows what the next five or ten years may bring.

But, today, surveys regarding Bitcoin are premature.

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