New ERISA law interpretation encourages impact investing
In October, the U.S. Department of Labor
issued an interpretation that will accelerate the mainstreaming of
Impact Investing, which are investment strategies that consider
environmental, social and governance (“ESG”) factors. This trend is
driven by millennials who invest based on the impact their investment
has on society and not just on economic yields. According to The Forum
for Sustainable and Responsible Investment, U.S. domiciled assets under
management using ESG principles rose 76 percent to $6.57 trillion at the
start of 2014 from $3.74 trillion at the start of 2012.
Sections 403 and
404 of the Employee Retirement Income Security Act (“ERISA”) require a
fiduciary of retirement assets to act prudently, which, up to now, the
DOL interpreted to mean that fiduciaries could never subordinate the
economic interests of their investment choices to unrelated objectives,
such as ESG factors. Now, according to the new Interpretive Bulletin
2015-01 “fiduciaries need not treat commercially reasonable investments
as inherently suspect or in need of special scrutiny merely because they
take into consideration environmental, social or other such factors.”
A DOL Fact Sheet and the Interpretative Bulletin can be found at the Department of Labor’s website at dol.gov/ebsa.
Previously, the
DOL had said that fiduciaries who were willing to accept reduced returns
or greater risk to secure collateral benefits such as impact on society
were in violation of ERISA. Such ESG factors could only be considered
by fiduciaries as “tie-breakers” when choosing between investment
alternatives that were otherwise equal with respect to return and risk
over the appropriate time horizon. This standard was referred to as the
“all things being equal test” test. In 2008, the DOL softened their
position by saying that the fiduciary’s consideration of ESG,
non-economic factors in selecting investments should be “rare” and
should be documented in a manner that demonstrated compliance with
ERISA’s “rigorous fiduciary standards.”
Now the DOL is whistling a different tune. The new DOL Interpretative Bulletin states that:
1.
Environmental, social, and governance issues may have a direct
relationship to the economic value of an investment, not as
tie-breakers, but as components of the fiduciary’s primary analysis of
the economic merits of competing investment choices.
2.
ERISA does not prohibit a fiduciary from incorporating ESG factors in
investment policy statements or integrating ESG-related tools, metrics
and analyses to evaluate an investment’s risk or return or choose among
otherwise equivalent investments.
3.
Fiduciaries who consider ESG criteria in making investment decisions
are not required to maintain additional documentation to demonstrate
compliance with ERISA’s fiduciary provisions.
Even Goldman Sachs
is getting on the impact investing bandwagon through two recent
experiments in issuing “social impact bonds”. The first issuance failed
followed by a successful issuance last month. Here’s how Social Impact
Bonds work: Goldman Sachs raises money and then lends the money to a
government via a bond to meet certain social goals. If the goals are
met, the government agency that received the bond proceeds, pays back
the full amount of the amount borrowed plus an above-market return. If
the goals are not met, the government pays nothing.
The failure
involved Goldman Sachs issuing a bond this summer that funded a program
to reduce recidivism at Rikers Island Prison in New York. Since
recidivism was not reduced, Goldman Sachs lost the full amount of the
bond. But last month, there was a different, better result. In Utah,
Goldman Sachs issued a $4.6 million bond to fund programs in Utah to
help students with special education needs. If the kids were
mainstreamed, the government would pay back to Goldman $2,500 for each
student. Result: Enough students were mainstreamed to repay Goldman back
the full amount plus more than 5 percent.
KOLBER'S TIPS
1.
This is not the final word by DOL because in the DOL Fact Sheet the DOL
makes the statement that ERISA fiduciaries are still required to
“choose economically and financially superior investments.” If you are
an ERISA fiduciary getting into impact investing, consult your lawyer.
2.
Before engaging in impact investing, do your due diligence. For
example, just because someone says his products are “organic” doesn’t
mean that they are.
3.
If you are raising capital abroad for impact investing, Europeans are
more advanced than the U.S. in this area but the European Union recently
adopted a law called the AIFMD Directive that restricts marketing of
funds there.
4.
Traditionally, most impact investments have been issued as exempt,
unregistered securities via Regulation D. Increasing, there are socially
responsible publicy-traded mutual funds. Morningstar said it will
attach impact scores to these funds.
Dan Kolber is an Atlanta attorney and owner of Intellivest Securities Research Inc.
