Amid a pandemic, a recession, and an upcoming election, changes to pension rules are easy to miss. However, the US Department of Labor’s rule change[i] proposed last Tuesday, June 23, would profoundly complicate the already challenging task of effectively managing the $10.7 trillion invested in private pension plans. And given that rules for pension plans could easily be extrapolated to cover qualified retirement accounts such as IRAs as well as other investment portfolios controlled by fiduciaries, the ramifications of this rule change could be profound for both institutional and retail investors.

The rule strives to stem the flow of investment assets into strategies that rely in part on Environmental, Social or Governance (ESG) criteria for selecting stocks and bonds. Specifically, the rule change would, “…confirm that ERISA[ii]requires plan fiduciaries to select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.”[iii]

According to Secretary of Labor, Eugene Scalia, in a Wall Street Journal column released the same day as the proposed rule change, “The department’s proposed rule reminds plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end.”[iv] Scalia goes on in the same column to state that, “…the standards for ESG investing are often unclear and sometimes contradictory.” In doing so, he gets to the heart of how the investment industry functions and why this rule change could have a paralytic effect on all investment managers, active and passive alike, as well as on any advisors or consultants charged with guiding pensions.

As any investment manager or advisor will attest, there is no universal definition of risk, no singular metric for defining whether someone has sacrificed return, and certainly no uniform standards for investing. That is why there are markets. One manager thinks that a security is too expensive and thus sells it to someone who sees opportunity in the same holding. Forget ESG for a moment; Scalia’s proposal implies that there is some universal standard for investment decision-making to which he and his regulatory allies at the Department of Labor are privy. He has insinuated that the Department of Labor is prepared to accuse fiduciaries of breaking the law if the Department’s standards are not met, and yet offers standards ripe for broad interpretation. 

Consider what the Department of Labor might do in the following circumstances:

  • A faith-based pension plan divests itself of investments in tobacco, alcohol, and gaming companies because such investments violate the organization’s tenets of faith, not just the preferences of the trustees. While this decision has not impaired the value of the portfolio over the long-term, year-to-year performance has deviated from the markets because of the social screens. Should the pension be forced by the government to invest in securities that violate its religious values?
  • A corporate pension plan seeks to reduce the economic risk of its portfolio versus the broad market. To that end, they reduce or eliminate holdings with significant risk of stranded assets such as coal miners. Though the investment allocation reflects a well-researched and well-reasoned economic decision, an energy company accuses the pension of making decisions based on environmental values. Should the pension be forced to buy economically riskier companies to satisfy the Department of Labor? If so, would the pension be able to seek damages from the Department of Labor if those securities underperform? 
  • Another pension plan decides to proactively invest a portion of their private equity allocation in companies developing renewable energy technologies because they see significant financial opportunity for such companies to grow revenues in the decades ahead. For the same reason, they also invest in biotech companies developing new therapies and information technology companies developing new applications. Does the Department of Labor allow the pension to invest in biotech and information technology companies, but not in renewable energy companies?
  • Through anonymous, confidential participant surveys, the vast majority of participants in a pension plan indicate their desire to avoid investing in companies that profit from child labor. Given that companies using child labor can be quite profitable, the decision is driven more by social concerns than by economic ones. As a result of the participant perspective, the pension reduces holdings in some companies based in Southeast Asia as well as the American and European companies that do business with the them. Should the Department of Labor intervene to force the pension to invest in companies that fail to meet American labor law, let alone the collective wishes of the participants? 
  • A hedge fund used by many pensions takes a short position in a company[v] with a long record of environmental regulatory violations that have caused adverse economic impact. The hedge fund sees an opportunity to profit from anticipated further declines in the value of the stock. While the hedge fund is making an economic decision, the energy company in question asks the Department of Labor to intervene with the hedge fund, accusing it of making an ESG-based values decision. How would the Department of Labor determine the hedge fund’s motives? Might it force the hedge fund to close its short position? To take a long position? How far might the Department of Labor go in dictating portfolio decisions?
  • An investment manager invests in companies that have done a better job than their peers of promoting women to the C-suite (CEO, CFO, CIO, etc.) and to the board of trustees. The manager’s research indicates that companies that do a better job of integrating women into leadership positions tend to outperform financially over time. As such, the strategy represents both social and financial objectives. The manager has outperformed most of its regular market peers over the past several years. Should the Department of Labor prevent pensions from using this strategy? 
  • An investment manager does not apply ESG criteria. The manager consistently underperforms its peers and the market net of its considerable fees while experiencing greater risk. The investment manager is owned by the same firm as the pension’s advisor, trades through the advisor’s brokerage division, and pays for research sold to it by its own firm. Should the Department of Labor intervene because the strategy sacrifices return, takes too much uncompensated risk, and otherwise fails to serve the pension participants? Historically, the Department of Labor has not intervened in cases of poor investment choices; will the proposed rule mean that the Department will now be vetting all pension investment decisions? Or perhaps levying penalties retroactively on poor investment decisions? 

I have served as a financially conservative trustee, investment committee member, and Vice Chair of the board for Colorado’s $45 billion Public Employees Retirement Association (PERA).[vi] With that experience, I anticipate pensions will potentially be stymied by this rule change because it provides unclear standards while promising punishment to those fiduciaries it deems violators of the Department’s intentions. As an investment advisor to fiduciaries across the country—including nonprofit pensions, foundations, and public charities—I am concerned that the Department of Labor’s proposed rule change would invite additional governmental intervention in due diligence and portfolio construction without commensurate benefit to pension participants. Any advisor or manager worth their salt already conducts and documents extensive due diligence to demonstrate meeting fiduciary standards.

If the Department of Labor wishes to improve the quality of investment management across the industry, there are ample opportunities to mitigate conflicts of interest, promote fee transparency, and create more uniform standards for public pension discount rates, inflation rates, and mortality tables. I share the Department of Labor’s drive for improved governance and better fiduciary conduct; I just want such improvements to be authentic and actionable.


[i] US Dept of Labor: Financial Factors in Selecting Plan Investments

[ii] The Employee Retirement Income Security Act (ERISA) governs most pension plans

[iii] Summary Statement, US Dept of Labor: Financial Factors in Selecting Plan Investments

[iv] Wall Street Journal, Retirees Security Trumps Other Social Goals, June 23, 2020

[v] Shorting a company is a way of investing to profit from the decline of the company’s stock price

[vi] Colorado PERA. Ben served as a governor-appointed trustee from 2012 – 2015.