You may have retirement plan clients who like the idea of their assets going to support worthy causes, such as companies that fight pollution, or local public works projects.
The U.S. Department of Labor chilled retirement plan fiduciaries’ do-gooder instincts about nine years ago, in Interpretive Bulletin 2008-1. In that batch of guidance, issued while President George W. Bush was in office, DOL officials warned fiduciaries against putting any good causes before the interests of their clients.
While former President Barack Obama was in office, DOL officials issued an IB 2008-1 sequel, Interpretive Bulletin 2015-1. In IB 2015-1, DOL officials eased up on some of the IB 2008-1 wariness toward socially conscious investing at retirement plans.
But IB 2008-1 is still out there, it still shapes the IB 2015-1 rules, and it’s one of the old DOL classics that could still come back in style.
Here’s a short look at the IB 2008-1 rules, written by Frank J. Bitzer and Nicholas W. Ferrigno Jr.
“Economically targeted investments” are investments selected for the economic benefits they create apart from any investment returns they provide for an employee benefit plan.
DOL officials gave their views on how Section 403 and Section 404 of the Employee Retirement Income Security Act (ERISA) affect a plan fiduciary’s efforts to make economically targeted investments in IB 2008-1.
Officials note in IB 2008-1 that ERISA requires a fiduciary to act solely in the interest of the plan’s participants and beneficiaries, and for the exclusive purpose of providing benefits for the plan’s participants and beneficiaries.
ERISA states that:
“[A]ssets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purposes of providing benefits to participants in the plan and their beneficiaries.”
“[A] fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of providing benefits to participants and their beneficiaries.”
DOL officials wrote in 2008-1 that ERISA’s plain text does not permit fiduciaries to make investment decisions on the basis of any factor other than the economic interest of the plan.
Officials acknowledged, however, that, in some situations, two or more investment alternatives are of equal economic value to a plan. In those situations, officials said, fiduciaries can choose between the investment alternatives on the basis of a factor other than the economic interest of the plan.
DOL officials have interpreted the statute to permit this selection because:
ERISA requires fiduciaries to invest plan assets and to make choices between investment alternatives;
ERISA does not itself specifically provide a basis for making the investment choice in this circumstance; and
the economic interests of the plan are fully protected by the fact that the available investment alternatives are, from the plan’s perspective, economically indistinguishable.
Given the significance of ERISA’s requirement that fiduciaries act “solely in the interest of participants and beneficiaries,” DOL officials argued that, before selecting an economically targeted investment, fiduciaries must first conclude that the alternative options are truly equal, taking into account a quantitative and qualitative analysis of the economic impact on the plan.
ERISA’s fiduciary standards expressed in ERISA Section 403 and ERISA Section 404 do not permit fiduciaries to select investments based on factors outside the economic interests of the plan until they have concluded, based on economic factors, that alternative investments are equal, officials said.
Officials said a less rigid rule might lead fiduciaries to use ERISA trust assets to “promote myriad public policy preferences,” and to compromise or subordinate the interests of plan participants and their beneficiaries.
DOL officials stated that a plan fiduciary’s analysis is required to comply with, but is not necessarily limited to, the requirements set forth in Labor Regulation Section 2550.404a-1(b).
In evaluating the plan portfolio, as well as portions of the portfolio, the fiduciary must examine the level of diversification, the degree of liquidity, and the potential risk/return in comparison with available alternative investments, officials said.
The fiduciary must also perform the same type of analysis when choosing between investment alternatives. Potential investments should be compared to other investments that would fill a similar role in the portfolio with regard to diversification, liquidity, and risk/return, officials said.
In light of the rigorous requirements established by ERISA, DOL officials said they believed that fiduciaries who relied on factors outside the economic interests of the plan in making investment choices and subsequently found their decisions challenged would rarely be able to demonstrate compliance with ERISA, absent a written record demonstrating that a contemporaneous economic analysis showed that the investment alternatives were of equal value.
The following five examples were provided in IB 2008-1 (and may now, in some cases, be affected by IB 2015-1):
1. A plan owns an interest in a limited partnership that is considering investing in a company that competes with the plan sponsor.
The fiduciaries may not replace the limited partnership investment with another investment based on this fact unless they prudently determine that a replacement investment is economically equal or superior to the limited partnership investment and would not adversely affect the plan’s investment portfolio, taking into account factors including diversification, liquidity, risk, and expected return.
Under IB 2008-1, the competition of the limited partnership with the plan sponsor is a factor outside the economic interests of the plan, and thus cannot be considered unless an alternative investment is equal or superior to the limited partnership.
2. A multiemployer plan covering employees in a metropolitan area’s construction industry wants to invest in a large loan for a construction project located in the same area because it will create local jobs.
The plan has taken steps to ensure that the loan poses no prohibited transaction issues. The loan carries a return fully commensurate with the risk of nonpayment. Moreover, the loan’s expected return is equal to or greater than construction loans of similar quality that are available to the plan. The plan has already made several other loans for construction projects in the same metropolitan area, however, and this loan could create a risk of large losses to the plan’s portfolio due to lack of diversification.
Under 2008-1, the fiduciaries may not choose this investment on the basis of the local job creation factor because, due to lack of diversification, the investment is not of equal economic value to the plan.
3. A plan is considering an investment in a bond to finance affordable housing for people in the local community.
The bond provides a return at least as favorable to the plan as other bonds with the same risk rating. However, the bond’s size and lengthy duration raise a potential risk regarding the plan’s ability to meet its predicted liquidity needs. Other available bonds under consideration by the plan do not pose this same risk.
The return on the bond, although equal to or greater than the alternatives, would not be sufficient to offset the additional risk for the plan created by the role that this bond would play in the plan’s portfolio.
Under 2008-1, the plan’s fiduciaries may not make this investment based on factors outside the economic interest of the plan because it is not of equal or greater economic value as compared to other investment alternatives.
4. A plan sponsor adopts an investment policy that favors plan investment in companies meeting certain environmental criteria (so-called “green” companies).
In carrying out the policy, the plan’s fiduciaries may not simply consider investments only in green companies. They must consider all investments that meet the plan’s prudent financial criteria.
Under 2008-1, the fiduciaries may apply the investment policy to eliminate a company from consideration only if they appropriately determine that other available investments provide equal or better returns at the same or lower risks, and would play the same role in the plan’s portfolio.
5. A collective investment fund, which holds assets of several plans, is designed to invest in commercial real estate constructed or renovated with union labor.
Fiduciaries of plans that invest in the fund must determine that the fund’s overall risk and return characteristics are as favorable, or more favorable, to the plans as other available investment alternatives that would play a similar role in their plans’ portfolios. The fund’s managers may select investments constructed or improved with union labor, after an economic analysis indicates that these investment options are equal or superior to their alternatives. The managers will best be able to justify their investment choice by recording their analysis in writing.
If real estate investments that satisfy both ERISA’s fiduciary requirements and the union labor criterion are unavailable, however, the fund managers may have to select investments without regard to the union labor criterion.
The guidance set forth in Interpretive Bulletin 2008-1 modifies and supersedes the DOL’s prior guidance that was set forth in Interpretive Bulletin 94-1 that addressed the limited circumstances under which fiduciaries, consistent with the requirements of ERISA Section 403 and ERISA Section 404, could, in connection with investment decisions, take into account factors other than the economic interests of the plan.
—Read DOL Clears Way for Impact Investing in Retirement Plans on ThinkAdvisor.