At the same time that the federal government, through the U.S. Department of Labor, appears to be relaxing the pathways for pension plan trustees to consider certain environmental, social, or governance (ESG) factors in pension decision-making. investment, some states are adopting laws that prohibit states from doing business with managers who invest on the basis of ESG criteria. These anti-ESG legislative efforts by states could complicate the use of ESG by public pension plans and put pension plan trustees and providers of pension plan investment products in a difficult position, seeking to meet their fiduciary obligations with these new limitations. These legislative activities could also create challenges for investment providers seeking to simultaneously serve public and private pension plans.
The Department of Labor regulates the majority of employer-sponsored pension plans in the United States through the Employees Retirement Income Security Act of 1974 (ERISA), but public pension plans are not subject to ERISA requirements and are instead regulated by state and local laws. Some states use the ERISA framework as the standard for their public pension laws, directly or indirectly. There are currently more than 5,500 of these state and local government-sponsored retirement plans, with nearly 21 million participants and $4 trillion in assets. These public retirement plans represent nearly 20% of total retirement savings assets in the United States.
In the past year, 17 states have proposed or passed state legislation that would limit the ability of state government, including public pension plans, to do business with entities that are identified as ” boycotting” certain industries on the basis of ESG criteria or objectives or which take ESG factors into account in their investment processes.
These “anti-ESG bills” work in different ways. Some prohibit governments from entering into contracts with companies identified by state officials as “discriminatory” against certain industries, including the gun industry or the fossil fuel industry. For example, Texas enacted SB 19, prohibiting a government entity from entering into contracts with companies for more than $100,000 unless the company verifies in writing that it will not discriminate against a weapons entity. firearms or firearms trade association.
Other types of anti-ESG bills prohibit public funds, such as public pension plans, from investing in ESG-type investment products. For example, Kentucky enacted SB 205, requiring state government entities to divest from financial companies that boycott energy companies. Some states have enacted or proposed only one type of bill (for example, West Virginia’s SB 262 and Utah’s HB 312 prohibit certain types of government contracts with companies that “discriminate” against energy companies, but do not require state divestiture) while other states have proposed or enacted both types of anti-ESG bills (e.g. Oklahoma’s HB 2034 and HB 3144 and HB 25 and HB 978 from Louisiana).
Texas led state efforts to increase oversight of ESG investments with the passage of both types of anti-ESG laws in May 2021. Texas’ SB 13 directly addresses retirement funds held by the State and permanent school funds and impose the divestiture of companies that “boycott” the fossil fuel industry. The funds affected by this law are worth around $330 billion, although it is not clear how many of these assets are invested in companies that would be considered “boycotting” the fossil fuel industry. The law would also prohibit the Texas state government and municipalities from entering into a contract with a supplier over $100,000 unless the supplier declares that it does not and will not boycott energy companies as defined in Texas. law.
Texas SB 13 defines “boycott” very loosely – even companies that invest in fossil fuels but also offer non-fossil fuel financial products could be caught in the ban. As a former Texas lawmaker who once helped oversee pension fund investments explained, “If they have mutual funds or exchange-traded funds in their portfolios that prohibit or limit investments in fossil fuels, then that’s problematic.”
That said, the specific terms of the rule leave room for some interpretation. For example, it is not clear that a company that avoids doing business with energy companies would instantly be considered to be “boycotting” energy companies. Texas law provides an exception for companies acting for a “normal business purpose,” and the definition presents its own complications.
Specifically, the definition of “boycotting energy companies” requires that the determination to avoid doing business with the energy company be twofold:
- because the company engages in the exploration, production, use, transportation, sale or manufacture of energy from fossil fuels; and
- the company neither undertakes nor undertakes to comply with environmental standards beyond applicable federal and state laws.
This two-pronged approach could leave open the possibility that a financial company could refuse to do business with an energy company without “boycotting” the energy company under Texas law, so long as that refusal is not not motivated by the company’s inability to adopt enhanced measures. Environmental standards.
More recently, Florida Governor Rick DeSantis announced in July 2022 his intention to propose a Florida state bill that would prohibit the State of Florida Board of Administration (SBA) from hiring investment managers who consider ESG criteria when managing state assets, including state-sponsored pension funds. . The proposed legislation would amend the state of Florida’s Deceptive and Unfair Trade Practices Act to “prohibit discriminatory practices by large financial institutions based on ESG social credit score metrics,” and would require SBA fund managers to “only consider maximizing return on investment on behalf of Florida Retirees.
At the federal level, ERISA has long required that pension plan trustees make decisions solely in the best interests of plan members and beneficiaries and for the exclusive purpose of providing benefits to plan members and their beneficiaries (see 29 CFR 2550.404a-1(a) ). The question of whether and how ESG factors can be taken into account has been a game of regulatory ping-pong, changing with successive presidential administrations.
The recently proposed version of the Department of Labor’s ESG investment guidelines reiterated ERISA’s focus on the financial interests of participants, requiring that a fiduciary “cannot sacrifice return on investment or take risk of additional investment to promote the benefits of objectives unrelated to the interest of members and beneficiaries in their retirement income or financial benefits under the plan (see 86 Fed. Reg. 57302, 57303 (Oct. 14, 2021) The proposed rule also states that “[a] the fiduciary’s assessment of an investment or investment course of action should be based on risk and return factors that the fiduciary prudently determines to be material to the value of the investment . »
The Department of Labor seems to be trying to clarify that ESG factors can be taken into account when material to an investment. This DOL approach contrasts with recent anti-ESG state bills that appear to be aimed at discouraging the use of ESG investing. These anti-ESG legislative efforts by states could complicate the use of ESG by public pension plans and create challenges for pension plan trustees. The distinction could also create headaches for investment providers looking to serve both public pension plans and plans governed by ERISA.
If you have any questions about how these federal or state regulations may impact investing or the impact of public or private pension plans, company operations, or investment products, please contact the one of the authors of this article or your other Morgan Lewis contacts.