How the Department of Labor interprets fiduciary duty is getting a lot of attention these days.
Much of the concern about its proposal to apply fiduciary duty to individual retirement accounts and other retirement product sales arises because people don’t know how realistic DOL will be in doing so.
It’s clear that there’s a real problem: Consumers, including 401(k) plan participants moving assets to IRAs, are buying financial products that don’t make sense for them. It’s also clear the DOL is trying to show that it will be smart in applying the fiduciary concept, but since the department’s record in the past has been mixed, many businesses remain nervous or outright antagonistic.
One way to provide some comfort would be for the DOL to undo other ill-advised fiduciary regulation. A clear signal would be to bring its fiduciary guidance on Employee Retirement Income Security Act of 1974 investing back in line with the current practices of other institutional investors: with evolving standards of fiduciary duty and the recognition that social, environmental and corporate governance risks are being and should be incorporated into prudent investment decision-making.
Pension fund investment practices always have evolved in response to changes in finance theory, markets, technology and changing standards of prudence. Before the 1970s, for example, public market equities were considered by many to be too risky for pension funds. Since then, they have become the dominant form of pension fund investment, accounting for 60% or more of the asset allocation at some. Pension funds also have since become a major source of the capital in real estate, private equity, venture capital, commodities, hedge funds and other alternative assets classes and strategies.
The DOL enforces fiduciary standards and ERISA pension funds are clearly fiduciaries, but for decades before 2008, the department avoided telling funds how they should or should not invest. A few weeks before the 2008 election, however, the DOL issued new guidance designed to prevent ERISA plans from exercising their rights as shareholders to improve business performance and to discourage green investing. It did so by requiring certain cost-benefit analyses and documentation prior to acting — requirements that were practically impossible to meet. Since there were no public hearings before the DOL acted, it’s hard to know for sure why officials departed from decades of prior practice, but it appears they were responding to some elements of the business community that feared the kind of shareholder activism other institutional investors already were practicing.
Sadly, the DOL was closing the door on practices that many other institutional investors had adopted to improve their returns. Exercising shareholder rights is widely recognized as an important tool to improve returns. Many institutional investors have concluded they cannot simply sell shares when disappointed in a company’s performance, that the size of holdings and the increasing efficiency of markets now means that doing so further reduces share values and returns. Many now use their rights as shareholders to demand improvements both in corporate performance and in corporate governance.
Similarly, institutional investors increasingly are taking environmental and social (i.e., future regulatory) risks into account. These factors might not yet show up in quarterly earnings, but they can and do affect the long-run returns that pension funds will need to meet their equally long-term obligations.
In the past seven years, some institutional investors have asked the DOL to withdraw the 2008 guidance, so that ERISA fiduciaries can return to using their own professional judgment about when to exercise their rights as shareholders and when and how to take environmental, social and governance factors into account.
The DOL has not yet responded to these requests. But at a time when the department is trying to show that it can apply fiduciary standards in ways that keep pace with professional practices, now might be a good time to do so.
Editor’s Note: This post originally appeared on Pensions & Investments