Bloomberg Law Q&A With George Michael Gerstein: Key Issues for Fiduciaries When Investing for a Cause


Gerson, George

Many retirement plan participants and plan sponsors are no longer content with investments that simply bring them good returns. They also want their investments to do some good in the world.

This approach is commonly known as ESG investing because it targets environmental, social, or governance goals. The key question for plan fiduciaries is whether they can pursue these types of investments while also meeting the requirement to act in the best interest of plan participants.

The Labor Department issued guidance on the subject in April, and fiduciaries are still feeling their way for the right course of action.

Bloomberg Law interviewed George Michael Gerstein, co-chair of the Fiduciary Governance Group at the Washington law firm Stradley Ronon, to learn more about ESG investing and what fiduciary obligations apply when choosing between ESG-themed and non-ESG-themed investments.

This interview was edited for brevity and clarity.

Bloomberg Law: What is ESG investing and how does it differ from other investing?

George Michael Gerstein: I’ve managed to get to know a number of thought leaders and practitioners in the ESG industry, and the confusion over labeling and acronyms regarding similar, yet distinct, approaches is on everyone’s mind. Whether a named fiduciary or outsourced ERISA section 3(38) investment manager pursues “socially responsible investing,” “impact investing,” “ESG investing,” “sustainable investing,” “responsible investing,” or “economically-targeted investing” means different things, though they are often used interchangeably.

In general, fiduciaries may pursue environmental, social, or governance factors in their own right or because of the investment effect they have. Keep in mind, however, that some of the issues falling under the ESG umbrella have more data than others supporting a nexus with investment performance.

Fiduciaries trying to pursue these types of factors can do so by screening investments for certain criteria they wish to include or exclude. Historically, a fiduciary would implement a negative screening process, which excluded certain investments for moral or ethical reasons. Now, though, the thinking has evolved as there is a much greater understanding that a particular ESG factor can have a material financial effect on the plan.

To help clients think through these issues, I pose the following question: “Why are you pursuing this particular ESG factor?” If it’s for something other than purely financial performance risk or return reasons, then we focus a bit more on the fiduciary duty risks. Shareholder engagement is becoming a more common practice for incorporating ESG factors, sometimes preferred over the negative and positive screens and other techniques.

Bloomberg Law: Is the push for this type of investing coming more from plan sponsors or participants?

Gerstein: Knowing there is more and more interest among participants in ESG investing, some plan sponsors have educated themselves on ESG-themed investment products, and plan consultants have come out with helpful surveys and research. Some say the 2016 election galvanized different stakeholders to pursue ESG investments more aggressively, which may be true, but I think this area has evolved in sophistication and understanding, and the push for ESG investing was inevitable.

Some plan sponsors may be hearing a lot from younger participants (namely, Millennials) on this issue, but whether the participants follow through and invest in accordance with those beliefs is an entirely different matter. But Millennials (and I can say this as one of them) are interested in more than pursuing social policy goals through their investments; they are also greatly interested in the growth of their 401(k) balances and retirement security, having entered the job market during the Great Recession. And that is where we see convergence between plan participants and the DOL guidance: plan sponsors and fiduciaries absolutely have to keep their eye on retirement income.

Bloomberg Law: What role do environmental, social, and governance factors play in socially responsible investing?

Gerstein: Any particular ESG factor can be part of a decision to add an investment option to a plan lineup or for a plan’s direct investment. But again, it boils down to why it’s being considered. Does the fiduciary think that selecting companies who score particularly well for corporate governance will in fact lead to better performance, or is the fiduciary wanting to send a political or social message via the investment selection? Both are technically permissible under the DOL guidance (provided certain conditions are met), but the test is more arduous for the latter.

Bloomberg Law: What are a retirement plan fiduciary’s obligations regarding ESG investments?

Gerstein: A fiduciary’s obligations in pursuing a “socially responsible investment,” “ESG investment,” “impact investment,” and the like are the same as any other investment decision: to adhere to your duties of prudence, loyalty, and diversification, and to remain faithful to plan documents provided the terms of those documents do not result in imprudent investments. When there’s more focus on the social, ethical, and political reasons, then we have greater loyalty concerns, but that risk recedes when an integration of factors is used in a portfolio analysis. Fiduciaries can get there, it’s just a matter of how.

Bloomberg Law: What process should a prudent fiduciary follow in such considerations?

Gerstein: I tell clients to document the process and the reasons why an ESG factor is being considered. The fiduciaries should understand the different approaches to ESG investing and make sure everyone is on the same page regarding why the factor is important.

Bloomberg Law: When should a fiduciary conclude that ESG or socially responsible investing is not appropriate for the plan?

Gerstein: The starting place for fiduciaries should be why ESG investing is important. If they can’t answer that question, then bring in a third party expert who can walk through some of the issues. Fiduciaries need to gain a complete understanding of the different factors and approaches, the available data, product availability, and plan demographic information. At that point, if fiduciaries cannot demonstrate why this approach to selecting plan options and investments is consistent with their fiduciary duties, then they should not go any further. I suspect that this will become a less and less likely occurrence over the next 10 years.

Bloomberg Law: Can ESG investing serve as the default investment option under the plan?

Gerstein: The recent DOL guidance, Field Assistance Bulletin 2018-01, warns the fiduciary selecting a plan’s default investment option to be careful in selecting any ESG-themed target date fund, for example, because of potentially insurmountable fiduciary duty concerns. However, the DOL has much more of an open mind to a default option that pursues ESG factors as part of ordinary portfolio management.

Bloomberg Law: What is the Labor Department’s stance on reliance on ESG factors in investing?

Gerstein: Again, entirely permissible, but tread very carefully when pursuing investments for reasons other than investment performance. Keep in mind that the focus of fiduciaries is on retirement income for participants, so it’s vital that investments don’t sacrifice return (or take on extra risk without compensation) for the sake of pursuing environmental, social, or governance-related goals. Also, documentation is key. I am oversimplifying here, but you get the gist.

Bloomberg Law: The Government Accountability Office recently issued a study on consideration of ESG factors in investing. What are the implications of this study for ESG investing?

Gerstein: As usual, the GAO does a great job explaining complex issues, such as the evolution of ESG, in a clear and concise manner. My suggestion for fiduciaries who want to get up to speed is to read the background in the GAO report and the central issues the GAO identifies, then flip to DOL FAB 2018-01 for the DOL’s current view. I don’t think the GAO’s recommendations are as crucial, because FAB 2018-01 addressed them to some extent, though not entirely.

Bloomberg Law: Do you anticipate additional DOL guidance on the use of these factors?

Gerstein: Yes, but I doubt we’ll see anything more until a change in administration occurs. The April FAB issued by the Labor Department is likely the final word from the Trump administration on ESG, unless the DOL is pressed by relevant stakeholders for additional guidance.

Gain a deeper understanding of the legal complexities of employee benefits and executive compensation with if you a free trial to  Bloomberg Law: Benefits and Executive Compensation.