How to Put ERISA in Your Corner

The Department of Labor administers and enforces ERISA laws. Above all, the DOL clearly mandates that the interests of participants are prioritized.

In recent years, the DOL has implemented regulations allowing retirement plan sponsors more leeway when considering environmental, social and governmental factors while choosing investments. But will the new rules help or hurt participants?

ERISA protections

The ERISA safeguards initially came about alongside the collapse of Studebaker. When the carmaker closed its Indiana plant in 1963, approximately 70% of Studebaker's workforce lost a portion of, if not all, their benefits.

The initial function of the legislation was to set minimum standards in private industries for voluntarily established health and retirement plans. Although ERISA does not compel firms to offer pensions, it demands adherence to rigid standards in the event that they do.

ERISA rules were enacted to outline the conduct of plan managers and provisions designed to guard the interests and the rights of participants, even if employers face bankruptcy. Above all, two primary hallmarks of the legislation are transparency and accountability.

The main goal behind the law is to protect the savings of millions of workers from mismanagement, unethical practices and improper practices. The law defines an absolute standard for plan sponsors, which is the requirement to act exclusively in the best interest of the plan participants. That is the basis of the relationship known as fiduciary responsibility, which includes loyalty, good faith and prudence.

ERISA requires plan sponsors to do the following:

• Offer information about the plan's features and funding sources.
• Practice fiduciary responsibility.
• Establish an appeals process.
• Give participants the right to sue for their benefits or after breaches of fiduciary duty.
• File annual reports to the federal government.
• Avoid discrimination toward participants.

Should plan sponsors include environmental, social and governance factors in their investment decisions?

This is a question that has become rather political. Democrats say yes, while Republicans are more hesitant. The Trump DOL ruled that plan fiduciaries must act solely in the interests of participants, which means plan fiduciaries can only take ESG aspects into account if they had a direct impact on investment returns.

Alternatively, the Biden DOL has modified the guidance originally established by the Trump DOL with the goal of pivoting to a focus on climate and government policies that might improve risk-adjusted returns.

In November 2022, the DOL announced a final rule that allowed plan fiduciaries to consider ESG factors in plan investments. In other words, fiduciaries no longer need to only consider raw performance. The current DOL asserts that the earlier rules had a chilling effect on ESG investments and created barriers that did not need to be there.

They now hope to make pensions more resilient. Moreover, the DOL would allow plans to use ESG funds as a default investment option, as long as the fund's returns are respectable. Therefore, ESG funds are particularly popular among younger workers.

A can of worms

The battle over ERISA and ESG has just begun. In 2023 alone, 25 states have already filed lawsuits and challenged the new rules because of concerns that they put retirement money at risk. The states refer to these rules as politically motivated and immaterial, complaining that they supersede ERISA's authority.

It is interesting to see how major asset managers loudly support the new DOL position, which is the suggestion that ESG factors can improve performance. But that is because major asset managers have vested interests in the new ESG factors. Note that the average expense ratio they charge for sustainable funds is much greater than that of other mutual funds and exchange-traded funds.

So will ESG aspects ultimately drive fund performance? The jury is out. Global ESG funds trailed the broader market from 2017 to 2022, returning 6.3% in 2017 and 8.9% in 2022, according to data from Bloomberg. The data for U.S. ESG funds shows a similar average discrepancy per year of 10.2% in 2017 and 12.6% in 2022.

The field is still amassing data, clarifying costs and trying to understand the benefits. Indeed, the DOL's position may oscillate with each new administration, leaving plan administrators in limbo.

Are you still confused about which option to choose? Speak with an investment professional for help as you work to select the appropriate funds for your 401(k).