Data & Research May 31, 2016

Clients Want and Need Deeper ESG Insights

Enthusiasm about environmentally responsible investing has bloomed in the wake of recent DOL rulemaking, but a new TIAA survey shows a knowledge gap persists. 
Reported by

The Department of Labor moved the better part of a year ago to encourage wider use of environmental, social and governance (ESG) investing factors by retirement plan fiduciaries, both in defined contribution (DC) and defined benefit (DB) plan contexts.

Speaking to reporters at the time, Labor Secretary Thomas Perez said the new guidance essentially returns the ESG investing paradigm “back the way things worked between 1994 and 2008.” While the regulatory outlook for ESG is still somewhat complicated from the perspective of ERISA plan sponsors and advisers, the move by DOL was taken to give significantly more freedom to plan officials to implement ESG thinking without risking lawsuits.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

Rather than ESG, Perez and DOL favor the term ETI, short for “economically targeted investments,” but  “we’re talking about the same thing here when we say ESG, SRI [socially responsible investing] or ETI,” Perez explained. “Whatever term you favor, ETIs are investments that are selected for the benefits they create, for example environmental or social benefits, in addition to the investment return to the employee benefit plan investor.”

New research from TIAA shows the definition and proper role of ESG/ETI is still far from universally understood among the plan participants investing in plans governed by the Employee Retirement Income Security Act (ERISA). In fact, about 40% of investors recently polled by TIAA report they are unsure if they even currently own responsible investments within their portfolios, highlighting just how low the general knowledge level around ESG investing is.

Perhaps more startling, says Amy O’Brien, managing director and head of TIAA Global Asset Management’s Responsible Investment team, is that even many advisers seem to lack deep knowledge about ESG themes.

“Even with interest in social impact growing, and the availability of more responsible investment options than ever before, greater than one in three investment advisers concede that they are not able to adequately evaluate performance of responsible investments,” TIAA warns. “These findings … expose a fundamental challenge to the investing category—the lack of understanding among investors and advisers of what responsible investing really is.”

Strictly speaking, under the DOL’s new guidance ESG investing factors can still only serve as a tiebreaker when considering economically similar investments. As Perez has clearly reiterated, “fiduciaries still may not accept lower expected returns or take on greater risks in order to secure collateral benefits.” But under the new paradigm, the DOL directly acknowledges that environmental, social, and governance factors “may have a direct relationship to the economic and financial value of an investment.” When they do, these factors are more than just tiebreakers, but rather are proper components of the fiduciary’s analysis of the economic and financial merits of competing investment choices.

NEXT: Other points of ESG confusion 

According to TIAA, many advisers are still coming to terms with this solution to the ESG Catch 22.

As the preamble to the DOL’s latest guidance states, the requirements of Sections 403 and 404 of ERISA “do not prevent plan fiduciaries from investing plan assets in ETIs if the ETI has an expected rate of return that is commensurate to rates of return of alternative investments with similar risk characteristics that are available to the plan, and if the ETI is otherwise an appropriate investment for the plan in terms of such factors as diversification and the investment policy of the plan. Some commenters have referred to this standard as the ‘all things being equal’ test.” Yet at the same time, the rulemaking “does not in any way supersede the investment duties regulatory standard of 29 CFR § 2550.404a-1, nor does it address any issues that may arise in connection with the prohibited transaction provisions of ERISA.”

Rather, Perez explained, the new rulemaking “confirms the department's longstanding view that plan fiduciaries may invest in ETIs based, in part, on their collateral benefits so long as the investment is appropriate for the plan and economically and financially equivalent with respect to the plan's investment objectives, return, risk, and other financial attributes as competing investment choices.”

Taking all this together, TIAA predicts that advisers will have more success getting clients to trust and use ESG investments only as they build up their own knowledge base about ESG pros and cons. Now is the time to learn such things, because almost three-quarters of investors say they would be “more likely to work with an adviser who could give them competitive investment returns from investments that also made a positive impact on society, and 65% of investors would be more likely to stay with an adviser who could discuss responsible investing with them.”

Meanwhile, just 45% of advisers believe this would be the case, TIAA explains, and they often choose not to address responsible investing options with their clients. “Over three in five investors (61%) indicated that their adviser had not brought up the topic of responsible investing in the past twelve months. This disconnect suggests that too many advisers forgo a chance to develop stronger relationships with their clients as a result of not communicating about these strategies.”

NEXT: Better communication and education needed 

One clearly positive sign emerging from the research is that a strong majority (75%) of advisers reported an interest in learning more about responsible investing options to better serve their clients. In addition, the TIAA research indicates a variety of valuable opportunities for advisers moving forward in doing this work, especially as it pertains to coaching clients on the interplay of ESG factors and portfolio performance.

For example, TIAA finds investors are clearly doubtful of the availability of best-in-class products in the ESG market, giving advisers an opportunity to help them find and purchase high-quality products. “In fact, more than one in four affluent investors and advisers responded that responsible investment options are very limited or that the category lacks quality choices,” TIAA finds. “Even more notably, over half (51%) of financial advisers believe responsible investing does not provide the same rate of return as other investment strategies, while 57% of investors believe responsible investing offers a lower rate of return than other strategies.”

Simply put, these broadly negative categorical statements around ESG are untrue, TIAA concludes.

“More investors are considering the balance between leveraging their assets to have a social or environmental outcome while seeking competitive performance. According to our recent socially responsible investing performance analysis, indexes that follow SRI guidelines delivered long-term performance returns comparable to the broad market benchmarks,” O’Brien explains. “Incorporating environmental, social and governance criteria in individual security selection can in fact deliver market-competitive returns.”

Thinking specifically about the ERISA domain, TIAA finds the availability of ESG investment options through workplace retirement plans “would cause 71% of affluent investors to feel good about working for their employer.” This is an even clearer effect among younger employees, with 90% of Millennial investors saying they want their investments to “deliver competitive performance while promoting positive social and environmental outcomes.”

Additional findings are presented here. 

Compliance May 31, 2016

DOL Agrees Foot Locker Should Reform Cash Balance Plan

The agency filed a brief in a federal appellate court case about whether Foot Locker misled employees upon conversion from a traditional pension to a cash balance plan.
Reported by

In a case before the 2nd U.S. Circuit Court of Appeals in which Geoffrey Osberg claims his employer, Foot Locker, issued false and misleading summary plan descriptions (SPDs) in violation of the Employee Retirement Income Security Act’s (ERISA) disclosure requirements when it converted from a traditional defined benefit plan to a cash balance plan, the U.S. Department of Labor (DOL) has filed a brief in support of a district court’s decision that plan reformation is justified.

Osberg said Foot Locker failed to provide plan participants with notice, as required by ERISA, that the cash balance arrangement could potentially reduce future benefit accruals.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

The DOL says the district court properly concluded that plaintiffs timely filed their complaint asserting fiduciary breach claims under ERISA’s provision allowing suit within six years of discovery of a statutory breach or violation in cases involving “fraud or concealment.” Contrary to Foot Locker’s assertion, plaintiffs were not required to establish the elements of common law fraud, including intentionality and reliance, to show concealment for purposes of this statutory provision.

According to the DOL, “Foot Locker likewise errs in arguing that each member of the class must demonstrate that he or she detrimentally relied on Foot Locker’s misrepresentations in order to establish that Foot Locker breached its duties as a fiduciary and to obtain equitable relief in the form of reformation.” The brief says this argument ignores the 2nd Circuit’s own precedent in Amara where, after remand from the Supreme Court, it soundly rejected the argument that plan participants and beneficiaries need to show detrimental reliance to obtain reformation under ERISA Section 502(a)(3) as relief for fiduciary misrepresentations and omissions.

The DOL adds that no pre-Amara case from the 2nd actually holds that each member of a class of plan participants must establish detrimental reliance to prove a fiduciary breach based on misrepresentations or to obtain reformation as relief, nor does any other case cited by Foot Locker so hold.

Just as each class member need not establish detrimental reliance, each and every member need not show mistake in order to obtain plan reformation, the brief says. “Again, in arguing to the contrary, Foot Locker ignores this Court’s decision in Amara, which concluded that plan participants can prove mistake for purposes of reformation ‘through generalized circumstantial evidence in appropriate cases,’ such as where ‘defendants have made uniform misrepresentations about an agreement’s contents and have undertaken efforts to conceal its effect.’”

NEXT: Case history

When the case was first filed, the U.S. District Court for the Southern District of New York granted defendant's motion for summary judgment in its entirety, thereby dismissing the case.

On appeal, however, the 2nd Circuit reversed the district court's decision, first determining that plaintiff's Employee Retirement Income Security Act (ERISA) Section 404(a) claim was timely. The appellate court also noted that in CIGNA Corp. v. Amara, to obtain contract reformation, equity does not demand a showing of actual harm.

“We disagree Foot Locker construes Amara to hold that monetary relief is only available in ERISA cases via surcharge; therefore, absent a viable surcharge claim, the only beneficiaries with standing to pursue reformation are those that can prospectively benefit from a modification of plan terms, which does not include former employees. This interpretation is supported by neither Amara,… nor equity,” the court said in its opinion, remanding the case back to the District Court for further review.

Upon review, U.S. District Judge Katherine B. Forrest found from testimony of plan participants that the communications to them led them to believe their pension benefits were growing with their years of service. In her opinion, Forrest said all of the communications share core common characteristics: all failed to describe wear-away, and all failed to clearly discuss the reasons for the difference between a participant’s accrued benefit under the old plan and his or her balance under the new plan. She determined that all the statements were intentionally false and misleading, and that the summary plan description (SPD) contained a number of intentionally false misstatements.

“Here, there is no doubt that Foot Locker committed equitable fraud,” Forrest wrote. “It sought and obtained cost savings by altering the Participants’ Plan, but not disclosing the full extent or impact of those changes.”

Comparing the case to that of Amara, but calling Foot Locker’s violations “more egregious,” Forrest said to remedy Foot Locker’s misrepresentations, the plan must be reformed to actually provide the benefit that the misrepresentations caused participants to reasonably expect. With respect to class members who have already retired, the court ordered that retirees and former employees shall be entitled to receive the difference in value between the reformed plan calculation and the benefit they received, in addition to prejudgment interest at a rate of 6% per annum.

Foot Locker appealed to the 2nd Circuit.

«