Products January 31, 2023

Morningstar, PAi Follow DOL Rule with ESG-Driven Pooled Employer Plan

Third-party administrator PAi has teamed up with Morningstar to offer small and medium-sized businesses an employer retirement plan with an ESG overlay.

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Plan Administrators Inc. and Morningstar Inc.’s retirement investing division have launched a pooled employer plan comprised of funds that limit exposure to environment, social and governance risks.

The two firms announced that the PEP became available to firms on January 30, after first introducing the concept in October 2021. Chicago-based Morningstar will be the 3(38) investment manager of the plan—responsible for selecting, managing and monitoring the funds—and PAi, which is an Ascensus company, will be the pooled plan provider.

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Morningstar and PAi are launching the PEP on the heels of the U.S. Department of Labor finalizing a rule in November 2022 that retirement plan fiduciaries can consider ESG factors when selecting investment for defined contribution retirement plans. It also comes, however, shortly after 25 Republican states filed a challenge to the rule in a Texas federal court, continuing the debate and discussion of ESG investing’s future in retirement savings.

“The Department of Labor ruling is a great win for employers and advisers, as it gives them options to choose investments that not only provide an appropriate diversification and return profile, but also gets employees engaged with their retirement savings and comfortable that their investments are being mitigated against long-term ESG risk,” Brock Johnson, president of global retirement and workplace solutions at Morningstar, said in a statement.

Flying with ESG

The PEP will be offered on PAi’s CoPilot recordkeeping platform, which seeks participant engagement through event-based alert messages, and a separate tool that shows participants how long their savings are expected to last, De Pere, Wisconsin-based PAi said in the announcement.

There are no employers signed up yet for the PEP, but the firms have received a number of interested parties in the option since introducing the idea in late 2021, according to a spokesperson.

Morningstar Investment Management will select and manage the investment lineup for the PEP using the same qualitative and quantitative processes it uses to oversee the investments in 21,756 plan lineups—as of the third quarter of 2022—as part of its 3(38) and 3(21) fiduciary service, according to the firm. Morningstar has also designed a custom target-date model for the PEP that will use the underlying investment lineup to provide a default investment option and a glide path to retirement for participants.

The ESG analysis includes manager interviews and a review of each fund’s Morningstar Sustainability Rating, the firm said. Within its ESG retirement plan methodology, Morningstar notes that it will “focus on selecting funds that work to mitigate material environmental, social, and governance risks that could impact the risk and return of an investment. We do this while also meeting our rigorous selection criteria for retirement investments, including the consideration of the risk of loss and opportunity for gain of a fund in alignment with the plan’s purpose, and assessing how those selections compare to available alternatives.”

PEP 2.0

PEPs were originally introduced in late 2019 with the passage of the Setting Every Community Up for Retirement Act. The retirement plan vehicle was designed with input from the retirement industry as a way to offer retirement plans to small businesses at lower cost and with less administration and fiduciary burden.

In December 2022, the passage of the SECURE 2.0 Act of 2022  made PEPs available for non-profit 403(b) plans as well, extending them to a sector that has previously been familiar with shared-employer benefits through multiple employer plans.

“Working with Morningstar Investment Management will help employers meet the needs of their employees with a lineup that would otherwise be difficult for a plan sponsor or advisor to recreate and manage themselves,” Amy Hermann, director of sales and marketing at PAi, said in the statement.

Compliance January 30, 2023

Republican States Challenge DOL ESG Rule in Court

A 2022 DOL rule clarifying that ESG strategy can be used in fiduciary decisions was challenged by 25 states in a Texas federal court.

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What do 25 Republican state attorneys general, a fossil-fuel company, a fossil-fuel advocacy group and a Manhattan Institute scholar all have in common? All claim to be negatively affected by a Department of Labor rule that would permit fiduciaries to apply environmental, social and governance investment strategies when selecting investments for ERISA retirement plans.

The rule, finalized in November 2022 and which takes effect today, permit ESG analysis in retirement plans, but does not require it. “Collateral benefits” related to ESG can be considered as a tiebreaker between two investments, but only if they would both equally serve the interests of the plan.

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The lawsuit argues that the rule undermines protection for retirement savings and seeks declaratory and relief against the “politicized ESG criteria.” The lawsuit also sought a temporary stay on the rule, but the District Court for the Northern District of Texas has not yet ruled on that request, and the Department of Justice did not return a request for comment.

Legal Issues

The crux of this issue is whether ESG factors meet the standard of prudence and loyalty as required by the Employee Retirement Income Security Act of 1974. Put another way, is using ESG primarily a strategy for evaluating financial risks, a moralizing political philosophy, or some combination of the two?

James Copland, the only plaintiff listed in the complaint as an individual and a senior fellow and director of legal policy at the Manhattan Institute, says that it is primarily the E and the S in ESG that are problematic. He explains that considering governance practices is important, but environmental and social factors are often not pecuniary factors. He says there is nothing problematic with investors investing with their ethical principles; the problem is when fiduciaries do so at the expense of their clients.

Lourenco Miranda, managing director of ESG and sustainability solutions at the Eisner Advisory Group, says ESG factors are legitimate financial considerations. He argues that including ESG in risk assessments leads to a more steady and predictable cash flows. It is a more risk-averse strategy that carries long-term benefits.

The lawsuit itself asserts that ESG factors are nonpecuniary, which, it argues, would open the door to fiduciaries intentionally providing less attractive investment options merely for political purposes.

Standing Issues

The states assert standing in the complaint by appealing to the legal concept of parens patriae identifying the government as a legal protector and claiming that permitting ESG considerations will undermine the welfare of state residents by reducing investment in the fossil-fuel industry and by damaging the performance of retirement portfolios. The suit also argues that states will lose tax revenue, since their residents will have less valuable retirement portfolios.

Plaintiffs Liberty Energy and Liberty Oilfield Services claim standing on the grounds that since the companies’ officers are plan fiduciaries, they must now evaluate the selection of investments it offers in light of the new rule, since those investment products may be considering nonpecuniary factors. (The DOL rule does not require ESG factors to be used and only says they may be considered.) The lawsuit also says plainly that Liberty itself will receive less investment if ESG is permitted.

Western Energy Alliance, an advocacy group, also sponsors a retirement plan, according to the suit, and claims standing on the same basis as Liberty.

Copland asserts standing on the grounds that he is a retirement plan participant and stands to lose money if this rule passes. Copland explains in an interview that this rule will require him to look more closely at the funds being offered in his retirement plan, since some may change their strategy in light of this new rule.

Brad Campbell, a partner at the Faegre Drinker law firm, says it is “quite likely” the plaintiffs in the case assembled such a diverse group of litigants for this complaint to propose as many standing theories as possible in the hope that at least one will stick.

In particular, the arguments put forward for state government standing here, which rely on tax revenue, are tenuous and unlikely to be successful, according to Campbell. He describes the suit as a “political exercise, not a legal one.”

Campbell says it is also “not an accident they picked a court in the [jurisdiction of the 5th U.S. Circuit Court of Appeals]” He says that the 5th Circuit has a history of ruling against DOL regulations, and selecting this venue when others were presumably available is most likely “venue shopping.”

Ken Paxton, the Texas attorney general, said in a statement that the lawsuit is intended to push back against the administration of President Joe Biden’s, “Woke ESG goals.”

Woke is a term that originated as a descriptor for someone or something that demonstrated a deep awareness of social injustice, especially as applied to racial discrimination. When applied by social conservatives, it is typically used in mockery and condemnation to refer to philosophies or frameworks perceived as left-wing in the extreme. ESG is the first major political issue not directly related to social identity to be widely and consistently labeled as woke by conservatives.

 

 

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