At the same time that the federal government, through the US Department of Labor, appears to be ease Ways for retirement plan fiduciaries to consider certain environmental, social or governance (ESG) factors in making investment decisions, some states are passing legislation that would prohibit states from doing business with investment managers based on ESG criteria. These state anti-ESG legislative efforts may complicate the use of ESG by public pension plans and place pension plan fiduciaries and providers of pension plan investment products in a difficult position as they seek to reconcile the obligations of their fiduciaries with these new restrictions. These legislative activities may also create challenges for investment providers seeking to simultaneously serve public and private retirement plans.

The Department of Labor regulates most employer-sponsored retirement plans in the US through the Employee Retirement Income Security Act of 1974 (ERISA), but public retirement plans are not subject to ERISA’s requirements and in instead they are governed by state and local laws. Some states use the ERISA framework as the standard for their public pension statutes, either directly or indirectly. There are currently over 5,500 such sponsored by state and local government pension plans, with nearly 21 million participants and $4 trillion in assets. These public retirement plans are calculated close to 20% of total US retirement savings assets.

Over the past year, 17 states have proposed or passed state legislation that would limit the ability of state governments, including public retirement plans, to do business with entities that are identified as “boycotting” certain industries based on criteria or ESG goals or that consider ESG factors in their investment processes.

These “anti-ESG bills” work in different ways. Some prohibit government contracting with companies identified by state officials as “discriminating” against certain industries, including the firearms industry or the fossil fuel industry. For example, Texas has adopted SB 19prohibiting a government entity from contracting with the company for over $100,000 unless the company verifies in writing that they will not discriminate against a firearms entity or a firearms trade association.

Other types of anti-ESG bills prohibit state funds, such as state pension plans, from investing in ESG-type investment products. For example, Kentucky has adopted SB 205, forcing state government units to divest from financial companies boycotting energy companies. Some states have passed or proposed only one type of bill (for example, West Virginia’s SB 262 and Utah HB 312 ban certain types of government contracting with companies that “discriminate against” energy companies but do not mandate state divestment) while other states have proposed or passed both types of anti-ESG bills (for example, Oklahoma HB 2034 AND HB 3144 and Louisiana HB 25 AND HB 978).

Texas led the state’s push to increase oversight over ESG investing by passing both types of anti-ESG laws in May 2021. Texas’ SB 13 it goes directly to state pension funds and permanent school funds and mandates divestment by companies that “boycott” the fossil fuel industry. Funds affected by this law are valuable about 330 billion dollars, although it is unclear how much of these assets are invested in companies that would be considered to “boycott” the fossil fuel industry. The law also would prohibit Texas state government and municipalities from entering into any contract with a vendor valued at more than $100,000 unless the vendor declares that it does not and will not “boycott” energy companies as defined in Texas for the duration of the contract. statute.

TEXAS SB 13 defines “boycott” very loosely – even firms that invest in fossil fuels, but also offer fossil fuel-free financial products, can be included in the ban. As a former Texas lawmaker who previously helped oversee pension fund investments explained, “If they have any mutual funds or exchange-traded funds in their portfolios that prohibit or limit investments in fossil fuels, then that’s problematic.”

That said, the specific terms of the rule leave room for several interpretations. For example, it is not clear that a firm that avoids doing business with energy companies will immediately be considered to be “boycotting” energy companies. Texas law carves out an exception for companies operating for a “normal business purpose,” and the definition presents its own complications.

Specifically, the definition of “energy company boycott” requires that the determination to avoid doing business with the energy company is based on two points:

  • because the company engages in the exploration, production, exploitation, transportation, sale or production of energy based on fossil fuels; AND
  • the company does not undertake or undertake to meet environmental standards beyond applicable federal and state law.

This two-pronged approach could leave open the possibility that a financial company could refuse to do business with a power company without “boycotting” the power company under Texas law as long as that refusal was not motivated by the company’s failure to adopted increased growth. environmental standards.

Recently, Florida Governor Rick DeSantis announced in July 2022 his plan to propose a Florida state bill that would prohibit the Florida State Board of Trustees (SBA) from engaging investment managers who consider ESG criteria when managing state assets, including endowments state-sponsored pensions. The proposed legislation would amend Florida’s state statute on deceptive and unfair trade practices to “prohibit discriminatory practices by large financial institutions based on ESG social credit score measures” and require SBA fund managers to “only consider maximizing return on investment on behalf of Florida’s Retirees.”

At the federal level, ERISA has long required that retirement plan fiduciaries make decisions only in the best interests of plan participants and beneficiaries and for the exclusive purpose of providing benefits to participants and their beneficiaries (see 29 CFR 2550.404a-1(a) ). Whether and how ESG factors can be considered has been a game of regulatory ping pong, changing with successive presidential administrations.

Recently proposed version of the Department of Labor’s ESG investment guidance reiterated ERISA’s focus on participants’ financial interests, requiring that a fiduciary “may not sacrifice investment return or assume additional investment risk to promote the benefits of the purposes that are not related to the interest of participants and beneficiaries in their retirement income or financial benefits under the plan.” (see 86 Fed. Reg. 57302, 57303 (Oct. 14, 2021)).The proposed rule also UNITED that “[a] A fiduciary’s evaluation of an investment or investment course of action must be based on risk and return factors that the fiduciary reasonably determines are material to the value of the investment.”

The Department of Labor appears to be trying to clarify that ESG factors can be considered when they are material to an investment. This DOL approach is in contrast to recent anti-ESG state bills that seem intended to discourage the use of ESG investments. These state legislative efforts against ESG may complicate the use of ESG by public retirement plans and create challenges for retirement plan fiduciaries. The difference can also create headaches for investment providers seeking to serve both public retirement plans and ERISA-governed plans.

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