This article originally appeared in Forbes on September 22, 2020.
The time to ensure that pension fund managers are bound by their fiduciary obligation to their beneficiaries and not by any other political motives is now. Prioritizing issues other than pure financial returns may be an acceptable strategy for individuals managing their own money or for corporate board rooms contemplating the future of their company, but for fiduciaries, prioritizing any kind of self-interest or ulterior motive over maximizing returns is a dereliction of duty.
Over the past several months, the Department of Labor has begun to take steps to curb this trend, releasing two new regulatory proposals seeking to re-affirm the responsibilities of pension fund fiduciaries. The first proposed rule examines tax-qualified retirement plans governed by ERISA in order to determine the extent to which Environmental, Social, and Governance (ESG) considerations factor into investment decisions. The question at hand is whether the plan managers, bound by fiduciary duty to their beneficiaries, are sacrificing investment returns or increasing risks to meet ESG goals unrelated to participant’s bottom-line financial interests. The second rule seeks to re-evaluate the outsized role that proxy advisory firms have played in pension fund investment and the associated costs that have been passed down to beneficiaries.
As a former state treasurer of Connecticut, I have personally overseen the management of a public pension system. It is not possible to fully protect the financial security of a plan’s beneficiaries if those charged with managing a pension fund are trying to build an investment strategy around nonfinancial considerations. Decisions on new investment strategies, whether they are driven by political reasons or simply as an attempt to chart a new path forward, must be made in the boardroom. There are many laudable social initiatives that individuals, religious endowments, schools, and other private entities may wish to consider. However, it is never correct to impose personal political motives on pension funds. This principle is even more prevalent given the financial ramifications that the economic fallout of the COVID-19 pandemic has had on pensions.
The Department of Labor should be applauded for taking these necessary steps toward clarifying and correcting guidance on the fiduciary obligations of pension fund managers. As Labor Secretary Scalia noted, these actions aim to “remind plan providers that it is unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end.”
Despite these efforts, public pensions are still vulnerable to ESG strategies. The trend towards “impact investing” has permeated the proxy voting industry, where two firms effectively control significant numbers of shareholder votes in thousands of publicly traded companies. These votes would be an important weapon against ESG policy that does not serve the shareholders, but under the current rules mostly serve an ideological agenda separate from the interests of retirees and public employees. For this reason, the Department’s second proposed rule clarifying the roles and responsibilities of proxy advisory firms and the obligations that fund managers have toward their proposals is of the utmost importance.
SEC commissioner Daniel M. Gallagher acknowledged the problems with the proxy industry as far back as 2013, noting that the current system is not built to increase company value or generally operate on behalf of shareholders, but rather to serve the interests of the proxy advisory companies themselves. While the proposal is a step in the right direction, it is important to think not only about how pension money is invested, but also how the voice that comes with a stake in any given company is used. Until we reform the proxy voting industry, that voice will be vulnerable to the whims of third parties.
One major issue which is not adequately addressed by the Department’s proposed regulations is the issue of “robo-voting,” a practice which has long allowed for the proxy advisory firm duopoly to pursue a personal agenda with limited scrutiny. Under this practice, some fund managers have simply accepted the voting recommendations of proxy advisors automatically, blindly moving forward on proxy firms’ recommendations without consideration of their overall fiduciary impact on the fund. The growth of robo-voting in the industry is understandable given the cost savings that pension plans can accrue as a result, but the desire to implement sound cost-saving measures cannot be upheld if proxy voting is relied upon to determine the course of action on contested issues. In these instances, fiduciaries should end their reliance on proxy voting in order to ensure that all final decisions are truly in the best interest of beneficiaries.
While more work is needed, it appears that the Department of Labor is finally in a position to implement much-needed reforms to a pension system that has for too long neglected the underlying financial security of its beneficiaries. Given the widespread problem of unfunded pension liabilities, the economic fallout from the pandemic, and increased politicization of pension investments, a re-commitment to fiduciary responsibility is a welcome sight. The retirees of this nation deserve as much.