Ethics, Earnings, and ERISA: Ethical-Factor Investing of Savings and Retirement Benefits
NYU Rev. Employee Benefits and Exec. Comp., 6-1 (2020)
116 Pages Posted: 7 Dec 2020 Last revised: 30 Jan 2021
Date Written: 2020
Ethical-factor investing shall be defined as using ethics, such as an enterprise’s policies regarding social/economic/health justice, sustainability, climate change, or corporate governance, as a factor to determine whether to acquire, dispose of, or how to exercise ownership rights in an equity or debt interest in a business enterprise. Such investing is becoming increasingly popular among Americans, and American savings and retirement plans.
Ethical-factor investing includes, but is not limited to the ESG, sustainable, socially responsible, impact, and faith-based investing. The article discusses a variety of the current types of such investments, their history, and their progenitors.
Ethical-factor investing may. but need not, be intended to enhance the investor’s financial performance. Ethical-factor investing also may, but need not, be intended to enhance an enterprise’s ethical behavior, i.e., to be socially beneficial. If intended to do so, it is an expansion of the broadly held pre-biblical and current beliefs that loans must be extended on benevolent terms to the beliefs that investments, including, but not limited to loans, must be made to encourage others, not merely the investor, to behave benevolently. A significant part of the 19th century campaign that led to the government action that abolished American slavery were such investments, with the most effective being the engagement efforts made in concert with other enterprise stakeholders. As with the abolition campaign, ethical-factor investing is most often socially beneficial when part of a broad engagement campaigns, which may, but need not, include (1) large institutional investors, who may make direct overtures to enterprises to behave more benevolently, (2) other enterprise stakeholders, who may encourage more benevolent behavior by affecting enterprise operations, and (3) governments, who may mandate more benevolent enterprise behavior.
Two fiduciary and tax-qualification questions arise in the retirement/savings plan realm with respect to ethical factor investing. Fiduciaries of non-ERISA plans, such as many government plans, often must satisfy tax-qualification rules similar to fiduciary rules governing ERISA plans. To what extent may fiduciaries make available ethical-factor investment options to participants and beneficiaries, who self-direct their investments, such as those for 401(k) plans or 403(b) plans? To what extent may plan fiduciaries, make ethical-factor investments on behalf of participants and beneficiaries, such as those for defined benefit plans?
Retirement/savings plan fiduciaries may encourage what they perceive as better ethical behavior with their investment choices, as long as no expected financial cost is imposed on participants or beneficiaries. This is called the Tie-Breaker approach. It is often the case that two or more investment alternatives have the same expected economic performance, and it is necessary to use non-economic factors, such as ethical factors, to decide between or among such alternatives. Individuals, unlike retirement/savings plan fiduciaries, may encourage what they perceive as better ethical behavior with their investment choices, as long as the expected financial cost is relatively small. The costs must be limited so that investments remain profit-seeking investments. This is called the Concessionary approach. IRA participants and beneficiaries may pursue this investment approach.
Finally, retirement/savings plan fiduciaries may also use an ethical-factor, like any non-ethical factor, to enhance their investment’s expected financial performance in a cost-effective fashion. This is called the Incorporation approach. As with other financial approaches, if it is readily available to a fiduciary, the fiduciary has a duty to use the Incorporation approach.
Keywords: Fiduciary, Tax-Qualification, Ethics, ESG, Asset Management, Corporate Governance, Sustainable Investing, Faith-Based Investing, Responsible Investing, Socially Beneficial Investing, Ethical-Factor Investing, ERISA, 401(k) Plans, IRAs, Self-Directed Plans
JEL Classification: G11, G34, J32, K19, K22, K34, M14, Q01,Q56
Suggested Citation: Suggested Citation