Fast Exit From Russian Funds for 401(k)s? Yes, Under ESG Plan – Bloomberg Law

Private-sector retirement plans can’t move as fast as their counterparts in the public sphere to divest from Russian securities in reaction to the outbreak of war in Ukraine.

Many retirement investors have swiftly gutted their holdings in Russian assets since hostilities broke out in eastern Europe, highlighting the speed and agility with which large public pension plans can target money to direct social investing.

A U.S. Labor Department proposal would change that by equipping private-sector pensions and 401(k)s with environmental, social, and corporate governance investment factors to apply a similar kind of flexibility to the rest of the retirement investment marketplace. That latitude for speedy capital adjustments could have big implications for savers’ workplace retirement balances, protecting them from risky market sinkholes or co-opting their savings for social and political gains.

“It would enable plans to act faster because it’s less restrictive,” said Alicia Munnell, director of the Center for Retirement Research at Boston College. “I just don’t know if that’s a desirable goal.”

Almost ESG

Using public pensions as political ammunition isn’t the same thing as strict ESG investing, Munnell said. ESG criteria are usually defined as a measure of an investment’s environmental impact, a company’s community outreach, and its management culture as a relevant factor in long-term value.

But the financial impact of a U.S. and European rebuke of Russian goods and services can’t be ignored. Lawmakers in at least seven states have proposed sanctions that would pull public worker pension dollars from Russian-backed entities. Governors in seven states have ordered regulators to stop doing business with Russian companies. That’s effectively helped tank the Russian economy, devaluing assets for the foreseeable future.

State-run pensions aren’t subject to federal regulations and are uniquely prone to state-led political interests, Munnell added. Public pensions were divested from South African interests in the 1980s during apartheid.

“People are considering these kinds of measures because they want to make a statement against Putin’s aggression,” Munnell said. “That’s a rational and altruistic concern. It’s a constructive thing to do while you’re in war.”

Proposed Change

Private-sector pensions and 401(k)s aren’t nearly as malleable as their public-sector counterparts, said Jean-Pierre Aubry, the Retirement Research Center’s associate director for state and local research.

“The framework of funds that exist today don’t align with what we’re seeing with public pensions,” he said. “They don’t yet have the political component.”

The Labor Department’s proposed ESG rule seeks to undo Trump-era regulations that curbed ESG investment criteria and shareholder powers. It would break new ground by directly tying the financial materiality of those considerations to government actions.

Plan officials’ duty of prudence “may often require” them to consider certain economic effects, the rule states.

“You can see how that would make it easier for investment committees to consider, for example, the performance of Russian securities from an economic standpoint,” said Diane Dygert, a partner at Seyfarth Shaw LLP in Chicago.

More Flexible

If the proposed ESG rule were to take effect, Dygert said, private-sector pensions and defined-contribution plans would be more flexible to make adjustments to align with financially material world events, but they still wouldn’t be as agile as public pensions.

Plan committees usually only meet quarterly, and she said she envisions investment managers cautioning decision-makers against immediate change. Within the defined-contribution space, plans offering small-cap or emerging market equity classifications would have the most global exposure. Defined-benefit plans would stand to gain the most from quick divestment, Dygert added.

But even that level of fast-acting trading could pose a risk to plan participants, said Andrew Biggs, a senior fellow at the American Enterprise Institute who testified before a House panel last week.

“I fear that current proposals to give ESG factors greater emphasis in retirement planning could undermine Americans’ retirement savings as a means to pursue public policy goals that are distinct from the retirement system,” he told the Subcommittee on Health, Employment, Labor and Pensions.

The California Public Employees Retirement System opted to divest in tobacco companies in 2018, at a cost of more than $3.6 billion to the public employees and employers who had a stake in that plan, Biggs said.

“The only saving grace is that, since for every seller there also is a buyer, someone else whose investments were not controlled by CalPERS made that $3.6 billion instead,” Biggs said.