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August 02, 2005
Retirement Plans, Fiduciary Duty, and SRI: Complicated But Compatible
    by William Baue

A paper published in a professional journal establishes the validity of employing socially responsible investing in retirement plans while also outlining the complexities of the practice.

The US Environmental Protection Agency (EPA) is currently surveying its employees to gauge interest in offering a socially responsible investment (SRI) index fund option in its Thrift Savings Plan (TSP), a defined contribution retirement plan for government workers. The survey echoes the "Federal Employees Responsible Investment Act," a bill introduced in the US House of Representatives (HR 4140) last year by Representatives James Langevin (D-RI) to offer an SRI index fund option to the TSP for all federal employees.

While the decision to employ SRI in retirement plans remains fraught with complexities that may never disappear, they can be mitigated. This is the conclusion reached by George Gay and Johann Klaassen of the First Affirmative Financial Network (FAFN), a national network of SRI financial advisors, in a paper published in the current edition of the Journal of Deferred Compensation.

The paper, entitled "Retirement Investment, Fiduciary Obligations, and Socially Responsible Investing," restates the pair's 2003 argument "that there is nothing intrinsically contrary to fiduciary duty involved in an investment advisor's use of SRI investment strategies . . . ." The current paper extends this line of reasoning to examine the opportunities and obstacles of employing SRI in the three main retirement investing vehicles, self-directed (SD) plans, defined contribution (DC) plans, and defined benefit (DB) plans.

SD plans, such as tax-deferred individual retirement accounts (IRAs), clearly allow SRI since the individual is free to choose--only when investment advisors enter the equation are they accompanied by questions of fiduciary duty. These questions become more pronounced with DC plans, such as 401(k) accounts, which are individualized by employees' choices but are typically administered by employers. Fiduciary obligations fall solely on the shoulders of the trustees of DB plans, such as pensions, which deprive participants choice in exchange for the security of pooled funds and professional management.

"It seems clear that different people are responsible for different decisions in these three classes of retirement plan; we contend that SRI strategies are not inherently irresponsible choices in any of them," state Mr. Gay, CEO of FAFN, and Dr. Klaassen, FAFN's vice president of managed account programs.

Recapitulating their 2003 argument for investment advisors to use SRI in SD plans, the authors debunk the main stumbling block--claims that SRI necessarily underperforms--by citing studies finding the opposite. A less easily surmountable obstacle is the claim that SRI cannot achieve adequate diversification. The authors cede the difficulty of creating SRI portfolios with diversity across asset classes, but point out that current computer modeling software makes it no more difficult to construct an efficient SRI portfolio as a non-SRI portfolio.

The key hurdle DC plan trustees must vault in considering whether to add SRI funds to the list of options for plan participants is the question of "prudence."

"Fiduciary liability is not determined by investment performance, but rather by whether prudent practices were followed," states Donald Trone of the Foundation for Fiduciary Studies (FFS), as quoted in the paper. "It has become a generally accepted practice to permit the inclusion of an SRI strategy."

Factors that can monkey-wrench the decision to offer options SRI include the fact that adding more options can sometimes overwhelm participants into paralysis instead of liberating them through free choice. Also, the inclusion of a single SRI options can "lead to undesirable outcomes" such as participants concentrating all their assets in this one fund instead of diversifying across asset classes. And the fact that SRI funds span an incredibly wide spectrum of values, from funds that screen producers of abortifacients to those that reward corporate support for Planned Parenthood, can lead to the charges of trustees politicizing their fiduciary decisions.

The paper ends with a fascinating hypothetical related to this last point.

"The possibility of converting some portion of the largest defined benefit plan in the country, Social Security, into a plan offering some investment choices to the plan participants could elevate the question of SRI to an even higher level," state the authors. "A partial privatization of Social Security . . . could easily include a socially screened choice for participants."

"If given a choice in how some portion of these retirement assets are to be invested, why shouldn't taxpayers be allowed to 'opt out' of certain investments they may find objectionable?" the authors ask.

However, this question opens up a Pandora's Box of other questions: "How will [the Social Security Administration's trustees] decide which social and environmental goals to prioritize? Whose research will they follow?"

The authors conclude by distinguishing between the difficult and the impossible.

"There may be no simple solutions to these and similar practical conundrums," they write. "The key point here, though, is that these are practical problems, not conflicts with fiduciary duty."

"Certainly some practical problems could make it extremely difficult [to employ SRI], and some political problems could make it almost impossible, but retirement plan trustees do not have a fiduciary duty to choose the easiest course, or to avoid controversy," they conclude.


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