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
"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.
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."
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
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.