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Biden’s ESG Tax on Your Retirement Fund

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BlackRock CEO Larry Fink wrote in 2020 that “sustainable investing is the strongest foundation for client portfolios.” Al Gore said in 2021 that “you don’t have to trade values for value. Green can enhance returns.” These claims haven’t aged well: ESG (environmental, social and governance) funds have trailed the market since the beginning of the year and are badly underperforming the sectors they shun, including oil, gas and coal.

That may spur retirement fund managers to reconsider their commitments to ESG funds. But new ESG-favoring regulations may come to the rescue. Last year the U.S. Labor Department proposed a regulation that would tell retirement-fund managers to consider ESG factors such as “climate change” and “collateral benefits other than investment returns” when investing employees’ money.

This would encourage America’s perpetually underfunded pension plans to invest in politically correct but unproven ESG strategies. It would also violate retirees’ basic right to have their money invested solely to advance their financial interests.

Retirement and pension-fund managers are fiduciaries, legally required to make every investment decision with one purpose—maximizing retirees’ financial interests. The Uniform Prudent Investor Act, a model law adopted by 44 states, makes clear that “no form of so-called ‘social investing’ ” is lawful “if the investment activity entails sacrificing the interests of . . . beneficiaries . . . in favor of the interests . . . supposedly benefitted by pursuing the particular social cause.” This principle is built into the Employee Retirement Income Security Act itself, as the Supreme Court held in Fifth Third Bancorp v. Dudenhoeffer (2014). The Biden administration can’t change that by regulation.

Trump-era regulations allowed ESG factors to be used as a tiebreaker when a fund manager chooses between two equal investments. This is itself a dubious notion. Law professors Robert Sitkoff and Max Schanzenbach argue that in cases of a tie, fund managers should split available capital between the investments to increase portfolio diversification. Kentucky Attorney General Daniel Cameron in May formally issued a legal opinion that investing with “mixed motives” breaches fiduciary duties, suggesting that ties likely can’t be legally broken this way.

Amid these concerns, Trump-era regulations applied safeguards against ESG expansionism. Investment managers could call a tie only if they are “unable to distinguish investment alternatives on the basis of pecuniary factors alone.” Investment managers must document the basis for such a tie and for selecting particular ESG factors as the tiebreaker.

The Biden administration seeks to remove those limits, allowing fund managers to consider ESG factors whenever they deem two investments “equally serve the financial interests of the plan.” Fiduciaries need not document the reason for the tie or how they broke it, the Labor Department explains in announcing the rule, so as to not “chill investments based on climate change or other ESG factors.” The department asserts that “two hours of labor to maintain the needed documentation” might prove too onerous for fund managers.

The new rule suggests that fund managers weigh factors such as “climate change,” “board composition” and “workforce practices.” While the drafters were smart enough not to mandate consideration of ESG factors explicitly, the draft rule’s one-sided list of examples tilts the scale in favor of ESG-linked investment selection, proxy voting and shareholder engagement.

The rule states not only that ESG factors can be considered, but that prudent investing “may often require” it. The proposed regulation thus transforms ESG from one factor that may be considered when it has a material effect on the investment to a factor that should be considered in all instances.

The new regulation may also expose fiduciaries who don’t consider ESG factors to lawsuits. Already, activist shareholders are pursuing litigation against public companies that don’t take ESG-approved steps. NortonLifeLock was sued for allegedly breaching its fiduciary duties by telling investors it was committed to “diversity” when it had no racial minorities on its board. Exxon was sued for allegedly misleading investors by failing to disclose the likely effect of climate change on its bottom line. To date, courts have generally found that no reasonable investor would make investment decisions based on board diversity or, as one judge put it, “speculative assumptions of costs that may be incurred 20+ or 30+ years in the future.”

But the Biden administration’s proposed rule, and the supplementary guidance provided with it, claims otherwise: “Climate change and other ESG factors are material economic considerations” and can play an “important role . . . in the evaluation and management of plan investments.” This language will give fresh ammunition to plaintiff lawyers seeking to wage wasteful litigation against not only American businesses but also plan fiduciaries.

An investment fiduciary must seek to advance the beneficiaries’ objectives, not the fiduciary’s own values or third-party interests. Doing so requires learning clients’ preferences. That is why the Securities and Exchange Commission requires investment advisers to make a “reasonable inquiry into the client’s objectives,” and also why a recently proposed European Union regulation requires investment firms to collect information from clients on their ESG preferences, including whether clients want to invest in or avoid such products.

If American fund managers asked clients about this, their answers might be very different from what ESG proponents favor. Most Americans disagree that the “collateral benefits” pursued by ESG activists are benefits at all. While ESG activists seek to curtail U.S. energy production, 61% of Americans favor expanding domestic production of natural gas. While ESG activists demand race and sex quotas for corporate boards, 74% of Americans believe that employment decisions should be based on qualifications alone. And while ESG funds often exclude gambling companies from their investments, 80% of Americans support legal sports betting.

Perhaps that is why the drafters of the proposed rule expressly state that it doesn’t require a fund manager to consult with beneficiaries before implementing ESG investments.

But the result is a plain violation of fiduciary duty, allowing politicians and fund managers to substitute their investment goals for those of American retirees. Washington should remember that the law governing retirement accounts already spells out the ESG goal that fiduciaries must honor: “Providing a secure retirement for American workers is the paramount and eminently worthy social goal of ERISA plans.” The Labor Department should scrap the rule now.

Mr. Ramaswamy is executive chairman of Strive Asset Management and the author of “Woke, Inc.: Inside Corporate America’s Social Justice Scam” and “Nation of Victims: Identity Politics, the Death of Merit, and the Path Back to Excellence,” forthcoming in September. Mr. Acosta served as U.S. labor secretary, 2017-19.

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