Morningstar - Q4 2020 - 15

For their part, financial advisors will need
to figure out procedures to analyze their rollover
recommendations. In many cases, the
rollovers they recommend will cost retirement
savers more in fees than investors would pay
to leave their money in a 401(k). Such a
recommendation could still be in an investor's
best interest, however. Advisors add a lot
of value by tailoring portfolios based on retirees'
needs and other sources of income, helping
retirees invest in asset classes that are
not in their 401(k), and providing more holistic
financial advice. Advisors will still need
to justify a rollover and document that the value
exceeds the costs.

DOL Misconstrues ESG Investing
The U.S. Department of Labor has proposed
a rule that would limit the ability of retirement
plans to include strategies that integrate
environmental, social, and governance factors
into their investment process. For years,
DOL guidance has allowed plan fiduciaries to
select ESG fund options under the "all things
equal" test: If an ESG fund is substantially
similar to other possible investments from the
standpoint of risk-adjusted return and fees, then
its ESG focus can be used to break the tie.

The proposal reflects a (willful?) misunderstanding of ESG investing. First, ESG investing
is about carefully evaluating a set of risks
and opportunities that are measurable and
analyzable. Second, ESG investing is about
focusing on financially material risks. More than
2,300 asset managers with nearly $80 trillion
in assets under management have signed
the Principles for Responsible Investment, which
commits them to incorporating ESG issues into
investment analysis.

The DOL proposal doesn't assert that plan
fiduciaries are misusing the "all things equal"
test. It only notes the increasing use of
ESG investment strategies. It might have also
noted, in full disclosure, that the Trump
administration sees ESG as a threat to fossil fuel
investments. A 2019 executive order aimed at
encouraging fossil fuel development asked the
DOL to review rules related to energy
investments in retirement plans. The proposed
rule would remove ESG funds from consideration
as a Qualified Default Investment Alternative
and would only allow an ESG strategy in
a 401(k) lineup if it doesn't take up space for
non-ESG options.

The DOL should be requiring that our best
investment thinking be brought to bear on
behalf of U.S. workers, not proscribing it based
on outdated views or an administration's
attempts to prop up a fading industry. And if
material ESG analysis also leads to reduced
climate risk, better treatment of workers, and
companies run more ethically and transparently, what's not to like about that? Reduced
systemic risks should lead to better investment performance over the long run and enable
more Americans to enjoy a better retirement.

Regulation Best Interest Confusion

The DOL said that its goal was to reduce investor
confusion and better align the rules governing
retirement accounts to the broader SEC standards
of conduct for brokers, which is laid out
in Regulation Best Interest. Unfortunately, this
proposal would increase investor confusion
and would be difficult for professionals to interpret.
Advisors acting under Regulation Best Interest
can generally accept payments from asset
managers, which could cause a conflict of interest
and is therefore generally barred under ERISA.
But under the new rules, many advisors
will be able to accept these payments while
calling themselves ERISA fiduciaries.
The DOL first needs to explain what it means
to be an ERISA fiduciary and to be regulated
by Regulation Best Interest. Right now,
there is little daylight between the two standards,
except for the requirement to document
rollover recommendations, which is hard to
decipher because the DOL's language veers from
the SEC's in places. (To complicate matters,
Regulation Best Interest requires such
recommendations to be in a client's best interest,
but there is no requirement to document it.)
The DOL also needs to clarify which agency
is enforcing what and how it will conduct
enforcement. We recommend that a more helpful
disclosure-an expanded version of the
SEC's client relationship summary-be provided
to everyone receiving advice on a rollover
into an IRA or on an IRA account and that this

document explain an individual's rights and
remedies under both SEC and DOL regulations.
Parsing Best Interest and Fiduciary Terms

If the DOL fails to take these steps, investors
will no longer be able to assume that a fiduciary
follows the highest standards of care. They
will need to parse complex disclosures to ascertain
the extent to which a fiduciary advisor might
be accepting payments that could affect his or her
recommendations or limit the product shelf
to which the investor has access. This proposal
seems to be the result of a decadelong fight on the
proper regulation of financial advice. Ironically,

Jon Hale, Ph.D., CFA, is director of sustainability
research, Americas, with Morningstar.

during that decade, things have become
unquestionably better for investors, as assetweighted fees have continued to fall. Policymakers
need to redefine the problem they are trying
to solve. We agree that rollover recommendations
should be intensively analyzed and documented
because they represent many people's life savings.
The DOL's regulation mostly addresses the
rollover issue-although we've recommended
ways to make it even stronger-but it is a
step backward on elucidating investment advice
for ordinary people. K
Aron Szapiro is director of policy research with Morningstar.

Morningstar - Q4 2020

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