Biden’s First Veto: How We Got Here In The ESG Debate

President Joe Biden issued his first veto, reinstating an ERISA rule regarding the use of ESG in pension funds. If you are a bit confused, you are not alone. There are a lot of complex terms being thrown around in the wake of the veto. A very nuanced topic has been propelled to national attention, with little explanation. I’ve been involved in it for four years, and I still get lost.

The starting point in this battle begins in 1974, with the passage of the Employee Retirement Income Security Act (ERISA). When Congress passed ERISA, they delegated authority to the United States Department of Labor (DOL) to regulate standards for pension plans, like your 401k. Rather than Congress having to pass every minor detail of how a 401k operates, lawmakers told the DOL to figure it out.

This is common because Congress moves slow and are not equipped for detail work. When an agency, like the DOL, works out the details, it is called a rule. Rules are created through the rulemaking process, with proposals and public input, before being implemented. This delegation of authority and rulemaking process has been the focus of a number of recent opinions by the Supreme Court of the United States.

However, Congress does not just give away authority without the ability to override the decisions. Under ERISA, the House of Representatives has the ability to override a rule with a majority vote. It does not require a vote in the Senate. The president has the ability to veto the action of the House. The only way to override the veto of the president is through a two-third vote in both the House and the Senate.

Under ERISA, the DOL has managed what factors fund managers can consider when investing your retirement savings. The primary factor has been, and continues to be, profit. The money you put into your retirement savings should be invested to get you the best profit, so when you retire you have more money in your retirement fund. What factors go into calculating profit is where we get into the ESG debate.

Environmental, social, and governance (ESG) is a relatively new concept. Generally, ESG looks at things beyond straight profit to calculate how a business or fund performs. What falls under ESG is not clear, simply because it is not defined yet. Every organization looks at different factors, and they prioritize them based on their own ideals. Some may focus on the environmental aspect, others may care more about the social policies of an investment.

In the United States, the Securities and Exchange Commission has begun to look at reporting standards. The European Union is working on their own. There are a number of independent international organizations that are also working on their own standards. However, until they are in place, there is no clear understanding of how ESG should be calculated.

This is a problem for fund managers. Their job is to invest your money in the areas that will get the most profit, but they have to predict returns. That is a complex process that needs clarity.

There has been some back and forth with the DOL as to how ESG can be considered when calculating future profits. In 2020, the DOL issued a rule that said investments should be made based on “pecuniary factors” only. That just caused more confusion. In 2022, the DOL issued a new rule saying that investments can consider ESG as a tiebreaker. In other words, if two investments are going to make the same amount of money over the next 10 years, one is very environmentally friendly and one is not, they can pick the environmentally friendly one. The 2022 rule also allows for the consideration of ESG factors, if, and only if, they are going to make the investment more profitable.

The reason this rule became so controversial gets back to the lack of clarity. Conservatives, rightfully or wrongly, believe that ESG has become a tool for outside interests to impose their beliefs on private companies. Not just environmental concerns, but also political debates. Be on the right side of this issue, or we think you’ll make less profits. This has become a significant concern within the business sector, hence the congressional override by Republicans.

Biden’s veto most likely means the DOL ERISA rule is going to stand, for now. The next wave of this debate will be at the state level and in the development of ESG reporting standards.