If something is legal, but no one does it because they are afraid of regulators and being sued into oblivion, is it actually legal? The answer is yes, and today in a new proposed rule the Department of Labor emphatically made that point regarding alternative assets’ role in America’s retirement system.
More than 90 million Americans have retirement accounts with practically no exposure to private markets. While such exposure is perfectly legal, the prior Administration stuck its thumb on the regulatory scale to threaten those that would dare try – and for those who believe these investments fit their portfolios – opportunistic trial lawyers stand ready waiting to sue.
The United States has the greatest retirement system in the world, but overregulation and lawsuits are two powerful disincentives that have stifled innovation for far too long. Those days are over. The President asked us to help deliver a Golden Age for the American worker, and we are doing that with vigor.
America’s retirement laws have one crystal clear social purpose – to let more Americans retire with dignity. It’s a new day for those 90 million Americans and their families. The Labor Department has taken its thumb off the scale. Our laws and regulations do not permit us to disfavor (or to favor) specific investments or investment types. The Department is now fully out of the game of picking winners and losers.
Managers that oversee 401(k) investments have a duty of loyalty and a duty of prudence. Together, these have been called the highest duties known to law, and they are. The new rule we proposed spells out a prudent process for managers to follow in selecting any investment, including one with exposure to alternative assets. This process is deeply rooted in American retirement law. In fact, its concepts predate the landmark Employee Retirement Income Security Act of 1974 (ERISA).
We have heard concerns about the risky nature of these investments from some corners, including on the pages of the Wall Street Journal, which recently suggested that “[i]nvestors should also resist the temptation to add ‘alternative’ private investment to their portfolios,” using scare quotes around alternatives to drive home the point.
But, under Labor’s regulatory oversight, investors will not be throwing darts at a board and picking assets. Fiduciaries are the goalies tasked with blocking bad assets from investment lineups and they are good at it. All investments are not right for all plans.
As is often cautioned, all that glitters is not gold. In engaging in a prudent process, fiduciaries must be wise and distinguish those investments that are truly golden from the ones that simply glitter. ERISA fiduciaries have a great track record in doing so. For example, trillions of dollars have been spent on social and political investing, commonly known as ESG, in all kinds of investment vehicles overseen by other regulatory frameworks. However, managers of ERISA funds have largely seen through this overpriced social ruse and kept these noxious assets out of their plans. ERISA managers have a tremendous history of separating the wheat from the chaff, and if anything, our proposed rule will help them do an even better job with that solemn task.
While the proposal focuses on a fiduciary’s duty of prudence, it doesn’t operate in a vacuum. Fiduciaries must also strictly adhere to their duty of loyalty. Under that obligation, fiduciaries need to keep in mind that their exclusive purpose is to maximize risk adjusted financial returns. And, once again, our rule should help them achieve that aim. In a world where more companies are choosing to remain in the private markets, it can make sense to include alternative asset products as part of the selection menu, or, more often, as a component of an item in that menu. Right now, fiduciaries are invited to an all-you-can-eat buffet and then restricted to the salad bar—not by law but by veiled regulatory and litigation threats. That’s never what was intended by ERISA.
So while it’s time to change that innovation-destroying environment, one thing that is not changing is Labor’s unbending conflict of interest regime. When engaging in a prudent process, fiduciaries must be conflict free. The law refers to conflicted transactions as “prohibited,” and while the Department sometimes issues exemptions for transactions when they are in the interest of plans and their participants, self-dealing is a non-starter. A prudent process only works when a fiduciary makes conflict-free judgments with a focus on maximizing risk adjusted financial return. And we don’t anticipate relaxing those rules, in any way, with respect to alternative assets. That’s what our proposed rule makes clear.
It’s long been the law that managers of ERISA funds have the legal authority to invest in alternative assets. They just lacked the legal ability due to regulatory shackles and a legal landscape that locked the door. We are removing the shackles and unlocking the door. That’s how we are delivering President Trump’s new Golden Age.
