Now That The Supreme Court Overruled The Chevron Deference, What Will Happen to Responsible Investing?
On Friday June 28, 2024 in Loper Bright Enterprises v. Raimondo, the Supreme Court overruled its decision in Chevron U. S. A., Inc. v. Natural Resources Defense Council (1984), which for 40 years required courts to defer to executive agencies’ reasonable interpretations of broad statutes. In overturning what Justice Kagan in her 33-page dissent describes as a “cornerstone of administrative law,” the courts gave themselves more say “over the provision of healthcare, the protection of the environment, the safety of consumer products, the efficacy of transportation” and, by extension, even the practice of responsible investing.
Much has already been written about the decision’s impact on courts, companies, and communities. Accordingly, this article focuses solely on its impact on responsible investing, which encompasses strategic engagement, ESG integration, and impact investing.
The Chevron Deference is important to responsible investing which flourished and scaled only after administrative agencies issued notices that specified under which conditions and with which parameters responsible investing is permissible.
The Supreme Court’s decision on Friday means that these notices are only valid if the court agrees that they are. The combination of the uncertainty that this creates and the conservative majority on the Supreme Court casts a shadow over responsible investing. But before we look to the future, let’s quickly review how administrative agency rulemaking fostered the growth of responsible investing for pensions and private foundations.
The Role of the Department of Labor Rulemaking on Responsible Investing at Pensions
The Department of Labor (DOL), under Employee Retirement Income Security Act of 1974 (ERISA), regulates approximately $12 trillion in retirement savings for 150 million Americans. To protect future retirees, ERISA requires plan fiduciaries (investment managers) to inform themselves of all material information reasonably available to them (duty of care) and have the sole interests of plan participants in mind (duty of loyalty).
The DOL has vacillated along party lines as administrations have turned over since the Clinton administration on the “all things being equal” test. The issue here is a plan’s fiduciary’s ability to consider “collateral benefits” as tiebreakers where investments were otherwise equal with respect to their risk and return characteristics. Collateral benefits may include social and environmental policy goals, and therefore the “all things being equal” test is viewed as enabling integration of environmental, social, and governance (ESG) issues into investment decision-making and strategic engagement.
Most recently, in 2022, the DOL under the Biden administration reinstated the “all things being equal” test, and following last Friday’s Supreme Court ruling, this rule is only valid if the court agrees that it is. Accordingly, the Supreme Court decision creates regulatory uncertainty.
The Role of the IRS Rulemaking on Responsible Investing at Private Foundations
The Internal Revenue Service (IRS) enforces the Internal Revenue Code, administers federal tax laws, and collects federal taxes. Section 4944 of the Internal Revenue Code safeguards the purchasing power of U.S. private foundation assets—currently over $1.3 trillion—by imposing excise taxes on foundations and individual foundation managers that make investments that would financially jeopardize the tax-exempt purpose. No category of investments is treated as an intrinsic violation, but the IRS carefully scrutinizes activities like trading in securities on margin and commodity futures and investing in working interests in oil and gas wells, and whether an investment jeopardizes a foundation’s exempt purposes is determined at the time that the investment is made. For example, a foundation purchasing a lottery ticket would be a jeopardizing investment, even if it were to win the lottery.
In 2015 the IRS catalyzed the growth of the then new field of mission-related investing, or market-rate investing, by foundations’ investment offices that have positive social or environmental impacts by specifying in IRS Notice 2015-62 that private foundations may make prudent, non-jeopardizing investments that further its “charitable purposes at an expected rate of return that is less than what the foundation might obtain from an investment that is unrelated to its charitable purposes.”
This explicit permission to include the relationship between a particular investment and the foundation’s charitable purposes in the facts and the circumstances considered when exercising ordinary business care and prudence unlocked a new pool of assets for impact investing, or investing with the intention to generate positive, measurable social and/or environmental impact. Accordingly, since then, storied foundations like Ford Foundation, Rockefeller Foundation, Kresge Foundation, and W.K. Kellogg Foundation have made significant commitments to mission-related investing. Following last Friday’s Supreme Court ruling, IRS Notice 2015-62 is only valid if the court agrees that it is.
When the Tide Goes Out
During a Berkshire Hathaway annual meeting in 1993, Warren Buffet illustrated how market downturns reveal which businesses have been taking on too much risk or have been poorly managed with a now famous metaphor: “Only when the tide goes out do you discover who’s been swimming naked.”
The same should hold true for responsible investing during a period of regulatory uncertainty. As Said Business School (at Oxford) Professor Robert Eccles and former Bipartisan Policy Center Senior Policy Advisor Timothy Doyle explain, the DOL’s interpretation of the “duties of loyalty and prudence” in ERISA did not change when the “all things being equal” test was reinstated in 2022. Similarly, IRS Notice 2015-62 requires that mission-related investments be made with “ordinary business care and prudence.”
With or without Chevron Deference, the ESG considerations that are incorporated into investment decision-making and strategic engagement should be material—in that they should have a direct impact on a company’s financial performance—and mission-related investments should be prudent and non-jeopardizing.
It’s Time To Get A Bathing Suit If You Need One
Since the courts will be working through the impact of Friday’s decision for many years, there should still be time before the tide goes out for responsible investors to fine-tune the responsible investing sections of their investment policy statements, seek to identify and eliminate any unconscious biases in responsible investing underwriting, document the materiality of any ESG considerations and the mission-alignment with charitable purposes, and monitor financial and impact performance thoughtfully and rigorously enough to withstand legal scrutiny.
May this article encourage some readers to purchase bathing suits if they need them, particularly ahead of July 4th weekend. And may the courts allow fiduciaries to do their jobs with minimal political pressure.
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