New DOL Proposal on ESG Investing and Fiduciary Exercise of Shareholder Rights

On October 14, 2021, the U.S. Department of Labor (the “DOL”) issued a proposed rule (the “Proposed Rule”) clarifying whether investments made by fiduciaries of plans subject to the Employee Retirement Income Security Act of 1974 (“ERISA”) may take into account environmental, social and governance (“ESG”) concerns in selecting investments and investment courses of action, as well as fiduciary duties in exercising shareholder rights. [1] The Proposed Rule aligns more closely with recent trends toward ESG-oriented investing and seeks to reduce any chilling effects introduced by the Trump administration’s regulatory and non-regulatory guidance on fiduciary duty-compliant ESG investing.

The DOL’s Proposal

As stated in its press release, the DOL’s aim is to “bolster the resilience of worker’s retirement savings and pensions by removing the artificial impediments—and chilling effect on environmental, social and governance investments—caused by the prior administration’s rules.” [2] The Proposed Rule would supplant the Trump administration’s two final rules on ERISA fiduciary duties, “Financial Factors in Selecting Plan Investments” and “Fiduciary Duties Regarding Proxy Voting Shareholder Rights” (the “Current Rules”) [3] and follows the DOL’s March 2021 announcement that, until publication of further guidance, the Biden administration would decline to pursue enforcement against any plan fiduciary for failure to comply with the Current Rules. [4] The Proposed Rule would amend the Current Rules and revert to stances taken in earlier non-regulatory guidance espoused by previous Democratic presidential administrations, [5] as summarized below.

• Investment Duties. The Current Rules indicate that a fiduciary’s duties of loyalty and prudence under ERISA will be satisfied in connection with an investment decision if the fiduciary has selected investments and/or investment courses of action solely on the basis of “pecuniary factors” that have a material effect on the risk and return of an investment based on appropriate horizons and the plan’s funding and investment objectives. ESG factors currently qualify as economic considerations only to the extent that they present “economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.” Under the Current Rules, fiduciaries may only take non-pecuniary factors (e.g., ESG considerations that would not qualify as economic considerations in the foregoing sentence) into account if, based on pecuniary factors only, investment alternatives are “economically indistinguishable” (a circumstance that the DOL at the time believed would occur very rarely, if at all). If the investment is then selected on the basis of an ESG factor, the fiduciary must document how it determined that the investments were indistinguishable, as well as the rationale for choosing the investment based on the plan’s purposes, investment diversification and the interests of plan participants and beneficiaries.
  • In contrast, the Proposed Rule, if approved, would eliminate the “pecuniary factors only” standard of the Current Rules, revise the formulation of the tie-breaker standard and make clear that, when a plan fiduciary considers projected returns on an investment, the duty of prudence will often require an evaluation of the economic effects of ESG factors. A fiduciary must base its evaluation of investment choices and courses of action on risk and return factors that it prudently determines are material to investment value. Following such analysis, if the fiduciary concludes that competing investment options equally serve the financial interests of the plan over the appropriate time horizon, it is not prohibited from selecting investments based on collateral benefits other than investment returns. However, a fiduciary is not permitted to accept expected reduced returns or greater risks to secure such collateral benefits. In addition, the Proposed Rule eliminates the requirement that fiduciaries specially document the use of, and rationale behind choosing, non-pecuniary factors when deciding between “economically indistinguishable” investments. The DOL instead considers the ERISA general prudence obligation to be sufficiently protective of relevant interests and imposes less of an administrative burden that could “tip the scale” against an investment that offers collateral benefits.
• 401(k) Plans. The Current Rules state that a prudently selected, well managed, and properly diversified fund with an ESG mandate could be added to a 401(k) plan without violating ERISA, provided that, inter alia, an ESG alternative is not added as a qualified default investment alternative, or a component thereof, into which participants automatically invest (a “QDIA”).
  • The Proposed Rule does not prohibit ESG alternatives from being used as a QDIA, citing concerns that, under the Current Rules, funds that expressly considered ESG factors could be excluded from QDIA treatment, even if their selection might be prudent based on financial attributes alone. However, the Proposed Rule adds a documentary requirement that any collateral-benefit characteristic of an investment selected as a designated investment alternative (including a QDIA) must be prominently displayed in participant and beneficiary disclosure materials.
• Exercise of Shareholder Rights. The Current Rules also state that the fiduciary duty to manage shareholder rights does not require the voting of every proxy or the exercise of shareholders rights in all instances and that, upon deciding that the exercise of shareholder rights is appropriate, plan fiduciaries must maintain records on such exercise.
  • The Proposed Rule does not carry forward the relevant language from the Current Rules on these issues, as the DOL raised a concern that both provisions may be misread to imply that plan fiduciaries should be indifferent to the exercise of their rights as shareholders and that proxy voting and similar activities are disfavored and carry a heavier fiduciary burden. The Proposed Rule does require that when determining to exercise those proxy and other rights that the fiduciary must do so prudently and in the sole interests of the participants. Finally, the Proposed Rule blesses plans’ maintenance of a proxy voting policy designed to further the purpose and the funding policy of the plan.
• Comment Period and Effective Date. The DOL has provided a 60-day comment period on the Proposed Rule (ending December 13, 2021). The Current Rules provided for only a 30-day comment window, which resulted in some public criticism on the adequacy of the comment process.
  • Among other issues, the DOL requested comments specifically addressing any evidence on the financial materiality of ESG factors in various investment contexts.

Endnotes

1Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, 86 FR 57272 (proposed Oct. 14, 2021) (to be codified at 29 CFR Part 2550).(go back)

2DOL Press Release, US Department of Labor Proposes Rule to Remove Barriers to Considering Environmental, Social, Governance Factors in Plan Management (Oct. 13, 2021), https://www.dol.gov/newsroom/releases/ebsa/ebsa20211013.(go back)

3See, Financial Factors in Selecting Plan Investments, 85 FR 72846 (Nov. 13, 2020) (codified at 29 CFR 2509, 2550); Fiduciary Duties Regarding Proxy Voting and Shareholder Rights, 85 FR 81658 (December 16, 2020) (codified at 29 CFR 2509, 2550)(go back)

4DOL Press Release, U.S. Department of Labor Statement Regarding Enforcement of Its Final Rules on ESG Investments and proxy Voting by Employee Benefit Plans (Mar. 10, 2021, https://www.dol.gov/sites/dolgov/files/ebsa/laws-and-regulations/laws/erisa/statement-on-enforcement-of-final-rules-on-esg-investments-and-proxy-voting.pdf. Our previous post on that announcement is available here.(go back)

5See, 59 FR 32606 (June 23, 1994) (appeared in Code of Federal Regulations as 29 CFR 2509.94-1); Interpretive Bulletin 2008-01, 73 FR 61734 (Oct. 17, 2008); Interpretive Bulletin 2015-01, 80 FR 65153 (Oct. 26, 2015); Field Assistance Bulletin No. 2018-01 (Apr. 23, 2018). The prior DOL guidance generally emphasized that the focus of plan fiduciaries should be on financial returns and applicable risk to participants and beneficiaries, and suggested that non-pecuniary interests should be taken into account only in two scenarios: (1) as a “tie-breaker”, when multiple investments are being considered and all are equal in every economic respect, and (2) if the socially-oriented investment concerns have a material economic impact on the risk or opportunity inherent in the investment.(go back)