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DOL Proposes New ESG Investment Rules

Updated: Oct 28, 2022

Dating back to 1994 the Department of Labor has issued guidance in regards to fiduciaries considering inclusion of ESG (environmental, socially responsible, or governance) directed investments in ERISA plans. Though the perspective may have changed from administration to administration a few elements always remained constant: fiduciariesshould not sacrifice opportunity for return or take on additional risks, they should not subvert economic goals to non-economic policies, they must comply with the duties of loyalty and prudence, and in instances where “all things being equal” among investment options they could use collateral considerations to serve as tie-breakers.

In October of 2020, the Department of Labor (DOL) announced a final rule titled “Financial Factors in Selecting Plan Investments” (effective January 12, 2021). The rule stated that such decisions must be based solely on pecuniary factors (factors expected to have a material effect on risk and/or return). Fiduciaries were tasked to properly weigh all factors. At the time the new rules were released, the DOL stated that “ESG investing raises heightened concerns under ERISA,” but they also stated that ESG funds are not expressly forbidden in ERISA plans if they pass muster from a pecuniary perspective. Non-pecuniary factors (such as ESG elements) could be utilized as a tie-breaker if fiduciaries are unable to distinguish between two investments based on pecuniary factors alone. In these rare instances where non-pecuniary criteria are applied, fiduciaries were required to document how they fulfilled their responsibility to act in the best interest of plan participants. Plans were also precluded from offering ESG funds as their QDIA under these rules. And a separate set of rules were issued governing fiduciaries’ actions in regards to investment voting rights.

In March of 2021, the current administration put in place a nonenforcement policy on those 2020 rules, and on October 13, 2021 issued new proposed rulemaking regarding “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.” Though these regulations are merely in proposed form and open to a comment period, it is worthwhile to understand the changes that are contemplated therein for fiduciaries.

The following is a high level review of what is contained in the rulemaking:

  • When considering an investment’s potential return a fiduciary’s duty may actually require analysis of climate change and other ESG-type factors.

    • Example 1 – a corporation’s exposure to physical and transitional risks of climate change or the +/- effect of governmental regulations related to climate change;

    • Example 2 – corporate governance factors such as board composition, executive compensation, transparency/accountability of corporate decision-making and avoidance of criminal liability and compliance with regulatory mandates; and

    • Example 3 – workforce practices such as diversity, inclusion, and other drivers of employee hiring, promotion, and retention.

  • The special rule prohibiting use of ESG investments as QDIA have been removed. The same standards that apply to all investments apply to QDIA selection.

  • The “all things being equal,” or “tie-breaker” rule is changed to replace the “economically indistinguishable” standard with a determination that investments “equally serve the financial interests of the plan” and thus non-pecuniary factors are being used to make the selection. The additional documentation requirements are eliminated other than the requirement that a plan “prominently disclose the collateral considerations that were used as tie-breakers to the plans’ participants” if the tie-breaker process what utilized.

  • Changes made to the exercise of shareholder rights (including proxy voting) include:

    • Elimination of the phrase “the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right.”

    • Removal of two safeharbors for proxy voting policies that hinge on proposals being substantially related to issuer’s business or having an effect on value of the investment or allowing abstention from voting a proxy when the plan’s investment was below a defined quantitative threshold.

    • Elimination of the record creation/retention rule for proxy voting.

For additional ESG content on the CSi blog, click below:


Source: RPAG News Flash, New Investment Rules (ESG) 2021 Version.

This information is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.

An Environmental, Social and Governance (ESG) fund’s policy could cause it to perform differently compared to funds that do not have such a policy. The application of social and environmental standards may affect a fund’s exposure to certain issuers, industries, sectors, and factors that may impact relative financial performance— positively or negatively— depending on whether such investments are in or out of favor.

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