In our September column, we highlighted a proposed rule by the Biden Administration regarding the ability of plan sponsors of qualified retirement plans under ERISA to consider Environmental, Social, and Governance (ESG) factors as part of a prudent investment process. On November 22nd, 2022, the Biden Administration Department of Labor (DOL) released “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights”, (the “Rule”) which is briefly summarized below.
Whether and when the consideration of ESG factors may be part of a prudent process by a fiduciary of an ERISA plan has been the subject of many formal and informal rulemaking processes by the DOL over the previous decades. The Rule is the latest chapter in such rulemaking.
The Rule
The Rule amends the portion of the Code of Federal Regulations that regulates “Investment Duties”, 29 CFR § 2550.404a-1, in the following notable ways:
• Language Stating ESG Factors May Be Permissible Considerations: The Rule states that fiduciaries may, but are not required to, consider “climate change and other environmental, social, or governance factors” when those factors are economically relevant to the consideration of an investment or investment course of action. Of course, plan fiduciaries must still act as prudent experts in selecting these funds and the Rule does not change the rigorous standards that fiduciaries are subject to when making investment decisions.
• Participant Preferences: The Rule also includes a provision that “fiduciaries do not violate their duty of loyalty solely because they take participants’ preferences into account when constructing a menu…”. The provision is carefully constructed to only reflect that the duty of loyalty is not violated when taking participant preferences into account. We note that an investment option must also be prudent and thus fiduciaries must carefully evaluate any investment option requested by participants before placing the option on a plan investment lineup.
• Tiebreaker: In the past, the DOL has said non-economic factors may only be considered in case of a “tie,” or when investment options are indistinguishable in terms of risk and return; however, successive administrations have disagreed about the frequency of ties and when ties may occur. The preamble to this new rule seems to suggest that ties may occur with much more frequency than prior administrations, which stated or implied that the instance of ties were “rare.” Specifically, the new standard in the Rule of situations in which a tie has occurred are when “competing alternative investments equally serve the financial interests of the plan.” (emphasis added), rather than when the investments are ‘indistinguishable.’
• ESG in QDIAs: The previous DOL rule under the Trump Administration included a blanket ban on ESG-themed funds being considered as the default fund. The Rule explicitly repealed this ban, requiring fiduciaries to instead evaluate QDIAs the same as any other investment option.
Regulatory uncertainty may continue
As stated above, the Rule represents the latest in a decades-long back and forth spanning five presidential administrations. However, the conversation around ESG investing in retirement plans is likely far from finished.
On November 3rd, several Senate Republicans sent a letter to 51 law firms warning that “Congress will increasingly use its oversight powers to scrutinize the institutionalized antitrust violations being committed in the name of ESG.” Several pieces of legislation are currently pending in the House of Representatives and Senate focused on ESG issues. In addition, 19 State Attorneys General in August sent a letter to a major asset manager warning that their pivot towards focusing on ESG may be inconsistent with the state laws of the states represented. These stances by Republicans at the state and federal level suggest that the Rule is not the last word on these issues and that further changes may be expected in future administrations.
George Sepsakos is a principal at Groom Law Group, Chartered, where he represents clients on a broad range of ERISA, federal tax, and securities law matters. Jake Eigner is an associate at Groom Law Group, Chartered, who specializes in ERISA’s application to financial institutions.
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