DOL’s New Proposal to Limit ESG Investments
On June 23, 2020, the Department of Labor introduced a new proposed rule to better define plan fiduciaries’ duties under ERISA involving environmental, social, and governance (“ESG”) factors in investment decisions. The proposed rule embodies much of the DOL’s prior guidance about the issue, but it also adds a few core provisions aimed to establish clear regulatory guideposts for ERISA fiduciaries.
Existing ERISA Fiduciary Responsibilities
Under ERISA requirements, plan fiduciaries are required to act with “duties of care, skill, prudence, and diligence under the circumstances.” This means plan fiduciaries must act prudently and diversify plan investments to minimize the risk of large losses. Plan fiduciaries are not permitted to take on additional risks when making ERISA plan decisions because fiduciaries must act solely in the interests of plan participants and beneficiaries. Accordingly, considering policy goals when investing could be an ERISA violation if a plan fiduciary accepts greater risks or reduced expected returns in pursuing those goals.
Under prior guidance, ERISA plan fiduciaries were permitted to consider non-economic factors of potential investments as a tie-breaker, or what is sometimes referred to as the “all things being equal” test. Non-economic benefits could be considered only if: (1) the investment has an expected rate of return commensurate to that of available alternative investments with similar risk characteristics, and (2) the investment is otherwise an appropriate investment for the plan.
These non-economic factors include ESG factors: environmental factors, which could involve a commitment to combat climate change; social factors, which include employee relations; and governance factors, such as how a corporation is governed or managed. These factors have become central to “socially responsible investing,” in which investors look to moral and ethical considerations when making investment selections.
The DOL expressed concerns with growing market trends that emphasized the benefits of ESG investing over investment strategies that maximize returns for plan participants.
DOL’s New Proposed Rule
The DOL’s proposed rule amends regulations under §404(a) of ERISA. The focus of the rule is to reiterate prior DOL guidance that ERISA plan fiduciaries must primarily focus on the financial returns and risks to plan participants—not on ESG factors or policy goals.
The key take-aways under the proposed rule are as follows:
- These proposed rules codify the DOL’s position that ERISA plan fiduciaries must select investments and investment courses of action based on financial considerations;
- A fiduciary must not subordinate the retirement income and financial interests of plan participants and beneficiaries to unrelated objectives, sacrifice investment return, or take on additional investment risk;
- Plan fiduciaries must consider other available investments to meet their duties under ERISA;
- ESG factors may be considered pecuniary factors, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories;
- Plan fiduciaries must continue to provide proper documentation explaining why the investments were chosen; and
- The proposed rules would not permit defined contribution plans to select an ESG-oriented investment as a qualified default investment alternative (“QDIA”), even if that investment alternative would satisfy the pecuniary factor requirement.
As Labor Secretary, Eugene Scalia, said in a news release, “private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan. Rather, ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers.”
The proposed rule includes a 30-day comment period which will conclude on July 23, 2020. These proposed regulations, if finalized, will make it difficult for plans to select or retain ESG types of investments in ERISA retirement plans. These rules emphasize achieving maximum investment results for ERISA plans above all considerations.
Sapphire Andersen (Summer Associate)