The Department of Labor (DOL) released on October 13, 2021, a Notice of Proposed Rulemaking on Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights (Proposed Rule), which would amend a prior regulation (the 2020 Rule). This blog post provides a high-level summary of the Proposed Rule and outlines how it may affect environmental, social, and governance (ESG) investing for ERISA plans.
Overall, if finalized in its current form, the Proposed Rule should provide comfort to ERISA plan fiduciaries seeking to incorporate climate change and other ESG factors into plan investment decisionmaking and plan fund lineups by (a) treating climate change and other ESG factors like the myriad of other considerations that may be material to investment value/risk-return; (b) allowing investments selected to serve as qualified default investment alternatives (QDIAs) to incorporate climate change and other ESG considerations and (c) expanding the application of the “tie-breaker” doctrine from prior guidance.
This Proposed Rule is the most recent volley in a 25-year-long game of regulatory ping-pong with respect to the use of ESG factors in making investment decisions for ERISA plans and successive DOL administrations altering interpretations. For instance, the 2020 Rule, released by the DOL under the prior administration, imposed new standards related to the use of ESG by ERISA plans. It was largely seen as cautious (if not negative) on the use of ESG factors in investment decisions by ERISA plan fiduciaries.
The Proposed Rule would amend the 2020 Rule—and the DOL’s legal interpretation—in three important ways:
- First, the Proposed Rule clearly states that a fiduciary making an investment decision may consider ESG factors material to the risk-return analysis, specifically providing a non-exclusive list of three examples that could be considered: climate change, corporate governance factors and workplace factors. This represents a clear departure from language in the preamble to the 2020 Rule, which seemed to take the view that there were only limited circumstances under which a fiduciary could consider ESG factors based on the presumption that they may not be “pecuniary” in nature. The Proposed Rule would provide greater latitude to consider ESG factors even if they would not be “pecuniary” under the definition of the 2020 Rule, although the Proposed Rule still requires that investments based on ESG considerations serve the financial interests of the plan and not promote benefits or goals unrelated to the interests of plan participants and beneficiaries in their retirement income.
- Second, the Proposed Rule would remove the special rules—present in the 2020 Rule—on the use of ESG in the selection of QDIAs. The Proposed Rule departs from this approach of treating QDIAs differently and instead applies the same standard to QDIAs as is applied to all other investments (subject, in the case of participant-directed plans, to disclosure of the ESG-themed nature of the investment option to the plan participants). If finalized, this should clear the way for climate change and other ESG factors to potentially serve a role in a plan’s QDIA. This would be helpful to fiduciaries because funds that serve as QDIAs may already incorporate ESG factors into their investment decisionmaking in a variety of ways.
- Third, the Proposed Rule would reduce burdens of the “tie-breaker” standard, which permits fiduciaries to consider collateral benefits (such as ESG factors that aren’t clearly material to the risk-return analysis). Two investments are no longer required to be economically indistinguishable to invoke the tiebreaker; rather, the two investments must both “equally serve the financial interest of the plan.” In a change from the 2020 Rule, no special documentation would be required for the reliance on the tie-breaker provision.
Of course, our study and analysis of the Proposed Rule will continue, and we hope to publish a more in-depth analysis in the coming days.