The Interplay Between ESG Investing and ERISA’s Fiduciary Duties


September 21, 2022

Environmental, social, and governance (ESG) investing—especially the “E”—is an increasingly hot topic for investors, but it presents unique legal issues for retirement plan decisionmakers who have strict fiduciary duties to retirement plans and their participants. There are certain considerations for US retirement plans, especially regarding the interplay between the primary applicable US law, ERISA, and environmental-focused investing.

Interest in ESG investing has skyrocketed in recent years. Financial analysts predict that assets invested in ESG-type strategies are on track to reach somewhere between $30 trillion and $50 trillion by 2025, which could represent more than a third of the projected total global assets under management. One area that presents unique considerations is one of the most popular American savings vehicles: retirement plans.

Retirement plans face unique considerations because of obligations under the Employee Retirement Income Security Act (ERISA), the primary law regulating retirement assets. ERISA is a federal law that regulates most employer-sponsored retirement plans and all 401(k) plans and establishes minimum standards for retirement plans falling within its regulatory ambit. (Note that ERISA does not regulate public retirement plans sponsored by state and local governments—read our summary of recent state regulation of ESG investing with public retirement plan assets.)

ERISA was enacted to protect the interests of benefit plan participants and to ensure proper management of employer-sponsored benefit plans. One of the ways ERISA provides benefit plan protection is by placing enormous responsibilities (and corresponding potential liabilities) on individuals who have decisionmaking authority over those plans. ERISA imposes strict fiduciary duties on individuals tasked with discretionary authority over plan decisions, including the duties of prudence and loyalty to the plan and its participants. These duties require that fiduciaries make decisions that are both financially responsible and solely in the best financial interest of the plan and its participants.

The US Department of Labor (DOL), an executive agency headed by a presidential appointee, is tasked with interpreting many of ERISA’s rules, including the scope of its fiduciary duties. The specific issue that ESG investing raises regarding ERISA’s fiduciary duties is the extent to which fiduciaries can consider certain types of ESG factors while still upholding their duties of prudence and loyalty. In particular, ERISA’s fiduciary duties require that environmental investing and other ESG factors can be considered only if they are appropriate for retirement savings and in the best interests of plan participants, and cannot be considered solely for ancillary political or social reasons.

The DOL’s interpretation of this issue has repeatedly flip-flopped with different administrations. Generally, Democratic administrations have recognized the broader role that ESG factors can play in a fiduciary’s discharge of the duties of prudence and loyalty, while Republican administrations have tended to view ESG factors as less material to retirement investing considerations.

In 2020, under the Trump administration, the DOL issued the Financial Factors in Selecting Plan Investments rule (the 2020 rule), which interpreted the duties of prudence and loyalty as requiring retirement plan providers to make investment decisions based solely on “pecuniary factors,” or factors affecting the financial risk and/or return of an investment. The 2020 rule was viewed by many as discouraging the inclusion of ESG investments in retirement plans by increasing the costs of compliance with this strict interpretation of ERISA’s fiduciary duties.

Upon President Joseph Biden’s election and the nomination of a new secretary of labor, the DOL issued a nonenforcement policy of the 2020 rule. In October 2021, the DOL released a notice of proposed rulemaking, Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholding Rights (the proposed rule), reinterpreting ERISA’s fiduciary duties as they relate to ESG investing. The rule has not been finalized yet, though DOL officials have hinted it will be finalized by the fall of 2022.

If approved in its current form, the proposed rule would roll back the 2020 rule and give plan fiduciaries greater support to consider ESG factors in plan investing without violating ERISA’s fiduciary duties.

The proposed rule remains consistent with past guidance by explaining that ERISA-regulated plan investment decisions “must be based on risk return factors that the fiduciary prudently determines are material to investment value,” but specifies that these decisions may include considerations of climate change, corporate governance, and workforce practices. The proposed rule recognizes ESG as a material factor in consideration of investment risk and return. Fiduciaries would no longer risk violating their duty of prudence when considering the impact of material ESG factors on an investment’s risk or return.

In keeping with the theme of political ping-pong regarding ESG investing and retirement plan assets, many Republican-led state legislatures (17 as of this writing) have recently proposed or adopted state laws that attempt to restrict ESG investing with state assets, including state retirement plan assets. This pushback against ESG investing suggests that the DOL’s recent interpretation of ESG investing with ERISA-regulated plan assets could be up for reinterpretation if a Republican president were elected in 2024.

The exposure of ESG investing to political reinterpretation adds complexity to retirement plan–related considerations of ESG investing. While the choice to consider certain ESG factors when selecting retirement plan investments may be deemed prudent and loyal under one administration, the guidance could change under the next. ERISA fiduciaries and employers should proceed with caution, and seek out appropriate legal counsel, on issues related to the interplay between retirement plans and ESG investing.