Overview
On November 22, 2022, The US Department of Labor (DOL) issued a final rule that allows plan fiduciaries to consider environmental, social, and governance (ESG) factors when they choose retirement investments and exercise shareholder rights.
This rule, titled, "Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights," rolls back two rules issued in 2020 during the Trump administration and is intended to put an end to the almost annual equivocations of the DOL on how to look at non-pecuniary factors. The 2020 DOL rule made it virtually impossible for a plan fiduciary to determine that it should consider ESG factors. In the preamble to the new final rule, DOL noted that the previous rules needlessly restrained plan fiduciaries’ ability to weigh ESG factors when selecting investments, even when those factors would benefit plan participants.
The rule follows Executive Order 14030, signed by President Biden in May 2021, which directed DOL to identify and recommend actions that would protect the life savings and pensions of employees from the threats of climate-related financial risk.
Notable Provisions Include:
- ESG is not a mandate: Retirement plan fiduciaries are not required to consider ESG factors under all circumstances. Instead, plan fiduciaries have discretion in determining the relevance of ESG factors to a risk-return analysis of an investment in light of the surrounding facts and circumstances.
- Fiduciary duties apply: The duties of prudence and loyalty continue to constrain plan managers. A fiduciary’s determination with respect to an investment must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis. However, such factors may now include the economic effects of climate change and other ESG factors on the risk and return of an investment.
- Tiebreaker test: The previous rule permitted fiduciaries to consider collateral benefits as tiebreakers only where the competing investments were indistinguishable based on “pecuniary” factors alone. The new rule gets rid of the “pecuniary/ non-pecuniary” terminology and instead allows a fiduciary to consider collateral benefits (such as ESG factors when not relevant to risk and return) if the fiduciary prudently concludes that competing investments equally serve the plan’s financial interests over the appropriate time horizon. However, a fiduciary is not allowed to accept expected reduced returns or greater risks to secure such collateral benefits. The new regulation also removes prior special documentation requirements for use of ESG factors as a tiebreaker.
- Participants preferences: Fiduciaries do not violate their duty of loyalty solely because they take participants’ preferences into account in constructing a menu of prudent investment options for a participant-directed plan. Accommodating such preferences may lead to greater participation and higher deferral rates, thus leading to greater retirement security. This calculus can therefore be relevant to furthering the purposes of the plan.
- Expanding proxy voting: The new rule eliminates the provisions in the 2020 regulation that suggested that fiduciaries could only participate in proxy votes when they determined that the matter had an economic impact on the retirement plan. This 2020 provision was a notable departure for the DOL. At least since 1980, DOL guidance had indicated that proxy voting was an inherent obligation of owning an asset. The new final rule reinstates that philosophy. The new rule also removes specific requirements on maintaining records on proxy voting activities and monitoring obligations when using investment managers. All of these changes aim to combat the misperception created by the 2020 rules that proxy voting is disfavored.
The rule will be effective 60 days after its publication in the Federal Register.
