ERISA Plan Fiduciaries May Be Able to Save the Planet Under Proposed DOL Regulations Relating to ESG Factors and Proxy Voting

On October 13, 2021, the U.S. Department of Labor (DOL) released a proposed rule (Proposal) that would amend the DOL’s investment duties regulation with respect to the consideration of environmental, social, and governance (ESG) factors in the selection of investments for retirement plans that are subject to the Employee Retirement Income Security Act of 1974, as amended (ERISA). The Proposal also would amend the proxy voting rules under ERISA.

ESG Investing. The Proposal represents a significant change from the prior administration’s fiduciary rule relating to ESG investing, which is now subject to a nonenforcement policy by the DOL ( Current Rule ). 

• Elimination of Pecuniary Factors Concept. The Current Rule requires that plan fiduciaries consider only “pecuniary factors” in making investment decisions and does not even mention the term “ESG.” The Proposal removes the concept of pecuniary factors and states that “a prudent fiduciary may consider any factor in the evaluation of an investment or investment course of action that, depending on the facts and circumstances, is material to the risk-return analysis.” 
• Specific Incorporation of ESG Factors That May Be Relevant. The Proposal includes the following ESG factors as examples of the facts and circumstances that can be considered if material to the risk-return analysis:
  
  • climate change-related factors, such as a corporation’s exposure to the real and potential economic effects of climate change including exposure to the physical and transitional risks of climate change and the positive or negative effect of government regulations and policies to mitigate climate change
  • governance factors, such as those involving board composition, executive compensation, and transparency and accountability in corporate decision-making, as well as a corporation’s avoidance of criminal liability and compliance with labor, employment, environmental, tax, and other applicable laws and regulations
  • workforce practices, including the corporation’s progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion, and retention; its investment in training to develop its workforce’s skill; equal employment opportunity; and labor relations 

• No Sacrifice of Economic Returns. According to the DOL, the purpose of this change is to make it clear that in appropriate situations, ESG factors are risk-return factors that fiduciaries should consider in making investment decisions. However, the Proposal is clear that “a fiduciary may not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives” and may not sacrifice economic returns to promote ancillary goals.
• The Tie-Breaker Rule. The Proposal also sets forth guidance regarding “tie-breakers” pursuant to which a fiduciary may consider collateral benefits in selecting a plan investment if the fiduciary concludes that competing investments “equally serve the financial interests of the plan.” The DOL notes that the investments don’t have to be “indistinguishable” for collateral benefits to be considered. Instead, the fiduciary must conclude that the alternative investments are equally appropriate for the plan before deciding that collateral benefits can be considered in selecting one of the investments. 
• Use of ESG in Participant Investment Alternatives. The Proposal permits fiduciaries of participant-directed defined contribution plans to offer investment alternatives (including a “qualified default investment alternative” or QDIA) using ESG factors if the alternatives satisfy the requirements of the Proposal. If a plan fiduciary selects a designated investment alternative (including a QDIA) for a participant-directed defined contribution plan on the basis of collateral benefits in a tie-breaker situation, the Proposal requires that the characteristics of the collateral benefits be “prominently” disclosed to plan participants. This is a significant change from the Current Rule, which prohibits the use of an investment alternative as a QDIA if the alternative reflects “non-pecuniary” factors in its investment strategy.

Proxy Voting. The Proposal makes the following changes to the proxy voting and exercise of shareholder rights provisions in the Current Rule:  

• Duty to Vote. Removes the statement that the fiduciary duty rules do not require the voting of every proxy or exercise of every shareholder right. The DOL explained that this removal doesn’t mean that every proxy must be voted but noted that the DOL’s longstanding view is that proxies generally should be voted unless a fiduciary determines the costs would outweigh the benefits. 
• Monitoring Obligation . Removes the explicit requirement that a plan fiduciary must monitor any third-party proxy voting service to which voting has been delegated. The DOL noted that the intent of this change is not to reflect a change in the DOL’s view that a fiduciary must monitor its delegates but to signal that there is nothing special about monitoring proxy voting services.
• Voting Policies. Removes the two “safe harbor” proxy voting policies that plan fiduciaries can use. The DOL explained that it does not believe those two safe harbor policies are necessary or helpful and requests comments on those provisions.
• Records Maintenance. Eliminates the requirement for plan fiduciaries to maintain records on proxy voting and other exercises of shareholder rights. The DOL made this change to remove any misperception that heightened fiduciary standards, and corresponding liability, apply to proxy voting and other exercises of shareholder rights.

The DOL has requested comments on its Proposal, which must be submitted on or before 60 days of publication of the Proposal in the Federal Register.