The Department of Labor’s Reversal on ESG for ERISA Plan Fiduciary Investment Decision-making

There are many emerging issues for fiduciaries of 401(k) and 403(b) plans. These issues include the Department of Labor’s (“DOL”) regulation of ERISA investment duties and ESG considerations, as well as its recently re-proposed rule regarding the same. Compared to the prior rule enacted by the Trump administration at the end of 2020, the latest proposal represents a significant shift in the DOL’s attitude towards ESG factors. If the rule is finalized, it would significantly change the investment landscape for ERISA plan sponsors and fiduciaries.

The Proposal retains the existing prudence safe harbor for evaluating investments or investment courses of action, which requires the fiduciary to (i) give appropriate consideration to the role the investment or investment course of action plays in the plan’s portfolio with respect to which the fiduciary has duties, and (ii) act accordingly.

New in the proposal and a fundamental change is the statement that when fiduciaries give appropriate consideration to factors related to the projected return of the portfolio relative to the funding objectives of the plan, their analysis “. . . may often require an evaluation of the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action.”

In many cases, these ESG factors may be relevant to this analysis because the risk-return potential could be realized decades after the date of the investment.

The proposed rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” follows Executive Order 14030, signed by President Biden on May 20, 2021. The order directs the federal government to implement policies to help safeguard the financial security of America’s families, businesses, and workers from climate-related financial risk that may threaten the life savings and pensions of U.S. workers and families.

“The proposed rule announced today will bolster the resilience of workers’ retirement savings and pensions by removing the artificial impediments – and chilling effect on environmental, social and governance investments – caused by the prior administration’s rules,” said Acting Assistant Secretary for the Employee Benefits Security Administration Ali Khawar. “A principal idea underlying the proposal is that climate change and other ESG factors can be financially material and when they are, considering them will inevitably lead to better long-term risk-adjusted returns, protecting the retirement savings of America’s workers.”

As the DOL explains in the proposed rule, the new language seeks to reverse the negative perception of climate change (and other ESG factors) in investment evaluation and selection spurred by the regulation of the prior administration. In addition, it clarifies that a fiduciary’s duty of prudence may often require an evaluation of the effect of climate change and government policy changes on investments’ risks and returns.

In effect, the DOL is expressly directing plan fiduciaries to consider that ESG issues could present material business risks or opportunities. The result is the creation of a new presumption that a prudent fiduciary should consider ESG issues when evaluating the risk and return profiles of investment opportunities.

The Proposal reaffirms that ERISA fiduciaries have broad discretion to consider any factor in evaluating an investment that, based on the facts and circumstances, is material to the risk-return analysis. The Proposal describes how climate change-related factors, governance factors, and workforce practices are relevant factors a fiduciary may consider using the following examples.

  • 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; and
  • 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.

This new language should clearly resolve any question of whether climate change and other ESG factors are equal to any other “traditional” material risk-return factors in any decision-making about investments. Although the examples are not exclusive, they should provide some guidance to bolster the confidence of fiduciaries that, by selecting funds that prominently incorporate ESG factors, which they have deemed to be economically advantageous for participants, they are acting consistently with ERISA’s duty of prudence.

HBL has experience in all areas of benefits and employment law, offering a comprehensive solution to all your business benefits and HR/employment needs. We help ensure you are in compliance with the complex requirements of ERISA and the IRS code, as well as those laws that impact you and your employees. Together, we reduce your exposure to potential legal or financial penalties. Learn more by calling 470-571-1007.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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