PLANSPONSOR - August/September 2020 - 47

INSIDE ANGLE
DOL Doubles Down
The agency's recent proposal creates stricter limits for ESG investments
T
he Department of Labor (DOL) made headlines in late
June when it issued a notice of proposed rulemaking titled
" Financial Factors in Selecting Plan Investments. " The proposed
rule both embraces and attempts to codify the DOL's strictest
position yet on the role of environmental, social and governance
(ESG) factors in benefit plan investments. It also attempts to redefine
the duty of loyalty under the Employee Retirement Income
Security Act (ERISA) with a new five-part test. Both elements of
the DOL's proposal have proved controversial. The agency issued
the proposed rule with only a 30-day window for comments,
which has closed with scores of those having been filed by the
regulated community. What follows is a description of the proposed
rule and some of its more controversial aspects.
Codification of ERISA's Duty of Loyalty
The proposed rule amends the DOL's existing investment duties
regulation that clarifies ERISA's duty of prudence in the context
of plan investments. The proposed rule expands the " Investment
Duties " regulation to cover ERISA's duty of loyalty and creates a
five-part test that must be met to satisfy the act's duties of prudence
and loyalty. These requirements apply without regard to whether
the plan invests in ESG-oriented investments. Importantly, the
proposed rule seeks to harmonize ERISA's duty of loyalty with
other fiduciary and fiduciary-like standards such as the Securities
and Exchange Commission (SEC)'s Regulation Best Interest (Reg
BI). Nevertheless, the DOL's proposed rule, and its five-part test,
represent a significant deviation for those in the retirement space.
ERISA fiduciaries would be required to ensure compliance with
the DOL's more exacting five-part test.
Proposed Rule and ESG
Historically, the DOL's position on ESG has shifted between more
permissive approaches under Democratic administrations versus
more restrictive approaches under Republican administrations.
However, regardless of the party in power, the DOL has generally
rested on the " all things being equal test, " which permits fiduciaries
to consider non-pecuniary factors as a tiebreaker between
otherwise identical investments.
The proposed rule alters the department's prior guidance
and severely limits fiduciaries' ability to consider ESG factors
when making plan investments. The proposed rule's overarching
theme-which the DOL articulates in unambiguous terms-is
that fiduciaries must " solely " consider pecuniary factors when
selecting plan investments in order to satisfy their duties of loyalty
and prudence under ERISA. In other words, fiduciaries must
compare investments solely on economic factors, such as anticipated
risk and return. In the preamble, the DOL cautions that
" fiduciaries must not let non-pecuniary considerations draw them
away from an alternative option that would provide better financial
results. " This area was aggressively scrutinized by commenters
who wrote that ESG considerations are pecuniary in nature.
The proposed rule contemplates only very narrow circumstances
where fiduciaries' consideration of ESG factors would
be appropriate. Specifically, these circumstances are only if the
ESG factors themselves constitute economic considerations-i.e.,
" only if they present economic risks or opportunities that qualified
investment professionals would treat as material economic
considerations under generally accepted investment theories. "
For circumstances where investment choices are economically
indistinguishable, the DOL retains the " all things being
equal test " to allow fiduciaries to make the decision based on
non-pecuniary factors. That said, the DOL assigns some major
homework in the process. For such decisions, fiduciaries would
need to document why they determined the investment choices
to be indistinguishable and describe why the particular investment
is selected based on the non-pecuniary factors.
Lastly, the DOL adds additional hurdles for fiduciaries that
may be considering including ESG-oriented investments in their
defined contribution (DC) plan. In this respect, the proposed rule
provides that a fiduciary's inclusion of such an investment alternative
would comply with ERISA Sections 403 and 404 if: a) the plan
fiduciary evaluates the investments solely using objective risk and
return criteria; b) the plan fiduciary documents its decision; and c)
such ESG-oriented investments are not included as part of a plan's
qualified default investment alternative (QDIA). These hurdles
and restrictions would require that fiduciaries further document
their analysis, potentially setting up, for later, second guessing by
plaintiffs of the DOL.
It remains to be seen how the agency's controversial
proposed rule will be amended before it is finalized.
Steve Saxon is a partner with Groom Law Group, Chartered,
and George Sepsakos is a principal with Groom. Offices for
Groom are in Washington, D.C.
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