PLANSPONSOR - October/November 2021 - 39

INSIDE ANGLE
ESG for Fiduciaries
DOL proposal gives green light to ESG investing
O
n October 13, the Department of Labor (DOL) published
a proposed regulation that would amend the department's
investment duties regulation under the Employee
Retirement Income Security Act (ERISA). The proposed rule was
issued in response to the Biden administration's executive order
directing agencies to review regulations that could be inconsistent
with the administration's policies related to climate change and
environmental, social and governance (ESG) factors.
The proposed rule generally retains the longstanding principle
that the duties of prudence and loyalty require ERISA plan
fiduciaries to focus on material risk-return factors and not subordinate
the interests of participants and beneficiaries to objectives
unrelated to the provision of benefits under the plan. Nevertheless,
while the framework is the same, the proposed rule would include
changes that seem likely to result in greater leeway for fiduciaries
to include ESG investments in plans.
Background
ERISA requires that fiduciaries act prudently and solely in the
interest of the plan participants and beneficiaries. Over the past
40 years, the DOL has periodically issued guidance addressing the
extent to which these duties under ERISA allow for ESG-based
investment decisions. While the emphasis of prior guidance has
shifted depending on the policy priorities of the administration at
the time, the DOL has been consistent in its position that a fiduciary
may not sacrifice returns or take on additional risk when
making investment decisions for ERISA plans. Last year's Trump
administration ESG rule was the first time the agency addressed
ESG in regulations, rather than in sub-regulatory guidance.
The Proposed Rule
The newly proposed rule expressly states that a fiduciary's duty
of prudence " 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. "
For example, the DOL explained that climate-change-related
factors may affect an investment economically, such as a corporation
being exposed to the physical and transitional risks of climate
change and the positive or negative effect of government regulations
and policies to mitigate climate change.
Moreover, the DOL observed that governance factors, too,
could have an economic impact on an investment. For instance,
the DOL described that board composition, executive compensation,
as well as a corporation's avoidance of criminal liability
and compliance with labor, employment, environmental, tax and
other applicable laws and regulations could all have an economic
impact on an investment.
Notably, the proposed rule removes restrictions included
in the Trump administration's rule that prohibited plans from
utilizing a fund, product or model portfolio as a plan's qualified
default investment vehicle if its objectives, goals or principal
investment strategies include, consider or indicate the use of one
or more nonfinancial factors.
The DOL's historical ESG-related guidance has focused on
whether, when choosing among prudent investments, a fiduciary
is permitted to select an investment alternative based on " collateral
benefits " associated with that investment. The proposed rule
reaffirms the DOL's long-standing " tiebreaker " position that fiduciaries
are permitted to consider noneconomic, collateral benefits
when choosing among otherwise prudent investments. The DOL
explains in the preamble that the change is necessary because
the 2020 ESG rule's " indistinguishable " standard could be interpreted
too narrowly and appears to be chilling the consideration of
ESG factors by fiduciaries making investment decisions.
Under the proposed rule, investments do not have to be
indistinguishable to permit consideration of collateral objectives
that favor one investment over the other. The preamble to the
proposed rule explains that " two investments may differ on a
wide range of attributes, yet when considered in their totality,
can serve the financial interest of the plan equally well. These
investments are not indistinguishable, but they are equally
appropriate additions to the plan's portfolio. "
The proposed rule notes that it " does not place parameters
on the collateral benefits that may be considered by a fiduciary
to break a tie. " Instead, it says, such considerations, like any fiduciary
decision, are dependent on the facts and circumstances of
each particular situation. The proposed rule also removes the
heightened documentation requirements for a tiebreaker, set
forth in the 2020 ESG rule.
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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