Defined Contribution

DOL Calls for Stricter Rules Around ESG Investing in Retirement Plans

DOL Calls for Stricter Rules Around ESG Investing in Retirement Plans
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2 min 42 sec

The Department of Labor (DOL) in late June proposed guidance for considering environmental, social, and governance (ESG) factors in the investment duties of fiduciaries for both defined benefit and defined contribution plans subject to ERISA.

In general, the DOL rule seems intended to create a larger hurdle to incorporating ESG factors into ERISA plan investments.

Background

In the proposed rule, the DOL states it is aiming to clarify these key points:

  1. That ERISA requires plan fiduciaries to select investments and investment courses of action based on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.
  2. That compliance with the exclusive purpose (loyalty) duty in ERISA section 404(a)(1)(A) prohibits fiduciaries from subordinating the interests of plan participants and beneficiaries in retirement income and financial benefits to non-pecuniary goals.
  3. That fiduciaries are required to consider other available investments to meet their prudence and loyalty duties under ERISA in furthering the purposes of the plan.
  4. That ESG factors can be pecuniary factors, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories. New regulatory text outlines the required investment analysis and documentation requirements in the rare circumstances when fiduciaries are choosing among economically “indistinguishable” investments (related to the so-called “tiebreaker rule” in interpretive bulletins issued in 1994, 2008, and 2015).
  5. That the prudence and loyalty standards set forth in ERISA apply to a fiduciary’s selection of a designated investment alternative to be offered to plan participants and beneficiaries in a 401(k)-type plan. The proposal describes the requirements for the selection of investment alternatives for such plans that purport to pursue one or more environmental, social, and corporate governance-oriented objectives in their investment mandates or that include such parameters in the fund name.

Bottom Line

The DOL reiterates the duties of prudence and loyalty to beneficiaries in selecting and monitoring investments that will not be news to any fiduciaries. Along these lines, consideration of financially material ESG factors would appear to still be deemed prudent, though the proposal narrowly defines material ESG factors.

However, this DOL guidance assigns a higher burden on plan sponsors to determine and document when investments are economically indistinguishable from one another and, thus, non-financial matters can be considered as tiebreakers, stating that these circumstances are “very rare.” The proposal also provides new guidance on selecting investment options for DC plans in which proposed options incorporate ESG considerations.

This proposed rule explicitly states that the QDIA in an ERISA DC plan should not incorporate ESG considerations, applying a higher standard to investments that serve as a default and stating that incorporating ESG factors in the QDIA could violate the duty of loyalty. The document states that this “is intended to help ensure that the financial interests of plan participants and beneficiaries in retirement benefits remain paramount by removing ESG considerations in cases in which participant’s retirement savings in individual accounts designed for participant direction are being automatically invested by a plan fiduciary.”

It is important to understand that this is a proposal. Once published, the rule undergoes a 30-day comment period. Early indications show there will be considerable response to this proposal.

The full text of the proposal can be found here.

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