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DOL Enforcement of its Final Rules on ESG Investments & Proxy Voting

On March 10, 2021, the Department of Labor (“DOL”) issued a news release and accompanying “Statement Regarding Enforcement of Its Final Rules on ESG Investments and Proxy Voting By Employee Benefits Plans” (“Enforcement Statement”).

ESG Funds

This announcement  means that the current rules related to investing based on environmental, social and governance (“ESG”) factors that were announced as final rules in the waning days of the Trump administration will not be enforced.  The DOL pledges that it is going to issue additional guidance, but until then, the Final Rule entitled Financial Factors in Selecting Plan Investments, which became effective on January 12, 2021,  and the Final Rule entitled Fiduciary Duties Regarding Proxy Voting and Shareholder Rights, which became effective January 15, 2021, will not be enforced by the DOL.1

If you offer an employer-sponsored retirement plan(s), the Enforcement Statement may impact your plan(s).  This communication provides information about ESG investing and what steps you may consider taking as a plan fiduciary to a plan covered by the Employee Retirement Income Security Act (“ERISA”).

What is ESG?

Growth and interest in sustainable investing2 has developed exponentially in recent years.3 To regulate sustainable investing and the ESG factors that are used to evaluate these investments, the DOL has issued guidance since 1994.  Confusingly, some of the guidance has changed from one presidential administration to the next (See ESG Regulatory History).

Added to the confusion is the terminology surrounding this type of investing.  ESG factors are non-accounting factors that can be used by professional investment managers to evaluate companies and tell a more complete financial story for an organization.  Examples of ESG factors might include climate change and carbon emission (E factor); gender and diversity policies (S factor), or executive compensation (G factor).  Not all ESG factors are relevant for all companies.  It is the role of the prudent fiduciary to determine which factors may be material for which industry or company.

Selecting and Monitoring ESG Today

For those selecting and monitoring investments for ERISA-covered plans, this Enforcement Statement may create some confusion as to what rules to follow,4 but it remains clear that the DOL stands by the requirement that:

  • Fiduciaries have a duty of loyalty which requires them to put the interests of participants and beneficiaries first; here, that means that fiduciaries may not sacrifice investment returns or assume greater investment risks as a means of promoting ESG.
  • Fiduciaries must document their decisions, including the tools, metrics or information which demonstrates that even where ESG factors are considered, it is for the economic interests of participants and beneficiaries.

These are the long-held views of the DOL based on their guidance over the years; therefore, selecting and monitoring replacements by following those principles will continue to be critical for plan fiduciaries.  For those plan fiduciaries that lack the expertise to do so on their own, consider working with an experienced consultant to assist in meeting these requirements.

Next Steps

While the DOL pledged to issue additional guidance, the timing of such additional guidance is unclear.  Plan fiduciaries should consider the following:

  1. Seek additional training and education regarding ESG, if needed, as many terms and investments have changed in recent years.
  2. Review current investment policy statement to ensure alignment with status of the current regulations and DOL enforcement policy.
  3. Review procedures for monitoring investment selection and monitoring to ensure alignment with the status of the current regulations and enforcement policy; here, if working with a consultant, initiate the discussion with your consultant.
  4. Continue to monitor for additional guidance and be prepared to make updates once the additional guidance is published.

ESG Regulatory History

Interpretive Bulletin 1994-01 DOL guidance issued to correct a popular misperception at the time that investments in economically-targeted investments were incompatible with ERISA’s fiduciary obligations; later replaced by Interpretive Bulletin 2008-01.  In Interpretive Bulletin 2015-01, this language was later reinstated.
Interpretive Bulletin 2008-01 DOL guidance that replaced Interpretive Bulletin 1994-01, but was later replaced by Interpretive Bulletin 2015-01.
Interpretive Bulletin 2015-01 Replaced the prior guidance from 2008 and made clear that ESG factors could be considered by fiduciaries when evaluating the economic merits of a plan investment.  The DOL continued to clarify its long-standing position in this guidance that “ERISA fiduciaries may not sacrifice investment returns or assume greater investment risks as a means of promoting collateral social policy goals.”
Interpretive Bulletin 2016-01 DOL provided guidance as to how ERISA applies to fiduciary responsibilities with respect to proxy voting and exercising shareholder rights.
Field Assistance Bulletin 2018-01 DOL developed this guidance to address questions related to IB 2015-01 and IB 2016-01.  Published on April 23, 2018, FAB 2018-01 recognizes that for the plan’s designated investment alternatives (“DIAs”) there could be instances where ESG factors present material business risk or opportunities to companies that officers or directors need to manage as a part of the company’s business plan.  In these cases, prudent investment fiduciaries would treat these ESG factors as economic considerations under generally accepted investment theories.  The DOL warned that fiduciaries should not too readily treat all ESG factors as economically relevant.

As for the plan’s qualified default investment alternatives (“QDIAs”), the DOL took a different position given that in the instance of QDIAs, the plan is not merely offering an “additional investment alternative” for the participant’s selection.  Plan fiduciaries using ESG factors in the selection of QDIAs would need to ensure compliance with IB 2015-01.

As for proxy voting, the DOL stood by its long-held view that “plan fiduciaries should engage in traditional and customary proxy voting activities in discharging their fiduciary obligation to prudently manage plan investments.”  In doing so, investment policy statements that contemplate shareholder activities which are intended to monitor or influence management of corporations in which the plan owns stock would be in line with one’s fiduciary obligations under ERISA so long as there is a reasonable expectation that these activities are tied to economic value of the plan’s investments.

Financial Factors in Selecting Plan Investments    Financial Factors in Selecting Plan Investments Rule became effective January 12, 2021, and included the following:

 

·        Updated the duty of loyalty under ERISA Section 404(a) to prohibit “fiduciaries from subordinating the interests of participants to unrelated objectives, and bars them from sacrificing investment return or taking on additional investment risk to promote non-pecuniary goals.”

·        Required that fiduciaries evaluate investments based solely on pecuniary factors whereby pecuniary means financial considerations that have a material effect on the risk and/or return of an investment.

·        Required fiduciaries to consider reasonably available alternatives as a part of their prudent process under ERISA.

·        For instances in which two investments are indistinguishable, required additional documentation when non-pecuniary factors are utilized to make an investment selection.

·        For participant-directed plans, a fiduciary may select a DIA that considers non-pecuniary goals so long as the prudence and loyalty provisions are met, but as to the plan’s QDIA, if the investment’s objectives or goals or its principal investment strategies include, consider, or indicate the use of non-fiduciary objectives, that investment would be prohibited as a QDIA.

 

Fiduciary Duties Regarding Proxy Voting and Shareholder Rights  Fiduciary Duties Regarding Proxy Voting and Shareholder Rights (“Proxy Voting Final Rule”) became effective on January 15, 2021.  The Proxy Voting Final Rule replaced IB 2016-01 and required that fiduciaries put the economic interests of the plan and its participants first when exercising shareholder rights.

 

As always, please contact Pensionmark advisor or info@pensionmark.com if you have any questions.

 

1The ESG Final Rule and Proxy Voting Final Rule will not be enforced by the DOL, but there is a possibility that there could be a private right of action (in other words, a lawsuit) for not following those rules.  As such, continuing to follow the final rules may be the most conservative approach until further guidance is issued. 

2Sustainable investing is an umbrella term that encompasses a variety of investment strategies that utilize ESG factors including divesting, ESG integration, thematic and others. 

3Driven by demographic shifts, social movements, and availability of data, the flows into sustainable open-end and exchange-traded funds available to investors in the United States reached $51.1 billion in 2020.  See Jon Hale, A Broken Record: Flows for U.S. Sustainable Funds Again Reach New Heights, available at: https://www.morningstar.com/articles/1019195/a-broken-record-flows-for-us-sustainable-funds-again-reach-new-heights.

4Financial Factors in Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting and Shareholder Rights will not be enforced by the DOL, but those rules replaced Field Assistance Bulletin 2018-01 and Interpretive Bulletin 2016-01 (See Attachment A: ESG Regulatory History), thus creating a lack of clarity until further guidance is issued.