End of Week Notes
More good ESG news from the Biden Administration
4 elements that should be in a new DOL ESG rule
The Department of Labor (DOL) announced this week that it will not enforce the last-minute rule promulgated by the Trump Administration widely seen as limiting the use of ESG funds in ERISA retirement plans.
The final rule, “Financial Factors in Selecting Plan Investments,” effective in early January, was a somewhat watered-down version of the proposed rule, which drew near-unanimous opposition from public commenters. It required defined-benefit and defined-contribution plan fiduciaries to base their investment decisions solely on financial considerations, except in what it indicated was the unlikely event of a tie between traditional and ESG strategies, in which case, the ESG focus could be a tiebreaker so long as the decision were rigorously documented. The tiebreaker does not apply to Qualified Default Investment Alternatives (QDIAs), however, foreclosing ESG considerations from those options, most of which are target-date funds. The rule also failed to clarify whether ESG strategies that focus on financially material ESG considerations were appropriate selections and not subject to the tiebreaker or to the ESG ban for QDIAs.
The DOL announcement noted that the many stakeholders it has consulted since the new administration has taken office have indicated that the rule:
“…failed to adequately consider and address the substantial evidence submitted by public commenters on the use of environmental, social, and governance (ESG) considerations in improving investment value and longterm investment returns for retirement investors. The Department has also heard from stakeholders that the rules, and investor confusion about the rules, have already had a chilling effect on appropriate integration of ESG factors in investment decisions, including in circumstances that the rules can be read to explicitly allow.”
Four key elements that should be included in a new rule
I’m not an attorney but my read is that not enforcing the new rule pending further clarification, which may or may not result in a new rule, moves us for now back to the 2015 Obama-era DOL guidance that allows plan fiduciaries to consider ESG factors and the “all things equal” test. In selecting ESG funds or strategies, plan fiduciaries can choose the ESG option so long as its risk-adjusted return profile is equal to that of traditional investment options that are similarly situated. That’s a much more straightforward approach, but it could be improved via a new DOL rulemaking process.
Because there’s nothing quite like making a few policy suggestions on a Friday afternoon, here are four key elements that I think should be in a new rule:
- Require plan fiduciaries under ERISA to act prudently in the interest of plan participants and beneficiaries by considering material ESG factors. This is 2021, folks. The world is burning. The idea that the fiduciaries in charge of making investment decisions about American workers’ retirement security should have a choice on whether to even consider ESG is lunacy.
- Recognize that there are a range of approaches that a plan fiduciary can take to fulfill the requirement to consider ESG materiality. Requiring simply that all funds/strategies in a plan must show that they consider ESG in their investment process might be a minimum standard. But a rule should also make clear that more-comprehensive approaches that apply ESG are also appropriate. (All fund/strategy selections must still meet risk-adjusted return standards.)
- Clarify that ESG-focused funds/strategies pursuing impact objectives are appropriate, so long as they also consider material ESG factors and have risk-adjusted performance characteristics of similar traditional offerings.
- Treat QDIAs no differently from other plan options.
DOL also will not enforce proxy voting rule
The DOL also took aim at a second last-minute Trump administration rule discouraging retirement fiduciaries from voting their proxies at company meetings and engaging with companies as shareholders. Also watered down after public comments that were overwhelmingly opposed to the proposed rule, “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights,” applies more to pension plans than 401(k) plans.
The rule makes clear that plan fiduciaries are not required to vote every proxy (more of a clarification of previous policy than an outright change) and says they should act in accordance with the economic interest of the plan and its participants and beneficiaries and not “subordinate” those interests “to any non-pecuniary objective.” The rule also says plans should consider the costs of engagement and proxy voting, evaluate material facts before voting, and keep a watch over proxy advisors, which the Trumpers at both DOL and the SEC seemed to find particularly pernicious.
