By Kellie M. Thomas with Jackson Lewis P.C.
We recently summarized the regulatory back and forth of the past few years relating to environmental, social, and corporate governance (“ESG”) factors and their impact on ERISA retirement plans and the fiduciaries that oversee them.
As expected, the Biden administration released a proposed rule last year that re-opened the door (previously closed by the Trump administration) for retirement plan fiduciaries to consider ESG factors as part of their overall process in choosing retirement plan investments and making proxy voting decisions.
After reading the proposed rule, many were concerned that it imposed a mandate to consider ESG factors. The Department of Labor assuages that concern with the recent release of the final rule. In the preamble to the final rule, the DOL confirms that the rule imposes no such mandate (and modified the questioned language of the proposed rule in the final rule).
The final rule reflects these three principles:
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A fiduciary must base a determination relating to plan investments on factors that the fiduciary reasonably determines are relevant to a risk and return analysis, using appropriate investment horizons consistent with the plan’s investment objectives and considering the funding policy of the plan;
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The risk and return factors may include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action. Whether any particular consideration is a risk-return factor depends on the individual facts and circumstances; and
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The weight given to any factor by a fiduciary should appropriately reflect an assessment of its impact on risk and return.
The DOL is also clear that nothing in the final rule changes the longstanding principle that “the duties of prudence and loyalty require plan fiduciaries to focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives unrelated to the provision of benefits under the plan.”
The final rule also provides that the standards for qualified default investment alternatives (“QDIAs”), i.e., the investments into which a plan places participant funds when participants haven’t made an investment election, are the same as any other plan investment. (This is a change from the prior regulations.)
Another key component of the final rule is an amendment to the “tiebreaker” test under the current regulations, which requires competing investments to be indistinguishable based entirely on pecuniary factors before fiduciaries can break a tie with collateral factors (like ESG). The current regulations also impose a special disclosure requirement if considering such collateral factors. The final rule instead requires a fiduciary to conclude prudently that competing investments equally serve the financial interests of the plan over the appropriate time horizon. It also removes the special disclosure requirement.
The final rule further indicates that fiduciaries do not violate their duty of loyalty solely because they take participants’ preferences into account when choosing a menu of plan investment options for participant-directed individual account plans. The DOL recognizes that considering whether an investment option aligns with participants’ preferences can be relevant to furthering the purposes of a plan—i.e., greater participation and higher deferral rates, as suggested by commenters, which may lead to greater retirement security. Plan fiduciaries may see this as a means to consider other types of investments in response to participant requests, such as private equity and crypto-based products (though the choice of investment options will, first and foremost, always be subject to general fiduciary considerations).
Finally, the final rule retains the core principle that when a plan’s assets include shares of stock, the fiduciary duty to manage plan assets includes the management of shareholder rights related to those shares, such as the right to vote proxies. It does make certain changes that may encourage proxy voting (rather than abstention) and clarifies that proxy voting and other exercises of shareholder rights carry the same fiduciary obligations as any other plan fiduciary activities.
The final rule will go into effect 60 days following its publication in the Federal Register, with extended deadlines for certain proxy provisions.
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