In November, the Department of Labor (DOL) issued a final rule (Final Rule) that will remove certain restrictions on environmental, social, and governance (ESG) considerations in plan investments. These restrictions were adopted in 2020 and effectively prevented ERISA plan fiduciaries from considering ESG factors when selecting investment choices or exercising shareholder rights, such as proxy voting.
The Final Rule effectively takes a neutral approach to ESG investments. It retains the core principle that the duties of prudence and loyalty require ERISA plan fiduciaries to focus on relevant risk-return factors in the best interest of plan participants and beneficiaries. Other objectives not related to the provision of benefits to such participants and beneficiaries cannot take priority.
However, the Final Rule clarifies that under these duties, ERISA plan fiduciaries can determine which risk-return factors are relevant. Such factors may include ESG considerations, such as the economic effects of climate change, with respect to any particular investment choice. The Final Rule further specifies that ERISA plan fiduciaries can take into account participants’ preferences, even if based on ESG considerations when determining which investment options will be offered to plan participants. Doing so does not constitute a breach of fiduciary duty per se.
In addition to the changes summarized above concerning ESG investments, the Final Rule makes the following changes:
- It re-affirms that when plans are invested in shares of stock, ERISA plan fiduciaries should manage shareholder rights attached to those shares, specifically when doing so could positively impact protecting participants’ interests. It effectively reverses the prior position under the 2020 rules, which stated that ERISA plan fiduciaries, as a rule, should not participate in proxy votes unless it would have a financial impact on the plan.
- It simplifies the so-called “Tiebreaker Test” that applies when two competing investment choices cannot be easily differentiated. It removes the documentation requirement on the use of non-financial factors, such as ESG considerations. If ERISA plan fiduciaries prudently conclude that competing investment choices are equally appropriate for the plan participants, the ultimate selection of the better investment choice for the plan participants can be based on non-financial factors, including ESG considerations.
- It removes certain special rules for qualified default investment alternatives (QDIAs) that applied under the 2020 rules and effectively prevented the use of non-financial factors when selecting a QDIA. Under the Final rule, standards applied to QDIAs are no different from those applied to other investments.
The Final Rule is set to become effective 60 days after publication in the Federal Register. Certain proxy voting provisions are delayed for a year to allow fiduciaries to prepare for the aforementioned changes.