November 2, 2021Client Alert

DOL Proposed Rule on Investment Duties: Fiduciaries May Need to Consider ESG Factors to Satisfy ERISA Fiduciary Duties

The U.S. Department of Labor (DOL) recently released a proposed rule that would amend the regulations under the Employee Retirement Income Security Act (ERISA) and may cause investment fiduciaries to revisit their approach. This latest development continues the roller coaster of ESG guidance from the DOL and highlights the difference in philosophies between the former and current Administrations. 

ERISA establishes minimum standards that govern the operation of private-sector employee benefit plans, including fiduciary standards. Currently, these fiduciary standards regulate a fiduciary’s duties of prudence and loyalty in making retirement plan investments and exercising shareholder rights, including proxy voting. The DOL’s proposed changes address when plan fiduciaries are permitted to consider environmental, social, and governance (ESG) factors in selecting plan investments, without violating their fiduciary duties under ERISA. 

The proposed changes also address ERISA fiduciary duties as they relate to voting of proxies on securities held in employee benefit plan investment portfolios and exercising other shareholder rights.

ESG Investments

ESG investments are investments that are selected, at least in part, for their collateral economic or social benefit. Since ESG factors focus on certain social policy goals, the question becomes how this focus will dovetail with the traditional fiduciary considerations of investment returns, investment risks, and other more purely economic factors. Certain retirement plans have already started using ESG factors in their decision-making. Although the proposed rule retains most of the current regulations, the proposed changes clarify that fiduciaries may, when appropriate, consider ESG factors when making plan investment decisions.

  • Duty of Prudence

The proposed rule seeks to amend the prudence provisions of ERISA Regulation Section 2550.404a-1 to clarify that, when considering projected returns, the duty of prudence is met with respect to an investment or an investment course of action if the fiduciary has both (1) given appropriate consideration (see definition below) to those facts and circumstances that the fiduciary knows are relevant, including the role it plays in the portion of the plan’s investment portfolio; and (2) has acted accordingly.

“Appropriate consideration” includes, among other things, consideration of the projected return of the portfolio relative to the funding objectives of the plan, which may often require an evaluation of the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action. 

Under this construct, the DOL is taking the position that a fiduciary’s duty of prudence may, in certain instances, require an evaluation of the economic effects of climate change and other ESG factors on the particular investment or investment course of action.

Examples of the types of ESG factors a fiduciary may need to consider in the proposed rule include climate change, governance, and workforce practices.

  • Climate Change factors may include consideration of the plan sponsor’s physical and transitional risks of climate change and the positive or negative effect of government regulations and policies to mitigate climate change.
  • Governance factors may include board composition, executive compensation, and transparency and accountability in corporate decision-making, as well as a corporation’s avoidance of criminal liability and compliance with labor, employment, environmental, tax, and other applicable laws and regulations.
  • Workforce Practices factors may include the plan sponsor’s progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion, and retention; its investment in training to develop its workforce’s skill; equal employment opportunity; and labor relations.
  • Duty of Loyalty

The proposed rule seeks to make several changes to ERISA’s duty of loyalty provisions.

First, the proposed rule integrates ESG factors into the factors a fiduciary may need to consider, depending on the facts and circumstances, when making investment decisions.

Second, the proposed rule amends the tie-breaker standard to say that, where competing investments would serve the plan’s interests equally, fiduciaries are not prohibited from selecting an investment based on “collateral benefits” (like ESG factors) other than investment returns, as long as the following requirements are met:

  • If the fiduciary uses a collateral benefit when selecting a designated investment alternative for an investment account plan, the collateral benefit must be prominently displayed in the disclosure materials provided to participants and beneficiaries; and
  • The fiduciary did not accept expected lower returns or higher risks to secure the collateral benefit.

Third, the proposed rule removes the documentation requirement that applies if fiduciaries use a collateral benefit when deciding between competing investment choices under the tie-breaker rule.

Fourth, for participant-directed individual account plans, the proposed rule eliminates the current rule that prohibits an investment fund, product, or model portfolio from being used as a qualified default investment alternative (QDIA) if its objectives, goals, or principal investment strategies indicate that it uses non-pecuniary factors.

Proxy Voting and Exercising Shareholders Rights

The proposed rule extends the fiduciary’s duties of prudence and loyalty to include monitoring service providers, including investment managers and proxy advisory firms, that exercise shareholder rights on behalf of the plan.

Additionally, the proposed rule modifies the current fiduciary standards on exercising shareholder rights.

Next Steps

The DOL’s comment period runs through mid-December.  Final regulations seem likely to follow soon thereafter.  Given this timing, responsible fiduciaries should educate themselves on the application of the ESG regulations once finalized, particularly when it comes to directing plan investments and/or selecting investment alternatives (particularly default investments).  As a reminder of good prudence, responsible fiduciaries should seek external expertise on the new ESG regulations if needed.


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