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Recently, the U.S. Department of Labor released a new highly anticipated final regulation under which retirement plan fiduciaries, such as 401(k) plan sponsors, are permitted—but are not obligated—to consider climate change and other environmental, social and governance (“ESG”) factors when selecting retirement plan investments or exercising shareholder investment rights, such as proxy voting, under the plan. Though only issued last month and generally effective January 30, 2023, the regulation is already under attack by the attorneys general of 25 states, two oil services companies and an oil and gas advocacy group who have sued to stop the regulation from taking effect.  See  Bloomberg Law, Red States Sue to Block Labor Department’s ‘Woke’ ESG Rule and Plan Adviser, States’ Suit Could Delay DOL-Rule On ESG Investing.

Background.  In the closing days of President Donald Trump’s administration, the Department of Labor published a regulation under the Employee Retirement Security Act of 1976, as amended (“ERISA”) that was intended to prohibit the use of ESG factors in making investment choices for ERISA plans by stating that the selection of investment and investment courses of action should be based solely on “pecuniary factors.”  Then, following President Joe Biden’s election, the DOL was directed to review the Trump regulation and to not enforce the regulation pending the DOL’s review.  A new proposed regulation was released by the DOL in 2021 under which the DOL proposed removing barriers to plan fiduciaries’ ability to consider ESG factors when they select investments and exercise shareholder rights.  There was concern that upon finalization of the DOL regulation retirement plan fiduciaries would be required to apply ESG factors when making investment decisions, with speculation that requirement might effectively force a “boycott” of energy company stock. See, e.g., CNBC’s report “ESG on the Edge: Controversy weighs on sustainable ETFs” and’s article ESG Investors Should Support Big Oil.

As retirement plans contain over $32 trillion in assets (see Investment Company Institute Release:  Quarterly Retirement Market Data for the Third Quarter 2022), the construct of these rules is significant.  With regard to non-ERISA plans, activity in this area has also been significant and at times controversial.  See, e.g., Nineteen Attorneys General Letter to Laurence D. Fink, CEO, BlackRock, Inc.; Louisiana and Indiana Attorneys General Issue Guidance–Investment Firms Incorporating ESG Factors Violate Their Fiduciary Duty; Barron’s, Florida, Texas Crack Down on ESG Investments in State Funds  (discussing the States of Florida’s and Texas’s efforts to ban their non-ERISA pensions from investing plan assets based on ESG factors), Bloomberg Law, Public, Private Pensions Set to Collide Over ESG Investing (containing map of states with pro- or anti-ESG bills or policies pending).

New Regulations.  The DOL recently released the new highly-anticipated final regulation under which it takes a somewhat neutral position regarding focusing on ESG factors when making retirement plan investment decisions.  The final DOL regulation allows plan fiduciaries to consider ESG factors when they select plan investments and exercise shareholder rights, such as proxy voting.  In brief, the final regulations provide as follows:

  • ESG Factors.  Plan fiduciaries may – but are not required to – take into account ESG factors when analyzing projected returns on an investment, provided those factors are economically relevant to the investment.  Notably, the DOL specifically states in the preamble to the final regulations that it did not want to create a mandate for the consideration of ESG factors.
  • QDIAs No Longer Treated Differently.  The same fiduciary standards are to be applied to the selection and monitoring of a Qualified Default Investment Alternative (“QDIA”) as are applied to other designated investment alternatives.  Therefore, ESG factors may – but are not required to—be taken into account when selecting a QDIA for a plan.
  • The Tiebreaker.  Fiduciaries may consider non-economic, “collateral benefits” as a tiebreaker when choosing among otherwise equal prudent investments.  Under the new tie-breaker test, a fiduciary must prudently determine that competing investments or investment courses of action equally serve the financial interests of the plan over the appropriate time horizon, in which case, the fiduciary may select the investment or investment course of action, based on collateral benefits other than investment returns.  A collateral benefit is not defined in the final regulations except by example, but ostensibly would include ESG factors.
  • Participant Direction.  Plan fiduciaries do not violate their duty of loyalty under ERISA solely because they respond to participant demands for ESG investment options, and they may address such demands when designing a prudent line-up of investment options.
  • Proxy Voting.  Proxies should be voted as part of the process of managing a plan’s investments, unless a plan fiduciary determines that voting proxies may not be in the plan’s best interest (e.g., when voting involves significant cost or effort).
  • Elimination of Certain Rules in the Prior Regulations.
    • Specific Monitoring Obligations.  A fiduciary no longer has a specific obligation to monitor third-party providers authorized to vote proxies (i.e., the fiduciary’s duties in this regard are the same as its duties with respect to the selection and monitoring of other plan service providers).
    • Safe Harbors.  The final regulations no longer contain any safe harbors regarding permissible proxy voting policies.  The DOL stated that it removed the safe harbors to ensure that fiduciaries understood it is impermissible to broadly abstain from proxy voting.
    • Elimination of Proxy Voting Records.  A fiduciary no longer has a specific obligation to maintain certain types of records on exercising shareholder rights (e.g., proxy voting).  The DOL stated that a fiduciary’s exercise of shareholder rights should be treated the same as other fiduciary activities.

Caveat.  The final regulations provide the DOL’s position that plans can begin offering ESG investments to the extent they are otherwise prudent.  However, plan fiduciaries must exercise due caution in offering ESG investments under an ERISA plan given the extent of class action ERISA litigation in recent years as the new final regulations do not mitigate any litigation risks regarding potential claims if a fiduciary selects and offers plan participants an ESG investment alternative that underperforms and/or costs more than non-ESG peer investments.

Action Items.  Regardless of potential future issues, in general, the new regulations are effective January 30, 2023, with certain provisions (e.g., reliance on proxy voting firms) effective December 1, 2023.  As such, plan fiduciaries should review their investment and proxy voting policies based on the rules of the new final regulations.  In addition, investment managers of ERISA plans will likely need to change their proxy voting policies which will require working with investing plan fiduciaries to reconcile these policies.

Should you have any immediate questions or need more specific information concerning the new regulations and how it may affect your plan(s), please contact Robert T. Mashburn, Jr., Randye C. Snyder, Leon H. Rittenberg III, or Thomas J. McGoey II.

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