ERISA Fiduciary Duty Rule
Regulatory Topic: ESG
Regulatory Agency: Department of Labor
While there has long been a complicated and shifting network of laws and regulations governing private sector retirement plan investing, legal requirements have traditionally established that investors/fiduciaries have a fiduciary responsibility to retirement plan holders to focus on loyalty and prudence. This is to ensure investment decisions are focused on pecuniary factors of risk and return on investment that are consistent with account holder expectations.
However, many including President Biden are increasingly attempting to steer financial investments towards broader investment factors no longer primarily focused on only rate of return or risk. This includes a major emphasis on environment, social, and corporate governance (ESG) factors that can put political objectives over financial ones, jeopardizing the retirement security of tens of millions of Americans as is the case with a currently proposed Biden DOL rule.
Key aspects of the newly proposed Biden DOL rule and recent Trump era DOL rule
In November 2020, the Trump Department of Labor (DOL) finalized a rule, Financial Factors in Selecting Plan Investments, that went into effect in January 2021. An earlier version of the proposed rule included more specifics on ESG perspectives in investing, but the final version of the rule simply focused on ensuring that consideration of any factors be based upon financial impact. The rule defined a pecuniary factor as a “factor that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy established pursuant to section 402(b)(1) of ERISA.” Non-pecuniary factors were excluded from investment decision-making aside from serving as potential secondary “tie-breakers.”
The Biden DOL proposed rule in October 2021, Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, would replace the Trump era rule and usher in a wide array of new factors when considering investments and shareholder proxy voting by fiduciaries, redefining the notion of what risk-return analysis is and how fiduciaries can more subjectively determine what the financial interests of account holders are.
The DOL argues that its 2021 proposed rule is consistent with meeting the fiduciary responsibilities of loyalty and prudence to account holders because considering ESG and related factors can improve investment decisions in the interest of plan holders. Defending the expansion towards politically contentious factors at the time the rule was proposed, Acting Assistant Secretary for the Employee Benefits Security Administration Ali Khawar said a “principal idea underlying the proposal is that climate change and other ESG factors can be financially material and when they are, considering them will inevitably lead to better long-term risk-adjusted returns, protecting the retirement savings of America’s workers.”
In the proposed rule itself, the DOL further argued: “In summary, a significant benefit of this proposal would be to ensure that plans do not overcautiously and improvidently avoid considering material climate change and other ESG factors when selecting investments or exercising shareholder rights, as they might otherwise be inclined to do under the current regulation.” (see Section 1.8 Conclusion)
New factors for consideration in investment strategies listed in the Biden rule include:
- “Climate change-related factors, such as a corporation’s exposure to the real and potential economic effects of climate change including exposure to the physical and transitional risks of climate change and the positive or negative effect of Government regulations and policies to mitigate climate change;”
- “Governance factors, such as those involving 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; and”
- “Workforce practices, including the corporation’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.”
What is the DOL role in retirement investments?
One responsibility of the United States DOL is to enforce the Employee Retirement Income Security Act of 1974, which sets forth standards for establishing, participating in, and managing private sector retirement investment accounts.
Numerous regulatory and statutory changes have occurred over the decades with policy debates increasingly growing contentious around what factors can be considered when making investment choices on behalf of plan holders. Controversy over ESG-focused investing, which involves many politically charged policies, is one of the biggest issues at this time.
What is ESG?
ESG, short for “environmental, social, and governance” policies, is a broad array of shifting issues pushed by supporters inside and outside of government as criteria that businesses and investors should drive investments towards, some of which are outlined in the Biden DOL rule above. ESG investments may prioritize climate policies that reduce energy usage, workplace policies focused on social movements, and governance policies that scrutinize executive pay and compensation approaches towards employees.
In essence, the purpose behind pushing ESG by many leaders is to “globally coordinat[e] the consideration of non-financial factors across corporations, asset managers, and regulators, in pursuit of politically determined goals” that are also being pursued through other government and societal paths as well.
Brief DOL ERISA Rule Timeline:
- 1974 – Employee Retirement Income Security Act (ERISA) enacted, which sets standards for private retirement and health plans surrounding participation, investment, management, access, and more. ERISA also includes fiduciary responsibilities for asset/investment managers on what the primary focus around investments should be including loyalty to account owners and prudence.
- November 2020 – Trump DOL publishes Financial Factors in Selecting Plan Investments rule on November 13, which becomes effective on January 12, 2021. The rule required “plan fiduciaries to select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.” The Biden DOL has not enforced this rule, however.
- January 2021 – Biden signs Executive Order (E.O.) 13990 (“Protecting Public Health and the Environment and Restoring Science To Tackle the Climate Crisis”). This E.O. directed agencies to review changes to climate and environmental policies via regulations promulgated, issued, or adopted by the Trump administration.
- May 2021 – Biden signs E.O. 14030 on “Climate-Related Financial Risk.” This E.O. specifically called on the DOL to remove Trump DOL rules related to ERISA and shareholders, asking DOL to prioritize adding environmental factors into investment and shareholder regulations.
- October 2021 – Biden DOL proposes Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, which would add ESG and related factors into retirement investment decision-making by fiduciaries.
- February 2022 – DOL also published a Request for Information on Possible Agency Actions to Protect Life Savings and Pensions from Threats of Climate-Related Financial Risk, an effort by the Biden administration to further open the door for politically motivated environmental investments.
- DOL Proposes Rule to Support ESG Funds in Retirement Plans. https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/dol-proposes-rule-to-remove-barriers-to-esg-funds-in-retirement-plans.aspx
- Introduction to Financial Services: Environmental, Social, and Governance (ESG) Issues. https://crsreports.congress.gov/product/pdf/IF/IF11716
- Foxx, Allen Oppose Biden Administration’s Attack on Retirement Savings. https://republicans-edlabor.house.gov/news/documentsingle.aspx?DocumentID=407966
- New Study Finds ESG Funds Underperform Broader Investment Funds Over Long-Term. https://www.pacificresearch.org/new-study-finds-esg-funds-underperform-broader-investment-funds-over-long-term/
- De-ESG or Keep Paying the ESG Tax. https://www.nationalreview.com/2022/09/de-esg-or-keep-paying-the-esg-tax/
- The Threat from Biden’s ‘Whole of Government’ Regulatory Approach. https://www.nationalreview.com/2022/10/the-threat-from-bidens-whole-of-government-regulatory-approach/
- Employee Retirement Income Security Act (ERISA). https://www.dol.gov/agencies/ebsa/laws-and-regulations/laws/erisa
- Summary of the Employee Retirement Income Security Act (ERISA). https://crsreports.congress.gov/product/pdf/RL/RL34443/6
- ERISA Fiduciaries Must Invest Money they Control Only for Pecuniary Benefits of Plan Participants and Beneficiaries. https://www.regulations.gov/comment/EBSA-2020-0004-0484
- Opinion: Here’s an easier way to think about ESG investing. https://www.marketwatch.com/story/heres-an-easier-way-to-think-about-esg-investing-2020-11-02?mod=alicia-h-munnell
- Murphy Introduces ESG Legislation to Protect American Retirement Savings. https://gregmurphy.house.gov/media/press-releases/murphy-introduces-esg-legislation-protect-american-retirement-savings
- The dual action of Capital Markets transforms the Net Zero cost curve. https://www.goldmansachs.com/insights/pages/gs-research/dual-action-of-capital-markets-transforms-net-zero-cost-curve/the-dual-action-of-capital-markets-transforms-the-net-zero-cost-curve.pdf