Department of Labor Provides Guidance on Environmental, Social and Governance (ESG) Investing

While employers and workers alike have understandably been extremely focused on coronavirus–related matters, the U.S. Department of Labor (DOL) recently (June 23, 2020) decided that employee benefit plan fiduciaries need to be reminded of their investment objectives under the Employee Retirement Income Security Act of 1974, as amended (ERISA).

Since the enactment of ERISA, plan fiduciaries (i.e., including those charged with investing plan assets) have been subject to “exclusive purpose and prudence” duties found here.  In a 1979 regulation, the DOL, based on its interpretive and enforcement authority under Title I of ERISA, provided additional investment-related duties’ guidance to plan fiduciaries. The 1979 DOL regulation focuses on numerous factors relating to plan investments that plan investment fiduciaries are supposed to consider, including the portfolio’s diversification, liquidity and current return relative to anticipated cash flow requirements (i.e., clearly more of a defined-benefit plan focus since the ability to adopt a 401(k) plan was not available until 1978), and the portfolio’s projected return relative to the plan’s funding objectives.

Overall, though, the DOL’s position since the inception of ERISA, as administered through its Employee Benefits Security Administration (EBSA) division, formerly known until February 2003 as the Pension and Welfare Benefits Administration, is that employee pension benefit plans, including 401(k), defined benefit and stock bonus plans, are intended to provide financial benefits for employee benefit plan participants.  In addition, the DOL has stated that the “goal of Title 1 of ERISA is to protect the interests of participants and their beneficiaries in employee benefit plans.”

So, how does the DOL’s historic position regarding protecting the financial interests of participants and their beneficiaries in employee benefit plans align with a plan fiduciary who may have decided to adopt the longstanding proverb (especially in these difficult times of dealing with COVID-19) that money is not everything?  May a plan fiduciary responsible for employee benefit plan investments decide to take the old proverb to heart and focus a bit on nonfinancial objectives for what may be intended to be the good of society at large?

Bottom line, the DOL in its proposed rule intends to “update” and “clarify” its longstanding investment duties’ regulation.  According to the DOL announcement, “the proposed rule is intended to provide clear regulatory guideposts for plan fiduciaries in light of recent trends involving ESG investing.”

There are five core additions to the DOL’s existing 1979 regulation that are being proposed as follows, per the DOL’s announcement:

1. Expand the DOL’s longstanding position that ERISA requires plan fiduciaries to select investments and investment courses of action based on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.
2. An express regulatory provision stating that compliance with the exclusive purpose (i.e., loyalty) duty under ERISA prohibits fiduciaries from subordinating the interests of plan participants and beneficiaries in retirement income and financial benefits under the plan to nonpecuniary goals.
3. A new regulatory provision that requires fiduciaries to consider other available investments to meet their prudence and loyalty duties under ERISA.
4. A regulatory acknowledgment that ESG factors can be pecuniary factors, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories (i.e., the proposed regulation includes new regulatory text on required investment analysis and documentation requirements in the rare circumstances when fiduciaries are choosing among truly economically “indistinguishable” investments).
5. A new DOL regulatory provision on selecting designated investment alternatives for 401(k)-type plans, whereby the DOL reiterates its view that the prudence and loyalty standards set forth in ERISA apply to a fiduciary’s selection of an investment alternative to be offered to plan participants and beneficiaries in an individual account plan (commonly referred to as a 401(k)-type plan). In summary, the proposal describes the requirements for selecting investment alternatives for such plans that purport to pursue one or more environmental, social, and corporate governance-oriented objectives in their investment mandates or that include such parameters in the fund name.

The DOL ESG proposal should be welcome guidance to plan fiduciaries who are striving to meet their fiduciary obligations under ERISA and who, at the same time, are seeking to offer investment alternatives with an ESG focus. 

From the DOL’s perspective, the fiduciary’s mission under ERISA remains the same; provide investment alternatives to plan participants that are prudent, provide diversity and should result in a proper and necessary investment return to the affected plan participants.