Labor Department Final Rule Allows Fiduciaries to Consider ESG Factors

On November 22nd, 2022, the U.S. Department of Labor (DOL) announced a final rule that allows 401(k) plan fiduciaries to consider climate change and other environmental, social, and governance factors (or ESG factors) when they select retirement investments or exercise shareholder rights like proxy voting. Briefly, the DOL reviewed feedback from various stakeholders before making its decision. The DOL concluded that 2020 regulations issued under the prior administration made it unnecessarily difficult for plan fiduciaries to consider ESG factors when choosing plans, even when those factors would be financially beneficial to participants. The DOL announced the proposed rule to consider ESG factors in plan management more than a year ago, in October 2021.

Plan Fiduciary Duties Under ERISA

The DOL has periodically considered adjusting the application of specific fiduciary duties. Specifically, these duties include “prudence” and “loyalty” under the Employee Retirement Income Security Act of 1974 (ERISA). Specifically, ERISA requires plan fiduciaries to act in the financial interests of plan participants. To that end, plan fiduciaries must take professional care when choosing investment options for inclusion in 401(k) plan menus. Meanwhile, under ERISA, employers must keep employee records containing benefit information for at least six years after the filing date. Presently, the DOL wants to clarify that ESG factors are allowable. The DOL has constantly recognized that ERISA does not prohibit fiduciaries from making investment decisions that consider ESG factors. However, the agency also feels that guidance identifying such statements could be confusing. The final rule affects several tenets of fiduciary plan management, including:

• selecting qualified default investment alternatives,
• exercising shareholder rights, i.e., proxy voting, and
• using written proxy voting policies and guidelines.

Final Rule on Considering ESG Factors

The final rule on considering ESG factors, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” follows Executive Order 14030, signed by President Biden on May 20th, 2021. Briefly, the Executive Order directed the federal government to implement policies safeguarding the financial security of Americans from climate-related risk. Overall, the final rule on ESG factors affirms that the duties of prudence and loyalty require fiduciaries to consider relevant risk-return factors in the interests of participants and beneficiaries. Additionally, the final rule affirms the fiduciary duty to manage shareholder rights, like the right to vote proxies, related to plan assets in stock. Finally, the final rule removes previous special rules for qualified default investment alternatives (QDIAs). QDIAs are mutual funds that fiduciaries may select as a default investment in defined contribution employer-sponsored 401(k) plans. Under the final rule, fiduciaries may use EDG funds as QDIAs.