The Department of Labor (DOL) issued a final rule titled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.” The title does not mention Environmental, Social, and Governance (ESG) factors in making investment decisions, but the rule does address this issue. While using ESG factors for investment decisions remains an area of political ping pong, this final rule clarifies the fiduciaries of retirement plans… for now.
This final rule replaces a rule that was enacted in November 2020 by the previous administration. That rule required all investment decisions to be made based on ‘pecuniary’ factors and would have limited the ability to use ESG investments in retirement plans. In 2021 the DOL issued a notice that it would not enforce that 2020 rule until it had completed a review. According to the DOL, the 2020 rule ‘resulted in the undesirable effect of discouraging ERISA fiduciaries from using [ESG] considerations, even in cases where this consideration served the plan’s financial interest.’
The new rule removes several provisions of the old rule and will make it easier for retirement plans to use ESG factors and ESG-focused products. There are four components of this new rule:
1. A fiduciary must continue to base decisions on risk and return analysis. However, the rule states that ‘such factors may include the economic effects of climate change and other ESG considerations on the particular investment or investment course of action.’
2. When selecting a qualified default investment alternative (QDIA), the same considerations apply as used for other investments in the plan, thereby allowing ESG consideration in QDIA selection. This was not allowed in the 2020 rule.
3. Clarification of the tiebreaker standard which will allow fiduciaries to consider collateral benefits beyond investment performance when comparing similar funds.
4. Introduction of a new provision allowing fiduciaries to consider plan participants’ ‘non-financial preferences’ when selecting investment options for a plan.
The new rule removes the ‘pecuniary’ requirement and clarifies how ESG considerations can be used. The biggest change is the provision allowing a fiduciary to consider plan participants non-financial preferences in constructing the investment menu. Offering investment options that participants are requesting may result in greater plan participation which could lead to more successful retirement outcomes. The order is clear that taking participant input into consideration is not a violation of the duty of loyalty.
This final rule makes it easier for fiduciaries to consider ESG factors and include ESG focused investments in their plans. Given the political interest in ESG investing, the rule could change again based on the results of the 2024 election. While plan sponsors may use ESG factors, they should continue to be certain that ESG investments are selected and monitored using the same criteria as non-ESG investments.
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