DOL Proposed Rule Addresses Retirement Plan ESG Investments and Proxy Voting

On October 13, 2021, the DOL released a proposed rule entitled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.” The proposed rule clarifies that retirement plan fiduciaries may consider environmental, social and governance (ESG) factors when making investment decisions and exercising shareholder voting rights. If finalized, the proposed rule will amend the current “Investment Duties” regulation under ERISA.

Historically, DOL guidance indicated that ERISA duties of loyalty and prudence do not prevent plan fiduciaries from making investment decisions that reflect ESG considerations, provided certain conditions are satisfied. Additionally, the DOL views ERISA fiduciary duties as encompassing the management of shareholder voting rights related to stock shares held by the plan. However, according to the DOL fact sheet accompanying the proposed rule, stakeholders expressed concerns that the existing 2020 rule created uncertainty regarding the integration of ESG factors into plan investment decisions.

Therefore, the proposed rule addresses stakeholder concerns by recommending several important changes to the investment selection process. First, the guidance recognizes that an evaluation of the economic effects of ESG factors on a particular investment may be required if material to the risk-return analysis. The proposed rule retains the basic principle that ERISA duties of prudence and loyalty require fiduciaries to focus primarily on material risk and return factors and no other objectives when making plan investment decisions. The proposed rule provides examples of ESG factors that may be material to the risk-return analysis, such as climate-change related factors (e.g., a corporation’s exposure to physical risks of climate change), governance factors (e.g., board composition) and workforce practices (e.g., equal employment opportunities).

Second, the rule proposes a change to the “tie-breaker” standard, which allows plan fiduciaries to consider collateral benefits (such as ESG considerations) when making investment selections under certain circumstances. Under the existing rule, competing investments must be “indistinguishable” before fiduciaries can consider collateral factors as tie-breakers. The proposed rule is more flexible, allowing fiduciaries to consider collateral benefits when there are two competing investment options that are equally appropriate additions to the plan (even if not indistinguishable). Additionally, the proposed rule removes special documentation requirements for applying the tie-breaker standard. However, if the tie-breaker is used in the selection of a designated investment alternative (such as a 401(k)-plan investment option), the plan must prominently display the collateral considerations to plan participants in fund disclosures.

Third, the proposed rule changes the existing rule by allowing for a fund to be chosen as a Qualified Default Investment Alternative (QDIA) despite its consideration of collateral ESG factors (provided the fund otherwise satisfies the QDIA regulation requirements). Accordingly, the proposed rule applies the same investment standards to QDIAs as to other plan investments.

The proposed rule also makes several notable changes regarding the current rule’s provisions with respect to shareholder rights and proxy voting. First, the proposed rule removes language stating that the fiduciary duty to manage shareholder stock rights does not require the voting of every proxy or the exercise of every shareholder right. The DOL view is that proxies should be voted unless the plan fiduciary decides the voting would not be in the plan’s interest (e.g., due to excessive costs).

Second, the proposed rule eliminates a provision in the current rule that sets out specific requirements when the authority to vote proxies or exercise shareholder rights has been delegated to an investment manager or involves proxy advisory services. The DOL believes that general ERISA prudence and loyalty duties already impose a monitoring requirement.

Third, the rule removes two existing safe harbors for proxy voting policies, due to concerns these do not adequately safeguard the interest of plans and participants. One safe harbor permits a policy to limit voting resources to particular types of proposals that the fiduciary has prudently determined are substantially related to the issuer’s business activities or are expected to have a material effect on the value of the investment. The other safe harbor permits a policy of refraining from voting on proposals or particular types of proposals when the plan’s holding in a single issuer relative to the plan’s total investment assets is below a quantitative threshold.

Fourth, the proposed rule eliminates the specific requirement that plan fiduciaries must maintain records on proxy voting activities and other exercises of shareholder rights. Again, the DOL view is that the general ERISA duties of prudence and loyalty should govern.

Employers that sponsor retirement plans should be aware of the proposed changes to the existing Investment Duties regulations. Comments can be submitted on or before December 13, 2021, in accordance with the directions specified in the proposed rule.

Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights »
Notice of Proposed Rulemaking on Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights »