What the DOL's final ESG rule means for plan sponsors

Background on the DOL's ESG guidance

Over the years, the DOL has issued a series of guidance addressing the extent to which plan fiduciaries may consider ESG factors. While the DOL has been back and forth on the degree to which they can be considered, it has consistently affirmed that the duties of prudence and loyalty require ERISA fiduciaries to focus on relevant risk/return factors and not subordinate the interests of participants and beneficiaries to objectives unrelated to the provision of benefits under the plan.

November’s final rule consolidates and amends the two final rules issued in 2020 during the prior administration. It follows an executive order signed by President Biden in May 2021 directing federal agencies to assess and mitigate financial risks related to climate change. Specifically, Section 4 of the order directed the DOL to consider publishing for notice and comment a proposed rule to suspend, revise, or rescind the 2020 rules. Shortly thereafter, the DOL issued a new proposed rule replacing the previous ones. The 2022 final rule is mostly consistent with the DOL's 2021 proposal.

With this final rule, the DOL concluded that the 2020 final rule—“Financial Factors in Selecting Plan Investments”—unnecessarily restrained ERISA fiduciaries’ ability to weigh ESG factors when choosing investments, even when those factors would benefit participants financially. The 2020 final rule required that plan fiduciaries make investment decisions based solely on “pecuniary” factors. The new rule allows—but doesn’t require—ERISA fiduciaries to consider climate change and ESG factors when selecting their plan investments.

The DOL also determined that the 2020 final rule—“Fiduciary Duties Regarding Proxy Voting and Shareholder Rights”—was somewhat misleading and may result in plan fiduciaries being indifferent to voting every proxy.

Highlights of DOL's 2022 final ESG rule

Among the key changes from the two 2020 final rules are:

• The removal of the previous rule’s standard of “pecuniary factors only” and a reaffirmation of ERISA's duty of loyalty in the context of investment decisions.
• A broader description of which factors a fiduciary may deem as relevant to a risk/return analysis, such as climate change and other ESG factors.
  
• The retention and simplification of the tiebreaker test, replacing previous provisions with ERISA's duty of prudence and eliminating the special documentation requirement.
  
• A general clarification that fiduciaries of participant-directed plans don’t violate the duty of loyalty because the fiduciary considers participant preferences.
  
• The removal of restrictions that disallowed a fund to serve as a qualified default investment alternative (QDIA) if it included or considered the use of any non-pecuniary factors in its investment objective.
  
• The removal of two proxy voting safe harbors that allowed sponsors to refrain from voting if they deemed the item to be immaterial or their plan’s position to be below a quantitative threshold.
  

Final thoughts on 12/1/2022

The final rule is designed to allow ERISA fiduciaries to consider the effects of a broader range of factors, including climate change and ESG factors, on plan investments. However, it still requires that ERISA fiduciaries focus on relevant risk/return factors and to refrain from subordinating the interests of participants and beneficiaries to non-pecuniary objectives—i.e., you can’t sacrifice investment returns or assume a high level of risk for such objectives.

As a result of the final rule, plan participation could potentially increase as plan investments more closely align with some participants’ interests and investment goals.

The new guidance is effective January 30, 2023, except for certain sections pertaining to exercises of proxy voting and other shareholder rights, which will take effect on December 1, 2023 (one year after publication in the Federal Register).  

4/10/2023 Update on the DOL ESG rule

Challenges from Congress, individual states, and the courts

The DOL ESG Rule has been and continues to be a topic of debate. On February 28 and March 1, 2023, the U.S. House of Representatives and the Senate passed a joint resolution—H. J. Res. 30—to overturn the Rule. The joint resolution was passed through the Congressional Review Act, which allows Congress to repeal a final rule by a federal agency within 60 legislative days of its effective date.  The final rule mostly went into effect on January 30, although some proxy voting policies are not effective until December 1.

As expected, on March 20, President Biden vetoed the measure, saying in a White House Statement,

 “The Department of Labor’s final rule protects the hard‑earned life savings and pensions of tens of millions of workers and retirees across the country. It allows retirement plan fiduciaries to make fully informed investment decisions by considering all relevant factors that might impact a prospective investment, while ensuring that investment decisions made by retirement plan fiduciaries maximize financial returns for retirees.

There is extensive evidence showing that environmental, social, and governance factors can have a material impact on markets, industries, and businesses…Retirement plan fiduciaries should be able to consider any factor that maximizes financial returns for retirees across the country.”

The DOL ESG Rule has also been challenged on the state level and has been subject to litigation.  More than 20 states have recently proposed their own versions of ESG investing regulations, with many seeking to further limit the consideration of ESG factors.  There have been two separate lawsuits filed seeking to block the DOL from enforcing the final rule.

Lisa Gomez, assistant secretary of labor for the Employee Benefits Security Administration (EBSA), has defended the final rule, calling it “a return to neutrality.”¹ She also commented that the DOL’s priorities this year include implementing the ESG rule. 

1 "DOL ESG rule resolution passes House; Biden vows veto," Pensions & Investments (pionline.com), 2/28/23.