DOL Rule Greenlights ESG, But Questions Remain

The Department of Labor announced the final rule on ESG investment in ERISA-governed plans Tuesday, solidifying long-awaited permission to use environmental, social and governance analysis in retirement investing, but not making it mandatory. Even as the decision came down, however, there are still details to be worked out for real-world implementation, according to multiple ERISA attorneys.

As legal authority for the rule, the DOL cites Executive Orders 14030, which directed the federal government to protect pensions from climate risk, and Executive Order 13990, which instructed federal agencies to evaluate Trump-era regulations that could be obstacles to improving the environment.

The new rule is a reversal of a rule published in the closing days of President Donald Trump’s term that intended to prevent consideration of ESG factors in investment choices for ERISA plans. In March 2021, the DOL under President Joe Biden announced it would review that rule and not enforce it in the meantime. The new rule clarifies that ESG factors may be considered in investment choices, among other changes.

One such change was that the Trump-era rule did not allow qualified default investment alternatives (QDIA) to take ESG into account, whereas the new rule permits it, according to Alex Ryan, a partner at the law firm Willkie Farr & Gallagher.

Plans may also consider “collateral benefits” as a tiebreaker if both investments in question would equally serve the interests of the plan, whereas the Trump-era rule required the investments to be economically indistinguishable, which is a higher standard.

This new standard allows non-financial concerns to be used as a “tiebreaker,” though Elizabeth Goldberg, a partner at the law firm Morgan Lewis, says those sorts of situations are relatively rare.

The new rule also allows plan sponsors to include investment menu options that take participants non-financial interests and preferences into account, as long as those menu options are still prudent. This provision is intended to increase plan participation by allowing sponsors to provide investment incentive beyond economic returns.

It is not clear, however, how participant preferences are to be measured in order to support a prudent investment option that might not have been included absent those expressed preferences.

Bradford Campbell, a partner at the law firm Faegre Drinker, says it is unclear if a sponsor should wait for explicit requests, or if it should send out surveys to gauge participant interest in certain funds.

Goldberg says these options still cannot sacrifice returns or take on additional risks, but it will take more time for it to become clear what sponsors can consider adequate participant demand or interest.

David Levine, co-chair of the Groom Law Group’s plan sponsor practice, agrees that it will take some time for the precise meaning of the rule to be understood. When asked if participant demand for certain investments could be a defense against possible ERISA-related litigation, his response was that all involved will “have to see how this plays out.”

Ryan says the DOL has not spelled out a process for sponsors to solicit or receive participant preferences for this purpose, and it ultimately may vary from employer to employer. This menu provision might provide some cover for sponsors who like to consider employee preference in investment options.

Several industry actors came out quickly in support of the new rule.

Charlie Nelson, the chief growth officer at Voya Financial said the menu provision could help firms attract competitive talent since many younger workers are seeking ESG-informed retirement options. Ceres, a sustainability non-profit, said that the new rule makes it easier to invest in ESG, which is a positive because climate risk impacts financial performance.

The Insured Retirement Institute said it had been concerned about the initial rule proposal but is glad to see that the group’s recommendation of permitting ESG strategies rather than requiring them was ultimately accepted.

Campbell of Faegre Drinker explains that the perceived neutrality of the final rule, as opposed to the proposal, makes it less likely to be revoked or significantly modified by a future Republican administration.

He noted however, that this depends in part on who the next Republican president might be. Having already tried to remove ESG considerations from ERISA plans, Trump could do so again if he were elected in 2024, Campbell says. Since this new regulation is a formal rule, instead of interpretative guidance, it would be more difficult to reverse, as any anti-ESG administration would have to go through the normal notice and comment process to approve a new rule.

Goldberg concurs and adds that the rule adds some useful clarity for her foreign clients whose domestic laws require fiduciaries to account for ESG. Notable members of the Republican Party do not agree that this new rule is “neutral,” however. Rep. Virginia Foxx, R-North Carolina and the ranking member of the House Committee on Education and Labor, released a statement Tuesday in which she said the Biden administration was prioritizing political considerations over retirement security.

“The Biden administration’s new rule jeopardizes the financial security of many retirement savers, especially workers and retirees who may be put into ESG investments by default,” she said in the statement. “The new rule overturns the strong protections implemented by the Trump administration, which guarded retirement savers from investment managers seeking to advance social and political objectives unrelated to the financial benefits to workers and retirees. The Biden administration is choosing its climate and social agenda over retirees and workers. This is bad news.”

On the Democratic side of the aisle, Sen. Patty Murray, D-Washington and the chair of the Senate HELP Committee, said in an emailed statement that, “Financial security is about planning for the future, and you just can’t plan for the future if you aren’t allowed to consider the environmental, social, and governance factors that are shaping it.”