ESG and Shareholder Rights Rule Under White House Review

The U.S Department of Labor (DOL) has submitted a new proposed regulation to the White House’s Office of Management and Budget (OMB), titled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.”

The submission represents a key step forward for the Biden administration’s stated plans of modifying the regulatory framework that controls retirement plan fiduciaries’ actions when considering and using environmental, social and governance (ESG)-themed investments. The title of the regulation also suggests it will address the related but distinct issue of proxy voting advice and shareholder activism among retirement plan fiduciaries.

OMB typically reviews proposed regulations within 60 days from the date of their submission or publication of the 30-day Federal Register notice—whichever is later—but, in some circumstances, the process can take longer.

Sources expect the forthcoming regulations to take a substantially different track compared with the work of the Trump administration, which finalized new restrictions on the use of ESG funds and proxy voting advisers by retirement plan fiduciaries late in 2020.

With respect to ESG investments, although the final 2020 rule did not expressly limit the use of ESG funds, given its framing of the “pecuniary” concept, experts argued it would still likely have that effect if or when it was enforced. This is because fiduciaries would seemingly have to comb through an ESG fund’s prospectus and marketing materials for any references to non-pecuniary factors being used in the investment process. Such requirements present potentially significant legal risk to fiduciaries and, therefore, may deter some from considering ESG funds.

Similar concerns have been voiced by stakeholders in the financial services and retirement planning industry with respect to the proxy voting regulation implemented late last year. In basic terms, the final rule confirmed that proxy voting decisions and other exercises of shareholder rights must be made “solely in the interest of providing plan benefits to participants and beneficiaries considering the impact of any costs involved.” As the DOL stated under former President Donald Trump, the proxy voting rule seeks to ensure that plan fiduciaries do not subordinate the interests of participants and beneficiaries in their retirement income or financial benefits under the plan to any non-pecuniary objective or promote non-pecuniary benefits or goals.

When the DOL first issued its final rule on benefit plan proxy voting, some retirement industry stakeholders voiced concern that it risked seriously chilling proxy voting activities and other forms of shareholder engagement executed by investment managers and other parties on behalf of retirement plan investors. Similar fears were raised on the ESG front, leading the Biden administration to adopt a nonenforcement policy as it reviews both regulations.

Given President Joe Biden’s words and actions regarding the importance of fighting climate change and promoting corporate social responsibility, experts say it is almost certain that the current DOL will move to ease those concerns about proxy voting and ESG activities.

That said, some insiders think the Biden administration’s proposal itself may not have to be radically different from the pecuniary-focused framework already in place, in part because the final version of the ESG rule included important changes relative to the proposal. Chief among these changes is the fact that the text of the final rule no longer refers explicitly to “ESG” as an investment theme that deserves additional scrutiny. Rather, as noted, it presents a framework that emphasizes that retirement plan fiduciaries should only use pecuniary factors when assessing investments of any type—which is to say that they should only use factors that have a material, demonstrable impact on performance.

Editor’s note: PLANADVISER Magazine is owned by Institutional Shareholder Services (ISS). ISS has engaged in litigation related to the Trump administration’s proxy voting regulations.