A lot has happened in 2021 already. The election of Joe Biden as President was certified by the Senate after an unprecedented attack on the Capitol on January 6. The House of Representatives impeached former President Donald Trump one week later. Biden was inaugurated on January 20 at a heavily secured ceremony.
The inauguration was the final step in the most contentious election in American history. One where before votes were cast, the incumbent President signaled that if he didn’t win, the election was fraudulent. A sentiment that he continued after his loss, through dozens of lawsuits challenging results and was only silenced by the certification and social media companies suspending his accounts.
Through all this it might have been easy to miss that before the election, the Department of Labor had finalized a regulation relating to ERISA plan fiduciary’s consideration of environmental, social, and governance (ESG) factors when making investment decisions for ERISA plans. The final regulation significantly changed the DOL’s proposed rule that was issued in June of 2020. The final regulation became effective January 12, 2021. However, it appears that the Biden administration will attempt to reverse the regulation because it is not very climate friendly, but that effort will take considerable time.
The ESG Issue. The issue is to what extent plan fiduciaries can consider how a mutual fund or company that the plan might invest in addresses ESG factors in deciding whether to invest or offering the investment for participants to invest. Fiduciaries owe a duty of loyalty and a duty of prudence to plan participants. In a nutshell the duty of loyalty requires fiduciaries to act solely in the interest of plan participants and beneficiaries for the exclusive purpose of providing benefits and defraying expenses of administering a plan. The duty of prudence requires the fiduciary to act in the same manner that a reasonable expert would. That is, with the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use.
Thus, a plan fiduciary should not invest in electric cars because he/she thinks its good for the environment if doing so is putting his/her concern for the environment above the interests of plan participants. Likewise, if a reasonable expert fiduciary would not make the investment, doing so would not be prudent.
The Proposed Regulation. The proposed regulation was fairly hostile toward ESG investments. It generally provided that a fiduciary should only consider economic or pecuniary factors and cannot consider ESG factors in an investment decision except in the case when all pecuniary factors between alternative investments were equal. A fiduciary cannot subordinate the interests of participants by forgoing return or accepting higher risk due to a noneconomic factor such as ESG factors. Further, if ESG factors are considered to break a tie, the fiduciary was required to document why it found the pecuniary factors equal and why it chose the investment. Additionally, the proposed regulations provided that an ESG investment could not be a qualified default investment alternative (QDIA) where a participant’s account would be invested if they don’t make an affirmative election.
The Final Regulation. The final regulation departs from the proposed regulation and softens the rule a bit. This was likely due to the fact that the DOL received thousands of negative comments on the proposed regulation. The final regulation eliminates using the term “ESG” because the DOL found that it lacks a precise definition. Instead, the final rule emphasizes pecuniary factors over non-pecuniary factors. A pecuniary factor is defined as a factor that a fiduciary prudently determines will have a material effect on the risk or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and policies. The DOL acknowledged that ESG factors could be compatible with a purely financial analysis of an investment option or strategy.
The final rule eases the tie breaker scenario by changing the language to allow non-pecuniary factors to be considered when a fiduciary is unable to distinguish between investment options based on pecuniary factors alone. The decision must still be documented. However, when choosing an investment option for an individual account plan the decision to include an investment option that contains ESG factors in its investment goals need not be documented if the decision is made on only pecuniary factors. An investment whose objectives, goals, or strategies use non-pecuniary factors still cannot be made the plan’s QDIA investment. Plans have until April 30, 2021 to remove any such investments considered QDIAs.
Biden Administration. Within hours of taking office the new President signed an Executive Order on “Protecting Public Health and the Environment and Restoring Science to Tackle the Climate Crisis” ordering an immediate review of all federal regulations issued in the last four years, and, as appropriate and consistent with applicable law, take action to address regulations and other actions that conflict with the important national objectives of listening to the science to improve public health, protect the environment, and bolster resilience to the impacts of climate change.
The ESG final regulation is among the regulations to be reviewed. It is clear that the Biden administration is in favor of policies that protect the environment. Therefore, there is likely to be yet another change in these rules. Proponents would like to see guidance issued clarifying what ESG criteria are pecuniary or to rewrite the regulation completely. While the former might be able to be accomplished relatively soon, revising the final regulation could take over a year to accomplish.
Better guidance is clearly needed in this area.