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.
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).
Incorporating environmental, social, and governance (ESG) criteria and investing primarily in instruments that have certain ESG characteristics, as determined by the manager, carry the risk that the fund may perform differently, including underperforming, funds that do not use an ESG investment strategy.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.
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MGTS-PS 401605-GE 12/22 401605 MGR1219222645287