ESG Investing – Was Sort of Allowed, Was Disallowed, Now Allowed Again?
Date: December 13, 2021
Many employers, listening to the requests of employees, added or considered adding investment options in a retirement plan that consider “environmental, social, and governance” aspects of a particular company in the fund’s portfolio. The Department of Labor’s prior advice was that ESG factors could be used as a “tie-breaker” among investment alternatives that were otherwise comparable in terms of the financial factors used to determine suitability of the option.
The Department of Labor issued a final rule in October 2020 discouraging the use of funds that include ESG considerations providing that plan fiduciaries may only use nonfinancial objectives when evaluating investment options in limited circumstances. If an ESG option was selected, the fiduciaries would have to document:
- why financial factors were not sufficient to select or monitor the investment
- how the selected investment compares to the alternative investments with regard to certain specified investment consideration factors; and
- how the chosen non-financial factor or factors are consistent with the interests of participants and beneficiaries under the plan
The final rule essentially precluded any fund with ESG attributes to be a component of a qualified default investment alternative. This final rule left plan sponsors in a quandary on whether they needed to eliminate previously-selected ESG investments from their fund lineups.
In October 2021, the Department of Labor issued a proposed rule eliminating, in large part, the prior administration’s rules regarding ESG investments. In the preamble to the final rule, the Department noted that it “. . . does not view collateral benefits [of ESG investments] as being presumptively illegal, provided that the investment at issue is otherwise selected in accordance with ERISA's duties of prudence and loyalty.” Rather, a prudent fiduciary may consider any factor in the evaluation of an investment or investment course of action that, depending on the facts and circumstances, is material to the risk-return analysis, that might include, for example:
- Climate change-related factors, such as a corporation's exposure to the real and potential economic effects of climate change;
- Governance factors, such as those involving board composition, executive compensation, and transparency and accountability in corporate decision-making; and
- Workforce practices, including the corporation's progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion, and retention; its investment in training to develop its workforce's skill; equal employment opportunity; and labor relations.
The proposed rule does not preclude the use of ESG investments in a qualified default investment alternative.
Notwithstanding the apparent blessing of ESG investments, generally, a fiduciary may not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives, and may not sacrifice investment return or take on additional investment risk to promote benefits or goals unrelated to interests of the participants and beneficiaries in their retirement income or financial benefits under the plan.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.