The Department of Labor reversed a rule by the previous DOL that deterred pension fund fiduciaries from considering ESG factors in directing their funds’ investments. The new rule eliminates the requirement that investments be directed solely on the basis of “pecuniary” factors, but does not require consideration of ESG factors.
Background: Beginning with the rise in “social investing” by union plans in the 1990s, there has been a long-standing debate over whether ERISA’s fiduciary duties prevent plan administrators from considering factors not directly related to companies’ financial performance when determining retirement plan investments. The union plans’ strategy directed investments into companies based on track records regarding employee and community relations. The debate has been revived with the adoption by large companies of ESG practices and policies promoted and applauded by asset managers, such as BlackRock. ESG efforts now go well beyond the issues labor was pressing for and include climate change, DE&I and other factors. ESG proponents argue that influences like climate change and diversity impact the long-term economic health and prosperity of the company and that such factors are likewise relevant to investment decisions.
Trump DOL requirement regarding “pecuniary” factors: Even before the Trump DOL rule, there was confusion regarding the contours of the fiduciary rule, though the absence of litigation has resulted in little if any guidance from the courts. The preamble to the new rule acknowledges this, noting the “differences in the tone and tenor of guidance across Administrations during these approximately 40 years.” The Trump DOL rule sought to resolve this by limiting plan fiduciaries to considering only “pecuniary factors.” At the time, the rule received very little public attention since the political debate over ESG had not yet heated up.
New rule emphasizes potential relevance of ESG to “risk/return” analysis: Early in his administration, President Biden signed E.O. 14030, “Climate-Related Financial Risk” (May 20, 2021), which, among other things, directed DOL to consider publishing a proposed rule to modify or rescind the 2020 rule. The final rule eliminates the “pecuniary factors” requirement, noting that it “puts a thumb on the scale against ESG factors, and chills fiduciaries from considering any ESG factors even when they are relevant to a risk-return analysis.” Meanwhile, the final rule abandons controversial language that had appeared in the proposed rule that opponents contended would have required consideration of ESG factors. It also retains the “core principle” that fiduciaries may not subordinate the interests of beneficiaries “to objectives unrelated to the provision of benefits under the plan.” This part of the rule is scheduled to take effect January 30, 2023.
Duty to engage in proxy voting: The rule also clarifies the fiduciary duty includes the management of shareholder rights related to those shares, such as the right to vote proxies. The rule reverses a separate 2020 rule and reiterates the 2016 interpretation that fiduciaries are expected to cast proxy votes, with limited exceptions. The rule also eliminates the requirement that companies monitor proxy advisory firms and other third parties authorized to cast proxy votes. This part of the new rule takes effect December 1, 2023.
Political controversy to continue: The new DOL rule is being issued at a time when the ESG debate is far more politically charged than when the “pecuniary factors” rule was issued. On the eve of taking over the House, Education and Labor Committee Republicans have criticized the new rule as denying retirees protection against “investment managers seeking to advance social and political objectives unrelated to the financial benefits to workers and retirees.” The new rule will likely be one of the policy focal points of a congressional broadside against ESG generally. If nothing else, it will bring to the forefront the issue of whether factors such as climate change and DE&I have a material impact on the financial well-being of companies. Many if not most larger companies strongly believe that they do.
