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New Emphasis in ESG and Proxy Voting Rules Under Proposed Department of Labor Regulations New Emphasis in ESG and Proxy Voting Rules Under Proposed Department of Labor Regulations

New Emphasis in ESG and Proxy Voting Rules Under Proposed Department of Labor Regulations

On October 13, 2021, the U.S. Department of Labor (DOL) released a proposed rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights” (Proposal). The Proposal would amend the DOL’s investment duties regulation with respect to the consideration of environmental, social, and governance (ESG) factors in the selection of investments for retirement plans that are subject to the Employee Retirement Income Security Act of 1974, as amended (ERISA). The Proposal also would amend the rules for the exercise of shareholder rights and proxy voting under ERISA.

These newly proposed rules should help eliminate the chilling effects and confusion caused by the Trump Administration’s rules regarding integration of climate change and other ESG factors in investment decisions and proxy voting by ERISA plan fiduciaries. The DOL’s Proposal now specifically permits plan fiduciaries to consider ESG factors, including climate change, that are material to a risk-return analysis when considering and ultimately selecting plan investments. According to a DOL Fact Sheet, the Proposal also addresses the confusion that was created for fiduciaries when exercising shareholder rights. These changes appear likely to result in greater ability for fiduciaries to include ESG investments in retirement plans.   

The Proposal provides for a 60-day comment period, which will end on December 13, 2021. Below is an overview of the key components of the DOL’s Proposal.  


The Proposal follows the DOL’s policy announcement on March 10, 2021, that it was reexamining the regulations published by the prior administration on November 13, 2020 (“Financial Factors in Selecting Plan Investments”), and on December 16, 2020 (“Fiduciary Duties Regarding Proxy Voting and Shareholder Rights”), (referred together in this article as the “2020 ESG Rules”). In the March 10, 2021, policy announcement, the DOL also stated that it would not enforce the 2020 ESG Rules until further guidance was published.  

Overview of DOL’s Proposal for ESG Investing

Elimination of Pecuniary Factors

The 2020 ESG Rules require that plan fiduciaries consider only “pecuniary factors” in making investment decisions and does not even mention the term “ESG.” The DOL Proposal removes the concept of pecuniary factors, which was believed to be ambiguous in application, and states that “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.” 
Changes Allow Incorporation of Relevant ESG Factors

According to the DOL, the purpose of this Proposal is to make it clear that in appropriate situations, ESG factors are risk-return factors that fiduciaries should consider in making investment decisions. The DOL considers the projected return of a portfolio relative to the funding objectives of the plan as important and that ESG factors may be relevant to that analysis because the risk-return potential could be realized decades after the investment date. As such, the DOL believes ESG factors could present material business opportunities or risk to companies, and explicitly states that a prudent fiduciary should consider these issues in the risk and return analysis when making plan investments. 

The Proposal includes the following non-exclusive ESG factors as specific examples of the facts and circumstances that can be considered if material to the fiduciary’s risk-return analysis:
  • Climate change-related factors, such as a corporation’s exposure to the real and potential economic effects of climate change including exposure to the physical and transitional risks of climate change and the positive or negative effect of government regulations and policies to mitigate climate change.
  • Governance factors, such as those involving board composition, executive compensation, and transparency and accountability in corporate decision-making, as well as a corporation’s avoidance of criminal liability and compliance with labor, employment, environmental, tax, and other applicable laws and regulations.
  • 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 DOL’s language confirms that climate change-related factors, governance factors and workforce practices are no different than “traditional” material risk-return factors, should be considered equally in the investment process, and are consistent with ERISA’s duty of prudence. 
Changes to Tie-Breaker Rule

The 2020 ESG Rules contain a “tie-breaker” standard. Under the tie-breaker standard, if a fiduciary determines that two investment options are economically indistinguishable when considering risk and return factors, the fiduciary can then consider “non-pecuniary” or non-economic collateral benefits, such as the ESG goals, to break the tie between otherwise prudent investments.  

The Proposal modifies the tie-breaker rule so that a fiduciary may consider collateral benefits in selecting a plan investment if the fiduciary concludes that competing investments “equally serve the financial interests of the plan.” The DOL notes that the investments don’t have to be “indistinguishable” based on consideration of risk and return for collateral benefits to be considered under the tie-breaker rule. Instead, the fiduciary must conclude that the alternative investments are equally appropriate to serve the financial interests of the plan before deciding that collateral benefits can be considered in selecting one of the investments.  The preamble to the Proposed Rule explains that “two investments may differ on a wide range of attributes, yet when considered in their totality, can serve the financial interest of the plan equally well.  These investments are not indistinguishable, but they are equally appropriate additions to the plan’s portfolio.”  
Qualified Default Investment Alternative (QDIA) Provisions May Consider ESG Factors

The 2020 ESG Rules prohibit a fund from serving as a QDIA if the investment objectives or strategies consider the use of non-financial factors, even when the fund is objectively prudent from an economic risk/return perspective.  

The DOL’s Proposal eliminates this prohibition and would permit fiduciaries of participant-directed defined contribution plans to offer investment alternatives (including a QDIA) using ESG factors if the alternatives satisfy the requirements of the Proposal. Specifically, climate change or other ESG factors may be considered if they are financially prudent and meet the DOL’s existing QDIA standards. Essentially, a plan fiduciary must apply the same standards to QDIAs as apply to other investments and may not subordinate the interests of the participants and beneficiaries to objectives unrelated to providing benefits under the retirement plan. Further, a fiduciary cannot prudently accept greater risks or anticipated reduced returns by prioritizing the ESG-related collateral benefits.    

If a plan fiduciary selects a designated investment alternative (including a QDIA) based on collateral benefits in a tie-breaker situation, the Proposal also requires that the characteristics of the collateral benefits be “prominently” disclosed to plan participants. The additional disclosure is intended to ensure plan participants are provided sufficient information and are aware of the collateral factors the fiduciary used when selecting among economically equivalent investment options.  

This is a significant change from the 2020 ESG Rules, which prohibit the use of an investment alternative as a QDIA if the alternative reflects “non-pecuniary” factors in its investment strategy. The 2020 ESG Rules also require burdensome extra documentation to disclose why pecuniary factors were not sufficient to select the investment, how the investment compares to alternative investments, and how the factors are consistent with the interests of participants and beneficiaries. With many plan participants selecting or defaulting into QDIAs, permitting ESG factors in a plan’s QDIA should be a welcome change to the current guidance.   

Proxy Voting

The Proposal makes the following changes to the proxy voting and exercise of shareholder rights provisions in the 2020 ESG Rules:  
Duty to Vote – “No Vote” Statement Removed

Removes the statement that the fiduciary duty rules do not require the voting of every proxy or exercise of every shareholder right. The DOL explained that this removal doesn’t mean that every proxy must be voted but noted that the DOL’s longstanding view is that proxies generally should be voted unless a prudent fiduciary determines the costs or efforts would outweigh the benefits. Further, prudent fiduciaries should take reasonable steps to confirm the cost and effort of voting a proxy is commensurate with the relative significance of the issues to the plan’s overall financial interests.
Voting Policies – Removal of “Safe Harbors”

Removes the two “safe harbor” proxy voting policies that plan fiduciaries can use. The DOL explained that it does not believe those two safe harbor policies are necessary or helpful and requests comments on those provisions. One of the safe harbors permits a fiduciary to implement a policy limiting voting resources to certain types of proposals the fiduciary has prudently determined will have a material impact on the value of the investment. The other safe harbor would allow a policy of deciding not to vote on certain investment choices when the plan’s holdings are minimal relative to its total investment holdings. The DOL is concerned these safe harbors may incorrectly encourage plans to refrain more broadly from proxy voting without fully considering the interests of shareholders.   
Records Maintenance

Eliminates the requirement for plan fiduciaries to maintain records on proxy voting and other exercises of shareholder rights. The DOL made this change to remove any misperception that heightened fiduciary standards in the 2020 ESG Rules, and corresponding liability compared to other types of fiduciary activities, apply to proxy voting and other exercises of shareholder rights.
Elimination of Monitoring Obligation

Removes the explicit requirement that a plan fiduciary must monitor any third-party proxy voting service to which voting has been delegated (e.g., investment manager or proxy voting firm). The DOL noted that the intent of this change is not to reflect a change in the DOL’s view that a fiduciary must monitor its delegates, but to signal that there is nothing special about monitoring proxy voting services beyond the statutory obligations of prudence and loyalty under ERISA.

Closing Thoughts

The DOL’s Proposed Rule is intended to (i) clarify that a fiduciary’s duty of prudence may require consideration of the economic effects of climate change and/or other ESG factors, (ii) modify the 2020 ESG Rules to eliminate the chilling effects of considering climate change and other ESG factors when making investment decisions, and (iii) provide examples of how ESG factors may become material to the fiduciary’s risk and return analysis when selecting plan investments.  The Proposed Rule also addresses a plan fiduciary’s duty to manage shareholder rights when investing in shares of stock, such as proxy voting.  

The DOL is clearly signaling that ESG factors are intended to be considered on equal footing with other more “traditional” financial factors, which should be a welcome development for retirement plan sponsors and investment managers.  It is also very likely that the DOL’s Proposal will result in an increase in the use of ESG funds by ERISA plans, including default investment options that include ESG target date funds.  The DOL has requested comments on all aspects of the Proposed Rule by the December 13, 2021, deadline. 

For additional information, please contact Audra Ferguson-Allen, Rob Gauss, Tara Sciscoe, Christopher Sears, Lisa Harrison, Shalina Schaefer, Lindsay Knowles, or the Ice Miller Employee Benefits attorney with whom you regularly work.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.
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