Key Points

• If finalized as proposed, a Department of Labor (DOL) proposed rule would require plan fiduciaries to select investments based solely on pecuniary factors.
• The proposed rule would also tighten conditions for treating environmental, social, and corporate governance (ESG) factors as pecuniary factors plan fiduciaries may consider in selecting investments.
• The proposed rule would require plan fiduciaries to satisfy specific conditions before adding an ESG investment to a participant-directed individual account plan's investment lineup.

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On June 23, 2020, the DOL issued a proposed rule that would amend its long-established regulations defining plan fiduciaries' investment duties under ERISA section 404(a) to provide a regulatory structure for plan fiduciaries to assist them when considering ESG investments. While the proposed rule is reflective of earlier DOL guidance, it would also impose significant new restrictions on ESG investing.

Proposed Rule Expands on Earlier Guidance

Consistent with the DOL's earlier guidance on ESG investing in Interpretive Bulletin 2015-01 and Field Assistance Bulletin 2018-01, the proposed rule reiterates the fundamental principle that a fiduciary's duties of prudence and loyalty prohibit subordinating participants' economic interests to unrelated objectives. Specifically, the proposed rule reflects the DOL's consistent position that a fiduciary can appropriately consider ESG factors in investing only if they relate directly to an investment's economic value or as tiebreakers in deciding between economically equivalent investments. The proposed rule also carries forward the DOL's caution in earlier guidance that, while ESG factors may themselves be economic considerations plan fiduciaries can properly consider, they should be appropriately weighted based on the relative risk-return compared to other economic factors, and the plan fiduciary should not too readily treat them as economically relevant.

Proposed Rule Adds Significant New Restrictions on ESG Investing

While the proposed rule builds on earlier DOL guidance on ESG investing, it would also impose several significant new restrictions on ESG investing.

First, under the proposed rule plan fiduciaries would, to satisfy their investment duties under ERISA, be required to compare investments based solely on pecuniary—economic—factors, and not on the basis of any non-pecuniary factors.

Second, the proposed rule would provide that ESG factors are pecuniary factors a fiduciary may properly consider in making investment decisions only if they present economic risks or opportunities that qualified investment professionals would consider material economic considerations under generally accepted investment theories. Although similar, this appears to be a stricter articulation of that standard than under earlier guidance. As under earlier guidance, the weight given those factors must be appropriate to the relative risk and return, but must also reflect a prudent assessment of that impact.

Third, the proposed rule would raise the bar for when a fiduciary may appropriately consider ESG factors as tiebreakers in deciding between investments. Earlier guidance required only that the investments be economically equivalent. By contrast, the proposed rule would require that the investments be economically indistinguishable. This apparently heightened standard reflects the DOL's current view, articulated in the preamble, that true ties between investments based solely on economic factors rarely, if ever, occur. Thus, while the proposed rule would retain the "all things being equal test," it would require a fiduciary to specifically document its basis for concluding investments are economically indistinguishable, and why the selected investment was chosen based on the plan's purposes, investment diversification, and participants' and beneficiaries' interests in receiving plan benefits.

Fourth, the proposed rule would, as a condition for adding an ESG investment to a participant-directed individual account plan investment lineup, require that the fiduciary:

• Use only objective risk-return criteria to select and monitor all of the plan's investment alternatives, including ESG investment alternatives;
• Document its selection and monitoring of the investment based on that criteria; and
• Not add the ESG investment as, or as a component of, a QDIA.

Effective Date and Comments

The rule is proposed to be effective 60 days after publication of the final rule. The DOL has requested comments on the proposed rule.

If you have any questions, please reach out to your contact in the Hanson Bridgett Employee Benefits Group.