November 2022 Compliance Article

DOL Issues ESG Final Rule

The U.S. Department of Labor (DOL) has issued its final rule for environmental, social, and governance (ESG) factors used by plan sponsors when selecting retirement plan investments and exercising shareholder rights, such as proxy voting. The final rule mostly repeals the “pecuniary-only” standard created under the 2020 final rule and closely follows the 2021 proposed rule.

Background

On November 13, 2020, the DOL published a final version of the ESG rule that amended plan sponsor investment duties on treatment of ESG considerations in selecting investments available under a qualified retirement plan. Under that version of the rule, investment selection would have been based solely on financial factors such as return, risk, and a plan’s documented investment objectives. ESG factors were only to be considered if they were treated as material economic considerations. The rule became effective on January 12, 2021.

The final version of the proxy voting rule addressed the obligations of plan fiduciaries when voting proxies and exercising shareholder rights regarding shares of stock invested in the plan. The rule was published on December 16, 2020, and became effective on January 15, 2021.

On March 10, 2021, the DOL announced that it would not enforce either final rule.

On October 14, 2021, the DOL issued a proposed rule that included the following changes:

ESG Considerations: When considering risk-return factors, the proposed rule allowed for evaluation of the economic effects of climate change and other ESG factors, depending on the facts and circumstances.
QDIA Changes: The proposal removed the prohibition of usage of ESG factors in selection of Qualified Default Investment Alternatives (QDIAs).
Tie-breaker Test: Unlike the previous rule, the proposed rule allowed fiduciaries to consider collateral benefits as tie-breakers when investment would serve the financial interest of the plan equally.
Proxy Safe Harbors Removed: The following safe harbor proxy voting policies were removed under the proposed rule:
- A policy to limit voting to when fiduciary deems it to be substantially related to the issuer’s business activities or expected effect on the value of the investment.
- A policy to refrain from voting on particular types of proposals when below a quantitative threshold.
Removal of other proxy voting requirements, such as higher standard of maintaining proxy voting records.

Changes

The DOL notes that the new final rule does not change the core principle that plan sponsors are required under ERISA to follow the duties of prudence and loyalty and not subordinate the interests of participants and beneficiaries to any other objectives unrelated to the provision of benefits under the plan.

When making investment decisions, an ERISA fiduciary meets their:

Duty of prudence when “appropriate consideration” is given of relevant facts and circumstances in the fiduciary’s scope including the determination of role of investment action as part of the plan’s investment portfolio or menu.
Duty of loyalty when there is a prudent review of investment alternatives that would equally serve the financial interests in the plan with no sacrifice of investment return or taking additional investment risk for another objective.

The final ESG rule:

Adds clarifying wording that when a fiduciary selects investments for a qualified plan, the choice must be based on relevant risk and return analysis, which can include the economic effects of climate change and other ESG considerations.
Specifies that the same standards apply to QDIAs as when selecting other plan investments.
Removes the previous tie-breaker rule and instead requires the fiduciary to prudently conclude that competing investments or investment strategies equally serve the financial interests of the plan over time. In the case of a tie, the fiduciary can select investments or investment strategies based on collateral benefits other than investment returns. Special documentation is no longer required.
Adds a new provision stating that fiduciaries can consider participant preferences when creating a menu of prudent investment options for participant-directed individual account plans.
The proxy voting rules established in 2020 were largely repealed. The new version states that the fiduciary has duty to manage shareholder rights and rights to vote proxies for the exclusive interest of the plan with consideration of costs involved. This duty does not require the voting of every proxy or exercise of every shareholder right.

Questions on the final rule can be directed to the EBSA’s Office of Regulations and Interpretations at 202-693-8500.

The subject matter in this communication is educational only and provided with the understanding that Principal^® is not rendering legal, accounting, investment or tax advice. You should consult with appropriate counsel, financial professionals or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

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