On March 10, 2021, the Department of Labor’s Employee Benefits Security Administration (EBSA), the agency charged with interpreting and enforcing ERISA, announced that it will not enforce the Trump-era “Financial Factors in Selecting Plan Investments” rule, which has been perceived as potentially discouraging retirement plan fiduciaries from selecting investment alternatives which emphasize environmental, social, and governance factors (commonly referred to as “ESG investments”).
The rule, which was finalized in November 2020 and technically became effective on January 12, 2021, does not prohibit ESG investments. However, it has been widely criticized as fostering a misapprehension that ESG investments may be subjected to a higher degree of fiduciary scrutiny than others. Following the election, EBSA’s announcement of its non-enforcement policy comes as no surprise, as the Biden administration had already identified the rule on its “List of Agency Actions for Review.”
Further, the non-enforcement policy appears to be a precursor to more comprehensive and authoritative guidance regarding fiduciary considerations relevant to ESG investments. In the words of one of the agency’s heads:
“(T)hese rules have created a perception that fiduciaries are at risk if they include any environmental, social and governance factors in the financial evaluation of plan investments…
…We intend to conduct significantly more stakeholder outreach to determine how to craft rules that better recognize the important role that environmental, social and governance integration can play in the evaluation and management of plan investments, while continuing to uphold fundamental fiduciary obligations.” (Emphasis added)
Again, the Trump-era rule does not prohibit the consideration of ESG factors when selecting retirement plan investments. Further, on its face, the rule does not even discourage their consideration by plan fiduciaries. Rather, it requires merely that investment decisions be made solely on the basis of “pecuniary factors” (i.e., those expected to affect risks and/or returns), with non-pecuniary considerations being used only to “break ties” between otherwise-equivalent options. And, it specifically acknowledges that environmental, social and other like factors may indeed be “pecuniary” and thus proper economic considerations.
However, portions of the rule (and in particular its lengthy preamble commentary) have nonetheless triggered some concerns. For example, plan fiduciaries are cautioned on multiple occasions against adopting overly expansive notions of “pecuniary” when comparing available investment options. Likewise, the tie-breaking scenario in which non-pecuniary factors may be considered is described as “rare,” and the rule also imposes additional documentation requirements in such cases. Further, the rule contains an absolute prohibition against the use of Qualified Default Investment Alternatives (QDIAs) for 401(k), 403(b) and other participant-directed plans that “include, consider, or indicate the use of one or more non-pecuniary factors.”
These aspects of the rule have been interpreted by some as indicating that EBSA is likely to apply heightened scrutiny to ESG investments – for example when reviewing plans and service providers for ERISA compliance. The announcement of the non-enforcement policy, while it makes clear that EBSA is not precluded from pursuing fiduciary breach claims generally (as it can in connection with any investment), indicates that this is not the case, and that a substantial policy shift has occurred:
Until it publishes further guidance, the Department will not enforce (the rule) or otherwise pursue enforcement actions against any plan fiduciary based on a failure to comply with (the rule) with respect to an investment, including a Qualified Default Investment Alternative…
In our experience, the rule has not caused plans to flee en masse from their ESG investments, particularly because it was not expected to be embraced by the Biden Administration. While the industry awaits further guidance, EBSA’s non-enforcement policy should give plan fiduciaries and investment professionals additional comfort that utilizing ESG investments – so long as they are selected and monitored applying the same standards of prudence and loyalty that attach to all plan investments – is not likely to subject them to a higher level of regulatory scrutiny.