DOL Proposes Amending Investment Duties Regulation to Counter Perception That ESG Considerations and Exercises of Shareholder Rights Are Disfavored

The DOL has proposed amendments to its ERISA investment duties regulation to address concerns that the current regulation inappropriately discourages plan fiduciaries from exercising shareholder rights and giving appropriate consideration to climate change and other environmental, social, or governance (ESG) factors when selecting plan investments. Here are highlights of the proposed changes:

• ESG Factors Explicitly Allowed. The regulation’s discussion of investment prudence would be modified to explicitly acknowledge that appropriate consideration of an investment or investment course of action may require an evaluation of ESG factors. A new provision would confirm that any factor material to an investment’s risk-return analysis may be considered, including ESG factors, offering as examples climate change, governance, and workforce practices.
• Tiebreaker. The proposal permits fiduciaries to consider collateral benefits (i.e., benefits that do not have a material effect on the risk and return of an investment) as tiebreakers in expanded circumstances. Unlike the current regulation, which allows consideration of collateral benefits only if competing investments are economically indistinguishable, fiduciaries would be permitted to consider collateral benefits so long as the competing investment alternatives “equally serve the financial interests of the plan.” (The DOL requests comments on whether the regulation should be more specific, e.g., regarding what collateral benefits should be available to break a tie.) The proposal would also eliminate the special documentation requirements added in 2020 as a condition for use of the tiebreaker provision. Instead of those requirements, the proposal would only require that the plan’s disclosure materials prominently disclose the collateral benefit that tipped the balance when a designated investment alternative is chosen using the tiebreaker rule.
• QDIAs. The proposal would eliminate the current rule precluding the use of an investment as a qualified default investment alternative (QDIA) if its investment objectives or goals or its principal investment strategies include, consider, or indicate the use of one or more non-pecuniary factors, such as climate change. Stakeholders warned that the provision in the current rule could exclude funds that would be prudent based solely on their financial attributes, and the DOL saw no reason for barring plan fiduciaries from investing in such funds.
• Pecuniary Factor Terminology Dropped. The current regulations rely on the term “pecuniary factors” when discussing the factors that a fiduciary may properly take into account when evaluating an investment or investment course of action. The proposal would remove that recently added term to eliminate ambiguity regarding its meaning and application, and would integrate the concept of factors materially affecting an investment’s risk-return characteristics directly into the description of fiduciaries’ duties.
• Voting Obligation. The proposal would delete a statement that fiduciaries do not have to vote every proxy or exercise every shareholder right due to the DOL’s concern that the statement might be misread and lead fiduciaries to not act on shareholder rights as needed, considering the issue’s significance to the plan. The proposal would also eliminate the two “safe harbor” examples of permissible proxy voting policies added to the current regulations in 2020. These examples allow policies to (1) limit voting to matters “substantially related” to the issuer’s business activities or (2) refrain from voting on proposals that are not expected to materially affect the plan’s investment performance based on the investment’s size relative to the plan’s total investment portfolio. Instead of the safe harbors, the proposed rule directs fiduciaries to the generally applicable fiduciary duties of prudence and loyalty.
• Proxy Monitoring and Records Requirements. Specific monitoring obligations applicable when the authority to exercise shareholder rights has been delegated would be deleted to avoid suggesting that the duty to monitor in this situation is greater than it is for other service providers. The proposal would also—and for a similar reason—eliminate the current regulation’s requirement that plan fiduciaries maintain records on proxy voting and other shareholder rights.

EBIA Comment: The proposal would retain much of the current regulation’s basic framework, but it would undo or substantially modify provisions added or revised in November (see our Checkpoint article) and December (see our Checkpoint article) of 2020 that suggested skepticism about fiduciaries’ reliance on ESG considerations and imposed additional limitations and burdens. According to the DOL, explicit recognition of ESG factors is needed to counteract negative perceptions created by the 2020 amendments and to eliminate unwarranted concerns about investing in ESG funds when they are economically advantageous. Stakeholders are encouraged to comment on any issues germane to the subject matter of the proposal on or before December 13, 2021. Pending further action, enforcement of the current regulation remains suspended (see our Checkpoint article). For more information on the current rule and related matters, see EBIA’s 401(k) Plans manual at Sections XXV.D (“Selecting the Plan’s Investment Funds”), XXV.L (“Proxy Voting and Shareholder Rights”), and XXVI.J (“Fiduciary Protection for Qualified Default Investment Alternative (QDIA)”).

Contributing Editors: EBIA Staff.