Funds that are comprised of investments partly based on environmental, social, and corporate governance (“ESG”) factors have grown in popularity. Where once a strategy only utilized to service a niche market of investors, using ESG factors to select securities are now seen by some financial institutions as a viable investment strategy. The DOL has taken notice of these funds, and has recently issued updated guidance on the fiduciary responsibility plan sponsors have when it comes to ESG investments.
The recent DOL guidance affirms previous guidance, while at the same time advising plans to take caution. The DOL’s previous guidance acknowledged that ESG issues present a material business risk and opportunity for companies, and can be considered alongside other economic factors or used as a tiebreaker. The recent DOL guidance confirmed that a prudently selected ESG fund added to available investments options of a 401(k) plan did not violate the plan sponsor’s fiduciary responsibilities. But plan sponsors were also put on notice that not all investment decisions are equal. Specifically, decisions regarding using an ESG fund as a QDIA (qualified default investment alternative) were distinguished as not analogous to merely offering participants an additional investment option. A plan sponsor would violate its fiduciary responsibility if it could not show that the fund as a default investment does not create a conflict of interest, and that the fund does not offer lower expected rate of return or higher risk than a non-ESG alternative.
Plan sponsors must always act prudently when selecting a plan’s fund line-up. Plans are not permitted to sacrifice investment return or take additional risk to promote collateral social goals, and the DOL echoed this rule as it relates to ESG investments. Plan sponsors may continue to provide ESG investments as options for plan participants as long as it is prudent to do so, but should know that an ESG investment as a QDIA will receive heavy scrutiny.