The US Department of Labor (DOL) released the Final ESG Rule on November 22, 2022, regulating the consideration of environmental, social, and governance (ESG) factors by fiduciaries of employee benefit plans subject to the Employee Retirement Income Security Act of 1974, as amended (ERISA). The Final ESG Rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” also addresses proxy voting.
The Final ESG Rule is another effort by the DOL to interpret how ERISA plan fiduciaries may consider ESG factors as part of their investment decision-making process on behalf of ERISA-regulated retirement plans. It comes nearly a year after the DOL released the Proposed ESG Rule. The Proposed ESG Rule generated more than 2,000 comments during the comment period.
The Final ESG Rule also comes at a time when retirement plans and other investors are facing both increased interest in ESG investing and competing threats from an emerging anti-ESG movement. For more of our analysis of state-level ESG investing regulation, read our recent blog post and article, and view our chart summarizing state-level ESG investing regulations.
While the DOL has a long history of back-and-forth on the extent to which fiduciaries could consider ESG-type factors, it has been consistent in affirming that plan fiduciaries must make investment decisions in accordance with ERISA’s fiduciary duties of loyalty and prudence. Both the Proposed ESG Rule and the Final ESG Rule emphasized this long-standing, bedrock ERISA principle and focused on how the consideration of ESG factors can be consistent with the duties of loyalty and prudence and, specifically, what economic impact certain ESG factors may have on an investment’s risk-return profile.
We plan to provide a more extensive analysis in the coming days, but our initial assessment is that the Final ESG Rule moves the ball away from a 2020 DOL rulemaking in this area and toward a position that is more supportive of ESG investing. The Final ESG Rule provides fiduciaries with an interpretation of ERISA’s fiduciary standards that could allow for the consideration of ESG factors without violating those duties.
In issuing the Final ESG Rule, the DOL stated its prior rulemaking “unnecessarily restrained plan fiduciaries’ ability to weigh environmental, social and governance factors when choosing investments, even when those factors would benefit plan participants financially.” With the Final ESG Rule, the DOL clarifies that “retirement plan fiduciaries can take into account the potential financial benefits of investing in companies committed to positive environmental, social and governance actions.”
Key Differences from Proposed ESG Rule
But while the DOL seems to have given a (green) thumbs up to ESG factors, its interpretation is more measured, and it would appear more principles based, than the proposal. A key difference between the Proposed ESG Rule and the Final ESG Rule is the extent to which the DOL is encouraging or mandating whether ERISA fiduciaries may or must consider ESG factors.
The Proposed ESG Rule had included a nonexhaustive list of specific ESG factors that under certain circumstances might have been required factors to consider as part of a fiduciary’s investment analysis. That list was removed in the Final ESG Rule, as was the suggestion that an analysis of an investment’s projected return “may often require” an evaluation of ESG factors. These changes appear to take the DOL’s interpretation away from “ESG factors must be considered, in certain circumstances,” to “ESG factors may be considered, in certain circumstances.”
In this regard, the Final ESG Rule could be viewed as a more “middle of the road” pro-ESG approach that would make room for ESG considerations where appropriate in connection with a risk/return analysis, without requiring fiduciaries to consider ESG. But more importantly, this rulemaking represents a significant change from the 2020 regulation’s approach that was seen as placing burdens on plan fiduciaries to justify any ESG-based investing.
As noted, the Final ESG Rule also makes changes to provisions in the 2020 regulation that were seen as possibly discouraging proxy voting by ERISA plan fiduciaries, instead placing further emphasis on the responsibility of plan fiduciaries under ERISA to vote proxies.
Most changes become “applicable” 60 days after the rule’s publication in the Federal Register. Certain subsections related to proxy voting, including one that could possibly lead to a plan’s proxy voting policy being treated as superseding that of a pooled fund in which the plan invests, will apply one year after publication.