The Department of Labor has issued its final rules on the investment duties of fiduciaries under the Employee Retirement Income Security Act (“ERISA”). These rules differed from the proposed rules issued over the summer which required additional responsibility for retirement plans who wanted to consider environmental, social, or governance factors in their investing (known as “ESG” investments). This is of particular concern to Taft-Hartley Plans, who often include investment options that emphasize the use of organized labor in their portfolios or investment options to members. However, the new rules dialed back these responsibilities, and did not specifically mention ESG investments but focused on the use of “pecuniary” factors in choosing investments. Pecuniary factors are those that have an impact on the risk and return.
These rules provide guidance as to how ERISA fiduciaries perform their investment responsibilities under Section 404 of ERISA, which requires fiduciaries to discharge their duties “with the care, skill prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims,” and act “for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the Plan.”
The Department of Labor reasoned that ESG investments had the potential to expose plan participants and beneficiaries to unnecessary investment risks and that environmental, social, and governance reasoning behind investments were unrelated to protecting retirement benefits. The initial rules specifically disallowed the use of non-pecuniary factors when selecting investments. ESG investments could be considered only if a review of “economically indistinguishable alternative investments” determined that there would be no sacrifice of return or increased risk. However, many were concerned about this rule because there was a lack of guidance as to the definition of environmental, social, and governance factors. Also, it was not clear how it would be determined that there would be equal risk and return when evaluating “economically indistinguishable alternative investments.”
The final rule, which is effective January 12, 2021, provides less stringent guidelines. ERISA Fiduciaries may consider non-pecuniary reasons for investment if they document why 1) pecuniary factors are not sufficient to select a particular investment; 2) how alternative investments relate to diversification, liquidity, and projected return; and 3) how non-pecuniary factors are consistent with the interests of participants or beneficiaries in the Plan.
Although these rules are less aggressive then those initially proposed, Plan fiduciaries should proceed with caution whenever selecting investments for reasons other than their relative risk and return. That is especially important today, as many plan participants are looking to invest their retirement assets in companies whose practices align with their own personal social and environmental concerns. Accordingly, any plan fiduciaries that are considering other non-economic concerns (i.e., concerns other than risk and return) when selecting investments should consult with legal counsel prior to making any decisions.