On October 13, 2021, the Department of Labor released a proposed regulation on “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights” (environmental, social, or governance (ESG) investing and proxy voting), proposing to significantly revise the position taken by the Trump DOL at the end of 2020 on these issues. (We discuss the Trump DOL ESG regulation here, and the Trump DOL proxy regulation here.)
In this article we discuss the new proposal, beginning with the highlights.
Highlights – changes to the Trump DOL’s ESG and proxy regulations
The proposal eliminates a number of rules, and changes language, that in the Trump DOL regulations were seen to discourage ESG investing and shareholder engagement:
- The proposal explicitly states that prudent investment “may often require” consideration of ESG factors. It goes on to give (in the proposed regulation text itself) examples of different ESG factors that may be appropriately considered.
- The proposal eliminates strict documentation requirements for “tie-breaker” investment decisions, although in participant-invested DC plans disclosure of the tie-breaker considerations must be “prominently displayed in disclosure materials.”
- The proposal eliminates the stricter requirements for inclusion of ESG investments in a QDIA.
- The proposal eliminates the two proxy voting (or non-voting) policy safe harbors.
- The proposal eliminates special recordkeeping requirements for proxy voting decisions.
- The overall tone of both the proposed regulation and the accompanying preamble is much more “pro” both ESG investment and involvement in corporate governance where the Trump DOL regulations were “anti” (or at least skeptical about) ESG investment and involvement in governance.
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The proposal deals with three significant issues: (1) The ERISA prudence standard with respect to retirement plan fiduciary investment decisions based on environmental, social, or governance (ESG) factors. (2) The ERISA duty of loyalty standard with respect to those investment decisions. (3) The retirement plan fiduciary’s duties with respect to shareholder rights appurtenant to shares of stock held in a plan (e.g., proxy voting and shareholder activism).
In what follows we summarize the proposal’s changes to the Trump DOL regulations on each of these issues.
ESG factors incorporated into the ERISA fiduciary “prudent investment” analysis
The proposed regulation provides that, when considering an investment or investment course of action, the fiduciary must generally give appropriate consideration to, among other things:
The projected return of the portfolio relative to the funding objectives of the plan, which may often require an evaluation of the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action. [Emphasis added.]
The italicized language, added by this new proposal, can be read not just to authorize consideration of ESG factors but to require it “often.”
The proposal gives explicit examples of the sorts of ESG factors that may be part of a prudent “risk-return” analysis:
(i) Climate change-related factors, such as a corporation’s exposure to the real and potential economic effects of climate change including exposure to the physical and transitional risks of climate change and the positive or negative effect of Government regulations and policies to mitigate climate change;
(ii) Governance factors, such as those involving board composition, executive compensation, and transparency and accountability in corporate decision-making, as well as a corporation’s avoidance of criminal liability and compliance with labor, employment, environmental, tax, and other applicable laws and regulations; and
(iii) Workforce practices, including the corporation’s progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion, and retention; its investment in training to develop its workforce’s skill; equal employment opportunity; and labor relations.
ESG factors and the duty of loyalty
The proposal cross-references the discussion of ERISA investment prudence to make it clear “that ESG considerations, including climate-related financial risk, are, in appropriate cases, risk-return factors that fiduciaries should take into account when selecting and monitoring plan investments and investment courses of action.”
The proposal eliminates the rule in the Trump DOL regulation requiring special documentation of the basis for any “tie-breaker” decision. It also reformulates the definition of a tie-breaker (to “more closely [align] with the Department’s original non-regulatory guidance in this area”) as follows:
If … a fiduciary prudently concludes that competing investments, or competing investment courses of action, equally serve the financial interests of the plan over the appropriate time horizon, the fiduciary is not prohibited from selecting the investment, or investment course of action, based on collateral benefits other than investment returns.
With respect to designated investment alternatives (including QDIAs) in a DC plan in which participants select investments from a fund menu, where a fund has (on a tie-breaker basis) been included in the plan fund menu because of an ESG tie-breaker/“collateral benefit,” “the plan fiduciary must ensure that the collateral-benefit characteristic of the fund, product, or model portfolio is prominently displayed in disclosure materials provided to participants and beneficiaries.” DOL anticipates that this disclosure would be part of the standard fund description provided participants.
Finally, the proposal would eliminate the Trump DOL regulation’s stricter requirements for inclusion of ESG investments in a QDIA.
The proposed changes to the Trump DOL proxy regulation (now incorporated as part of a comprehensive re-proposal of rules for both investment and proxy voting) are less extensive:
The proposal eliminates the statement in the current regulation that “the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right.” In the preamble, however, DOL states that “[t]he proposed removal of the statement, however, does not mean that fiduciaries must always vote proxies or engage in shareholder activism.”
Specific rules in the Trump DOL regulation for monitoring the proxy voting activities of investment managers and proxy voting firms are absorbed into a description of the general duty of plan fiduciaries to monitor the work of service providers.
The Trump DOL regulation provides two “safe harbor” examples of permissible proxy voting policies: (1) A policy limiting voting resources “to particular types of proposals that the fiduciary has prudently determined are substantially related to the issuer’s business activities or are expected to have a material effect on the value of the investment.” And (2) a policy of not voting on proposals when the plan’s holding is below a prudently determined threshold. The proposal would eliminate these safe harbors, but DOL states in the preamble that “The Department continues to believe … that the maintenance by an employee benefit plan of a statement of investment policy designed to further the purposes of the plan and its funding policy is consistent with [ERISA] fiduciary obligations.”
The proposal would eliminate the special proxy voting recordkeeping requirements included in the Trump DOL regulation.
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We note that DOL announced in March 2021 a nonenforcement policy with respect to ESG and proxy rules under the Trump DOL regulations.
The (Biden) DOL’s proposed regulation liberalizes, considerably, DOL’s position on the fiduciary issues presented by retirement plan ESG investments and proxy voting. This will generally be good news to sponsors and sponsor-fiduciaries interested in pursuing one or both of these activities.
We will continue to follow these issues.