In what some commentators are describing as the latest volley in a game of regulatory ping-pong, the Department of Labor (DOL) published proposed regulations that would change the way an ERISA fiduciary should consider environmental, social and governance (ESG) issues and related proxy voting decisions with respect to plan investments (the proposed regulations). The proposed regulations would provide more flexibility than prior guidance and greater encouragement to fiduciaries to consider taking ESG factors into account for their investment decisions. They also would encourage fiduciaries to vote on more shareholder activist types of proxy proposals. Although this guidance is new, tried-and-true best practices such as documenting investment decisions and having (and following) an investment policy should remain best practices throughout this evolving guidance.
As a starting point, it is important to remember that the ERISA fiduciary duties require fiduciaries to act prudently and diversify plan investments to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so. They also require fiduciaries to act solely in the interest of the plan’s participants and beneficiaries, and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. In the most general sense, when selecting investment options for defined contribution plans, ERISA fiduciaries should analyze the rates of return, fees and degrees of risk of various fund options.
The DOL occasionally has issued sub-regulatory guidance that has taken the general position that under the appropriate circumstances, ERISA fiduciaries can make investment decisions that reflect climate change and other ESG concerns. That particularly is the case as a tie-breaker among investments that otherwise had at least commensurate rates of return. The guidance also stated that ERISA fiduciary duties included the management of voting and other shareholder rights with respect to investments, and thus proxy voting is subject to ERISA’s duties of prudence and loyalty.
In November 2020, the DOL published regulations that increased the documentation requirements when selecting ESG funds and suggested that acting upon proxy resolutions related to ESG and other issues not directly concerned with economic issues would be inappropriate. In January 2021, the DOL issued a non-enforcement order for these regulations in order to examine whether the regulations were consistent with the Biden administration’s broader goals with respect to climate change, health and labor policies.
Proposed regulations—ESG guidance
With the proposed regulations, the DOL appears to be moving back in the direction of the prior guidance. The proposed regulations remove many of the documentation requirements related to selecting funds that use an ESG strategy. The proposed regulations also provide greater ability to use ESG funds as qualified default investment alternatives, although special disclosures may need to be made to participants. Interestingly, comments in the preamble suggest that in the final regulations, ESG factors may not only be permitted considerations, but required considerations (especially with respect to climate change). That will be something we will keep an eye on.
Proposed regulations—proxy voting guidance
Additionally, the proposed regulations remove restrictions on voting proxies that the prior final regulations impose. The proposed regulations restore fundamental principles that have been a consistent part of the DOL’s fiduciary guidance with respect to proxy voting. These principles state that proxy voting decisions must make the plan’s financial interest the primary concern. Fiduciaries also must evaluate both the facts that form the basis of a proxy vote and the persons who play a role in proxy voting. For example, the decision to follow recommendations of a proxy advisory form could be considered a fiduciary decision. Interestingly, the proposed regulations suggest that fiduciaries adopt proxy voting policies to provide guidelines designed to ensure that proxy voting decisions are consistent with fiduciary duties to the plan. The proposed regulations add that such proxy voting policies should be consistent with investment policy statements.
Conclusion and next steps
While the proposed regulations demonstrate a change in direction from last year’s regulations, they also demonstrate the importance of keeping the core fiduciary duties of prudence, loyalty and diversification in mind with respect to investment decisions. Fiduciaries should consider three best practices:
- When making core investment decisions, fiduciaries should act by following ERISA’s core fiduciary requirements of prudence, loyalty and diversification.
- Fiduciaries should document the analysis and conclusions with respect to the selection or removal of investment funds. That will always be a smart practice that withstands shifts in regulatory guidance. The proposed regulations suggest climate change and other ESG factors may be part of this analysis, but documenting decisions remains important.
- Fiduciaries should review their investment policy statements. Having—and following—an investment policy statement can demonstrate that plan investment decisions were made in a manner consistent with ERISA’s fiduciary duties. The proposed regulations suggest these policies should include a statement on proxy voting.
The DOL is requesting comments on the proposed regulations by Dec. 13, 2021. We will monitor how the guidance progresses to final regulations. In the meantime, fiduciaries should work with legal counsel to strengthen their fiduciary processes and determine how to apply the latest guidance in the proposed regulations.