Labor Finalizes Controversial ESG Rule

Labor Department headquarters in Washington. (Photo: Mike Scarcella/ALM)

The Labor Department released a final rule Friday that updates and clarifies its plan to provide clear regulatory guideposts for fiduciaries of private-sector retirement and other employee benefit plans in light of recent trends tied to environmental, social and governance (ESG) investing.

The amendments, according to Labor, require plan fiduciaries to select investments and investment courses of action based on pecuniary factors — i.e., any factor that the responsible fiduciary prudently determines is expected to have a material effect on risk and/or return of an investment, based on appropriate investment horizons that are consistent with the plan's investment objectives and funding policy.

Labor's "rulemaking is controversial because many have viewed it as treating ESG investments as being suspect, when in fact more and more data point to [their] material benefit to investment performance," George Michael Gerstein, a partner at Stradley Ronon in Washington, told ThinkAdvisor in an email.

See: DOL's ESG Proposal Blasted in Public Comments

The final ESG rule "appears to provide fiduciaries greater flexibility in utilizing ESG strategies, including selecting ESG funds in 401(k) plan lineups," Gerstein said. "DOL attempted to address some of the concerns raised in the comment letters but compliance risk will remain an issue" with this final rule.

Aron Szapiro, Morningstar's director of policy research, said the research firm "did not think there was a problem that needed to be solved by putting more hurdles on plan sponsors from considering ESG investments," according to a statement sent via email.

To the contrary, he said, "we wanted to see clarifications that would encourage plan sponsors to consider ESG data as they set their plan lineup."

Szapiro added: "We don't think this rule addresses any issues investors face. Although it does not bar plans from considering including ESG strategies, it will make it harder for investors to access strategies that consider long-term sustainability."

Furthermore, "Since this is an increasingly mainstream consideration, the rule creates risks that 401(k) investors will be left behind," he explained.

"Finally, the DOL retained the Qualified Default Investment Alternative provisions," Szapiro said. "While the changes they made are somewhat helpful, this part of the rule is also out-of-step with embracing ESG considerations many professional asset managers now view as material."

More DOL Details

Labor's final rule amends the Department's longstanding investment duties regulation, first issued in 1979, to codify a clear regulatory structure for considering investments for ERISA plans.

During the last 30 years, Labor stated that it has periodically considered the application of the fiduciary duties of prudence and loyalty under the Employee Retirement Income Security Act (ERISA) to plan investments that promote non-financial objectives, such as furthering environmental, social and public policy goals.

According to Labor, "The Department has issued different iterations of sub-regulatory guidance during this period that may have created confusion about these investment issues, and the rapid increase in so-called ESG investments has also raised important and substantial questions about shortcomings in the rigor of the prudence and loyalty analysis by some participating in the ESG investment marketplace."

"Protecting retirement savings is a core mission of the U.S. Department of Labor and a chief public policy goal for our nation," said Labor Secretary Eugene Scalia. "This rule will ensure that retirement plan fiduciaries are focused on the financial interests of plan participants and beneficiaries, rather than on other, non-pecuniary goals or policy objectives."

Acting Assistant Secretary of Labor for the Employee Benefits Security Administration Jeanne Klinefelter Wilson added: "Our goal is to ensure that retirement security remains the top priority of those who manage the retirement assets that millions of Americans have worked so hard to earn.

"Retirement plan fiduciaries vindicate the public policy behind ERISA — and comply with the law — when they manage plan assets with a clear and determined focus on participants' financial interests in receiving secure and valuable retirement benefits," she said. "Plan fiduciaries should never sacrifice participants' interests in their benefits to promote other nonfinancial goals."

The department expects the final rule will result in higher returns by preventing fiduciaries from selecting investments based on non-pecuniary considerations and requiring them to base investment decisions on financial factors.

The final rule and a summary of the rule's key provisions are available on the EBSA website.

The rule will be effective 60 days after publication in the Federal Register, but plans will have until April 30, 2022, to make any changes to certain qualified default investment alternatives, where necessary to comply with the final rule.

Also on ThinkAdvisor: DOL Proposes Limit on ESG Investments in Retirement Plans