DOL Supports Connecting ESG to Companies’ Financial Performance in Retirement Plans

October 22, 2021

proposed Labor Department rule stating that retirement plan fiduciaries may—and sometimes would be required to—consider ESG factors in making investment decisions has revived a longstanding debate about whether so-called “social investing” is consistent with a plan fiduciary’s obligation to ensure sound financial investments.

“Social investing” raised early fiduciary concerns:  The genesis of the new rule predates the rise of ESG strategies by large companies.  The concept arose in the 1990s and early 2000s when union pension plans began directing investments into companies based on their goals and track records regarding employee and community relations.  Many ERISA lawyers cautioned at the time that such investments could undermine the fiduciary obligation of the plans to direct investments based solely on financial performance.

Rise of ESG provides a new context:  In recent years, large companies for a variety of reasons have adopted ESG practices and policies, which have been both promoted and applauded by large asset managers, such as BlackRock as well as “issue investors”.  The ESG factors now go well beyond the issues labor was pressing for, now including climate change, DE&I, and other factors.  Meanwhile, companies have been far more receptive to these strategies than had been the case when the “social investing” debate initially arose.

Biden DOL reverses predecessor:  Since the Department of Labor has the leading role on interpreting ERISA and its fiduciary requirements, its position on the boundaries of fiduciary requirements is critical.  Not surprisingly, this position has varied in recent years between Republican and Democratic administrations. 

In the Trump administration, DOL issued an interpretation stating: 

It does not ineluctably follow from the fact that an investment promotes ESG factors… that the investment is a prudent choice for retirement or other investors.

 DOL is now proposing a rule which, according to a fact sheet:

makes it clear that, when considering projected returns, a fiduciary’s duty of prudence may often require an evaluation of the economic effects of climate change and other ESG factors on the particular investment or investment course of action. 

It is worth noting that the rule, which includes consistent provisions regarding proxy voting, is being proposed pursuant to a Biden executive order with a number of initiatives directed at addressing climate change.

In the end, it’s all about financial performance.  A Wall Street Journal editorial this week opposing the proposed rule restated the fundamental opposition to social investing, and predicting, “Retirement plan sponsors won’t merely be allowed to prioritize climate and social factors in how they invest. They could be sued if they don’t.”  Many large companies would strongly disagree with the Journal’s approach, seeing a very close connection between ESG goals and financial performance.  Nevertheless, this could very well be one of those “ping pong” policies that, with a different administration in a different year, could bounce back the other way.  Indeed, Republican Senators’ concerns regarding the rule this week slowed down consideration of President Biden’s nominee to head DOL’s Employee Benefits Security Administration, which enforces ERISA.