DOL Won't Enforce Rules Limiting 401(k) Plans' Use of Nonfinancial Factors

Move signals support for 'socially conscious' investments and proxy votes

Stephen Miller, CEBS By Stephen Miller, CEBS March 15, 2021
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DOL Wont Enforce Rules Limiting 401(k) Plans Use of Nonfinancial Factors

[updated: 3/20/21]

​The U.S. Department of Labor (DOL) announced it will not enforce a rule finalized last November under the Trump administration that limits fiduciaries use of nonfinancial factors—such as environmental, social and governance (ESG) criteria—when choosing mutual funds, corporate equities and other retirement plan investments.

The DOL is also tabling enforcement of a related rule, finalized in December, that stopped fiduciaries from casting corporate-shareholder proxy votes in favor of social or political positions that don't advance the financial interests of retirement plan participants.

"Until it publishes further guidance, the Department will not enforce either final rule or otherwise pursue enforcement actions against any plan fiduciary based on a failure to comply with those final rules," the DOL announced on March 10. The department said it will continue to enforce fiduciaries' duties to make prudent decisions on behalf of plan participants as required by the Employee Retirement Income Security Act (ERISA).

"These rules have created a perception that fiduciaries are at risk if they include any environmental, social and governance factors in the financial evaluation of plan investments, and that they may need to have special justifications for even ordinary exercises of shareholder rights," said Ali Khawar, principal deputy assistant secretary for the DOL's Employee Benefits Security Administration.

He added, "We intend to conduct significantly more stakeholder outreach to determine how to craft rules that better recognize the important role that environmental, social and governance integration can play in the evaluation and management of plan investments, while continuing to uphold fundamental fiduciary obligations."

The DOL's announcement "signals the end of the DOL's current enforcement effort around ESG usage by ERISA plans," blogged attorneys at Morgan Lewis. "This may be a sign that the Biden DOL will prepare a new set of rulemaking in the areas of ESG and proxy voting that replaces or modifies the Trump era rules."

Reviewing the Basics: What Are ESG Investments?

ESG or "socially responsible" mutual funds invest in companies that meet the fund managers' criteria for environmental stewardship, social justice and fund governance. Some ESG funds exclude the stock of tobacco, fossil fuel, firearm and defense companies, and firms that are opposed to union organizing or that pay excessive executive compensation. They may favor companies that use renewable resources and are committed to gender equality, diversity and community engagement.

ESG investment funds tend to charge higher fees than non-ESG funds, reports 401kSpecialist.


Weighing ESG Factors

The Trump-administration rule, Financial Factors in Selecting Plan Investments, bars fiduciaries from taking on additional investment risks to promote nonfinancial goals.

The top-ranking Republicans on the House Education and Labor committees last year, Reps. Virginia Foxx, R-N.C., and Tim Walberg, R-Mich., said the final rule "clarifies how retirement plan fiduciaries can meet their legal obligations to serve retirement savers exclusively, free from potential ulterior motives."

Supporters of the rule also pointed to a research paper from the Center for Retirement Research at Boston College. It concluded, "the evidence suggests, however, that social investing: 1) yields lower returns; and, 2) is not effective at achieving social goals."

Among the rule's opponents, Lisa Woll, CEO of the nonprofit US SIF: The Forum for Sustainable and Responsible Investment in Washington, D.C., criticized it for putting "a substantial burden on fiduciaries who consider ESG factors in their retirement plans, requiring additional documentation to justify why ESG factors are financially material." She said that "abundant data debunks the premise that utilization of ESG criteria is problematic."

Mindy Lubber, CEO and president of sustainability organization Ceres, called the rule "another harmful action by the Trump administration, at a time when the global climate crisis looms large as another systemic risk upending lives, livelihoods, and causing deadly devastation and damage."

Default Investments

The DOL announcement highlighted the regulation's effect on ESG funds as qualified default investment alternatives (QDIAs), which are the funds where employee contributions are invested when the employee has not made an investment election. Under the plan investments rule, QDIAs could not include a fund "if its investment objectives or goals or its principal investment strategies include, consider, or indicate the use of one or more [nonfinancial] factors."

According to retirement plan advisory firm October Three, "QDIA ESG investments [are] particularly significant, as most new fund flows go into QDIAs (overwhelmingly, target date funds) and this was an ESG investment singled out for special, more stringent treatment."


Participant Lawsuits Still Possible

Attorneys at law firm Gordon Proctor advised that while the DOL's non-enforcement policy toward the plan investments rule will limit the risk of DOL actions against fiduciaries that pursue ESG investment strategies, this relief "does not extend to private litigation risk. Until the DOL formally changes the [Trump-era] amended rule, it will remain the law and will govern fiduciary investment decisions under ERISA."

They added, "As a practical matter, private litigation risk involving the amended rule will likely fall mostly on fiduciaries responsible for selecting investment options under participant-directed individual account plans."

Voting on Shareholder Measures

Retirement plan fiduciaries cast corporate-shareholder proxy votes based on participants' stock holdings in the plans they oversee.

The suspended proxy voting rule, Fiduciary Duties Regarding Proxy Voting and Shareholder Rights, limits plan fiduciaries from casting shareholder votes in favor of social or political positions that don't advance the financial interests of retirement plan participants.

Instead, proxy voting decisions and other exercises of shareholder rights must be solely in the interest of, and for the exclusive purpose of, providing benefits to plan participants and beneficiaries.

Unions have been critical of the rule. The United Food and Commercial Workers International Union, for instance, wrote in a comment letter that the regulation would "create an overly burdensome and unjustified process for the consideration of voting proxies," such as on behalf of union-supported shareholder ballot measures.

According to the Service Employees International Union, proxy voting by retirement plan fiduciaries "reflects appropriate monitoring and engagement efforts by institutional investors ... and the growing recognition that the environment, diversity, and other societal issues present economic risks and opportunities."

Commenting in favor of the proxy rule, Chris Burnham, president of the Institute for Pension Fund Integrity, which advocates for transparency and accountability in the management of public pension plans, said that reforms to the current proxy advisory system were needed "because decision-making has increasingly become subject to political pressure and personal influence."

[update]

"DOL's refusal to enforce these rules will harm Americans' retirement savings by allowing plan fiduciaries to sacrifice investment returns to promote non-pecuniary policy objectives like social justice, diversity quotas and lower carbon emissions," three GOP senators wrote in a March 18 letter to Al Stewart, acting secretary of labor.

The letter was signed by Senators Richard Burr, R-N.C., ranking member of the Senate Health, Education, Labor and Pensions Committee; Mike Crapo, R-Idaho, ranking member of the Senate Finance Committee; and Pat Toomey, R-Pa., ranking member of the Senate Banking Committee.

Related SHRM Articles:

Biden DOL Allows Investment Advice Rule to Take Effect, SHRM Online, February 2021

Biden Administration to Review Rules for Employee Health and Retirement Plans, SHRM Online, January 2021

DOL Final Rule Limits Proxy Voting by Retirement Plan Fiduciaries, SHRM Online, December 2020

Final Rule Limits 401(k)s from Picking Funds Based on Nonfinancial Factors, SHRM Online, November 2020






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