By: Evelyn A. Haralampu, Partner
Background
Fiduciaries responsible for the investment of almost $30 trillion in U.S. retirement funds are required by federal law (ERISA) to discharge their duties “solely in the interest of participants and beneficiaries” for the “exclusive purpose” of providing benefits to plan participants using “the care, skill, prudence, and diligence” that a “prudent” expert would use. This admonition includes the diversification of plan investments.
The U.S. Department of Labor, the agency regulating fiduciary duty under ERISA, buffeted by the political crosswinds of the Biden and Trump administrations, has issued differing guidelines regulating investments with environmental, social, and governance (“ESG”) aspects. The 2020 rule prioritized maximizing investment returns over ESG investing but permitted considering ESG factors only as a “tie-breaker” between investments with the same economic factors. When using non-pecuniary factors to distinguish between economically similar investment options, the fiduciary under the 2020 rule had to document factors leading to its decision, emphasizing pecuniary considerations. The 2021 rule continues the obligation of fiduciaries to consider material risk and return factors on plan investments and not subordinate the maximization of investment returns to unrelated, non-financial interests. However, the 2021 rule allows fiduciaries to consider the economic effects of climate change, corporate governance factors, and workplace practices on selecting retirement plan investments, including default investment funds for employees who do not actively choose other investments. Under the 2021 proposal, fiduciaries choosing plan investments may consider board composition, executive pay, diversity and inclusion, equal employment opportunity, and compliance with labor, employment, environmental, criminal, and other laws.
As long as investment choices “equally serve” the financial interests of plan beneficiaries over a specified period, fiduciaries can choose investment options based on non-economic criteria. Although the 2021 proposal would not require that fiduciaries document the reasons for their investment choices, best practices favor documentation.
Ongoing Issues
The 2021 proposal is unlikely to protect plan fiduciaries who might choose default funds with ESG aspects if those funds are more costly than similar funds and are without the same or better investment results. Also, ESG investments do not, per se, shield plan fiduciaries from litigation challenges for subpar investment returns.
New Congress
After the mid-term elections, Congress pushed to block the Biden administration’s ESG proposal, and the President has vowed to veto any legislation repudiating the administration’s latest ESG investment guidance. Even though that guidance does not mandate ESG investing, Congress has expressed concern that the rule taints ERISA investing with political considerations. Congress favors the prior rule that unambiguously focuses on choosing investments for their returns.
While the ESG political drama plays out, retirement plan fiduciaries must continue to focus on decision-making that meets ERISA’s requirements of acting for the exclusive purpose of plan participants and beneficiaries.
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