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Practical Tips for Plan Sponsors and ESG Investments

Sept. 8, 2022, 8:00 AM

Regulatory and legislative developments continue to accelerate around investments incorporating environmental, social, and governance factors into retirement plans. Plan sponsors and fiduciaries should take note of the fast-changing landscape when selecting and monitoring investment options.

In late 2020, the Department of Labor under the Trump administration finalized a rule that seemingly questioned whether ESG investing could be compatible with the duty of prudence outlined in the Employee Retirement Income Security Act of 1974 (ERISA).

After President Joe Biden was elected, DOL announced it would not enforce this rule, and presented a new proposed rule in October 2021 that would remove barriers to plan fiduciaries’ ability to consider ESG factors more permanently. However, since the comment period for the proposed rule closed on Dec. 13, 2021, it has been unclear when DOL will issue a final rule.

Meanwhile, Republican legislators introduced bills in the US Senate and House that would discourage use of ESG factors. Eighteen Republican state attorneys general issued a letter warning about use of ESG factors, and several state governments have taken steps to limit ESG investing.

In this fast-changing environment, to minimize the risk of lawsuits and DOL investigations based on ERISA’s duty of prudence, plan sponsors and fiduciaries considering ESG investments may wish to consider the issues outlined below.

Focus on Process

Since the passage of ERISA, DOL has not promulgated any specific rules regarding steps plan sponsors and fiduciaries should take to ensure a prudent process. However, courts have consistently interpreted the duty of prudence as requiring the plan sponsor to select and monitor the plan’s investment options with the skill of a prudent expert.

This subjective “prudent expert” standard makes it more important than ever to conduct an “objective, thorough, and analytical review” of all material factors in the fund selection and monitoring process.

Specifically, a prudent expert may choose to measure an investment option’s performance relative to, for example, a widely used benchmark and comparable peer investments.

Fiduciaries that do choose to consider ESG factors as part of their process, consequently, should be prepared to provide comprehensive documentation demonstrating that they have conducted a review that concludes the inclusion of ESG factors is material to an investment’s risk and return profile.

Implement Rigorous Documentation

In its Meeting Your Fiduciary Responsibilities publication, DOL specifies that plan sponsors may limit their liability and show they complied with their fiduciary duties by documenting the processes used to carry out these responsibilities.

In particular, to the extent the fiduciary relied on information and advice from others, documentation is critical to establishing the qualifications of the expert, the subject of the advice, and why the expert was consulted.

The rigor and detail of the documentation generally is critical to defending against challenges to a fiduciary’s prudent process, whether investigations or lawsuits. As such, DOL explicitly counsels plan sponsors to document their fund selection and monitoring process as well as how fees are paid.

Economics Still Matter

The proposed regulations specifically list climate change, corporate governance, diversity and inclusion, and labor relations as factors that a prudent fiduciary may determine are economically relevant to an investment decision.

However, the proposal is not yet law, and even if it is finalized as-is, a prudent fiduciary may still need to conclude that the factors are economically relevant for the investment at issue.

Monitor Developments

The Employee Benefits Security Administration has committed not to pursue enforcement actions against any plan fiduciary based on the 2020 ESG rule. However, the non-enforcement policy does not provide relief from general fiduciary violations, so fiduciaries must still be careful to undergo a prudent process when evaluating investments.

Additionally, as the non-enforcement policy will likely sunset when DOL issues a final regulation, plan sponsors and fiduciaries should continue to monitor these developments closely in this rapidly changing environment. It may be helpful for some plans to employ expert advice to accomplish this end.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Author Information

Jacob Eigner is an attorney at Groom Law Group. He specializes in ERISA’s application to financial institutions. Eigner’s practice covers qualified retirement plans, compliance with the DOL’s fiduciary rules, investment due diligence, and contractual relationships with service providers.