While the American Retirement Association is broadly supportive of its stated intentions, the Labor Department’s proposed rule regarding consideration of ESG factors in plan investments and proxy voting should adopt a more neutral stance.
In a Dec. 13 comment letter, the ARA recommends that in its proposed rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” the DOL develop neutral language clarifying that prudence does not preclude consideration of ESG factors, which it comments “are no different than other relevant risk-return factors.” The ARA noted that the language should establish that “fiduciaries should be free to consider any factor that is, in their judgment, material to a risk-return analysis”—and—as it had previously—supported the availability of ESG options as a qualified default investment alternative (QDIA).
In mid-October, the Department of Labor released a proposal that would set aside the previous administration’s final rules on the use of ESG factors in selecting plan investments and fiduciary duties regarding proxy voting for one that explicitly allows a consideration of those factors. The proposed rule sought to remove barriers to plan fiduciaries’ ability to consider climate change and other environmental, social and governance (ESG) factors when they select investments and exercise shareholder rights. The ARA’s comments came in response to a call by the Department of Labor for comments—not only on the provisions of the proposal but also on any issues germane to the subject matter of the proposal.
Principle of Neutrality
In its letter, the ARA comments that the final rule should adopt an approach that reflects ERISA’s longstanding principle of neutrality in the application of duties of loyalty and prudence regarding whether and how ESG factors are material a fiduciary investment analysis—and that the DOL do so “by removing references to ESG factors from the regulatory text, instead relying on references to discretionary non-economic considerations.”
ARA also commented that the ESG proposal, including the preamble discussion, should be modified to eliminate the implication that prudent evaluations of investment options often involve consideration of ESG factors. “This language implies that a prudence nearly always requires evaluation of ESG factors,” the ARA explained, while recommending the removal of the phrase (in subclause (b)(2)(ii)(C) of the Proposal), “which may often require an evaluation of the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action.”
The ARA said it “strongly believes” that a regulatory preference for investment theories that “often” evaluate climate-change and ESG considerations contravenes ERISA’s fundamental deference to fiduciaries’ judgment, commenting that “…neutrality should be the goal of a prudence and loyalty regulation,” while in its assessment “…the Proposal would inappropriately influence fiduciaries’ judgment, mindful of the required nature of the safe harbor considerations.”
Shift of Burden?
The ARA acknowledged that a fiduciary may determine that ESG factors are material to a risk and return analyses and, in those cases, those factors should be viewed no differently than other relevant risk-return factors. However, and noting that “nothing in the Proposal gives fiduciaries license to pursue ESG objectives unmoored from or indifferent to an investment’s underlying economic merits,” the ARA expressed concern that the “may often require” language, included in the required considerations, taken together with the Proposal’s preamble, “strongly implies that fiduciaries not only have the option to consider ESG investments but should be considering climate change and other ESG factors.”
Whether or not this apparent shift in burden was intended, the ARA said it wanted to “make clear that, based on our survey of plan sponsor and plan advisor stakeholders, we firmly believe that the Proposal will be interpreted and applied this way. “We cannot emphasize enough how sensitive these stakeholders are to possible litigation risk,” the letter continued.
Additionally, ARA commented that the proposed new subparagraph of discretionary factors should eliminate the examples, instead moving those to preamble discussion. Moreover, ARA recommended that the tie-breaker provision should be modified to reflect “the evolving diversity of ESG approaches and investments and to permit selection of an alternative investment based on non-economic criteria and not based on the untenable standard of equally serving the plan’s financial interests.”
Finally, ARA concurred with the proposal in allowing ESG investments as qualified default investment alternatives (QDIAs). That had been one of ARA’s concerns with the Trump administration’s proposal, as noted in its comments on that proposal.
The ARA’s comment letter is available here.
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