DOL won't enforce Trump-era ESG rules

The Department of Labor will not enforce two controversial Trump-era rules that restricted the use of ESG investments in retirement plans, the agency announced Wednesday.

In a statement, the DOL said that it will take a hands-off approach to the recently passed rules, Financial Factors in Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting and Shareholder Rights. The first pertains to “pecuniary” considerations when vetting investment options within 401(k)s and other defined-contribution plans, while the latter deals with traditional pension plans’ involvement in environmental, social and governance concerns.

The DOL indicated that it will likely publish further guidance on the rules, though it is possible it could opt for full rulemaking procedures for them.

The two rules were among the most heavily contested measures instituted by the DOL under former Secretary Eugene Scalia, with the 401(k) rule drawing nearly 9,000 public comments, most of them opposing it.

The Biden administration had made clear that it would seek to unwind the rules, and Labor Secretary nominee Marty Walsh last month said he would direct the DOL to reexamine them.

The 401(k) rule on pecuniary considerations was finalized Nov. 13, and the proxy voting and shareholder rights rule was published in final form Dec. 16.

“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,” Ali Khawar, principal deputy assistant secretary at the DOL's Employee Benefits Security Administration, said in the announcement. “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.”

Since the rules were finalized, the DOL has heard from stakeholders who said the rules have had a chilling effect on the inclusion of investments with ESG factors in retirement plans, the agency noted. The 401(k) rule did not explicitly prohibit funds with ESG considerations from being on plan menus, though it did limit considerations for such investments to those that are financial in nature. The proxy-voting rule took nonfinancial considerations off the table for pension plan fiduciaries deciding whether to support shareholder resolutions.

The timing of Wednesday’s announcement “was an unexpected surprise,” said Lisa Woll, CEO of US SIF.

“We really wanted them to do something like this. There needed to be some interim step,” Woll said. “I suspect there will be rulemaking that will happen that will reverse all of this.”

Of particular concern was language in the final version of the 401(k) rule that all but prevented the qualified default investment alternatives in such plans — usually target-date funds — from being ESG-specific products. That the DOL won’t enforce that provision is a positive sign for plan fiduciaries seeking to incorporate ESG investments in their plans, Woll said.

“It makes really clear that DOL thinks ESG criteria are very much part of a good investment process, and it’s no less true for retirement plans,” Woll said.

Numerous public comments pointed to the potential benefit that ESG considerations can have on material factors, such as long-term investment returns, the DOL noted in its announcement.

The rule affecting DC plans still technically allows ESG considerations to be taken into account, as long as they are clearly related to material financial issues, said George Michael Gerstein, fiduciary governance group co-chair at Stradley Ronon Stevens & Young.

“This is not an ESG rule only — this applies to all fiduciaries, whether it’s an ESG strategy or not,” Gerstein said.

The DOL’s new nonenforcement stance is unlikely to prompt any plan fiduciaries who were on the fence to change course, he said. And those who have determined that ESG considerations are material financially have already made up their minds, Gerstein said.

“The clear trend is a greater recognition that ESG is a material risk and opportunity,” he said. “ERISA clearly allows fiduciaries to take material risk and opportunity factors into account, ESG-related or not.”

On the proxy-voting and shareholder rights issue, the DOL “will likely pull back on how granular the analysis has to be,” Gerstein said. “I think they will focus a little bit less on costs, particularly indirect costs related to proxy voting.”

Nonetheless, pension plan fiduciaries should continue to be very careful about what fights they want to take up, especially because of the SEC’s existing rule on proxy adviser conflicts, he said.

“Fiduciary obligations remain in place. Litigation risk remains in place. Issues around proxy adviser firms remain outstanding,” Gerstein said.