Until recently, ERISA seldom appeared in national headlines—let alone the Speaker of the House making an Instagram video about it. But many Members of Congress have proclaimed that the new Department of Labor (DOL) prudence regulation allows investment managers for ERISA plans to “push a political agenda at the expense of retirement savers.”
Everyone with a workplace plan presumably wants the investment managers overseeing their hard-earned retirement savings to make the best possible decisions, taking all relevant factors into account. My opinion is that the new regulation—in line with decades of bipartisan practice—ensures that they can. Attacks on this common-sense rule are based on a misunderstanding of what it actually does.
The Regulation
The new regulation, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” often called the “ESG Rule,” clarifies the legal duties of ERISA fiduciaries—the people who sponsor, manage, or advise ERISA plans, and are obligated to act in the best interests of participants and beneficiaries.
As the rule states, a fiduciary’s investment decisions “must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis.” Depending on the circumstances, this could include “ESG” factors, a term the financial world uses to describe assessment of the risk (and opportunity) to an investment deriving from environmental, social, and governance issues.
For example, a company may have key coastal facilities at risk of flooding due to climate change or may have high liability risk due to poor compliance protocols. Considering the potential financial impact of ESG factors is an established, mainstream investment practice.
Historical Context
The Labor Departments of every presidential administration of the last 40 years have issued guidance on this topic, including both of those in which I served—under George W. Bush and Barack Obama. Regardless of political party, the guidance never departed from the core principle that ERISA fiduciaries may not sacrifice investment returns or assume greater investment risks as a means of promoting collateral social policy goals. ERISA duties are principles-based, neutrally applying prudence and loyalty requirements to all investment decisions without favoring or disfavoring a particular investment strategy.
The Trump administration departed from this neutral stance, suggesting that ESG considerations should rarely be taken into account. The new Rule sensibly returns to the tradition of neutrality, ensuring that fiduciaries can use their professional judgment and expertise to consider all factors that could affect investment risk and return.
ERISA
ERISA requires that fiduciaries neither sacrifice investment returns nor assume greater investment risks in order to promote collateral social policy goals. Still, an investment is not automatically impermissible under ERISA solely because it may have some nonpecuniary utility to some investors. ESG factors sometimes have material impacts on companies, which means they may be material to risk and return, and if so should be considered along with all other financial factors. And when multiple investment options equally serve the financial interests of the plan, ERISA does not preclude consideration of non-financial benefits as a tie-breaker. In other words, within ERISA’s ground rules there is a degree of principled discretion.
Fiduciary Duty
Hewing to the longstanding principles of prudence and loyalty, the rule requires ERISA fiduciaries to focus on investment risk and return factors and not to subordinate the economic interests of participants and beneficiaries to objectives unrelated to the provision of benefits under the plan—investment returns.
The fiduciary also has a duty to monitor and assess the performance of selected investment options over time and to act accordingly. Pursuant to the duty of loyalty, the fiduciary must act solely in the interest of plan participants and beneficiaries. Contrary to some messages in media, from politicians, and at least two lawsuits trying to strike down the rule, it does not mandate nor favor consideration of ESG factors in choosing investments for ERISA plans. Rather, when ESG factors are financially relevant to a decision, the rule permits an ERISA fiduciary to take them into account just like any other relevant financial attribute. Against this backdrop, it is vexing to see the rule construed as anything other than neutral.
Criticism of the Rule
Critics of the ESG Rule who cast it as supporting “a political agenda at the expense of retirement savers” should take note: restrictions on considering nonpecuniary benefits may also mean that well-known investment strategies are restricted. A good example is faith-based investing. As with any other type of?investment philosophy, faith-based investing strategies aim to maximize investor?returns. Where they are distinguishable is their commitment to using investments that align with their investors’ religious values. Some mutual fund families are marketed to appeal to investors interested in financially sound investments in companies that do not violate certain religious principles. Current objections to “woke capitalism” could result in the exclusion of faith-based funds from ERISA plans.
Moreover, attacks on the rule largely have failed to acknowledge that the vast majority of workplace retirement plans permit participants to direct the investment of their accounts. Nearly all 401(k) plan participants choose from a diversified platform of investment options or have access to a brokerage window. For 2021, the most recent year for which complete data is available, approximately 90 percent of 401(k) plans reported in filings with the DOL that they offer participant-directed investing.
In other words, most 401(k) plan participants can decide where their accounts are invested.
The Bottom Line
Politics notwithstanding, a secure retirement for all Americans is itself a fundamental social goal that ERISA supports and that should drive fiduciaries’ investment choices. Fiduciaries should be able to take all relevant factors into account to best protect the retirement savings upon which workers and their families depend. The DOL’s new rule upholds these uncontroversial principles.
Allison Wielobob is the General Counsel of the American Retirement Association.
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