DOL Issues Regulations Prescribing Conditions for ESG Investments in Retirement Plans

The Department of Labor’s Employee Benefits Security Administration (EBSA) has issued proposed regulations intended to govern the use of so-called “socially responsible” investments in retirement plans. Investments considered to have these characteristics are officially called environmental, social, and governance (ESG) investments. This guidance is being widely viewed as advising greater caution when retirement plan fiduciaries consider ESG investments for their retirement plans.

In general terms, ESG investments involve investment strategies that take into account environmental, social, and governance factors. Investors in such funds or strategies may do so with the motive of investing in entities that—for example—are considered environmentally responsible, or that support certain social causes.

EBSA has a history of issuing sub-regulatory guidance on the use of ESG investments as options for retirement plans, because of employers’ fiduciary obligation to administer their plans in a manner that places the interests of participants and their beneficiaries above other considerations. Prior EBSA guidance has generally taken the form of Interpretive Bulletins, the latest being IB-2016-1.

EBSA policy towards ESG investments in retirement plans has tended to reflect the philosophy of the administration in power. IB 94-2, issued during President Bill Clinton’s administration, asserted that—while selecting investments to achieve social objectives does not justify inferior returns for plan participants and beneficiaries, considering ESG factors was acceptable as a “tie-breaker” in investment selection.

IB-94-2 was viewed by the succeeding administration of President George Bush as unduly encouraging fiduciaries to include social, environmental, or political considerations in plan investment decisions, and it was replaced by IB 2008-2. To continue the swing of the pendulum, IB-2015-1 and IB-2016-1—issued during President Barack Obama’s administration—expressed an intention to revert to the less cautionary tone of EBSA’s guidance issued under President Clinton.

Now, under President Donald Trump’s administration, EBSA has gone beyond sub-regulatory Interpretive Bulletins by issuing proposed regulations. Public comments will be accepted for a 30-day period following the guidance’s publication in the Federal Register. Elements of these proposed regulations in prepublication form, and as articulated in an EBSA news release, include the following.

  • Fiduciaries may not invest in an ESG if they understand that its underlying investment strategy would give less priority to investment returns, or would increase investment risk, for the sake of a nonfinancial objective.
  • Compliance with ERISA’s exclusive-purpose and loyalty duties prohibits fiduciaries from subordinating the interests of plan participants and beneficiaries in retirement income and financial benefits under the plan to nonfinancial goals.
  • The regulations describe required investment analysis and documentation for what EBSA describes as “the rare circumstances” when fiduciaries are choosing among investments that are truly “indistinguishable” from one another—investments essentially equal—from an economic standpoint.
  • The proposed regulations state that “The Department does not believe that investment funds whose objectives include non-pecuniary [i.e., ESG] goals …even if selected by fiduciaries only on the basis of objective risk-return criteria…should be the default investment option in an ERISA plan.”