DOL Publishes Final Rule Regarding ESG Investing and Proxy Voting

January 20, 2023

Key Takeaways

  • ERISA fiduciaries may consider any factors the fiduciary reasonably determines are relevant to the risk return analysis of an investment, including the economic effects of climate change and other environmental, social, or governance (“ESG”) factors.
  • The final rule eliminates the special guidelines and duties specific to ESG-related determinations and notes that ESG factors may be considered when the fiduciary considers such factors relevant.
  • The safe harbors from the prior rule, which permitted a policy of not voting proxies in a collection of instances, have been eliminated.
  • The “tiebreaker test” may be used when a fiduciary concludes that competing investments equally serve the financial interest of the plan over the appropriate time horizon.
  • ERISA Fiduciaries employing proxy voting service providers must review the services providers guidelines to assure the guidelines conform to ERISA’s fiduciary standards.
  • Managers of ERISA plan assets funds should review their subscription agreements to confirm the subscription representations have been updated so that plan investors adopt the manager’s proxy voting policy.

On December 1, 2022, the U.S. Department of Labor (“DOL”) published a final rule titled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights” (the “Rule”). The Rule is generally effective January 30, 2023; however, as noted below, two proxy voting provisions are not effective until December 1, 2023. This Rule replaces two Trump-era regulations regarding ESG considerations when (1) investing and (2) exercising shareholder rights, both of which were subject to a non-enforcement policy.

The Rule provides comfort to persons acting as fiduciaries under the Employee Retirement Income Security Act of 1974 (“ERISA”) that ESG factors may be considered when determining plan investments. The Rule states that a prudent fiduciary may consider any factors material to risk return analysis and provides that such factors may include “the economic effects of climate change and other environmental, social, or governance factors.”

The general framework governing an ERISA fiduciary’s investment decisions remains unchanged. A fiduciary may not sacrifice investment return or increase investment risk to promote non-financial goals. Whether any specific factor is relevant to the risk return analysis is to be determined by a prudent fiduciary and requires an analysis of the facts and circumstances. The Rule provides that ESG factors may be relevant to the risk return analysis.

The Rule revises the use of tiebreakers. An ERISA fiduciary may utilize non-financial factors as a tiebreaker if the fiduciary concludes two investments “equally serve the financial interests of the plan,” in which case the fiduciary may make the investment selection based on collateral benefits. The Rule removes the special recordkeeping and documentation requirements from the prior regulation, stating that the existing prudence obligation of Section 404 of ERISA sufficiently protects participants’ and beneficiaries’ financial interest in this regard.

The Rule allows fiduciaries of participant-directed individual account plans to take into account the preferences of participants when determining the appropriate investments to include as available options within a plan. Although participant preferences may not relate to the risk return analysis of investments, the DOL noted that including such considerations in a fiduciary’s analysis may lead to greater participation and higher deferral rates, furthering the purposes of the plan. Therefore, if participants are highly interested in having an ESG option, for example, available within the plan, fiduciaries may take this into consideration when selecting investment options. In addition, the Rule removes the prior regulation’s restriction on the use of ESG funds as a 401(k) plan’s designated investment alternative, and such funds are able to be a designated investment alternative if the fiduciary determines it is appropriate.

The Rule reaffirms that proxy voting and exercising shareholder rights are fiduciary activities. The Rule removes the prior regulation’s proxy voting safe harbors which allowed fiduciaries to not vote proxies, as well as other language that the DOL was concerned could be misread to suggest that a fiduciary should be indifferent to exercising shareholder rights, even if the cost to exercise those rights was minimal. In the Rule, the DOL reaffirmed its longstanding view that “proxies should be voted as part of the process of managing the plan’s investment in company stock unless a responsible plan fiduciary determines voting proxies may not be in the plan’s best interest (e.g., in cases when voting proxies may involve exceptional costs or unusual requirements, such as in the case of voting proxies on shares of certain foreign corporations).”

The Rule acknowledges that an ERISA fiduciary may adopt a practice of following the recommendations of a proxy advisory firm or other service provider, but only after a determination that such provider’s proxy voting guidelines are consistent with the fiduciary’s obligations regarding shareholder rights under ERISA. ERISA fiduciaries have until December 1, 2023, to comply with this provision of the Rule.

The Rule also requires managers of ERISA plan asset funds to reconcile any conflicting investment policy statements of different investors to the extent possible. With regard to voting proxies, the manager of an ERISA plan asset fund may impose its own proxy voting policy that is consistent with ERISA and require plans participating in the plan asset fund to accept that proxy voting policy before being allowed to invest. ERISA plan asset funds should review their subscription documents to ensure that investing plans adopt the manager’s proxy voting policy so that the manager will not be required to review and vote in compliance with each specific plan’s proxy voting policy. These requirements also do not become applicable until December 1, 2023.

For further information regarding this Rule, please contact S. John Ryan at (212) 574-1679, Michael O’Brien at (212) 574-1505, or Bradley Fay at (212) 574-1429 in Seward & Kissel’s Executive Compensation Group.