Department of Labor’s New Proposal on the Fiduciary Duty Rule Would Reset Standards to Allow Use of ESG Criteria
On October 14, 2021, the US Department of Labor (the “Department”) published in the Federal Register a proposed rule (“Proposal”) that would reverse many of the changes included in the final rule (the “2020 Final Rule”) that emerged from a 2020 rulemaking on the same subject by the Department under the Trump Administration. Comments on the Proposal are due on or before December 13, 2021. The Proposal makes clear that fiduciaries and their managers would be permitted to use ESG (i.e. “Environmental, Social and Governance”) criteria in their analysis, but there is no “carte blanche” to pursue ESG-related social-policy goals while ignoring responsibilities to beneficiaries. Fiduciaries should carefully review their practices and procedures and consult with their advisors, including lawyers at Practus, LLP, who are following these developments carefully and have the experience to advise you in this fast-changing area. We are also happy to help you with drafting comments on the Proposal if you would like to take part in the rulemaking process.
The Biden Administration previously stayed the enforcement of the 2020 Final Rule, which the Proposal would replace with an amended final rule. The Proposal would codify the non-regulatory guidance issued by the Department in 2016 that permitted fiduciaries and managers of funds on behalf of pension beneficiaries to choose investments based on ESG criteria, which is more in harmony with the goals of the Biden Administration’s climate initiatives. When it issued the 2020 Final Rule, the Department was responding to the political direction of the former Administration, reflecting worries that use of ESG criteria could allow fiduciaries to escape their duties of care and loyalty to promote exclusively the financial interests of beneficiaries and not to pursue “other objectives.” The Proposal does not overturn or circumscribe these duties, but clarifies that careful use of ESG standards does not necessarily violate the principles behind the fiduciary duty rule and in some circumstances may be required if climate-related and other social and environmental risks are material to a particular investment.
In a nutshell, the Proposal:
- States expressly that appropriate use of ESG factors is not discouraged. Notably the Department eliminates the distinction drawn by the 2020 Rules between “pecuniary” and “non-pecuniary factors.” The Proposal would remove these terms entirely from the final rule. Instead, the Department makes clear that “appropriate consideration” as an exercise of prudence may require that a fiduciary consider ESG factors if they are material to an investment decision or investment course of action.
- Amends the “tie-breaking rule” to eliminate the 2020 Final Rules’ requirement that consideration of “collateral benefits” other than financial risk and return be separately documented. The Proposal does not dispense with traditional guidance that loyalty requires putting financial return to beneficiaries above all “collateral benefits.” The Department once again would give deference to the decisions of fiduciaries in determining where competing investments offer similar risks and returns and when collateral benefits could be considered when “breaking a tie.”
- Rewrites the rules on exercise of proxy voting powers to provide for more clarity in a way that would encourage fiduciaries to exercise those rights on behalf of beneficiaries when appropriate, and to abstain or refrain from voting when not required. The Department states that the new language is designed to further the legislative intent of the ERISA statutes, not to create new duties or subject fiduciaries to new requirements.
- Eliminates the flat prohibition of a fiduciary choosing a fund that pursues “collateral benefits” as a designated investment alternative (i.e. the default investment when a beneficiary declines to elect an alternative in a 401k scheme that allows choice). The Proposal instead requires that a statement of the fund’s approach to “collateral benefits” be “prominently displayed” in disclosure materials.
- Removes 2020 provisions that generated uncertainty about whether fiduciaries could pursue shareholder activism on behalf of ESG-based proposals. The Department does not believe that these additional limits are necessary. In our view, it would be a mistake to interpret this change as a “carte blanche” to fiduciaries and managers to pursue causes unrelated to shareholder value. The text of the Proposal makes clear that the rule should not be read to prohibit shareholder activism where “the matter being voted upon is expected to have a material effect on the value of the investment or the investment performance of the plan’s portfolio (or investment performance of assets under management in the case of an investment manager) after taking into account the costs involved or refraining from voting when the fiduciary prudently determines that the matter being voted upon is not expected to have such a material effect after taking into account the costs involved.”
Specifically, the Proposal seeks comment on the following:
- Whether the proposed rules on proxy voting effectively clarify how to perform such duties consistent with the duties of prudence and loyalty.
- Whether the Department’s decision in the Proposal to leave unchanged the existing rule’s language on voting on behalf of pooled investment vehicles is correct or whether the final rule the Department issues rather should follow the language of the Department’s past non-regulatory guidance more closely.
Of course, the Department “invites” comments on all other aspects of the Proposal as well.