CLS Blue Sky Blog

Latham & Watkins Discusses Department of Labor Rule on ESG Investing

On October 30, 2020, the US Department of Labor (DOL) published Financial Factors in Selecting Plan Investments (the Rule) and a related Fact Sheet, a codification of the spirit, if not the exact words, of a controversial proposal issued by the DOL in June 2020 (the Proposal). The Rule adopts amendments to certain provisions of the “investment duties” regulation under Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and requires fiduciaries of pension plans (and other benefit plans covered by ERISA) to choose investments “based solely on pecuniary factors” relevant to a particular investment. The net effect is to restrict plan fiduciaries from making investment decisions guided by goals or policies other than achieving the highest possible return for investors. Non-financial goals would ostensibly include any environmental, social, or governance (ESG) factors that many investors consider important to their investment decision-making.

The Rule

Despite an overwhelming number of opposing comments submitted in the 30-day comment period after the Proposal was issued, the DOL quickly finalized the Rule substantially as it was proposed. The Rule preamble largely dismisses the materiality of ESG factors in investment decisions, and adopts the controversial idea that consideration of ESG factors are somehow at odds with financial factors and fiduciary responsibilities of plan sponsors. But rather than mandate a heightened standard of care for non-pecuniary factors in investment decisions, the DOL chose to prohibit them outright, providing that plan fiduciaries must select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action. The Rule pivots on two ERISA duties imputed to fiduciaries:

Key Differences From the Proposal

The Rule differs from the Proposal in a number of ways:

What the Rule May Mean in Practice

The Rule will become effective 60 days after publication in the Federal Register. The compliance deadline for retirement plans related to the selection of a qualified default investment alternative (QDIA) is April 30, 2022.

While fiduciaries are not absolutely prohibited from considering ESG factors if they are relevant to an investment’s financial analysis and are “pecuniary in nature,” market participants are rightfully concerned that the Rule will curb investment choice and specifically ESG investing in retirement plans. Fiduciaries may simply opt to steer clear of ESG factors when making investment decisions — even if they are justifiably pecuniary in nature — to avoid the additional documentation and compliance requirements, and possible regulatory scrutiny of adherence to fiduciary obligations under the Rule. The DOL’s heavy-handed approach to “safeguard the interests of [ERISA plan] participants and beneficiaries” does not bode well for increased commitments by North American pension funds to achieve net-zero carbon emissions across their portfolios, as is happening in Europe and Asia.

For those who consider ESG factors as fundamentally material to their investing decisions as pecuniary factors, the Rule is an unwelcome, if not unforeseen, development. Whether the rule will be enshrined in practice, or whether a new administration with opposing policy positions will curtail its impact, remains to be seen.

This post comes to us from Latham & Watkins. It is based on the firm’s memorandum, “US Department of Labor Puts ESG Investing on Ice,” dated November 10, 2020, and available here.

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