It’s Official: U.S. Retirement Plans Can Consider ESG Factors

After years of uncertainty around how U.S. retirement plans could consider ESG factors, the dust is finally settling. It’s official: A Nov. 22 rule issued by the Department of Labor (DOL) allows retirement plans to consider financially material ESG factors when selecting investments and exercising shareholder rights. What’s more, the neutrality of the final rule increases the odds the rule will endure under future administrations.

What changed, and is this actually a change?

In many ways this isn’t a change, rather a clarification. The DOL claims that the “the Department has consistently recognized that ERISA (the Employee Retirement Security Act) does not prohibit fiduciaries from making investment decisions that reflect ESG considerations, depending on the circumstances”, but two rules issued during 2020 under the Trump administration had a chilling effect, leaving plans wary of any decisions that may be perceived as considering climate change or other ESG factors.

The first1 of the two 2020 rules required plan fiduciaries to select investments based solely on pecuniary factors. Countless debates ensued around what constituted a pecuniary factor: did prevalence of overtly financially material ESG events justify inclusion of ESG considerations into investment decision making? Rather than splitting hairs, better to be safe than sorry was a common stance among fiduciaries of ERISA plans.

The second2 2020 rule related to proxy voting and exercising other shareholder rights. This rule stated that fiduciary duty did not extend to voting all proxies or the exercise of every shareholder right. And, an explicit safe harbor was introduced that allowed fiduciaries to limit voting. Two such acceptable approaches included limiting voting to only those proposals having a material effect on the value of the investment and refraining from voting when the size of the plan’s holdings in the securities were below quantitative thresholds set by the fiduciary. The rule also appeared designed to dissuade voting on non-pecuniary (generally interpreted as ESG) goals or those without a clear economic benefit to the plan participants.