The Department of Labor (DOL) grabbed headlines two weeks ago when it filed for review a draft regulation titled “Improving Investment Advice for Workers & Retirees Exemption” with the Office of Management and Budget (OMB).
The draft regulation had been expected for some time, and sources say it likely represents the DOL’s “new fiduciary rule,” and that the “exemption” referenced in the title of the rule will be related to the Regulation Best Interest (Reg BI) package currently being implemented by the U.S. Securities and Exchange Commission (SEC).
Though it received less attention at the time, the DOL also filed another unrelated regulation, dubbed “Financial Factors in Selecting Plan Investments.” According to George Michael Gerstein, co-chair of the fiduciary governance group at Stradley Ronon Stevens & Young, it is likely that this regulation will address the topic of environmental, social and governance (ESG) themed investing in the context of tax-qualified retirement plans governed by the Employee Retirement Income Security Act (ERISA).
“You may recall that back in 2019, there was an executive order coming out of the Trump administration that ordered the DOL to examine whether it needed to modify some of its proxy voting guidance related to ESG issues,” Gerstein says. “That examination has been percolating for a while now, and it seems progress is being made. We can’t say for sure at this early stage, before we see the text of the new regulation, but it appears the rule will go beyond merely the issue of proxy voting. It may turn out to be this administration’s ‘interpretive bulletin’ that will formally establish its position on ESG investing and ESG-related proxy voting as a general matter under ERISA.”
Gerstein says it is hard to glean too much insight from the limited information that has been released by OMB. In his assessment, the title suggests the regulation will not be limited to a small technical issue.
“It’s hard to learn too much about a regulation just from the title, but the title in my view suggests it will be somewhat expansive,” Gerstein says. “Discussing ESG funds in plan lineups has been a significant part of my work these days. There has been a lot of confusion about how to think about ESG-themed funds and whether they are subject to fiduciary challenges.”
Taking a step back, Gerstein says that the topic of ESG investing by tax-qualified retirement plans has been something of a political hot potato in the United States. This is at least in part because ESG investing has been narrowly associated with the issues of climate change and collective bargaining, rather than being viewed as a broad set of tools or approaches that can help improve investment performance. The situation stands in clear contrast with Europe and other parts of the world, where asset owners and their stewards have enthusiastically embraced ESG principles in the construction of institutional portfolios.
“There has clearly been some volleying back and forth between the previous administrations about whether it is appropriate to allow tax-qualified retirement plans to address environmental or social issues while directing their investments, really going all the way back to the Clinton administration,” Gerstein says. “However, I actually think the back-and-forth is finally settling around some middle ground principles. The differences of opinions between the administrations have not been as significant as some have suggested—the disagreement is really about the edges.”
Simply put, there is agreement that it is fine to consider and address ESG factors that will have a clear and material impact on the performance of the portfolio. Where there is disagreement is about exactly how to determine materiality in this sense and how rigorous and/or frequent such an analysis ought to be conducted. Another tough question is what time frame to consider when analyzing materiality.
Gerstein adds that Congress isn’t in much of a position to help settle this matter because the ERISA statutes “do not seek to pick winners and losers in terms of the investment types or styles that can be used by tax-advantaged retirement plans.”
“The way ERISA is written, it seeks to prohibit conflicted transactions and to eliminate the chance that fiduciaries will put their self-interest ahead of plan participants,” Gerstein says. “Beyond that, it is really left to broad, common law principles of fiduciary duty and the ultimate primary regulator—i.e., the DOL—to allow ERISA to evolve with the times and to issue fitting guidance. I’m not sure there is anything Congress could do with the statutes that would lend more clarity to this issue.”