As promised, President Joe Biden vetoed an attempt by House and Senate Republicans to strike down the Department of Labor's (DOL's) ESG rule Monday.
"I just signed this veto because the legislation passed by the Congress would put at risk the retirement savings of individuals across the country," Biden said in a video posted on Twitter. "They couldn't take into consideration investments that would be impacted by climate, impacted by overpaying executives and that's why I decided to veto it."
The rule allows ERISA retirement plan fiduciaries to consider environmental, social, and governance (ESG) factors when making investments or creating offerings.
It will remain in effect, barring a 2/3 majority vote to override the veto, which is considered highly unlikely.
- Biden's veto of Congressional legislation striking down the new ESG rule means the rule remains in place, barring a 2/3 majority override by Congress.
- The new rule retains core fiduciary duties of prudence and loyalty for retirement plan advisors while singling out ESG for consideration, provided it does not violate those duties.
- Fiduciaries continue to be duty-bound to manage shareholder rights, including the right to vote proxies. They are advised that considering participant preferences is not violating the loyalty duty.
Consideration of ESG investments is permissible but must follow certain principles.
Retirement plan advisors may consider the economic effects of climate change and other ESG factors in investments, based on individual facts and circumstances. Additionally, they must base that consideration on factors reasonably determines as relevant to risk and return analysis. Finally, they must ensure the weight given to any factor appropriately reflects an assessment of its impact on risk and return.
The new ESG rule doesn't give fiduciaries permission to elevate ESG funds over financial risk. The requirement to follow the core principles of prudence and loyalty remain.
Consideration of a participant's preferences is not a violation of the fiduciary duty of loyalty.
The new rule clarifies that fiduciaries do not violate the duty of loyalty solely because they take into account participants’ preferences when constructing a menu of investment options. The new guidance does not, however, alter the duty of prudence. In other words, fiduciaries may not add ill-considered or unwise investment options just because plan participants request them.
Special rules for qualified default investment alternatives (QDIAs) have been dropped.
Under previous rules, funds that served as "qualified default investment alternatives” (QDIAs) could not have goals or principal investment strategies that included non-financial factors in the fund's investment objectives, even if the fund was otherwise economically prudent from a risk-return perspective. The new ESG rule doesn't include this prohibition, meaning ERISA fiduciaries can consider funds with ESG factors in a QDIA.
The duty to manage shareholder rights, including proxy voting, has been retained.
ERISA fiduciaries continue to be duty-bound to manage shareholder rights, including the right to vote proxies. In deciding whether to exercise those rights, the fiduciary must determine whether the actions are in the economic interests of the plan and whether any factors (including ESG factors) are relevant. The fiduciary must also consider cost as it serves the financial interests of shareholders.
The tie-breaker standard is now more flexible.
Under previous guidance, competing investments had to be "economically indistinguishable" before a fiduciary could consider collateral factors as tie-breakers. This standard also imposed a special documentation requirement that made the tie-breaker approach impossible to employ. Under the new rule, if a fiduciary prudently concludes that competing investment opportunities “equally serve the financial interest of the plan,” the fiduciary is not prohibited from selecting an investment based on “collateral benefits other than investment returns.” In addition, the special documentation requirement was removed.
The Bottom Line
The new ESG rule seeks to clarify fiduciary duties when selecting investments, exercising shareholder rights, and processing participant preferences. While all this takes place in a climate that has become increasingly politically hostile, the rule relaxes some of the recent tension while maintaining the notion that fiduciaries are duty-bound to represent plan participants and beneficiaries properly.
Fiduciaries may be held personally liable for any losses resulting from a breach of duty with regard to the new ESG rule. This includes the return of any profits gained through the improper use of plan assets.