Pending rulemaking set to limit ESG-focused investments by ERISA plan fiduciaries, as DOL’s concurrent letters raise questions.

By Paul A. Davies, Paul M. Dudek, and Kristina S. Wyatt

Letters to Registered Investment Advisors (RIAs)

The US Department of Labor (DOL) has reportedly sent letters[1] to several registered investment advisors seeking information about their use of environmental, social, and governance (ESG) funds in retirement plans, as reported by media outlets including Financial Advisor Magazine and Think Advisor. According to news sources, the DOL’s Employee Benefits Security Administration has asked the RIAs for detailed information about their policies and practices regarding ESG-focused investments. The information requested reputedly includes the RIAs’ policies and procedures, communications, performance information, and the names of individuals who participated in making ESG-focused investment decisions.

The timing of the DOL letters has raised eyebrows given the agency’s pending rulemaking, which aims to restrict plan fiduciaries’ investments in ESG funds, as noted below. News outlets quoted Bryan McGannon, director of Policy and Programs at US SIF, the Forum for Sustainable and Responsible Investment, as objecting to the enforcement actions: “This is a move that is clearly designed to intimidate and if it’s followed up by enforcement it will have a chilling effect on fiduciaries’ willingness to consider ESG funds in retirement plans.”

Pending Rulemaking to Restrict Consideration of ESG Factors

The DOL’s letters come while rulemaking is pending that would severely restrict retirement plan fiduciaries from considering ESG factors, which are increasingly being used in making their investment decisions.

The rule proposal was subject to a 30-day comment period that ended July 30, 2020, although commenters, including the Principles for Responsible Investment, the American Bankers Association, and other industry groups, requested an extension given the proposal’s importance. During the short comment period, 1,100 comments were submitted, with the majority opposed to the DOL’s proposal. A few of these comments are highlighted below.

State Street Global Advisors noted that “as a fiduciary, State Street Global Advisors has a duty to act prudently and in the best interest of our clients, which, increasingly, includes consideration of environmental, social and governance (ESG) factors relevant to the performance of the companies in which our clients invest. We believe that addressing material ESG issues is good business practice and essential to a company’s long-term financial performance — a matter of value, not values — and we seek to capture these drivers of long-term shareholder value for our clients. … The (DOL’s) proposal unfortunately discourages such integration by US private sector plan fiduciaries, potentially disadvantaging plans, participants and beneficiaries by restricting access to an entire type of long-term, value-driven investment that could help ensure future retirement security.”

The Council of Institutional Investors made the point that the proposed rule “fails to identify and weigh the growing body of evidence linking certain environmental and social policy matters with large potential impacts on long-term shareholder value. The proposed rule also fails to recognize that investors increasingly view certain of those matters as complementary to their fiduciary duties of reducing risk and improving investment outcomes.” Institutional Shareholder Services asked the DOL “to confirm that where ESG investments present material economic considerations under generally accepted investment theories, they are to be treated pari passu with other types of investments for purposes of the ERISA duties of prudence and loyalty”

The US Chamber of Commerce also expressed its opposition to certain aspects of the proposal, including the provision imposing additional standards for plans with any ESG assessments in their investment mandates or in the fund names. “The regulations would require that plan fiduciaries apply a heightened standard and documentation to the selection of all investments in the plan’s lineup. We suggest deleting this additional requirement.”

Given the scope of the rule proposal and extent of critical commentary, the timing of the letters could raise some questions. Presumably, as part of the rulemaking process, if information received through the letters is considered, there presumably should be some level of transparency around that fact. Further, to the extent the proposed rules go beyond prior informal agency positions, as the Institutional Shareholder Services letter and others have suggested, the standards applied in any enforcement inquiries would need to look to the prior interpretive positions rather than the still-pending rule proposal.

Endnotes

[1] There is currently some debate as to whether these DOL letters are enforcement letters, as initially reported by Financial Advisor, or letters surveying for further information, as reported by InvestmentNews and the American Society of Pension Professionals & Actuaries. The DOL has not released a statement on the issue.