The Evolving Regulatory Landscape for ERISA Plan Fiduciaries—The Biden Administration & ESG and Proxy Voting Rules

February 9, 2021
23:05 minutes

Welcome to the first in a series of Ropes & Gray podcasts addressing emerging issues for fiduciaries of 401(k) and 403(b) plans to consider as part of their fiduciary process and litigation risk management strategy. In this episode, ERISA & benefits partner Josh Lichtenstein, benefits principal David Kirchner and benefits consultant Aneisha Worrell discuss the DOL’s final rules concerning ESG investing and proxy voting and what impact the change in presidential administration may have on the fates of these rulemakings.


Aneisha Worrell: Hello, and thank you for joining us today on this Ropes & Gray podcast. I’m Aneisha Worrell, an attorney in the Ropes & Gray benefits consulting group based in Boston. Joining me today are Josh Lichtenstein, an ERISA partner based in New York, and David Kirchner, a principal in our benefits consulting group, who’s also based in Boston. Today, we are going to talk about two major rules from the DOL finalized at the end of last year that may have a big impact on private sector retirement plan fiduciaries this year, and how the Biden administration may change those rules.

After years of relative inactivity on the rulemaking front, the DOL unleashed a wave of important regulations in 2020, including rules on (i) the role of ESG in fiduciary investment process and (ii) how fiduciaries must vote proxies on behalf of plans. Josh, before we get into the substance of these rules, can you let us know how you think the Biden administration is likely to react to these developments?1

Josh Lichtenstein: Thank you, Aneisha. This is the question that everyone is asking, and with good reason. As you mentioned, there was a huge wave of regulatory activity from the DOL last year, and the ESG and proxy voting rules may be the most consequential of those rules for the retirement marketplace. That said, just because there’s a new administration, that doesn’t mean that the President or the DOL, can just eliminate or reverse these actions with a stroke of a pen. The ESG and proxy rules were both adopted as amendments to existing DOL regulations, and they were finalized and published in the Federal Register with effective dates prior to President Biden’s inauguration. As a result, the day one regulatory freeze that was placed on in-progress rulemakings does not apply to these rules. Nonetheless, President Biden has issued an executive order requiring the ESG rule to be reviewed by the Secretary of Labor, so we know that at least that rule will be reconsidered by the Department.

There are several ways that the ESG rule (and the proxy voting rule, which wasn’t explicitly mentioned but could be considered) could be modified from their current forms, but it is important to remember that until some formal agency action is taken, both rules are effective, and compliance is required as a technical matter.

  • The first action that we would expect from the Biden administration is a stay on enforcement of one or both of these rules by the DOL. While this would not completely eliminate the need to comply with the rules (since claims for breaches of the fiduciary duties would still be permissible in court), it would be a major indicator that the DOL intends to make changes to the rules and would also ensure that any delays or compliance phase-in in response to the rules would not be an issue on any DOL examination.
  • Longer-term changes could also be implemented by proposing a new regulation or an amendment to the existing regulation; however, this is a time-consuming process that would require the DOL to draft a new rule and publish it in the Federal Register for public notice and comment, so this is no quick fix.

I assume that if the Department goes on with a wholesale rewrite of either or both of those rules, it will return to its traditional practice of offering 60-day or longer comment periods – this would differ from the Trump administration, which issued both rules with very short 30-day comment periods. In addition, the DOL would need to be prepared for a challenge to any new rule on the basis that it acted in an arbitrary and capricious manner, since a change in administration isn’t enough on its own, to reverse or rewrite a regulation. The DOL would likely need to both materially change the rule and have a well-supported rationale for why the change was needed in order to defeat this type of challenge in court.

An easier and faster route might be to clarify the final regulations that were issued and are currently effective by issuing additional sub-regulatory interpretative guidance. For example, the DOL could leave the ESG rule in place but release official guidance, such as FAQs or examples, and to make it clear that fiduciaries can incorporate ESG factors as pecuniary factors, and they would therefore be appropriate for consideration under the existing final rule. Even if the DOL does not take formal action like this, the rules could also be challenged in court, and the Biden administration could elect not to defend them in whole or in part, but it is important to remember that the rules were severable in all aspects, so even if one part of the rule was struck down by court, that doesn’t necessarily mean the whole rule would be struck down.

Finally, with the new Democratic majority in the Senate, it’s possible that Congress could invoke the Congressional Review Act (CRA) to eliminate one or both rules, but given the many pressing tasks that Congress has on its plate, it’s impossible to gauge how likely that scenario is. If the CRA was triggered, it would create a new set of concerns, because the DOL’s future authority to issue rules on ESG or proxy voting is applicable would actually be limited unless Congress took the highly unlikely step of amending ERISA to clarify how fiduciaries are supposed to consider ESG factors or vote proxies.

So the bottom line is that even if the Biden administration disagrees with these rules, which we believe they do, the paths to overturning them are uncertain and time-consuming, and, much like the process with the DOL’s prior fiduciary rule, there is likely to be significant uncertainty until a final resolution can be reached.

Aneisha Worrell: Josh, thanks for providing that helpful color. So it sounds like while it may feel like we are in a holding pattern and some plan sponsors and fiduciaries may be inclined to just wait and see how everything shakes out first, as you mentioned initially, both rules have been finalized and published in the Federal Register. Based on the status of the rules, it seems like it is important for plan fiduciaries to understand their requirements and come up with a compliance plan. Starting with ESG first, Josh, can you begin by giving listeners a little background as to what issues the DOL was looking to address with these final rules?

Josh Lichtenstein: Of course. As ESG funds have become more prominent, the DOL has continued to look at and evaluate ESG factors and the role that they have been playing in the fiduciary investment decision-making process for plan fiduciaries. For example, last year, the regional enforcement offices of the Employee Benefits Security Administration (or EBSA) sent out fact-finding requests to many defined contribution plan fiduciaries. The requests seem to be an attempt to better understand how these plan fiduciaries have selected ESG funds for inclusion among plan investment options on the 401(k) investment lineups. In particular, for each investment that was based on ESG factors, EBSA requested documents reflecting calculations or disclosures of gains or losses on plan investments; reports regarding investment performance or returns; financial statements or audits prepared for the plan; and disclosures and communications describing features such as the investment risks for each of the plan’s investments.

Essentially, the Department of Labor has been looking to confirm that fiduciaries were prudently selecting plan investments based on their economic and financial characteristics. This singular focus on financial factors has been the DOL’s policy for years—although historically it has been articulated in sub-regulatory guidance. In that sense, the final rules do not fundamentally shift the agency’s long-standing position. They are best understood as creating an explicit obligation that investments must be based only on pecuniary factors—i.e., factors that a fiduciary prudently determines are expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons and consistent with the plan’s investment objectives and funding policy. In addition, fiduciaries are explicitly required to weigh each of these pecuniary factors based on a prudent assessment of impact on risk and return, so fiduciaries have to only consider factors expected to have a material impact on the financial characteristics of the investment and appropriately weight them.

Aneisha Worrell: Thanks, Josh. So, under the final rules, can a fiduciary still select ESG investments without violating their duties under ERISA?

Josh Lichtenstein: Yes, Aneisha – there’s nothing in the rule that says that they can’t. In fact, the words “ESG” are not even mentioned in the final regulatory text. Put another way, including an ESG fund on a plan’s investment menu would be permissible as long as the basis for that decision is purely economic, and those economic benefits are material and were appropriately weighted by the fiduciary as I mentioned before. On that note, I just want to call attention to the recent Intel district court decision, which granted the defendants’ motion to dismiss a lawsuit challenging the prudence of including alternative investments on a 401(k) investment menu as part of a diversified investment option. This recent decision was the first decision of its kind to address the question head-on, and I think we can extrapolate from the ruling that if a plan fiduciary utilizes a comprehensive and diligent process in evaluating and selecting investments—whether they are private equity investments, hedge funds or ESG investments—as long as the selection is carried out following a prudent process that’s based solely on the economic and financial considerations of the participants, it should likely satisfy ERISA’s prudence obligations. We’ll have more to say on the Intel decision in a subsequent episode, so stay tuned because this is a pretty important development.

Aneisha Worrell: Thank you so much, Josh. Now, David, with the final rules taking effect a couple weeks ago, can you tell us what plan sponsors and fiduciaries of 401(k) and 403(b) plans should be doing now to ensure they are in compliance with these rules?

David Kirchner: Sure, Aneisha. As a preliminary matter, although the rule took effect on January 12, 2021, the DOL explained how fiduciaries will not be required to divest from existing investments even if they were originally selected in a manner that is now prohibited. Moreover, the prohibition in the final rule on selecting an investment fund, product or portfolio that includes the use of non-pecuniary factors as an individual account plan’s QDIA will not take effect until April 30, 2022.

Nonetheless, at this time, plan fiduciaries and investment committees should be evaluating their investment policies and procedures to make sure they align with the requirements of the rule on a go-forward basis. They should also revisit any ESG funds they previously selected and vet them through a more stringent process looking “purely” at the material economic characteristics of the funds. In other words, if certain investments had been selected in the past based on their ESG qualities—maybe there is even a separate investment category called “ESG Funds”—it is time to revisit those investments to determine if they still warrant inclusion based on a pecuniary analysis.

In evaluating the economic and financial appropriateness of an ESG fund, plan sponsors ought to avoid conducting that analysis in a vacuum – don’t just compare the ESG fund to other ESG funds. Make sure any comparative analysis looks at how the ESG fund performs relative to non-ESG funds as well.

Furthermore, from a documentation standpoint, plan fiduciaries may want to consider adding language to the investment policy statement for their plans explaining how investments will be reviewed and selected solely on the basis of pecuniary factors.

Aneisha Worrell: Thank you, David – that’s very helpful. So far, we have primarily been focused on how this rule affects plan sponsors. Josh, can you explain a little what impact these rules will have on investment managers to ERISA plans?

Josh Lichtenstein: Sure. I think that the most important impact of this rule on managers is going to be on marketing – not so much on the operation of managers’ funds. Right now, managers should be reevaluating any of their marketing documentation that is going to be distributed to current or prospective ERISA investors to make sure that the materials are evidencing their focus less on the ESG qualities of the fund (socially responsible investing and the like), and more on the financial and economic characteristics of an investment in those funds. Now admittedly, this is a tricky needle to thread because there are other regulatory pressures coming from other areas such as the EU, which has fully embraced the importance of ESG investing and expects asset managers to explicitly focus on ESG. But at the same time, if the materials suggest that non-pecuniary factors are being used in connection with an investment thesis, then it’s going to be harder for a plan sponsor to get comfortable choosing that investment. So this is a tricky balancing act, but it’s really important to make sure that real care, thought and attention is paid to especially these marketing materials.

Aneisha Worrell: Thanks so much, Josh – that does sound tricky indeed. Let’s shift gears a bit to another recent and important DOL rulemaking—proxy voting. In a prior podcast, we discussed how President Trump had issued an executive order to the DOL to undertake a review of existing guidance concerning fiduciary responsibilities as they apply to proxy voting. The DOL responded to that directive with its rulemaking last year. David, can you tell us where the DOL ultimately came out?

David Kirchner: Indeed. The DOL’s proxy voting final rule also incorporates the principle that financial factors impacting plans and their participants and beneficiaries should be the only considerations driving fiduciary decision-making, including the decision to vote on the proxies. According to the DOL, there had been a misconception among plan fiduciaries that they had to always vote proxies, even when doing so would not result in a financial benefit to the plan and its participants. The agency’s final rule took a principles-based approach for determining whether a plan fiduciary should vote proxies in the hopes that such an approach will reduce these alleged “unnecessary” expenditures of plan assets on matters that were not considered economically relevant.

Aneisha Worrell: Thank you so much, David. Josh, can you walk us through the approach the DOL adopted in the final rules, and in particular, what obligations the DOL said a plan fiduciary must satisfy when it comes to determining whether or not to vote proxies?

Josh Lichtenstein: As David was saying, the final rules explicitly provide that the fiduciary duty to vote proxies does not require that every proxy be voted, and this hews to the DOL’s historic stance on proxy voting, requiring a “cost-benefit” analysis to decide whether to vote. The final rule contains a list of requirements that must be met in order for a fiduciary to satisfy its duties of prudence and loyalty in this context, which include:

  • Acting solely in accordance with the economic interest of the plan and its participants and beneficiaries;
  • Considering any costs involved in voting or taking action;
  • Not subordinating the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to any non-pecuniary objectives;
  • Evaluating the material facts that are known (or that are available to and reasonably should be known by the fiduciary), which form the basis for any particular proxy vote; and
  • Maintaining records on proxy voting activities.

In addition, fiduciaries are required to exercise prudence and diligence in working with proxy advisory firms, so while the final rule is much less onerous than the proposed rule, there’s still a fair amount that does need to be considered. But in addition and perhaps of greater significance to many plan fiduciaries, there’s a new requirement to exercise prudence and diligence in working with proxy advisory firms. In other words, plan fiduciaries are no longer granting broad deference – just follow the recommendations provided to them by proxy advisory firms unless they first determine whether the firm’s proxy voting guidelines are consistent with the final rules. Separately, when the voting decisions are delegated to an investment manager, the plan fiduciary is required to prudently monitor the decisions that its investment advisers make regarding proxy voting.

Aneisha Worrell: That seems like a lot of work, Josh. Turning to David, did the DOL provide any safe harbors that could provide some comfort to the plan fiduciaries that they are meeting their obligations under the final rule without necessarily jumping through all of the hoops that Josh just described?

David Kirchner: Fortunately, Aneisha, the DOL included a couple safe harbor policies that plan fiduciaries can adopt, which include:

  1. Having a policy of limiting votes to proposals that the fiduciary has prudently determined are substantially related to the issuer’s business activities or are expected to have a material effect on the value of the plan’s investment; or
  2. Having a policy of refraining from voting on proposals where the size of the plan’s holding in that particular security is below a quantitative threshold that the fiduciary has prudently determined, that is so small that the outcome of the vote is unlikely to have a material impact on the investment performance of the plan’s portfolio.

For plan sponsors and investment committees, we think now is the time to consider revising written investment policies to add one or more of these safe harbors, and to periodically review policies moving forward. That said, just because you have them, that doesn’t mean that you are hard-pressed to always follow them. The DOL provided in the preamble that the safe harbors are intended to be applied flexibly rather than in a binary “all or none” manner. Moreover, a fiduciary may still override the policies if it prudently determines that the matter being voted upon would have an economic impact on the plan after taking into account the costs involved.

Aneisha Worrell: Thank you, David. That’s good to know and very helpful. Switching perspectives, will managers of pooled investment vehicles have to make big changes in response to this rule, Josh?

Josh Lichtenstein: Yes, Aneisha. These rules can actually create a surprising amount of work for investment managers. The final rule says that a plan asset fund manager must either reconcile the proxy voting policies of each investing plan or develop its own investment policy statement that governs proxy voting, in which case, they have to require each participating plan to accept it before they’re allowed to invest.

Practically speaking, we don’t anticipate managers to actually go through the process of trying to reconcile all of the different policies of different investing plans. Instead, we expect managers to require ERISA investors to review and sign on to the manager’s polices. On that note, plan sponsors should expect to receive a lot more paper this year, which will include the managers’ new or revised proxy voting policies and investment policy statements that incorporate them.

Aneisha Worrell: And finally, Josh, I want to briefly discuss what seems like one of the more confusing aspects of these releases. What are the applicability dates of the final rules, and did the DOL provide any kind of transition relief in the release?

Josh Lichtenstein: Generally speaking, the rules took effect on January 15, 2021. However, the DOL has provided a later applicability date for certain portions of the rule. In particular, fiduciaries other than registered investment advisers will have until January 31, 2022 to comply with:

  • the requirement to evaluate material facts that form the basis for any particular proxy vote or other exercise of shareholder rights; and
  • the requirement to maintain records on proxy voting activities and other exercises of shareholder rights.

Essentially, these are requirements that mirror what the SEC already requires registered investment advisors to do, and so fiduciaries other than those RIAs are not going to be required to comply with those until January of next year.

In addition, all fiduciaries will have until January 31, 2022 to comply with:

  • the requirement to reevaluate the use of proxy voting firms; and
  • the requirement that we just discussed for investment managers to pooled vehicles holding assets of multiple employee benefit plans to adopt new policies or to have to reconcile the policies of each investing plan.

Aneisha Worrell: Well, that’s all the time we have today. Thank you so much to Josh and David for joining us today and sharing some valuable insights. For more information on the topics that we discussed, please visit our website at And of course, if we can help you navigate any of the topics we discussed today, please don't hesitate to get in touch. You can also subscribe and listen to this series wherever you regularly listen to your podcasts, including on Apple and Spotify. Thanks again for listening and please take care.

  1. Update: On March 10, 2021, the U.S. Department of Labor (DOL) released a much-anticipated enforcement policy statement that says it intends to revisit its recently published final rules on “Financial Factors in Selecting Plan Investments” and “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.” Until it publishes further guidance, the DOL will not enforce either rule or otherwise pursue enforcement actions against any plan fiduciary based on a failure to comply with those final rules with respect to an investment (including a qualified default investment alternative) or investment course of action or with respect to an exercise of shareholder rights. Please click here to view our alert that contains additional information on this important development.
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