The DOL’s About-face on ESG for ERISA Plan Fiduciary Investment Decision-making

November 22, 2021
18:18 minutes

In the latest installment of our Ropes & Gray podcast series addressing emerging issues for fiduciaries of 401(k) and 403(b) plans to consider as part of their litigation risk management strategy, ERISA and benefits partner Josh Lichtenstein, benefits consulting group principal David Kirchner, and benefits consultant Aneisha Worrell revisit the Department of Labor’s (DOL) regulation of ERISA investment duties and ESG considerations, and in particular, its recently re-proposed rule. As compared to the prior rule passed by the Trump administration at the end of last year, which Messrs. Lichtenstein and Kirchner and Ms. Worrell discussed in the first episode of this series in February, the latest proposal signifies a major shift in the Department’s attitude towards ESG factors, and if finalized, would significantly alter the investment landscape for ERISA plan sponsors and fiduciaries.

Please stay tuned for part two of this discussion, where we will discuss the implications of the DOL’s ESG proposal for asset managers.


Aneisha Worrell: Hello, and thank you for joining us today for the latest installment in our ongoing Ropes & Gray podcast series addressing the emerging issues for 401(k) and 403(b) retirement plan fiduciaries to consider as part of their litigation risk management strategy. I’m Aneisha Worrell, an attorney in the Ropes & Gray benefits consulting group based in Boston. And joining me today are Josh Lichtenstein, an ERISA and benefits partner based in New York, and David Kirchner, a principal in our benefits consulting group, also based in Boston. Welcome, Josh and David. This series began in February with the three of us talking about the Trump administration’s final rules concerning ESG investing and proxy voting, and what impact the change in presidential administration would have on the fates of these rulemakings. Over the ensuing months, we have received some answers to that important question. Let’s dive in.

Following the DOL’s announcement in March that it would not enforce these rules and an executive order signed by President Biden in May directing the federal government to identify climate-related financial risk to protect the life savings and pensions of U.S. workers and their families, the DOL unveiled a new ERISA investment duties proposal last month that essentially reverses the prior rule’s implicit rejection of ESG factors as viable considerations in ERISA plan investment decision-making. Although the comment period remains open, we expect support for the proposal—we summarized our thoughts on this, and that’s available on our webpage. We anticipate much broader support than for the 2020 rule, which garnered widespread criticism from plan participants, sponsors and investment managers alike. Josh, before we go further, can you briefly walk through some of the proposal’s key changes from the prior rule for our listeners, and explain why plan sponsors have been so focused on this issue?

Josh Lichtenstein: Of course, Aneisha, and thanks for having me today. As we have previously discussed in these podcasts, the 2020 ESG rule had a chilling effect on plan fiduciary behavior because it narrowly restricted the universe of acceptable investment considerations for evaluating and selecting plan investment options by introducing the concept of pecuniary factors. That rule defined a “pecuniary factor” as a factor that a fiduciary had prudently determined was expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and funding policy. So, the rule required fiduciaries to weight each pecuniary factor based on a prudent assessment of that individual factor’s impact on risk and return. Moreover, the prior rule only permitted consideration by plan fiduciaries of collateral factors, such as ESG factors in very rare cases where two investment alternatives were deemed to be economically indistinguishable—what is referred to commonly as a tiebreaker scenario. Even though it did not mention ESG explicitly in the final regulatory text, when the final rule was read in the context of the original proposed regulation and the preamble, the 2020 rule evoked strong skepticism in the market around the ability for ESG factors to be considered as pecuniary factors.

The new proposal’s underlying principle, that plan fiduciaries have to remain singularly focused on economic risks and returns in choosing investments and cannot prioritize collateral considerations is consistent with long-standing Department of Labor guidance in this area. It is actually similar to the prior rule in that regard. But what the DOL has really changed is its tone with respect to the idea of when ESG factors can be legitimate economic factors and when they should be evaluated in that manner. The proposal requires fiduciaries to give appropriate consideration to the facts and circumstances relevant to a particular investment, which includes the projected return of a portfolio relative to its funding objectives, and this analytical process may often require an evaluation of the economic effects of climate change and other ESG factors according to the Department of Labor.  

Aneisha Worrell: Josh, thank you for that background. So, it sounds like the main change between the 2020 rule and the proposal is the tone—why is that so significant? 

Josh Lichtenstein: It’s a great question. The tonal shift is so significant because even though the prior rule was largely consistent with the historic Department guidance, all of the messaging around the prior rule combined to give the impression that ESG factors were disfavored as economic factors.  The proposed regulation has not substantively changed the legal standard imposed by the statute, ERISA, with respect to evaluating and selecting plan investments—and in fact, in multiple places in the preamble to the proposed rule, the Department describes the proposal as just clarifying the existing standard. But the shift in the Department’s tone tells us that ESG factors that will have a material impact on the financial risk/return of an investment are entitled to equal footing as more traditional economic considerations when evaluating investments. 

As an example of this tonal shift, for investments with long investment horizons—which, by their very nature, are often the types of investments that ERISA plans would make—the DOL states that fiduciaries may have to consider the negative economic effects of climate change, such as wildfires, flooding, droughts, sea level rise, and governments’ regulatory responses to climate change effects. This language appears to create a sort of soft presumption that in discharging its duties, a prudent fiduciary should be analyzing the ESG characteristics of an investment to see if those attributes will carry economic import in the longer term, so it becomes part of the regular consideration process for a typical investment.

Furthermore, while reiterating that fiduciaries have broad discretion to consider any factor in the evaluation of an investment so long as it is material to the investment’s risk-return analysis, the proposal explicitly refers to climate change-related factors, governance factors and workforce practices, individually, as examples that may be considered. And this is just another example of where this tonal shift makes it clear that the Department of Labor does view ESG considerations broadly as appropriate considerations.

Aneisha Worrell: Thanks for that additional color, Josh. Now, I’d like to focus a bit more on that chilling effect that the prior rule caused. David, why is that chilling effect so problematic in terms of the broader investment landscape, and how would the proposal change that?

David Kirchner: Well, Aneisha, what we have seen as a result of the prior rule is that ESG has become the Voldemort-like idea to sponsors and investment committees, where they have intentionally avoided any mention of these factors in their deliberations or they have resisted including ESG-themed investments on plan lineups, out of fear that doing so leaves them vulnerable to a potential lawsuit under the rule. Of course, this is increasingly at odds with the trajectory of the broader markets where ESG investing has exploded in recent years in response to investor desire—especially, amongst younger investors—as well as governmental initiatives in the U.S. and abroad to facilitate the promotion of these types of strategies. As a result, many investment products in the broader market currently tout the ESG qualities, even if the investment isn’t a traditional ESG-themed fund or an economically targeted investment.

That said, it seems as though it’s a whole new ballgame as a result of this proposal. Instead of avoiding any discussions of ESG, the proposal would encourage fiduciaries to actively discuss ESG factors as a part of the investment decision-making process. Furthermore, the discussions between plan sponsors and their investment advisors about these topics will take on more nuance—rather than just determining whether a bona fide ESG-themed investment fund is appropriate for the plan lineup, fiduciaries will want to evaluate any given investment’s ESG qualities to see how they differentiate it from other potential investment options, and whether these ESG qualities—or put it another way, the investment’s “ESGness”—is material to the economic risk and return of an investment. The proposal allows for fiduciaries to recognize there is a spectrum of funds that have ESG features (or not), and the fiduciaries should ensure they are discussing the materiality of these features with their investment advisors throughout any deliberation process of plan investments.

Aneisha Worrell: David, I like how you say, “ESGness” of an investment product. Can you elaborate on that point and explain how it is different than a fund that has ESG in its name?

David Kirchner: Sure.  Looking back a decade ago, when people spoke about ESG, they were referring to funds and investments that were marked as ESG products or that ESG was in their name. And in many ways, that perception has persisted such that many plan sponsors and fiduciaries still take a binary view of ESG—a fund is or is not an ESG investment. But what the proposal acknowledges is that any investment product or fund could have ESG attributes that could have a material impact on future cash flows or modeled discount rates, and therefore, it may be prudent to evaluate these ESG-related risks and opportunities in the context of the many investment funds in a plan.

For example, would a plan investment committee be prudently considering the risks and returns of including a large-cap energy fund that has a significant stake in coal in its lineup, without examining the deleterious effects that the coal industry may have on the climate and future profitability of coal? Under the 2020 rule, it’s unclear whether the investment committee would feel comfortable having that discussion. But under the proposal, it would behoove the fiduciaries to have these discussions internally and with their investment advisor, and in general, to take a more holistic and long-term view of the investments under consideration. 

Aneisha Worrell: David, it sounds like the proposal has the potential to dramatically alter decision-making processes used by plan sponsors and investment committees when choosing investments, is that right?

David Kirchner: Absolutely, Aneisha. As Josh explained earlier, the proposal says that ESG factors that have a material impact on risk-return should be treated like any other traditional, economic factor that the fiduciary should analyze, as part of giving consideration to facts and circumstances that the fiduciary either knows or should know are relevant to a particular investment. Furthermore, the proposal modifies the rules governing the prior rule’s tiebreaker or “all things being equal” standard by (i) easing the threshold of when those rules get triggered, and (ii) in the case of choosing between investments for a default investment alternative (like a QDIA), allowing the fiduciary to select an investment based on collateral considerations without having to comply with overly burdensome documentation requirements included in the prior regulation. Instead, the plan fiduciary would just have to ensure that the collateral-benefit characteristic of the fund, product, or model portfolio is prominently displayed in any disclosure materials provided to participants and beneficiaries. In this regard, the proposed changes better align the tiebreaker scenario rules with the framework the DOL had adopted in sub-regulatory guidance over the years prior to the 2020 rule.

In summary, under the proposal, we would expect plan sponsors to consider ESG factors as part of their ordinary course decision-making process, and if these considerations were ultimately disregarded, we would expect fiduciaries to diligently document the reasons why, just like how they would for any other factor.

Aneisha Worrell: We know from past episodes in this series—in particular, Episode 7, which focused on recent ERISA litigation trends and outcomes—that excessive fee lawsuits have been all the rage in recent years. Josh, how might a plan’s increased utilization of ESG funds and investments as a result of this rule—once it’s finalized, of course—tie into the broader litigation trends that we’ve been seeing?

Josh Lichtenstein: Well, obviously first, we’ll need to see how the Supreme Court ultimately rules in the Northwestern case that you were mentioning this term because that could shift the whole landscape, but given the popularity of excessive fee lawsuits, it is conceivable that these types of claims could actually proliferate in the ESG context. Future lawsuits may question whether choosing certain investments based, in part, on ESG considerations was prudent under ERISA, not withstanding the much more favorable language in the proposed regulation. We could also see lawsuits that make the opposite allegation—that a failure to include certain investments with significant ESG characteristics on the plan investment lineup was itself a breach of fiduciary duty under ERISA. Either way, fiduciaries will want to take proactive steps to mitigate this risk by following a diligent and well-documented process in evaluating investments, and in particular, they will want to rigorously document how they considered ESG factors as part of that process. As ERISA practitioners like to say, and as we’ve said many times on this series, “prudence is process.”

As the market for ESG investments continues to expand in the years to come, plan sponsors will likely be looking to their consultants and advisors to help them make sense of the various products that will become available to them. For sure, with improved benchmarking and ratings of ESG products, and more fulsome, standardized disclosure on ESG characteristics, and the economics and other impacts that a fund is having, this will help with the plan sponsor education process. But there’s certainly going to be a lot more for plan sponsors to learn and think about, and we will have more to say on these sorts of questions in our next episode where we’ll focus on some of these issues in more depth.

Finally, plan sponsors will want to engage in educating their participants and beneficiaries with respect to current as well as new plan investment options that consider ESG factors or focus on ESG. Some participants or beneficiaries may feel that the plan’s priorities have changed as a result of considering ESG factors. And sponsors will need to educate their plan participants and beneficiaries to reaffirm that the plan fiduciary’s central objective remains to act in the best interests of the participants and beneficiaries, and that is unchanged. Plan sponsors will also want to convey that any new investment options that include ESG features have been chosen following a process in which the fiduciary considered the economic factors that were material to the risk and return analysis of the investment, and that ESG attributes were just part of that deliberative process.

Aneisha Worrell: Well, before we get ahead of ourselves, let’s first see if the Supreme Court changes the applicable pleading standards in Northwestern, and then we can see how the fee litigation landscape evolves after that. On that note, that’s all the time we have today. We look forward to continuing this discussion in our next episode, which will address the DOL’s proposal from the asset manager’s perspective, and expand on some of the questions or issues that will arise with the promise of greater uptake of ESG by retirement plans. So, please stay tuned for that.

Thank you again to Josh and David for joining us today, and sharing many valuable insights. For more information on the topics we’ve discussed, please visit our website at And of course, if we can help you navigate any of these topics, 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.

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