Regulatory and legislative developments continue to accelerate around investments incorporating environmental, social, and governance factors into retirement plans. Plan sponsors and fiduciaries should take note of the fast-changing landscape when selecting and monitoring investment options.
In late 2020, the Department of Labor under the Trump administration finalized a rule that seemingly questioned whether ESG investing could be compatible with the duty of prudence outlined in the Employee Retirement Income Security Act of 1974 (ERISA).
After President Joe Biden was elected, DOL announced it would not enforce this rule, and presented a new proposed rule in October 2021 that would remove barriers to plan fiduciaries’ ability to consider ESG factors more permanently. However, since the comment period for the proposed rule closed on Dec. 13, 2021, it has been unclear when DOL will issue a final rule.
Meanwhile, Republican legislators introduced bills in the US Senate and House that would discourage use of ESG factors. Eighteen Republican state attorneys general issued a letter warning about use of ESG factors, and several state governments have taken steps to limit ESG investing.
In this fast-changing environment, to minimize the risk of lawsuits and DOL investigations based on ERISA’s duty of prudence, plan sponsors and fiduciaries considering ESG investments may wish to consider the issues outlined below.
Focus on Process
Since the passage of ERISA, DOL has not promulgated any specific rules regarding steps plan sponsors and fiduciaries should take to ensure a prudent process. However, courts have consistently interpreted the duty of prudence as requiring the plan sponsor to select and monitor the plan’s investment options with the skill of a prudent expert.
This subjective “prudent expert” standard makes it more important than ever to conduct an “objective, thorough, and analytical review” of all material factors in the fund selection and monitoring process.
Specifically, a prudent expert may choose to measure an investment option’s performance relative to, for example, a widely used benchmark and comparable peer investments.
Fiduciaries that do choose to consider ESG factors as part of their process, consequently, should be prepared to provide comprehensive documentation demonstrating that they have conducted a review that concludes the inclusion of ESG factors is material to an investment’s risk and return profile.
Implement Rigorous Documentation
In its Meeting Your Fiduciary Responsibilities publication, DOL specifies that plan sponsors may limit their liability and show they complied with their fiduciary duties by documenting the processes used to carry out these responsibilities.
In particular, to the extent the fiduciary relied on information and advice from others, documentation is critical to establishing the qualifications of the expert, the subject of the advice, and why the expert was …….