Fiduciaries managing US retirement plans subject to the Employee Retirement Income Security Act (ERISA) have a clear duty to maximize their clients’ portfolios while minimizing risk. As the importance of environmental, social, and governance (ESG) factors becomes more widely examined and embraced, many are considering whether the consideration of ESG factors is consistent with the duty owed by ERISA fiduciaries to retirement plans.

Fiduciary Duty and ESG Investing

Broadly speaking, a fiduciary is a party entrusted to act solely in the best interest of another. ERISA specifies that retirement plan fiduciaries must act prudently and solely in the interests of the plan’s participants and beneficiaries for the exclusive purpose of providing benefits to them and to diversify the investments of the plan so as to minimize the risk of large losses.

With ESG investing, there is some debate over whether ESG factors are appropriate for consideration by ERISA plan fiduciaries. This arises in part from the often-challenged perception that ESG investing necessitates lower returns. As Andrew Oringer of Dechert LLP told PLANSPONSOR: “Saying ESG will help me pick better-performing companies does work with ERISA, but focusing on ESG to better the world does not.”

Sonal Mahida, Intentional Endowments Network (IEN) senior advisor and head of North America for the Principles for Responsible Investment (PRI), is among those arguing that ERISA fiduciary duty and ESG investing are compatible. Citing “[o]utdated interpretations and limited understandings of materiality,” Mahida writes that failure to consider “key material factors,” including those tied to ESG, can mean “fall[ing] short of maximizing a portfolio’s risk and return profile.” PRI’s Untangling Stakeholders for Broader Impact: ERISA Plans and ESG Incorporation points out that the US has lagged behind peer countries on integrating ESG into private-sector retirement plans and offers strategic recommendations for aligning stakeholder interests and advancing ESG.

Evolving DOL Guidance and More Hurdles for ESG Investors

The DOL’s guidance on ESG investing has evolved from its 2008 statement discouraging the integration of nonfinancial factors to its 2015 guidance citing these factors as viable financial considerations. In 2018, the DOL added a note of caution, stressing that “[f]iduciaries must not too readily treat ESG factors as economically relevant.”

In June 2020, the DOL proposed new rules that some industry observers and ESG advocates worried would limit retirement plan fiduciaries’ ability to select ESG investments. The authors of one article published by the Harvard Law School Forum on Corporate Governance wrote that the proposed guidance would broaden the field of “ESG-themed fund[s] or mandate[s] triggering heightened scrutiny and procedural requirements,” including increased documentation. Industry groups like the IEN helped organize efforts to register opposition during the window for public comment. According to analysis by representatives of Morningstar, Ceres, the Interfaith Center for Corporate Responsibility, and others, roughly 95% of commenters opposed the proposed rules.

In response, the DOL pulled back on ESG language in the operative text of the final rule, which it announced this October. Acknowledging commenter concerns that the proposal could be read as “improperly” targeting ESG considerations, the DOL notes that the wording of the final rule emphasizes “pecuniary factors and non-pecuniary factors in defining the relevant fiduciary investment duties.” “The focus on the final rule is on whether a factor is pecuniary, not whether it’s an ESG factor,” according to one DOL official; this preserves the possibility for ESG factors to be considered pecuniary. Still, the DOL Employee Benefits Security Administration determined that the lack of standardized definitions of ESG “made ESG terminology not appropriate as a regulatory standard.”

Despite the changes reflected in the final rule, some investors remain concerned about its potentially chilling effects on ESG. “Today’s decision is unwelcome by pension funds and other fiduciaries and runs counter to global market trends and the mainstream US and global practice of integrating ESG factors into investment decisions,” said Ceres CEO Mindy Lubber, who fears that the rule could “impair the ability of pension funds to consider the short and long-term financial risks posed by extreme weather, water shortages and human rights abuses in performing their investment analysis and allocations.” Lisa Woll, CEO of the Forum for Sustainable and Responsible Investment said that the rule “will create confusion in the entire retirement market about the ability to offer funds that utilize ESG criteria.” She added that it “also puts a substantial burden on fiduciaries who consider ESG factors in their retirement plans, requiring additional documentation to justify why ESG factors are financially material.”

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