DOL Finalizes Guidance on ESG Investing in Retirement Plans

The Department of Labor (DOL) has finalized regulations meant to show retirement plan sponsors and their investment advisors how to meet ERISA fiduciary standards of loyalty and prudence when selecting plan investments. At issue has been whether and how fiduciaries could incorporate environmental, social, or corporate governance (ESG) factors into their investment selection process. Over the years, there have been concerns that plan fiduciaries who select socially responsible or other ESG-related investments could be sacrificing returns or taking on additional risk for collateral benefits. The DOL has issued several iterations of guidance on this issue, which have alternately encouraged or discouraged the consideration of ESG factors.

In contrast to regulations issued in 2020 that were never enforced, the newest regulations make clear that fiduciaries may consider the economic effects of ESG and other collateral factors if they reasonably determine the factors to be relevant to their risk/return analysis of a particular investment or investment course of action and when they exercise shareholder rights, such as proxy voting. Examples of such factors could include evaluating a corporation’s:

  • Exposure to the economic effects of climate change

  • Executive compensation

  • Compliance with labor, employment, environmental, and tax laws

  • Progress with workforce diversity and inclusion.

The final regulations permit the use of ESG investments as qualified default investment alternatives (QDIAs) and allow fiduciaries to take participant preferences for ESG investing into account when building an investment menu. Fiduciaries must still follow longstanding ERISA principles of prudence and loyalty when selecting plan investments, which means that fiduciaries must focus on relevant risk/return factors and not subordinate the interests of participants to objectives unrelated to the provision of benefits under the plan. Plan fiduciaries must focus on factors they deem relevant to a risk and return analysis, “using appropriate investment horizons consistent with the plan’s investment objectives and taking into account the funding policy of the plan.” These rules take effect on January 30, 2023.

Plan sponsors may want to review their plan’s investment policy statement (IPS), considering the DOL’s final regulations, and work with their plan advisors to ensure that their process for selecting and monitoring plan investments complies with the regulations and the plan’s IPS.