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Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights rule (2023)

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The Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights rule is a significant rule issued by the U.S. Department of Labor (DOL) effective January 30, 2023, that amended the Employee Retirement Income Security Act of 1974 (ERISA) to allow retirement plans to consider certain environmental, social, and corporate governance (ESG) factors in investment-related decisions. The rule replaced the Trump administration's Financial Factors in Selecting Plan Investments rule, which required fiduciaries under the ERISA to consider only financial returns and material risk factors in their investment decisions.[1]

A Congressional Review Act resolution (H.J. Res. 30) aiming to block the rule was passed by Congress on March 1, 2023, however, the resolution was vetoed by President Joe Biden (D) on March 20, 2023. For more information about the resolution and subsequent veto, click here.

HIGHLIGHTS
  • Name: Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights
  • Agency: Employee Benefits Security Administration, Department of Labor
  • Action: Final rule
  • Type of significant rule: Economically significant rule

    • Timeline

    The following timeline details key rulemaking activity:

    • January 30, 2023: The final rule took effect.[1]
    • December 1, 2022: DOL published the final rule.[1]
    • December 13, 2021: DOL closed the comment period.[2]
    • October 14, 2021: DOL published the proposed rule and opened the comment period.[2]
    • May 20, 2021: President Joe Biden (D) issued an executive order in an effort to reduce climate-related financial risks. The order directed the DOL to consider a proposed rule to suspend or amend the rules "Financial Factors in Selecting Plan Investments" and "Fiduciary Duties Regarding Proxy Voting and Shareholder Rights," published in 2020.[3]

    Background

    Environmental, social, and corporate governance
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    See also: Environmental, social, and corporate governance (ESG)

    Title I of the Employee Retirement Income Security Act of 1974 (ERISA) governs private-sector employee benefit plans and establishes standards for fiduciary responsibilities. The Trump administration published a final rule in November 2020 directing the U.S. Department of Labor to amend ERISA regulations to "require plan fiduciaries to select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action," according to the rule. This rule was followed by another final rule in December 2020, which aimed to amend and establish regulations regarding proxy voting and shareholder rights.[1]

    President Joe Biden (D) issued an executive order on January 20, 2021, directing executive agencies to review and amend regulations that may conflict with efforts to protect the environment and public health, according to the order. Biden issued another executive order on May 20, 2021, in an effort to reduce what the order refers to as climate-related financial risks. This order directed the U.S. Department of Labor to consider issuing a proposed rule to revise the ERISA rules published under the Trump administration.[1][3]

    Summary of the rule

    The following is a summary of the rule from the rule's entry in the Federal Register:

    “ The Department of Labor (Department) is adopting amendments to the Investment Duties regulation under Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA). The amendments clarify the application of ERISA's fiduciary duties of prudence and loyalty to selecting investments and investment courses of action, including selecting qualified default investment alternatives, exercising shareholder rights, such as proxy voting, and the use of written proxy voting policies and guidelines. The amendments reverse and modify certain amendments to the Investment Duties regulation adopted in 2020.[1][4] ”

    Summary of provisions

    The following is a summary of the provisions from the final rule's entry in the Federal Register:[1]

    “ The final rule generally tracks the NPRM but makes certain clarifications and changes in response to public comments. Before describing these changes, the Department emphasizes that the final rule does not change two longstanding principles. First, the final rule retains the core principle that the duties of prudence and loyalty require ERISA plan fiduciaries to focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives unrelated to the provision of benefits under the plan. Second, the fiduciary duty to manage plan assets that are shares of stock includes the management of shareholder rights appurtenant to those shares, such as the right to vote proxies. As described in further detail below in subsection B of this section III, the final rule adopts the following changes to the current regulation:
    • Like the NPRM, the final rule amends the current regulation to delete the “pecuniary/non-pecuniary” terminology based on concerns that the terminology causes confusion and a chilling effect to financially beneficial choices.
    • Like the NPRM, the final rule amends the current regulation to make it clear that a fiduciary's determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis and that such factors may include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action.
    • Like the NPRM, the final rule amends the current regulation to remove the stricter rules for QDIAs, such that, under the final rule, the same standards apply to QDIAs as to investments generally.
    • Like the NPRM, the final rule amends the current regulation's “tiebreaker” test, which permits fiduciaries to consider collateral benefits as tiebreakers in some circumstances. The current regulation imposes a requirement that competing investments be indistinguishable based on pecuniary factors alone before fiduciaries can turn to collateral factors to break a tie and imposes a special documentation requirement on the use of such factors. The final rule replaces those provisions with a standard that instead requires the fiduciary to conclude prudently that competing investments, or competing investment courses of action, equally serve the financial interests of the plan over the appropriate time horizon. In such cases, the fiduciary is not prohibited from selecting the investment, or investment course of action, based on collateral benefits other than investment returns. The final rule also removes the current regulation's special regulatory documentation requirements in favor of ERISA's generally applicable statutory duty to prudently document plan affairs.

    The final rule adds a new provision clarifying that fiduciaries do not violate their duty of loyalty solely because they take participants' preferences into account when constructing a menu of prudent investment options for participant-directed individual account plans. If accommodating participants' preferences will lead to greater participation and higher deferral rates, as suggested by commenters, then it could lead to greater retirement security. Thus, in this way, giving consideration to whether an investment option aligns with participants' preferences can be relevant to furthering the purposes of the plan.

    • Like the NPRM, the final rule amends the current regulation to eliminate the statement in paragraph (e)(2)(ii) of the current regulation that “the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right.” The final rule eliminates this provision because it may be misread as suggesting that plan fiduciaries should be indifferent to the exercise of their rights as shareholders, even if the cost is minimal.
    • Like the NPRM, the final rule amends the current regulation to remove the two “safe harbor” examples for proxy voting policies permissible under paragraphs (e)(3)(i)(A) and (B) of the current regulation. One of these safe harbors permitted a policy to limit voting resources to types of 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 investment. The other safe harbor permitted a policy of refraining from voting on proposals or types of proposals when the plan's holding in a single issuer relative to the plan's total investment assets is below a quantitative threshold. Taken together, the Department believes the safe harbors encouraged abstention as the normal course and the Department does not support that position because it fails to recognize the importance that prudent management of shareholder rights can have in enhancing the value of plan assets or protecting plan assets from risk. Because of this failure, the Department believes these safe harbors do not adequately safeguard the interests of plans and their participants and beneficiaries.
    • Like the NPRM, the final rule eliminates paragraph (e)(2)(iii) of the current regulation, which sets out specific monitoring obligations with respect to use of investment managers or proxy voting firms. The final rule instead addresses such monitoring obligations in another provision of the regulation that more generally covers selection and monitoring obligations. These amendments address concerns that the specific monitoring provision could be read as requiring special obligations above and beyond the statutory obligations of prudence and loyalty that generally apply to monitoring the work of service providers.
    • Like the NPRM, the final rule amends the current regulation to eliminate from paragraph (e)(2)(ii)(E) of the current regulation a specific requirement on maintaining records on proxy voting activities and other exercises of shareholder rights. The provision is removed from the current regulation because it is widely perceived as treating proxy voting and other exercises of shareholder rights differently from other fiduciary activities and, in that respect, risks creating a misperception that proxy voting and other exercises of shareholder rights are disfavored or carry greater fiduciary obligations than other fiduciary activities.[4]
    		 ”

    Significant impact

    See also: Significant regulatory action

    An agency rule can be deemed a significant rule if it has had or might have a large impact on the economy, environment, public health, or state or local governments. The term was defined by Executive Order 12866, which was issued in 1993 by President Bill Clinton. The following is drawn from the rule to determine its classification as economically significant or significant for some other reason:[1]

    “ OMB has determined that this final rule is economically significant within the meaning of section 3(f)(1) of Executive Order 12866. Given the large scale of investments held by covered plans, approximately $12.0 trillion, changes in investment decisions and/or plan performance may result in changes in returns in excess of $100 million in a given year.[4] ”

    Text of the rule

    The full text of the rule is available below:[1]

    Responses

    The following sections provide a selection of responses to the final rule issued by the DOL:

    Support for the rule

    Secretary of Labor Marty Walsh issued a press release announcing the rule, arguing that the changes will, in his view, benefit workers:[5]

    “ Today’s rule clarifies that retirement plan fiduciaries can take into account the potential financial benefits of investing in companies committed to positive environmental, social and governance actions as they help plan participants make the most of their retirement benefits. ... Removing the prior administration's restrictions on plan fiduciaries will help America's workers and their families as they save for a secure retirement.[4] ”


    The managing director of the Ceres Accelerator for Sustainable Capital Markets, Steven M. Rothstein, released a November 2022 statement in support of the rule, arguing that fiduciaries, in his view, have a responsibility to account for climate change in their investment options:[6]

    “ This rule removes restrictions imposed during the previous administration that made it difficult for 401(k) and other retirement plan sponsors to include climate-aligned and other ESG funds in the list of options available to participants. ... Fiduciaries have an obligation to provide investment options that take the physical and transition risks of climate change into account.[4] ”

    Opposition to the rule

    A coalition of 50 U.S. senators led by U.S. Senator Mike Braun (R-Ind.) introduced a Congressional Review Act (CRA) resolution on February 7, 2023, aiming to nullify the rule. U.S. Senator Rick Scott (R-Fla.) signed onto the resolution and issued the following statement opposing the rule:[7]

    “ Once again, Biden and his administration are putting their liberal priorities over the best interests of the American people by allowing ridiculous and illogical ESG policies into employer-sponsored retirement plans. This rule allows Wall Street fund managers to make choices on behalf of Americans based on their own beliefs and social agenda, not what’s financially sound. It jeopardizes the hard-earned nest egg millions of families rely on to retire comfortably. Families deserve better, and I’m glad to join my colleagues to fight this rule and reverse this horrible decision.[4] ”


    Kit Gleason, Vice President and Senior Relationship Manager at First Bank and Trust in Sioux Falls, South Dakota, released a statement arguing that uncertainty around the rule's requirements could lead to challenges for its implementation, according to Forbes:[8]

    “ The DOL is suggesting fiduciaries considering ESG investments can project the economic effects of climate change and other ESG factors on future risks and returns. If sponsors are having a difficult time documenting their prudent process for selecting a family of target-date funds, for example, why would we think they will be more qualified or skilled at estimating the long-term economic impacts of climate change, social norms or corporate governance?[4] ”

    Noteworthy events

    Fifth Circuit sends ESG rule to lower court following Loper Bright (2024)

    The United States Court of Appeals for the Fifth Circuit ruled July 18, 2024, that the United States District Court for the Northern District of Texas must rehear a case opposing the Department of Labor's (DOL) 2022 environmental, social, and corporate governance (ESG) investing rule. Appeals Judge Don Willett said the lower court needed a chance to review the merits of the case after the Supreme Court overturned Chevron deference in Loper Bright Enterprises v. Raimondo on June 28, 2024.[9]

    The district court’s September 2023 decision upholding the rule relied on Chevron deference. District Judge Matthew Kacsmaryk said in the opinion courts had to defer to the DOL's interpretation of the Employee Retirement Income Security Act of 1974 (ERISA) because the law was ambiguous and prior rules supported the department's interpretation.

    Federal court rules in favor of ESG retirement plan rule (2023)

    Judge Matthew Kacsmaryk of the United States District Court for the Northern District of Texas issued a ruling on September 21, 2023, denying a request to block the Department of Labor's rule allowing retirement plans to consider ESG factors in investment decisions. The lawsuit was led by Texas and Utah, joined by 24 additional Republican-led states, in an effort to block the rule. The plaintiffs argued that the rule was arbitrary and capricious and violated the Administrative Procedure Act. The complaint also argued that the rule overstepped the department's statutory authority under the Employment Retirement Income Security Act of 1974 (ERISA) and "contravenes ERISA's clear command that fiduciaries act with the sole motive of promoting the financial interests of plan participants and their beneficiaries."

    Judge Kacsmaryk found that the rule did not violate ERISA or the APA, arguing that "while the Court is not unsympathetic to Plaintiffs' concerns over ESG investing trends, it need not condone ESG investing generally or ultimately agree with the Rule to reach this conclusion." The judge invoked the Chevron doctrine and argued that the court must defer to the Department of Labor's interpretation of ERISA because the law does not directly speak to the question at issue and the department's interpretation is supported by prior rules.[10]

    President Joe Biden vetoes Congressional Review Act resolution regarding ESG retirement plan rule (2023)

    President Joe Biden (D) issued a veto on March 20, 2023, to block a Congressional Review Act resolution aiming to nullify the Department of Labor's rule that would allow retirement plans to consider environmental, social, and corporate governance (ESG) factors in investment decisions. Biden stated in his message, "There is extensive evidence showing that environmental, social, and governance factors can have a material impact on markets, industries, and businesses. ... Retirement plan fiduciaries should be able to consider any factor that maximizes financial returns for retirees across the country." As a result of the veto, the rule remains in effect.[11][12]

    Congress passes Congressional Review Act resolution aiming to block Biden's ESG retirement plan rule (2023)

    The U.S. House of Representatives voted 216-204 on February 28, 2023, to pass a Congressional Review Act resolution (H.J. Res. 30) aiming to block the U.S. Department of Labor from implementing its rule permitting ESG considerations in retirement plans. Democratic Representative Jared Golden (Maine) joined Republicans in the vote to pass the measure. The U.S. Senate passed the resolution on March 1, 2023, by a 50-46 vote. Democratic Senators Joe Manchin (W. Va.) and Jon Tester (Mont.) joined Republican senators in the vote.[13] President Joe Biden (D) on February 27, 2023, released a statement on his intent to veto the CRA resolution.[14]

    Congressional Review Act resolution aims to nullify ESG retirement plan rule (2023)

    See also: Congressional Review Act

    A coalition of 50 U.S. senators led by U.S. Senator Mike Braun (R-Ind.) introduced a CRA resolution on February 7, 2023, aiming to nullify a rule from the U.S. Department of Labor allowing retirement plans to consider certain environmental, social, and corporate governance (ESG) factors in certain investment-related decisions. “President Biden is jeopardizing retirement savings for millions of Americans” by encouraging “fiduciaries to make decisions with a lower rate of return for purely ideological reasons,” argued Braun in a statement.[15]

    The CRA resolution had the support of every Republican U.S. senator as well as Democratic U.S. Senator Joe Manchin as of February 21—one vote shy of the total votes needed for passage. U.S. Senator Angus King (I-Maine), who caucuses with Democrats, and U.S. Senator Jon Tester (D-Mont.) had not indicated how they plan to vote on the resolution as of a February 17 report from Bloomberg Law.[16]

    See also

    External links

    Footnotes

    1. ↑ 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 Federal Register, "Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights," December 1, 2022
    2. ↑ 2.0 2.1 Federal Register, "Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights," October 14, 2021
    3. ↑ 3.0 3.1 Federal Register, "Climate-Related Financial Risk," May 25, 2021
    4. ↑ 4.0 4.1 4.2 4.3 4.4 4.5 4.6 Note: This text is quoted verbatim from the original source. Any inconsistencies are attributable to the original source.
    5. ↑ U.S. Department of Labor, "US DEPARTMENT OF LABOR ANNOUNCES FINAL RULE TO REMOVE BARRIERS TO CONSIDERING ENVIRONMENTAL, SOCIAL, GOVERNANCE FACTORS IN PLAN INVESTMENTS," November 22, 2022
    6. ↑ SHRM, "DOL Final Rule Rolls Back Restrictions on Retirement Plans' Use of ESG Factors," November 23, 2022
    7. ↑ Rick Scott, "Sens. Rick Scott & Mike Braun lead bipartisan challenge to Biden rule politicizing Americans’ 401(k)s," February 1, 2023
    8. ↑ Forbes, "DOL's New ESG Rule 'Unremarkable'," November 23, 2022
    9. ↑ United States Court of Appeals for the Fifth Circuit, "Utah v. Department of Labor," July 18, 2024
    10. ↑ The New York Times, "U.S. Judge Denies States' Bid to Block Biden Rule on E.S.G." September 21, 2023
    11. ↑ The White House, "Message to the House of Representatives - President's Veto of H.J. Res 30," March 20, 2023
    12. ↑ NPR, "Biden has vetoed his first bill. Here's how that compares to other presidents," March 20, 2023
    13. ↑ Congress.gov, "H.J. Res. 30," accessed March 2, 2023
    14. ↑ White House, "Statement of Administration Policy," February 27, 2023
    15. ↑ Rick Scott, "Sens. Rick Scott & Mike Braun lead bipartisan challenge to Biden rule politicizing Americans’ 401(k)s," February 1, 2023
    16. ↑ Bloomberg Law, "Senate GOP One Vote Shy of Blocking ESG 401(k) Investing Rule," February 17, 2023
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