by Robert Eccles and Timothy Doyle
President Biden’s veto of a Congressional resolution, regarding recently finalized amendments to a 2020 Department of Labor (DOL) administrative rule on retirement security, has brought ESG to the forefront again. The DOL’s amendments address how fiduciaries of a person’s 401(k)s and private pension funds make decisions about their retirement savings and the role of ESG in making those investment decisions. The DOL, under ERISA (Employee Retirement Income Security Act of 1974), regulates private retirement plans. ERISA covers roughly $12 trillion in retirement savings for 150 million Americans.
Paramount to ERISA are the duties of “loyalty” and “prudence” owed by retirement plan fiduciaries (investment managers) to beneficiaries and plan participants (future retirees). The law and subsequent regulations are in place to make sure that the person or persons managing retirement accounts are required to have the sole interest of beneficiaries or plan participants in mind (duty of loyalty) and that decisions will be made with the exclusive purpose of providing benefits and minimizing reasonable expenses, using the care and due diligence of a financially knowledgeable prudent person (duty of prudence).
The previous DOL’s 2020 Rule attempted to clarify various guidance that the DOL has provided to fiduciaries going back almost 30 years. At the time, it was suggested that the 2020 Rule was needed given the increased use and prominence of ESG factors in making investment decisions. However, after receiving input during the rulemaking process, the DOL removed any mention of ESG in the 2020 final text of the Rule to depoliticize it. In turn, it required fiduciaries to only focus on “pecuniary” issues which were defined as those that have a “material effect on the risk and/or return of an investment based on appropriate investment time horizons” consistent with the plan.
In 2021 President Biden issued executive orders for his Administration to look at climate-related and ESG issues. Responding to President Biden’s executive orders, the DOL proposed and finalized its 2022 Amendments to the 2020 Rule. The 2022 Amendments removed the terms “material” and “pecuniary” from the 2020 Rule and instead required that fiduciaries should focus on “relevant risk and return factors” that may include the economic effects of climate change and ESG. It also held that a fiduciary’s duty requires that they “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 plan.
Is there a difference or is this just all political? Unfortunately, the Congressional resolution and the President’s rationale for vetoing it just added to the misinformation about the actual 2020 Rule and 2022 Amendments. The Congressional resolution indicated that under the 2022 Amendments climate change and other ESG factors could be considered in making investment decisions and exercising shareholder rights, as if the resolution, on the contrary, would have prevented its use. However, under the 2020 Rule those factors could also be considered. And in vetoing the resolution, President Biden indicated that the resolution would “force retirement managers to ignore relevant risk factors” and “prevent retirement plan fiduciaries from taking into account factors, such as the physical risks of climate change and poor corporate governance.”
Much like the Congressional resolution, this is objectively false given that if the Congressional resolution had not been vetoed, the 2020 Rule would be reinstated which clearly allowed for the aforementioned factors to be considered. So, the politics continues, but what are the real differences between the 2020 Rule and the 2020 Amendments?
The differences really come down to how fiduciaries evaluate factors that have a “relevant,” instead of a “material” or “pecuniary” effect on a risk and return analysis in making investment decisions. The fact of the matter is that, under both the 2020 Rule and the 2022 Amendments, fiduciaries must maintain their duties of loyalty and prudence in making investment decisions, which take precedence over the political back and forth of successive administrations and their war over words. Under both versions of the Rule the economic effects of climate change and ESG can be considered if “material” or “pecuniary” (2020) or “relevant” (2022) to the risk and return analysis used in making investment decisions.
Given the duties of loyalty and prudence and the nuances in language in the rules, much of the aforementioned political turmoil is probably due to the “tie-breaking” scenario in the Biden 2022 Amendments. In it, a fiduciary is allowed to consider collateral benefits, after conducting an “all things being equal” test. The consensus from the investment community appears to be that these “tie-breaking” situations would actually be incredibly rare and the back and forth between successive Administrations, going back to the Clinton Administration, has unnecessarily politicized the issue of collateral benefits thereby creating regulatory uncertainty. However, if truly a rare circumstance, why remove the 2020 Rule’s documentation requirement? Is politics again rearing its ugly head or is the documentation requirement truly an onerous burden? Unfortunately, we’ll never know because no documentation is required. If it were and proved onerous, the rule could always have been revised. Politics does seem to follow this “tie-breaking” scenario and therefore maybe it’s time to rethink its usefulness.
There has probably been too much discussion over how the 2020 Rule and now the 2022 Amendments will impact fiduciaries. Given that the duties of loyalty and prudence have not changed under either version, it would appear that allowing fiduciaries to do their job without undue political influence may be the most prudent action. However, more likely than not, as long as ESG is a political issue, these Rules will change with each successive Administration creating regulatory uncertainty, resulting in additional costs and unnecessary pressure on fiduciaries who already have an exceedingly difficult job to do.
If the purpose of ERISA is to protect retirement savings, both sides of the aisle should focus on the duties of loyalty and prudence owed to beneficiaries and plan participants, and less on an Administration’s policy agenda. Ironically, this is what ERISA was originally intended to protect against.
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Robert Eccles, Visiting Professor of Management Practice at the Said Business School, Oxford University and Timothy Doyle, Senior Policy Advisor at the Bipartisan Policy Center.