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  • Nicholas Zaiko, CIMA

ESG and Proxy Voting Rules Update

Source: American Society of Pension Professionals & Actuaries (ASPPA), October 13, 2021.


The Department of Labor released a proposal in October, 2021 that supersedes the previous administration’s final rules on the use of ESG factors in selecting plan investments and fiduciary duties regarding proxy voting for one that explicitly allows a consideration of those factors.


The Oct. 13 proposed rule seeks to remove barriers to plan fiduciaries’ ability to consider climate change and other environmental, social and governance (ESG) factors when they select investments and exercise shareholder rights.


The proposed rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” follows Executive Order 14030, signed by President Biden on May 20, 2021. That order called for the implementation of policies to “help safeguard the financial security of America’s families, businesses and workers from climate-related financial risk that may threaten the life savings and pensions of U.S. workers and families.”


“The proposed rule announced today will bolster the resilience of workers’ retirement savings and pensions by removing the artificial impediments—and chilling effect on environmental, social and governance investments—caused by the prior administration’s rules,” Acting Assistant Secretary for the Employee Benefits Security Administration Ali Khawar said in a statement. “A principal idea underlying the proposal is that climate change and other ESG factors can be financially material and when they are, considering them will inevitably lead to better long-term risk-adjusted returns, protecting the retirement savings of America’s workers.”


Among other things, the new proposal would clarify the application of ERISA’s fiduciary duties of prudence and loyalty in selecting investments and investment courses of action, including selecting qualified default investment alternatives and the use of written proxy voting policies and guidelines.


Permissibility of Consideration of ESG Factors

According to a fact sheet, the proposed rule addresses the DOL’s concern that the 2020 rules have created uncertainty and are having the undesirable effect of discouraging ERISA fiduciaries’ consideration of climate change and other ESG factors in investment decisions, even in cases when it is in the financial interest of plans to take such considerations into account.


This uncertainty may deter fiduciaries from taking steps that other marketplace investors take in enhancing investment value and performance, or improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors, the DOL notes.


Among the proposed changes is the addition of regulatory text that makes it clear that, when considering projected returns, a fiduciary’s duty of prudence may often require an evaluation of the economic effects of climate change and other ESG factors on the particular investment or

investment course of action. The proposed change is accompanied by three sets of examples that, depending on the facts and circumstances, may be material to the risk-return analysis.


QDIA Provisions

The proposal would also remove the special rules for QDIAs that apply under the current rule. The NPRM would instead apply the same standards to QDIAs as apply to other investments. Thus, when selecting a QDIA, a plan fiduciary must focus on, among other things, material 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. The preamble to the NPRM reaffirms that, in addition to the requirements under the “Investment Duties” regulation, other standards apply to qualified default investment alternatives.


Changes to the Tie-Breaker Test

The proposal seeks to change to the “tie-breaker” standard that permits fiduciaries to consider collateral benefits as tie-breakers in some circumstances. The DOL notes that the existing rule imposes a requirement that the competing investments be economically indistinguishable before fiduciaries can turn to collateral factors as tie-breakers and imposes a special documentation requirement on the use of such factors.


The proposed rule would replace those provisions with a standard that 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 economic or non-economic benefits other than investment returns.


The proposed change also would remove the special documentation requirements that create burdens for application of the tie-breaker provision, and that have “erroneously suggested to some fiduciaries that they should be wary of considering ESG factors, even when those factors are financially material to the investment decision.” To the extent individual account plans use a tie- breaker in the selection of a designated investment alternative, the plans must prominently disclose the collateral considerations that were used as tie-breakers to the plans’ participants.


Shareholder Rights/Proxy Voting Provisions

Finally, the proposal would also make three changes to the current rule’s provision on exercises of shareholder rights, including proxy voting:


  1. It would 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.”

  2. The proposal would 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 permits a policy to limit voting resources to particular 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 permits a policy of refraining from voting on proposals or particular 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.

  3. The NPRM would eliminate the requirement in paragraph (e)(2)(ii)(E) of the current regulation that, when deciding whether to exercise shareholder rights and when exercising shareholder rights, plan fiduciaries must maintain records on proxy voting activities and other exercises of shareholder rights. The proposed rule instead directs fiduciaries to the generally applicable statutory duties of prudence and loyalty set forth in ERISA section 404 for the governing standards in these areas.


Comments Requested

The DOL invited comments from all interested stakeholders on the proposed rule within 60 days after publication in the Federal Register. The DOL noted that commenters are free to express views not only on the provisions of the proposal but also on any issues germane to the subject matter of the proposal.


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