ESG, the DOL and a new world for 401ks

December 2021

Defined contribution plan sponsors may understandably be experiencing a sense of whiplash as it relates to environmental, social and governance (“ESG”) factors and the extent to which they’re allowed to consider non-financial factors as part of their fiduciary duties. Over the past five years, the Department of Labor (DOL) has issued interpretive guidance in favor of ESG considerations; then, in 2020, it amended its “investment duties” regulations to reverse previous guidance; and then, this past October, proposed a new rule, that yet again opens the doors for fiduciaries to consider ESG when selecting investments or exercising shareholder rights.

While the back and forth may generate confusion or, worse, regulatory risk for plan sponsors beholden to ERISA’s prudence and loyalty requirements, the latest proposal from the DOL provides affirmation this is the direction regulators are moving. ESG, which has gained so much traction in other, non-ERISA categories, seems here to stay, opening the door to allow fiduciaries to weigh the non-financial factors that will influence long-term investment performance.

But here come the caveats about ESG and 401(k)s: Despite the groundswell of interest in ESG investments, adoption in the defined contribution space will likely come slowly until there’s more clarity from the DOL and other regulators. Moreover, while progress has been made in the development of ESG data and consolidation among the sustainability frameworks, more uniform industry metrics will be needed to evaluate ESG investment options and provide appropriate benchmarks. And another major conundrum remains: The fundamental duties of fiduciaries — prudence and loyalty — have not changed. In that regard, for plan sponsors, it’s a new day with the same constraints.

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