Department of Labor to Impose ESG Investing on $12 Trillion Retirement Funds Affecting 150 Million Americans

The Department of Labor has announced final regulations on using environmental, social and governance factors in retirement investment plans under the Employee Retirement Income Security Act. Effective Jan. 30, employer retirement plans may take ESG factors into consideration when making investment decisions. The new ESG rule covers plans that collectively invest $12 trillion on behalf of 150 million Americans.

Most international and domestic public and private companies are now evaluated and rated on ESG performance by various third-party rating providers, such as Bloomberg, Dow Jones and Thomson Reuters. In terms of environmental factors, for example, businesses with higher ESG scores will be in compliance with governmental regulations and limit waste, pollution, carbon emissions and the usage of coal, petroleum and/or nuclear energy sources. Organizations will commonly have lower ESG scores if they do not focus on climate change, natural resource conservation or the use of renewable energy sources, such as wind and solar.

In terms of social factors, corporations will usually have higher ESG scores if they focus on diversity, equity, inclusion, LGBTQ+, social justice, nonprofit donations, employee volunteerism, anti-harassment, and health and safety. Companies involved with weapons, firearms, military defense and/or controversies over human rights will generally have lower ESG scores. In terms of governance, employers will normally obtain higher ESG scores if they pursue diversity in selecting board leadership, use accurate and transparent accounting methods, and focus on corruption and fraud prevention. Businesses found engaging in illegal conduct will have lower ESG scores.

The DOL recognizes investments may be rejected due to companies scoring poorly on ESG factors and selected if scoring high, or that they may be incorporated into a broader investment analysis. Two primary fiduciary duties are involved under ERISA. The duty of prudence would be violated if fiduciaries forfeit investment return or take on additional risk for participants by choosing investments due to ESG factors. The duty of loyalty would be breached if fiduciaries decide investments based on personal benefits, such as ESG policies important to fiduciaries at the expense of the investment return of the plan. The DOL states taking ESG factors into account in investment decisions does not necessarily violate these fiduciary duties. But the DOL regulations encourage using ESG factors when relevant to risk/return.

Proper documentation of the fiduciary process concerning ESG factors is required. The investment menu must include non-ESG funds, so participants have a real choice regarding investing in an ESG fund. Fiduciaries must select and monitor ESG funds by comparing risk and return to non-ESG funds. Special disclosures for ESG funds are not required, but fiduciaries should ensure plan communications clearly inform participants of any ESG strategies.

After the ESG rule went into effect, 25 states, including Missouri, filed a lawsuit for a temporary stay on the rule, stating the regulation would imperil the retirement savings of Americans and violate the standards of prudence and loyalty. On March 1, the U.S. Senate voted to overturn the rule after the resolution passed in the House of Representatives. President Joe Biden vetoed the bill – notably the first veto of his presidency. Then, on May 16, the 25 states asked a federal judge to rule on the January lawsuit, since the judge had not done so to date.

If an employee is concerned about the DOL regulation, whether for or against it, the staff member should contact the human resources department to obtain information regarding the use of ESG scores by the fiduciary. If the associate has similar interests about environmental, social or governance factors and appreciates the impact of ESG scores, the worker should consider investing even more money into the company retirement plan. If the team member does not endorse the issues promoted by the ESG scores, the laborer should consider contacting a financial adviser for other options, such as a 401(k) rollover to a non-ESG plan. In the meantime, be watching for a ruling by the federal judge.

Lynne Haggerman holds a master of science in industrial organizational psychology and is president/owner of Lynne Haggerman & Associates LLC, specializing in management training, retained search, outplacement and human resource consulting. She can be reached at lynne@lynnehaggerman.com.