ERISA and the challenges of using ESG in retirement plan investments to use retirement plans and retirement planning tools are the challenge
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Employers often ask for a consideration of "environmental, social, or governance" (ESG) factors when choosing investment options. This interest can be driven partly by corporate ESG objectives or by the employees (or other stakeholders) or a combination of both.
The answer to the question of whether ERISA permits the consideration of ESG is yes, but only if the application is conform to erISA's fiduciary standards. Those fiduciary standards require that ESG investments in retirement plans should be made in a prudent manner and in accordance with the employees' retirement investments interests. This means employers can't use ESG blindly. Rather, ERISA's fiduciary standards must be considered.
The Department of Labor (DOL) has provided conflicting guidance on how to apply ERISA's fiduciary standards to ESG for the last 25 years. The Trump and Biden administrations have sided with different positions through DOL action, resulting in a particularly hot environment in the last two years.
For these reasons, employers and retirement plan fiduciaries can use ESG criteria to identify and manage retirement plans investments, e.g. why this remains an area of change in legal standards, especially in the last few years.
In the retirement plan context, ESG investing consists of factors related to the environment (such as company's record of pollution and sustainability), social goals (like supporting unions or divesting from certain industries) or corporate governance (including company Employers and plan fiduciaries can evaluate ESG in many ways. Retirement plans may invest in (or offer) "ESG specific" funds, for example.
Plans can also apply ESG screening criteria to avoid investments that do not meet certain ERG standards. Retirement plans can also apply ESG indirectly. Plan fiduciaries can apply ESG considerations as only one type of financial evaluation criteria (such as risk, cost, and expected performance). Even though employers aren't directly considering ESG, the managers of plan investment funds and options may be using ERG factors, even if the investment isnt an EGS-themed fund.
ERISA is the primary law that sets out the legal duties of a private employer when deciding for restraining salaries and other benefits on the employer's employees. ERISA does not apply to government plans, but state and local laws often incorporate erISA's standards.
In accordance with the principles of ERISA, parties who are fiduciaries to a retirement plan (such as the employer or third-party managers) are required to make investment decisions in judicious manner, and with These twin duties are often referred to as ERISA's fiduciary duties, and particularly as duty of prudence and duty to loyalty. The second duty (the duty of loyalty) requires a singular concern for the interests of the retirement plan and the employees participating in it.
The principal regulator of these two fiduciary duties has consistently said that these duties require that ESG criteria can only be applied to retirement plan investing if the criteria otherwise meet these standards of prudence and loyalty, i. Under this framework, a fiduciary without ERISA could risk violating erISA if he or she used ESG solely to achieve political or social outcomes without making the decision to establish the criteria for re
Because employers can struggle to distinguish ESG factors that support retirement savings from those that are ancillary and outside employees' "best interests" also erode the second duty duty.
An example of this is a tradition where if he is an executive of re-election, illegitimate for the union focuses on responsibilities of the trustee whose tax is not deductible. There have been many cases of union plans investing in real property owned by the union, investing with union labor or buying a union-owned bank money. In those cases, courts and the DOL frequently, although not always, view this "social" investment as contrary to the ERISA duty of loyalty, because the investment may benefit the union and/or its members, but the benefit doesn
Other example is using an environmental critik, such as not investing a retirement plan in stocks of companies with bad environmental records. Using these types of investing "screens" would violate the ERISA duty of loyalty if the screen is only based on a pro-environmental goal. Likewise, applying diversity criteria (such as not investing in companies that fail diversity standards or have known record of discrimination or harassment) could be contrary to ERISA's loyalty standard if the investment option is made only to support diversity
In contrast, these same ESG factors can be applied as a retirement income contribution, depending on the facts and circumstances. There is a body of academic and investment literature that accepts the use of ESG factors as material investment criteria. In this framework, the ESG factor can affect an investment's risk, return or other substantial financial consideration. This is a good example of if compared to this point of view, difa, company's poor environmental record might be economically relevant to company development. Poor corporate governance could also negatively impact future stock performance.
Since these examples demonstrate, ESG factors can be both consistent and inconsistent with ERISA's fiduciary duties, in part due to the surrounding circumstances.
The DOL has taken different positions in the past 25 years in terms of interpretation and, particularly, how to distinguish ESG usage from ancillary. In the Democratic administration, the DOL generally views ESG as not inconsistent with ERISA's fiduciary duties and capable of being applied in a manner that'll suit the erISA plan'es interests. As an investment factor, the DOL under Republican administrations was more resistant to ESG and, particularly, more cautious that such factors can be used without violating ERISA's duties, especially the duty of loyalty.
Under the Trump administration, the DOL released a regulation that imposed new standards on ESG usage by ERISA plans. Many ERISA professionals consider this rule as a challenge to the use of ESG criteria. In 2020, the DOL performed enforcement examinations of ERISA plans on their use of ESG, thereby reducing the risks of using EGS criteria in erISA-regulated plans.
Under the Biden administration, the DOL is trying to repropose the ESG rule of the Trump-era. Although the Biden rule is expected to be more pro-ESG, the fundamental framework of the ERISA duties will remain and will likely continue to warrant care in applying ESG to retirement plans investment.
Employers seeking to consider ESG when investing in retirement plans may still face compliance questions. While ERISA does not prohibit the application of ESG criteria, employers who want to apply EGD criteria will need to ensure that such application meets erISA's fiduciary duties. This is true even if it is a strong company or employee interest in ESG matters. While there appears to be increasing corporate and employee focus on ESG goals, ESR investing, or some combination of both, employers can't satisfy this interest by applying ESA considerations blindly to retirement plans. Rather, ERISA's fiduciary standards must be considered.
Employers should confirm that ESG criteria are applied through an appropriate investment process and driven by the employees' best interests in regards to retirement. Finally, this area will likely continue to be subject to DOL guidance, including the current Biden administration's effort to reinterpret the regulations applicable to ESG through the DLO.
The author has his opinion expressed in respect of the opinion. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence and freedom from bias. Westlaw Today is a subsidiary of Thomson Reuters and operates independently of NBC News.
Celia A.Soehner is a partner with MorganLewis and the deputy leader of the firm's capital markets and public company practice. She previously served as an attorney-advisor for the U.S. Securities and Exchange Commission (SEC) Division of Corporation Finance. You can reach her at firstname.lastname@example.org.