Key Considerations for the DOL’s Proposed Rule Regarding ESG

Lew Minsky, of DCIIA, offers four considerations for the Department of Labor’s rule about including environmental, social and governance factors in the evaluation of retirement plan investments.

In October, the Department of Labor published a proposed rule titled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” which represented a significant shift away from regulations adopted under the Trump administration.

In a detailed blog post, law firm Morgan Lewis described five key changes from the 2020 rule, noting that it has:

  1. Outlined a de facto recognition of environmental, social and governance investing as material to investment risk and return;
    Changed what was formerly the pecuniary factors test to now be the risk-return test (and noted that ESG counts);
    3. Updated the tie-breaker test, which has been redrafted to be broader and easier;
    4. Clarified that qualified default investment alternatives can use ESG factors—and there are no special rules for defined contribution plans; and
    5. Moved mostly back to old proxy voting rules.

The Defined Contribution Institutional Investment Association (DCIIA) was one of the 22,393 organizations and individuals that submitted comments to the DOL late last year regarding the proposed rule. (Our comment letter was the result of collaboration among many of our members, but was submitted solely on behalf of DCIIA.) In it, we noted that we believe the proposed rule “seeks to balance a fiduciary’s consideration of the ERISA [Employee Retirement Income Security Act] duties of prudence and loyalty with appropriate consideration of environmental, social and governance factors.”

DCIIA supports the DOL’s considerable efforts and the proposed rule’s framing to seek to remove barriers that may prevent the prudent integration of ESG factors into ERISA fiduciary decisionmaking. Overall, we believe the proposed rule would support good actors who seek to use ESG approaches appropriately by reducing the uncertainty and costs of compliance when considering material ESG (and other) factors.

The proposed rule moves closer to a principles-based approach that does not uniquely target or single out (positively or negatively) ESG as compared to any other investment strategies, asset classes or investment styles. A uniform set of objectives and standards should apply to fiduciary decisionmaking and the application of the duties of prudence and loyalty. Therefore, we support that the proposed rule treats ESG factors the same as any other factor that may materially impact an investment’s risk/return analysis. We also support the DOL’s decision to omit the term “pecuniary” and instead use “materiality” as a more familiar term and concept.

Nonetheless, we cite four specific suggestions regarding the proposed rule, as follows:

Reconsider the proposed inclusion of specific examples of ESG factors: Delineating certain ESG factors in the rule potentially sets them apart from other ESG factors that are not so delineated, but which may be relevant to the analysis—for example, supply-chain management, product design and lifecycle management, and customer welfare. Including specific examples also could have the unintended consequence of signaling that the enumerated factors are “more important” to consider than other ESG factors that are not included in the list. This could also unintentionally signal that other non-enumerated (non-ESG) factors, such as cybersecurity precautions, may be less relevant. Additionally, it risks creating static definitions of which factors are considered “ESG,” and which factors are material to an investment’s risk/return analysis more generally, when these factors are expected to continue to evolve over time.

Reconsider including a tiebreaker: ERISA’s fiduciary standards should be principles-based so that fiduciary decisionmaking is judged by universal principles of prudence and loyalty. A tiebreaker test may be interpreted as inconsistent with a universal principles-based standard because it introduces an additional test beyond the principles-based standard. Moreover, a tiebreaker test may inadvertently promote a fallacy that only one “best” investment or investment option exists (or that there could be two “equal” investments or investment options).

Consider an expansion to the proxy voting rules to include separately managed accounts: DCIIA commends the changes to the regulations on proxy voting in the proposed rule that generally return the rulemaking to the prior framing on proxy voting. One specific suggested clarification is to expand them to apply not just to pooled accounts, but also to separately managed accounts that are managed by investment managers.

Consider additional context for the DOL’s economic impact analysis: In the regulatory-impact analysis of the proposed rule, the DOL estimates that 9% of plans are using ESG-inflected strategies. Yet, the number likely is much higher, at least among plans with more than 100 participants. (According to Morningstar’s broadest definition of ESG, as many as 36% of large retirement plans already offer strategies that use ESG considerations to evaluate investments. This number could be even larger among large plans if counting ESG integration in its broadest sense, such as using an ESG factor as one factor, among many others, in evaluating investment options, including options that do not explicitly reference ESG in their objectives or underlying information. Also see “Institutional Investors Increasingly Including ESG Factors in Portfolios.”) Finally, the Department of Labor’s impact analysis discusses studies pointing to the financial materiality of ESG information, as well as other studies that purport to show that ESG investing underperforms conventional strategies. It should be recognized that studies showing underperformance may reflect a negative screening methodology, while today’s plan fiduciaries may instead use a more comprehensive lens that incorporates ESG factors and seeks to maximize risk-adjusted returns.

Plan sponsors interested in learning more about ESG investing in the context of their defined contribution plans may wish to consult our two white papers, “Sustainable Investing in Defined Contribution Plans” and “Incorporating ESG in DC Plans.” We look forward to the DOL’s final rule on this topic and will continue to look for ways to foster industry conversation and education on ESG more broadly.


Lew Minsky is president and CEO of the Defined Contribution Institutional Investment Association (DCIIA).

This feature is to provide general information only, does not constitute legal or tax advice and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services Inc. (ISS) or its affiliates.