[UPDATED] On November 22, 2022, the Department of Labor (DOL) released a final rule1 addressing if employers with 401(k) plans should consider environmental, social, and governance (ESG) factors when selecting plan investments. The final rule also addresses ERISA fiduciary duties related to proxy voting on corporate shares held in the 401(k) plan’s investment portfolio (if applicable).

Overall, the DOL’s final rule follows its proposed rule, called the Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights2, issued on October 14, 2021, with the notable exceptions below:

  • The proposed rule stated that when considering which 401(k) plan investments to select, ESG factors “may often require” different analysis than non-ESG investments. The final rule removes the “may often require” language, stating that employers do not need to treat ESG investments any differently than non-ESG investments in their analysis.
  • The proposed rule listed some ESG factors (as examples) that employers should consider when choosing an ESG investment for the 401(k) plan. Some examples included climate change-related factors and workforce practices, such as embracing diversity, equity, and inclusion during hiring. The final rule has removed this list of examples, stating that factors relevant to any risk-return analysis “may include the economic effects of climate change and other environmental, social, or governance factors” but whether a factor should be considered (based on a risk-return analysis) “depends on the individual facts and circumstances.”

However, the DOL emphasizes that the final rule does not change the following ESG principles:

  • When choosing 401(k) plan investments, employers must focus on the relevant risk-return factors, while keeping the plan participants’ interests a primary concern.
  • Employer’s fiduciary responsibilities include the management of shareholder rights (such as proxy voting) for any corporate shares held in the 401(k) plan.

The DOL’s final rule is effective 60 days after its publication on November 22, 2022, which is January 21, 2023.

Over the last few years environmental, social, and governance (ESG) has been a topic of conversation in the 401(k) industry and among employee investors alike. It is a particularly interesting topic, as the Department of Labor (DOL) has changed their position from discouraging ESG investing in 401(k) plans to encouraging their consideration.

This shift in position has been confusing for most – especially 401(k) plan sponsors who have seen an increase in employees requesting more socially responsible retirement plan investments.

Here is a brief recap of the current law and where the DOL stands.

The DOL’s Current Position on 401(k) Plan ESG Investing

On May 20, 2021, President Joe Biden issued an Executive Order on Climate-Related Financial Risk3, where he directed the federal government to treat climate change as a threat to American workers’ retirement savings.

In response to this Executive Order, the DOL issued a proposed rule called the Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights4 on October 14, 2021. This proposed rule applies to 401(k) plans and allows employers to consider ESG investments for their 401(k) investment funds.

A final DOL rule is expected later in 2022.

Employers should keep in mind that ERISA’s fiduciary obligations always apply when choosing 401(k) investment options, whether a plan sponsor is considering an ESG investment or a non-ESG investment.

As legal guidance continues to evolve, here is what 401(k) plan sponsors should consider when deciding whether to add ESG funds to their 401(k) plan investment lineup:

4 Things for Plan Sponsors to Consider About ESG Funds

  1. Determine ESG goals and objectives. Plan sponsors must define their 401(k) investment goals and objectives as they relate to ESG funds. Then, they should memorialize these goals and objectives in their 401(k) investment policy statement5.
  2. Apply Non-ESG Investment Processes to ESG Funds. Next, plan sponsors should use the same decision-making processes, whether they are choosing traditional, non-ESG funds or ESG funds. By doing this, plan sponsors apply a consistent decision-making process while fulfilling their fiduciary responsibilities6 under the Employee Retirement Income Security Act of 1974, as amended (ERISA).
  3. Continually Monitor and Track ESG Investments for Risk. Once chosen, the plan sponsor should continue to monitor and track any potential ESG risks, just as a plan sponsor would do for other 401(k) investment funds.
  4. Communicate ESG Philosophy and Goals to Plan Participants. Plan sponsors must also communicate the plan’s ESG philosophy, goals, and objectives7 to plan participants. However, plan sponsors must be careful to educate plan participants8 and not cross over into giving investment advice, which is prohibited under ERISA.

Additional Resources

  1. Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, (November 22, 2022) (to be codified at 29 CFR 2550). https://www.dol.gov/sites/dolgov/files/ebsa/temporary-postings/prudence-and-loyalty-in-selecting-plan-investments-and-exercising-shareholder-rights-final-rule.pdf
  2. Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, 86 FR 57272 (October 14, 2021) (to be codified at 29 CFR 2550). https://www.federalregister.gov/documents/2021/10/14/2021-22263/prudence-and-loyalty-in-selecting-plan-investments-and-exercising-shareholder-rights
  3. White House. Executive Order on Climate-Related Financial Risk. May 20, 2021. https://www.whitehouse.gov/briefing-room/presidential-actions/2021/05/20/executive-order-on-climate-related-financial-risk/
  4. Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, 86 FR 57272 (October 14, 2021 (to be codified at 29 CFR 2550). https://www.federalregister.gov/documents/2021/10/14/2021-22263/prudence-and-loyalty-in-selecting-plan-investments-and-exercising-shareholder-rights
  5. Iekel, John. “Fiduciary Duty: A Refresher.” American Society of Pension Professionals and Actuaries (ASPPA). June 13, 2022. https://www.asppa.org/news/fiduciary-duty-refresher
  6. U.S. Department of Labor, Employee Benefits Security Administration (EBSA). (2021). Meeting Your Fiduciary Responsibilities [Brochure]. https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/meeting-your-fiduciary-responsibilities.pdf
  7. Defined Contribution Institutional Investment Association. “ESG and Participant Communications: Practical Ideas for How to Communicate the Integration of Sustainable Investing within DC Plans.” March 2022. https://cdn.ymaws.com/dciia.org/resource/collection/AD062AB9-8C8F-49C9-94F6-1156F6AB8225/DCIIA_ESG_Participant_Communications_final_2.pdf
  8. Interpretive Bulletin 96-1; Participant Investment Education, 61 FR 29586 (June 11, 1996) (codified at 29 CFR 2509). https://www.federalregister.gov/documents/1996/06/11/96-14093/interpretive-bulletin-96-1-participant-investment-education
  9. White House. Executive Order on Climate-Related Financial Risk. May 20, 2021. https://www.whitehouse.gov/briefing-room/presidential-actions/2021/05/20/executive-order-on-climate-related-financial-risk/
  10. Interpretive Bulletin 96-1; Participant Investment Education, 61 FR 29586 (June 11, 1996) (codified at 29 CFR 2509). https://www.federalregister.gov/documents/1996/06/11/96-14093/interpretive-bulletin-96-1-participant-investment-education
  11. Defined Contribution Institutional Investment Association. “ESG and Participant Communications: Practical Ideas for How to Communicate the Integration of Sustainable Investing within DC Plans.” March 2022. https://cdn.ymaws.com/dciia.org/resource/collection/AD062AB9-8C8F-49C9-94F6-1156F6AB8225/DCIIA_ESG_Participant_Communications_final_2.pdf
  12. U.S. Department of Labor, Employee Benefits Security Administration (EBSA). (2021). Meeting Your Fiduciary Responsibilities [Brochure]. https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/meeting-your-fiduciary-responsibilities.pdf

Pensionmark Financial Group, LLC (“Pensionmark”) is an investment adviser registered under the Investment Advisers Act of 1940. Financial Advisors at Pensionmark may also be registered representatives of Pensionmark Securities, LLC (member SIPC), which is affiliated with Pensionmark through common ownership.

Disclaimer: This content is intended for informational purposes only and should not be construed as legal, medical or tax advice. It provides general information and is not intended to encompass all compliance and legal obligations that may be applicable. This information and any questions as to your specific circumstances should be reviewed with your respective legal counsel and/or tax advisor as we do not provide legal or tax advice. Please note that this information may be subject to change based on legislative changes. © 2022 Sequoia Benefits & Insurance Services, LLC. All Rights Reserved

Jenny Kiesewetter — Jenny is a Retirement Plan Compliance Consultant for Sequoia, where she works with our clients to optimize and streamline retirement plan compliance. In her free time, Jenny enjoys spending time with her friends and family, traveling, live music, and dining out.