On June 23, 2020, the U.S. Department of Labor issued a proposal to regulate the use of environmental, social, and governance (ESG) strategies by investment fiduciaries under ERISA. The proposal, if finalized, would be the first rulemaking since ERISA was passed in 1974 in which the Department has singled out a specific strategy for more rigorous treatment under ERISA’s duties of loyalty and prudence.
The proposal’s stated goals are to ensure that retirement assets are maximized and not “enlisted in pursuit of other social or environmental objectives.” The effect of the proposal, if finalized as is, would likely suppress investment by ERISA plans in ESG strategies, without regard to their ability to help maximize retirement assets. Perhaps unintentionally, the proposal could also adversely impact investment in actively managed strategies and closed-architecture individual account plan menus, due to the breadth of its language.
Since 1994, the Department has addressed ESG strategies through non-binding sub-regulatory guidance. While all such guidance was premised on the principal that non-pecuniary ESG considerations cannot justify an investment that is less attractive from a risk/return perspective, the tenor of that guidance has shifted over time, swinging between favorable and cautionary positions depending on administration. The current administration issued its cautionary guidance in 2018. It now seeks to memorialize its position and inhibit future shifts to more favorable stances through regulatory action. It also appears to have made ESG a current enforcement priority notwithstanding that its proposal remains pending.
While the proposal expressly addresses perceived risks associated with the consideration of ESG factors, the proposal does not give significant attention to relevant data. For example, the proposal does not address the data reflected in the 2018 United States General Accounting Office (GAO) report on ESG investing, which states that the vast majority of peer-reviewed academic studies reviewed by the GAO found, in almost all cases considered, a neutral or positive correlation between the consideration of ESG factors and investment returns. The proposal also does not address similar data in a 2017 study on ESG investing commissioned by the Department of Labor itself. Instead, the proposal appears to merely assume that the consideration of ESG factors generally will have the opposite effect.
Addressing the economics of ESG strategies, the proposal suggests that they are suspect because they have higher fees than passively managed index funds. In a similar vein, the proposal states the Department’s hope that, once finalized, the regulation will cause plans to shift away from actively managed funds to lower-cost or passively managed index funds. These are remarkable positions, given that the Department has never opined that fiduciaries must always select the cheapest investment available. Indeed, just earlier this month, the Department confirmed that individual account plans may offer options with actively managed private equity components even though they “tend to involve more complex organizational structures and investment strategies, longer time horizons, and more complex, and typically, higher fees.”
The proposal’s treatment of ESG strategies departs from its prior treatment of both ESG and other strategies. Five years ago, the Department explained in the context of ESG investments: “Fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors.” Earlier this month, the Department affirmed this same general approach in the context of private equity. In the 1980s, the Department took a similar view of investing in derivatives.
The Department explains that regulation is now needed because of the growth in ESG investing and the marketing of ESG options. It is unclear why this is so. In the proposal, the Department states its belief that few fiduciaries are violating the law in connection with ESG strategies. Further, ERISA already requires fiduciaries to possess (or hire) the sophistication necessary to prudently consider investment alternatives — ESG or otherwise — regardless of how they are marketed and, to the extent they fail to do so, ERISA provides for expansive liability and other remedies.
The Terms of the Proposed Regulation
The proposal amends the Department’s existing regulation clarifying ERISA’s duty of prudence in the context of plan investments. The proposal expands the scope of the regulation to cover ERISA’s duty of loyalty, collapses the two duties together and then adds certain generally applicable rules (not ESG specific), all of which must be met to satisfy either duty. This represents a significant departure from current and historic treatment of the duty of loyalty, which focuses on the fiduciary’s subjective intent, not a checklist of objective factors. In addition, the proposal adds several rules that apply specifically to ESG strategies.
Several of the new generally applicable rules serve to emphasize that fiduciary decisions must be made based on material economic factors and no others. Legally, these rules appear to add little, if anything, to the statute, which already requires investment fiduciaries to act solely in the retirement interests of the participants and beneficiaries.” Practically, however, it could precipitate a substantial expenditure of resources in ensuring that compliance is tailored to the specifics of the rules. Investment fiduciaries, including both plan fiduciaries (e.g., investment committees and their investment consultants) and product fiduciaries (e.g., trustees, advisers, and managers) will have to consider whether they have taken a more expansive view of their ability to incorporate ESG factors in their investment decisions or advice. Even fiduciaries who are comfortable with the view they have taken regarding ESG factors may feel compelled to reconsider the strength of their due diligence process and their ability to prove compliance with the rule (e.g., in the face of a Department of Labor audit or investigation). Particularly for larger plans, identifying which investments or managers incorporate ESG factors into their strategies will likely require significant legwork, as many such investments are not readily branded or marketed as ESG focused. Fund sponsors, including those who do not brand or market their funds as ESG focused, would have to consider the impact of this rule on how they market their funds to plan investors.
Another generally applicable rule contains a catch-all provision clarifying that compliance with the amended regulation does not equate with compliance with the statute. In other words, the regulation does not shield compliant fiduciaries from claims of a statutory violation, whether by the Department or private plaintiffs. This differs from the current regulation, which contains no such catch all.
The final generally applicable rule requires that fiduciaries consider how “the investment or investment course of action compares to available alternative investments or investment courses of action . . .” The prudent consideration of alternatives is nothing new under ERISA. Indeed, the Department characterizes this rule as simply “an important reminder.” Still, the breadth of its language combined with the Department’s stated goal of pushing fiduciaries toward low-cost or passively managed index funds could be viewed, perhaps unintentionally, as requiring fiduciaries to broadly consider the entire universe of investment alternatives, especially low-cost, passively managed index funds, every time they make an investment decision, even if those alternatives are inconsistent with their policies, strategies, or mandates.
The ESG-specific rules define “pecuniary” ESG factors and prescribe certain special requirements for their consideration, even if they are pecuniary. This reflects a significant departure from the statutory duty of prudence, which requires consideration of all relevant factors, without favoring or disfavoring any particular type. Among other things, these rules require that undefined “qualified investment professionals” would agree that a given ESG factor is pecuniary. Who is “qualified” and how many must agree (e.g., some, a majority, or substantially all) is unclear. Would the fact that numerous other fiduciaries have invested in a given ESG-branded fund suggest that these requirements are met? Do new ESG strategies face an uphill battle (or perhaps are they even dead on arrival) with ERISA plans because they have yet to be widely utilized by others?
The ESG-specific rules also require fiduciaries to compare investments with available alternatives, again raising the specter of fiduciaries having to consider the entire universe of potential investments, whether or not consistent with applicable policies, strategies, or mandates. The rules also require special documentation for any decision to choose an ESG-oriented alternative from among economically equivalent options. Prior guidance had permitted reliance on non-pecuniary ESG factors to choose between such equivalents. The regulation permits this practice to continue, subject to the additional documentation requirements, although the Department now states that it believes such occasions for reliance will be rare.
A separate ESG-specific rule creates a safe harbor from the generally applicable rules for ESG-related investments included as options under individual account plans. Among other conditions, the rule requires that economic considerations still be determinative and that certain documentation supporting the decision must be developed and maintained. The safe harbor does not apply to non-ESG investment options, however, resulting in an odd preference for ESG-related options. It seems unlikely that the Department intends this result.
This safe harbor rule expressly provides that ESG-related options are not permitted as qualified default investment alternatives (QDIAs), even if selected on objective, economic risk/reward criteria. The Department reasons that permitting ESG-related options to serve as QDIAs would jeopardize the financial interests of participants and beneficiaries, but cites no supporting data for consideration.
As a practical matter, precluding ESG investments from qualifying as QDIAs will require plan fiduciaries to carefully review the marketing materials, disclosures, and organizational documents of potential QDIA options. Fiduciaries must avoid not only options specifically marketed as ESG, but also options that include any express consideration of ESG factors in their mandates, even otherwise qualifying pecuniary ESG factors. It is unclear whether this will also mean avoiding actively managed options altogether (in favor of passively managed index funds), given the potential for actively managed options to consider ESG-related investments even in the absence of a formal ESG policy.
The proposal provides an effective date of the date occurring 60 days after publication of the final rule. While the rule appears to have no retroactive effect, it would still apply to fiduciary decisions following the effective date to retain existing policies, strategies, and investments. In many instances, this may require a wholesale re-evaluation consistent with the new terms of the regulation.
The Department is affording a relatively short period for public comment, with comments due by July 30, 2020. Presumably, this is to afford the Department time to address comments and publish a final rule prior to any change in administration in early 2021.
 Department of Labor, Employee Benefits Security Administration, 29 CFR Part 2550, RIN 1210-AB95, Financial Factors in Selecting Plan Investments, published in the Federal Register on June 30, 2020, 85 Fed. Red. 39113, and available online at federalregister.gov/d/2020-13705, and on govinfo.gov (“Proposed Rule”).
 U.S. private retirement plans hold roughly $10 trillion in investible assets. “Private Pension Plan Bulletin Historical Tables and Graphs 1975-2017,” Employee Benefits Security Administration (Sep. 2019), available at https://www.dol.gov/sites/dolgov/files/ebsa/researchers/statistics/retirement-bulletins/private-pension-plan-bulletin-historical-tables-and-graphs.pdf.
 Interpretative Bulletin 94-1, 59 Fed. Reg. 32606 (June 23, 1994) (“IB 94-1”); Interpretative Bulletin 2008-01, 73 Fed. Reg. 61734 (Oct. 17, 2008) (“IB 2008-01”); Interpretative Bulletin 2015-01, 80 Fed. Reg. 65135 (Oct. 26, 2015) (“IB 2015-01”); Field Assistance Bulletin No. 2018-01 (April 23, 2018) (“FAB 2018-01”).
 FAB 2018-01.
 In the past year, the Department’s field offices have begun investigating plans and investment product providers (specifically, collective investment funds) with respect to their consideration of ESG factors.
 “Environmental, Social, and Governance (ESG) Investment Tools: A Review of the Current Field” (Washington, D.C., Dec. 2017), prepared by Ogechukwu Ezeokoli et. al., available at https://www.dol.gov/sites/dolgov/files/OASP/legacy/files/ESG-Investment-Tools-Review-of-the-Current-Field.pdf.
 Proposed Rule, n. 15 (citing Wayne Winegarden, ESG Investing: An Evaluation of the Evidence, Pacific Research Institute (May 2019), available at www.pacificresearch.org/wp-content/uploads/2019/05/ESG_Funds_F_web.pdf, at 11-12.
 Proposed Rule, p. 32.
 DOL Inf. Letter 06-03-2020 (emphasis added).
 Interpretative Bulletin Relating to the Fiduciary Standard Under ERISA in Considering Economically Targeted Investments, 2015-01, 80 Fed. Reg. 65135 (Oct. 26, 2015).
 Information Letter 06-03-2020 (June 3, 2020), available at https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020.
 See, e.g., Letter from Oleana Berg, Assistant Sec’y of Labor, to Comptroller of the Currency (March 21, 1996) (“Investments in derivatives are subject to the fiduciary responsibility rules in the same manner as are any other plan investments . . . [even though they] may require a higher degree of sophistication and understanding on the part of plan fiduciaries than other investments.”).
 Proposed Rule, p. 7-10.
 Proposed Rule, p. 26.
 See ERISA section 404(a)(1)(B), 409(a).
 In re: Wells Fargo ERISA 401(k) Litig., No. 16-cv-3405, 331 F. Supp. 3d 868, 875 (D. Minn. 2018) (ERISA’s duty of loyalty is evaluated under a “subjective standard” where “what matters is why the defendant acted as he did.”) (emphasis in original), appeal docketed, No. 18-2781 (8th Cir. Aug. 20, 2018).
 See Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982).
 The Department does not address the potential tension between these rules of general application and ERISA’s special authorization to invest in employer securities. While ERISA’s statutory provisions should largely control, the rules could give rise to at least some additional risk to fiduciaries investing in, or permitting investments in, employer securities.
 See, e.g., Marshall v. Glass/Metal Ass'n & Glaziers & Glassworkers Pension Plan, 507 F. Supp. 378, (D. Hawaii 1980); accord Delk v. Ford Motor Co., 96 F.3d 182 (6th Cir. 1996).
 Proposed Rule, p. 15.
 “Environmental, social, corporate governance, or other similarly oriented considerations are pecuniary factors only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.” Proposed Rule, §2550.404a-1(c)(1).
 Proposed Rule, p. 34-35.
 Proposed Rule, p. 22-23.