Investors want more from Biden White House

Institutional investors welcomed news earlier this month that the Department of Labor wouldn't be enforcing two high-profile rules promulgated during the Trump administration for ERISA fiduciaries on selecting investments and exercising voting rights, but will want to see more from the Biden administration before changing course, sources said.

"I don't think floodgates are going to open because I think people are still in a wait-and-see mode in regard to what the Biden administration is going to do beyond its non-enforcement policy," said Elizabeth S. Goldberg, a Pittsburgh-based partner with law firm Morgan, Lewis & Bockius LLP.

The non-enforcement policy pertains to two rules — which remain on the books — that went into effect just days before the Biden administration took office. Stakeholders fear the rules would cause a chilling effect on environmental, social and governance investments.

The first, called "Financial Factors in Selecting Plan Investments," stipulates that ERISA plan fiduciaries cannot invest in "non-pecuniary" vehicles that sacrifice investment returns or take on additional risk. It's often referred to as the "ESG rule" because the initial proposal, which was unveiled in June, focused on ESG investment factors, but the final rule walked back the ESG language. It was finalized in November and took effect Jan. 12, but President Joe Biden signed an executive order on his first day in office ordering a review of the rule.

The other rule — "Fiduciary Duties Regarding Proxy Voting and Shareholder Rights" — outlines the process a fiduciary must undertake when making decisions on casting a proxy vote. It underscores that fiduciaries are not required to vote every proxy and notes that they must act solely in accordance with the economic interest of the plan and maintain records on proxy voting activities and other exercises of shareholder rights.

"These rules have created a perception that fiduciaries are at risk if they include any environmental, social and governance factors in the financial evaluation of plan investments, and that they may need to have special justifications for even ordinary exercises of shareholder rights," said Ali Khawar, principal deputy assistant secretary for the Employee Benefits Security Administration, in a news release. "We intend to conduct significantly more stakeholder outreach to determine how to craft rules that better recognize the important role that environmental, social and governance integration can play in the evaluation and management of plan investments, while continuing to uphold fundamental fiduciary obligations."

Until the Biden administration acts further, fiduciaries are unlikely to change their plan lineups, sources said.

"The market is going to want that clarity from the DOL before it continues to move forward," said Sarah Bratton Hughes, New York-based head of sustainability, North America at Schroders PLC, adding that there's "pent-up" participant demand for ESG options. The latest global investor survey from Schroders, which was released in September, found that 47% of individual investors frequently invest in sustainable investment funds rather than those that don't consider sustainability factors, up from 42% in 2018.

The final version of the financial factors rule does not prohibit fiduciaries from incorporating ESG investments in plan lineups, but it still made them hesitant to do so, sources said.

Notably, the rule excludes a fund from being a qualified default investment alternative if its investment objectives, goals or principal investment strategy include or consider the use of one or more non-pecuniary factors.

Jason Berkowitz, chief legal and regulatory affairs officer at the Insured Retirement Institute in Washington, said in a statement that the rule would significantly impair plan sponsors' ability to consider ESG factors.

"The final rule reflected the Trump administration's posture regarding ESG investments without adequately considering the broader implications of the rule," Mr. Berkowitz said. "We believe the final rule would make the investment selection process for plan sponsors much more complicated and burdensome than is necessary to effectively protect plan participants."

Kary Moore, Pittsburgh-based senior corporate counsel and senior vice president at Federated Hermes Inc., said the final rule's main problem at the moment is the messaging around it.

"I think the proposed rule had so many problems that it didn't matter almost what the final rule had to say; I think the damage was done in the messaging," she said. "And even though the final rule was what we considered an improvement over the proposed rule, I think some of the harsh focus on ESG in the proposed rule sort of tainted the perception of the final rule."

Because the initial proposal was "anti-ESG," the Biden administration has the opportunity to promulgate a rule of its own that's similar in substance to the final rule, but takes a more positive ESG tone and pleases stakeholders, Ms. Moore added.

The Labor Department under the Biden administration is likely to recognize that applying ESG factors in investment decision-making is standard, Ms. Goldberg said.

Will Hansen, Arlington, Va.-based executive director of the Plan Sponsor Council of America and chief government affairs officer at the American Retirement Association, said he'd like the Labor Department "to ensure that it's crystal clear that this does not have any impact on QDIAs in particular. We want it known that you could have ESG factors in QDIAs."

With respect to the proxy voting rule, the new administration could scale back the reporting requirements for voting proxies, Ms. Goldberg added. "Those things seemed hard to apply as a practical manner and so would make it challenging for plan sponsor fiduciaries to implement."

The Labor Department's announcement is exactly what many stakeholders were asking for, said Michael P. Kreps, a Washington-based principal at Groom Law Group, in an email. "I am hopeful that the administration can thread the needle in such a way that it permanently ends the cycle of changing the rules every time a new president takes office," he said.

Preston Rutledge, who stepped down as the assistant secretary of labor for EBSA shortly before the rules were proposed last year, said in an email that EBSA has a long-standing practice of utilizing non-enforcement policies when it revisits an area of guidance critical to the regulated community. "Preserving the status quo while new guidance is developed is sound regulatory practice," he said.

But while the non-enforcement policy is welcomed news for many, the rules are still on the books and fiduciaries must still abide by them, sources said. "You can't pull back a rule by doing a press release," said Kevin Walsh, a fellow Washington-based principal at Groom Law Group, during Pensions & Investments' Defined Contribution Spring Virtual Series earlier this month.

With the rules still in effect, the risk of private ligation looms. "If you have a plan participant who's unhappy that a plan is making decisions that are costing them investment return or are causing them to take on more investment risk, a non-enforcement policy is helpful in that it provides some comfort for this interim period, but it's not a get-out-of-jail-free card because the law is the law, the regulations are the regulations, they went through notice and comment, so private litigants are still a real risk there," Mr. Walsh said.

Mr. Hansen said plan sponsors appreciate the new non-enforcement policy but hope the Labor Department acts "with great speed" in revising the financial factors rule.

Due to the private litigation threat, Mr. Hansen said plan sponsors will likely wait until a new rule is issue before making any ESG-related investments.