Green thumbs up: DOJ rule allows retirement advisors to consider ESG in offerings

Advisors for 401(k)s and similar plans would be able to offer retirement savers investment plans tailored to particular environmental, social and governance goals under a new federal rule.

But in doing so, advisors would still have to be careful to adhere to their fiduciary duties established by the Employment Retirement Income Security Act of 1974. Those duties call on retirement advisors to make prudent investments, minimize risks and avoid conflicts of interest.

The U.S. Department of Labor announced the adoption on Nov. 22 of a rule meant to clarify when advisors for 401(k) and similar defined-contribution plans are allowed to take so-called ESG principles into account when presenting investment options to retirement savers. In general, the rule says that advisors may consider ESG when recommending retirement plans but does not insist that they do.

ESG refers in part to the practice of considering how risks related to the environment, corporate governance or social policies could affect investors’ returns. It can also be used to further goals beyond securing the best returns possible, such as supporting companies believed to have environmentally sound business practices.

The DOL’s new rule, which will take effect in 60 days from being published in the Federal Register, replaces a pair of Trump Administration rules that DOL Assistant Secretary Lisa Gomez argues have had a “chilling effect” on ESG investment. The first rule, adopted on Oct. 30, 2020, called on retirement plan advisors to consider only “pecuniary” factors when making investing decisions. That meant they could take nothing into account beyond financial returns and risks. The second, from December of the same year, placed similar requirements on advisors when they made proxy votes on behalf of shareholders.

Andrew Behar, CEO of the shareholder-advocacy group As You Sow, said the DOL’s new rule will provide assurance to advisors who are looking to meet clients’ ESG preferences without running afoul of the law. It only makes sense, he said, that advisors would want to consider climate-related risks and ESG factors when selecting investment options. A company that’s reliant on cotton, Behar said, would be foolish not to consider how a greater propensity for droughts in places ranging from Pakistan to Texas could affect its bottom line. 

“I think these people who are trying to ignore environmental risks, or trying to not allow companies to assess these risks, are anti-capitalist,” Behar said.

He also said the people who have expressed a preference for ESG-related investments shouldn’t be barred from them. For one thing, there’s scant evidence that ESG funds perform worse than non-ESG ones. Financial services analyst Morningstar has even found they do slightly better. Morningstar estimates in a letter on the DOJ’s rule that 36% of retirement plans with more than 100 participants already offer ESG options.

According to the new rule, advisors “do not violate their duty of loyalty solely because they take participants’ preferences into account when constructing a menu of prudent investment options for participant-directed individual account plans. If accommodating participants’ preferences will lead to greater participation and higher deferral rates, as suggested by commenters, then it could lead to greater retirement security.” 

Nathan Voris, the director of investments, insight and consultant services at Charles Schwab’s Schwab Retirement Plan Services, said that percentage is likely to increase under the DOL’s new rule. The change, though, won’t be immediate, he said. Plan advisors will need time to study the new rule and learn exactly what they can offer in keeping with their fiduciary duties.

“There’s always a bit of a lag,” Voris said. “Advisors have to develop that expertise.”

In a survey of 1,000 investors conducted  from Feb. 17 to 28, the asset manager Schroders found that 74% of the respondents with defined-contribution plans participants either would increase or would consider increasing their contributions if they had an ESG option. Separately, 78% said they believe that companies that are socially responsible will have better results over time.

401(k) plans are estimated to hold more than $7 trillion for 60 million workers and retirees. The DOJ’s new ESG-related rule was first proposed in October 2021, attracting a wide range of opposition and praise.

Some of the loudest critics have been Republican lawmakers and their allies, who have worried that they are being used to further the agendas of various leftist and progressive groups. The skeptics also include groups like the National Association of Manufacturers and the U.S. Chamber of Commerce

Support, meanwhile, is coming from many corners of the retirement industry.

“The final rule makes it clear that ESG factors do not have to be considered for every plan investment but rather that they ‘may’ be considered if the plan fiduciary determines them to be relevant as part of a principles-based fiduciary analysis,” Brian Graff, the CEO of the American Retirement Association, said in a statement.

The Vanguard Group, which provides 401(k) plans to many sponsors, praised the DOL for providing greater clarity.

“These proposed changes will reduce the uncertainty ERISA fiduciaries face when selecting plan investments, will promote, rather than discourage, diligent investment stewardship practices, and will provide investors with more choice in the allocation of their retirement assets,” Vanguard said in a letter submitted before the rule’s adoption.

The ERISA Industry Committee, which represents large employers with retirement plans, was ambivalent. While saying further clarification may be needed, the committee praised the rule for establishing “a mandate to consider any specific factor in every circumstance or put a thumb on the scale when selecting investments, leaving fiduciaries to manage plans for the best interests of workers and retirees.”