ESG & Biden’s Administration: Department of Labor's & the SEC's recent efforts to enhance ESG's role
Several legal barriers have prevented institutional investors (including the employee benefit plans subject to the Employee Retirement Income Security Act of 1974 (“ERISA” and “ERISA Plans”)) from creating an impact on environmental, social and governance (“ESG”) matters. Nonetheless, Biden’s administration seems eager to remove many of such barriers and boost ESG’s role. Thus, in January 2021 President Biden issued an Executive Order instructing government agencies to revise any regulations, orders or guidelines issued during Trump’s administration that are inconsistent with certain environmental and social policies (“Executive Order”).
In compliance with the Executive Order, last October the Department of Labor (“DOL”) published a proposal (“DOL Proposal”) to amend the fiduciary duties’ regulation applicable to ERISA Plans’ managers (“ERISA Managers”). Similarly, in November the Division of Corporate Finance of the Securities and Exchange Commission (“SEC Division”) issued the Staff Legal Bulleting No. 14L, revising the criteria used by the SEC Division when reviewing the no-action requests filed by managers of listed corporations as to shareholder proposals regarding ESG issues (“SEC Statement” and, together with the DOL Proposal, the “Actions”). In this article I will briefly summarize the Actions and analyze their impact on ESG.
Pursuant to ERISA (as interpreted by the U.S. Supreme Court), ERISA Managers have a fiduciary duty to act in the sole financial interest of the plans’ beneficiaries (i.e. sole-benefit rule). In November 2020, the DOL issued a regulation regarding the ERISA Managers’ fiduciary duties (“DOL Current Regulation”), under which, as a general rule, investment decisions must be based exclusively on pecuniary factors (i.e. factors aimed at maximizing the risk-adjusted returns of the ERISA Plan’s portfolio). This rule implicitly mandates that, when discharging their fiduciary duties, ERISA Managers can only consider ESG factors that maximize the risk-adjusted returns of the plans (“Non-Concessionary ESG”), but are precluded from considering ESG factors that conflict with such returns (“Concessionary ESG”).
As an exception, non-pecuniary factors (e.g. Concessionary ESG) may be considered only as a tie-breaker between investment opportunities that offer the same financial returns. When this occurs, DOL Current Regulation imposes burdensome documentation requirements on the ERISA Managers.
According to the DOL, the DOL Current Regulation has caused the undesired effect of deterring ERISA Managers from taking into account even Non-Concessionary ESG issues when designing their portfolios. The following are the main changes under the DOL Proposal:
The DOL Proposal reaffirms the longstanding principle under which ERISA Managers cannot prioritize non-pecuniary factors over the plan’s returns and, hence, are generally prevented from taking into account Concessionary ESG factors (unless as tie-breakers).
In contrast to the implicit approach followed by the DOL Current Regulation, the DOL Proposal explicitly states that the Non-Concessionary ESG factors may be taken into account when making investment decisions. Additionally, the text lists some examples of ESG factors that could be relevant to the risk-adjusted return of the ERISA Plan’s portfolio.
As to the tie-breaker rule, the DOL Proposal removes the above mentioned burdensome documentation requirements.
The DOL Proposal removes the restriction to add investment products that consider non-pecuniary factors (e.g. Concessionary ESG) as qualified default investment alternatives (investments that the ERISA Managers can make if beneficiaries do not provide specific instructions on how to invest their contributions).
Shareholders have limited powers to influence the firm’s attitude towards ESG issues. Particularly, SEC’s regulations have entitled managers of a public corporation to exclude from the proxy statement shareholder proposals related to ESG matters (“ESG Proposals”) on the grounds that such proposals deal with the ordinary business of the corporation or lack significant economic impact on the latter. Recently, the SEC Division has revised some of its former criteria used to review ESG Proposals, granting shareholders more power to exert influence over the firm on ESG issues.
Under Staff Legal Bulletins No. 14I, 14K and 14L (“Rescinded SLBs”), when reviewing no-action requests regarding ESG Proposals, the SEC’s Division has permitted the exclusion of those proposals when they either (i) seek detailed targets, deadlines or reporting requirements (e.g. achieve net-zero greenhouse emissions by 2030 and report progress every year), as they amount to micromanaging the corporation, or (ii) are not significantly related to the core business of the corporation (e.g. a climate change proposal for a software development company). 14I; 14J; 14K.
As a result of the foregoing, even when authorized to take into account ESG factors, institutional investors (including the ERISA Managers) may be prevented from using ESG Proposals as a way of promoting ESG goals.
The SEC Division considered that the Rescinded SLBs had the effect of limiting the shareholders’ powers to submit relevant and material ESG Proposals. Thus, the main purpose of the SEC Statement is to incentivize the submission of ESG Proposals.
Under the aforementioned SEC Statement, managers of a public corporation will not be able to exclude ESG Proposals that (i) “[seek] detail or [seek] to promote timeframe or methods”, to the extent that the corporation’s board maintains adequate discretion as to how to implement and comply with the proposal, and (ii) raise broad societal policy matters (such as climate change), even if such matters are not significant to the corporation’s business.
Generally, the Actions should enhance the role of Non-Concessionary ESG in corporate business. First, the DOL Proposal clarifies that ERISA Managers may consider Non-Concessionary ESG factors when performing their fiduciary duties and also lifts some of the burdens and barriers that currently deter those managers from taking into account the referred factors.
Second, under the SEC Statement, ESG Proposals regarding the most relevant Non-Concessionary ESG issues (such as those related to climate change and energy transition) would be deemed as broad societal policy matters and, thus, non-excludable from a corporation’s proxy statement, to the extent they do not micromanage the corporation.
That said, the DOL Proposal does not materially enhance the Concessionary ESG’s role on the ERISA Plans’ investment decisions. Given that the sole-benefit rule preventing ERISA Managers from considering Concessionary ESG factors is set forth in the ERISA, it is hard to see how the DOL could further enhance the role of these factors via regulation. Instead, such enhancement could only come from a decision of the U.S. Congress to amend the ERISA.
Pedro Arango is a Corporations LLM candidate at NYU and serves as Graduate Editor at the NYU Journal of Law & Business. Pedro is licensed to practice law in Colombia and, before attending NYU, he practiced for almost six years at two prestigious law firm in Colombia. His practice is focused on Banking & Finance, Mergers & Acquisitions and Corporate Law.