What is ERISA and why does it matter?

What is the Employee Retirement Income Security Act (ERISA)’s fiduciary ESG standard and how does it affect my investments?

The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that protects the retirement and health plans of workers in the private sector. The law allows those managing workers’ money to take into account all types of risks and opportunities, but it also makes it easier for workers themselves to choose investments that consider Environmental, Social, and Governance (ESG) factors as well as investments that provide non-financial benefits — as long as they do not sacrifice returns. Without responsible investing options like ESG available in 401(k)s, workers are shut out from being allowed to even consider long-term risks to their retirement security.

How does ESG relate to the way asset managers manage their clients’ money?

Asset managers are fiduciaries and have a legal responsibility to consider long-term risks and opportunities, including when those risks and opportunities impact a client’s overall portfolio. Anti-ESG attacks include efforts to muddy the waters regarding whether asset managers are allowed to consider ESG risks and opportunities when making decisions about where to invest their clients’ money and how to engage with companies they are invested in. This puts workers’ retirement security at risk. 

Why is the anti-ESG movement targeting ERISA?

In addition to targeting state pension plans and government investments, far-right lawmakers have taken aim at ERISA as a means to exclude environmental, social, and governance considerations from private retirement plans. Some of the federal proposals also seek to restrict how ERISA plans can select retirement plan fiduciaries, counsels, employees, and other service providers by barring diversity considerations. By amending ERISA, these lawmakers hope to see restrictions imposed on a federal level that would limit the factors considered in investment decisions.

Under the Trump administration, two Department of Labor (DOL) rules were issued imposing barriers to ESG investing. This rule was criticized by many stakeholders, leading subsequent DOL leadership to be concerned that the regulations created the perception that fiduciaries “would need to have special justifications for even ordinary exercises of shareholder rights.” The AFL-CIO wrote in opposition, noting that the regulations included “vague terms that create additional liability for fiduciaries.” The federal proposals discussed above are based on these two Trump-era rules.

A new DOL rule, which took effect in January 2023, made amendments to correct these issues. These amendments safeguard ERISA retirement plans’ ability to consider factors reasonably determined to be “relevant to a risk and return analysis,” including the economic effects of climate change and other environmental, social, or governance factors, “using appropriate investment horizons consistent with the plan’s investment objectives.” Another provision of the rule allows fiduciaries to consider collateral benefits (such as stimulating union jobs and investing in the geographic region where participants live and work) as tie breakers in cases where investment options under consideration equally serve the financial interests of the plan.  Republican lawmakers attempted to nullify the new rule, an effort President Biden rejected by issuing the first veto of his presidency.