At the end of June, the Department of Labor (DOL) published a proposed rule that would, in the words of Secretary of Labor Eugene Scalia, “update and clarify” its set of investment duties and requirements enforced under the Employee Retirement Income Security Act (ERISA).

The rule is intended to provide “clear regulatory guideposts” for plan fiduciaries in light of recent trends involving environmental, social and governance (ESG) investing, according to a statement. The proposed regulation seems to create stricter limits than prior guidance for ESG investing in retirement plans. The vast majority of comments on the proposal were critical.

It has been revealed that prior to the issuance of the proposed rule, the DOL’s Employee Benefits Security Administration (EBSA) sent letters to plan sponsors requesting information “to better understand the plan fiduciaries’ selection of ESG funds for inclusion in the plan’s investment options and compliance with their duty to administer the plan prudently and solely for the purpose of providing benefits to participants and beneficiaries, and defraying reasonable expenses of administering the plan.” The letters, sent in early May, gave plan sponsors just two weeks to provide more than 14 pieces of information including investment policies or guidelines currently in effect for the plans, meeting notes or minutes relating to the consideration of ESG factors by plan fiduciaries, and several disclosures and reports for each investment that was based in whole or in part on the consideration of ESG factors.

Patrick Menasco, co-chair of the ERISA + Executive Compensation practice at Goodwin Procter in Washington, D.C., tells PLANSPONSOR there were two versions of the letter—one sent to plan sponsors and one sent to collective investment trust (CIT) providers. “My understanding is the letters were sent to those who mentioned ESG strategies in articles in the press,” Menasco says. “It appears to be an effort to enforce the current administration’s views on ESG investing even before the proposed rule is finalized.”

Menasco says if the DOL was interested in the views of the plan sponsor community, he would think it would do information collection through a request for information (RFI). “This format of sending a letter requesting a list of information impacts those entities,” he says. “The recipients are in the crosshairs. If the DOL disagrees with [a recipient’s] practices, it can ratchet up its attention. That could be in the form of a letter saying, ‘Do things differently,’ or ‘We think you violated the law.’ Subpoenas could follow.”

The two-week response time frame is impractical, and it’s likely a plan sponsor or CIT provider requested more time, Menasco says. He adds that the DOL historically has worked with plan sponsors and allowed for additional time. Where the process goes from there, Menasco is unsure. Recipients “might provide information on a rolling basis while protecting proprietary information. It’s a bit of a dance,” he says. “Depending on [the recipient’s] cooperation, the issue can go away, or if the DOL didn’t get what it needed or found something troublesome, it can start a more formal process.”

“I would have to think that this is related to the proposed rule. I’m not aware of any compliance effort by the DOL on ESG,” Menasco says. “In my experience, it’s the first effort to target ESG investing and it’s hard to view this as anything other than regulatory pressure on plan sponsors and CIT providers to adhere to the current administration’s views on ESG.”

Loreen Gilbert, founder and president of WealthWise Financial Services in Irvine, California, echoes Menasco’s belief. “I think the letters have something to do with the proposed rule. My suspicion is the DOL is trying to get a handle on what plan sponsors are actually doing,” Gilbert says. “I think responses to the letters probably influenced what was included in the proposed rule.”

Menasco says the regulatory effort is “to put teeth behind the administration’s policy and further dampen the use of ESG by making it presumptively imprudent and requiring sponsors to prove prudence and loyalty more so than with any other type of investment. I think the hope of this administration is to do what it can to dampen the use of ESG-themed investments or those with ESG components in retirement plans.”

Menasco reflects on what he calls the “pingpong” between Democrats and Republicans about ESG. The difference now, he says, is that while prior administrations have issued guidance, this administration “has taken a strong interest and will do what it can to achieve its goals even if they are inconsistent with historic views of prudence and loyalty and other priorities.”

Plan Sponsors Confused

Gilbert says the issue of whether ESG investments or factors can be used in retirement plans is at the forefront of clients’ minds because the DOL seems to go back and forth. There’s a history of confusion, and plan sponsors need clarity.

At the same time, she says, participants, especially Millennials, are wanting ESG investment options, so plan sponsors think it is important to have them available.

Gilbert says what has plan sponsors concerned is the move to include ESG in target-date funds (TDFs), which many plan sponsors use as their plan’s default investment. “If they’ve done all the metrics, why wouldn’t it be OK to use them?” she says plan sponsors are asking.

Her message to plan sponsors is to be detailed in why they are making certain decisions and make sure they are documenting performance and all the reasons a specific fund was added to their investment lineups. Gilbert says plan sponsors should not rely on investment marketing materials to dictate their reasoning.

She adds that it’s important that advisers talk to plan sponsors about ESG in general. “Engage with plan sponsors about employee interest. If there is employee interest, look for options that include ESG but are not just ESG,” Gilbert says.

“I think the DOL has eyes on whether plan sponsors are making decisions based on marketing materials—or words only. A fund company can say we’re ESG, but what is ESG? Plan sponsors need to scrutinize investments,” she says. “Rely on a prudent process for analyzing investments, so you can say, ‘All things being equal, here’s our decision.’”

Gilbert says we’re in a world that can’t ignore ESG and she’s hopeful the DOL will understand that. “They may be trying to provide guidelines and a protection mechanism so plan sponsors won’t be fooled, but there is demand [for ESG investments],” she says.

As for the DOL letters, “I do think we may continue to see these letters as potential targets may pop up,” Menasco says. “If a particular plan’s use of an ESG-themed investment or a fund provider’s use of an ESG strategy were to surface through the press or otherwise and catch the attention of the DOL, it may be the next recipient of a letter. I expect it to continue as long as this administration is in office.”