As Expected, the Biden Administration Plans to Walk Back the New Regulation Restricting the Use of ESG Funds in 401(k) Plans

  • ESG investing looks at environmental, socially responsible and corporate governance criteria in evaluating investments. The belief is that, over the long term, these factors can positively impact financial performance.

  • The popularity of ESG investing has increased in recent years. Many defined contribution plans now include an ESG option in their lineup. Net flows into these funds reached $51 billion 2020, which represents a tenfold increase over 2018.

  • The Department of Labor’s new rule for ESG investments took effect January 12th of this year. The rule manifests significant skepticism of ESG investing and created additional requirements for plan fiduciaries to add ESG funds to investment line ups. The Biden Administration announcement of a non-enforcement policy, and review, of the new rule is not surprising as the Democrat platform has historically tended to look more favorably upon ESG investing than has the Republican platform.

  • The proposed rule, issued early last year, generated a fair amount of negative response from the financial services sector. In response to the many negative comments, the final rule goes so far as to completely remove reference to the term “ESG” altogether. Rather, it employs the terms pecuniary and nonpecuniary factors and permits the use of nonpecuniary factors, such as ESG criteria, only as a tie breaker.

  • Two things that are of note. First, promulgating a regulation that contains specific criteria for evaluating investments was unprecedented. While the Securities & Exchange Commission and FINRA have promulgated many rules over the years, there are none that establish specific criteria that must be applied to evaluate a particular type of investment. Second, the manner in which the rule is drafted manifests a fundamental misunderstanding of modern portfolio theory and the manner in which investments are evaluated.

  • If the Biden administration is so inclined, promulgating a new rule will likely take a minimum of 18 months. In the meantime, it is expected that the Department of Labor will issue guidance to the effect that pecuniary factors may include ESG criteria. The result should be a roadmap provided to fiduciaries for the prudent selection and ongoing monitoring of ESG investments in ERISA plans.

  • It is important for plan fiduciaries to understand that ESG funds can be complex.  They do not represent a separate and distinct asset class (like large cap value or international equity), but rather are typically managed to an existing asset class. Thus, it is not a necessity for plan sponsors to add an ESG fund for diversification purposes. However, for plans that already offer an ESG option the Biden administration’s nonenforcement announcement is welcome relief that they need not undertake the additional requirements outlined in the new rule at present. For plan sponsors that are considering adding an ESG option, it may be advisable to take a wait and see approach until new guidance is published to better understand the prudent process that we hope the DOL will provide.


For any further questions, please do not hesitate to contact your Wellspring Financial Partners at (520) 327-1019 or info@wellspringfp.com.

This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation.