Just before year end, the Department of Labor finalized its new rules on ESG investing and voting for retirement and pension funds.  The rules sharply restrict the ability of the fiduciaries of retirement and pension funds to make investments based on ESG factors, or to vote shares held by such funds in favor of ESG issues.  The rules are unlikely to prove popular with the Biden administration, but regardless of how long they survive, the rules currently apply to trillions of dollars of investments, and raise interesting questions about who will ultimately control the placement of a huge amount of the public’s investment capital and the voting on ESG matters of shares held by fiduciaries. 


The first rule, issued just prior to the election, deals with investing based on ESG considerations. Curiously, the final rule itself does not mention the term ESG. The DOL decided that “ESG” was not appropriate terminology for a regulatory standard, due to the “lack of a precise or generally accepted definition of ‘ESG’, either collectively or separately as ‘E, S and G.”’ The earlier proposed rule – which received over 1100 comments letters, mostly in opposition – was perhaps clearer about the driving force behind the rule:   to eliminate independent ESG considerations from the selection of investments by fiduciaries.  

The final rule instead focuses on “pecuniary” versus “non-pecuniary” factors, with non-pecuniary factors presumably standing in as a proxy for the more fuzzy-headed aspects of ESG.   Non-pecuniary factors (i.e., factors other than those that are expected to have a material effect on the risk or return of the investment) are now permissible investment considerations only as fully documented “tie-breakers” between investments that cannot be distinguished on pecuniary factors alone. To take into account these non-pecuniary tie-breakers, fiduciaries are required to document why pecuniary factors alone were not sufficient to select the investment, how the selected investment compares to alternative investments on a variety of factors, and how the non-pecuniary factors are “consistent with the interests of participants and beneficiaries . . . in retirement income or financial benefits.”  This is death by documentation for any fund manager wishing to consider ESG matters in making investments.  

Significantly, the rule also prohibits funds that “include or consider non-pecuniary factors” as part of their investment objectives (i.e., ESG focused funds) from appearing as “qualified default investment alternatives” in 401(k) plans.  In short, individuals will not have the choice to dedicate any 401(k) savings to furthering personal ESG goals.

To underline the significance of this new rule, consider that ESG investments now constitute roughly one-third of US assets under management – $51.4 trillion. [1]  It is a very considerable market, with offerings from every major fund manager for both “integrated” funds (that only invest in companies that follow “leading” ESG practices), and “exclusionary funds” (that won’t invest in industries such as tobacco, alcohol, arms, or fossil fuels, or that do not meet diversity, labor, environmental or other ESG criteria).  Many of these funds do quite well on financial metrics, and so, if appropriately documented, may fit the criteria for investment at the discretion of fiduciaries, but may not be offered as part of 401(k) offerings. 


The DOL prohibition on ESG investing necessarily raises the companion question of whether fiduciaries’ enforced agnosticism on ESG while investing should carry over to a neutral position on ESG when voting shares purchased pursuant to the DOL restrictions. It would seem odd for funds to take an agnostic position while investing in companies, but a more activist role in pursuing ESG policies when managing those same investments.[2]  Accordingly, one might have anticipated that the proposed proxy voting rule from DOL would, in logically consistent manner, require funds to manage their investments with an “eye-single” toward increasing return and minimizing risk, justifying all of their votes on ESG matters based strictly on identified (and perhaps individually documented) “pecuniary” factors. 

Fans of logical consistency are often disappointed by governmental action, and there is some ground for such disappointment here.  Consistent with the rule on investment, the voting rule prohibits voting to “promote non-pecuniary benefits or goals unrelated to [the] financial interests” of beneficiaries – potentially bringing a disciplined approach to the evaluation of ESG proposals that would be welcome and of value. But drastically undermining this new standard for ESG voting is the fact that the rule does not require fiduciaries to vote – rather, it expressly permits fiduciaries not to vote. 

While the role of fiduciaries in voting shares of public companies was already
somewhat limited (given the amount of investments held by ERISA fiduciaries through mutual funds), the new rule expressly permits the fiduciary
not to vote on matters that are not “substantially related to the issuer’s business activities or . . . expected to have a material effect on the value of the investment.”  Given the apparent assumption from the DOL’s investing rule that most ESG policies are presumptively not “pecuniary” in nature, this would seem to give fiduciaries something close to a free pass to not vote on ESG matters. Moreover, a fund can decide not to vote on any matters at a particular portfolio company if the value of that particular portfolio company is less than a specified percentage of the fund’s overall portfolio, such that the matter being voted on is not expected to have a “material effect on the investment performance of the plan’s portfolio.”  

Of course, if ESG measures are not voted on by fiduciaries, it does not mean that those measures will be stripped from the ballot, or otherwise voted down.  To the contrary, it simply clears fiduciaries from the field of battle over what ESG standards should rule U.S. public companies. 

To step back for a moment, recall that the SEC has charged fund complexes with the responsibility to both disclose and formulate voting policies on a variety of matters – including matters of “social and corporate responsibility.”[3]  To discharge this responsibility, the fund complexes – with the SEC’s explicit approval (recently withdrawn) – turned to proxy advisors, the lowest cost providers of voting advice.  ISS and Glass Lewis, in response to this regulatory-driven market for voting advice, have in recent years developed, in an opaque and seemingly random manner, a hodge-podge of policies on ESG issues from animal welfare to climate change, diversity, data security, political activities and every aspect of corporate governance. Large fund complexes, doing their part in this empty feedback loop, have assisted in implementation and enforcement of these policies by voting shares held by them in accordance with proxy advisor recommendations – creating a de facto civil code on ESG matters for U.S. public companies. [4]  That this civil code affects value is beyond dispute – the only debate – which is quite vigorous – is over which parts of the civil code create value, and which parts destroy value.

Regardless of one’s view of fiduciaries’ historical role in monitoring and contributing to the creation of a sensible ESG civil code, removing ERISA fiduciaries – arguably the longest term of all shareholders – from the debate would not seem likely to promote an approach to ESG rules that will tame proxy advisors or create long-term value.  The absence of a requirement to vote makes clear that what undergirds the DOL rules is not a belief that pursuing ESG agendas may subtract value from portfolio companies, but rather the belief that ESG agendas will not add or subtract material value from portfolio companies.  While the rule allows funds not to “waste” money on voting on ESG issues, it ignores the reality that ESG issues – particularly when taken in the aggregate – can significantly affect value at portfolio companies.  One prominent example is the huge amount of value lost in the rush to de-classify boards across the spectrum of public companies.[5]  A recent study concluded that while the evidence is mixed, for the most part, the influence of proxy advisory firms “on corporate and shareholder value is shown to be negative” – not neutral. [6] Accordingly, it is difficult to understand why the DOL saw fit to allow fiduciaries to decline exercising influence over these topics.

Who Controls the Public’s Vote?

Most prominently, the DOL rules add another player to the clash over who will  control the vast pool of undirected voting power at U.S. public companies. Who will have the right to characterize the collective views of the ultimate individual beneficial owners buried under the layers of regulators, fund managers and proxy advisors? Alternatively, who will decide what is good for those owners? As importantly, how will those decisions be made? 

Long before the DOL rules were issued, fund complexes had been pushed by the SEC into laying claim to the otherwise abandoned voting power of the investing public.  The funds promptly unburdened themselves from this responsibility by delegating voting power to proxy advisors. (For analysis of the power wielded by proxy advisors over America’s public companies, listen to my Law, Policy & Markets podcast episode on corporate governance.) Over time, proxy advisors began wielding this power in an ever more aggressive manner, punishing boards that failed to follow an ESG civil code designed behind the inkiest of black curtains. 

Now the DOL has staked out its own position. Limiting the flow of pension and retirement money into ESG funds, of itself, seems unlikely to change the voting pattern of fund complexes, as one suspects the voting policies of the fund complexes are largely the same for both their ESG funds and their index funds. Moreover, a large percentage of money invested by fiduciaries ends up in mutual funds, which results in the fund manager (who is not an ERISA fiduciary) voting any shares held by the mutual fund. Accordingly, the practical impact of these rules on voting is likely to be limited.

Nonetheless, to the extent fiduciaries are charged with voting, the DOL seems to be  encouraging fiduciaries (and their proxy advisors) to throw the new civil code in the trash.  Fiduciaries will either not vote (in which case they have no need for the ESG civil code), or the code will have to be re-written for fiduciaries, with a new lodestar – pecuniary interest – guiding the policy positions. [7]


[1] Market Watch, Debbie Carlson, ESG Investing Now Accounts for One-Third of Total US Assets Under Management, November 17, 2020.

[2] Even if the DOL rule is ultimately repealed, the appropriate role for fund complexes in promoting ESG positions on behalf of a largely silent client base is a difficult question. Professor Coffee’s view that the large fund managers have an economic interest in addressing ESG to the extent it constitutes systemic risk is no doubt correct, and may be the only example of the government delegating its regulatory powers to the market one could applaud.  However, given the breadth of concerns the funds (or at least their proxy advisors) seem to want to address, one can question whether a disciplined approach to addressing systemic risk is behind most of the policy interventions recommended by proxy advisory firms. See John C. Coffee, Jr. “ESG, Common Ownership and Systemic Risk: How They Intersect” The CLS Blue Sky Blog, September 14, 2020.

[3] Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies, Investment Company Act Release No. 25922, 17 C.F.R. [Section] 239, 249, 270, 274 (Jan. 31, 2003).

[4] See Neil Whoriskey “The New Civil Code: ISS and Glass Lewis as Lawmakers” The CLS Blue Sky Blog, July 28, 2020.

[5] See K.J. Martijn Cremers & Simone M. Sepe, Board Declassification Activism: The Financial Value of the Shareholder Rights Project, SSRN (June 26,2017).

[6] See James Copland, David F. Larcker & Brian Tayan, The Big Thumb on the Scale: an Overview of the Proxy Advisory Industry, Rock Center for Corporate Governance at Stanford University, Closer Look Series: Topics, Issues and Controversies In Corporate Governance No. CGRP72(2018).

[7] For those who have acquiesced to the shareholder primacy theory pushed by large funds, proxy advisors, activists and certain academics (but not part of Delaware law), there is an additional trickle-down question for boards – should the board also ignore ESG factors (other than as tie-breakers) if a large percentage of their ultimate shareholders are invested through funds that explicitly reject furthering “non-pecuniary interests” as a goal of their investing, an equally large percentage of their ultimate shareholders are effectively silent on ESG topics (having invested through directly or through funds which do not include ‘non-pecuniary” investment objectives or strategies), and another, in some cases robust, number of their ultimate shareholders have explicitly adopted ESG goals as part of their investing strategy. How should ESG figure into the Board’s planning knowing that the large percentage of shareholders expressing a preference prefer that the board simply does not consider ESG outside of the context of risk and return?