Between A Rock and A Hard Place... ESG Investments in 401(k) Plan Line-Ups

Seyfarth Synopsis:  The ever evolving landscape of environmental, social and governance (ESG) factors and 401(k) plan investment options may have just become even more complicated.

Yet Another Twist

As we’ve covered on our blog over the last few years, the DOL’s guidance on whether environmental, social and governance (ESG) investments are an appropriate investment for ERISA plans has changed significantly. (See our prior blog posts here, here, and here for more background on that complicated history.) The Securities and Exchange Commission (“SEC”) has added a new potential twist that could place fiduciaries of retirement plans, like 401(k) plans, and the Board of Directors of companies that sponsor such plans in a very difficult position.  Specifically, the SEC recently released correspondence related to its denial of the request from two different companies to exclude from its proxy materials a shareholder’s proposal concerning the investment options under the company’s retirement plan. 

The Shareholder’s Proposal

Shareholders in a public company have the right to bring certain matters to a vote in order to require the company to take an action that it otherwise might not take. Such shareholder proposals are typically voted on by shareholders using a “proxy voting” process, where a shareholder submits a proposal to the company for inclusion in the company’s proxy statement.  If the proposal is included, shareholders can effectively vote for or against the proposal at a shareholder meeting. This proxy voting process is regulated by the SEC, and a company seeking to exclude a shareholder proposal from its proxy statement can request a “no action” letter from the SEC staff addressing whether the proposal can be excluded.

Here, the relevant shareholder’s proposal was for the Board to prepare a report reviewing the company’s retirement plan investment options and the Board’s assessment of how those options align with the company’s climate action goals.  In its request, the shareholder asserted that:

• every investment option in the company’s retirement plan (including the default investment option(s)) contains “major oil and gas, fossil-fired utilities, coal, pipelines, oil field services, or companies in the agribusiness sector with deforestation risk”; and
• the retirement plan does not offer any equity funds that are “low carbon” and only includes a very limited number of funds that screened for “environmental/social impact”.

The shareholder also noted that the retirement plan investment options contradicted the company’s stated climate reduction commitment, which the shareholder asserted raises reputational risks for the company and could make it difficult to retain employees. Two companies sought to exclude this proposal from their proxy statements and requested a “no action” letter from the SEC staff permitting them to do so. These requests were denied.

Evolution of SEC’s Position on Shareholder Proposals

The SEC’s refusal to exclude the proposal is part of a decades-long evolution of the SEC’s position on how to implement SEC Rule 14a-8 (the “Shareholder Proposal Rule”). Under the Shareholder Proposal Rule, a company may exclude shareholder proposals under certain circumstances, including where the proposal involves the company’s “ordinary business operations.” Before doing so companies generally request that the SEC staff issue a “no action” letter indicating the staff’s agreement that a shareholder proposal can be excluded. In a recent speech, the Director of the SEC’s Division of Corporate Finance laid out the history from the 1960s to today of how stakeholders sought to influence social policy through shareholder proposals and the SEC’s recognition that a proposal involving “substantial public policy” might go beyond “ordinary business” and might not be excluded.

Most recently, on November 3, 2021, the SEC staff published Staff Legal Bulletin 14L (CF), providing a broader interpretation of the Shareholder Proposal Rule than had been seen under the Trump-era SEC, and highlighting that proposals involving human capital and climate would be less likely to be excluded. Specifically, the SEC stated the “staff will no longer focus on determining the nexus between a policy issue and the company, but will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal.  In making this determination, the staff will consider whether the proposal raises issues with a broad societal impact, such that they transcend the ordinary business of the company.” This statement is significant as it reflects the continued march toward taking into account all stakeholders, a fundamental principle of ESG.

While Bulletin 14L advances the ESG focus of the Biden Administration, it received mixed reviews from the SEC Commissioners, with the SEC Chair praising it, while Commissioners Hester Pierce and Elad Roisman released a sharply critical statement. Thus, while the SEC staff has indicated it will take a broad approach to shareholder proposals, the open disagreement amongst Commissioners reflects that the SEC’s internal debate over the Shareholder Proposal Rule is far from over.

What’s a Plan Fiduciary to Do?

In its request to exclude the shareholder’s proposal, the company raised two ERISA-related concerns. First, the company noted that the Board did not have responsibility for, or other control of, the company’s retirement plan. Second, the company asserted that applicable law (i.e., ERISA) mandates that a responsible fiduciary select retirement plan investment options solely in the interest of plan participants.  In response, the shareholder asserted that the proposal was limited to a report and that it did not request or require any changes to the company’s retirement plan investment options. Further, the shareholder asserted that the proposal was consistent with the Biden administration’s initiatives for fiduciaries to consider climate impact when evaluating the investment options under a retirement plan.

So, what happens if the requested report concludes that the retirement plan’s investment options do not align with the company’s climate action goals, with the Board’s related assessment reaching the same conclusion? Does it put the company at risk for potentially having its retirement plan investment options misaligned with its overall ESG strategy? For many companies, the Board is not the ERISA fiduciary responsible for making decisions related to the retirement plan’s investments. So, the Board, itself, likely would not be in a position to actually change any investments as a result of such assessment. 

The question then is what, if anything, should ERISA plan fiduciaries do with such a report?

• Would some plan participants allege that the ERISA fiduciaries breached their fiduciary duties if they don’t change investment options as a result of such a report?
• Would other plan participants allege a breach of fiduciary duty if the fiduciaries do change the investment options as a result of such a report?

ERISA requires plan fiduciaries to act in the sole interest of plan participants, even under the guidance cited by the shareholder here (and described here), and analyze the risk-return of a particular investment. So, plan fiduciaries could face allegations of breach of fiduciary duties if they simply change investments as a result of such a report without careful analysis.

The SEC’s ruling may be just another chapter in this story. If a company’s shareholders approve one of these proposals, it will be interesting to see the ultimate outcome. Yet another reason to stay tuned to the ever-evolving landscape of environmental, social and governance (ESG) factors, and ERISA’s fiduciary duties and responsibilities when evaluating a retirement plan’s investments.  

If you have questions or would like to discuss, please reach out to your Seyfarth Employee Benefits or ESG, Corporate Citizenship & Human Rights attorney.