Biden’s first veto upheld a 401(k) investment rule

To keep a recent U.S. law in place, President Joseph Biden used his first veto. 401(k) and other employer retirement plans are subject to Department of Labor regulations on investment options.

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The regulation, which became enforceable in January, is applicable to funds marketed as "environmental, social, and governance" funds.

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These ESG investments, also known as impact or sustainable funds, come in a variety of forms. For instance, fund managers may invest in renewable energy companies or businesses with diverse corporate boards.

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According to analysts, the Biden administration rule reversed a Trump administration regulation that effectively prohibited companies from choosing ESG funds for their workplace 401(k) plans.

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Will Hansen, executive director of the Plan Sponsor Council of America and chief government relations officer of the American Retirement Association, described the Biden regulation in the simplest terms possible: "It took a Trump-era rule that said 'You shall not have ESG' and said 'You may have ESG.'"

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Biden's veto preserves the Labor Department’s ESG rule

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The perspective of his administration was preserved by Biden's veto on Monday.

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There don't seem to be enough votes in Congress to override the veto. Both the House and the Senate would need to vote in favor of it by two-thirds.

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Recent years have seen an increase in the popularity of ESG investment despite growing political pushback, especially from Republican lawmakers who mock it as "woke" investing.

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According to Trade Algo, investors invested approximately $69 billion in the funds in 2021, setting an annual record and more than tripling the amount from the previous year. However, inflows substantially decreased to $3.1 billion in 2022, a year when equities and bonds were destroyed. This was the largest investor exodus in the history of the U.S. funds universe, according to Morningstar.

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Approximately 5% of 401(k) plans provide an ESG fund, according to data from the PSCA survey. One of the main explanations given by employers for why they haven't provided one to employees is a lack of legislative certainty.

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The Labor Department rule implemented under Trump doesn't specifically mention or prohibit ESG funds in 401(k) plans. Nevertheless, according to experts, the rule's broad requirement that companies solely consider "pecuniary reasons" when selecting 401(k) funds for employees hindered uptake.

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These variables limit fund research to solely financial metrics such as fund fees, return, and risk, according to experts. Yet, elements related to the environment, society, and governance are typically "non-pecuniary."

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At Cabin John, Maryland-based Experiential Wealth's founder and chief investment officer, Philip Chao, said, "The Trump rule made it so harsh, so onerous, that it placed a cool blanket over E, S, and G factors. This one, on the other hand, doesn't really discuss whether ESG considerations are appropriate or bad.”

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"It gives the fiduciary back control," he continued. 

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“The [Biden] rule doesn’t force you to consider ESG. It says ‘you may do that." - Philip Chao, Chief Investment Officer of Experiential Wealth

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Under the Employee Retirement Income Security Act of 1974, employers are obligated to act in the most beneficial interests of their company's 401(k) plans.

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The fiduciary duty requires them to run the plan, including investment decisions, in the employee's best interest. Employers are still required to take ESG factors into account under the Biden rule in the context of what is most beneficial for investors.

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The Labor Department stated in November that employers wouldn't violate their legal obligations by taking into account employees' non-financial preferences in their final fund selection. According to the government, accommodating their choices might, for instance, encourage more plan enrollment and improve retirement security.

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The [Biden] regulation "doesn't require you to take ESG into account," Chao added. It states that "you may" do that.

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The veto may not change behavior much

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On February 28, the House of Representatives, which is under Republican control, voted to repeal the rule. It did so by utilizing the Congressional Review Act. This is a procedure that provides representatives with a chance to repeal any rules passed close to the end of a legislative session.

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The final version of the Biden administration's investment rule was released in November, just before Republicans took over the House.

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On March 1, the Senate decided to repeal the Biden-era rule. Two Democrats, Joe Manchin of West Virginia and Jon Tester of Montana joined the Republican opposition.

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Although the Biden administration's rule is expected to stand, it's not obvious if it will provide companies with comfort.

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Employers continue to be concerned about being sued for their investment decisions in the face of regulatory ambiguity because the problem has been political whiplash, according to Hansen.

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What they can or should do has become even murkier as a result of the CRA vote and veto, according to Hansen.