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Many investors believe ESG investing already accords with the Labor Department’s emphasis on economic interest.

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The Labor Department is getting closer to dealing a one-two punch to ESG investing.

Even as it weighs a controversial rule that would limit the ability of 401(k) plans to make sustainable investments, Labor is considering another rule about proxy voting that may also make it harder to practice environmental, social, and governance investing, analysts say.

According to the new proxy rule, which was proposed in September, fiduciaries must thoroughly research and analyze each proxy vote it makes to determine if it has an economic benefit to the retirement plan and doesn’t pursue “non-pecuniary objectives.”

The rule would require retirement-plan fiduciaries to keep more thorough record-keeping and conduct deeper analysis before voting their proxies, analysts say, except in certain cases, such as voting in accordance with management’s recommendations and voting only on specific proposals related to activities like mergers and acquisitions, buybacks, and other corporate events.

In addition, a fiduciary may refrain from voting if the plan owns a small amount of shares in a company. The Labor Department has asked for comment on whether a 5% cap would be appropriate.

“As a practical matter, it significantly changes the fiduciary analysis and record-keeping requirements for plans voting proxies held by virtue of the plans’ investments,” according to an analysis by Groom Law Group, which specializes in benefits and retirement law. The rule “is thematically consistent” with Labor’s proposed rule on ESG investing, Groom Law wrote.

The comment period for the rule closed on Oct. 6. The Labor Department didn’t return a request for comment.

Labor was already weighing a different rule to require retirement-plan fiduciaries to choose investments “based solely on financial considerations,” a move aimed to slow the interest in ESG investing, analysts said. That rule is widely unpopular, and more than half the asset managers of defined-contribution retirement plans, including 401(k) plans, intend to keep promoting funds that use ESG criteria in the next 12 months, despite pushback from regulators, according to a study by Cerulli Associates. There is $10.7 trillion in private pension plans.

Many investors believe ESG investing already accords with the Labor Department’s emphasis on economic interest, because they believe, among other things, that sustainable funds can outperform traditional investments and that ESG is a critical tool to manage risk. Many are also active in terms of engaging with corporate management, and typically make shareholder proposals only when management ceases to engage on particular topics.

As a result, the new rule has met with opposition from ESG investors. “What the rule says is proxy voting is expensive and onerous…so that a fiduciary of an Erisa plan no longer needs to consider it mandatory to vote their proxies,” says Julie Gorte, senior vice president at Impax Asset Management, a sustainable investment firm. “It’s another way to let companies control the entire narrative.” Erisa stands for the Employee Retirement Income Security Act of 1974.

Gorte points out that companies often make mistakes. Some high-profile examples include Wells Fargo’s manipulation of customer accounts and Volkswagen’s emissions cheating scheme. In a letter to Labor, Gorte shared a variety of studies showing that ESG helps investors outperform.

Jim Coburn, senior manager of disclosure at Ceres, a shareholder advocacy group, told Barron’s in an email that the rule misunderstands how proxy voting works. “Proxy voting sends important signals to management about risks they should consider, no matter the size of investor,” he says.

The rule to document a fund’s decision to vote proxies a certain way is “absurd,” says Coburn, because investors have already created proxy-voting policies about issues. Thus the rule is “an attempt to make it so burdensome to vote proxies that investors will not do so.”

In a statement, the U.S. Impact Investing Alliance also said the rule “would harm retirement savers and suppress their voices on critical environmental, social and governance issues. [It] would force Erisa-regulated fiduciaries to ignore material, long-term considerations in their proxy voting policies, or risk facing high-cost, burdensome documentation requirements.”

Write to Leslie P. Norton at leslie.norton@barrons.com