The Trump administration's expected proposal requiring 401(k) plans to consider only financial factors in their investment offerings might conflict with the goals of another proposal intended to open private markets to the defined-contribution retirement plans, according to lawyers and fund managers.

The two measures highlight the Trump administration's somewhat contradictory approaches to governing investment offerings by 401(k) sponsors.

Regulators are reviewing a forthcoming Labor Department proposal to repeal Biden-era rules that let administrators consider environmental, social and corporate governance aspects of their investment offerings for participants in 401(k) and similar plans. The proposal will likely require plan sponsors to focus solely on "pecuniary" factors and exclude ESG considerations.

Labor's rule-making is the latest salvo in a broader backlash that began a few years ago against investment strategies pursued by so-called ESG funds. Some federal and state officials publicly criticized the funds-many of which produced poor returns and made dubious claims about their nonfinancial benefits-as vehicles often used to promote unstated political agendas to the detriment of investors.

The proposed rule follows the principle that investments based on nonfinancial factors breach the fiduciary duties established by the Employee Retirement Income Security Act, or Erisa, which set standards for retirement plans, legal specialists say. The 52-year-old law requires plan sponsors to act solely in the interest of participants as part of their fiduciary responsibilities. Daniel Aronowitz, the head of the Labor Department's Employee Benefits Security Administration, has characterized ESG and diversity investment strategies as "disloyal" to 401(k) savers.

"The loyalty rule in Erisa asks, 'What factors did you use to make your decision?' especially if there is some kind of conflict of interest," said Robert Mashburn, a lawyer at Liskow & Lewis who focuses on employee benefits and compensation. "You wouldn't want to do anything that may not be beneficial to your plan participants on a financial basis."

Labor's proposal to exclude ESG considerations likely will make plan sponsors think twice before backing any strategy remotely linked to issues such as climate change, including offering clean energy-focused and impact funds into which public pensions have poured billions of dollars, according to lawyers and fund managers.

"Anything involving climate change as an investment option could just become an automatic enforcement red flag and litigation red flag" under the proposed rule, said Ada Dolph, a partner in the labor and employment practice of law firm Seyfarth Shaw.

But stripping some popular investment strategies from 401(k) plan investment options would conflict with the objectives of another Labor Department proposal to facilitate investments in private assets that have long been a staple for traditional pensions. That rule focused on enabling 401(k) plans to invest in private assets without fear of lawsuits as one of its main goals.

A number of private-equity firms have invested for years through impact funds, or strategies that seek to combine financial returns with social and environmental benefits such as curbing carbon emissions and increasing access to housing, healthcare and small-business financing. Asset manager TPG's prominent Rise strategy alone manages about $35 billion and has received hundreds of millions of dollars in commitments over the past few years from public pensions in California, Michigan, New Jersey, Ohio and Washington, among others, according to the WSJ Pro Private Equity LP Commitments database.

Overall, impact pools worldwide had assets of $1.571 trillion in 2024, the latest data available from the Global Impact Investing Network, or GIIN, according to Chief Executive Amit Bouri.

"Many pension funds around the world and other institutional investors have seen impact investing as consistent with their fiduciary duties," said Bouri, whose organization advocates for the strategy. GIIN research shows that strategies representing 89% of impact-focused assets target risk-adjusted, market-rate returns.

The proposed rule to expand 401(k) plans' access to private markets isn't centered on loyalty to participants' financial interests, but on a different Erisa fiduciary principle-prudence. The proposal, which regulators are reviewing after receiving public comments, sets out several procedures that, when followed, should provide plan sponsors with a legal safe harbor to invest in any assets they see as fitting. The proposed rule calls Erisa "a law grounded in process" that gives plan sponsors "maximum discretion" to choose investments-aspects that the ESG-related proposal largely ignores.

"One rule says that, as long as you follow the process, you're good. But the ESG rule says, 'Well, regardless of your process, you can't include consideration of these particular factors,'" said Elizabeth Bray, a partner in law firm Benesch Friedlander Coplan & Aronoff's executive compensation and benefits practice.

"There is a kind of tension between the two rules," she said.

The frequency and severity of weather events makes it nearly impossible for 401(k) plans not to consider both the resulting risks for investments and the opportunities to back strategies that can profit from helping mitigate climate effects, she added.

"There are certain environmental factors, especially climate change, that you would be imprudent if you did not take into account, especially if you're thinking about investing in real-estate or other real-asset funds," Bray said.

Some clean-energy fund managers might rebrand their strategies to make them more palatable to 401(k) plans, reducing the emphasis on climate and instead highlighting goals such as energy resilience or security, according to lawyers and fund managers. That would also avoid running afoul of a strict interpretation of the proposed rule.

Liskow & Lewis's Mashburn said there is a chance that the proposed rule can be refashioned to strike a balance between 401(k) plan participants' interest in ESG-related investment strategies and the requirement that plan options rely solely on financial merits.

"I believe the DOL will not be saying you can't invest in ESG-type assets. What the DOL is likely to say is, 'You've got to be doing things looking after the financial interests of the participants,'" he said.

Still, some lawyers and fund managers raise questions about the need for more changes in 401(k) rules regarding ESG investing, which have whipsawed for years across different administrations. First, the threat of ESG-related lawsuits against 401(k) plan administrators never went away despite a Biden administration rule that let them consider ESG factors as a "tiebreaker" when choosing between similar investment options, lawyers said. They pointed to recent court decisions against corporate pensions that backed ESG funds.

Meanwhile, the political backlash against ESG investing and other market disturbances scared off many fund managers who entered the clean-energy sector mostly to take advantage of rising investor appetite for such assets, industry participants said.

"Many [fund manager] tourists have come in because they thought it was easy to raise money, and now they're leaving," said Peter Davidson, CEO of Aligned Climate Capital, which invests in clean-energy businesses such as developers and operators of community-solar projects.

"Some of us have been asset managers solely in this space. We're committed to a low-carbon future. We are not tourists," he said.

Davidson pointed to rising demand for electricity in the U.S. and the decreased cost of renewable-energy projects as factors that will likely continue to attract investors to clean-energy funds.

"No matter what your politics are, you can't get in the way of the economic rationale of lower-cost energy," he said. He added that he has no intention of removing "Climate" from his firm's name.