[Federal Register Volume 85, Number 220 (Friday, November 13, 2020)]
[Rules and Regulations]
[Pages 72846-72885]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-24515]
[[Page 72845]]
Vol. 85
Friday,
No. 220
November 13, 2020
Part III
Department of Labor
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Employee Benefits Security Administration
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29 CFR Parts 2509 and 2550
Financial Factors in Selecting Plan Investments; Final Rule
Federal Register / Vol. 85 , No. 220 / Friday, November 13, 2020 /
Rules and Regulations
[[Page 72846]]
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Parts 2509 and 2550
RIN 1210-AB95
Financial Factors in Selecting Plan Investments
AGENCY: Employee Benefits Security Administration, Department of Labor.
ACTION: Final rule.
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SUMMARY: The Department of Labor (Department) is adopting amendments to
the ``investment duties'' regulation under Title I of the Employee
Retirement Income Security Act of 1974, as amended (ERISA). The
amendments require plan fiduciaries to select investments and
investment courses of action based solely on financial considerations
relevant to the risk-adjusted economic value of a particular investment
or investment course of action.
DATES: The final rule is effective on January 12, 2021.
FOR FURTHER INFORMATION CONTACT: Jason A. DeWitt, Office of Regulations
and Interpretations, Employee Benefits Security Administration, (202)
693-8500. This is not a toll-free number.
Customer Service Information: Individuals interested in obtaining
information from the Department of Labor concerning ERISA and employee
benefit plans may call the Employee Benefits Security Administration
(EBSA) Toll-Free Hotline, at 1-866-444-EBSA (3272) or visit the
Department of Labor's website (www.dol.gov/ebsa).
SUPPLEMENTARY INFORMATION:
A. Background
Title I of the Employee Retirement Income Security Act of 1974
(ERISA) establishes minimum standards that govern the operation of
private-sector employee benefit plans, including fiduciary
responsibility rules. Section 404 of ERISA, in part, requires that plan
fiduciaries act prudently and diversify plan investments so as to
minimize the risk of large losses, unless under the circumstances it is
clearly prudent not to do so. Sections 403(c) and 404(a) also require
fiduciaries to act solely in the interest of the plan's participants
and beneficiaries, and for the exclusive purpose of providing benefits
to participants and beneficiaries and defraying reasonable expenses of
administering the plan.
Courts have interpreted the exclusive purpose rule of ERISA section
404(a)(1)(A) to require fiduciaries to act with ``complete and
undivided loyalty to the beneficiaries,'' \1\ observing that their
decisions must ``be made with an eye single to the interests of the
participants and beneficiaries.'' \2\ The Supreme Court as recently as
2014 unanimously held in the context of ERISA retirement plans that
such interests must be understood to refer to ``financial'' rather than
``nonpecuniary'' benefits,\3\ and Federal appellate courts have
described ERISA's fiduciary duties as ``the highest known to the law.''
\4\ The Department's longstanding and consistent position, reiterated
in multiple forms of sub-regulatory guidance, is that when making
decisions on investments and investment courses of action, plan
fiduciaries must be focused solely on the plan's financial returns, and
the interests of plan participants and beneficiaries in their benefits
must be paramount.
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\1\ Donovan v. Mazzola, 716 F.2d 1226, 1238 (9th Cir. 1983)
(quoting Freund v. Marshall & Ilsley Bank, 485 F. Supp. 629, 639
(W.D. Wis. 1979)).
\2\ Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982).
\3\ Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 421
(2014) (the ``benefits'' to be pursued by ERISA fiduciaries as their
``exclusive purpose'' does not include ``nonpecuniary benefits'')
(emphasis in original).
\4\ See, e.g., Tibble v. Edison Int'l, 843 F.3d 1187, 1197 (9th
Cir. 2016).
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The Department has been asked periodically over the last 30 years
to consider the application of these principles to pension plan
investments selected because of the non-pecuniary benefits they may
further, such as those relating to environmental, social, and corporate
governance considerations. Various terms have been used to describe
this and related investment behaviors, such as socially responsible
investing, sustainable and responsible investing, environmental,
social, and corporate governance (ESG) investing, impact investing, and
economically targeted investing. The terms do not have a uniform
meaning and the terminology is evolving.\5\
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\5\ For a concise history of the current ESG movement and the
evolving terminology, see Max Schanzenbach & Robert Sitkoff,
Reconciling Fiduciary Duty and Social Conscience: The Law and
Economics of ESG Investing by a Trustee, 72 Stan. L. Rev. 381, 392-
97 (2020).
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The Department's first comprehensive guidance addressing these
types of investment issues was in Interpretive Bulletin 94-1 (IB 94-
1).\6\ There, the term used was ``economically targeted investments''
(ETIs). The Department's objective in issuing IB 94-1 was to state that
ETIs \7\ are not inherently incompatible with ERISA's fiduciary
obligations. The preamble to IB 94-1 explained that the requirements of
sections 403 and 404 of ERISA do not prevent plan fiduciaries from
investing plan assets in ETIs if the investment has an expected rate of
return commensurate to rates of return of available alternative
investments with similar risk characteristics, and if the investment
vehicle is otherwise an appropriate investment for the plan in terms of
such factors as diversification and the investment policy of the plan.
Some commentators have referred to this as the ``all things being
equal'' test or the ``tie-breaker'' standard. The Department stated in
the preamble to IB 94-1 that when competing investments serve the
plan's economic interests equally well, plan fiduciaries can use such
non-pecuniary considerations as the deciding factor for an investment
decision.
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\6\ 59 FR 32606 (June 23, 1994) (appeared in Code of Federal
Regulations as 29 CFR 2509.94-1). Interpretive Bulletins are a form
of sub-regulatory guidance that are published in the Federal
Register and included in the Code of Federal Regulations. Prior to
issuing IB 94-1, the Department had issued a number of letters
concerning a fiduciary's ability to consider the non-pecuniary
effects of an investment and granted a variety of prohibited
transaction exemptions to both individual plans and pooled
investment vehicles involving investments that produce non-pecuniary
benefits. See Advisory Opinions 80-33A, 85-36A and 88-16A;
Information Letters to Mr. George Cox, dated Jan. 16, 1981; to Mr.
Theodore Groom, dated Jan. 16, 1981; to The Trustees of the Twin
City Carpenters and Joiners Pension Plan, dated May 19, 1981; to Mr.
William Chadwick, dated July 21, 1982; to Mr. Daniel O'Sullivan,
dated Aug. 2, 1982; to Mr. Ralph Katz, dated Mar. 15, 1982; to Mr.
William Ecklund, dated Dec. 18, 1985, and Jan. 16, 1986; to Mr. Reed
Larson, dated July 14, 1986; to Mr. James Ray, dated July 8, 1988;
to the Honorable Jack Kemp, dated Nov. 23, 1990; and to Mr. Stuart
Cohen, dated May 14, 1993; PTE 76-1, part B, concerning construction
loans by multiemployer plans; PTE 84-25, issued to the Pacific Coast
Roofers Pension Plan; PTE 85-58, issued to the Northwestern Ohio
Building Trades and Employer Construction Industry Investment Plan;
PTE 87-20, issued to the Racine Construction Industry Pension Fund;
PTE 87-70, issued to the Dayton Area Building and Construction
Industry Investment Plan; PTE 88-96, issued to the Real Estate for
American Labor A Balcor Group Trust; PTE 89-37, issued to the Union
Bank; and PTE 93-16, issued to the Toledo Roofers Local No. 134
Pension Plan and Trust, et al. In addition, one of the first
directors of the Department's benefits office authored an
influential article on this topic in 1980. See Ian D. Lanoff, The
Social Investment of Private Pension Plan Assets: May It Be Done
Lawfully Under ERISA?, 31 Labor L.J. 387, 391-92 (1980) (stating
that ``[t]he Labor Department has concluded that economic
considerations are the only ones which can be taken into account in
determining which investments are consistent with ERISA standards,''
and warning that fiduciaries who exclude investment options for non-
economic reasons would be ``acting at their peril'').
\7\ IB 94-1 used the terms ETI and economically targeted
investments to broadly refer to any investment or investment course
of action that is selected, in part, for its expected non-pecuniary
benefits, apart from the investment return to the employee benefit
plan investor.
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Since 1994, the Department's sub-regulatory guidance has gone
through an iterative process, but the Department's emphasis on the
primacy of plan participants' economic interests has stayed constant.
In 2008, the Department replaced IB 94-1 with Interpretive Bulletin
2008-01 (IB 2008-01).\8\ In 2015, the Department replaced IB 2008-01
with Interpretive Bulletin 2015-01 (IB 2015-01),\9\ which is codified
at 29 CFR 2509.2015-01. Each Interpretive Bulletin has consistently
stated that the paramount focus of plan fiduciaries must be the plan's
financial returns and providing promised benefits to participants and
beneficiaries. The Department has construed the requirements that a
fiduciary act solely in the interest of, and for the exclusive purpose
of providing benefits to, participants and beneficiaries as prohibiting
a fiduciary from subordinating the interests of participants and
beneficiaries in their retirement income to unrelated objectives. Thus,
each Interpretive Bulletin, while restating the ``all things being
equal'' test, also cautioned that fiduciaries violate ERISA if they
accept reduced expected returns or greater risks to secure social,
environmental, or other policy goals.
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\8\ 73 FR 61734 (Oct. 17, 2008).
\9\ 80 FR 65135 (Oct. 26, 2015).
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The preamble to IB 2015-01 explained that if a fiduciary prudently
determines that an investment is appropriate based solely on economic
considerations, including those that may derive from ESG factors, the
fiduciary may make the investment without regard to any collateral
benefits the investment may also promote. In 2018, the Department
clarified in Field Assistance Bulletin 2018-01 (FAB 2018-01) that IB
2015-01 had merely recognized that there could be instances when ESG
issues present material business risk or opportunities to companies
that company officers and directors need to manage as part of the
company's business plan, and that qualified investment professionals
would treat the issues as material economic considerations under
generally accepted investment theories. As appropriate economic
considerations, they should be considered by a prudent fiduciary along
with other relevant economic factors to evaluate the risk and return
profiles of alternative investments. In other words, in these instances
the factors are not ``tie-breakers,'' but pecuniary (or ``risk-
return'') factors affecting the economic merits of the investment.
The Department cautioned, however, that ``[t]o the extent ESG
factors, in fact, involve business risks or opportunities that are
properly treated as economic considerations themselves in evaluating
alternative investments, the weight given to those factors should also
be appropriate to the relative level of risk and return involved
compared to other relevant economic factors.'' \10\ The Department
further emphasized in FAB 2018-01 that fiduciaries ``must not too
readily treat ESG factors as economically relevant to the particular
investment choices at issue when making a decision,'' as ``[i]t does
not ineluctably follow from the fact that an investment promotes ESG
factors, or that it arguably promotes positive general market trends or
industry growth, that the investment is a prudent choice for retirement
or other investors.'' Rather, ERISA fiduciaries must always put first
the economic interests of the plan in providing retirement benefits and
``[a] fiduciary's evaluation of the economics of an investment should
be focused on financial factors that have a material effect on the
return and risk of an investment based on appropriate investment
horizons consistent with the plan's articulated funding and investment
objectives.'' \11\
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\10\ Field Assistance Bulletin 2018-01 (Apr. 23, 2018).
\11\ Id.
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B. Purpose of Regulatory Action
Available research and data show a steady upward trend in use of
the term ``ESG'' among institutional asset managers, an increase in the
array of ESG-focused investment vehicles available, a proliferation of
ESG metrics, services, and ratings offered by third-party service
providers, and an increase in asset flows into ESG funds. This trend
has been underway for many years, but recent studies indicate the
trajectory is accelerating. For example, according to Morningstar, the
assets invested in sustainable funds was nearly four times larger in
2019 than in 2018.\12\
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\12\ See Jon Hale, The ESG Fund Universe Is Rapidly Expanding
(March 19, 2020), www.morningstar.com/articles/972860/the-esg-fund-universe-is-rapidly-expanding. This trend is most pronounced in
Europe, where authorities are actively promoting consideration of
ESG factors in investing. See, e.g., Principles for Responsible
Investment (PRI), Fiduciary Duty in the 21st Century (Oct. 2019),
www.unpri.org/download?ac=9792, at 34-35 (quoting official from EU
securities regulator that ``ESG is part of [their] core mandate.'');
Emre Peker, What Qualifies as a Green Investment? EU Sets Rules,
Wall Street Journal (Dec. 17, 2019), www.wsj.com/articles/eu-seals-deal-to-create-regulatory-benchmark-for-green-finance-11576595600
(``European officials have been racing to set the global benchmark
for green finance''); Principles for Responsible Investment,
Investor priorities for the EU Green Deal (April 30, 2020),
www.unpri.org/sustainable-markets/investor-priorities-for-the-eu-green-deal/5710.article (discussing proposal to require ESG data to
be disclosed alongside traditional elements of corporate and
financial reporting, including a core set of mandatory ESG key
performance indicators).
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As ESG investing has increased, it has engendered important and
substantial questions with numerous observers identifying a lack of
precision and consistency in the marketplace with respect to defining
ESG investments and strategies, as well as shortcomings in the rigor of
the prudence and loyalty analysis by some participating in the ESG
investment marketplace.\13\ There is no consensus about what
constitutes a genuine ``ESG'' investment, and ESG rating systems are
often vague and inconsistent, despite featuring prominently in
marketing efforts.\14\ The use of terms such as ESG, impact investing,
sustainability, and non-financial performance metrics, among others,
encompass a wide variety of considerations without a common nexus and
can take on different meanings to different people. In part, the
confusion stems from the fact that, from its beginning, the ESG
investing movement has had multiple goals, both pecuniary
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and non-pecuniary.\15\ Moreover, ESG funds often come with higher fees,
because additional investigation and monitoring are necessary to assess
an investment from an ESG perspective.\16\
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\13\ See, e.g., OECD Business and Finance Outlook 2020 (Sept.
2020), www.oecd.org/daf/oecd-business-and-finance-outlook-26172577.htm, at 29 (``The review of academic and industry
literature reveals a wide range of approaches and results, which are
largely inconsistent with one another. The research highlights the
difficulty of identifying the real impact of ESG on investment
performance.''); Scarlet Letters: Remarks of SEC Commissioner Hester
M. Peirce before the American Enterprise Institute (June 18, 2019),
www.sec.gov/news/speech/speech-peirce-061819; Paul Brest, Ronald J.
Gilson, & Mark A. Wolfson, How Investors Can (and Can't) Create
Social Value, European Corporate Governance Institute, Law Working
Paper No. 394 (Mar. 29, 2018), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3150347, at 5; Ogechukwu Ezeokoli et al.,
Environmental, Social, and Governance (ESG) Investment Tools: A
Review of the Current Field (Dec. 2017), www.dol.gov/sites/dolgov/files/OASP/legacy/files/ESG-Investment-Tools-Review-of-the-Current-Field.pdf, at 11-13.
\14\ See, e.g., OECD Business and Finance Outlook 2020 (Sept.
2020), at 26-33, 47-58; Feifei Li & Ari Polychronopoulos, What a
Difference an ESG Ratings Provider Makes! (Jan. 2020),
www.researchaffiliates.com/documents/770-what-a-difference-an-esg-ratings-provider-makes.pdf; Florian Berg, Julian K[ouml]lbel, &
Roberto Rigobon, Aggregate Confusion: The Divergence of ESG Ratings
(Aug. 2019), MIT Sloan Research Paper No. 5822-19, https://ssrn.com/abstract=3438533; Schroders, 2018 Annual Sustainable Investment
Report (March 2019), www.schroders.com/en/insights/economics/annual-sustainable-investment-report-2018, at 22-23 (majority of passive
ESG funds rely on a single third party ESG rating provider that
``typically emphasize tick-the-box policies and disclosure levels,
data points unrelated to investment performance and/or backward-
looking negative events with little predictive power'').
\15\ See, e.g., Who Cares Wins: Connecting Financial Markets to
a Changing World (2004), www.unepfi.org/fileadmin/events/2004/stocks/who_cares_wins_global_compact_2004.pdf, at v. (``Overall
goals'' include ``[s]tronger and more resilient financial markets''
and ``[c]ontribution to sustainable development'').
\16\ See, e.g., Principles for Responsible Investment, How Can a
Passive Investor Be a Responsible Investor? (Aug. 2019),
www.unpri.org/download?ac=6729, at 15 (ESG passive investing
strategies likely result in higher fees compared to standard passive
funds); Wayne Winegarden, ESG Investing: An Evaluation of the
Evidence, Pacific Research Institute (May 2019),
www.pacificresearch.org/wp-content/uploads/2019/05/ESG_Funds_F_web.pdf, at 11-12 (finding average expense ratio of 69
basis points for ESG funds compared to 9 basis points for broad-
based S&P 500 index fund). In recent years, the asset-weighted
expense ratio for ESG funds has decreased as ESG funds with lower
expense ratios have attracted more fund flows than ESG funds with
higher expense ratios. See Elisabeth Kashner, ETF Fee War Hits ESG
and Active Management (Jan. 22, 2020), https://insight.factset.com/etf-fee-war-hits-esg-and-active-management.
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The Securities and Exchange Commission (SEC) has also undertaken
initiatives related to ESG. The examination priorities of the
Securities and Exchange Commission (SEC) for 2020 include a particular
interest in the accuracy and adequacy of disclosures provided by
registered investment advisers offering clients new types or emerging
investment strategies, such as strategies focused on sustainable and
responsible investing, which incorporate ESG criteria.\17\ The SEC also
solicited public comment on the appropriate treatment for funds that
use terms such as ``ESG'' in their name and whether these terms are
likely to mislead investors.\18\
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\17\ See Office of Compliance Inspections and Examinations, U.S.
Securities and Exchange Commission, 2020 Examination Priorities, at
15, www.sec.gov/about/offices/ocie/national-examination-program-priorities-2020.pdf.
\18\ See Request for Comment on Fund Names, Release No. IC-33809
(Mar. 2, 2020) (85 FR 13221 (Mar. 6, 2020)).
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ESG investing raises heightened concerns under ERISA. Public
companies and their investors may legitimately pursue a broad range of
objectives, subject to the disclosure requirements and other
requirements of the securities laws. Pension plans and other benefit
plans covered by ERISA, however, are bound by statute to a narrower
objective: Prudent management with an ``eye single'' to maximizing the
funds available to pay benefits under the plan.\19\ Providing a secure
retirement for American workers is the paramount, and eminently worthy,
``social'' goal of ERISA plans; plan assets may never be enlisted in
pursuit of other social or environmental objectives at the expense of
ERISA's fundamental purpose of providing secure and valuable retirement
benefits.
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\19\ Donovan v. Bierwirth, supra note 2, 680 F.2d at 271.
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Section 404(a)(1)(A) of ERISA expressly requires that plan
fiduciaries act ``for the exclusive purpose of: (i) Providing benefits
to participants and their beneficiaries; and (ii) defraying reasonable
expenses of administering the plan.'' The Department is concerned,
however, that the growing emphasis on ESG investing may prompt ERISA
plan fiduciaries to make investment decisions for purposes distinct
from providing benefits to participants and beneficiaries and defraying
reasonable expenses of administering the plan. The Department is also
concerned that some investment products may be marketed to ERISA
fiduciaries on the basis of purported benefits and goals unrelated to
financial performance.\20\ For example, the Department understands that
the fund managers of some ESG investment funds offered to ERISA defined
contribution plans represent that the fund is appropriate for ERISA
plan investment platforms, while acknowledging in disclosure materials
that the fund may perform differently, forgo investment opportunities,
or accept different investment risks, in order to pursue the ESG
objectives.
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\20\ See, e.g., James MacKintosh, A User's Guide to the ESG
Confusion, Wall Street Journal (Nov. 12, 2019), www.wsj.com/articles/a-users-guide-to-the-esg-confusion-11573563604 (``It's hard
to move in the world of investment without being bombarded by sales
pitches for running money based on `ESG' ''); Mark Miller, Bit by
Bit, Socially Conscious Investors Are Influencing 401(k)'s, New York
Times (Sept. 27, 2019), www.nytimes.com/2019/09/27/business/esg-401k-investing-retirement.html.
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This regulatory project was undertaken in part to make clear that
ERISA plan fiduciaries may not subordinate return or increase risks to
promote non-pecuniary objectives. The duty of loyalty--a bedrock
principle of ERISA, with deep roots in the common law of trusts--
requires those serving as fiduciaries to act with a single-minded focus
on the interests of beneficiaries.\21\ The duty of prudence prevents a
fiduciary from choosing an investment alternative that is financially
less beneficial than reasonably available alternatives. These fiduciary
standards are the same no matter the investment vehicle or category.
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\21\ See Unif. Prudent Inv. Act section 5 cmt. (1995) (``The
duty of loyalty is perhaps the most characteristic rule of trust
law.''); see also Susan N. Gary, George G. Bogert, & George T.
Bogert, The Law of Trusts and Trustees: A Treatise Covering the Law
Relating to Trusts and Allied Subjects Affecting Trust Creation and
Administration section 543 (3d ed. 2019) (quoting Justice Cardozo's
classic statement in Meinhard v. Salmon, 249 N.Y. 458, 464 (1928)
that ``[a] trustee is held to something stricter than morals of the
market place. . . . Uncompromising rigidity has been the attitude of
the courts of equity when petitioned to undermine the rule of
undivided loyalty.'').
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The Department believes that confusion with respect to these
investment requirements persists, perhaps due in part to varied
statements the Department has made on the use of non-pecuniary or non-
financial factors over the years in sub-regulatory guidance.
Accordingly, the Department intends, by this final regulation, to
promulgate principles of fiduciary standards for selecting and
monitoring investments, and set forth the scope of fiduciary duties
surrounding non-pecuniary issues. Under the final rule, plan
fiduciaries, when making decisions on investments and investment
courses of action, must focus solely on the plan's financial risks and
returns and keep the interests of plan participants and beneficiaries
in their plan benefits paramount. The fundamental principle is that an
ERISA fiduciary's evaluation of plan investments must be focused solely
on economic considerations that have a material effect on the risk and
return of an investment based on appropriate investment horizons,
consistent with the plan's funding policy and investment policy
objectives. The corollary principle is that ERISA fiduciaries must
never sacrifice investment returns, take on additional investment risk,
or pay higher fees to promote non-pecuniary benefits or goals.
The final rule recognizes that there are instances where one or
more environmental, social, or governance factors will present an
economic business risk or opportunity that corporate officers,
directors, and qualified investment professionals would appropriately
treat as material economic considerations under generally accepted
investment theories. For example, a company's improper disposal of
hazardous waste would likely implicate business risks and
opportunities, litigation exposure, and regulatory obligations.
Dysfunctional corporate governance can likewise present pecuniary risk
that a qualified investment professional would appropriately consider
on a fact-specific basis.
The purpose of this action is to set forth a regulatory structure
to assist ERISA fiduciaries in navigating these ESG investment trends
and to separate the legitimate use of risk-return factors from
inappropriate investments that sacrifice investment return, increase
costs, or assume additional investment
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risk to promote non-pecuniary benefits or objectives. The Department
believes that addressing these issues in the form of a notice and
comment regulation will help safeguard the interests of participants
and beneficiaries in the plan benefits.
C. June 2020 Proposed Rule
In June 2020 (85 FR 39113 (June 30, 2020)), the Department
published in the Federal Register a proposed rule to amend the
``investment duties'' regulation under Title I of the Employee
Retirement Income Security Act of 1974, as amended (ERISA), to confirm
that ERISA requires plan fiduciaries to select investments and
investment courses of action based solely on financial considerations
relevant to the risk-adjusted economic value of a particular investment
or investment course of action. The proposal was intended to provide
regulatory guideposts for plan fiduciaries in light of recent trends
involving ESG investing that the Department is concerned may lead ERISA
plan fiduciaries to choose investments or investment courses of action
to promote environmental, social, and other public policy goals
unrelated to the interests of plan participants and beneficiaries in
receiving financial benefits from the plan, and expose plan
participants and beneficiaries to inappropriate investment risks or
lower returns than reasonably available investment alternatives. The
proposal retained the core principles in the current regulation that
set forth requirements for satisfying the prudence duty under ERISA
section 404(a)(1)(B) when deciding on plan investments and investment
courses of action.
The proposal suggested five major additions to the investment
duties regulation. First, the proposal included new regulatory text
that would require plan fiduciaries to select investments and
investment courses of action based on financial considerations relevant
to the risk-adjusted economic value of a particular investment or
investment course of action. Second, the proposal added an express
statement that compliance with the exclusive purpose (loyalty) duty in
ERISA section 404(a)(1)(A) prohibits fiduciaries from subordinating the
interests of plan participants and beneficiaries in retirement income
and financial benefits to non-pecuniary goals. Third, a proposed new
provision required fiduciaries to consider other available investments
to meet their prudence and loyalty duties under ERISA. Fourth, the
proposal acknowledged that ESG factors can be pecuniary factors, but
only if they present economic risks or opportunities that qualified
investment professionals would treat as material economic
considerations under generally accepted investment theories. The
proposal added new regulatory text, setting forth required investment
analysis and documentation requirements in the rare circumstances when
fiduciaries are choosing among truly ``indistinguishable'' investments
(related to the so-called ``tie breaker rule''). The documentation
requirement was intended to prevent fiduciaries from improperly finding
economic equivalence and making decisions based on non-pecuniary
benefits without a proper analysis and evaluation. Fiduciaries already
commonly document and maintain records about their investment
selections. The provision in the proposal would have made that general
practice required where a fiduciary determines that alternative
investment options are economically indistinguishable and where the
fiduciary chooses one of the investments on the basis of a non-
pecuniary factor. Fifth, the proposal added a new provision on
selecting designated investment alternatives for a defined contribution
individual account plan (commonly referred to as 401(k)-type plans).
The proposal reiterated the Department's view that the prudence and
loyalty standards set forth in ERISA apply to a fiduciary's selection
of an investment alternative to be offered to plan participants and
beneficiaries in a defined contribution individual account plan. The
proposal described the requirements for the selection of investment
alternatives for such plans that purport to pursue one or more
environmental, social, and corporate governance-oriented objectives in
their investment mandates or that include such parameters in the fund
name.
Overall, the proposed rule was designed to assist fiduciaries in
carrying out their responsibilities, while promoting the financial
interests of current and future retirees. The Department acknowledged
in the proposal that some plans would have to modify their processes
for selecting and monitoring investments--in particular, plans whose
current document and recordkeeping practices were insufficient to meet
the proposal's requirements.
The Department invited interested persons to submit comments on the
proposed rule. In response to this invitation, the Department received
more than 1,100 written comments submitted during the open comment
period, and more than 7,600 submissions made as part of six separate
petitions (i.e., form letters). These comments and petitions came from
a variety of parties, including plan sponsors and other plan
fiduciaries, individual plan participants and beneficiaries, financial
services companies, academics, elected government officials, trade and
industry associations, and others, both in support of and in opposition
to the proposed rule. These comments were available for public review
on the ``Public Comments'' page under the ``Laws and Regulations'' tab
of the Department's Employee Benefits Security Administration
website.\22\
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\22\ See www.dol.gov/agencies/ebsa/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95. The Department received
some comment letters on the proposed rule that were submitted after
the close of the comment period. Those late comments were not
considered or posted on the Department's website.
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Many comments submitted on the proposal offered general support
for, or opposition to, the Department's proposal. These comments did
not contain specific or detailed arguments on provisions of the
proposal or otherwise include relevant, empirical information in the
form of data or cited studies. As such, the Department does not
separately identify or discuss these general comments in this document,
although the preamble, in its entirety, addresses the reasons for
undertaking this regulatory initiative and the rationales for the
Department's specific regulatory choices.
Some commenters asserted that the proposal was ``unsupported by
substantial evidence'' and was ``unwarranted by the facts,'' does not
meet the minimum requirements of the Administrative Procedure Act, the
Paperwork Reduction Act, or Executive order and Office of Management
and Budget guidelines on cost-benefit analysis, and argued that the
proposal could not withstand legal challenge in court. Several
commenters argued for withdrawal of the proposed rule stating that the
proposal neither demonstrated a compelling need for regulatory action
nor demonstrated any fiduciary action that was injurious to plans. Some
additionally argued that the Department had failed to employ the least
burdensome method to effect any necessary change or to present any
empirical data or evidence of a problem that justified the regulation.
The Department, the commenters asserted, failed to provide a single
example of any ERISA fiduciary allocating any investment on the basis
of non-pecuniary criteria or any investigations or enforcement activity
based on these concerns.
[[Page 72850]]
Other commenters indicated that current guidance is sufficient to
enable the Department to bring enforcement actions against fiduciaries
who fail to meet their responsibilities. Further, they asserted, the
regulation was not proposed pursuant to either an explicit statutory
mandate or evidence of an actual documented problem. Some commenters
responded to the Department's observation of the growing emphasis on
ESG in the marketplace by arguing that the more frequent use of the
term ``ESG'' does not indicate any improper fiduciary decision making.
Some also argued that the Department's approach is incongruent with
that of other regulators who require consideration of financially
material ESG factors and focus on the importance of disclosure of those
factors.
With respect to the arguments of commenters concerning the
Administrative Procedure Act, the Department believes that there are
sufficient reasons to justify the promulgation of this final rule,
including the lack of precision and consistency in the marketplace with
respect to defining ESG investments and strategies, shortcomings in the
rigor of the prudence and loyalty analysis by some participating in the
ESG investment marketplace, and perceived variation in some aspects of
the Department's past guidance on the extent a fiduciary may consider
non-pecuniary factors in making investment decisions. Further, the
iterative Interpretive Bulletins since 1994, followed by the Field
Assistance Bulletin issued in 2018, and the number of advisory opinions
and information letters historically issued on this topic demonstrate
the need for notice and comment guidance issued under the
Administrative Procedure Act.\23\ The Department does not believe that
there needs to be specific evidence of fiduciary misbehavior or
demonstrated injury to plans and plan participants in order to issue a
regulation addressing the application of ERISA's fiduciary duties to
the issue of investing for non-pecuniary benefits. The need for this
regulation was also demonstrated by some commenters who indicated their
intention to make, or current practice in making, plan investment
decisions based on non-pecuniary factors, rather than based on
investment risk and return. For example, some commenters claimed that
ERISA fiduciaries must prioritize the long-term, absolute returns for
``universal owners,'' and that collective investor action to manage
social and environmental systems is necessary. As another example,
other commenters argued that fiduciaries should be permitted to
consider the potential for an investment to create jobs for workers who
in turn would participate in the plan. These comments signal that the
Department needs to address the use of non-pecuniary factors by
fiduciaries when making decisions about ERISA plan investments and
investment courses of action. Under the Department's authority to
administer ERISA, the Department may promulgate rules that are
preemptive in nature and is not required to wait for widespread harm to
occur. The Department can ensure that demonstrated injury to plans and
plan participants and beneficiaries are protected prospectively.
Investing for non-pecuniary objectives raises heightened concerns under
ERISA.
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\23\ See Executive Order 13891, 84 FR 55235 (Oct. 15, 2019)
promoting notice and comment regulation for guidance.
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As the Department noted in the proposal, public companies and their
investors may legitimately and properly pursue a broad range of
objectives, subject to the disclosure requirements and other
requirements of the securities laws. However, fiduciaries of pension
and other benefit plans covered by ERISA are statutorily bound to
manage those plans with a singular goal of maximizing the funds
available to pay benefits under the plan. Indeed, the final rule
furthers the paramount goal of ERISA plans to provide a secure
retirement for American workers, and states that plans may not forego
investment opportunities or assume investment risk to promote other
non-financial goals.\24\ In response to comments stating that the
current guidance is sufficient, the Department believes that there is a
reasonable need for this rulemaking, for the reasons explained earlier.
The Department also believes that proceeding through notice-and-comment
rulemaking rather than promulgating further interpretive guidance has
other benefits, including the benefit of public input and the greater
stability of codified rules. Proceeding in this manner is also
consistent with the principles of Executive Order 13891 and the
Department's recently issued PRO Good Guidance rule, which emphasize
the importance of public participation, fair notice, and compliance
with the Administrative Procedure Act.\25\
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\24\ Executive Order 13868 on Promoting Energy Infrastructure
and Economic Growth directed the Department to complete a review of
available data filed with the Department in order to identify
whether there are discernible trends with respect to plan
investments in the energy sector. The order also required the
Department to provide an update to the Assistant to the President
for Economic Policy on any discernible trends in energy investments
by such plans and to complete a review of existing Department of
Labor guidance on the fiduciary responsibilities for proxy voting.
Nothing in the order dealt with investing for non-pecuniary
purposes. As a result, no reports related to the proposal were
required by the Executive order.
\25\ See 85 FR 53163 (Aug. 28, 2020) (promulgating the
Department's rule on promoting regulatory openness through good
guidance).
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Some commenters complained that the 30-day comment period was too
short given the complexity of the proposed changes, the magnitude of
such changes to the retirement marketplace, and the need to prepare
supporting data. They stated that those challenges were exacerbated by
the present COVID-19 pandemic. Many commenters requested an extension
of the comment period and that the Department schedule a public hearing
on the proposal and allow the public record to remain open for post-
hearing comments from interested parties. The Department has considered
these requests, but has determined that it is neither necessary nor
appropriate to extend the public comment period, hold a public hearing,
or withdraw or republish the proposed regulation. A substantial and
comprehensive public comment record was developed on the proposal
sufficient to substantiate promulgating a final rule. The scope and
depth of the public record that has been developed itself belies
arguments that a 30-day comment period was insufficient. In addition,
most issues relevant to the proposal have been analyzed and reviewed by
the Department and the public in the context of three separate
Interpretive Bulletins issued in 1994, 2008, and 2015 and the public
feedback that resulted.\26\ Finally, public hearings are not required
under the Department's general rulemaking authority under section 505
of ERISA, nor under the Administrative Procedure Act's procedures for
rulemaking at 5 U.S.C. 553(c). In this case, a public hearing is not
necessary to supplement an already comprehensive public record.
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\26\ Further, the Department has also considered this subject in
the context of specific questions submitted by stakeholders since
the 1980s. See, e.g., DOL Inf. Ltr to George Cox (Jan. 16, 1981);
DOL Adv. Op. to Theodore R. Groom (Jan. 16, 1981); DOL Adv. Op. to
Daniel E. O'Sullivan, Union Labor Life Ins. Co (Aug. 2, 1982); Ltr
from Ass't Sec. Dennis Kass to Sen. Howard Metzenbuam (May 27,
1985); DOL Adv. Op to James Ray, Union Labor Life Ins. Co. (July 8,
1988); DOL Inf. Ltr. to Stuart Cohen, General Motors Corp. (May 14,
1993).
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Thus, this final rulemaking follows the notice and comment process
required by the Administrative Procedure Act, and fulfills the
Department's mission to protect, educate, and empower retirement
investors as they face important choices
[[Page 72851]]
in saving for retirement in their employee benefit plans. This rule is
considered to be an Executive Order (E.O.) 13771 regulatory action.
Details on the estimated costs of this rule can be found in the final
rule's economic analysis. The Department concluded that the additions
to Sec. 2550.404a-1 (404a-1 regulation) and the rule's improvements to
the Department's previous sub-regulatory guidance are appropriate and
warranted. Accordingly, after consideration of the written comments
received, the Department has determined to adopt the proposed
regulation as modified and set forth below.
D. The Final Rule
The final regulation sets forth fiduciary standards for selecting
and monitoring investments held by ERISA plans, and addresses the scope
of fiduciary duties surrounding non-pecuniary issues. The final
regulation contains several important changes from the proposal in
response to public comments. The fact that the loyalty principles of
section 404(a)(1)(A) of ERISA are now coupled with the previous
prudence regulation under section 404(a)(1)(B) confirms that, in making
investment decisions of any kind, ERISA requires that both the
principles of loyalty and of prudence must be considered. The final
rule expressly applies these principles not just to investments and
investment courses of action, but also to the selection of available
investment options for plan participants in individual account plans.
As more fully described below, the final rule makes five major
amendments to the investment duties regulation under Title I of ERISA
at 29 CFR 2550.404a-1. First, the final rule adds provisions to confirm
that ERISA fiduciaries must evaluate investments and investment courses
of action based solely on pecuniary factors--financial considerations
that have a material effect on the risk and/or return of an investment
based on appropriate investment horizons consistent with the plan's
investment objectives and funding policy. The term ``investment course
of action'' is defined in paragraph (f)(2) of the final rule to mean
``any series or program of investments or actions related to a
fiduciary's performance of the fiduciary's investment duties, and
includes the selection of an investment fund as a plan investment, or
in the case of an individual account plan, a designated investment
alternative under the plan.'' Second, the final rule includes an
express regulatory provision stating that compliance with the exclusive
purpose (loyalty) duty in ERISA section 404(a)(1)(A) prohibits
fiduciaries from subordinating the interests of participants to
unrelated objectives, and bars them from sacrificing investment return
or taking on additional investment risk to promote non-pecuniary goals.
Third, the final rule includes a provision that requires fiduciaries to
consider reasonably available alternatives to meet their prudence and
loyalty duties under ERISA. Fourth, new regulatory text sets forth
required investment analysis and documentation requirements for those
circumstances in which plan fiduciaries use non-pecuniary factors when
choosing between or among investments that the fiduciary is unable to
distinguish on the basis of pecuniary factors alone. The final rule
includes a related documentation requirement for such decisions
intended to prevent fiduciaries from improperly finding economic
equivalence or making investment decisions based on non-pecuniary
benefits without appropriately careful analysis and evaluation. Fifth,
the final rule states that the prudence and loyalty standards set forth
in ERISA apply to a fiduciary's selection of designated investment
alternatives to be offered to plan participants and beneficiaries in a
participant-directed individual account plan. The final rule expressly
provides that, in the case of selecting investment alternatives for an
individual account plan that allows plan participants and beneficiaries
to choose from a broad range of investment alternatives, as defined in
29 CFR 2550.404c-1(b)(3), a fiduciary is not prohibited from
considering or including an investment fund, product, or model
portfolio merely because the fund, product, or model portfolio
promotes, seeks, or supports one or more non-pecuniary goals, provided
that the fiduciary satisfies the prudence and loyalty provisions in
ERISA and the final rule, including the requirement to evaluate solely
on pecuniary factors, in selecting any such investment fund, product,
or model portfolio. However, the provision prohibits plans from adding
any investment fund, product, or model portfolio as a qualified default
investment alternative described in 29 CFR 2550.404c-5, or as a
component of such an investment alternative, if the fund, product, or
model portfolio's investment objectives or goals or its principal
investment strategies include, consider, or indicate the use of one or
more non-pecuniary factors.
The provisions of the final rule are discussed below along with
relevant public comments.
1. Section 2550.404a-1(a) and (b)--General Prudence and Loyalty
Investment Duties
The final rule builds upon the core principles provided by the
original investment duties regulation on the issue of prudence under
section 404(a)(1)(B) of ERISA, at 29 CFR 2550.404a-1, which the
regulated community has been relying upon for more than 40 years.\27\
For example, as stated in the preamble to the 1979 regulation, it
remains the Department's view that (1) generally the relative riskiness
of a specific investment or investment course of action does not render
such investment or investment course of action either per se prudent or
per se imprudent, and (2) the prudence of an investment decision should
not be judged without regard to the role that the proposed investment
or investment course of action plays within the overall plan portfolio.
It also remains the Department's view that an investment reasonably
designed--as part of the portfolio--to further the purposes of the
plan, and that is made with appropriate consideration of the relevant
facts and circumstances, should not be deemed to be imprudent merely
because the investment, standing alone, would have a relatively high
degree of risk. The Department also continues to believe that
appropriate consideration of an investment to further the purposes of
the plan must include consideration of the characteristics of the
investment itself and how it relates to the plan portfolio.
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\27\ 44 FR 37221, 37225 (June 26, 1979).
---------------------------------------------------------------------------
Paragraph (a) of the final rule is unchanged from the proposal and
includes a restatement of the statutory language of the exclusive
purpose requirements of ERISA section 404(a)(1)(A) and the prudence
duty of ERISA section 404(a)(1)(B). The existing 404a-1 regulation
already included a restatement of the prudence duties that apply to
fiduciary investment decisions under ERISA section 404(a)(1)(B). The
final rule thus reinforces the core principles provided in the
investment duties regulation by expressly referencing the separate
loyalty duty imposed on fiduciary investment decisions under ERISA
section 404(a)(1)(A). In effect, paragraph (a) of this final rule
amends paragraph (a) in the 1979 investment duties regulation by adding
the exclusive purpose requirements to the existing duty of prudence.
That application of these
[[Page 72852]]
prudence and loyalty requirements is context-specific and depends on
the facts and circumstances as made clear by the rest of the provisions
of the rule.
Some commenters asserted that the combination of prudence and
loyalty in paragraph (a) of the proposal, together with the
requirements of paragraph (b) as to how to satisfy those joint
requirements when evaluating investments, were not simple
clarifications of the existing investment duties regulation. Rather, in
their view, that combination of amendments would have constituted the
development of a new theory of loyalty beyond the Department's stated
objective to address ESG investment developments, and which would have
resulted in confusion regarding investment duties more generally. Some
commenters, moreover, argued that the proposal's combination of
amendments could violate established principles of statutory
construction by establishing a regulation under which compliance with a
single set of objective requirements would be sufficient to satisfy the
requirements of both section 404(a)(1)(A)'s duty of loyalty and (B)'s
duty of prudence. Unlike ERISA's duty of prudence, the duty of loyalty
has not been interpreted by the courts to be an objective test
requiring compliance with appropriate procedures, but has instead been
measured by the subjective intent or motivation of the fiduciaries,
according to the commenters. Nor have the courts extended the duty of
loyalty to prohibit a fiduciary from considering implications external
to the fiduciary's self-interest, so long as the fiduciary was focused
on benefiting participants and beneficiaries and defraying reasonable
plan expenses, according to the commenters. And finally, some
commenters asserted that at least some authority interprets ERISA
section 404(a)(1)(A) to permit some incidental benefits to others'
interests as long as the primary purpose and effect of the action is to
benefit the plan.
As to the interplay between paragraphs (a), (b), and (c) of the
proposal, one commenter requested clarification that paragraph (b) of
the proposal was intended to continue as a safe harbor, and was not the
exclusive means for satisfying prudence. This commenter observed that
the Department originally described paragraph (b) as a safe harbor in
1979 when the investment duties regulation was originally published.
This commenter was concerned that the specific requirements of
paragraph (c) of the proposal did not appear to constitute a safe
harbor. This commenter argued that if the Department's intent is to
transform paragraph (b) from a safe harbor into minimum requirements,
the Department must provide specific notice of this fact and solicit
comments from the public while also assessing the costs and benefits of
such a change.
Some commenters also raised concerns that the Department should not
have multiple prongs in the regulation variously stating that a
fiduciary ``should not subordinate'' and ``should not otherwise
subordinate.'' Similarly, one commenter argued that the phrase in the
proposal ``and has otherwise complied with the duty of loyalty'' is
circular because it includes compliance with the duty of loyalty as an
element of complying with the duty of loyalty. Commenters argued that
the addition of the phrase ``the duty of loyalty'' inside the
definition of the duty of loyalty creates an invitation for courts to
graft on additional responsibilities not included within either the
Department's rule or section 404(a)(1)(A) of ERISA.
One commenter asked the Department to replace its multi-part
articulation of the duty of loyalty in the proposal with a simple
clarification stating that ``a fiduciary may not subordinate the
interests of participants and beneficiaries as retirement savers to any
other interests of the participants, beneficiaries, the fiduciary
itself or any other party.'' This commenter also proposed eliminating
paragraph (c) regarding pecuniary factors in investment decisions
altogether. The commenter argued that the advantage would be an easily
understood, one-part test that captures both elements of the proposal
without the need for special rules for ``pecuniary factors'' and other
rules for ``non-pecuniary factors.''
Other commenters argued that the prohibition in paragraph (b)
against subordinating the interest of the participants and
beneficiaries to the fiduciary's or another's interest is unnecessary
in light of ERISA's prohibited transaction provisions, and, moreover,
would likely have unintended consequences by making many common,
accepted, and generally beneficial practices suspect, such as the use
of proprietary products, fee sharing, and fee aggregation.
The principles of loyalty under section 404(a)(1)(A) of ERISA
prohibit a fiduciary from subordinating the interests of the
participants and beneficiaries in their retirement income or other
financial benefits under the plan to unrelated objectives. No commenter
suggested to the contrary. Thus, the Department believes that including
the duty of loyalty in a regulatory provision regarding investment
activity should not be the surprise nor innovation some commenters
alleged.
The Department is persuaded by the comments that there is a better
way than presented in the proposal to express the view that a fiduciary
engaged in investments and investment courses of action may not
subordinate the interests of the plan to unrelated objectives and that
the fiduciary needs to focus on the pecuniary interests of the plan in
complying with its prudence obligation under the plan. The Department
is persuaded by the comments that it would be preferable to retain
paragraph (b) as a provision addressing only the ERISA section
404(a)(1)(B) prudence duty and revising paragraphs (c) and (d) to more
specifically address the element of the duty of loyalty that requires
fiduciaries to focus investment decision-making on providing financial
benefits to participants under the plan and prohibits fiduciaries from
subordinating the interests of participants and beneficiaries in their
retirement income or financial benefits under the plan to unrelated
objectives. This approach incorporates the duty of loyalty into the
regulation while recognizing that the statute sets forth the duty of
prudence and the duty of loyalty as separate fiduciary obligations.
Further, the Department is persuaded by the comments that the
``safe harbor'' nature of paragraph (b) in the original investment
duties regulation should be preserved. However, the Department does not
agree that its safe-harbor characterization of the 404a-1 regulation in
1979 can fairly be read to suggest an unrestricted open field. Rather,
in describing the regulation as a safe harbor, the Department cautioned
that it was expressing no view on whether the prudence duty could be
satisfied outside of the ``safe harbor'' provisions in the regulation:
``It should also be noted that the Department does not view compliance
with the provisions of the regulation as necessarily constituting the
exclusive method for satisfying the requirements of the `prudence'
rule. Rather, the regulation is in the nature of a `safe harbor'
provision; it is the opinion of the Department that fiduciaries who
comply with the provisions of the regulation will have satisfied the
requirements of the `prudence' rule, but no opinion is expressed in the
regulation as to the status of activities undertaken or performed that
do not so comply.'' \28\ Although there may be
[[Page 72853]]
distinct circumstances where some other process would be prudent, in
every case, ERISA fiduciaries are required to have a soundly reasoned
and supported investment decision or strategy to satisfy the ERISA
prudence requirement.
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\28\ 44 FR at 37222 (June 26, 1979) (emphasis added).
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As a result, proposed paragraph (b)(1) is modified in the final
rule to remove the general references to the duty of loyalty under
section 404(a)(1)(A) of ERISA, such as those contained in paragraphs
(b)(1)(iii) and (iv) of the proposal, and to maintain its character as
a safe harbor for prudent investment and investment courses of action
as described in the original 1979 investment duties regulation.
However, the safe harbor in paragraph (b) applies only to the duty of
prudence under section 404(a)(1)(B) of ERISA. Under the final rule, the
provisions set forth in paragraphs (c) and (d) are set forth as minimum
requirements with respect to the aspects of the duty of loyalty
addressed in those paragraphs, including the obligation to focus on
pecuniary factors when making investment decisions. Thus, the final
rule does not revise the current requirements that the fiduciary give
appropriate consideration to a number of factors concerning the
composition of the plan portfolio with respect to diversification, the
liquidity and current return of the portfolio relative to the
anticipated cash flow needs of the plan, and the projected return of
the portfolio relative to the funding objectives of the plan. Paragraph
(b)(1) of the final rule continues to provide that with regard to the
consideration of an investment or investment course of action taken by
a fiduciary of an employee benefit plan pursuant to the fiduciary's
investment duties, the requirements of section 404(a)(1)(B) of the Act
set forth in paragraph (a) are satisfied if the fiduciary (i) has given
appropriate consideration to those facts and circumstances that, given
the scope of such fiduciary's investment duties, the fiduciary knows or
should know are relevant to the particular investment or investment
course of action involved, including the role the investment or
investment course of action plays in that portion of the plan's
investment portfolio with respect to which the fiduciary has investment
duties, and (ii) has acted accordingly.
Paragraph (b)(2) of the proposal provided that for purposes of
paragraph (b)(1) of the proposal, ``appropriate consideration'' shall
include, but is not necessarily limited to (i) a determination by the
fiduciary that the particular investment or investment course of action
is reasonably designed, as part of the portfolio (or, where applicable,
that portion of the plan portfolio with respect to which the fiduciary
has investment duties), to further the purposes of the plan, taking
into consideration the risk of loss and the opportunity for gain (or
other return) associated with the investment or investment course of
action, and (ii) consideration of the composition of the portfolio with
regard to diversification, the liquidity and current return of the
portfolio relative to the anticipated cash flow requirements of the
plan, the projected return of the portfolio relative to the funding
objectives of the plan as those factors relate to such portion of the
portfolio, and how the investment or investment course of action
compares to available alternative investments or investment courses of
action with regard to those factors listed.
Paragraph (b)(2) of the proposal was essentially the same as the
provision in the 1979 investment duties regulation except for proposed
paragraph (b)(2)(ii)(D) which required the consideration of how the
investment or investment course of action compares to available
alternative investments or investment courses of action with regard to
those factors listed in paragraphs (b)(2)(ii)(A) through (C). Thus,
most related comments concerned proposed paragraph (b)(2)(ii)(D).
Commenters assert that this provision is unclear as to extent of the
requirement to evaluate alternatives. In some cases, commenters
alleged, there may be no true alternative to a particular investment,
because the opportunity is so unique. In other cases, the opportunity
may lapse if a thorough undertaking of all alternatives is pursued. In
yet other situations, the number of potential alternatives might be so
numerous that consideration of every alternative is impossible. This
lack of clarity may give rise to inappropriate second-guessing in which
questions are raised as to whether a particular alternative (selected
with the benefit of hindsight) should have been considered. Similarly,
some commenters complained that the requirement does not necessarily
take into account the complexities involved in defined benefit plan
investment, which varies, among other items, by plan design,
participant census, the sponsor's risk tolerance and a company's cash,
and whether a proposed investment adds litigation risk. Commenters also
argued the proposed provision may be at odds with the ERISA section
404(c) regulation because it is unclear what ``available alternative
investments'' means in the context of satisfying the 404(c)
regulation's requirement to make available at least three investment
alternatives meant to provide a broad-based selection. Further,
commenters asked how to apply the obligation to consider alternative
investments applies in situations where company stock is purchased for
a plan through a plan provision that mandates such purchase.
Commenters were concerned that the proposed rule provides no
guidance as to how the relevant alternatives would be determined and
how many of those alternatives the fiduciary is to use in performing
the newly required comparison. For example, one commenter posited that
the proposal might be read to require a fiduciary making a decision on
a diversified stock fund that falls within Morningstar's large cap
growth category to compare that investment to all of the approximately
1,350 mutual funds within that category. Some commenters suggested that
the Department should tell fiduciaries exactly how to conduct such an
analysis to make the best prospective decision. Some expressed concern
that the requirement opened fiduciaries to ``20/20 hindsight'' legal
attacks by class action lawyers.
The Department notes that the concept of comparing available
investment alternatives is not new. Interpretive Bulletins on ESG and
ETI investing issued by the Department expressed the view that facts
and circumstances relevant to an investment or investment course of
action would, in the view of the Department, include consideration of
the expected return on alternative investments with similar risks
available to the plan. Specifically, the Department observed that,
because every investment necessarily causes a plan to forego other
investment opportunities, an investment would not be prudent if it were
expected to provide a plan with a lower rate of return than available
investment alternatives with commensurate degrees of risk, or were
riskier than available investment alternatives with commensurate rates
of return.\29\ Such an analysis is similar to that required by
paragraph (b)(2)(ii)(D) of the proposal. As a result, the concept of
comparing investment opportunities as set forth in paragraph
(b)(2)(ii)(D) cannot fairly be cast as new to the retirement investing
community.
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\29\ See 29 CFR 2509.94-1 and 2509.2015-01.
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Furthermore, the proposal was not intended to require fiduciaries
to ``scour the market'' and incur search costs on a practically
infinite number of potential portfolios, nor could such a requirement
be consistent with the duty
[[Page 72854]]
of prudence.\30\ Rather, as the Department noted when it issued the
404a-1 regulation in 1979, the Department recognizes that a fiduciary
should be required neither to expend unreasonable efforts in
discharging his duties, nor to consider matters outside the scope of
those duties. Accordingly, the regulation requires fiduciaries to give
consideration to those facts and circumstances which, taking into
account the scope of his investment duties, the fiduciary knows or
should know are relevant to the particular investment decision
involved.\31\ The scope of the fiduciary's inquiry in this respect,
therefore, is limited to those facts and circumstances that a prudent
person having similar duties and familiar with such matters would
consider relevant. That same principle applies to consideration of
alternative investment opportunities.
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\30\ See Hecker v. Deere & Co., 556 F.3d 575, 586 (7th Cir.
2009) (``nothing in ERISA requires every fiduciary to scour the
market'').
\31\ See 44 FR at 37223 (June 26, 1979).
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Accordingly, the Department has determined to keep the general
concept of paragraph (b)(2)(ii)(D) in the final rule. However, we
believe a better approach than the proposal is one that incorporates
the concept in a way that is consistent with the Department's prior IB
statements and at the same time addresses the requests of commenters
for guidance as to the extent of the requirement to evaluate
alternatives. The Department added new language to paragraph (b)(2)(i)
to state that the consideration of risk and loss and the opportunity
for gain (or other return) associated with the investment or investment
courses of action should take place ``compared to the opportunity for
gain (or other return) associated with reasonably available
alternatives with similar risks.'' Under the final rule, a fiduciary is
required only to compare alternatives that are reasonably available
under the circumstances. The Department used the phrase ``reasonably
available alternatives'' not only to confirm that the rule does not
require fiduciaries to scour the market or to consider every possible
alternative, but also to allow for the possibility that the
characteristics and purposes served by a given investment or investment
course of action may be sufficiently rare that a fiduciary could
prudently determine, and document, that there were no other reasonably
available alternatives for purpose of this comparison requirement. As a
result, paragraph (b)(2) of the final rule provides that for purposes
of paragraph (b)(1), ``appropriate consideration'' shall include, but
is not necessarily limited to (i) a determination by the fiduciary that
the particular investment or investment course of action is reasonably
designed, as part of the portfolio (or, where applicable, that portion
of the plan portfolio with respect to which the fiduciary has
investment duties), to further the purposes of the plan, taking into
consideration the risk of loss and the opportunity for gain (or other
return) associated with the investment or investment course of action
compared to the opportunity for gain (or other return) associated with
reasonably available alternatives with similar risks, and (ii)
consideration of the composition of the portfolio with regard to
diversification, the liquidity and current return of the portfolio
relative to the anticipated cash flow requirements of the plan, the
projected return of the portfolio relative to the funding objectives of
the plan as those factors relate to such portion of the portfolio, and
how the investment or investment course of action compares to
alternative investments or investment courses of action that were
considered with regard to those factors listed.
With respect to the comments arguing that ERISA section
404(a)(1)(A) is purely a subjective motivation test, the Department
does not believe that is a viable analytical approach and is concerned
that such an interpretation would raise substantial feasibility
questions about the application and enforcement of such a requirement.
Rather, while motivation is undeniably a proper focus in applying a
loyalty requirement under which fiduciary action must be based solely
on the interests of participants and beneficiaries and for their
``exclusive benefit,'' the Department believes that establishing
regulatory guideposts, like the requirement to focus on pecuniary
factors in investment decision-making, is an appropriate way to
establish objective criteria that help fiduciaries understand how to
comply with their duty of loyalty in the context of evaluating
financial factors when selecting investments or investment courses of
action.
Since the scope of paragraph (b) in the final rule has been revised
from the proposal to encompass only the obligations set forth in ERISA
section 404(a)(1)(B), the proposal's inclusion in paragraph (b)(1)(iv)
of a specific prohibition on a fiduciary subordinating the interests of
participants and beneficiaries to the fiduciary's or another's interest
is unnecessary. The Department further agrees that it is not necessary
to have multiple provisions of the final rule contain the prohibition
on ``not subordinating'' the interests of participants and
beneficiaries. Thus, the Department eliminated paragraph (b)(1)(iv) of
the proposal from the final rule, and, as described below, revised the
final rule to address the Department's concerns regarding a focus in
fiduciary investment activity on ``pecuniary factors'' through a
revised provision in paragraph (c).\32\
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\32\ For similar reasons, the final rule does not carry forward
the reference to the parallel exclusive purpose provision in ERISA
section 403 that was in the proposal. The Department also concluded
that the final rule should continue the focus of the current 404a-1
regulation on section 404 of ERISA. Section 403(c) of ERISA provides
in relevant part that the assets of the plan shall never inure to
the benefit of any employer and shall be held for the exclusive
purpose for providing benefits to participants in the plan and their
beneficiaries and defraying reasonable expenses of the plan.
Although similar, the text of ERISA section 403 is not identical to
section 404(a)(1)(A) of ERISA, and the Department wanted to avoid
any possible inference that compliance with the provisions of the
final rule would also necessarily satisfy all the provisions of
section 403 of ERISA.
---------------------------------------------------------------------------
Paragraph (b)(3) of the final rule merely moves what was paragraph
(d) of the proposal to this new position in the regulatory text. This
move was judged appropriate because the paragraph concerns compliance
with the immediately preceding regulatory text of paragraphs (b)(1) and
(2). Paragraph (d) of the proposal repeated a paragraph in the current
404a-1 regulation which states that an investment manager appointed
pursuant to the provisions of section 402(c)(3) of the Act to manage
all or part of the assets of a plan may, for purposes of compliance
with the provisions of paragraphs (b)(1) and (2) of the proposal, rely
on, and act upon the basis of, information pertaining to the plan
provided by or at the direction of the appointing fiduciary, if such
information is provided for the stated purpose of assisting the manager
in the performance of the manager's investment duties, and the manager
does not know and has no reason to know that the information is
incorrect. This provision was originally part of the 1979 regulation,
has remained unchanged since then, and no commenter suggested that the
substance of the provision be changed. Paragraph (b)(3) of the final
rule is essentially the same as the parallel provision in the original
1979 investment duties regulation.
2. Section 2550.404a-1(c)(1)--Consideration of Pecuniary Factors
Paragraph (c)(1) of the proposed rule required that a fiduciary's
evaluation of an investment be focused only on pecuniary factors. The
proposal expressly provided that it is unlawful for a fiduciary to
sacrifice return or
[[Page 72855]]
accept additional risk to promote a public policy, political, or any
other non-pecuniary goal. Paragraph (c)(1) also expressly acknowledged
that ESG factors and other similar considerations may be pecuniary
factors and economic considerations, but only if they present economic
risks or opportunities that qualified investment professionals would
treat as material economic considerations under generally accepted
investment theories. The proposal emphasized that such factors, if
determined to be pecuniary, must be considered alongside other relevant
economic factors to evaluate the risk and return profiles of
alternative investments. The proposal further provided that the weight
given to pecuniary ESG factors should reflect a prudent assessment of
their impact on risk and return--that is, they cannot be
disproportionately weighted. The proposal also emphasized that
fiduciaries' consideration of ESG factors must be focused on their
potential pecuniary elements by requiring fiduciaries to examine the
level of diversification, degree of liquidity, and the potential risk-
return profile of the investment in comparison with available
alternative investments that would play a similar role in their plans'
portfolios.
A number of commenters offered nearly unqualified support for the
rule, and endorsed the Department's efforts in moving forward with the
proposal. Although some commenters expressed concern that the rule was
complex and posited possible attendant compliance costs and uncertain
legal liabilities, they deemed these costs justified by the protections
offered by the proposal. Commenters also shared the concern of the
Department that the growing emphasis on ESG investing may be prompting
ERISA plan fiduciaries to make investment decisions for purposes
distinct from providing benefits to participants and beneficiaries and
defraying reasonable expenses of administering the plan. They agreed
that the proposal was designed to make clear that ERISA plan
fiduciaries may not invest in ESG vehicles when they understand an
underlying investment strategy of the vehicle is to subordinate return
or increase risk for the purpose of non-pecuniary objectives. They
stated that investments should be made based on an evaluation of
whether the investments will improve the financial performance of the
plan. Other commenters stated that while they support individual
investors' ability to pursue ESG investments that align with their
values, they support the proposal's focus on decisions made by ERISA
fiduciaries on plan participants' behalf, where enhancing financial
returns is the overriding legal obligation of ERISA plan fiduciaries
when making investment decisions. Some commenters supported the
proposal's acknowledgement that ESG factors and other similar
considerations may be economic considerations and the proposal's
guidance to fiduciaries regarding how to consider pecuniary ESG factors
when contemplating an investment decision, such as the importance of
understanding the ``economic risks or opportunities'' attached to such
considerations and appropriately weighing pecuniary ESG factors based
on ``a prudent assessment of their impact on risk and return''
alongside other relevant economic factors necessary to make an
investment decision. These commenters said that the proposed regulation
would protect plan participants by ensuring that ERISA fiduciaries are
making reasoned investment decisions based on all material information,
including pecuniary ESG factors, available to them. Other commenters
shared DOL's concern that the growing emphasis on ESG investing may be
prompting fiduciaries to make investment decisions for reasons other
than maximizing return to beneficiaries. Some commenters asserted that
some ESG-focused funds have a stated goal of subordinating investor
return or increasing investor risk for the purpose of achieving
political or social objectives, citing ESG funds' disclosures that the
commenters said highlighted the potential for reduced returns,
increased risks, and heightened fees in service of social goals. These
commenters asserted that the proposed rule clarifies that ERISA plan
fiduciaries may not invest in ESG funds when the investment strategy of
the fund subordinates return or takes on additional investment risk or
costs for purposes of non-pecuniary objectives.
Many commenters, however, expressed concern that the Department did
not classify ESG as material financial factors that should be
considered by fiduciaries in their investment evaluation and decision-
making. They pointed to evidence and research that they asserted makes
clear that ESG factors are material economic considerations that must
be integrated into fiduciary investment decisions. Some commenters
asserted that ESG integration has been evolving and growing for decades
primarily to help manage investment risks and to provide a proxy for
management quality, which, they argued, were both pecuniary factors.
Other commenters stated that the proposed rule appeared to be based on
a presumption that ESG funds commonly select portfolio constituents
based on ``non-pecuniary'' factors, without regard to risk and return.
These commenters stated that they were not aware of any fund managers
that select portfolio constituents without regard to financial
performance, or risk and return.
Some commenters acknowledged that the proposal expressly provided
that ESG factors and other similar considerations may be pecuniary
factors and economic considerations, but argued that, if the purpose of
the rule is to establish a clear distinction between ESG used for risk-
return assessment and ESG used for collateral benefits (e.g. ESG
investing for moral or ethical reasons or to benefit a third party),
the Department should better define ESG risk-return factors to more
clearly distinguish between the permissible and impermissible uses
thereof, which are the heart of this issue. Some commenters similarly
argued that the proposal would cause confusion because of its failure
to distinguish ESG integration and economically targeted investing. ESG
integration, the commenters assert, is the consideration of ESG factors
as part of prudent risk management and a strategy to take investment
actions aimed at responding to those risks, whereas economically
targeted investing, by comparison, is investing with the aim to provide
financial as well as collateral, non-financial benefits. These
commenters argued that the proposal is aimed at ETIs and problems
associated with ETIs rather than ESG integration into the risk-return
analysis of investments, and raised concerns that the lack of a clearer
distinction between the two in the proposal will discourage proper ESG
risk-return integration. Another commenter raised a similar concern,
but in the specific context of selecting investment funds for
individual account plans, by asking that the Department distinguish
between ESG-themed investment funds, where the primary investment
strategy or principal purpose is to promote impermissible collateral
benefits, and those investment funds that are not primarily focused on
ESG factors, but instead use one or more ESG factors as part of their
overall investment analysis.
Some commenters asserted that instead of providing the needed
flexibility to consider all material factors, the proposal would
unnecessarily limit the discretion of the fiduciary to determine that
ESG factors
[[Page 72856]]
may have a ``material effect on the return and risk of an investment''
by requiring ``qualified investment professionals'' to treat the factor
as material economic considerations under generally accepted investment
theories. They argued that the proposal, although based on generally
accepted investment theories which by definition include changes to
reflect an evolving financial marketplace, would still place restraints
on the discretion fiduciaries need to adjust their investment practices
to keep pace with the constantly changing investment landscape and
emerging theories that develop alongside. For example, some commenters
stated that the Department should avoid a regulatory structure that
would require the Department and plan fiduciaries to referee references
to ``qualified investment professionals,'' ``material,'' and
``generally accepted investment theories.'' The commenters expressed
concern that those terms invite subjective interpretations. One
commenter expressed concern that some parties will likely attempt to
undermine the rule's intent with claims that ESG-focused investing is
already ``generally accepted.'' Other commenters argued that the
proposal creates a heightened level of scrutiny for investments that
involve ESG-integration that do not apply to any other type of
investment.
Many commenters stated that EBSA ignored academic and financial
studies and papers showing that more sustainable companies and funds do
not sacrifice performance compared with less sustainable peers, and in
fact are somewhat more likely to outperform than to underperform. They
cite, for example, a 2018 Government Accountability Office study that
concluded the majority of asset managers interviewed found that
incorporating ESG factors enhanced retirement plans' risk
management.\33\ The GAO also noted more than half of the asset managers
interviewed were ``incorporating ESG factors to improve the long-term
performance of retirement plan portfolios.'' Another commenter cited a
study saying that sustainable funds provided returns in line with
comparable traditional funds while reducing downside risk. During a
period of extreme volatility, the commenters assert that they saw
strong statistical evidence that sustainable funds are more stable. A
2015 Harvard Business School paper found that firms with strong ratings
on material sustainability issues have better future performance than
firms with inferior ratings on the same issues. In contrast, firms with
strong ratings on immaterial issues do not outperform. Some commenters
stated that numerous sophisticated investors have indicated that their
ESG investments, social benefits notwithstanding, are fundamentally
driven by expected financial returns, including considerations
regarding long-term value, opportunity, and risk, and cited studies
indicating that an ESG perspective can improve performance, including
studies that purport to show, according to the commenters, that ESG-
focused indexes have matched or exceeded returns of their standard
counterparts, with comparable volatility. They also cited studies
purporting to show that investors who screened for ESG factors could
have avoided 90 percent of S&P 500 bankruptcies from 2005 to 2015 and
that S&P 500 companies in the top 25 percent by ESG ratings experienced
lower future earnings-per-share volatility than those in the bottom 25
percent. A commenter observed, in its view, that there was better risk-
adjusted performance across ``sustainable'' products globally under
recent market stress (including severe turmoil in the first quarter of
2020).
---------------------------------------------------------------------------
\33\ Government Accountability Office Report No. 18-398,
Retirement Plan Investing: Clearer Information on Consideration of
Environmental, Social, and Governance Factors Would Be Helpful
(2018).
---------------------------------------------------------------------------
Representatives of the multiemployer plan community commented on
the proposal's provisions requiring that the focus of fiduciaries when
making investment decisions must be on pecuniary interests of the plan,
and requested that the Department add a particular consideration within
the meaning of ``pecuniary'' factor. According to these commenters, the
proposal failed to consider and distinguish between the different types
of defined benefit pension plans and how relevant pecuniary factors
might differ between different types of ERISA plans. They asserted that
there are several differences between multiemployer and single employer
defined benefit pension plans relevant for purposes of this regulation:
The source and nature of plan contributions; the pecuniary impact of
contributions on the plan, its participants, and beneficiaries; and the
consequent ability of the plan to make investments that advance,
promote, and support the pecuniary interests of the plan, its
participants, and beneficiaries through plan contributions. These
commenters argued that, unlike single employer plans, multiemployer
plans have a significant track record of being able to make investments
that earn competitive risk-adjusted returns and that directly put plan
participants to work, thereby generating new contributions to the plan.
According to these commenters, if a given investment results in a
pension fund receiving additional contributions, such contributions are
as much a pecuniary factor as any gain or loss on the investment. Some
commenters made a similar point with respect to defined contribution
plans. They asserted that increased participation and contributions
should be recognized as pecuniary factors for defined contribution
plans and pointed to surveys demonstrating that including ESG
investment alternatives has a positive effect on employees' interest in
participating in and contributing to retirement savings plans.
Some commenters questioned the proposal's requirement to consider
only pecuniary factors when ERISA investment fiduciaries routinely
consider non-pecuniary interests as part of their fiduciary process.
They argued, for example, that ERISA specifically provides for plan
investments in qualifying employer securities. In the case of employee
stock ownership plans (ESOPs), they noted that such plans are designed
for investment primarily in employer securities. They said that the
proposal conflicted with statutory authorization to invest in employer
securities by requiring plan fiduciaries to justify the inclusion of
company stock based solely on ``pecuniary'' factors and by comparison
to ``available alternative investments or investment courses of
action.'' Other commenters suggested that the proposal's focus on risk-
return features of an investment or investment course of action would
likely have unintended consequences on many common, accepted, and
generally beneficial practices by rendering them suspect, such as the
use of proprietary products, fee sharing, and fee aggregation. Some
comments contended that investment managers and fiduciaries routinely
take into consideration a variety of factors that do not necessarily
have a ``material effect on the risk and/or return'' of a particular
investment. They cited, for example, that a plan committee may consider
a fund manager's brand or reputation when determining whether to
include that fund in the plan's menu. A fiduciary might account for
operational considerations when selecting one investment fund over
another, where those operational considerations may have a bearing on
the fees borne by participants or the smooth operation of the plan. A
fiduciary also might decide to choose an investment regulated in
[[Page 72857]]
one legal regime over another because of the protection the fiduciary
believes the particular regulatory regime offers, or it might find the
disclosures produced by one investment provider easier for participants
to understand. Another commenter noted that reasonable and necessary
plan administrative expenses are commonly offset with payments or
credits attributable to the plan's investment options, and asked
whether the focus on risk-return characteristics would prohibit a
fiduciary from considering the administrative fee offset the plan would
receive when selecting an investment option. Some commenters expressed
concern that the proposal also could encourage litigation by having the
plaintiffs' bar second-guess whether a decision is solely for the
financial benefit of participants and beneficiaries based on incidental
benefits that may accrue to plan fiduciaries (even though case law and
Departmental guidance have approved such benefits if they are merely
incidental and flow from a fiduciary decision that satisfies ERISA's
prudence and loyalty requirements).\34\ One of these commenters also
expressed concern about such litigation alleging that the selection of
one investment over another sacrificed investment returns even if the
decision was justified by the use of revenue sharing to obtain lower
administrative fees.
---------------------------------------------------------------------------
\34\ See Lockheed Corp. v. Spink, 517 U.S. 882 (1996); Hughes
Aircraft Co. v. Jacobsen, 525 U.S. 432 (1999). See also Advisory
Opinion 2011-05A (noting that a fiduciary decision to use plan
assets to add a wellness benefit to plan benefits under existing,
supplemental or new insurance policies or contracts would not
violate ERISA because the employer sponsoring the plan may receive
incidental benefits, such as lower plan costs, as a result of the
wellness benefits being added to the plan).
---------------------------------------------------------------------------
Some commenters argued that the Department's focus on risk and
return was not an appropriate approach for addressing ESG
considerations in decisions regarding management of plan investments.
They argued that given the critical importance of overall market
return, and the danger to that return from company activities that
damage social and environmental systems, plan beneficiaries need
protection from individual companies that focus on their own
performance in ways that damage overall market return. Commenters
argued that in order to protect the interest of plans and
beneficiaries, plan fiduciaries must consider whether they can
effectively engage with companies to limit or eliminate conduct that
threatens the social and economic systems that diversified portfolios
rely on over the long term. They argued that fiduciary investors must
focus on and prioritize outcomes at the economy or society-wide scale,
or ``beta'' issues such as climate change and corruption, not just on
the risks and returns of individual holdings. They contended that
fiduciary investment duties must prioritize the long-term, absolute
returns for ``universal owners,'' and that collective investor action
to manage social and environmental systems is needed in order to
satisfy the fiduciary duties of investment trustees.
One commenter suggested that the definition of ``pecuniary factor''
was too narrow and recommended modifying it to mean a factor that could
reasonably be expected to have a material effect on the risk and/or
return of an investment based on appropriate investment horizons
consistent with the plan's investment objectives and the funding policy
established pursuant to section 402(b)(1) of ERISA.
Still another commenter suggested that ``appropriate investment
horizon'' be better defined in the definition of ``pecuniary factor''
to ensure that the long-term horizons for certain policy objectives are
not substituted for those relating to the time-horizon of retirees.
As the Department explained in the proposal, it is the long-
established view of the Department that ERISA fiduciaries must always
put first the economic interests of the plan in providing retirement
benefits. A fiduciary's evaluation of the economics of an investment
should be focused on financial factors that have a material effect on
the return and risk of an investment based on appropriate investment
horizons consistent with the plan's articulated funding and investment
objectives. In the preamble to the proposal, the Department recognized
that there could be instances when ESG issues present material business
risk or opportunities to companies that company officers and directors
need to manage as part of the company's business plan and that
qualified investment professionals would treat as economic
considerations under generally accepted investment theories. In such
situations, these issues are themselves appropriate economic
considerations, and thus should be considered by a prudent fiduciary
along with other relevant economic factors to evaluate the risk and
return profiles of alternative investments. The proposal even provided
additional guidance as to when it was appropriate to consider ESG
matters as pecuniary factors in making investment decisions. Thus, the
proposal fundamentally accepted, rather than ignored as claimed by some
commenters, the economic literature and fiduciary investment experience
that showed ESG considerations may present issues of material business
risk or opportunities to companies that company officers and directors
need to manage as part of the company's business plan and that
qualified investment professionals would treat as economic
considerations under generally accepted investment theories. Rather,
the proposal sought to make clear that, from a fiduciary perspective,
the relevant question is not whether a factor under consideration is
``ESG'', but whether it is a pecuniary factor relevant to an evaluation
of the investment or investment course of action under consideration.
Nonetheless, the Department is persuaded by its review of the public
comments that ``ESG'' terminology, although used in common parlance
when discussing investments and investment strategies, is not a clear
or helpful lexicon for a regulatory standard. As one commenter put it,
```ESG investing' resists precise definition.'' Rather, ``[r]oughly
speaking, it is an umbrella term that refers to an investment strategy
that emphasizes a firm's governance structure or the environmental or
social impacts of the firm's products or practices.'' The Department
agrees that ESG terminology suffers from two distinct shortcomings as a
regulatory standard. First, as the Department noted in the proposal,
and many commenters agreed, various other terms have been used to
describe this and related investment behaviors, such as socially
responsible investing, sustainable and responsible investing, impact
investing, and economically targeted investing. Moreover, the terms do
not have a uniform meaning and the terminology is evolving, and the
non-pecuniary goals being advocated today may not be the same as those
advocated in future years. Second, by conflating unrelated
environmental, social, and corporate governance factors into a single
term, ESG invites a less than appropriately rigorous analytical
approach in evaluating whether any given E, S, or G consideration
presents a material business risk or opportunity to a company that
corporate officers and directors should manage as part of the company's
business plan and that qualified investment professionals would treat
as economic considerations in evaluating an investment in that company.
The Department also believes that adopting ESG terminology in an
investment duties regulation invites the arguments, made by some
commenters, that all manner of ESG considerations are always and in
every case a pecuniary factor that must be
[[Page 72858]]
considered as such in all investment decisions, or even that ESG should
be a mandatory investment strategy for prudent fiduciaries. Such
positions are inconsistent with the Department's considered view and
sound policy.
Thus, the final rule removes all ESG terminology from the proposed
regulatory text. The Department anticipates that when a fiduciary is
faced with a purported ESG factor in an investment, the regulatory
requirement will be clearer and more consistent if it demands that
fiduciaries focus on providing participants with the financial benefits
promised under the plan and focus on whether a factor is pecuniary,
rather than being required to navigate imprecise and ambiguous ESG
terminology. The ERISA fiduciary duty of prudence requires portfolio-
level attention to risk and return objectives reasonably suited to the
purpose of the account, diversification, cost-sensitivity,
documentation, and ongoing monitoring. The proposal was not intended to
suggest that these principles apply other than neutrally to all
investment decisions by a trustee or other fiduciary, whether in the
context of a direct investment or menu construction in an individual
account plan. For similar reasons, the Department declines to follow
suggestions from some commenters that ESG factors are necessarily
pecuniary and that the Department should specifically mandate that
fiduciaries consider ESG factors as part of their investment duties.
At the time of the investment decision, fiduciaries should be
focused on whether or not any given factor would materially affect the
risk and/or return of the investment over an appropriate time horizon.
The intent of the proposal was to address the Department's continued
concern about the growing emphasis on ESG investing that seeks to
achieve non-pecuniary objectives or goals that are unrelated to the
interests of the plan's participants and beneficiaries in their
retirement income or financial benefits under the plan, and the
consequence that ERISA plan fiduciaries may be prompted to make
investment decisions for purposes distinct from providing benefits to
participants and beneficiaries and defraying reasonable expenses of
administering the plan. Thus, the proposal was intended to ensure that
ERISA fiduciaries comply with their investment duties in a consistent
and appropriate fashion in the face of ESG-driven market
developments.\35\ The Department believes that the generally applicable
prudence requirements in paragraph (a) of the final rule, together with
a requirement in paragraphs (c) and (d) of the final rule demanding a
focus on pecuniary factors and the definition of pecuniary factors in
paragraph (f), are sufficient to establish an appropriate regulatory
standard in this context.
---------------------------------------------------------------------------
\35\ See, e.g., James MacKintosh, A User's Guide to the ESG
Confusion, Wall Street Journal (Nov. 12, 2019), www.wsj.com/articles/a-users-guide-to-the-esg-confusion-11573563604 (``It's hard
to move in the world of investment without being bombarded by sales
pitches for running money based on `ESG' ''); Mark Miller, Bit by
Bit, Socially Conscious Investors Are Influencing 401(k)'s, New York
Times (Sept. 27, 2019), www.nytimes.com/2019/09/27/business/esg-401k-investing-retirement.html.
---------------------------------------------------------------------------
As a result, paragraph (c)(1) of the final rule retains the
requirement in the proposal that fiduciary evaluation of an investment
must be focused only on pecuniary factors. As in the proposal, the
final rule's paragraph (c)(1) is a legal requirement and not a safe
harbor. The final rule also retains the text from the proposal that
expressly states that plan fiduciaries are not permitted to sacrifice
investment return or take on additional investment risk to promote non-
pecuniary benefits or any other non-pecuniary goals, but has been
revised to include text from proposed paragraph (b)(1)(iii), modified
slightly, that a fiduciary may not subordinate the interests of the
participants and beneficiaries in their retirement income or financial
benefits under the plan to other objectives. Even commenters that
opposed the Department's proposal generally agreed that such a
provision appropriately described a fiduciary's duty of loyalty under
ERISA.\36\
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\36\ The language in proposed (b)(1)(iii) referred to
``unrelated objectives,'' rather than ``other objectives.'' The
Department has used ``unrelated objectives'' in previous sub-
regulatory guidance. However, that language could be misconstrued as
providing a loophole to allow fiduciaries to consider and to
subordinate participants and beneficiaries' financial interests to
objectives that are in any way related to the interests of
participants and beneficiaries in their retirement income or
financial benefits under the plan. It was not the Department's
intent--and nor would it be consistent with ERISA--to allow
fiduciaries to subordinate the interests of participants and
beneficiaries in their retirement income or financial benefits under
the plan to any other objective, and the Department has revised the
language used in the final rule text to ensure that it is not
misconstrued.
---------------------------------------------------------------------------
With respect to the provisions of paragraph (c) of the proposal
that would have separately required compliance with prudence
obligations set forth in paragraph (b) (e.g., that the weight given to
any particular pecuniary factors should appropriately reflect a prudent
assessment of their impact on risk and return, and that fiduciaries
considering pecuniary factors examine the level of diversification,
degree of liquidity, and the potential risk-return in comparison with
other available alternative investments that would play a similar role
in their plans' portfolios), the Department agrees with the observation
of one commenter that identifying these requirements separately in
paragraph (c)(1) and tying them to regulatory text about
``environmental, social, corporate governance, or other similarly
oriented factors'' could be misconstrued as applying these general
prudence criteria in some unique (or at least more rigorous) fashion to
ESG and ``other similarly oriented'' investment strategies.
Accordingly, in order to avoid redundant and potentially confusing
regulatory requirements, the specific provisions on those obligations
that were in paragraph (c) of the proposal have been eliminated from
paragraph (c) of the final rule and replaced with a more general
requirement that the weight given to any pecuniary factor by a
fiduciary should appropriately reflect a prudent assessment of its
impact on risk and return. As modified, this provision will provide
fiduciaries the necessary flexibility to evaluate and consider the
particular pecuniary factors relevant to a specific investment or
investment course of action, while focusing paragraph (c) on the
principal objective of adding to the regulation an express provision
that the duty of fiduciaries is to act with an eye single toward
furthering participants' ``financial'' rather than ``nonpecuniary''
benefits.
Further, the Department did not intend the reference to ``generally
accepted investment theories'' to foreclose ERISA fiduciaries from
considering emerging theories regarding prudent investment practices or
otherwise freeze investment practice as of the date of the rule.
Rather, the intent was to establish a regulatory guardrail against
situations in which plan investment fiduciaries might be inclined to
use, as one example, policy-based metrics in their assessment of the
pecuniary value of an investment or investment plan that are inherently
biased toward inappropriate overestimations of the pecuniary value of
policy-infused investment criteria. The Department intended to
communicate the idea that the fiduciary is required to have a soundly
reasoned and supported investment decision or strategy to satisfy the
ERISA prudence requirement. However, the Department has decided not to
include this provision in the final rule, but rather to rely on the
definition of pecuniary factor as the governor for investment decisions
without specifically constraining the criteria that a fiduciary
[[Page 72859]]
could consider in making a prudent judgment. Although not retained as
express regulatory text in the final rule, the Department believes that
it would be consistent with ERISA and the final rule for a fiduciary to
treat a given factor or consideration as pecuniary if it presents
economic risks or opportunities that qualified investment professionals
would treat as material economic considerations under generally
accepted investment theories. In this regard, it is based on the
essence of the 1979 investment duties regulation, the conditions of
which basically require the judgment of a prudent expert--and if the
decision maker does not have the expertise himself, he should consult
such an expert. For example, in a 1996 letter to Eugene Ludwig,
Comptroller of the Currency, regarding the ERISA duty of prudence in
the context of an evaluation of the prudence of derivative investments,
the Department stated that among other things, the fiduciary should
determine whether it possesses the requisite expertise, knowledge, and
information to understand and analyze the nature of the risks and
potential returns involved in a particular derivative investment. The
letter pointed out that the fiduciary must determine whether the plan
has adequate information and risk management systems in place given the
nature, size, and complexity of the plan's investment activity, and
whether the plan fiduciary has personnel who are competent to manage
those systems.\37\
---------------------------------------------------------------------------
\37\ See Letter to Eugene A. Ludwig from Olena Berg (March 21,
1996), and also Advisory Opinions 2002-14A and 2006-08A; and Letter
to J. Mark Iwry (Oct. 23, 2014).
---------------------------------------------------------------------------
The Department also did not intend that the provision be read, as
some commenters did, as a limitation on the ability of ERISA
fiduciaries to consider all relevant factors in evaluating whether
factors may have a ``material effect on the return and risk of an
investment.'' Rather, when comparing investment or investment courses
of action, including selection of designated investment alternatives in
the case of participant-directed individual account plans, a fiduciary
satisfies its obligations under paragraph (c)(1) by evaluating factors
that are expected to result in a material difference among reasonably
available alternatives with respect to risk and/or return. Thus, the
final rule neither specifically prohibits nor permits the use of
proprietary products, fee sharing, and fee aggregation, but requires
the fiduciary to evaluate whether such practices are expected to have a
material effect on risk and/or return as compared to the reasonably
available alternatives. If a fiduciary were to prudently conclude that
a fund manager's brand or reputation will materially affect the
expected risk and/or return as funds, then such factors would be
pecuniary. Similarly, to the extent that the net expenses incurred by
the plan, such as for plan administration or to develop disclosures
that are easier for participants to understand, are expected to
materially affect the risk and return of one alternative as compared to
another, such factors would be considered pecuniary. Finally, in
response to some commenters, the Department did not intend to imply in
the proposal that, in evaluating investments or investment courses of
action, a fiduciary must always select the one with the lowest cost.
Depending on the facts and circumstances, a fiduciary may conclude that
a particular investment or investment course of action is prudent even
though it entails higher risk or cost.
The Department, however, cautions fiduciaries against too hastily
concluding that ESG-themed funds may be selected based on pecuniary
factors or are not distinguishable based on pecuniary factors, thereby
triggering the tie-breaking provision of paragraph (c)(2) of the final
rule. A number of commenters touted the performance of ESG-themed funds
for selected time periods, particularly after the widespread COVID-19
outbreak, as compared to more conventional alternatives. However,
questions have been raised as to whether such performance was caused by
a particular ESG strategy or merely correlated with broader economic
trends unrelated to a specific ESG factor. The Department observes that
many ESG-themed funds have been over-weighted in technology and
underweighted in energy as compared to more conventional alternatives,
which has affected certain funds' returns in recent periods. Technology
assets performed relatively better during the recent pandemic, while
energy markets that were already in turmoil from global excess supply
declined further due to widespread decrease in demand, including due to
reductions in travel. This difference in portfolio composition can
affect the level of risk associated with the corresponding return and a
fiduciary would need to prudently balance such considerations when
comparing alternatives.
In response to the commenter who suggested that the definition of
``pecuniary factor'' should be modified to include a ``reasonably be
expected'' provision, the Department has revised the definition to mean
a factor that a fiduciary prudently determines is expected to have a
material effect on risk and/or return of an investment based on
appropriate investment horizons consistent with the plan's investment
objectives and the funding policy established pursuant to section
402(b)(1) of ERISA. The Department believes that a prudent
determination incorporates a reasonableness standard of care, but has
revised the definition to use terminology that is more consistent with
the statutory language of ERISA section 404(a)(1)(B), which includes
more than reasonableness. Thus, the final rule recognizes that the
nature of the fiduciary investment judgments will necessarily involve
forward-looking expectations when evaluating investment alternatives
and strategies. The Department is also retaining the concept of
materiality in the definition of ``pecuniary factor'' as it believes
that fiduciaries and investment managers are generally familiar with
that concept from its use in connection with both ERISA and the Federal
securities laws.
With respect to the consideration of how the final rule and its
emphasis on pecuniary factors would influence the selection of company
stock for a plan, the Department notes first that commenters should not
have concern on this issue. The basic ERISA principles governing
fiduciaries have coexisted with the use of ESOPs for many years, and
this rule does not disturb them. This rule is focused on principles of
pecuniary and nonpecuniary investing in the broader marketplace. This
rule does not have as one of its objectives any changes to the long-
established use of ESOPs by companies that wish to do so.
Second and relatedly, the Department recognizes that ESOPs are
typically set in most respects by the employer's settlor function, and
further that they are congressionally sanctioned under a particularized
statutory framework compatible with this rule. Most acquisitions of
company stock and use of company stock funds in individual account
plans are directed by the plan or instruments governing the plan.
Investments in qualifying employer securities are explicitly authorized
by statutory provisions in ERISA, and subject to specific statutory
conditions that Congress enacted as elements of Federal employee
benefits law. For example, there are specific provisions for employer
securities in the requirements under ERISA section 101(i) related to
notice of blackout periods to participants or beneficiaries under
individual account plans. Section 101(m) includes special disclosure
rules
[[Page 72860]]
for individual account plans on the right to divest employer securities
with respect to any type of contribution. Section 105 on individual
benefit statements requires individual account plans to include an
explanation, written in a manner calculated to be understood by the
average plan participant, of the importance, for the long-term
retirement security of participants and beneficiaries, of a well-
balanced and diversified investment portfolio, including a statement of
the risk that holding more than 20 percent of a portfolio in the
security of one entity (such as employer securities) may not be
adequately diversified. Section 204(j) of ERISA includes special
diversification requirements for certain individual account plans
governing investments in employer securities. ERISA sections 404(a)(2)
and 407 provide specific rules for the application of ERISA's
diversification requirements to the acquisition of ``qualifying
employer securities.'' The U.S. Supreme Court has concluded that there
is no special presumption of prudence under ERISA favoring ESOP
fiduciaries, stating that ``the same standard of prudence applies to
all ERISA fiduciaries, including ESOP fiduciaries, except that an ESOP
fiduciary is under no duty to diversify the ESOP's holdings.'' \38\
Similarly, the duties of prudence and loyalty set forth in this
regulation apply in the context of the pertinent provisions of ERISA.
In short, the statutory provisions in ERISA, and others in the Internal
Revenue Code, make clear that plan fiduciaries are permitted to invest
in employer securities following the direction of a plan document with
respect to acquisitions or holding of employer stock,\39\ provided the
fiduciary satisfies the applicable conditions in the statute, and acts
prudently and loyally.
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\38\ Dudenhoeffer, 573 U.S. at 418-419.
\39\ The Department has taken the position that there is a class
of activities that relate to the formation, rather than the
management, of plans. These activities, generally referred to as
settlor functions, include decisions relating to the formation,
design, and termination of plans and, except in the context of
multi-employer plans, generally are not activities subject to Title
I of ERISA. As such, decisions that are settlor functions would not
be subject to the final rule provisions that govern fiduciary
investment duties. The Department notes, however, that actions taken
to implement settlor decisions may involve fiduciary activities,
and, to the extent those activities involve fiduciary investment
decisions, they would be subject to the provisions of this final
rule. See Advisory Opinion 2001-01A; Advisory Opinion 97-03A;
Letters to Kirk Maldonado from Elliot Daniel (March 2, 1987); and
Letter to John Erlenborn from Dennis Kass (March 13, 1986).
---------------------------------------------------------------------------
With respect to the comments by the multiemployer plan community
requesting that the Department adjust its definition of pecuniary
factor to include increased contributions to plans as a result of
investments, the Department has previously addressed this and similar
issues in a number of advisory opinions and information letters.\40\
Specifically, the Department has repeatedly explained that increased
plan contributions and similar factors are not economic factors, but
that they are the type of non-economic factor that may be considered
where a fiduciary is permitted to make an investment decision on the
basis of a non-pecuniary factor.\41\ Increasing plan contributions and
similar factors do not assist a fiduciary in determining the expected
return on or riskiness of an investment, as plan contributions do not
constitute a ``return'' on investment.
---------------------------------------------------------------------------
\40\ See, e.g., DOL Inf. Ltr to George Cox (Jan. 16, 1981); DOL
Adv. Op. to Theodore Groom (Jan. 16, 1981); DOL Adv. Op. to Daniel
O'Sullivan, Union Labor Life Ins. Co (Aug. 2, 1982); DOL Adv. Op to
James Ray, Union Labor Life Ins. Co. (July 8, 1988); DOL Inf. Ltr.
to Stuart Cohen, General Motors Corp.. (May 14, 1993).
\41\ See, e.g., DOL Inf. Ltr. to Ralph Katz (March 15, 1982)
(``A decision to make an investment may not be influenced by a
desire to stimulate the construction industry and generate
employment, unless the investment, when judged solely on the basis
of its economic value to the plan, would be equal or superior to
alternative investments available to the plan.'').
---------------------------------------------------------------------------
The Department's position on this issue has not changed and as a
result we disagree with these commenters. The potential for increased
contributions to a plan as a result of an investment is not a pecuniary
factor associated with the return on a particular investment. Nor may
increased contributions be considered a return on an investment. In
terms of determining what is or is not a pecuniary factor, the relevant
performance to be measured is that of the investment in question, not
future plan contributions. The purpose of plan investments under ERISA
is to provide and protect retirement benefits--not to strengthen
employers or unions or provide job security. Under ERISA, plans are to
be operated solely in the interest of participants and beneficiaries as
participants and beneficiaries, not in some other role or capacity,
such as union members, employees, or members of some other interest
group. However, the Department agrees--consistent with the advisory
opinions and information letters referenced above--that an objective to
increase contributions or respond to participant interest in investment
options for their retirement savings are permissible factors to use in
the tie-breaker provisions in paragraph (c)(2), discussed below, based
on their connection to the interests of the plan and plan participants
and beneficiaries.
Finally, the Department does not agree with the position that ERISA
permits or requires plan fiduciaries to premise investment decisions on
the idea that, as investors, they own a share of the world economy,
and, therefore, that their financial interests demand that they adapt
their investment-related actions to promote a theoretical benefit to
the world economy that might redound, outside the plan, to the benefit
of the participants in the plan.\42\ The Department has acknowledged in
the proposal and in this final rule that particular environmental or
social factors may present material and current business risks or
opportunities for specific companies (and may be reflected in potential
market risk and return). But the Department cannot reconcile the
approach described above with the requirements of prudence and loyalty
under ERISA. On the contrary, that approach and the potential
consequences of advocacy to plan fiduciaries based on that approach is
one of the concerns that underlies this final rule, and illustrates why
the Department considers the rule to be warranted at this time. As the
Department has stated, it does not ineluctably follow from the fact
that an investment promotes ESG factors, or that it arguably promotes
positive general market trends or industry growth, that the investment
is a prudent choice for retirement or other investors. Rather, ERISA
fiduciaries must always put first the economic interests of the plan in
providing retirement benefits. A fiduciary's evaluation of the
economics of an investment should be focused on financial factors that
have a material effect on the return and risk of an investment based on
appropriate investment horizons consistent with the plan's articulated
funding and investment objectives.
---------------------------------------------------------------------------
\42\ See also supra at 83-84.
---------------------------------------------------------------------------
3. Section 2550.404a-1(c)(2)--Choosing Between or Among Investment
Alternatives That the Plan Fiduciary Is Unable to Distinguish on the
Basis of Pecuniary Factors Alone
Prior to the proposal, the Department's interpretive guidance
provided that if, after an evaluation, alternative investments appear
economically indistinguishable, a fiduciary may then, in effect,
``break the tie'' by relying on a non-pecuniary factor. The proposal
carried forward this idea and paragraph (c)(2) of the proposal was
designed to guide application of the ``all things being equal'' test by
requiring fiduciaries to adequately document any such occurrences. In
the preamble to the proposal, the Department noted that there are
highly
[[Page 72861]]
correlated investments and otherwise very similar ones. The Department
observed that seldom, however, will an ERISA fiduciary consider two
investment funds, looking only at objective measures, and find the same
target risk-return profile or benchmark, the same fee structure, the
same performance history, and the same investment strategy, but a
different underlying asset composition. The Department explained that,
even then, those two alternatives may function differently in the
overall context of the fund portfolio and going forward may perform
differently based on external economic trends and developments.\43\ As
a result, the Department expressed concern that the ``all things being
equal'' test could invite fiduciaries to find ties without a proper
analysis in order to justify the use of non-pecuniary factors in making
an investment decision. Nonetheless, because it appeared that some form
of ties may theoretically occur, and the Department did not have
sufficient evidence to say they do not occur in fact, the Department
proposed to retain a version of an ``all things being equal'' test.
However, in the proposal, the Department specifically requested comment
on the tie-breaker concept, whether true ties exist, and, if they do,
how fiduciaries may appropriately break ties.
---------------------------------------------------------------------------
\43\ See Schanzenbach & Sitkoff, supra note 5, at 410
(describing a hypothetical pair of truly identical investments as a
``unicorn'').
---------------------------------------------------------------------------
The Department also believed that using non-pecuniary factors to
choose among investments merited closer scrutiny. As one commenter
noted, trust fiduciary law recognizes that there are circumstances,
mainly in the context of conditionally permitted conflicts of interest,
that call for enhanced scrutiny of the substance of the fiduciary's
decision.\44\ The Department believes that relying on non-pecuniary
factors to select among investments is a circumstance that similarly
warrants some form of enhanced scrutiny. Thus, paragraph (c)(2) of the
proposal was designed to guide application of the ``all things being
equal'' test by requiring fiduciaries to adequately document any such
occurrences. If, under proposed paragraph (c)(2) after completing an
appropriate evaluation, alternative investments appear economically
indistinguishable, and one of the investments is selected on the basis
of a non-pecuniary factor or factors such as environmental, social, and
corporate governance considerations, the fiduciary must document why
pecuniary factors were not sufficient to select the investment or
investment courses of action, how the investment compares to
alternative investments with respect to the factors listed in
paragraphs (b)(2)(ii)(A) through (C), and how the non-pecuniary factor
or factors was chosen based upon the purposes of the plan, the
diversification of investments, and the interests of the participants
and beneficiaries in receiving benefits from the plan. The Department
included the documentation requirement to provide a safeguard against
the risk that fiduciaries will improperly find economic equivalence and
make decisions based on non-pecuniary factors without a proper analysis
and evaluation.
---------------------------------------------------------------------------
\44\ See, e.g., Restatement (Third) of Trusts section 37 cmt.
f(1) (2007) (``especially careful scrutiny'').
---------------------------------------------------------------------------
Many commenters characterized proposed paragraph (c)(2) of the
proposal as a new stricter ``tie breaker'' or ``all things being equal
test'' that was inappropriately rigid. One commenter asserted that
proposed paragraph (c)(2) effectively required plan fiduciaries to
demonstrate that the chosen investment was ``outright superior'' to the
available alternative investments. Many commenters stated that the
standard in the Department's interpretive guidance was an easier
standard to comply with and required the comparison only of investments
of comparable financial value. Some commenters stated that the proposal
appeared to require that the alternatives under consideration have
``the same target risk-return profile or benchmark, the same fee
structure, the same performance history, same investment strategy, [and
that it not] function differently in the overall context of the fund
portfolio, and [not] perform differently based on external economic
trends and developments.'' In short, the commenters argued the prior
standard, which they said is best characterized as functional
equivalence, was replaced with a new, more restrictive economically
identical standard. These commenters asserted that the impossibility of
satisfying this standard suggested that the Department's objective in
designing the provisions was to deter fiduciaries from considering
investments with non-pecuniary benefits.
Some commenters argued that true ``ties'' of the sort envisioned in
the proposal do not exist because they read the proposal as requiring
investments to have identical characteristics, not just equivalent
roles in the plan's investment portfolio. They argued that such
indistinguishability in liquid markets is all but impossible. The risk
of any two assets, even if identical on some risk metric, will
nonetheless not be perfectly correlated. Further, they argued that
breaking the tie is not the correct response. Rather, if there is no
liquidity constraint and trading costs are low, they assert that
textbook financial economics teaches that in the event of two
economically equivalent investments so defined, the investor should buy
both of them and achieve improved diversification.
Other commenters said that ``ties'' are actually quite common in
the investment process and that for almost every portfolio, there are
some economically indistinguishable alternatives when viewed in terms
of the role the investments would play in the plan's portfolio. The
commenters argued that two or even several investments' expected
overall economic impact on a plan may be essentially the same even if
the investments' risk-return profile, fee structure, performance
history, and investment strategy are not each literally identical. Some
mutual fund commenters suggested that the proposal appears to assume
that evaluation of two alternative investments based solely on
pecuniary factors can be reduced to a single number. That assumption,
they asserted, underestimates the complexity of portfolio construction.
Some commenters said that putting the burden on the fiduciary to
justify a finding of economic equivalence that would permit a non-
pecuniary tie-breaker is an appropriate policy response. They claimed
there is considerable opportunity in the assessment of investment
alternatives for those with an incentive to favor an ESG plan to nudge
the process so that a slightly economically inferior ESG investment
could be considered ``economically indistinguishable'' from a non-ESG
alternative.
Other commenters argued that the tie-breaker idea should be
available to fiduciaries when selecting investment alternatives for
defined contribution plans. Those commenters argued that applying the
tie breaker test to investment choices with the same overall economic
role and impacts in a plan's portfolio, within a reasonable range of
expected outcomes, rather than only those that are identical in each
and every respect (except for asset composition), would more
appropriately reflect the process by which ERISA fiduciaries select
plan investments.
Some commenters claimed that the proposal was vague and nonspecific
as to what form the additional documentation required under proposed
paragraph (c)(2) should take. Further, the commenters asserted, prudent
plan fiduciaries already document their decision-making process. Other
[[Page 72862]]
commenters asserted that no other Federal regulator mandates this much
documentation. One commenter noted that there is no ESG documentation
for investment managers under the Investment Advisers Act or the
Investment Company Act. The commenter said the SEC Regulation Best
Interest provides significant flexibility by leaving it largely up to
individual firms to determine how best to memorialize decisions.
Commenters asserted that although the Department explained in the
preamble that the documentation safeguards against fiduciaries making
decisions based on non-pecuniary factors without proper analysis or
rigor, a lack of rigor is not synonymous with a lack of writing and
does not explain why ESG factors are treated differently than other
investment factors. Commenters also asserted that the proposed rule's
documentation requirement would effectively create a unique and
unwarranted presumption against ESG investing that does not apply to
any other kind of investment. Some commenters asserted that the
proposed rule if implemented would add new costs and these new costs
would chill sponsors from considering any investment incorporating ESG
factors, even if pecuniary and part of the risk assessment of the
investment. Some commenters argued that paragraph (c)(2) would result
in additional documentation burdens on plans that did not actually rely
on the tie-breaker because fiduciaries would feel compelled to document
ESG risk-reward integration as non-pecuniary collateral consideration
for strategies in order to protect against second-guessing about the
fiduciary's determination that the ESG factor was properly treated as a
pecuniary factor. Some commenters stated that by requiring the
documentation the proposed regulation would invite manufactured breach-
of-fiduciary-duty lawsuits based on claimed documentation failures even
in cases where there was no evidence of a failure in fiduciary
decision-making.
Another commenter called for the documentation requirement to be
expanded. The commenter argued that paragraph (c)(2) of the proposal,
while a valuable addition, would not capture situations in which plan
managers who are inclined toward policy-based investment have used
policy-based metrics in their evaluation of the pecuniary value of an
investment or investment plan that are inherently biased toward
inappropriate overestimations of the pecuniary value of policy-infused
investment decisions. This commenter suggested that the requirement be
expanded to require complete explanation and documentation any time
policy-based analysis plays any role in the determination of the
anticipated pecuniary value of an investment or investment strategy.
Fiduciaries are not compelled to break ties on the basis of non-
pecuniary factors, and--consistent with their core obligation to
discharge their duties solely in the interests of participants and
beneficiaries--fiduciaries are encouraged to make their best judgment
on the basis of pecuniary factors alone, or where prudent to diversify
by selecting all indistinguishable alternatives. As described in the
proposal and above, proposed paragraph (c)(2) is intended to provide a
safeguard against the possibility that fiduciaries interested in making
policy-based investments would improperly find economic equivalence and
make decisions based upon non-pecuniary benefits without proper
analysis and evaluation.
The Department does not agree that the final rule should adopt what
some commenters referred to as a less restrictive ``all things being
equal'' test. However, the Department notes there was disagreement
among commenters as to whether true ties actually occur, and a great
deal of confusion as to the meaning of ``economically distinguishable''
and whether that requires mathematical precision in the evaluation of
investment characteristics that is unrealistic with respect to how
investment professionals operate. After considering the public
comments, the Department is persuaded that the tie-breaker test should
be simplified and focus on situations in which the fiduciary is unable
to distinguish investment alternatives on the basis of pecuniary
factors alone, rather than demanding that investments be identical in
each and every respect before the tie-breaker provision would be
available.
The Department remains convinced, however, that it is appropriate
for the regulation to include a safeguard against the risk that
fiduciaries will improperly find economic equivalence and make
decisions based on non-pecuniary factors without a proper analysis and
evaluation. The Department thus decided to retain, with some
modifications, the documentation requirements as part of the ``all
things being equal'' test in paragraph (c)(2). The Department does not
believe those requirements prohibit investments with non-pecuniary ESG
or other components. Moreover, because the final rule does not require
any documentation of decisions that use pecuniary ESG factors, the
Department does not believe that it will inappropriately chill
fiduciaries from considering investments that incorporate ESG factors
that can be shown to be pecuniary as part of the investment's risk
assessment relative to non-ESG factors. In other words, the final rule
does not single out ESG investing or any other particular investment
theory for particularized treatment.
Rather, and specifically, paragraph (c)(2) of the final rule
provides that if a fiduciary is unable to determine which investment is
in the best interests of the plan on the basis of pecuniary factors
alone, the fiduciary may base the investment decision on non-pecuniary
factors, provided the fiduciary documents the following: why pecuniary
factors were not sufficient to select the investment or investment
course of action; how the investment compares to the alternative
investments with regard to the factors listed in paragraphs
(b)(2)(ii)(A) through (C); and how the chosen non-pecuniary factor or
factors are consistent with the interests of the participants and
beneficiaries in their retirement income or financial benefits under
the plan. With respect to the third documentation requirement, the
Department has consolidated the proposed requirement to document why
the selected investment was chosen based on the purposes of the plan
and the interests of plan participants and beneficiaries in receiving
benefits from the plan into a single requirement. When a fiduciary
makes an investment decision based on non-pecuniary factors as
permitted under the final rule, the fiduciary remains subject to
ERISA's general loyalty obligation and must act in a manner that is
consistent with the interests of participants and beneficiaries in
their retirement income or financial benefits. For example, responding
to participant demand in order to increase retirement plan savings or
investments in contribution creating jobs for current or future plan
participants may be consistent with the interests of participants and
beneficiaries in their retirement income or financial benefits under
the plan, while selecting based on which investment would bring greater
personal accolades to the chief executive officer of the sponsoring
employer, or solely on the basis of a fiduciary's personal policy
preferences, would not.
The proposal did not expressly incorporate the tie-breaker
provision in paragraph (c)(2) on ``economically indistinguishable
alternative investments'' into the regulatory
[[Page 72863]]
provision on selection of investment options for individual account
plans. The Department explained in the proposal that it was of the view
that the concept of ``ties'' may have little relevance in the context
of fiduciaries' selection of menu options for individual account plans
as such investment options are often chosen precisely for their varied
characteristics and the range of choices they offer plan participants.
Further, the Department explained that because the proposal did not
restrict the addition of prudently selected, well managed investment
options for individual account plans which include non-pecuniary
factors if they can be justified solely on the basis of pecuniary
factors, there would be little need for a tie-breaker between selected
investment funds. Nonetheless, some commenters expressed some
uncertainty regarding the interaction of paragraph (c)(2) and the
provisions of the proposal on selecting investment options for
individual account plans. Some commenters asked the Department to
expressly make the tie-breaker available for such investment decisions.
The Department continues to doubt that the concept of a ``tie'' when
adding designated investment alternatives to a platform of investments
that allow participants and beneficiaries to choose from a broad range
of investment alternatives as defined in 29 CFR 2550.404c-1(b)(3) is
relevant. Nevertheless, the final rule makes the tie-breaker provisions
in paragraph (c) generally available for use in selecting investment
options for individual account plans in the event the fiduciaries of
the plan believe that it gives them some added flexibility and
protection when adding an investment fund, product, or model portfolio
that promotes, seeks, or supports one or more non-pecuniary goals in
circumstances where the fiduciary could not distinguish such investment
option from an alternative on the basis of pecuniary factors alone.
4. Section 2550.404a-1(d)--Investment Alternatives in Participant-
Directed Individual Account Plans
Paragraph (c)(3) of the proposed rule contained standards
applicable to participant-directed individual account plans.
Participant-directed plans are a subset of individual account
retirement plans that provide for the allocation of investment
responsibilities to participants and beneficiaries of the plans,
sometimes referred to as ``self-directed'' plans. Paragraph (c)(3) of
the proposal, in relevant part, stated the general proposition that
sections 403 and 404 of ERISA apply to a fiduciary's selection of an
investment fund as a designated investment alternative in an individual
account plan.
Paragraph (c)(3) of the proposal further provided that a
fiduciary's addition (for the platform) of one or more prudently
selected, well managed, and properly diversified investment
alternatives that include one or more environmental, social, corporate
governance, or similarly oriented assessments or judgments in their
investment mandates, or that include these parameters in the fund name,
would not violate the standards in section 403 and 404 provided three
conditions were met. The first condition, at paragraph (c)(3)(i) of the
proposed rule, was that the fiduciary uses only objective risk-return
criteria, such as benchmarks, expense ratios, fund size, long-term
investment returns, volatility measures, investment manager investment
philosophy and experience, and mix of asset types (e.g., equity, fixed
income, money market funds, diversification of investment alternatives,
which might include target date funds, value and growth styles, indexed
and actively managed funds, balanced and equity segment funds, non-U.S.
equity and fixed income funds), in selecting and monitoring all
investment alternatives for the plan including any environmental,
social, corporate governance, or similarly oriented investment
alternatives. The second condition, at paragraph (c)(3)(ii) of the
proposed rule, was that the fiduciary must document its compliance with
the first condition. The third condition, at paragraph (c)(3)(iii) of
the proposed rule, was that the environmental, social, corporate
governance, or similarly oriented investment mandate alternative is not
added as, or as a component of, a qualified default investment
alternative described in 29 CFR 2550.404c-5.
Paragraph (d) of the final rule contains standards applicable to
participant-directed individual account plans. The standards in
paragraph (d) of the final rule reflect substantial revisions from the
proposed rule. The predecessor provisions in paragraph (c)(3) of the
proposal are revised, reorganized, and relocated into paragraph (d) of
the final rule in response to concerns raised by the public
commenters.\45\ As in the proposal, the final rule's paragraph (d) is a
legal requirement and not a safe harbor.
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\45\ For the reasons explained above in footnote 32, supra, the
final rule no longer contains an explicit reference to section 403
of ERISA. This omission better aligns the scope of paragraph (d) of
the final rule with the scope of paragraph (a) of the final rule.
---------------------------------------------------------------------------
Paragraph (d)(1) of the final rule provides that the standards set
forth in paragraph (a) (relating to the statutory duties of loyalty and
prudence) and paragraph (c) (the pecuniary-only and anti-subordination
provisions, including the tie-breaker test) of the final rule apply to
a fiduciary's selection of designated investment alternatives that will
be made available to participants and beneficiaries for investing their
individual accounts. This provision makes clear that the same prudence
and loyalty duties that apply generally to evaluating investments under
ERISA (such as stock selection) also apply to a fiduciary's evaluation
and selection of designated investment alternatives from which
participants and beneficiaries select where to direct their retirement
assets. Thus, when assembling, choosing, or modifying an investment
menu for participants' investment choices, a fiduciary must evaluate
the designated investment alternatives on the menu based solely on
pecuniary factors, not subordinate the interests of participants to
unrelated objectives, and not sacrifice investment return or take on
additional investment risk to promote non-pecuniary objectives or
goals.
Paragraph (d)(1) of the final rule responds to commenters who
objected to what they perceived as the proposal's establishment of
stricter or different rules for self-directed individual account plans
than for all other types of plans. For instance, a number of commenters
on the proposal questioned the relationship between the ``objective-
criteria only'' standard in paragraph (c)(3)(i) of the proposal, and
the ``pecuniary only'' standard in paragraph (c)(1) of the proposal.
The commenters argued that these two standards did not harmonize with
each other, and that their overlay was unnecessarily protective and
would have created ambiguity or possibly even inconsistency. This
concern was generated, in part, by the fact that some of the listed
examples of permissible objective criteria were seen as neither
``objective'' nor pecuniary, according to the commenters. Many
commenters also questioned the accuracy of the list of objective
criteria contained in the paragraph (c)(3)(i) of the proposal, with
some commenters suggesting additions and other commenters suggesting
deletions. A number of commenters also strongly objected to the
objectivity standard on the basis that it disfavors active investment
strategies for self-directed plans, and that the Department should
refrain from interfering in the
[[Page 72864]]
investment marketplace by favoring or disfavoring any particular
investment alternatives or strategies.
In response to these concerns, the final rule omits the
``objective-criteria only'' standard. The Department agrees that this
standard, as structured in the proposal, was perhaps more restrictive
than necessary and potentially confusing as to exactly how it was
intended to relate to other proposed provisions subsequently removed
from the proposal. The Department does not agree with the commenters,
however, to the extent that their comments could be construed as
suggesting that the duty of prudence does not apply to a fiduciary's
selection of designated investment alternatives for investment menus.
Nor does the Department agree that a plan fiduciary need not consider
objective risk-return criteria or need not document the selection and
monitoring processes to comply with ERISA's duty of prudence. Since the
final rule makes it clear that ERISA's duty of prudence (as contained
in paragraph (a) of the final rule) and the pecuniary factor provisions
in paragraph (c) of the final rule apply to the selection of designated
investment alternatives that will be made available to participants and
beneficiaries for investing their individual accounts, it is
unnecessary to retain the ``objective-criteria only'' provisions from
the proposal.
Paragraph (d)(1) of the final rule, moreover, responds to
commenters who raised concerns with the ESG terminology in the
introductory portion of paragraph (c)(3) of the proposal. The objected-
to terminology made reference to investment alternatives ``that include
one or more environmental, social, corporate governance, or similarly
oriented assessments or judgments in their investment mandates, or that
include these parameters in the fund name.'' The principal concern with
this terminology, which operated as the triggering mechanism for the
substantive requirements in paragraphs (c)(3)(i) through (iii) of the
proposal, was that it improperly equated all ESG considerations with
non-financial considerations, according to commenters. Greatly
compounding this concern, according to the commenters, was that this
terminology lacked sufficient clarity and definition to enable
implementation and compliance by fiduciaries as well as the investment
managers they oversee. The final rule does not contain this or similar
terminology in paragraph (d)(1) or elsewhere. This omission makes it
clear that the Department understands that at least some ESG factors,
at times, may also be pecuniary factors.
Paragraph (d)(2) of the final rule reinforces the principles in
paragraph (d)(1) by providing that a fiduciary is not automatically
prohibited from considering or including an investment fund, product,
or model portfolio merely because the fund, product, or model portfolio
promotes, seeks, or supports one or more non-pecuniary goals, provided
that the fiduciary satisfies the requirements of paragraphs (a) and (c)
of this section in selecting any such investment fund, product, or
model portfolio. This provision makes it clear that fiduciaries are
indeed permitted to add, to platforms or menus, designated investment
alternatives that may produce collateral benefits or otherwise are
viewed by some as socially desirable. But, importantly, these
alternatives may be added only if they can be justified solely on the
basis of pecuniary factors. Fiduciaries who choose investments with
expected reduced returns or greater risks to secure non-pecuniary
benefits are in violation of ERISA. Thus, fiduciaries who are
considering investment alternatives for individual account plans should
carefully review the prospectus or other investment disclosures for
statements regarding ESG investment policies and investment approaches.
Fiduciaries should be particularly cautious in exercising their
diligence obligations under ERISA when disclosures, whether in
prospectuses or marketing materials, contain references to non-
pecuniary factors or collateral benefits in a fund's investment
objectives or goals or its principal investment strategies.
With further regard to paragraph (d)(2) of the final rule, many
commenters reported evidence of strong participant preference for
investment alternatives that promote, seek, or support one or more non-
financial goals. These commenters, moreover, suggested a positive
correlation between the in-plan availability of such alternatives and
increased participation and savings rates by participants in plans with
such alternatives. For example, one commenter in the business of
providing financial services cited research finding that 76 percent of
consumers think it important for their employer to apply ESG principles
to workplace benefits, and that 60 percent would likely contribute more
to an ESG-aligned retirement plan if it were certified. Another
commenter cited a 2018 GAO study finding that more than half of the
asset managers interviewed stated that incorporating ESG factors into
retirement plan investment options would help meet participant
expectations and increase participation, especially of younger
investors.\46\ Nothing in the final rule precludes a fiduciary from
looking into certain types of investment alternatives in light of
participant demand for those types of investments. But in deciding
whether to include such investment options on a 401(k)-style menu, the
fiduciary must weigh only pecuniary (as that term is defined in this
rule) factors. Paragraph (d)(2) does not diminish the pecuniary-only
standards in paragraph (c)(1) of the final rule; rather, it applies the
principles in paragraph (c)(1) to the search for and selection of
designated investment alternatives. In addition, participant
preferences of the type discussed in this paragraph also can be
directly relevant to compliance with the tie-breaking provision in
paragraph (c)(2) of the final rule. In such tie-breaker scenarios, plan
fiduciaries may consider the express demands or interests of plan
participants to be consistent with the interests of participants and
beneficiaries for purposes of the documentation requirement in
paragraph (c)(2)(iii) of the final rule.
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\46\ Government Accountability Office Report No. 18-398,
Retirement Plan Investing: Clearer Information on Consideration of
Environmental, Social, and Governance Factors Would Be Helpful
(2018).
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Paragraph (d)(2) of the final rule does not contain the
documentation requirement that existed in paragraph (c)(3)(ii) of the
proposal. That provision of the proposal would have required a
fiduciary to document its compliance with the requirement, in paragraph
(c)(3)(i) of the proposal, to use only objective risk-return criteria
in the selection and monitoring of investment platform or menu
alternatives. Some commenters objected to this requirement on the
grounds that it would have applied more stringent requirements to ESG
investment alternatives than other types of investment alternatives.
These commenters argued that it is inappropriate to impose separate
documentation requirements that vary by investment strategy. Other
commenters objected to this requirement on the grounds that it would
increase costs to plans and potentially provide grounds for unwarranted
class action lawsuits. As discussed above, the final rule does not
contain the ``objectivity'' test from paragraph (c)(3)(i) of the
proposal. Therefore, the final rule similarly omits the related
requirement to document compliance with that test.
Paragraph (d)(2)(ii) of the final rule provides special treatment
for qualified
[[Page 72865]]
default investment alternatives (QDIA or QDIAs) as defined in 29 CFR
2550.404c-5. As was more fully explained in the preamble to the
proposed rule, QDIAs warrant special treatment because they are unique
arrangements under ERISA that help ensure that the retirement savings
of plan participants who have not provided affirmative investment
directions for their individual accounts, e.g., because they may not be
comfortable making such investment decisions, are put into a single
investment capable of meeting the participant's long-term retirement
savings needs. Indeed, the relevant provisions of ERISA and the
Department's implementing regulations encourage plans to offer QDIAs by
providing fiduciaries with relief from liability for investment
outcomes by deeming a participant to have exercised control over assets
in his or her account if, in the absence of investment direction from
the participant, the plan fiduciary invests the assets in a QDIA. Thus,
selection of an investment fund as a QDIA is not analogous to merely
offering participants an additional investment alternative as part of a
prudently constructed lineup of investment alternatives from which
participants may choose.
The proposed rule, in relevant part, therefore provided that even a
prudently selected, well managed, and properly diversified investment
alternative could not be added as, or as a component of, a QDIA if the
investment alternative included ``one or more environmental, social,
corporate governance, or similarly oriented assessments or judgements''
in its ``mandate'' or included those parameters in the fund name. Thus,
paragraph (c)(3)(iii) of the proposal would have banned any alternative
containing this type of mandate from being a QDIA even if it was
selected using only objective risk-return criteria and was otherwise
prudent. This ban was limited to QDIAs and would not have affected an
otherwise compliant alternative from being added to an investment
platform or investment menu.
Many commenters interpreted paragraph (c)(3)(iii) of the proposal
as a ban on any investment alternative serving as a QDIA if the
investment alternative (or any component of the investment alternative)
was constructed using any `E', `S', or `G' factor even if such factor
was pecuniary in nature, (i.e., it has a material effect on the risk
and/or return of the investment based on an appropriate time horizon).
That was not the Department's intention or, in the Department's view, a
reasonable reading of paragraph (c)(3)(iii) of the proposal. The intent
behind that paragraph, rather, was to prohibit an investment
alternative (or any component of the investment alternative) whose
investment objectives or principal strategies included a non-financial
goal from being a QDIA. Investment alternatives falling into this
category often are referred to as ``ESG-themed funds,'' ``impact
funds,'' ``sustainability funds,'' ``social funds,'' ``society-first
funds,'' and so on, according to the commenters.
The foregoing misinterpretation notwithstanding, some commenters
supported a ban on any investment alternative serving as a QDIA if the
investment alternative (or any component of the investment alternative)
was constructed using ESG factors. According to these commenters, ESG
is a vague and contradictory concept, ESG performance is difficult to
measure and does not convey the same information as traditional
performance measures, ESG investments may contain unidentified risks,
many ESG funds do not execute on their stated principles, some ESG
alternatives involve considerations other than purely economic
considerations, and social issues are contentious and will vary across
plan participants. Consequently, these commenters argued that allowing
ESG funds to be included as, or as a component of, a QDIA could
encourage plan participants to hold ESG investments that are either
inappropriate or not consistent with their individual investment goals.
A number of commenters, however, were not supportive of paragraph
(c)(3)(iii) of the proposal. Many commenters believe no special
treatment is needed for QDIAs. If an investment alternative is chosen
based only on pecuniary factors, according to these commenters, the
alternative should be eligible to serve as a QDIA if it otherwise meets
the requirements of the QDIA regulation. These commenters question why
an otherwise compliant investment alternative, constructed only on the
basis of sound pecuniary factors as defined in the proposal, should be
per se ineligible to be a QDIA. Further, commenters were concerned that
the breadth of the proscription in paragraph (c)(3)(iii) of the
proposal, as they understood it, would be extremely disruptive to the
market and that it might inadvertently result in a lack of available
investment alternatives that could qualify as QDIAs, to the detriment
of participants and beneficiaries of ERISA covered plans.
After considering the comments, the final rule limits the scope of
the special rule for QDIAs. Paragraph (d)(2)(ii) of the final rule
expressly provides that in no circumstances may any investment fund,
product, or model portfolio be ``added as, or as a component of, a
qualified default investment alternative described in 29 CFR 2550.404c-
5 if its investment objectives or goals or its principal investment
strategies include, consider, or indicate the use of one or more non-
pecuniary factors.''
Thus, by omitting all references to ``environmental,'' ``social,''
``corporate governance,'' and ``similarly oriented'' assessments and
judgments, paragraph (d)(2)(ii) of the final rule clarifies that the
special rule for QDIAs is not focused on whether an investment
alternative employs or applies any particular `E', `S', or `G' factors
in operation. This omission responds directly to the many commenters
who stated their belief that the proposal's use of these terms
unhelpfully conflated financial and non-financial factors. In place of
these terms, paragraph (d)(2)(ii) of the final rule focuses on whether
the investment alternative includes, considers, or indicates the use of
non-pecuniary factors in its investment objectives or goals or its
principal investment strategies. This refocusing is an acknowledgement
that individual `E', `S', and `G' factors can be both pecuniary and
non-pecuniary in nature, and that the selection of ESG funds is not per
se prudent or imprudent.\47\
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\47\ This acknowledgement does not change the Department's views
expressed on ESG rating systems. See Section 8.e. of this preamble
for further discussion on ESG ratings systems and comments received
on them.
---------------------------------------------------------------------------
Accordingly, paragraph (d)(2)(ii) clarifies that the special rule
for QDIAs only prevents a designated investment alternative, which
otherwise satisfies the requirements in paragraph (d)(1) of the final
rule, from being selected as a QDIA if it, or any of its components,
has investment objectives or goals or principal investment strategies
that include, consider, or indicate the use of one or more non-
pecuniary factors. These circumstances would trigger the ban in
paragraph (d)(2)(ii) of the final rule against a particular designated
investment alternative from being selected as a QDIA, even if the
investment alternative could otherwise permissibly be selected as a
designated investment alternative for the investment platform or
investment menu by fiduciaries only on the basis of pecuniary factors.
In these circumstances, the Department agrees with those commenters
who believe a heightened prophylactic approach for QDIAs is the best
course of action. QDIAs by
[[Page 72866]]
definition exist for participants and beneficiaries who do not actively
direct their investments, and by operation tend to sweep in many
participants and beneficiaries with less investment experience and
sophistication than more active investors, according to the commenters.
ERISA is a statute whose overriding concern relevant here has always
been providing a secure retirement for America's workers and retirees,
and it is inappropriate for participants to be defaulted into a
retirement savings fund that may have other objectives absent their
affirmative decision. This is especially true if the default investment
alternative, or any of its components, has investment objectives or
principal strategies that reflect one or more non-pecuniary factors.
The use of non-pecuniary factors, even if co-existing with financially-
oriented strategies or goals, raise questions as to the extent to which
the QDIA's managers may be forgoing financial returns in pursuit of
non-financial objectives.
The test in paragraph (d)(2)(ii) of the final rule can be applied
objectively without difficulty. A plan fiduciary, for instance, can
simply look at the investment fund's prospectus to determine whether
the fund is subject to the prohibition on its use as a QDIA or as a
component investment of a QDIA. Under the Investment Company Act of
1940, as amended,\48\ investment companies and their managers have
routinely dealt with the concepts underpinning the provisions in
paragraph (d)(2)(ii) of the final rule, i.e., providing disclosure on
an investment alternative's ``investment objectives'' and ``principal
investment strategies.'' Under Form N-1A,\49\ for example, to the
extent that non-pecuniary considerations form a material part of a
fund's investment objective or principal strategies, these factors
would need to be disclosed accordingly in the fund's prospectus. For
example, if the prospectus or similar disclosure states that the fund
(or any component) is constructed using an ESG or sustainability rating
system or index, and that ratings system or index evaluates one or more
factors that are not financially material to investments (i.e.,
evaluates non-pecuniary factors), then paragraph (d)(2)(ii) of the
final rule would prohibit such fund from being used as a default
investment alternative.\50\ The Department understands that the final
rule applies to investment alternatives other than registered
investment companies, such as bank collective investment trusts and
insurance company separate accounts. However, these vehicles typically
adhere to similar rules and maintain operating documents comparable to
a prospectus.
---------------------------------------------------------------------------
\48\ 17 CFR 270.0-1 through 270.60a-1.
\49\ Referenced at 17 CFR 239.15A and 274.11A. See, e.g., Item 2
and Item 4 of Part of Form N-1A.
\50\ See Section 8.e. below, which further discusses ESG and
similar rating systems and indexes.
---------------------------------------------------------------------------
Paragraph (d)(2)(ii) of the final rule also responds to concerns
with so-called ``screening strategies,'' which include, for example,
the act of excluding from a fund certain sectors or companies involved
in activities deemed unacceptable or controversial, such as screens or
exclusions on investments in companies engaged in the production or
distribution, for example, of alcohol, tobacco, fossil fuels, weapons,
or gaming. Other screening strategies will only select sectors or
companies that satisfy certain attributes, such as carbon emissions,
board diversity, or employee compensation. Screening strategies,
regardless of whether they are characterized or described as ``positive
screening'' or ``negative screening,'' may implicate paragraph
(d)(2)(ii) of the final rule if the screening involves non-pecuniary
factors that effectively results in the exclusion of certain sectors or
categories of investments. Investment alternatives that use these
exclusions may not be QDIAs (or components of QDIAs) if these
exclusions involve non-pecuniary goals and are reflected in the
investment alternatives' objectives or goals or its principal
investment strategies. This is because such an exclusion in an
investment alternative's objectives or principal strategies raises
questions as to the extent to which the QDIA's manager may be foregoing
financial returns in pursuit of non-financial objectives.
If these exclusions are not reflected in an investment
alternative's objectives or principal strategies, however, the
alternative is not prohibited as a QDIA (or a component). It must be
prudently selected as required by paragraph (a) of the final rule, and
comply with paragraph (c) of the final rule and the Department's QDIA
regulation. ERISA's duty of prudence dictates that before a fiduciary
of an ERISA covered pension plan can make a decision to exclude a
category of investments for non-pecuniary purposes, the fiduciary must
first make a determination that the exclusion of such category of
investments would not reduce the return or increase the risk of the
plan's investment portfolio. An investment policy or strategy that is
exclusionary runs the risk of being imprudent because, if the decision
results in the exclusion, for example, of certain sectors or markets,
without first doing an economic analysis of the economic consequences
to the plan of such an exclusion and determining that such an
exclusionary policy would not be economically harmful to the plan, the
fiduciary making such a decision would be imprudent under ERISA.\51\
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\51\ See Letter to Sen. Howard Metzenbaum from Dennis Kass (May
27, 1986) (defending statement in press that ``an investment policy
that is on its face exclusionary runs the risk of being on its face
imprudent'' and explaining that ``before a fiduciary of an ERISA
covered pension plan can make a decision to exclude a category of
investments for social purposes, the fiduciary must first make a
determination that the exclusion of such category of investments
would not reduce the return or raise the risk of the plan's
investment portfolio. If such a determination can be made, then
social judgments as to the composition of the portfolio would be
permissible.'').
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Finally, a commenter stated that, although paragraph (c)(3) of the
proposal helpfully clarifies that ERISA's duties of loyalty and
prudence apply to ``designated investment alternatives,'' the final
regulation should further clarify that these statutory duties (and,
hence, the requirements of the final rule) do not apply more broadly to
other investment alternatives that may be available through the plan.
For instance, some participant-directed individual account plans
contain brokerage windows, self-directed brokerage accounts, or similar
plan arrangements that enable participants and beneficiaries to select
investments beyond those designated by the plan. The commenter appears
to have had these arrangements in mind and specifically requested that
the final rule define the term ``designated investment alternative'' so
as to exclude investments of this type from the requirements of the
rule.
In response to this commenter, the final regulation defines the
term ``designated investment alternative'' for purposes of paragraph
(d) of the final rule. Specifically, paragraph (e)(5) of the final rule
defines this term as ``any investment alternative designated by the
plan into which participants and beneficiaries may direct the
investment of assets held in, or contributed to, their individual
accounts.'' Thus, whether an investment alternative is a ``designated
investment alternative'' for purposes of the regulation depends on
whether it is specifically identified as available under the plan. This
necessarily is a fact driven analysis. Further, the definition
specifically clarifies that the term does not include ``brokerage
windows,'' ``self-directed brokerage accounts,'' or similar plan
arrangements that enable participants and beneficiaries to select
investments beyond those designated by
[[Page 72867]]
the plan. The inclusion of this definition in the final rule also
obviates the need for explicit references in the operative regulatory
text to ``platforms,'' which appeared in the proposal essentially as a
synonym for menus of designated investment alternatives.
Consequently, this regulation does not apply to investment
alternatives that are not designated investment alternatives under the
plan. The Department in other contexts has made it clear, however, that
ERISA's duties of loyalty and prudence do not contain exceptions for
circumstances in which plans with brokerage windows, self-directed
brokerage accounts, or similar plan arrangements enable participants
and beneficiaries to select investments beyond those designated by the
plan. For instance, in addressing questions under 29 CFR 2550.404a-5 (a
disclosure regulation focusing on fees in 401(k)-type plans) in the
case of participant-directed individual account plans that do not
designate any of the funds on the platform or available through the
brokerage window, self-directed brokerage account, or similar plan
arrangement as ``designated investment alternatives'' under the plan,
the Department stated that fiduciaries ``are still bound by ERISA
section 404(a)'s statutory duties of prudence and loyalty to
participants and beneficiaries who use the platform or the brokerage
window, self-directed brokerage account, or similar plan arrangement,
including taking into account the nature and quality of services
provided in connection with the brokerage window, self-directed
brokerage account, or similar plan arrangement.'' \52\ In this same
context, the Department also stated that a plan fiduciary's failure to
designate investment alternatives, for example, to avoid the standards
and obligations under ERISA or implementing regulations raises
questions under ERISA section 404(a)'s general statutory fiduciary
duties of prudence and loyalty.\53\ The Department has also stated in
the context of the 404(c) regulation that the relief from fiduciary
liability for participant or beneficiary exercises of control over
their individual accounts does not extend to any instruction, which if
implemented (A) would not be in accordance with the documents and
instruments governing the plan insofar as such documents and
instruments are consistent with the provisions of title I of ERISA; (B)
would cause a fiduciary to maintain the indicia of ownership of any
assets of the plan outside the jurisdiction of the district courts of
the United States other than as permitted by section 404(b) of the Act
and 29 CFR 2550.404b-1; (C) would jeopardize the plan's tax qualified
status under the Internal Revenue Code; or (D) could result in a loss
in excess of a participant's or beneficiary's account balance.
Similarly, relief from fiduciary liability under the 404(c) regulation
would not extend to: (1) The implementation of instructions which would
result in a direct or indirect sale, exchange, or lease of property
between a plan sponsor or any affiliate of the sponsor and the plan
except for the acquisition or disposition of any interest in a fund,
subfund, or portfolio managed by a plan sponsor or an affiliate of the
sponsor, or the purchase or sale of any qualifying employer security
(as defined in section 407(d)(5) of the Act) which meets the conditions
of section 408(e) of ERISA and 29 CFR 2550.404c-1(d)(2)(ii)(E)(4); (2)
a loan or extension of credit to a plan sponsor or any affiliate of the
sponsor; or (3) the acquisition or sale of any employer real property
(as defined in section 407(d)(2) of the Act).\54\ The Department has
not addressed in these other contexts whether, or under what
circumstances, the duties of prudence or loyalty compel a fiduciary to
disregard or overrule a participant's or beneficiary's affirmative
selection of a particular investment or investments through a brokerage
window or similar arrangement, and these matters similarly are not
addressed here. Accordingly, nothing in this regulation should be
construed as addressing the application of ERISA's duties of prudence
and loyalty to such investments or to the particular investment options
(e.g., brokerage windows) that grant participants and beneficiaries
access to investments that are not designated investment alternatives.
Although the Department has determined that the establishment of
regulatory standards governing such arrangements is beyond the scope of
this particular regulation, this issue could be addressed in future
rulemaking or sub-regulatory guidance if necessary. The Department,
therefore, is available as necessary to engage in discussions with
interested parties to help determine how best to assure compliance with
these duties in a practical and cost effective manner.
---------------------------------------------------------------------------
\52\ Field Assistance Bulletin 2012-02R, Q&A 39 (July 30, 2012).
\53\ Id. at Q&A 39.
\54\ See 29 CFR 2550.404c-1(d)(2) (imposing limits on the relief
otherwise available to plan fiduciaries in the case of implementing
improper investment instructions of participants and beneficiaries).
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5. Section 2550.404a-1(e)--Reserved
Paragraph (e) is reserved for the operative text, if finalized, of
the rulemaking on proxy voting and exercise of shareholder rights.
6. Section 2550.404a-1(f)--Definitions
Paragraph (f) of the final rule provides definitions and is largely
unchanged from the proposal.
The term ``investment duties'' in the proposal was unchanged from
the current 404a-1 regulation. It was defined to mean any duties
imposed upon, or assumed or undertaken by, a person in connection with
the investment of plan assets which make or will make such person a
fiduciary of an employee benefit plan or which are performed by such
person as a fiduciary of an employee benefit plan as defined in section
3(21)(A)(i) or (ii) of the Act. The term ``investment course of
action'' is amended from the current 404a-1 regulation to mean any
series or program of investments or actions related to a fiduciary's
performance of the fiduciary's investment duties, and the selection of
an investment fund as a plan investment, and now includes the selection
of an investment fund as a plan investment, or in the case of an
individual account plan, a designated alternative under the plan, as
part of this term. One commenter noted that neither the definition of
``investment duties'' nor the definition of ``investment course of
action'' expressly included the notion of stewardship activity and
argued that the allocation of resources to voting, engagement, and
related activity should be treated as an ``action related to'' the
investment of plan assets. The commenter expressed that the focus on
investment is less on the risks and returns of individual holdings and
more on addressing systemic or ``beta'' issues such as climate change
and corruption where outcomes are prioritized at the economy or
society-wide scale with long-term, absolute returns for universal
owners, including real-term financial and welfare outcomes for
beneficiaries.
The Department does not see how it is possible for the stewardship
approach advocated by the commenters to be justified, given the
requirements of prudence and loyalty under ERISA. As the Department has
stated, it does not ineluctably follow from the fact that an investment
promotes ESG factors, or that it arguably promotes positive general
market trends or industry growth, that the investment is a prudent
choice for retirement investors. Rather, ERISA fiduciaries must always
put first the economic interests of the plan in
[[Page 72868]]
providing retirement benefits. A fiduciary's evaluation of the
economics of an investment should be focused on financial factors that
have a material effect on the return and risk of an investment based on
appropriate investment horizons consistent with the plan's articulated
funding and investment objectives.\55\ Accordingly, as noted above,
paragraphs (f)(1) and (2) of the final rule are the same as the
language of the proposal.
---------------------------------------------------------------------------
\55\ See Field Assistance Bulletin 2018-01 (Apr. 23, 2018).
---------------------------------------------------------------------------
The term ``pecuniary factor'' was a new definition in the proposal.
The proposal defined it as a factor that has a material effect on the
risk and/or return of an investment based on appropriate investment
horizons consistent with the plan's investment objectives and the
funding policy established pursuant to section 402(a)(1) of ERISA. Many
commenters urged the Department to re-examine the definition of
``pecuniary factor.'' The Department's discussion of those comments is
included in the section of this preamble that addresses paragraph
(c)(1) above.
Finally, the term ``plan'' was unchanged from the current 404a-1
regulation. It was defined in the proposal to mean an employee benefit
plan to which Title I of ERISA applies. Although not commenting
specifically on the proposal, some commenters raised issues regarding
the consequences for plans maintained for their employees by states,
political subdivisions of states, and the agencies or instrumentalities
of either. Section 4(b)(1) of ERISA excludes from coverage under ERISA
all such governmental plans. Accordingly, issues regarding the
investment practices of such plans or the duties of persons who may be
fiduciaries with respect to such plans are outside the scope of both
the Department's jurisdiction under Title I of ERISA and this
regulation.
Some commenters suggested that the Department define ``ESG,'' ``ESG
vehicle,'' ``ESG consideration,'' or any other similar term, and
``environmental,'' ``social,'' or ``corporate governance,'' or give
guidance on what might be ``similarly oriented assessments or
judgments.'' These commenters argued that without an ESG definition,
fiduciaries would be left in the undesirable position of being unable
to determine exactly what the Department seeks to regulate and the
scope of that regulation, opening the door to expensive litigation that
seeks to exploit those ambiguities. Other commenters stated that a
definitive list of ESG issues does not exist and that it would not be
possible or desirable to produce a list or set of definitions, and any
attempt at such list or definition would soon be outdated in any event.
The same commenter said a definition of ESG was needed so that
fiduciaries would know whether the Department intends for ``ESG'' to
apply narrowly, such as with respect to only those investment
alternatives that prominently call themselves ``ESG,'' or if the
Department intended to sweep in a much broader set of investment
alternatives under ``ESG,'' because the resulting impact, burden,
expense, and collateral consequences of the proposed amendments could
significantly differ. As described earlier in this preamble, the
Department has concluded, based on the comments, that the use of ESG
terminology is not appropriate for a regulatory standard precisely
because of the ambiguity and lack of precision that exists in the use
of ESG in the marketplace. Since the Department has removed ESG
terminology from the operative text of the final rule, inclusion of the
sort of definitions requested by commenters is no longer necessary.
7. Section 2550.404a-1(g) and (h)--Effective Date and Severability
The proposal included a provision under which the effective date
for the rule would be a date 60 days after the date of the publication
of the final rule. The Department requested comment in the proposal,
including whether any transition or applicability date provisions
should be added to any of the proposed provisions. Some commenters
suggested that a grandfather provision of existing investments be
adopted to avoid market disruption, including forced sales at sub-
optimal prices. Other commenters said grandfathering is necessary not
only because fiduciaries will be unable to comply retrospectively with
prescriptive requirements, but also to avoid the wide-ranging economic
harms that could follow a sudden investment mandate. The commenters
suggested that, at a minimum, the provisions of the final rule would
not apply to investments made on or prior to the effective date of any
final regulation. In the alternative, the commenters requested that the
Department permit those investments that have been made on or preceding
such effective date not to become subject to the provisions of any
final rule for a period of one year following such effective date.
Other commenters suggested that this period of transition and
grandfathering be generous. Other commenters suggested that the
Department allow plan fiduciaries adequate time to prepare the
documentation and analysis required by the proposal to identify,
assess, and consider alternative investment options in accordance with
the proposal. These commenters believed the proposal greatly
underestimated the time required for plan fiduciaries to consider and
implement the new framework. As a result, they suggested that plan
fiduciaries should be afforded at least 12 months before the rule
becomes effective to mitigate hastened decision-making and potential
financial losses resulting from modifying investment strategies that
may inadvertently harm plan participants in the current volatile and
uncertain market environment. Finally, a commenter suggested that due
to COVID-19 and its financial fallout, the effective date should be
delayed by at least a year to allow time for compliance.
The same principles of prudence and loyalty under section
404(a)(1)(A) and (B) of ERISA are on display in the proposal and final
rule as have been applied in all the previous guidance on ESG investing
and investing in general by the Department since the investment duties
regulation was published in 1979. Indeed, since the 1980s the
Department has stated that a fiduciary in its decision-making,
regarding investments or otherwise, cannot subordinate the interests of
the participants and beneficiaries in their retirement income or
financial benefits under the plan to unrelated objectives. Following
consideration of the public comments, the Department is not persuaded
that there is sound reason to delay the anticipated benefits and
protections to plan participants and beneficiaries of this rule. As the
Department has previously stated, the final rule, including changes
from the proposal, primarily explains existing statutory requirements
and regulations with respect to the investment duties of plan
fiduciaries and is not a major departure from its previous guidance on
the basic investment duties of fiduciaries. Thus, the Department does
not believe an overall delay in the applicability of the final rule is
necessary to allow additional time for plans to prepare for the
significantly scaled-back investment documentation requirements of the
final rule.
However, the Department acknowledges that some plans may have to
make adjustments to their investment policies and practices in light of
the final rule. As a result, paragraph (g)(1) of the final rule
provides that the effective date of the new regulatory text in the
final rule will be 60 days following the date of publication in the
Federal Register and shall apply
[[Page 72869]]
prospectively in its entirety to investments made and investment
courses of action taken after such date. Plan fiduciaries are not
required to divest or cease any existing investment, investment course
of action, or designated investment alternative, even if originally
selected using non-pecuniary factors in a manner prohibited by the
final rule; however, after the effective date, all decisions regarding
such investments, investment courses of action, or designated
investment alternatives, including decisions that are part of a
fiduciary's ongoing monitoring requirements, must comply with the final
rule.\56\ Also, although the Department believes that much of the final
rule explains pre-existing duties under the statute, the Department of
course will not pursue enforcement, and does not believe any private
action would be viable, pertaining to any action taken or decision made
with respect to an investment or investment course of action by a plan
fiduciary prior to the effective date of the final rule to the extent
that any such enforcement action would necessarily rely on citation to
this final rule. Of course, nothing in this regulation forecloses the
Department from taking enforcement action based on prior conduct that
violated ERISA's provisions, including the statutory duties of prudence
and loyalty, based on the statutory and regulatory standards in effect
at the time of the violation.
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\56\ Tibble v. Edison Int'l, 135 S. Ct. 1823, 1828-29 (2015),
confirmed that ERISA fiduciaries have a continuing duty--separate
and apart from the duty to exercise prudence in selecting
investments at the outset--to monitor, and remove imprudent, trust
investments. How that monitoring obligation would be applied in the
context of the final rule's application to individual investments
would depend on the facts and circumstances. When and what kind of
review would depend on the facts and circumstances. ERISA
fiduciaries must discharge their fiduciary responsibilities ``with
the care, skill, prudence, and diligence'' that a prudent person
``acting in a like capacity and familiar with such matters'' would
use. ERISA section 404(a)(1). The Department notes that it may be
that a fiduciary could prudently determine that the expected return
balanced against the costs and risks of loss associated with
divesting an investment made before the effective date of the rule
are such that continuing to hold that investment would be
appropriate even if the fiduciary as part of its monitoring process
determined that the investment, or aspects of the decision-making
process, does not comply with the final rule.
---------------------------------------------------------------------------
The final rule does include one extended compliance date; new
paragraph (g)(2) provides that plans shall have until April 30, 2022 to
make any changes to qualified default investment alternatives described
in 29 CFR 2550.404c-5, where necessary to comply with the requirements
of paragraph (d)(2). Unlike other provisions of the final rule, which
apply only to prospective investment decisions, paragraph (d)(2)
prohibits certain designated investment alternatives from being used as
a QDIA where the investment objectives or goals or the principal
investment strategies include, consider, or indicate the use of one or
more non-pecuniary factors. Although the Department believes the
paragraph (d)(2), as modified from the proposal, will only affect a
very small number of plans,\57\ the Department recognizes that those
plans will need appropriate time to modify their QDIA selections.
Therefore, in response to a commenter's requests for at least a 12
month transition period, the Department is providing a QDIA compliance
date of April 30, 2022.
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\57\ In the Regulatory Impact Analysis, the Department estimates
that only 0.1 percent of plans may have an affected QDIA.
---------------------------------------------------------------------------
Moreover, EBSA confirms that until January 12, 2021, the prior
404a-1 regulation under the Act (as it appeared in the July 1, 2020,
edition of 29 CFR part 2550) applies.
The final rule also includes, in paragraph (h), a severability
provision, which provides that if any provision in the final rule is
found to be invalid or unenforceable by its terms, or as applied to any
person or circumstance, or stayed pending further agency action, such
provision shall be severable and the remaining portions of the rule
would remain operative and available to plan administrators. Thus, if a
Federal court were to find a specific provision to be legally
insufficient, then the remaining requirements would remain applicable
and in place.
8. Miscellaneous Issues and Public Comments
a. Religious Freedom Restoration Act
One commenter argued that the proposal violates the Religious
Freedom Restoration Act (RFRA). The commenter averred that the proposal
is a burden on religion and is contrary to RFRA because, in the
commenter's view, it prohibits the inclusion of investment options in
defined contribution plans for retirement savers whose beliefs and
values dictate that they take material environmental and societal
effects of corporate activities into consideration in stewardship of
their worldly riches. As a result, many people of faith would be forced
to support economic activity that violates their beliefs. By singling
out ESG investment options as raising ``heightened concerns under
ERISA'' whenever an option ambiguously might involve ``one or more
environmental, social, and corporate governance-oriented assessments or
judgments,'' despite the availability of numerous prudently managed and
outperforming ESG investment options for ERISA pension plans, the
proposal would have the practical effect of unnecessarily limiting
access by people of faith to prudent pension investment options aligned
with their religious beliefs, according to this commenter. The
commenter asserted that RFRA provides an exception only if two
conditions are met, that the restriction must be in furtherance of a
compelling government interest and the rule must be the least
restrictive way in which the government can further its interest, and
the proposal does not meet those conditions. Other commenters also
suggested that the proposal's interference with the investment
preferences of retirement investors potentially would constitute a
violation of their First Amendment rights, though they did not explain
whether they were referring to the Free Exercise Clause or the Free
Speech Clause.
A commenter also explained that some funds, not marketed as ESG
funds, exclude ``sin'' stocks, such as alcohol and tobacco. Typically,
these restrictions are not part of the investment objectives or
strategy and do not impact the fund's ability to find suitable
investments, according to the commenter. The commenter suggested that
the proposed rule's broad definition of ESG would sweep in many such
funds and subject them to heightened fiduciary scrutiny. According to
the commenter, such restrictions, dating back to the 1950s,
qualitatively differ from those embraced by the emerging universe of
ESG funds. Faith-based organizations operating under Title I (e.g.,
ERISA-electing church plans) use such funds and use faith-based filters
to eliminate certain categories. According to the commenter, these are
founded on the concern of discouraging plan participation if the only
investment options available to participants with strong religious
convictions permitted investments relating to alcohol or tobacco. These
restrictions may also fairly be viewed by some as relevant to an
analysis about the likely long-term value of an issuer deriving the
majority of revenue from products whose continued use could be impacted
by societal changes, according to this commenter.
The Department is committed to fulfilling its obligations under
RFRA and respecting religious liberty. The Department is confident that
the RFRA concerns raised by the commenter can be reviewed and resolved
as needed on an individual basis. While broader discussion and
resolution of RFRA-
[[Page 72870]]
related issues can be appropriate in rulemaking, especially when they
are a prominent aspect of the rulemaking, see Little Sisters of the
Poor Saints Peter & Paul Home v. Pennsylvania, 140 S. Ct. 2367, 2383-84
(2020), the Department believes that it need not conduct a broadly
applicable RFRA analysis in this particular rule, which does not have
religious concerns as a central focus. If RFRA's interaction with this
final rule reveals over time that a broader project is warranted, the
Department will consider doing so.
Moreover, the Department believes that changes made in the final
rule, including significant changes to specific conditions related to
use of ESG considerations, may provide enough flexibility to
sufficiently address the commenters' concerns, even without invocation
of RFRA. Further, paragraph (d)(2) of the final rule permits a
prudently selected ESG-themed investment alternative, which complies
with paragraphs (a) and (c) of the final rule, to be added to the
available investment options on a participant-directed individual
account plan platform without requiring the plan to forego adding other
non-ESG-themed investment options to the platform. Paragraph (d)(2)
applies equally to an investment fund, product, or model portfolio that
promotes, seeks, or supports participant preferences regarding
religion. In addition, paragraph (d)(2)(ii) of the final rule does not
prevent a negatively screened fund from being selected as a QDIA if no
non-pecuniary factors are reflected in its investment objectives or
principal strategies.
b. Coordination With Other Federal Laws and Policies
A number of commenters suggested that the Department's action is
untimely, and might redirect or stall the continuing development of ESG
practice at a time when the SEC continues to monitor and evaluate ESG
developments, with a clear focus on disclosure and accuracy. For
example, several commenters noted that the proposal appeared to reflect
concerns with the marketing of investment strategies that use ESG
criteria. These concerns, commenters suggested, may be addressed by the
SEC, which recently solicited public comment on a number of issues
(including use of the term ``ESG'' in a fund name) under the ``Names
Rule'' under the Investment Company Act of 1940.\58\ Other commenters
believed that the proposal's characterization of the materiality of ESG
criteria was potentially out of step with the SEC, which has noted the
importance of disclosing ESG factors to the extent that they are
material. A commenter indicated that risk disclosure is fundamental to
protecting investors. The commenter criticized the proposal for
cautioning fiduciaries to scrutinize fund risk disclosures when
evaluating the impact of ESG considerations, and suggested that any
additional risk added by ESG considerations is unacceptable regardless
of the reason for the risk or the effect on returns. The commenter
explained that ESG considerations are used in a variety of ways in fund
portfolios--some pecuniary in nature and others solely as an incidental
component of the fund's investment strategy. Further, the comment
indicated that when funds take ESG considerations into account, they
are pursuing an investment strategy. Each strategy is different, and
will perform differently with different risks. In the commenter's
opinion, if the ESG consideration is used to enhance the overall value
of the investment, and the risk and return are appropriately balanced,
then the fact that the risks are ``different'' should not be the focus
of the analysis. The commenter concluded that the Department's focus
instead should be on risk disclosures that suggest the fund is
sacrificing investment returns or assuming greater investment risk as a
means to promote collateral social policy goals.
---------------------------------------------------------------------------
\58\ 85 FR 13221 (Mar. 6, 2020).
---------------------------------------------------------------------------
Another commenter indicated that some ESG issues pose systemic
risks to financial markets, which the US financial regulatory community
is beginning to examine. A commenter also suggested that the proposal
might have the unintended consequence of concentrating investment in
securities and products that may or may not bear less risk and greater
return in the future, relying on mechanical use of financial data from
one reporting source rather than employing human judgment and prudence.
The commenter cautioned that this concentration will pose systemic
financial risk and is something the Office of Financial Research (OFR)
is tracking and seeking to minimize. The commenter suggested that the
OFR should be consulted on any sweeping new ERISA rule that might cause
herding and market concentration.
With respect to the Names Rule, the Department does not believe
there is a need to delay a final rule until the SEC decides whether to
take action as a result of its solicitation. Although disclosures may
be helpful to fiduciaries in evaluating investment funds, the primary
goal of the proposed and final rule is to provide, in the form of a
final rule, guidance on the scope of fiduciary duties surrounding non-
pecuniary issues. However, the Department will continue to monitor SEC
activity, and consider providing further guidance as may be
appropriate. With respect to the other comments, the Department
believes that changes made in the final rule, including a focus on
pecuniary factors rather than ESG factors, are sufficient to address
the stated concerns. As to the comments regarding ESG disclosure, the
Department has clarified that they apply to circumstances where
prospectuses or marketing materials discuss non-pecuniary objectives or
benefits. We note that the Department's concerns under ERISA, and the
policies underlying this final rule, are focused on safeguarding the
interests of participants and beneficiaries in their plan benefits. If
financial regulators adopt new rules or policies that affect financial
market participants, that may create pecuniary or non-pecuniary
considerations for plan fiduciaries apart from ERISA.
Commenters noted that the Department of State, Department of the
Treasury, Department of Commerce, and Department of Homeland Security
have taken positions on risks of supply chain links to entities that
engage in human rights abuses, including forced labor, in China. They
argued that the Department should not issue a rule that fundamentally
undermines policy from four other Departments and should ensure that
pension fiduciaries are not discouraged from making the appropriate
calculations about supply chain risks. Further, commenters criticized
that the proposal conflicts with the Department's own statements
regarding the need to divest the Federal Thrift Savings Plan (TSP) from
investments in China due to increased risk. The Department believes the
concerns expressed by these commenters are beyond the scope of issues
being addressed by the final rule, which is limited to the investment
duties of fiduciaries under Title I of ERISA. Nonetheless, if a
fiduciary prudently determines that an investment is appropriate based
solely on pecuniary considerations, including those that may derive
from ESG factors, the fiduciary may make the investment without regard
to any collateral benefits. Accordingly, the Department does not agree
that there is any fundamental conflict between the positions other
agencies have articulated on supply chain risk, and this final rule.
Nothing in the final rule is intended to or does prevent a fiduciary
from appropriately
[[Page 72871]]
considering any material risk with respect to an investment. Moreover,
with respect to the TSP, which is not covered by Title I of ERISA, we
note that the Department's position with respect to investments in
China was informed by consideration of specific matters relating to
investment risk, including inadequate investor disclosures and legal
protections, that are consistent with ``pecuniary factors'' as used in
the final rule. We note that matters relating to investments in China
continue to be examined by other Federal agencies.\59\ Moreover, other
concerns were raised because the Federal Government matches TSP
contributions and investments in China might result in the Federal
Government funding activities that are opposed to U.S. national
security interests.
---------------------------------------------------------------------------
\59\ See, e.g., Statement on SEC Response to the Report of the
President's Working Group on Financial Markets (Aug. 10, 2020),
www.sec.gov/news/public-statement/statement-presidents-working-group-financial-markets.
---------------------------------------------------------------------------
One commenter claimed that the DOL's failure to consult with the
Fish and Wildlife Service and the National Marine Fisheries Service
regarding the proposed rule's impacts upon endangered species violates
the Endangered Species Act (ESA), and the DOL's failure to assess the
proposed rule's environmental impacts violates the National
Environmental Policy Act (NEPA). The Department has reviewed the
relevant legal provisions of the ESA and NEPA and concludes neither
statute is implicated by the rule. In addition, the final rule's
operative language does not expressly address ESG investments, but
rather centers on the fiduciary duty to focus plan investment decisions
on pecuniary factors only, a duty arising from ERISA and confirmed in
the case law. The Department believes this change further renders the
final rule beyond the scope of either ESA or NEPA, and any accompanying
consultation or assessment requirements.
c. Comparison of Proposal to International Standards and Practices
Commenters also asserted that the Department's proposal is against
an international trend in the consideration of ESG factors. Other
regulators, they argued, are requiring consideration of financially
material ESG factors and focusing on the importance of the disclosure
of those factors. European regulators have imposed rules, effective
March 10, 2021, that require investment managers governed by the
regulations to incorporate financially material ESG factors into the
investment process. Another commenter contended that across the world's
50 largest economies, there have been more than 730 hard and soft law
policy revisions across some 500 policy instruments, which support,
encourage, or require investors to consider long-term value drivers,
including ESG factors. To the extent that these foreign standards
condone sacrificing returns to consider non-pecuniary objectives, they
are inconsistent with the fiduciary obligations imposed by ERISA.
According to this commenter, of these top 50 economies, 48 have some
form of policy designed to help investors consider sustainability
risks, opportunities, or outcomes. The Department believes that
assertions by these commenters do not fairly characterize the
statements the Department made in the proposal. The final rule does not
preclude consideration of any factor that is financially material to an
investment or investment course of action. In addition, a few comments
cited statements supporting non-financial investment considerations,
thereby confirming the need for the Department to clarify ERISA
fiduciary duties in the face of investment practices that stray from
pecuniary considerations. Moreover, the final rule reflects ERISA's
requirements, and commenters acknowledged that the duties of prudence
and loyalty under ERISA may not be the same investment standards under
which international regulation is taking place. Accordingly,
international trends in the consideration of ESG factors or the actions
of regulators in other countries are not an appropriate gauge for
evaluating ERISA's requirements as they apply to investments of ERISA-
covered employee benefit plans.
d. Proxy Voting
Commenters expressed concern that the proposal does not directly
mention proxy voting or corporate stewardship and argue that any
treatment of ESG investment practices should include those topics.
Those issues technically are outside of the scope of this rulemaking.
On September 4, 2020, the Department published a proposed amendment to
the investment duties regulation to address the application of the
prudence and exclusive purpose duties to the exercise of shareholder
rights, including proxy voting, the use of written proxy voting
policies and guidelines, and the selection and monitoring of proxy
advisory firms.\60\
---------------------------------------------------------------------------
\60\ 85 FR 55219 (Sept. 4, 2020).
---------------------------------------------------------------------------
e. ESG Rating Systems and ESG Indices
Some commenters were concerned that the Department's expressed
skepticism about ESG rating systems and its assertion that ``[t]here is
no consensus about what constitutes a genuine ESG investment, and ESG
rating systems are often vague and inconsistent,'' is unfair. They also
challenged the Department's observation that ``fiduciaries should also
be skeptical of `ESG rating systems'--or any other rating system that
seeks to measure, in whole or in part, the potential of an investment
to achieve non-pecuniary goals--as a tool to select designated
investment alternatives, or investments more generally.'' Such
cautions, the commenters assert, cast a pall on the use of ESG ratings
and substitute the judgment of the Department for that of plan
fiduciaries who may find one or more of these ratings an appropriate
investment tool. However, one commenter submitted materials describing
sustainability ratings as ``black boxes'' in which ratings providers
publish only a general description of their approaches; to the extent
that any more detailed information is available, it is provided only to
subscribers.
Another commenter stated that manufacturing companies often face
calls from third-party actors (who do not have a stake in the business
or any interest in shareholders' long-term returns) to address ESG
issues in a one-size-fits-all way that meets only the political needs
of outside activists. In recent years, the commenter argued, this
pressure has been driven in large part by ESG ratings firms that have a
financial interest in ensuring more widespread adoption of non-
pecuniary ESG investing criteria. The commenter complained that these
firms operate by boiling down a complex issue (or, often, multiple
complex issues) into a single numerical score or letter grade with
little to no disclosure as to how such score or grade is calculated,
nor its impact on shareholder value creation. These one-size-fits-all
standards do not take into account the individual circumstances of a
given company or provide any context for a company's ESG work outside
of the check-the-box approach favored by the ratings firms.
Furthermore, the commenter avers, it is often unclear to issuers and
investors alike exactly what data went into calculating a given rating.
This commenter stated that pension plan managers making investment
decisions based on these ratings are staking plan participants'
retirement savings on the opinions of unregulated, nontransparent
[[Page 72872]]
entities that have no obligation to make decisions in pensioners' best
interests. The commenter has called for the Securities and Exchange
Commission to provide effective oversight of ESG raters and strongly
supports the DOL's guidance that ERISA fiduciaries should be
``skeptical'' of ESG ratings systems. Similarly, the commenter
appreciated that the proposed rule highlights the fact that ESG ratings
firms ``typically emphasize tick-the-box policies and disclosure
levels, data points unrelated to investment performance, and/or
backward-looking negative events with little predictive power.''
In footnote 24 of the proposal, the Department stated that
fiduciaries should be skeptical of ESG rating systems--or any other
rating system that seeks to measure, in whole or in part, the potential
of an investment to achieve non-pecuniary goals--as a tool to select
designated investment alternatives, or investments more generally. The
Department has not changed its views as to the need for fiduciaries to
carefully examine ESG rating systems before relying on them to make
investment decisions. The Department notes that an ERISA plan fiduciary
should evaluate any rating system with care, skill, prudence, and
diligence in order to determine that the rating system appropriately
considers only pecuniary factors if such rating system is used to
evaluate an investment.
Skepticism of ESG or sustainability rating systems is warranted
under ERISA because such ratings systems may involve the evaluation of
non-pecuniary factors. While individual `E', `S', or `G' factors
evaluated by a ratings provider may be a pecuniary factor for a
particular investment or investment course of action it does not follow
that all factors under the ESG rubric are pecuniary for all
investments. And because ESG factors are so disparate--and often
idiosyncratic--a fiduciary may not assume that combining them into a
single rating, index, or score creates an amalgamated factor that is
itself pecuniary. If ESG or sustainability rating systems are to be
used, a fiduciary should conduct appropriate due diligence to
understand how the ratings are determined, for example methodology,
weighting, data sources, and the underlying assumptions used by such
rating systems. Similarly, in selecting an investment fund that follows
an ESG index, a fiduciary should also conduct appropriate due diligence
and understand the ESG index objective, how the ESG index is
constructed and maintained, its performance benchmarks, and how the
factors and weightings used by the ESG index are pecuniary. For
example, should specific ESG factors become reliably and consistently
identified, and widely recognized by qualified investment managers as
pecuniary factors that are predictive of financial performance, then
nothing in the final rule would prohibit their use by plan fiduciaries.
f. Interpretive Bulletin 2015-1 (IB 2015-1) and Field Assistance
Bulletin 2018-01 (FAB 2018-01)
The final rule also withdraws IB 2015-1 and removes it from the
Code of Federal Regulations. Accordingly, as of publication of this
final rule, IB 2015-1 may no longer be relied upon as reflecting the
Department's interpretation of the application of ERISA's fiduciary
responsibility provisions to the selection of investments and
investment courses of action.
Similarly, FAB 2018-01, which concerned both ``ESG Investment
Considerations'' and ``Shareholder Engagement Activities,'' is
superseded in part. Accordingly, as of publication of this final rule,
the portion of FAB 2018-01 under the heading ``ESG Investment
Considerations'' will be null and void and will be disregarded by the
Department.
E. Regulatory Impact Analysis
This section analyzes the regulatory impact of a final regulation
concerning the legal standard imposed by sections 404(a)(1)(A) and
404(a)(1)(B) of ERISA with respect to investment decisions involving
plan assets. In particular, it addresses the selection of a plan
investment or, in the case of an ERISA section 404(c) plan or other
individual account plan, a designated investment alternative under the
plan. This final rule addresses the limitations that section
404(a)(1)(A) and 404(a)(1)(B) of ERISA impose on fiduciaries'
consideration of non-pecuniary benefits and goals when making
investment decisions, including environmental, social, and corporate
governance and other similar factors.
Thus, the rule sets forth standards of prudence and loyalty for
selecting and monitoring investments. This rule imposes some costs. For
example, some plans will incur costs to review the rule to ensure
compliance, document the basis for certain investment decisions, and
ensure their QDIA does not contain prohibited characteristics. The
research and analysis used to select investments may change, but such a
change is unlikely to increase the overall cost. The transfer impacts,
benefits, and costs associated with the final rule depend on the number
of plan fiduciaries that are currently not following or are
misinterpreting the Department's existing sub-regulatory guidance.
While the Department does not have sufficient data to estimate the
number of such fiduciaries, the Department's educated estimate is
small, because most fiduciaries are operating in compliance with the
Department's sub-regulatory guidance. The Department acknowledges,
however, that some plan fiduciaries may be making investment decisions
that do not comply with the requirements of this final rule.
Nevertheless, the Department expects that the gains to investors will
justify the costs for participants and beneficiaries covered by plans
with noncompliant investment fiduciaries. If the Department's educated
estimate regarding the number of noncompliant fiduciaries is
understated, the final rule's transfer impacts, and costs will be
proportionately higher. Even in this instance, however, the Department
believes that the rule's benefits and gains to retirement investors
justify its costs.
The Department has examined the effects of this rule as required by
Executive Order 12866,\61\ Executive Order 13563,\62\ the Congressional
Review Act,\63\ Executive Order 13771,\64\ the Paperwork Reduction Act
of 1995,\65\ the Regulatory Flexibility Act,\66\ section 202 of the
Unfunded Mandates Reform Act of 1995,\67\ and Executive Order
13132.\68\
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\61\ Regulatory Planning and Review, 58 FR 51735 (Oct. 4, 1993).
\62\ Improving Regulation and Regulatory Review, 76 FR 3821
(Jan. 18, 2011).
\63\ 5 U.S.C. 804(2) (1996).
\64\ Reducing Regulation and Controlling Regulatory Costs, 82 FR
9339 (Jan. 30, 2017).
\65\ 44 U.S.C. 3506(c)(2)(A) (1995).
\66\ 5 U.S.C. 601 et seq. (1980).
\67\ 2 U.S.C. 1501 et seq. (1995).
\68\ Federalism, 64 FR 153 (Aug. 4, 1999).
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1. Executive Orders 12866 and 13563
Executive Orders 12866 and 13563 direct agencies to assess all
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits (including potential economic, environmental, public
health and safety effects; distributive impacts; and equity). Executive
Order 13563 emphasizes the importance of quantifying costs and
benefits, reducing costs, harmonizing rules, and promoting flexibility.
Under Executive Order 12866, ``significant'' regulatory actions are
[[Page 72873]]
subject to review by the Office of Management and Budget (OMB). Section
3(f) of the Executive Order defines a ``significant regulatory action''
as an action that is likely to result in a rule (1) having an annual
effect on the economy of $100 million or more, or adversely and
materially affecting a sector of the economy, productivity,
competition, jobs, the environment, public health or safety, or state,
local, or tribal governments or communities (also referred to as
``economically significant''); (2) creating a serious inconsistency or
otherwise interfering with an action taken or planned by another
agency; (3) materially altering the budgetary impacts of entitlement
grants, user fees, or loan programs or the rights and obligations of
recipients thereof; or (4) raising novel legal or policy issues arising
out of legal mandates, the President's priorities, or the principles
set forth in the Executive Order. It has been determined that this rule
is economically significant within the meaning of section 3(f)(1) of
the Executive Order. Therefore, the Department has provided an
assessment of the final rule's potential costs, benefits, and
transfers, and OMB has reviewed this final rule pursuant to the
Executive Order. Pursuant to the Congressional Review Act, OMB has
designated this final rule as a ``major rule,'' as defined by 5 U.S.C.
804(2), because it would be likely to result in an annual effect on the
economy of $100 million or more.
1.1. Introduction and Need for Regulation
Recently, there has been an increased emphasis in the marketplace
on investments and investment courses of action that further non-
pecuniary objectives, particularly what have been termed environmental,
social, and corporate governance (ESG) investing.\69\ The Department is
concerned that the growing emphasis on ESG investing, and other non-
pecuniary factors, may be prompting ERISA plan fiduciaries to make
investment decisions for purposes distinct from their responsibility to
provide benefits to participants and beneficiaries and defray
reasonable plan administration expenses. The Department is also
concerned that some investment products may be marketed to ERISA
fiduciaries on the basis of purported benefits and goals unrelated to
financial performance.
---------------------------------------------------------------------------
\69\ See Jon Hale, Sustainable Funds U.S. Landscape Report:
Record Flows and Strong Fund Performance in 2019 (Feb. 14, 2020),
www.morningstar.com/lp/sustainable-funds-landscape-report.
---------------------------------------------------------------------------
The Department has periodically considered the application of
ERISA's fiduciary rules to plan investment decisions that are based, in
whole or part, on non-pecuniary factors, and not simply investment
risks and expected returns. The Department has made various statements
on the subject over the years in sub-regulatory guidance not issued
pursuant to the Administrative Procedure Act. Accordingly, this final
rule is necessary to interpret ERISA regarding the scope of fiduciary
duties surrounding non-pecuniary issues.
Some commenters asserted that ERISA's prudence and loyalty duties
do not justify the need for the final rule. The Department disagrees
and firmly believes that fiduciaries must evaluate plan investments
based solely on pecuniary factors and not subordinate the interests of
the participants and beneficiaries in their retirement income or
financial benefits under the plan to unrelated objectives or sacrifice
investment return or take on additional investment risk to promote
goals unrelated to the financial interests of the plan's participants
and beneficiaries or the purposes of the plan. The Department believes
that providing a final regulation will help safeguard the interests of
participants and beneficiaries in their plan benefits.
1.2. Affected Entities
The final rule will affect certain ERISA-covered plans whose
fiduciaries consider or will begin considering non-pecuniary factors
when selecting investments and the participants in those plans. Indeed,
the Department received multiple comments from entities who described
their use of non-pecuniary factors when selecting investments and their
intention to continue using them in the future. The best data available
on the topic of non-pecuniary investing comes from surveys of ESG
investing by plans, thus the data used in this analysis is on ESG
investing. A challenge in relying on survey data, however, is that one
cannot tell how much of the ESG investing described is pecuniary or
non-pecuniary.\70\ Further complicating matters is that in selecting
investments, some plans may use non-pecuniary factors that are not ESG
factors, or are not perceived to be ESG factors. If survey respondents
do not view them as ESG factors, these plans would not be identified by
surveys.
---------------------------------------------------------------------------
\70\ See Schanzenbach & Sitkoff, supra note 5, at 389-90
(distinguishing between ``collateral benefits ESG'' investing--
defined as ``ESG investing for moral or ethical reasons or to
benefit a third party''--which is not permissible under ERISA, and
``risk-return ESG'' investing, which is).
---------------------------------------------------------------------------
The final rule requires plan fiduciaries to meet a documentation
requirement when they are unable to distinguish among alternative
investments based on pecuniary factors alone and base their investment
decision on non-pecuniary factors. In such circumstances, the fiduciary
must document (i) why pecuniary factors were not sufficient to select
the investment or investment course of action; (ii) how the investment
compares to the alternative investments with regard to the certain
factors, and (iii) how the non-pecuniary chosen factor is, or factors
are, consistent with interests of the participants and beneficiaries in
their retirement income or financial benefits under the plan. According
to a 2018 survey by the NEPC, approximately 12 percent of private
pension plans have adopted ESG investing.\71\ Another survey, conducted
by the Callan Institute in 2019, found that about 19 percent of private
sector pension plans consider ESG factors in investment decisions.\72\
Both of these estimates are calculated from samples that include both
defined benefit (DB) and defined contribution (DC) plans. Some DB plans
that consider ESG factors will not be affected by the final rule
because they focus only on the financial aspects of ESG factors, rather
than on non-pecuniary objectives. In order to generate an upper-bound
estimate of the costs, however, the Department assumes that 19 percent
of DB plans will be affected by the final rule. This represents
approximately 8,905 DB plans.\73\ The Department also assumes that 19
percent of DC plans with investments that are not participant-directed
will be affected; this represents an additional 17,676 plans.\74\
---------------------------------------------------------------------------
\71\ Brad Smith & Kelly Regan, NEPC ESG Survey: A Profile of
Corporate & Healthcare Plan Decisionmakers' Perspectives, NEPC (Jul.
11, 2018), https://cdn2.hubspot.net/hubfs/2529352/files/2018%2007%20NEPC%20ESG%20Survey%20Results%20.pdf?t=1532123276859.
\72\ 2019 ESG Survey, Callan Institute (2019), www.callan.com/wp-content/uploads/2019/09/2019-ESG-Survey.pdf.
\73\ DOL calculations are based on statistics from Private
Pension Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports,
Employee Benefits Security Administration (forthcoming 2020),
(46,869 * 19% = 8,905 DB plans).
\74\ Id. (93,033 * 19% = 17,676 plans).
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Participant-directed individual account DC plans and their
participants will be affected by the final rule if fiduciaries respond
to participant demand by examining ESG options for inclusion among
their plans' designated investment alternatives. Fiduciaries of
[[Page 72874]]
such plans may also select investments using non-pecuniary factors when
the fiduciary is unable to distinguish alternative investment options
based on pecuniary considerations. A small share of individual account
plans offer at least one ESG-themed option among their designated
investment alternatives. According to the Plan Sponsor Council of
America, about three percent of 401(k) and/or profit sharing plans
offered at least one ESG-themed investment option in 2018.\75\
Vanguard's 2018 administrative data show that approximately nine
percent of DC plans offered one or more ``socially responsible''
domestic equity fund options.\76\ In a comment letter, Fidelity
Investments reported that 14.5 percent of corporate DC plans with fewer
than 50 participants offered an ESG option, and that the figure is
higher for large plans with at least 1,000 participants. Considering
these sources together, the Department estimates that nine percent of
participant-directed individual account plans have at least one ESG-
themed designated investment alternative and will be affected by the
final rule. This represents 52,378 participant-directed individual
account plans.\77\ In terms of the actual investment in ESG options,
one survey indicates that about 0.1 percent of total DC plan assets are
invested in ESG funds.\78\
---------------------------------------------------------------------------
\75\ 62nd Annual Survey of Profit Sharing and 401(k) Plans, Plan
Sponsor Council of America (2019).
\76\ How America Saves 2019, Vanguard (June 2019), https://institutional.vanguard.com/iam/pdf/HAS2019.pdf.
\77\ DOL calculations based on statistics from Private Pension
Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports, Employee
Benefits Security Administration (forthcoming 2020), (581,974 * 9% =
52,378 individual account plans with participant direction).
\78\ 62nd Annual Survey of Profit Sharing and 401(k) Plans, Plan
Sponsor Council of America (2019).
---------------------------------------------------------------------------
The rule prevents any investment fund, product, or model portfolio
from being added as, or as a component of, a Qualified Default
Investment Alternative (QDIA) if its investment objectives or goals or
its principal investment strategies include, consider, or indicate the
use of one or more non-pecuniary factors. To assess the impact of this
provision, it is important to determine how many DC plans have a QDIA.
According to a 2018 survey conducted by the Plan Sponsor Council of
America, about 70 percent of DC plans have a QDIA.\79\ This represents
approximately 407,382 individual account plans with participant
direction.\80\ As specified in 29 CFR 2550.404c-5, there are four
permitted types of QDIAs: Target-date funds, professionally managed
accounts, balanced funds, and capital preservation products for only
the first 120 days of participation. The 2018 survey from Plan Sponsor
Council of America also found that approximately 75 percent of QDIAs
are target-date funds, while 12 percent are balanced funds, 7 percent
are professionally managed accounts, 4 percent are stable value funds,
and the remaining 2 percent are investments classified as ``other.''
\81\
---------------------------------------------------------------------------
\79\ Id.
\80\ DOL calculations based on statistics from Private Pension
Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports, Employee
Benefits Security Administration (forthcoming 2020), (581,974 * 70%
= 407,382 individual account plans with participant direction).
\81\ 62nd Annual Survey of Profit Sharing and 401(k) Plans, Plan
Sponsor Council of America (2019).
---------------------------------------------------------------------------
To better understand how many plans with QDIAs would be affected by
the rule, the Department looked at the holdings of target-date fund
providers. According to Morningstar, the five largest target-date fund
providers account for 79 percent of target-date strategy assets.\82\
The Department examined the most recent holdings, as of September 2020,
of the target-date funds offered by the five largest target-date fund
providers, denoting target-date funds that either had an investment
strategy considering non-pecuniary factors or that were invested in a
fund with a non-pecuniary investment focus. Within this sample, the
Department found only one target-date fund provider that had issued a
target-date series with an ESG focus. This series was launched in 2020,
and as of September 2020, this series accounted for less than 0.002
percent of assets in the sample. The Department also examined other
target-date funds it was aware of that had an ESG focus. When looking
at the total net asset value for each of the target date series from
Morningstar Direct, the Department found that target-date funds with an
ESG focus account for a very small portion of the assets invested in
the target-date market. When looking at preliminary data from
BrightScope on the holdings of 401(k) and 403(b) plans for 2018, the
Department found that target-date funds with an ESG focus account for
an even smaller portion of the target-date assets in ERISA plans.
---------------------------------------------------------------------------
\82\ Morningstar, 2020 Target-Date Strategy Landscape, How
Target-Date Shareholders Fared in the Coronavirus Bear Market and
the Trends Shaping the Future of Investing for Retirement (2020).
---------------------------------------------------------------------------
For the purpose of this analysis, the Department assumes that the
characteristics of the five largest providers of target-date funds are
representative of the investment alternatives offered as QDIAs. As the
target-date series noted above is relatively new, and the Department is
aware of at least one other target-date series focusing on non-
pecuniary factors, the Department assumes that 0.1 percent of plans
will need to make changes to their QDIAs. Based on the foregoing, the
Department assumes that 407 plans with QDIAs will be affected by the
rule.\83\
---------------------------------------------------------------------------
\83\ 407,383 * 0.001 = 407.
---------------------------------------------------------------------------
1.3. Gains to Retirement Investors
The final rule will replace existing guidance on the use of ESG and
similar factors in the selection of investments. It will lead to less
use of non-pecuniary factors in selecting DB plan investments and
participant-directed individual account plan QDIAs. These effects may
provide gains to retirement investors in the form of higher returns by
preventing fiduciaries from selecting investments by factoring in non-
pecuniary ESG considerations and requiring them to base investment
decisions on financial factors.
The final rule states that fiduciaries for DB plans must base
investment decisions on pecuniary factors unless the plan fiduciary is
unable to distinguish alternative investment options on the basis of
pecuniary factors and such a conclusion is properly documented. This
will lead to a decrease in the use of non-pecuniary factors in
selecting DB plan investments. Defined contribution plans that do not
have participant direction will be similarly affected with the same
results.
This rule specifically addresses circumstances when participant-
directed individual account plan fiduciaries select designated
investment alternatives. Such fiduciaries are not automatically
prohibited from casting a broad net to consider or include an
investment fund, product, or model portfolio merely because the fund,
product, or model portfolio promotes, seeks, or supports one or more
non-pecuniary goals, so long as fiduciaries meet the final rule's
requirement to base final selection decisions on pecuniary factors. If
the pecuniary factors lead to situations where plan fiduciaries are
unable to distinguish alternative investment options on the basis of
pecuniary factors, the plan fiduciary can make a selection based on
non-pecuniary factors if they properly document the basis for their
decision. It is unclear whether fiduciaries will
[[Page 72875]]
increase selection of non-pecuniary funds as designated investment
alternatives, and consequently, how returns may be affected.
Furthermore, the rule prohibits plan fiduciaries from adding any
investment fund, product, or model portfolio as, or as a component of,
a QDIA if its investment objectives or goals or its principal
investment strategies include, consider, or indicate the use of one or
more non-pecuniary factors. The Department expects that requiring a
fiduciary's selection of a QDIA to be based solely on pecuniary factors
will lead to higher returns for the reasons discussed above.
Some commenters objected to the Department's characterization in
the proposal of the empirical research assessing ESG investing. Indeed,
the research studies have a wide range of findings. Some studies have
shown that ESG investing outperforms conventional investing. Verheyden,
Eccles, and Feiner's research analyzes stock portfolios that used
negative screening \84\ to exclude operating companies with poor ESG
records from the portfolios.\85\ The study finds that negative
screening tends to increase a stock portfolio's annual performance by
0.16 percent. Similarly, Kempf and Osthoff's research, which examines
stocks in the S&P 500 and the Domini 400 Social Index (renamed as the
MSCI KLD 400 Social Index in 2010), finds that it is financially
beneficial for investors to positively screen their portfolios.\86\
Additionally, Ito, Managi, and Matsuda's research finds that socially
responsible funds outperformed conventional funds in the European Union
and United States.\87\
---------------------------------------------------------------------------
\84\ Negative screening refers to the exclusion of certain
sectors, companies, or practices from a fund or portfolio based on
ESG criteria.
\85\ Tim Verheyden, Robert G. Eccles, and Andreas Feiner, ESG
for all? The Impact of ESG Screening on Return, Risk, and
Diversification. 28 Journal of Applied Corporate Finance 2 (2016).
\86\ Alexander Kempf and Peer Osthoff, The Effect of Socially
Responsible Investing on Portfolio Performance, 13 European
Financial Management 5 (2007).
\87\ Yutaka Ito, Shunsuke Managi, and Akimi Matsuda,
Performances of Socially Responsible Investment and Environmentally
Friendly Funds, 64 Journal of the Operational Research Society 11
(2013).
---------------------------------------------------------------------------
In contrast, other studies have found that ESG investing has
resulted in lower returns than conventional investing. For example,
Winegarden shows that over ten years, a portfolio of ESG funds has a
return that is 43.9 percent lower than if it had been invested in an
S&P 500 index fund.\88\ Trinks and Scholten's research, which examines
socially responsible investment funds, finds that a screened market
portfolio significantly underperforms an unscreened market
portfolio.\89\ Ferruz, Mu[ntilde]oz, and Vicente's research, which
examines U.S. mutual funds, finds that a portfolio of mutual funds that
implements negative screening underperforms a portfolio of
conventionally matched pairs.\90\ Likewise, Ciciretti, Dal[ograve], and
Dam's research, which analyzes a global sample of operating companies,
finds that companies that score poorly in terms of ESG indicators have
higher expected returns.\91\ Marsat and Williams' research has very
similar findings.\92\ Operating companies with better ESG scores
according to MSCI had lower market valuation.
---------------------------------------------------------------------------
\88\ Wayne Winegarden, Environmental, Social, and Governance
(ESG) Investing: An Evaluation of the Evidence. Pacific Research
Institute (2019).
\89\ Pieter Jan Trinks and Bert Scholtens, The Opportunity Cost
of Negative Screening in Socially Responsible Investing, 140 Journal
of Business Ethics 2 (2014).
\90\ Luis Ferruz, Fernando Mu[ntilde]oz, and Ruth Vicente,
Effect of Positive Screens on Financial Performance: Evidence from
Ethical Mutual Fund Industry (2012).
\91\ Rocco Ciciretti, Ambrogio Dal[ograve], and Lammertjan Dam,
The Contributions of Betas versus Characteristics to the ESG Premium
(2019).
\92\ Sylvain Marsat and Benjamin Williams, CSR and Market
Valuation: International Evidence. Bankers, Markets & Investors: An
Academic & Professional Review, Groupe Banque (2013).
---------------------------------------------------------------------------
Furthermore, there are many studies with inconclusive results.
Goldreyer and Diltz's research, which examines 49 socially responsible
mutual funds, finds that employing positive social screens does not
affect the investment performance of mutual funds.\93\ Similarly,
Renneboog, Ter Horst, and Zhang's research, which analyzes global
socially responsible mutual funds, finds that the risk-adjusted returns
of socially responsible mutual funds are not statistically different
from conventional funds.\94\ Bello's research, which examines 126
mutual funds, finds that the long-run investment performance is not
statistically different between conventional and socially responsible
funds.\95\ Likewise, Ferruz, Mu[ntilde]oz, and Vicente's research finds
that a portfolio of mutual funds that implement positive screening \96\
performs equally well as a portfolio of conventionally matched-
pairs.\97\ Finally, Humphrey and Tan's research, which examines
socially responsible investment funds, finds no evidence of negative
screening affecting the risks or returns of portfolios.\98\
---------------------------------------------------------------------------
\93\ Elizabeth Goldreyer and David Diltz, The Performance of
Socially Responsible Mutual Funds: Incorporating Sociopolitical
Information in Portfolio Selection, 25 Managerial Finance 1 (1999).
\94\ Luc Renneboog, Jenke Ter Horst, and Chendi Zhang, The Price
of Ethics and Stakeholder Governance: The Performance of Socially
Responsible Mutual Funds, 14 Journal of Corporate Finance 3 (2008).
\95\ Zakri Bello, Socially responsible investing and portfolio
diversification, 28 Journal of Financial Research 1 (2005).
\96\ Positive screening refers to including certain sectors and
companies that meets the criteria of non-financial objectives.
\97\ Ferruz, Mu[ntilde]oz, and Vicente, Effect of Positive
Screens on Financial Performance (2012).
\98\ Jacquelyn Humphrey and David Tan, Does It Really Hurt to be
Responsible?, 122 Journal of Business Ethics 3 (2014).
---------------------------------------------------------------------------
The final rule emphasizes the importance of plan fiduciaries
focusing on pecuniary factors when selecting investments. This emphasis
may encourage fiduciaries to pay greater attention to fees. If, as a
result of the final rule, assets are invested in funds with lower fees
on average, the reduced fees, minus potential upfront transition costs,
will represent gains to retirement investors.
To the extent that ESG and other investing decisions sacrifice
return to achieve non-pecuniary goals, it reduces participant and
beneficiaries' retirement investment returns, thereby compromising a
central purpose of ERISA. Given the increase in ESG investing, the
Department is concerned that, without this rulemaking, non-pecuniary
ESG investing will present a growing threat to ERISA fiduciary
standards and, ultimately, to investment returns and retirement income
security for plan participants and beneficiaries. The gains to
investors derived from higher investment returns compounded over many
years could be considerable for plans and participants that would be
impacted by plan fiduciaries' increased reliance on pecuniary factors
as required by the final rule.
If some portion of the increased returns realized by the rule are
associated with ESG investments generating lower pre-fee returns than
non-ESG investments (as regards economic impacts that can be
internalized by parties conducting market transactions), then the new
returns qualify as gains to investors from the rule. It would, however,
be important to track externalities, public goods, or other market
failures that might lead to economic effects of the non-ESG activities
being potentially less fully internalized than ESG activities' effects
would, and thus generating costs to society on an ongoing basis.
Finally, if some portion of the increased returns would be associated
with transactions in which the opposite party experiences decreased
returns of equal magnitude, then this portion of the rule's impact
would, from a society-wide perspective, be appropriately categorized as
a transfer (though it should be noted that, if there is evidence of
wealth differing
[[Page 72876]]
across the transaction parties, it would have implications for marginal
utility of the assets).
1.4. Costs
This final rule provides guidance on the investment duties of a
plan fiduciary. Under this final rule, plan fiduciaries who consider
ESG and similar factors when choosing investments will be reminded that
they may evaluate only the investments' relevant economic pecuniary
factors to determine the risk and return profiles of the alternatives.
It is the Department's view that many plan fiduciaries already
undertake such evaluations, though many that consider ESG and similar
factors may not be treating those as pecuniary factors within the risk-
return evaluation. This final rule will not impair fiduciaries'
appropriate consideration of ESG factors in circumstances where such
consideration is material to the risk-return analysis and, as a result,
advances participants' interests in their retirement benefits. The
Department does not intend to increase fiduciaries' burden of care
attendant to such consideration; therefore, no additional costs are
estimated for this requirement. While fiduciaries may modify the
research approach they use to select investments as a consequence of
the final rule, the Department assumes this modification will not
impose significant additional cost.
The Department solicited comments on its cost analysis in the
regulatory impact analysis for the proposed rule. While some commenters
provided insights the Department could use to improve its analysis, few
commenters provided additional data or data sources to help the
Department quantify the cost impacts of the rule.
Commenters suggested that the analysis did not account for the
movement from ESG assets to non-ESG assets due to the rule and the
related costs of this movement. Commenters provided several reasons for
this movement including, the proposed rule favors non-ESG investments;
additional costs are required to document decisions to invest in ESG
investments in certain circumstances; and increased litigation risk.
Commenters suggested that this movement from ESG to non-ESG investments
would create a cost due to lost returns, suggesting that ESG
investments outperform non-ESG investments.
The Department disagrees with most of these comments; changes made
in the final rule strengthen the Department's view that commenters'
concerns are overstated. For example, the final rule reaffirms that
plan investments and investment alternatives are to be chosen based on
pecuniary factors. If an investment, including an ESG investment, is
expected to outperform other similar investments, fills a plan's needs,
and meets other relevant requirements under ERISA, it can be selected
and the plan and plan participants will benefit from its inclusion. If
an investment, including an ESG investment, is expected to underperform
other similar investments, it does not satisfy the final rule's
requirements and should not be selected. Plan investments or investment
alternatives that previously followed this requirement will not
experience a change in economic performance. If plan investments or
investment alternatives were selected based on non-pecuniary factors
and they are not maximizing the economic benefits of the plan, they
should be replaced, which would increase the returns to the plan. Thus,
the requirement to consider only pecuniary factors only serves to
benefit the plan, and additional losses are less likely to be incurred
as suggested by commenters.
Commenters also suggested that the requirement to document the
decision when fiduciaries use non-pecuniary factors to choose between
alternative investment options that cannot be distinguished based on
pecuniary factors could drive up costs. Commenters said that these
costs would lead plans to avoid selecting ESG assets due to the added
cost, even when they are beneficial. The final rule significantly
reduces the documentation requirements from the proposal. In the final
rule, the Department explicitly requires plan fiduciaries to document
three elements identified in the final rule only in the discrete (and
likely rare) situations in which a fiduciary cannot distinguish between
alternatives based on pecuniary factors. Stating precisely what is
required to be documented in the final rule should help both lower
compliance costs and address concerns about liability exposure, because
fiduciaries will have clear expectations of what is expected. While the
Department does include a requirement to document the decision, it
continues to believe that a prudent process would already require plan
fiduciaries to have considered responses to these questions, so the
only added costs would be to document their reasoning and many plan
fiduciaries already are doing this as part of a prudent selection
process.
Further, commenters suggested that the requirement to document the
use of non-pecuniary factors would subject ESG factors to a different
standard of analysis that would diminish a fiduciary's ability to act
in the best interest of plan participants. In response to comments, the
Department has removed the proposed requirement to document the
selection and monitoring of designated investment alternatives that
include ESG assessments. A different standard is not being created in
this final rule. Fiduciaries should use a prudent process for selecting
all investments. In exchange for using a non-pecuniary factor to select
between or among investment alternatives that the fiduciary prudently
determines would serve equivalent roles in the plan's portfolio, the
rule requires fiduciaries to prepare a justification to help ensure
that the decision is consistent with interests of participants and
beneficiaries in their retirement income or financial benefits under
the plan and not based on any other consideration.
Some commenters also expressed concern that the regulation would
limit diversification and a fiduciary's ability to consider all
material factors in an investment decision. The regulation specifies
that compliance with section 404(a)(1)(B) of ERISA requires a fiduciary
of an employee benefit plan to evaluate investments and investment
courses of action based solely on pecuniary factors that have had a
material effect on the return and risk. The regulation does not
restrict consideration of any asset classes or sectors of investment so
long as investment decisions are made solely in the interest of the
plan's financial objective of providing retirement income for plan
participants and beneficiaries.
Commenters suggested that the Department did not appropriately
consider an investment's time horizon at all or focused only on a
short-time horizon. The Department disagrees. The rule requires plan
fiduciaries to ``evaluate investments and investment courses of action
based solely on pecuniary factors that have a material effect on the
return and risk of an investment based on appropriate investment
horizons.'' The appropriate time horizon to consider for an investment
or investment alternative can be plan specific, and the rule allows the
plan fiduciary to make that determination for their plan.
Some commenters expressed concern regarding how the regulation will
affect the behavior of plan participants (participation rates, elective
deferrals, and investment choices) and plan sponsors (offering of ESG
options in plan investment menus). A change to
[[Page 72877]]
the final rule makes it clear that participant-directed individual
account plan fiduciaries are not automatically prohibited from
considering or including an investment fund, product, or model
portfolio merely because the fund, product, or model portfolio
promotes, seeks, or supports one or more non-pecuniary goals, provided
that certain requirements are met. As discussed above, this could lead
to increased participation or inflows of assets into plans.
Several of the commenters note that the rule would require plan
fiduciaries to read the rule and review investment policy statements to
ensure they are in compliance. The Department estimates that 78,959
plans have exposure to investments with non-pecuniary objectives,
consisting of 8,905 DB plans,\99\ 52,378 participant-directed
individual account plans,\100\ and 17,676 DC plans with ESG investments
that are not participant directed.\101\ In the proposal, the Department
estimated that the incremental costs would be ``minimal.'' The
Department agrees with commenters that fiduciaries of each of these
types of plans will need to spend time reviewing the final rule,
evaluating how it affects their investment practices, and implementing
any necessary changes. The Department now estimates that this review
process will require a lawyer to spend approximately four hours to
complete, resulting in a cost burden of approximately $44 million.\102\
The Department believes that these processes will likely be performed
by a service provider for most plans that likely oversee multiple
plans. Therefore, the Department's estimate likely is an upper bound,
because it is based on the number of affected plans. The Department
does not have data that would allow it to estimate the number of
service providers acting in such a capacity for these plans.
---------------------------------------------------------------------------
\99\ DOL calculations based on statistics from U.S. Department
of Labor, Employee Benefits Security Administration, ``Private
Pension Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports,''
(forthcoming 2020), (46,869 DB plans * 19% = 8,905 DB plans; 93,033
DC Plans * 19% = 17,676 DC plans; 581,974 * 6% = 34,918 individual
account plans with participant direction).
\100\ DOL calculations based on statistics from Private Pension
Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports, Employee
Benefits Security Administration (forthcoming 2020), (581,974 * 9% =
52,378 individual account plans with participant direction).
\101\ DOL calculations based on statistics from U.S. Department
of Labor, Employee Benefits Security Administration, ``Private
Pension Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports,''
(forthcoming 2020), (46,869 DB plans * 19% = 8,905 DB plans; 93,033
DC Plans * 19% = 17,676 DC plans; 581,974 * 6% = 34,918 individual
account plans with participant direction).
\102\ The Department estimated that there are 78,959 plans that
will need to ensure compliance with the final rule. The burden is
estimated as follows: (78,959 plans * 4 hours) = 315,836 hours. A
labor rate of $138.41 is used for a lawyer. The cost burden is
estimated as follows: (78,959 plans * 4 hours * $138.41) =
$43,714,860.76. Labor rates are based on DOL estimates from Labor
Cost Inputs Used in the Employee Benefits Security Administration,
Office of Policy and Research's Regulatory Impact Analyses and
Paperwork Reduction Act Burden Calculation, Employee Benefits
Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
---------------------------------------------------------------------------
Some fiduciaries will select investments that are different from
what they would have selected pre-rule. As part of a routine evaluation
of the plan's investments or investment alternatives, fiduciaries may
replace an investment or investment alternative. This could lead to
some disruption, particularly for participant-directed DC plans. If a
plan fiduciary removes an ESG fund as a designated investment
alternative and does not replace it with a more appropriate ESG fund as
a result of this final rule, participants invested in the ESG fund will
have to pick a new fund that may not be comparable from their
perspective. This could be disruptive.
Paragraph (c)(1) of the final rule provides that a fiduciary's
evaluation of an investment must be focused on pecuniary factors.
Paragraph (c)(2) addresses investment alternatives that the fiduciary
prudently determines would serve equivalent roles in the plan's
portfolio and that which the plan fiduciary is unable to distinguish on
the basis of pecuniary factors alone. In such cases, a fiduciary may
choose between such alternatives based on non-pecuniary factors
provided the fiduciary documents (1) why the pecuniary factors were not
sufficient to select the investment; (2) why the fiduciary believes
diversification among the investments under consideration would not be
prudent; and (3) how the chosen non-pecuniary factors are consistent
with the interests of the plan. The Department continues to believe
that the likelihood that a plan fiduciary will be unable to distinguish
between two investment options based on pecuniary factors is rare;
therefore, the need to document such circumstances also will be
rare.\103\ In those rare instances, the documentation requirement could
be burdensome if fiduciaries are not currently documenting decisions.
The Department estimates that this requirement will not result in a
substantial cost burden, because it concludes that situations where
plan fiduciaries are unable to distinguish between alternative
investment options based on pecuniary factors are rare. The cost for
the documentation requirement is estimated to be $122,000 annually. The
estimation of this cost is discussed in the Paperwork Reduction Act
(PRA) section.
---------------------------------------------------------------------------
\103\ See Schanzenbach & Sitkoff, supra note 5, at 410
(describing a hypothetical pair of truly identical investments as a
``unicorn'').
---------------------------------------------------------------------------
The final rule provides that under no circumstances may any
investment fund, product, or model portfolio be added as, or as a
component of, a QDIA if its investment objectives or goals or its
principal investment strategies include, consider, or indicate the use
of one or more non-pecuniary factors. The final rule provides a
transition provision requiring plans to bring their QDIAs into
compliance with the final rule by April 30, 2022. This transition
provision is intended to provide sufficient time for plans to review
and make any necessary changes to their QDIAs to bring them into
compliance. The Department believes as plans familiarize themselves
with the rule, they are likely to make necessary changes. Accordingly,
the Department assumes that associated costs will be incurred during
the first year. The Department estimates that it will take on average
20 hours (in addition to any time fiduciaries customarily spend
reviewing and changing their QDIAs) for fiduciaries of a plan offering
QDIAs with exposure to non-pecuniary investment objectives to review
and change their QDIAs resulting in a cost of $1.1 million.\104\
---------------------------------------------------------------------------
\104\ The Department estimated that there are 407,383 DC plans
with QDIAs and that 0.1 percent, or 407 plans, will need to
reconsider their QDIAs as a result of the rule. The burden is
estimated as follows: (407,383 plans * 0.001 * 20 hours) = 814
hours. A labor rate of $134.21 is used for a plan fiduciary. The
cost burden is estimated as follows: (407,383 plans * 0.001 * 20
hours * $134.21) = $1,092,469.40. Labor rates are based on DOL
estimates from Labor Cost Inputs Used in the Employee Benefits
Security Administration, Office of Policy and Research's Regulatory
Impact Analyses and Paperwork Reduction Act Burden Calculation,
Employee Benefits Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
---------------------------------------------------------------------------
The use of ESG investment alternatives in participant-directed
plans has potential as a marketing tool that may increase retirement
savings contributions for some investors. To the extent the rule
reduces access to ESG investment alternatives retirement investors may
reduce their future contributions. The Department is not aware of any
empirical evidence assessing whether ESG investing is associated with
increased rates of retirement savings.
[[Page 72878]]
1.5. Uncertainty
It is unclear how many plan fiduciaries use non-pecuniary factors
when selecting investments and the total asset value of investments
that are selected in this manner, particularly for DB plans. While
there is some survey evidence on how many DB plans factor in ESG
considerations, the surveys were based on small samples and yielded
varying results. It is also not clear whether survey information about
ESG investing accurately represents the prevalence of investing that
incorporates non-pecuniary factors. For instance, some non-pecuniary
investing concentrates on issues that are not thought of as ESG-
related. At the same time, some investment policies take account of
environmental factors and corporate governance in a manner that focuses
exclusively on the financial aspects of those considerations.
The final rule will replace the Department's existing sub-
regulatory guidance on using non-pecuniary factors while selecting plan
investments. It is very difficult to estimate how many plans have
fiduciaries that are currently using non-pecuniary factors improperly
while selecting investments. Such plans will experience significant
effects from the final rule. It is also difficult to estimate the
degree to which the use of non-pecuniary factors by ERISA fiduciaries,
ESG or otherwise, would expand in the future absent this rulemaking,
though trends in other countries suggest that pressure for such
expansion will continue only to increase.\105\ However, based on
current trends the Department believes that the use of non-pecuniary
factors by ERISA plan fiduciaries would likely increase moderately in
the future without this rulemaking.
---------------------------------------------------------------------------
\105\ See generally Government Accountability Office Report No.
18-398, Retirement Plan Investing: Clearer Information on
Consideration of Environmental, Social, and Governance Factors Would
Be Helpful (May 2018), at 25-27; Principles for Responsible
Investment, Fiduciary Duty in the 21st Century, supra note 12, at
21-22, 50-51.
---------------------------------------------------------------------------
1.6. Alternatives
The Department considered several alternatives to the final
regulation. One alternative would prohibit plan fiduciaries from ever
considering ESG factors. This would address the Department's concerns
that some plan fiduciaries may sacrifice return or increase investment
risk to promote goals that are unrelated to the financial interests of
the plan or its participants. However, the Department rejected this
alternative, because it would prohibit fiduciaries from considering
such factors even when the fiduciaries are focused on the financial
aspects rather than the non-pecuniary aspects of the investments.
The Department also considered prohibiting plan fiduciaries from
basing investment decisions on non-pecuniary factors and prohibiting
the use of non-pecuniary factors even where the alternative investment
options cannot be distinguished based on pecuniary factors (the so-
called ``tie-breaker'' provision). However, if the alternative
investment options cannot be distinguished on the basis of pecuniary
factors, it is not clear what factors would be available to a plan
fiduciary to base its decision on other than a non-pecuniary factor.
Regardless, the Department believes that investment options that cannot
be distinguished on the basis of pecuniary factors occur very rarely in
practice, if at all. Accordingly, this final rule provides that when
choosing between investment alternatives that the fiduciary prudently
determines would serve equivalent roles in the plan's portfolio or the
portion of the portfolio over which the fiduciary has responsibility
and which the plan fiduciary is unable to distinguish on the basis of
pecuniary factors alone, the fiduciary may base the investment decision
non-pecuniary factors provided the fiduciary documents the following:
(1) Why the pecuniary factors were not sufficient to select the
investment; (2) how the investment compares to alternative investments
with regard to the factors listed in paragraphs (b)(2)(ii)(A) through
(C) of the final rule; and (3) how the chosen non-pecuniary factors are
consistent with the interests of the plan.
The Department notes that the proposal did not expressly
incorporate the tie-breaker provision into the regulatory provision on
selection of investment options for individual account plans. The
Department explained in the proposal its perspective that the concept
of ``ties'' may have little relevance in the context of fiduciaries'
selection of menu options for individual account plans as such
investment options are often chosen precisely for their varied
characteristics and the range of choices they offer plan participants.
Further, the Department explained that because the proposal did not
restrict the addition of prudently selected, well managed investment
options for individual account plans that include non-pecuniary factors
if they can be justified solely on the basis of pecuniary factors,
there would be little need for a tie-breaker between selected
investment funds. Nonetheless, some commenters expressed uncertainty
regarding the interaction of paragraph (c)(2) and the provisions of the
proposal on selecting investment options for individual account plans.
Some commenters asked the Department to expressly make the tie-breaker
available for such investment decisions.
Although the Department continues to doubt the relevance of a
``tie'' concept when adding investment alternatives to a platform of
investments that allow participants and beneficiaries to choose from a
broad range of investment alternatives as defined in 29 CFR 2550.404c-
1(b)(3), the final rule makes the tie-breaker provisions in paragraph
(c) generally available for use in selecting investment options for
individual account plans in the event the fiduciaries of the plan
believe that it gives them some added flexibility and fiduciary
protection when adding an investment fund, product, or model portfolio
that promotes, seeks, or supports one or more non-pecuniary goals.
Paragraph (d) of the final rule contains standards applicable to
participant-directed individual account plans. The predecessor
standards for participant-directed individual account plans were set
forth in paragraph (c)(3) of the proposal. Paragraph (c)(3)(ii) of the
proposal would have required plan fiduciaries to document their
compliance with the requirement to use only objective risk-return
criteria in the selection and monitoring of investment platforms or
menu alternatives. The Department included the cost plan fiduciaries
would incur to comply with this documentation requirement in its cost
estimates for the proposal.
The Department considered including this documentation requirement
in the final rule; however, it determined not to include such
requirement in paragraph (d)(2) of the final rule. The Department was
persuaded by some commenters' concerns that this requirement would have
applied more stringent requirements to ESG investment alternatives than
other types of investment alternatives. These commenters argued that it
is inappropriate to impose separate documentation requirements that
vary by investment strategy. Other commenters objected to this
requirement on the grounds that it would increase costs to plans and
potentially provide grounds for unwarranted class action lawsuits. The
Department believes that the approach reflected in the final rule best
reflects ERISA's statutory obligations of prudence and loyalty,
appropriately ensures that small and large plan fiduciaries' decisions
will be guided by the financial interests of the plans and
[[Page 72879]]
participants to whom they owe duties of prudence and loyalty, and is
the most efficient alternative to apply and enforce.
1.7. Conclusion
The final rule describes when and how fiduciaries can fulfill their
responsibilities by factoring in only pecuniary considerations when
selecting and monitoring investments. Some plans and their service
providers will incur costs to (1) review the rule and if necessary,
modify their processes for selecting and monitoring investments, (2)
make changes to their QDIA if it does not align with the final rule's
requirements, and (3) document selections where alternative investment
options cannot be distinguished on the basis of pecuniary factors. The
Department does not expect these requirements to impose a significant
cost increase. The final rule mitigates some costs by allowing plans to
make any required changes to QDIAs when necessary to comply with the
requirements of paragraph (d)(2) by April 30, 2022. The Department also
believes cost will be mitigated, because circumstances where
alternative investment options that cannot be distinguished based on
pecuniary factors should occur very rarely in practice.
Although the final rule will replace its prior sub-regulatory
guidance, the Department believes that there is significant overlap in
the content of each. Overall, the final rule will assist fiduciaries in
carrying out their responsibilities by avoiding making investment
decisions based on non-pecuniary factors, while protecting the
financial interests of participants and beneficiaries in their
retirement benefits under their plans.
The Department estimates that the final rule would impose
incremental costs of approximately $44.9 million in the first year and
$122,000 in subsequent years. Over 10 years, the associated costs would
be approximately $42.7 million with an annualized cost of $6.1 million,
using a seven percent discount rate.\106\ Using a perpetual time
horizon (to allow the comparisons required under Executive Order
13771), the annualized costs in 2016 dollars are $2.9 million at a
seven percent discount rate.\107\
---------------------------------------------------------------------------
\106\ The costs would be $44.5 million over 10-year period with
an annualized cost of $5.2 million, applying a three percent
discount rate.
\107\ The annualized costs in 2016 dollars would be $1.4 million
applying a three percent discount rate.
---------------------------------------------------------------------------
1. Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1995 (PRA 95) (44
U.S.C. 3506(c)(2)(A)), the Department solicited comments concerning the
information collection request (ICR) included in the Financial Factors
in Selecting Plan Investments ICR (85 FR 39113). At the same time, the
Department also submitted an information collection request (ICR) to
the Office of Management and Budget (OMB), in accordance with 44 U.S.C.
3507(d). OMB filed a comment on the proposed rule with the Department
on August 25, 2020, requesting the Department to provide a summary of
comments received on the ICR and identify changes to the ICR made in
response to the comments. OMB did not approve the ICR, and requested
the Department to file future submissions of the ICR under OMB control
number 1210-0162.
The Department received several comments that specifically
addressed the paperwork burden analysis of the information collection
requirement contained in the proposed rule. The Department took into
account such public comments in developing the revised paperwork burden
analysis discussed below.
In connection with publication of this final rule, the Department
is submitting an ICR to OMB requesting approval of a new collection of
information under OMB Control Number 1210-0162. The Department will
notify the public when OMB approves the ICR.
A copy of the ICR may be obtained by contacting the PRA addressee
shown below or at www.RegInfo.gov. PRA ADDRESSEE: G. Christopher Cosby,
Office of Regulations and Interpretations, U.S. Department of Labor,
Employee Benefits Security Administration, 200 Constitution Avenue NW,
Room N-5718, Washington, DC 20210; cosby.chris@dol.gov. Telephone: 202-
693-8410; Fax: 202-219-4745. These are not toll-free numbers.
In prior guidance, the Department has encouraged plan fiduciaries
to appropriately document their investment activities, and the
Department believes it is common practice. The final rule expressly
requires only that, where a plan fiduciary or its service provider
determines that alternative investments are unable to be distinguished
on the basis of pecuniary factors alone, the fiduciary or the plan's
service provider further documents the basis for concluding that a
distinguishing factor could not be found and the reason that the
investment was selected based on non-pecuniary factors. Nevertheless,
the Department believes that the likelihood of two investment options
that cannot be distinguished based on pecuniary factors is very rare.
While the incremental burden of the final regulation is small, the
full burden of the requirements will be included below as required by
the PRA to allow for evaluation of the requirements in the entire
information collection.
According to the most recent Form 5500 data and other assumptions
discussed in the affected entities section above, there are 8,905 DB
plans and 17,676 DC plans with ESG investments that are not participant
directed, and 52,378 participant-directed individual account
plans.\108\ These plans and their service providers could be affected
by the final rule. While the Department does not have data regarding
the frequency of the rare event of alternatives being not distinguished
on the basis of pecuniary factors and requiring documentation, the
Department models the burden using one percent of plans with ESG
investments as needing to comply with the documentation requirement.
---------------------------------------------------------------------------
\108\ DOL calculations based on statistics from U.S. Department
of Labor, Employee Benefits Security Administration, ``Private
Pension Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports,''
(forthcoming 2020), (46,869 DB plans * 19% = 8,905 DB plans; 93,033
DC Plans * 19% = 17,676 DC plans; 581,974 * 9% = 52,378 individual
account plans with participant direction).
---------------------------------------------------------------------------
While DB plans may change investments at least annually, DC plans
may do so less frequently. For this analysis, DC plans are assumed to
review their service providers and investments about every three years.
Therefore, the Department estimates that in a year, 89 DB plans and 59
DC plans with ESG investments that are not participant directed, and
175 participant-directed DC plans with ESG alternatives will encounter
alternative investment options that cannot be distinguished on the
basis of pecuniary factors.
2.1. Maintain Documentation
The final rule requires ESG plan fiduciaries to maintain
documentation when choosing between or among investment alternatives
that the fiduciary prudently determines would serve equivalent roles in
the plan's portfolio based on appropriate consideration of the
investment and that the plan fiduciary is unable to distinguish on the
basis of pecuniary factors and the fiduciary bases the investment
decision on non-pecuniary factors. While much of the
[[Page 72880]]
documentation needed to fulfill this requirement is generated in the
normal course of business, plans may need additional time to ensure
records are properly maintained and are up to the standard required by
the Department.
Some commenters suggested that the Department underestimated the
cost associated with documenting the required information.
Specifically, they asserted that the Department underestimated the
labor rates for attorneys and the time required to document the
required information. The Department disagrees with both of these
comments. Instead of using an attorney labor rate, the Department based
its estimate on a plan fiduciary's labor rate, because this task could
be performed by attorneys or other types of professionals including
financial professionals. The labor rate estimates were based on
estimates from the Bureau of Labor Statistics (BLS). While the
Department understands that hiring outside services can come at a
higher cost, the Department believes that using the BLS estimate is
appropriate for purposes of this analysis.
Commenters claimed that the two hours estimated to document when
alternative investments cannot be distinguished based on pecuniary
factors underestimated the burden. The Department continues to believe
that a prudent process required by ERISA should already include the
burden of research and consideration. The burden associated with this
ICR is for plan fiduciaries to meet the final rule's specific
documentation requirement. In the final rule, the Department explicitly
set forth the three items that must be documented. Stating precisely
what is required to be documented should help lower the cost of
compliance, because fiduciaries know the specific information that must
be documented. In response to the comments, and to avoid
underestimating the final rule's potential costs, the Department has
not reduced the total estimated quantified costs although the research
burden of the rule has been reduced.
The Department estimates that plan fiduciaries and clerical staff
will each expend, on average, two hours of labor to maintain the needed
documentation. This results in an annual burden estimate of 1,290 hours
annually, with an equivalent cost of $122,115 for DB plans and DC plans
with ESG investments.\109\ Plans that rely on service providers may
incur a lower cost due to economies of scale. However, the Department
does not know exactly how many plans use a service provider; therefore,
it estimated such costs on a per-plan basis.
---------------------------------------------------------------------------
\109\ The burden is estimated as follows: (8,905 DB plans * 0.01
* 2 hours) + (17,676 DC plans * 0.01 * 2 hours * 0.33) + (52,378 DC
plans with participant direction * 0.01 * 2 hours * 0.33) = 645
hours for both a plan fiduciary and clerical staff for a total of
1,290. A labor rate of $134.21 is used for a plan fiduciary and a
labor rate of $55.14 for clerical staff ((8,905 DB plans * 0.01 * 2
* $134.21) + (17,676 DC plans * 0.01 * 2 hours* 0.33 * $134.21)) +
(52,378 DC plans with participant direction * 0.01 * 2 hours * 0.33
* $134.21) + (8,905 DB plans * 0.01 * 2 * $55.14) + (17,676 DC plans
* 0.01 * 2 hours* 0.33 * $55.14)) + (52,378 DC plans with
participant direction * 0.01 * 2 hours * 0.33 * $55.14) = $122,115).
---------------------------------------------------------------------------
The Department's paperwork burden estimate associated with the
final rule is summarized as follows:
Type of Review: New collection.
Agency: Employee Benefits Security Administration, Department of
Labor.
Title: Financial Factors in Selecting Plan Investments.
OMB Control Number: 1210-0162.
Affected Public: Businesses or other for-profits.
Estimated Number of Respondents: 323.
Estimated Number of Annual Responses: 323.
Frequency of Response: Occasionally.
Estimated Total Annual Burden Hours: 1,290.
Estimated Total Annual Burden Cost: $0.
2. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) \110\ imposes certain
requirements with respect to Federal rules that are subject to the
notice and comment requirements of section 553(b) of the Administrative
Procedure Act \111\ and that are likely to have a significant economic
impact on a substantial number of small entities. Unless the head of an
agency determines that a final rule is not likely to have a significant
economic impact on a substantial number of small entities, section 603
of the RFA requires the agency to present a final regulatory
flexibility analysis of the final rule.
---------------------------------------------------------------------------
\110\ 5 U.S.C. 601 et seq. (1980).
\111\ 5 U.S.C. 551 et seq. (1946).
---------------------------------------------------------------------------
For purposes of analysis under the RFA, the Employee Benefits
Security Administration (EBSA) continues to consider a small entity to
be an employee benefit plan with fewer than 100 participants.\112\ The
basis of this definition is found in section 104(a)(2) of ERISA, which
permits the Secretary of Labor to prescribe simplified annual reports
for pension plans that cover fewer than 100 participants. Under section
104(a)(3), the Secretary may also provide for exemptions or simplified
annual reporting and disclosure for welfare benefit plans. Pursuant to
the authority of section 104(a)(3), the Department has previously
issued--at 29 CFR 2520.104-20, 2520.104-21, 2520.104-41, 2520.104-46,
and 2520.104b-10--certain simplified reporting provisions and limited
exemptions from reporting and disclosure requirements for small plans.
Such plans include unfunded or insured welfare plans covering fewer
than 100 participants and satisfying certain other requirements.
Further, while some large employers may have small plans, in general
small employers maintain small plans. Thus, EBSA believes that
assessing the impact of this final rule on small plans is an
appropriate substitute for evaluating the effect on small entities. The
definition of small entity considered appropriate for this purpose
differs, however, from a definition of small business that is based on
size standards promulgated by the Small Business Administration (SBA)
\113\ pursuant to the Small Business Act.\114\ In its initial
regulatory flexibility analysis for the proposal, the Department
requested, but did not receive, comments on the appropriateness of the
size standard used in evaluating the impact of the proposed rule on
small entities.
---------------------------------------------------------------------------
\112\ The Department consulted with the Small Business
Administration's Office of Advocacy before making this
determination, as required by 5 U.S.C. 603(c) and 13 CFR 121.903(c).
\113\ 13 CFR 121.201.
\114\ 15 U.S.C. 631 et seq.
---------------------------------------------------------------------------
The Department has determined that this final rule could have a
significant impact on a substantial number of small entities.
Therefore, the Department has prepared a Final Regulatory Flexibility
Analysis that is presented below.
3.1. Need for and Objectives of the Rule
The final rule confirms that ERISA requires plan fiduciaries to
select investments and investment courses of action based solely on
financial considerations relevant to the risk-adjusted economic value
of a particular investment or investment course of action. This will
help ensure that fiduciaries are protecting the financial interests of
participants and beneficiaries.
3.2. Affected Small Entities
The final rule has documentation provisions that will affect small
ERISA-covered plans with fewer than 100 participants. It also contains
provisions about the improper use of non-pecuniary factors when plan
fiduciaries select and monitor investments. These provisions will
affect only small plans that are improperly incorporating non-
[[Page 72881]]
pecuniary factors into their investment decisions.
As discussed in the affected entities section above, surveys
suggest that 19 percent of DB plans and DC plans with investments that
are not participant directed and 9 percent of DC plans with participant
directed individual accounts have ESG or ESG-themed investments. Plans
with ESG or ESG-themed investments are used as a proxy of the number of
plans that could be affected by the final rule. This represents
approximately 8,905 DB plans and 70,054 DC plans. Additionally, surveys
suggest 70 percent of DC plans with participant-directed individual
accounts offer a QDIA. Of the 70 percent, the Department estimates that
0.1 percent have exposure to ESG investments, representing
approximately 407 plans.
The distribution across plan size is not available in the surveys.
It should be noted that 84 percent of all DB plans and 87 percent of
all DC plans are small plans.\115\ Applying these proportions
uniformly, 7,480 small DB plans and 60,947 small DC plans are estimated
to be affected by the rule. Particularly for DB plans, it is likely
that most plans with ESG investments are large. In terms of the actual
utilization of ESG options, about 0.1 percent of total DC plan assets
are invested in ESG funds.\116\ In addition, one survey found that
among 401(k) plans with fewer than 50 participants, approximately 1.7
percent offered an ESG investment option.\117\ Therefore, a large
majority of small plan participants do not have an ESG fund in their
portfolio.
---------------------------------------------------------------------------
\115\ DOL calculations based on statistics from U.S. Department
of Labor, Employee Benefits Security Administration, ``Private
Pension Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports,''
(forthcoming 2020).
\116\ 62nd Annual Survey of Profit Sharing and 401(k) Plans,
Plan Sponsor Council of America (2019).
\117\ Id.
---------------------------------------------------------------------------
One commenter suggested that the Department underestimated the
percent of small DC plans that offer an ESG investment option. The
commenter asserted that their data analysis indicates that 14.5 percent
of corporate DC plans with fewer than 50 participants have an ESG
option. The experience of one service provider is insightful, but may
not be representative of the industry as a whole. While the Department
appreciates the input, the commenter did not provide the data source
for their statistic. Thus, the Department could not access the validity
of the data and general applicability of the statistic. The Department
did consider the statistic when reevaluating its estimates, and when
combined with other data points, raised its estimate from six percent
to nine percent of DC plans with individual accounts where a plan
fiduciary could not distinguish investment alternatives based on
pecuniary factors and such fiduciary is required to document its use of
a non-pecuniary factor.
One commenter was concerned that the Department did not survey plan
participants and fiduciaries in order to estimate the cost incurred by
the plan. While the Department acknowledges this concern, the
Department used survey data from the Plan Sponsor Council of America to
estimate the percent of small DC plans that offer an ESG investment
option. The Department believes that the impact of the rule has been
accurately assessed.
Other general comments about the final rule and its impacts are
discussed elsewhere in the preamble.
3.3. Impact of the Rule
While the rule is expected to affect small pension plans, it is
unlikely there will be a significant economic impact on many of these
plans. The final regulation provides guidance on how fiduciaries can
comply with section 404(a)(1)(B) of ERISA when investing plan assets.
The Department believes most plans are already fulfilling the
requirement in the course of following the Department's prior sub-
regulatory guidance.
The Department expects some small plans to experience rising costs
from three potential sources. The first cost is associated with the
time required for plan fiduciaries to review the rule and amending
investment policy statements to reflect it. The second cost is
associated with the requirement for plan fiduciaries to document
selections of investments based on non-pecuniary factors where the
alternative investment options are unable to be distinguished on the
basis of pecuniary factors alone. The third cost is associated with the
final rule's provision prohibiting plan fiduciaries from adding any
investment fund, product, or model portfolio as, or as a component of,
a QDIA if its investment objectives or goals or its principal
investment strategies include, consider, or indicate the use of one or
more non-pecuniary factors. The final rule allows for a transition
period for plans to review and make necessary changes to pre-existing
QDIAs; however, as discussed in the regulatory impact analysis, the
Department assumes that associated costs will be incurred during the
first year.
As illustrated in Table 1 below, the Department estimates a cost of
$3,599.74 per affected plan in year 1 and $379 per affected plan in
year two for plan fiduciaries and clerical professionals to become
familiar with the final rule, fulfill the documentation requirement,
and review their QDIA holdings. These costs reflect an instance in
which (1) a plan has exposure to investments with non-pecuniary
investment objectives, (2) a plan fiduciary uses a non-pecuniary factor
to make an investment decision between investments that cannot be
distinguished on the basis of pecuniary factors, and (3) a plan offers
a QDIA in which the QDIA, or component of the QDIA, considers, or
indicates the use of, one or more non-pecuniary factors in its
investment objectives or goals or its principal investment strategies.
As discussed throughout the regulatory impact analysis, most plans will
only incur the rule familiarization costs, while few plans will incur
both costs (2) and (3). Plans needing to provide documentation will be
rare, because tie-breakers rarely occur, and only an estimated 0.1
percent of plans need to update their QDIA holdings, because the QDIA
or a component thereof, includes, considers, or indicates the use of,
one or more non-pecuniary factors in its investment objectives or goals
or its principal investment strategies.
Table 1--Costs for Plans To Comply With Requirements
----------------------------------------------------------------------------------------------------------------
Affected entity Labor rate Hours Year 1 cost Year 2 cost
----------------------------------------------------------------------------------------------------------------
Documentation: Plan Fiduciary................... $134.21 2 $268.42 $268.42
Documentation: Clerical workers................. 55.14 2 110.28 110.28
Rule Familiarization: Plan Fiduciary............ 134.21 4 536.84 0
Update QDIA Holdings: Plan Fiduciary............ 134.21 20 2,684.20 0
[[Page 72882]]
Total: Plans Needing Familiarization Only... .............. .............. 536.84 0
---------------------------------------------------------------
Total: Plans Needing to Update QDIA and .............. .............. 3,599.74 $378.70
Provide Documentation......................
----------------------------------------------------------------------------------------------------------------
Source: DOL calculations based on statistics from Labor Cost Inputs Used in the Employee Benefits Security
Administration, Office of Policy and Research's Regulatory Impact Analyses and Paperwork Reduction Act Burden
Calculation, Employee Benefits Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
Small plans affected by the rule--those with exposure to
investments considering non-pecuniary factors--would incur a cost
associated with the time to review the rule and amend relevant
investment policy statements. The Department estimates that nine
percent of plans would fall into this category. Additionally, the
Department believes small plans are likely to rely on service providers
to monitor regulatory changes and make necessary changes to the plan.
Overall, the Department expects the costs associated with the
familiarization of the rule to be small on a per-plan basis.
As stated above, the final rule also prohibits plan fiduciaries
from adding any investment fund, product, or model portfolio as, or as
a component of, a QDIA if its investment objectives or goals or its
principal investment strategies include, consider, or indicate the use
of one or more non-pecuniary factors. While the cost in the table above
reflects a cost for participant-directed individual account plans with
exposure to investments with non-pecuniary objectives, the Department
believes this is likely to affect few small plans. The Department
estimates that 0.1 percent of all plans would need to reassess their
QDIAs; however, as the Department believes small plans are likely to
rely on service providers to propose compliant QDIAs, this estimate
likely represents an upper bound of the burden on affected small
entities. Further, the Department believes service providers should be
familiar with the available target-date funds and be able to propose an
alternative, compliant QDIA without expending material resources. As
discussed above, this restriction will affect small plans; however, the
Department expects that a minimal burden will be imposed on a small
number of them.
3.4. Regulatory Alternatives
As discussed above in this preamble, the final regulation
reiterates and codifies long-established principles of fiduciary
standards for selecting and monitoring investments, and thus seeks to
provide clarity and certainty regarding the scope of fiduciary duties
surrounding non-pecuniary issues. These standards apply to all affected
entities, both large and small; therefore, the Department's ability to
craft specific alternatives for small plans is limited.
The Department carefully considered the final rule's impact on
small entities by analyzing other alternatives for the proposal. One
alternative would prohibit plan fiduciaries from ever considering ESG
or similar factors. This would address the Department's concerns that
some plan fiduciaries may sacrifice return or increase investment risk
to promote goals that are unrelated to the financial interests of the
plan or its participants. However, the Department rejected this
alternative, because it would prohibit fiduciaries from considering
such factors even when the fiduciaries are focused on the financial
aspects rather than the non-pecuniary aspects of the investments.
The Department also has considered prohibiting plan fiduciaries
from basing investment decisions on non-pecuniary factors and
prohibiting the use of non-pecuniary factors even where plan
fiduciaries cannot distinguish alternative investment options based on
pecuniary factors. But if the alternative investment options cannot be
distinguished on the basis of pecuniary factors, it is unclear what
factors would be available for a plan fiduciary to base its decision on
other than non-pecuniary factors. Regardless, the Department believes
this circumstance occurs very rarely in practice, if at all.
Accordingly, this final rule retains the ``all things being equal''
test from the Department's previous guidance with a specific
requirement for plan fiduciaries to document (1) why the pecuniary
factors were not sufficient to select the investment; (2) how the
investment compares to alternative investments with regard to the
factors listed in paragraphs (b)(2)(ii)(A) through (C) of the final
rule; and (3) how the chosen non-pecuniary factors are consistent with
the interests of participants and beneficiaries in their retirement
income or financial benefits under the plan.
The Department notes that the proposal did not expressly
incorporate the tie-breaker provision into the regulatory provision on
selection of investment options for individual account plans. The
Department explained in the proposal its perspective that the concept
of ``ties'' may have little relevance in the context of fiduciaries'
selection of menu options for individual account plans as such
investment options are often chosen precisely for their varied
characteristics and the range of choices they offer plan participants.
Further, the Department explained that because the proposal did not
restrict the addition of prudently selected, well-managed investment
options for individual account plans that include non-pecuniary factors
if they can be justified solely on the basis of pecuniary factors,
there would be little need for a tie-breaker between selected
investment funds. Nonetheless, some commenters expressed some
uncertainty regarding the interaction of paragraph (c)(2) and the
provisions of the proposal on selecting investment options for
individual account plans. Some commenters asked the Department to
expressly make the tie-breaker available for such investment decisions.
Although the Department continues to doubt the relevance of a
``tie'' concept when adding investment alternatives to a platform of
investments that allow participants and beneficiaries to choose from a
broad range of investment alternatives as defined in 29 CFR 2550.404c-
1(b)(3), the final rule makes the tie-breaker provisions in paragraph
(c) generally available for use in selecting investment options for
individual account plans in the event the fiduciaries of the plan
believe that it gives them some added flexibility and fiduciary
protection when adding an investment fund, product, or model portfolio
that promotes, seeks, or supports one or more non-pecuniary goals.
Paragraph (d) of the final rule contains standards applicable to
participant-directed individual account plans. The predecessor
standards for
[[Page 72883]]
participant-directed individual account plans were set forth in
paragraph (c)(3) of the proposal. Paragraph (c)(3)(ii) of the proposal
would have required plan fiduciaries to document their compliance with
the requirement to use only objective risk-return criteria in the
selection and monitoring of investment platform or menu alternatives.
The Department included the cost plan fiduciaries would incur to comply
with this documentation requirement in its cost estimates for the
proposal.
The Department considered including this document requirement in
the final rule; however, it determined not to include such requirement
in paragraph (d)(2) of the final rule. The Department was persuaded by
some commenters' concerns that this requirement would have applied more
stringent requirements to ESG investment alternatives than other types
of investment alternatives. These commenters argued that it is
inappropriate to impose separate documentation requirements that vary
by investment strategy. Other commenters objected to this requirement
on the grounds that it would increase costs to plans and potentially
provide grounds for unwarranted class action lawsuits.
The Department believes that the approach taken in the final rule
best reflects the statutory obligations of prudence, appropriately
ensures that large and small plan fiduciaries' decisions would be
guided by the financial interests of the plans and participants to whom
they owe duties of prudence, and is the most efficient alternative to
apply and enforce.
3.5. Duplicate, Overlapping, or Relevant Federal Rules
The Department is issuing this final rule under sections
404(a)(1)(A) and 404(a)(1)(B) of Title I under ERISA. The Department
has sole jurisdiction to interpret these provisions as they apply to
plan fiduciaries' consideration of non-pecuniary factors in selecting
plan investment funds. Therefore, there are no duplicate, overlapping,
or relevant Federal rules.
4. Unfunded Mandates Reform Act
Title II of the Unfunded Mandates Reform Act of 1995 (Pub. L. 104-
4) requires each Federal agency to prepare a written statement
assessing the effects of any Federal mandate in a proposed or final
agency rule that may result in an expenditure of $100 million or more
(adjusted annually for inflation with the base year 1995) in any one
year by state, local, and tribal governments, in the aggregate, or by
the private sector. For purposes of the Unfunded Mandates Reform Act,
as well as Executive Order 12875, this final rule does not include any
Federal mandate that the Department expects would result in such
expenditures by state, local, or tribal governments.
5. Federalism Statement
Executive Order 13132 outlines fundamental principles of federalism
and requires the adherence to specific criteria by Federal agencies in
the process of their formulation and implementation of policies that
have ``substantial direct effects'' on the states, the relationship
between the National Government and the states, or on the distribution
of power and responsibilities among the various levels of
government.\118\ Federal agencies promulgating regulations that have
federalism implications must consult with state and local officials,
and describe the extent of their consultation and the nature of the
concerns of state and local officials in the preamble to the final
rule.
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\118\ Federalism, 64 FR 153 (Aug. 4, 1999).
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In the Department's view, this final regulation does not have
federalism implications because it will not have direct effects on the
states, the relationship between the National Government and the
states, or on the distribution of power and responsibilities among
various levels of government. Section 514 of ERISA provides, with
certain exceptions specifically enumerated, that the provisions of
Titles I and IV of ERISA supersede any and all laws of the states as
they relate to any employee benefit plan covered under ERISA. The
requirements implemented in the final rule do not alter the fundamental
reporting and disclosure requirements of the statute with respect to
employee benefit plans, and as such have no implications for the states
or the relationship or distribution of power between the National
Government and the states.
Statutory Authority
This regulation is finalized pursuant to the authority in section
505 of ERISA (Pub. L. 93-406, 88 Stat. 894; 29 U.S.C. 1135) and section
102 of Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17,
1978), effective December 31, 1978 (44 FR 1065, January 3, 1979), 3 CFR
1978 Comp. 332, and under Secretary of Labor's Order No. 1-2011, 77 FR
1088 (Jan. 9, 2012).
List of Subjects in 29 CFR Parts 2509 and 2550
Employee benefit plans, Employee Retirement Income Security Act,
Exemptions, Fiduciaries, Investments, Pensions, Prohibited
transactions, Reporting and Recordkeeping requirements, Securities.
For the reasons set forth in the preamble, the Department amends
parts 2509 and 2550 of subchapters A and F of chapter XXV of title 29
of the Code of Federal Regulations as follows:
Subchapter A--General
PART 2509--INTERPRETIVE BULLETINS RELATING TO THE EMPLOYEE
RETIREMENT INCOME SECURITY ACT OF 1974
0
1. The authority citation for part 2509 continues to read as follows:
Authority: 29 U.S.C. 1135. Secretary of Labor's Order 1-2003, 68
FR 5374 (Feb. 3, 2003). Sections 2509.75-10 and 2509.75-2 issued
under 29 U.S.C. 1052, 1053, 1054. Sec. 2509.75-5 also issued under
29 U.S.C. 1002. Sec. 2509.95-1 also issued under sec. 625, Pub. L.
109-280, 120 Stat. 780.
Sec. 2509.2015-01 [Removed]
0
2. Remove Sec. 2509.2015-01.
Subchapter F--Fiduciary Responsibility under the Employee Retirement
Income Security Act of 1974
PART 2550--RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY
0
3. The authority citation for part 2550 continues to read as follows:
Authority: 29 U.S.C. 1135 and Secretary of Labor's Order No.
12011, 77 FR 1088 (January 9, 2012). Sec. 102, Reorganization Plan
No. 4 of 1978, 5 U.S.C. App. at 727 (2012). Sec. 2550.401c-1 also
issued under 29 U.S.C. 1101. Sec. 2550.404a-1 also issued under sec.
657, Pub. L. 107-16, 115 Stat 38. Sec. 2550.404a-2 also issued under
sec. 657 of Pub. L. 107-16, 115 Stat. 38. Sections 2550.404c-1 and
2550.404c-5 also issued under 29 U.S.C. 1104. Sec. 2550.408b-1 also
issued under 29 U.S.C. 1108(b)(1). Sec. 2550.408b-19 also issued
under sec. 611, Pub. L. 109-280, 120 Stat. 780, 972. Sec. 2550.412-1
also issued under 29 U.S.C. 1112.
0
4. Revise Sec. 2550.404a-1 to read as follows:
Sec. 2550.404a-1 Investment duties.
(a) In general. Section 404(a)(1)(A) and 404(a)(1)(B) of the
Employee Retirement Income Security Act of 1974, as amended (ERISA or
the Act) provide, in part, that a fiduciary shall discharge that
person's duties with respect to the plan solely in the interests of the
participants and beneficiaries, for the
[[Page 72884]]
exclusive purpose of providing benefits to participants and their
beneficiaries and defraying reasonable expenses of administering the
plan, and with the care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent person acting in a like
capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims.
(b) Investment duties. (1) With regard to the consideration of an
investment or investment course of action taken by a fiduciary of an
employee benefit plan pursuant to the fiduciary's investment duties,
the requirements of section 404(a)(1)(B) of the Act set forth in
paragraph (a) of this section are satisfied if the fiduciary:
(i) Has given appropriate consideration to those facts and
circumstances that, given the scope of such fiduciary's investment
duties, the fiduciary knows or should know are relevant to the
particular investment or investment course of action involved,
including the role the investment or investment course of action plays
in that portion of the plan's investment portfolio with respect to
which the fiduciary has investment duties; and
(ii) Has acted accordingly.
(2) For purposes of paragraph (b)(1) of this section, ``appropriate
consideration'' shall include, but is not necessarily limited to:
(i) A determination by the fiduciary that the particular investment
or investment course of action is reasonably designed, as part of the
portfolio (or, where applicable, that portion of the plan portfolio
with respect to which the fiduciary has investment duties), to further
the purposes of the plan, taking into consideration the risk of loss
and the opportunity for gain (or other return) associated with the
investment or investment course of action compared to the opportunity
for gain (or other return) associated with reasonably available
alternatives with similar risks; and
(ii) Consideration of the following factors as they relate to such
portion of the portfolio:
(A) The composition of the portfolio with regard to
diversification;
(B) The liquidity and current return of the portfolio relative to
the anticipated cash flow requirements of the plan; and
(C) The projected return of the portfolio relative to the funding
objectives of the plan.
(3) An investment manager appointed, pursuant to the provisions of
section 402(c)(3) of the Act, to manage all or part of the assets of a
plan, may, for purposes of compliance with the provisions of paragraphs
(b)(1) and (2) of this section, rely on, and act upon the basis of,
information pertaining to the plan provided by or at the direction of
the appointing fiduciary, if--
(i) Such information is provided for the stated purpose of
assisting the manager in the performance of the manager's investment
duties; and
(ii) The manager does not know and has no reason to know that the
information is incorrect.
(c) Investments based on pecuniary factors. (1) A fiduciary's
evaluation of an investment or investment course of action must be
based only on pecuniary factors, except as provided in paragraph (c)(2)
of this section. A fiduciary may not subordinate the interests of the
participants and beneficiaries in their retirement income or financial
benefits under the plan to other objectives, and may not sacrifice
investment return or take on additional investment risk to promote non-
pecuniary benefits or goals. The weight given to any pecuniary factor
by a fiduciary should appropriately reflect a prudent assessment of its
impact on risk-return.
(2) Notwithstanding the requirements of paragraph (c)(1) of this
section, when choosing between or among investment alternatives that
the plan fiduciary is unable to distinguish on the basis of pecuniary
factors alone, the fiduciary may use non-pecuniary factors as the
deciding factor in the investment decision provided that the fiduciary
documents:
(i) Why pecuniary factors were not sufficient to select the
investment or investment course of action;
(ii) How the selected investment compares to the alternative
investments with regard to the factors listed in paragraphs
(b)(2)(ii)(A) through (C) of this section; and
(iii) How the chosen non-pecuniary factor or factors are consistent
with the interests of participants and beneficiaries in their
retirement income or financial benefits under the plan.
(d) Investment alternatives for participant-directed individual
account plans. (1) The standards set forth in paragraphs (a) and (c) of
this section apply to a fiduciary's selection or retention of
designated investment alternatives available to participants and
beneficiaries in an individual account plan.
(2) In the case of selection or retention of investment
alternatives for an individual account plan that allows plan
participants and beneficiaries to choose from a broad range of
investment alternatives as defined in Sec. 2550.404c-1(b)(3), a
fiduciary is not prohibited from considering or including an investment
fund, product, or model portfolio as a designated investment
alternative solely because the fund, product, or model portfolio
promotes, seeks, or supports one or more non-pecuniary goals, provided
that:
(i) The fiduciary satisfies the requirements of paragraphs (a) and
(c) of this section in selecting or retaining any such investment fund,
product, or model portfolio; and
(ii) The investment fund, product, or model portfolio is not added
or retained as, or as a component of, a qualified default investment
alternative described in Sec. 2550.404c-5 if its investment objectives
or goals or its principal investment strategies include, consider, or
indicate the use of one or more non-pecuniary factors.
(e) [Reserved]
(f) Definitions. For purposes of this section:
(1) The term investment duties means any duties imposed upon, or
assumed or undertaken by, a person in connection with the investment of
plan assets which make or will make such person a fiduciary of an
employee benefit plan or which are performed by such person as a
fiduciary of an employee benefit plan as defined in section 3(21)(A)(i)
or (ii) of the Act.
(2) The term investment course of action means any series or
program of investments or actions related to a fiduciary's performance
of the fiduciary's investment duties, and includes the selection of an
investment fund as a plan investment, or in the case of an individual
account plan, a designated investment alternative under the plan.
(3) The term pecuniary factor means a factor that a fiduciary
prudently determines is expected to have a material effect on the risk
and/or return of an investment based on appropriate investment horizons
consistent with the plan's investment objectives and the funding policy
established pursuant to section 402(b)(1) of ERISA.
(4) The term plan means an employee benefit plan to which Title I
of the Act applies.
(5) The term designated investment alternative means any investment
alternative designated by the plan into which participants and
beneficiaries may direct the investment of assets held in, or
contributed to, their individual accounts. The term ``designated
investment alternative'' shall not include ``brokerage windows,''
``self-directed brokerage accounts,'' or similar plan arrangements that
enable participants and beneficiaries to select investments beyond
those designated by the plan.
[[Page 72885]]
(g) Effective date. (1) This section shall be effective on January
12, 2021, and shall apply in its entirety to all investments made and
investment courses of action taken after January 12, 2021.
(2) Plans shall have until April 30, 2022 to make any changes to
qualified default investment alternatives described in Sec. 2550.404c-
5, where necessary to comply with the requirements of paragraph (d)(2)
of this section.
(h) Severability. If any provision of this section is held to be
invalid or unenforceable by its terms, or as applied to any person or
circumstance, or stayed pending further agency action, the provision
shall be construed so as to continue to give the maximum effect to the
provision permitted by law, unless such holding shall be one of
invalidity or unenforceability, in which event the provision shall be
severable from this section and shall not affect the remainder thereof.
Signed at Washington, DC, this 30th day of October 2020.
Jeanne Klinefelter Wilson,
Acting Assistant Secretary, Employee Benefits Security Administration,
Department of Labor.
[FR Doc. 2020-24515 Filed 11-12-20; 8:45 am]
BILLING CODE 4510-29-P