On October 30, 2020 the Department of Labor announced a final rule that provides guidelines to plan investment fiduciaries and clarifies the factors that must be taken into account when determining plan investment platforms and investments of plan assets. In brief, the final rule makes clear that environmental, social, governance (ESG) and other non-pecuniary goals must be strictly subordinate to a plan’s financial objectives and a plan participant’s retirement interests.
With the stated objective of strengthening retirement security, the Department’s final rule makes five major amendments to the regulations applicable to plan investment fiduciaries under Title I of ERISA (29 CFR 2550.404a-1), as follows:
- First, ERISA investment fiduciaries must evaluate plan investments and investment courses of action based solely on pecuniary factors – that is, financial considerations that have a material effect on the risk and/or rate of return of an investment based on appropriate investment horizons consistent with the plan's investment objectives and funding policy.
- Second, compliance with the exclusive purpose rule in ERISA Section 404(a)(1)(A) prohibits plan fiduciaries from subordinating the interests of participants to unrelated policy objectives, and bars them from sacrificing investment return or taking on additional investment risk to promote ESG or other non-pecuniary goals.
- Third, ERISA investment fiduciaries are required to consider reasonably available alternatives to satisfy their responsibilities of exercising prudence and acting in the exclusive interests of plan participants and beneficiaries.
- Fourth, ERISA investment fiduciaries must follow certain investment analysis and documentation requirements for those circumstances in which they 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 documentation requirement for such decisions is intended to prevent fiduciaries from improperly finding economic equivalence or making investment decisions based on ESG or other non-pecuniary benefits without appropriately careful analysis and evaluation.
- Fifth, the prudence and exclusive purpose standards set forth in ERISA Section 401(a) 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 also 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, 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 or supports one or more non-pecuniary goals; provided that in selecting any such investment the fiduciary bases the decision solely on financial factors. That is, an investment fiduciary may select an investment alternative based on financial factors even if such investment also happens to support ESG or other non-pecuniary objectives. However, the final rule prohibits investment plan fiduciaries from adding any investment fund, product, or model portfolio as a qualified default investment alternative (QDIA), or as a component of such QDIA, 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 final rule is effective 60 days after its publication in the Federal Register, although plans have until April 30, 2022 to make changes to QDIAs necessary to comply with the final rule.
ERISA plan investment fiduciaries, such as the plan sponsor and any designated plan investment fiduciary, should review their plan investment roster to confirm compliance with the final rule. If decisions to make or retain plan investments or to provide a platform of investment alternatives to plan participants were based on non-pecuniary factors, the plan investment fiduciary must determine whether the plan investment roster should be retained or adjusted in order to meet the requirements of the final rule. For example, if upon review an ESG-based investment is expected to outperform alternative investments and otherwise meets ERISA fiduciary standards, that investment could be retained on the basis that the investment would be in the best financial interests of the plan and plan participants. Conversely, if such ESG investment is expected to underperform investment alternatives or does not meet ERISA fiduciary standards, that investment should be replaced. Going forward, plan investment fiduciaries should make plan investment decisions and monitor plan investments consistent with the final rule.
If you have any questions relating to this Client Alert, or would like to discuss this matter, please contact James N. Karas, Jr., Robert C. Daleo, Jason D. Navarino, or Adam J. McInerney.