Final Investment Duties Rules Drop ESG Terminology and Separate Standard for Designated Investment Alternatives

The DOL has released the final version of its amended rules regarding the investment duties of ERISA plan fiduciaries. The amended rules respond to growth in the market for investments that consider environmental, social, corporate governance (ESG), and similar nonfinancial factors. According to the DOL, varied subregulatory guidance about ESG investments may have led to confusion about when and how those factors may be taken into account, so an amendment to the investment duties rules was needed to establish a regulatory structure that would focus decisionmaking on legitimate economic considerations and discourage investments that subordinate the financial interests of participants and beneficiaries to non-pecuniary goals. The final version of the rules includes substantial changes in response to comments on the proposed amendment (see our Checkpoint article). Highlights of those changes include—

• Prudence and Loyalty Addressed Separately. The final rules continue to address the duties of loyalty and prudence but separate the two discussions, treating only the rules’ description of a prudent process as a safe harbor. The loyalty provisions—which require evaluations of investments to be based only on pecuniary factors (except in certain tie-breaker situations) and prohibit subordinating participants’ retirement income and financial benefits to other objectives—are treated as minimum requirements, not safe harbors.
• Reasonably Available Alternatives. In response to commenters’ concern that the duty of prudence might require fiduciaries to “scour the market” for every possible investment alternative, the final rules clarify that fiduciaries need only compare investments with “reasonably available alternatives with similar risks.”
• ESG References Eliminated. All ESG terminology that appeared in the proposed rules has been removed. While ESG is a commonly used term, the DOL concluded that it is unhelpful as a regulatory standard because it has no uniform meaning and may muddy fiduciaries’ analysis of whether ESG factors are appropriate pecuniary considerations or inappropriate non-pecuniary considerations (outside of tie-breaker situations). The relevant question, the DOL notes, is whether a factor is pecuniary, not whether it is ESG.
• Tie-Breaker Situations. To alleviate confusion, the DOL has simplified the tie-breaker test for economically indistinguishable investments by focusing on situations in which the fiduciary is simply “unable to distinguish on the basis of pecuniary factors alone.” In those cases, non-pecuniary factors may be used as tie-breakers, but that decision must be documented to show (a) why pecuniary factors were insufficient, (b) how the selected investments compare to the alternatives, and (c) how any non-pecuniary factor used is “consistent with” the interests of participants and beneficiaries in their plan benefits. While the amendment does not elaborate on the factors that might be “consistent,” the preamble suggests that responding to participant demand for a type of investment to increase participation or contributions could qualify. The additional documentation requirement will not apply to designated investment alternatives unless the tie-breaker rules were used in their selection.
• Separate Standard for Individual Account Plans Eliminated. Under the proposed rules, individual account plans were permitted to use only “objective risk-return criteria” when selecting and monitoring investment alternatives. The final rules have eliminated that separate standard in response to comments that it was too restrictive and confusing. Instead, designated investment alternatives must satisfy the same standards as other investments, and fiduciaries will not be prohibited from selecting an investment solely because the investment also promotes, seeks, or supports a non-pecuniary goal, unless the investment is added or retained as a qualified default investment alternative (QDIA).
• QDIA Restriction Narrowed. An investment that promotes, seeks, or supports one or more non-pecuniary goals cannot be used as 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 preamble asserts that this narrower test can be applied objectively by simply looking at an investment fund’s prospectus, as non-pecuniary considerations must be disclosed if they form a material part of the fund’s investment objective or principal strategies.
• Effective Date. The final rules will take effect 60 days after their publication in the Federal Register. Plans will have until April 30, 2022, however, to make changes to their QDIAs in response to the final rules. The preamble suggests that the amendment will not require fiduciaries to immediately alter existing investments: The amendment applies only to decisions made after the effective date, “including decisions that are part of a fiduciary’s ongoing monitoring requirements.” Consistent with that interpretation, the DOL will not attempt to enforce the rule changes with respect to any investment action or decision taken prior to the rules’ effective date.

EBIA Comment: The preamble indicates that fiduciaries with investments that should be reassessed under the amended rules need not accelerate their decisionmaking. For example, they can apply the final rules to their current investments when they would next reconsider an investment under their established monitoring schedule. The preamble also notes that in some situations, the costs and risks of divesting may make holding an investment appropriate even if the investment or aspects of its decisionmaking process do not comply with the final rules. For more information, see EBIA’s 401(k) Plans manual at Sections XXV.D (“Selecting the Plan’s Investment Funds”) and XXVI.J (“Fiduciary Protection for Qualified Default Investment Alternative (QDIA)”).

Contributing Editors: EBIA Staff.