Seyfarth Synopsis: On October 30, 2020, the Department of Labor ("DOL") released a final regulation amending the fiduciary regulations governing investment duties under the Employee Retirement Investment Security Act of 1974 ("ERISA"). This final regulation is clear that an ERISA fiduciary should not consider "non-pecuniary" factors such as environmental, social or corporate governance ("ESG") or sustainability factors when considering an investment or investment strategy. Under the final rule, investment fiduciaries must evaluate investments and investment strategies solely based on pecuniary factors. The final regulation is generally effective 60 days after it is published in the Federal Register.
The DOL proposed this regulation on June 23, 2020, which is discussed in our July 1, 2020 post, Can You Invest Your Retirement Plan to Save the Planet? ERISA investment fiduciaries have been faced with the dilemma of whether social investing concepts have a role when investing ERISA plan assets. It appears that the DOL has answered this question. Specifically, social investing concepts only have a role if they potentially impact the risk of loss or opportunity for return of the proposed investment.
The DOL received numerous comment letters and objections critical to its proposed regulation, including claims that it was unnecessary rulemaking, reflected antiquated views, and provided too short a comment period. Despite the extensive comments it received, the final regulation is substantially the same as the proposed regulation. References to ESG were removed from the final regulation because the DOL did not want to narrow or limit the application of the final regulation. Under the final regulation, challenges remain for fiduciaries who consider non-pecuniary factors when making investment decisions.
The final regulation limited pecuniary factors to those factors that a fiduciary prudently determines are expected to have a material effect on the risk and/or return of an investment in light of the plan's investment horizon, investment objectives and funding policy. While many investors may believe that a company that incorporates ESG principles to manage its risks and create opportunities offers an inherently less risky investment, the DOL does not appear to be willing to accept the argument that ESG in and of itself could be a pecuniary factor.
The final rule continues to provide for "tie breakers," even though the preamble questions whether there could be a true tie-breaker situation. In such a situation, fiduciaries must document: why pecuniary factors were not sufficient to select the investment or investment course of action; how the selected investment compares to available alternatives; and how the non-pecuniary factors considered were consistent with the interest of the participants in their plan benefits. The DOL indicated in the preamble that whether an investment could increase plan contributions — e.g., investing the assets of a multiemployer plan in projects that will employ union members and increase contributions to the plan — was not a pecuniary interest. The same is true for adding an investment in response to interest expressed by plan participants.
For individual account plans that allow plan participants to choose from a range of investment alternatives, the regulation prohibits a fiduciary from considering or including an investment fund solely because the fund promotes, seeks or supports one of more non-pecuniary goals — e.g., an ESG focused fund. But, it does not prohibit including an ESG focused fund in the investment line-up. The final regulation, however, prohibits qualified default investment alternatives (QDIAs) with investment objectives or principal investment strategies that "include, consider, or indicate the use of one or more non-pecuniary factors." This prohibition could be interpreted to cast a wide net.
The regulations would make it difficult or impossible for plan fiduciaries to consider non-pecuniary factors (e.g., religious tenets, ESG factors, etc.) when selecting investment options under an ERISA participant-directed defined contribution plan. A potential solution could be offering a brokerage window, which can provide access to individuals who wish to invest their accounts according to non-pecuniary factors such as religious tenets. Brokerage windows have their pros and cons. In addition, a fiduciary's duties and responsibilities with respect to a brokerage window are not settled.
Historically, the DOL's position on the role of ESG in ERISA plan investing has shifted with changes in administrations. With these final regulations, there is no doubt that the DOL has clearly shifted against marketplace trends. But, with a Biden administration coming onboard, calls for the SEC to address ESG disclosures and a Senate task force aimed at overhauling corporate governance, questions remain on whether the door on the role of ESG investing is closed. For information on ESG in the broader marketplace and what it means from a company perspective, see our alert series here, here, here and here.
If you are concerned about an existing non-pecuniary investment or investment strategy (e.g., an ESG or sustainability investment) or are interested in such an investment or strategy, be sure to contact your Seyfarth employee benefits attorney.
Originally Published by Seyfarth Shaw, November 2020
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