[Federal Register Volume 85, Number 126 (Tuesday, June 30, 2020)]
[Proposed Rules]
[Pages 39113-39128]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-13705]
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AB95
Financial Factors in Selecting Plan Investments
AGENCY: Employee Benefits Security Administration, Department of Labor
ACTION: Proposed rule.
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SUMMARY: The Department of Labor (Department) in this document proposes
amendments to 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.
DATES: Comments on the proposal must be submitted on or before July 30,
2020.
ADDRESSES: You may submit written comments, identified by RIN 1210-AB95
to either of the following addresses:
[ssquf] Federal eRulemaking Portal: www.regulations.gov. Follow the
instructions for submitting comments.
[ssquf] Mail: Office of Regulations and Interpretations, Employee
Benefits Security Administration, Room N-5655, U.S. Department of
Labor, 200 Constitution Avenue NW, Washington, DC 20210, Attention:
Financial Factors in Selecting Plan Investments Proposed Regulation.
Instructions: All submissions received must include the agency name
and Regulatory Identifier Number (RIN) for this rulemaking. Persons
submitting comments electronically are encouraged not to submit paper
copies. Comments will be available to the public, without charge,
online at www.regulations.gov and www.dol.gov/agencies/ebsa and at the
Public Disclosure Room, Employee Benefits Security Administration,
Suite N-1513, 200 Constitution Avenue NW, Washington, DC 20210.
Warning: Do not include any personally identifiable or confidential
business information that you do not want publicly disclosed. Comments
are public records posted on the internet as received and can be
retrieved by most internet search engines.
FOR FURTHER INFORMATION CONTACT: Jason A. DeWitt, Office of Regulations
and Interpretations, Employee Benefits
[[Page 39114]]
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 and Purpose of Regulatory Action
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 their 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 plan fiduciaries
when making decisions on investments and investment courses of action
must be focused solely on the plan's financial returns and the
interests of plan participants and beneficiaries in their plan 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 ESG
investment issues was in Interpretive Bulletin 94-1 (IB 94-1).\6\
There, the term used was ``economically targeted investments'' (ETIs).
The Department's stated objective in issuing IB 94-1 was to state that
ETI investments \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 ETI investments 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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The Department's sub-regulatory guidance then went through an
iterative process. 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 risk 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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[[Page 39115]]
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, in
making its observation in IB 2015-01, the Department 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 as economic
considerations under generally accepted investment theories. In such
situations, the 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. 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 No. 2018-01 (Apr. 23, 2018).
\11\ Id.
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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
amount of assets invested in so-called sustainable funds in 2019 was
nearly four times larger 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 and inconsistencies, with numerous observers
identifying a lack of precision and rigor 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\
Moreover, ESG funds often come with higher fees, because additional
investigation and monitoring are necessary to assess an investment from
an ESG perspective.\15\ Currently 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.\16\ The SEC also
is soliciting 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.\17\
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\13\ See, e.g., 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; 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.
\14\ See, e.g., 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., 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.
\16\ 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.
\17\ 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 and properly pursue a
broad range of objectives, subject to the disclosure requirements and
other requirements of the securities laws. Pension plans covered by
ERISA are statutorily-bound to a narrower objective: management with an
``eye single'' to maximizing the funds available to pay retirement
benefits.\18\ Providing a secure retirement for American workers is the
paramount,
[[Page 39116]]
and eminently-worthy, ``social'' goal of ERISA plans; plan assets may
not be enlisted in pursuit of other social or environmental objectives.
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\18\ Donovan v. Bierwirth, supra, 680 F.2d at 271.
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The Department is concerned, however, 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. 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.
\19\ For example, the Department understands that in the case of some
ESG investment funds being offered to ERISA defined contribution plans,
fund managers are representing that the fund is appropriate for ERISA
plan investment platforms, while acknowledging in disclosure materials
that the fund may perform differently or forgo certain opportunities,
or accept different investment risks, in order to pursue the ESG
objectives.
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\19\ 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 proposed regulation is designed in part 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. 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.\20\ And the duty of prudence prevents a fiduciary from
choosing an investment alternative that is financially less beneficial
than an available alternative. These fiduciary standards are the same
no matter the investment vehicle or category.
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\20\ See Unif. Prudent Inv. Act Sec. 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 Sec. 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 subject over the years in
sub-regulatory guidance. Accordingly, the Department intends, by this
proposal, to reiterate and codify long-established principles of
fiduciary standards for selecting and monitoring investments, and thus
to provide clarity and certainty regarding the scope of fiduciary
duties surrounding non-pecuniary issues. The Department's longstanding
and consistent position, reiterated in multiple forms of guidance and
based on the explicit language of ERISA itself, is that plan
fiduciaries when making decisions on investments and investment courses
of action must be focused solely on the plan's financial risks and
returns, and the interests of plan participants and beneficiaries in
their plan benefits must be 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.
As the Department has recognized in its prior guidance, there may
be instances where factors that sometimes are considered without regard
to their pecuniary import--such as environmental considerations--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. These
would be appropriate economic considerations that qualified investment
professionals would treat as material under generally accepted
investment theories. 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 risk to promote non-pecuniary
benefits or objectives. The Department believes that providing further
clarity on these issues in the form of a notice and comment regulation
will help safeguard the interests of participants and beneficiaries in
the plan benefits. This proposed rule is considered to be an Executive
Order (E.O.) 13771 regulatory action. Details on the estimated costs of
this proposed rule can be found in the proposal's economic analysis.
B. Provisions of the Proposed Rule
The proposed 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.\21\
For example, 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
believes 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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\21\ 44 FR 37255 (June 26, 1979).
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Thus, the proposed rule does not revise the 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
[[Page 39117]]
return of the portfolio relative to the funding objectives of the plan.
Rather, the proposed rule elaborates upon the core principles
provided in the ``Investment duties'' regulation by making clear that
fiduciaries may never subordinate the interests of plan participants
and beneficiaries in their retirement income to non-pecuniary goals.
Application of this corollary principle and the nature of the
fiduciary's duties will, of course, depend on the facts and
circumstances, which take into account the scope of investment duties
the fiduciary knows or should know are relevant to the particular
investment decision that a prudent person having similar duties and
familiar with such matters would consider relevant.
Paragraph (a) of the proposed rule includes a restatement of the
statutory language of the exclusive purpose requirements of ERISA
section 404(a)(1)(A), in addition to the restatement in the existing
regulation of the prudence duty of ERISA section 404(a)(1)(B). As
stated above, the application of these requirements is context-
specific.
Paragraph (b)(1) provides that the loyalty and prudence
requirements of ERISA section 404(a)(1)(A) and 404(a)(1)(B) are
satisfied in connection with an investment decision if, in addition to
the requirements in the existing paragraph (b)(1), the fiduciary has
selected investments and/or investment courses of action based solely
on their pecuniary factors and not on the basis of any non-pecuniary
factor. To round out the requirements of the duty of loyalty, the
proposed rule includes in paragraph (b)(1) a requirement that
fiduciaries not act to subordinate the interests of participants or
beneficiaries to the fiduciary's or another's interests, and has
otherwise complied with the duty of loyalty.
Paragraph (b)(2) of the proposal adds to the original regulation a
requirement that appropriate consideration of an investment or
investment course of action includes a requirement to compare
investments or investment courses of action to other available
investments or investment courses of action with regard to the factors
listed in paragraphs (b)(2)(ii)(A) through (C). Facts and circumstances
relevant to a comparison of investments or investment courses of action
would include consideration of the level of diversification, degree of
liquidity, and potential risk and return in comparison to available
alternative investments. Clarifying that an investment or investment
course of action must be compared to available alternatives is an
important reminder that fiduciaries must not let non-pecuniary
considerations draw them away from an alternative option that would
provide better financial results. The paragraph also clarifies that the
listed factors are not necessarily the only factors that need to be
considered in order to emphasize that the paragraph is intended to
specify the central obligations associated with the ``appropriate
consideration'' requirement for proper management of an investment
portfolio but should not be read to more broadly address the
requirements in paragraph (b)(1)(ii) or paragraph (b)(1)(iii), or to
otherwise modify the statutory standards set forth in section
404(a)(1)(A) or 404(a)(1)(B) of ERISA.
Paragraph (c) is entirely new and is intended to expound upon the
consideration of pecuniary versus non-pecuniary factors in practice in
both defined benefit and defined contribution plans.
Paragraph (c)(1) directly provides that a fiduciary's evaluation of
an investment must be focused only on pecuniary factors. The paragraph
explains that it is unlawful for a fiduciary to sacrifice return or
accept additional risk to promote a public policy, political, or any
other non-pecuniary goal. Paragraph (c)(1) is careful to acknowledge,
however, that ESG factors and other similar considerations may be
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 proposed rule emphasizes 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 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 paragraph further emphasizes
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.
The Department's current guidance provides that if, after such an
evaluation, alternative investments appear economically
indistinguishable, a fiduciary may then, in effect, ``break the tie''
by relying on a non-pecuniary factor. The Department expects that true
ties rarely, if ever, occur. To be sure, there are highly correlated
investments and otherwise very similar ones. 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, same
investment strategy, but a different underlying asset composition. Even
then, moreover, those two alternatives would remain two different
investments that may function differently in the overall context of the
fund portfolio, and which going forward may perform differently based
on external economic trends and developments.\22\ The Department also
recognizes 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 ties may theoretically occur and the Department
does not presently have sufficient evidence to say they do not, the
Department proposes to retain the current guidance's ``all things being
equal'' test. As explained below, the Department specifically requests
comment on this test, including whether true ties exist and how
fiduciaries may appropriately break ties.
---------------------------------------------------------------------------
\22\ See Schanzenbach & Sitkoff, supra note 5, at 410
(describing a hypothetical pair of truly identical investments as a
``unicorn'').
---------------------------------------------------------------------------
Paragraph (c)(2) guides application of the ``all things being
equal'' test by requiring fiduciaries to adequately document any such
occurrences. If, 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 (notwithstanding the requirements of paragraph (b) and
paragraph (c)(1)), the fiduciary must document the basis for concluding
that a distinguishing factor could not be found and why the selected
investment was chosen based on the purposes of the plan,
diversification of investments, and the financial interests of plan
participants and beneficiaries in receiving benefits from the plan. The
Department believes this documentation requirement provides a safeguard
against the risk that fiduciaries will improperly find economic
equivalence and make decisions based on non-pecuniary
[[Page 39118]]
factors without a proper analysis and evaluation. As discussed in the
Regulatory Impact Analysis below, the proposal may result in costs on
fiduciaries whose current documentation and recordkeeping are
insufficient to meet the new requirement, but, because the Department
believes that truly economically indistinguishable alternatives are
rare, the Department estimates that this requirement would not result
in a substantial cost burden.
Paragraph (c)(3) describes the requirements for the prudent
consideration of designated investment alternatives for defined
contribution individual account plans that include one or more
environmental, social, and corporate governance-oriented assessments or
judgments in their investment mandates (e.g., ``ESG investment
mandates'') or that include these parameters in the fund name
(hereinafter ``ESG-themed funds''). As the Department has previously
explained, the standards set forth in sections 403 and 404 of ERISA
apply to a fiduciary's selection of an investment fund as 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.
Paragraph (c)(3) does not, however, supersede paragraph (c)(1).
Rather, paragraph (c)(3) includes provisions that are intended to apply
those principles in the context of the selection of designated
investment alternatives for participant-directed individual account
plans. Thus, paragraph (c)(3) provides in general that, in such a case,
a prudently selected, well managed, and properly diversified fund with
ESG investment mandates could be added to the available investment
options on a 401(k) plan platform without requiring the plan to forgo
adding other non-ESG-themed investment options to the platform,
consistent with the standards in ERISA sections 403 and 404. Adding
such a fund is permissible only if: (i) The fiduciary uses only
objective risk-return criteria, such as benchmarks, expense ratios,
fund size, long-term investment returns, volatility measures,
investment manager tenure, 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-US
equity and fixed income funds) in selecting and monitoring all
investment alternatives for the plan, including any ESG investment
alternatives; (ii) the fiduciary documents compliance with (i) above;
and (iii) the environmental, social, corporate governance, or similarly
oriented alternative is not added as, or as a component of, a qualified
default investment alternative (QDIA as described in 29 CFR 2550.404c-
5) that participants are automatically defaulted into as opposed to a
fund added to the menu from which they are free to choose. Under
paragraph (c)(3), a fiduciary could, for example, adopt an investment
policy statement with prudent criteria for selection and retention of
designated investment alternatives for an individual account plan that
were based solely on pecuniary factors, and apply the criteria to all
investment options in similar asset classes or funds in the same
category, including potential ESG-themed funds.\23\ While the proposal
would allow a plan fiduciary to include a prudently selected ESG-themed
investment alternative on a 401(k) plan investment platform if the
fiduciary uses objective risk-return criteria in selecting and
monitoring all investment alternatives for the plan, including any ESG
investment alternatives, the Department has consistently expressed the
view that fiduciaries who are willing to accept expected reduced
returns or greater risks to secure non-pecuniary benefits are in
violation of ERISA. Thus, fiduciaries 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.\24\
---------------------------------------------------------------------------
\23\ See, e.g., ``The Morningstar Category Classifications (for
portfolios available for sale in the United States),'' Morningstar
Methodology Paper (April 29, 2016), https://morningstardirect.morningstar.com/clientcomm/Morningstar_Categories_US_April_2016.pdf.
\24\ In that regard, 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.
---------------------------------------------------------------------------
The Department has not proposed to apply the provision in paragraph
(c)(2) on ``economically indistinguishable alternative investments'' to
the selection of investment options for individual account plans, but
has rather included a distinct documentation requirement for such
investment decisions in paragraph (c)(3)(ii). The Department believes
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.
As the Department explained in FAB 2018-01, in the case of an
investment platform that allows participants and beneficiaries in an
individual account plan an opportunity to choose from a broad range of
investment alternatives, adding one or more funds to a platform, unlike
fiduciary decisions to select individual investments for a plan, does
not necessarily result in the plan forgoing the placement of one or
more other non-ESG-themed investment alternatives on the platform. In
this connection, however, the Department reiterates fiduciaries'
obligation to comply with the objective standards set forth in
paragraph (c)(3), and not to sacrifice returns or increase investment
risk compared to other similar asset classes or funds in the same
category in order to achieve non-pecuniary goals.
With respect to the proposed paragraph (c)(3)(ii) documentation
requirement, fiduciaries already commonly document and maintain records
about their investment choices, since that is a prudent practice and a
potential shield from litigation risk. The proposed paragraph
(c)(3)(ii) is intended simply to confirm that general fiduciary
practice applies to the selection and monitoring of ESG investment
options for individual account plans and to provide a safeguard against
the risk that fiduciaries will select investment options based on non-
pecuniary factors without a proper analysis and evaluation.
The Department requests comments on whether the language in
paragraph (c)(3)(i) adequately reflects the same principles articulated
in paragraph (c)(1). The Department also requests comments on whether
it would be appropriate to expressly incorporate the provisions in
paragraph (c)(2) on choosing among indistinguishable investment
alternatives into paragraph (c)(3).
With respect to the QDIA provision in paragraph (c)(3)(iii) of the
proposal, QDIAs are intended to 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 in a single
investment capable of meeting the participant's long-term retirement
savings needs. 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
[[Page 39119]]
from the participant, the plan fiduciary invests the assets in a
QDIA.\25\ 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.
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\25\ Section 404(c)(5)(A) of ERISA provides that, for purposes
of section 404(c)(1) of ERISA, a participant in an individual
account plan shall be treated as exercising control over the assets
in the account with respect to the amount of contributions and
earnings which, in the absence of an investment election by the
participant, are invested by the plan in accordance with regulations
prescribed by the Secretary of Labor. On October 24, 2007, the
Department published a final regulation implementing the provisions
of section 404(c)(5) of ERISA. 29 CFR 2550.404c-5. A fiduciary of a
plan that complies with the final regulation will not be liable for
any loss, or by reason of any breach, that occurs as a result of
investment in a qualified default investment alternative but the
plan fiduciaries remain responsible for the prudent selection and
monitoring of the QDIA. The regulation describes the types of
investments that qualify as default investment alternatives under
section 404(c)(5) of ERISA.
---------------------------------------------------------------------------
The Department does not believe that investment funds whose
objectives include non-pecuniary goals--even if selected by fiduciaries
only on the basis of objective risk-return criteria consistent with
paragraph (c)(3)--should be the default investment option in an ERISA
plan. ERISA is a statute whose overriding concern relevant here has
always been providing a secure retirement for American workers and
retirees, and it is inappropriate for participants to be defaulted into
a retirement savings fund with other objectives absent their
affirmative decision. Furthermore, in the QDIA context a fiduciary's
decision to favor a particular environmental, social, corporate
governance, or similarly oriented investment preference--and especially
a decision to favor the fiduciary's own personal policy preferences--
would raise questions about the fiduciary's compliance with ERISA's
duty of loyalty. The QDIA regulation describes the attributes necessary
for an investment fund, product, model portfolio, or managed account to
be a QDIA. Each of the QDIA categories requires that the investment
fund, product, model portfolio, or investment management service apply
generally accepted investment theories, be diversified so as to
minimize the risk of large losses, and be designed to provide varying
degrees of long-term appreciation and capital preservation through a
mix of equity and fixed income exposures. It is already the case that a
QDIA may not invest participant contributions directly in employer
securities. Thus, this requirement in the proposal is intended to help
ensure that the financial interests of plan participants and
beneficiaries in retirement benefits remain paramount by removing ESG
considerations in cases in which participant's retirement savings in
individual accounts designed for participant direction are being
automatically invested by a plan fiduciary.
Paragraph (d) repeats a paragraph in the current 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.
Paragraph (e) is reserved for possible further clarification of the
requirements under section 403 and 404 of ERISA with respect to
fiduciary investment duties.
Paragraph (f) provides definitions. The term ``investment duties''
is unchanged from the current regulation and 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. The term ``investment course of
action'' is amended to mean any series or program of investments or
actions related to a fiduciary's performance of the fiduciary's
investment duties, and the proposed rule adds an additional provision
to specify that the definition 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. The term ``pecuniary
factor'' means 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. Finally, the term
``plan'' is unchanged from the current regulation and means an employee
benefit plan to which Title I of ERISA applies.
Paragraph (g) provides for the effective date for the proposed
rule. Under paragraph (g), the proposed rule would be effective on a
date sixty days after the date of the publication of the final rule.
The Department requests comment on paragraph (g), including whether any
transition or applicability date provisions should be added to for any
of the provisions of the proposal.
Paragraph (h) provides that should a court of competent
jurisdiction hold any provision of the rule invalid, such action will
not affect any other provision. Including a severability clause
provides clear guidance that the Department's intent is that any legal
infirmity found with part of the proposed rule should not affect any
other part of the proposed rule.
C. Request for Public Comments
The Department invites comments from interested persons on all
facets of the proposed rule. Commenters are free to express their views
not only on the specific provisions of the proposal as set forth in
this document, but on any issues germane to the subject matter of the
proposal. Comments should be submitted in accordance with the
instructions at the beginning of this document. The Department believes
that 30 days will afford interested persons an adequate amount of time
to analyze the proposed rule and submit comments.
D. Regulatory Impact Analysis
This section analyzes the regulatory impact of a proposed
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 proposed rule would address the
limitations that sections 404(a)(1)(A) and 404(a)(1)(B) of ERISA impose
on fiduciaries' consideration of non-pecuniary benefits and goals,
including environmental, social, and corporate governance and other
similarly situated factors, in making investment decisions. Thus, the
rule would eliminate confusion that plan fiduciaries may currently face
in the marketplace and reiterate long-established fiduciary standards
of prudence and loyalty for selecting and monitoring investments. While
this rule is expected to benefit plans and participants overall, it
would also impose some costs. For example, some plans would incur small
documentation costs. The research and analysis used to select
investments may
[[Page 39120]]
change, but such a change is unlikely to increase the overall cost. The
transfer impacts, benefits, and costs associated with the proposed rule
depends on the number of plan fiduciaries that are currently not
following or 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 believes it is
small, because most fiduciaries are operating in compliance with the
Department's sub-regulatory guidance. The Department expects that the
benefits of the rule would be appreciable for participants and
beneficiaries covered by plans with noncompliant investment
fiduciaries. If the Department's assumption regarding the number of
noncompliant fiduciaries is understated, the proposed rule's transfer
impacts, benefits, and costs would be proportionately higher; however,
even in this instance, the Department believes that the rule's benefits
would exceed its costs.
The Department has examined the effects of this rule as required by
Executive Order 12866,\26\ Executive Order 13563,\27\ the Congressional
Review Act,\28\ Executive Order 13771,\29\ the Paperwork Reduction Act
of 1995,\30\ the Regulatory Flexibility Act,\31\ section 202 of the
Unfunded Mandates Reform Act of 1995,\32\ and Executive Order
13132.\33\
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\26\ Regulatory Planning and Review, 58 FR 51735 (Oct. 4, 1993).
\27\ Improving Regulation and Regulatory Review, 76 FR 3821
(Jan. 18, 2011).
\28\ 5 U.S.C. 804(2) (1996).
\29\ Reducing Regulation and Controlling Regulatory Costs, 82 FR
9339 (Jan. 30, 2017).
\30\ 44 U.S.C. 3506(c)(2)(A) (1995).
\31\ 5 U.S.C. 601 et seq. (1980).
\32\ 2 U.S.C. 1501 et seq. (1995).
\33\ 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
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 proposed rule's potential costs, benefits, and
transfers, and OMB has reviewed this proposed rule pursuant to the
Executive Order. Pursuant to the Congressional Review Act, OMB has
designated this proposed 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.\34\ 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 defraying
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.
---------------------------------------------------------------------------
\34\ 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. Confusion with respect to these factors
persists, perhaps due in part to varied statements the Department has
made on the subject over the years in sub-regulatory guidance.
Accordingly, this proposed rule is necessary to interpret ERISA and
provide clarity and certainty regarding the scope of fiduciary duties
surrounding non-pecuniary issues. The Department believes that
providing further clarity on these issues in the form of a notice and
comment regulation will help safeguard the interests of participants
and beneficiaries in their plan benefits.
1.2. Affected Entities
The proposal would affect certain ERISA-covered plans whose
fiduciaries consider non-pecuniary factors when selecting investments
and the participants in those plans. For investments that are not
participant directed, defined benefit (DB) plans and defined
contribution (DC) plans would be required to maintain records when
different investments are ``economically indistinguishable,''
documenting specifically why the investments were determined to be
indistinguishable and the selected investment was chosen based on the
purposes of the plan and the financial interests of plan participants
and beneficiaries in receiving benefits from the plan. DC individual
account plans would be affected by the proposed rule if they offer ESG
options among their designated investment alternatives. As discussed
below, the best data available on this topic comes from surveys of ESG
investing by plans.
ESG investing approaches may consider non-pecuniary matters.\35\
Riedl and Smeets' research on individual investors in the Netherlands
shows that financial motives play less of a role than social
preferences and social signaling in explaining decisions to invest in
``socially responsible'' mutual funds.\36\ The same research also
presents survey evidence that most individual investors expect socially
responsible investing mutual funds to have lower returns and higher
fees than conventional mutual funds. In selecting investments, some
[[Page 39121]]
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.
---------------------------------------------------------------------------
\35\ 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).
\36\ Arno Riedl & Paul Smeets, Why Do Investors Hold Socially
Responsible Mutual Funds? 72 Journal of Finance 6 (2017). (This
study included administrative data on trading of mutual funds by
individual investors. They bought and sold funds only without the
involvement of an intermediary.)
---------------------------------------------------------------------------
According to a 2018 survey by the NEPC, approximately 12 percent of
private pension plans have adopted ESG investing.\37\ 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.\38\ Both of these estimates are calculated from samples that
include both DB and DC plans. Some DB plans that consider ESG factors
would not be affected by the proposed 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 would be
affected by the proposed rule. This represents approximately 8,870
defined benefit plans.\39\ The Department also assumes that 19 percent
of DC plans with investments that are not participant directed would be
affected; this represents an additional 18,400 plans.\40\
---------------------------------------------------------------------------
\37\ 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.
\38\ 2019 ESG Survey, Callan Institute (2019), www.callan.com/wp-content/uploads/2019/09/2019-ESG-Survey.pdf.
\39\ DOL calculations are based on statistics from Private
Pension Plan Bulletin: Abstract of 2017 Form 5500 Annual Reports,
Employee Benefits Security Administration (Sep. 2019), (46,698 x 19%
= 8,870 DB plans; 34,960,000 x 19% = 6,642,400, rounded to 6.6
million participants; $3,208,820,000,000 x 19% = $609,675,800,000,
rounded to $610 billion in assets).
\40\ Id. (96,860 x 19% = 18,403, rounded to 18,400 plans).
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A small share of individual account plans offer at least one ESG-
themed option among their investment alternatives. According to the
Plan Sponsor Council of America, about 3 percent of 401(k) and/or
profit sharing plans offered at least one ESG-themed investment option
in 2018.\41\ Vanguard's 2018 administrative data show that
approximately nine percent of DC plans offered one or more ``socially
responsible'' domestic equity fund options.\42\ Considering these
sources together, the Department assumes that six percent of individual
account plans have at least one ESG-themed investment alternative and
would be affected by the proposed rule. This represents 33,960
individual account plans with participant direction.\43\ In terms of
the actual utilization of ESG options, one survey indicates that about
0.1 percent of total DC plan assets are invested in ESG funds.\44\ The
Department seeks comments regarding its assumptions and additional
information describing the prevalence of ESG investing or ESG
investment options among ERISA plans, including their use as qualified
default investment alternatives.
---------------------------------------------------------------------------
\41\ 62nd Annual Survey of Profit Sharing and 401(k) Plans, Plan
Sponsor Council of America (2019).
\42\ How America Saves 2019, Vanguard (June 2019), https://institutional.vanguard.com/iam/pdf/HAS2019.pdf.
\43\ DOL calculations based on statistics from Private Pension
Plan Bulletin: Abstract of 2017 Form 5500 Annual Reports, Employee
Benefits Security Administration (Sept. 2019), ((565,969) * 6% =
33,958, rounded to 33,960 individual account plans).
\44\ 62nd Annual Survey of Profit Sharing and 401(k) Plans, Plan
Sponsor Council of America (2019).
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1.3. Benefits
The proposed rule would replace existing guidance on the use of ESG
and similar factors in the selection of investments, including that
fiduciaries must not base investment decisions on non-pecuniary factors
unless alternative investment options are ``economically
indistinguishable'' and such a conclusion is properly documented. The
Department anticipates that the resulting benefits will be appreciable.
When fiduciaries weigh non-pecuniary considerations as required by
this rule to select investments, some fiduciaries will select
investments that are different from those they would have selected pre-
rule. These selected investments' returns will generally tend to be
higher over the long run. Also, as plans invest less in actively
managed ESG mutual funds, they may instead select mutual funds with
lower fees or passive index funds.
In this case, the societal resources freed for other uses due to
lessened active management (minus potential upfront transition costs)
would represent benefits of the rule. Furthermore, if some portion of
the increased returns would be 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 benefits of the rule;
however, it would 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 across the transaction parties, it would
have implications for marginal utility of the assets).
To the extent that ESG investing sacrifices 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 rulemaking, ESG investing will present a growing threat to
ERISA fiduciary standards and, ultimately, to investment returns for
plan participants and beneficiaries. For the plans and participants
that would be affected by a reduced use of non-pecuniary factors, the
benefits they would experience from higher investment returns,
compounded over many years, could be considerable. The Department seeks
information that could be used to quantify the increase in investment
returns.
The Department also invites comments addressing the benefits that
would be associated with the proposed rule.
1.4. Costs
This proposed rule provides guidance on the investment duties of a
plan fiduciary. Under this proposed rule, plans that consider ESG and
similar factors when choosing investments would 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 proposal would not impair fiduciaries' appropriate
consideration of ESG factors in circumstances where such consideration
is material to the risk-return analysis and advances participants'
interests in their retirement benefits. The Department does not intend
to increase fiduciaries' burden of care attendant to such
consideration; therefore, and no additional costs are estimated for
this requirement. While fiduciaries may modify the research approach
they use
[[Page 39122]]
to select investments as a consequence of the proposed rule, the
Department assumes this modification would not impose significant
additional cost.
Some fiduciaries will select investments that are different from
what they would have selected pre-rule. This can happen in different
ways. Fiduciaries may realize that a current investment does not
conform to the rule and decide to choose a more appropriate investment,
or 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 DC plans with participant direction. 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 proposed rule, participants invested in the ESG fund would have to
pick a new fund that may not be comparable from their perspective. This
could be disruptive, but similar disruptions occur when plan
fiduciaries routinely change designated investment alternatives.
Furthermore, the proposed rule requires plan fiduciaries who select
investments based on non-pecuniary factors to document why alternative
investments are ``economically indistinguishable'' in terms of their
expected risk and return characteristics. The Department believes that
the likelihood that two investments will be ``economically
indistinguishable'' is rare, and therefore the need to document such
circumstances also will be rare.\45\ The Department seeks data and
comments on the frequency with which plans find two investments to be
``economically indistinguishable,'' and the process plan fiduciaries
use in this situation. In those rare instances, the documentation
requirement could be burdensome unless fiduciaries are already
documenting such decisions.
---------------------------------------------------------------------------
\45\ See Schanzenbach & Sitkoff, supra note 5, at 410
(describing a hypothetical pair of truly identical investments as a
``unicorn'').
---------------------------------------------------------------------------
Paragraph (c)(1) of the proposal provides that a fiduciary's
evaluation of an investment must be focused on pecuniary factors. The
paragraph explains that it is unlawful for a fiduciary to sacrifice
return or accept additional risk to promote a public policy, political,
or any other non-pecuniary goal. Paragraph (c)(2) provides that, if
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
ESG considerations, the fiduciary must document the basis for
concluding that a distinguishing factor could not be found and why the
selected investment was chosen based on the purposes of the plan,
diversification of investments, and the financial interests of plan
participants and beneficiaries in receiving benefits from the plan.
Thus, the rule may impose costs on fiduciaries whose current
documentation and recordkeeping are insufficient to meet the new
requirement. Because the Department concludes that truly ``economically
indistinguishable'' alternatives are rare, the Department estimates
that this requirement would not result in a substantial cost burden.
The Department has not proposed to apply the provision in
paragraphs (c)(1) and (c)(2) of the proposal on ``economically
indistinguishable'' alternative investments for the selection of
investment options for individual account plans, but rather included a
documentation requirement for such investment decisions in paragraph
(c)(3)(ii). Therefore, individual account plan fiduciaries will need to
document their selections of investment alternatives that include one
or more ESG or similarly oriented assessments or judgments in their
investment mandates or that include these parameters in the fund name.
The Department assumes that the documentation requirement in
paragraph (c)(3) would impose little, if any, additional cost on
individual account plan fiduciaries, because they already commonly
document and maintain records about their investment choices as a best
practice and potential shield from litigation risk. The Department
proposes to include this requirement to confirm the need to document
actions taken and to provide a safeguard against the risk that
fiduciaries will select investment options based on non-pecuniary
factors without a proper analysis and evaluation.
The PRA section below estimates the costs of the information
collection. As required by the PRA, the PRA estimates encompass the
entire burden of the proposed rule's information collection as opposed
to the incremental costs discussed in the regulatory impact analysis.
For this reason, the incremental costs of the proposed rule are
estimated to be minimal, while the PRA cost estimates are larger.
The Department invites comments addressing the costs that would be
associated with the proposed rule.
1.5. Transfers
There may be a transfer from mutual fund companies that offer ESG-
themed mutual funds to competing mutual fund companies that offer other
types of mutual funds. Companies offering ESG-themed mutual funds would
have fewer customers since ERISA plans that currently offer ESG-themed
mutual funds in their DC plans would no longer be able to offer them
under the proposed rule, except for any funds that would be selected
based on financial considerations alone. Often the same company will
offer both mutual funds with an ESG theme and mutual funds without;
there may be a transfer within the company from ESG mutual funds to
other mutual funds.
Moreover, as noted previously, if some portion of rule-induced
increases in returns would be associated with transactions in which the
opposite party experiences decreased returns of equal magnitude, then
this portion of the proposed rule's impact would, from a society-wide
perspective, be appropriately categorized as a transfer.
1.6. Uncertainty
It is unclear how many plans use ESG and similar factors when
selecting investments. Similarly unclear is the total asset value of
investments that were selected in this manner. This is particularly
true 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 also is 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 issues. At the same time, some investing takes
account of environmental factors and corporate governance in a manner
that focuses exclusively on the financial aspects of those
considerations.
The proposed rule would replace the existing guidance on using non-
pecuniary factors while selecting 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
would experience significant effects from the proposed 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
[[Page 39123]]
expansion will only continue to increase.\46\ However, based on current
trends the Department believes that the use of non-pecuniary factors by
ERISA plans is likely to increase moderately in the future without this
rulemaking, and thus on a forward basis the benefits of the proposed
rule will be appreciable.
---------------------------------------------------------------------------
\46\ 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.
---------------------------------------------------------------------------
1.7. Alternatives
The Department has considered alternatives to the proposed
regulation. 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, that approach would
prohibit the use of factors even when they have pecuniary consequences.
The Department also has considered prohibiting plan fiduciaries
from basing investment decisions on non-pecuniary factors and not
permitting the use of non-pecuniary factors where the alternative
investment options are indistinguishable. But if the alternative
investment options truly are ``economically indistinguishable,'' it is
not clear what would be available to a plan fiduciary to base the
decision on other than a non-pecuniary factor. Regardless, the
Department believes that truly indistinguishable alternative investment
options occur very rarely in practice, if at all. Accordingly, this
proposed rule retains the ``all things being equal'' test from the
Department's previous guidance with a specific requirement to document
applications of that test. However, the Department requests comment
regarding whether any variation of an ``all things being equal''
approach should be retained, or should be abandoned as inconsistent
with the fiduciary duties of ERISA section 404. The Department also
requests comment on how, assuming ``ties'' do occur, they might be
broken based on different considerations than set forth in the proposed
rule.
With respect to the requirements concerning individual account
plans in paragraph (c)(3), the Department considered expressly
incorporating paragraph (c)(1), which explains a fiduciary's obligation
to only focus on pecuniary factors. The Department decided it was
unnecessary to expressly incorporate paragraph (c)(1) into paragraph
(c)(3), because the latter already requires fiduciaries to focus on
only objective risk-return criteria. The Department requests comment on
whether paragraph (c)(1) should be expressly incorporated in paragraph
(c)(3).
Similarly, the Department considered whether to apply the
documentation requirement for indistinguishable investments contained
in paragraph (c)(2) of the proposal to fiduciaries' selection of
designated investment alternatives for individual account plans. For
the reasons set forth earlier in the preamble, Department decided not
to carry that requirement into paragraph (c)(3). Rather, as explained
above, investment options for individual account plans are often chosen
precisely for their varied characteristics. Still, the proposed rule
would require fiduciaries to document the selection and monitoring of
ESG-themed funds as designated investment alternatives. The Department
requests comment on whether it should apply the requirements in
paragraph (c)(2) to the selection of ESG-themed funds for individual
account plans.
The Department believes that the approach reflected in the proposal
best reflects the statutory obligations of prudence and loyalty,
appropriately ensures that fiduciaries' decisions will be guided by the
financial interests of the plans and participants to whom they owe
duties of prudence and loyalty, and is the easiest to apply and
enforce. Nevertheless, the Department solicits comments on all
alternatives, including any alternatives that the Department has not
identified in this NPRM.
1.8. Conclusion
The Department believes that the proposed rule would provide
clarity to fiduciaries in fulfilling their responsibilities by
describing when and how fiduciaries can factor in ESG and similar
considerations as they select and monitor investments, and when they
may not.
While this proposed rule is expected to benefit plans and
participants, some costs would be incurred as well. Some plans would
have to modify their processes for selecting and monitoring
investments. While some plans would need to document selections where
the alternative investment options are indistinguishable, and
individual account plans would need to document their decisions for
selecting ESG-themed funds as designated investment alternatives, the
Department does not expect these requirements to impose a significant
increase in hourly burden or cost because the Department believes that
truly indistinguishable alternative investment options should occur
very rarely in practice, if at all and defined contribution plans are
already documenting their decisions when selecting investment
alternatives for their participant directed investment platforms.
Although the proposed rule would replace previous guidance, the
Department believes that there is significant overlap; thus, this would
not result in substantial benefits or costs. Overall, the proposed rule
would assist fiduciaries in carrying out their responsibilities, while
promoting the financial interests of current and future retirees.
2. Paperwork Reduction Act
As part of its continuing effort to reduce paperwork and respondent
burden, the Department conducts a preclearance consultation program to
allow the general public and federal agencies to comment on proposed
and continuing collections of information in accordance with the
Paperwork Reduction Act of 1995 (PRA).\47\ This helps to ensure that
the public understands the Department's collection instructions,
respondents can provide the requested data in the desired format,
reporting burden (time and financial resources) is minimized,
collection instruments are clearly understood, and the Department can
properly assess the impact of collection requirements on respondents.
---------------------------------------------------------------------------
\47\ 44 U.S.C. 3506(c)(2)(A) (1995).
---------------------------------------------------------------------------
Currently, the Department is soliciting comments concerning the
proposed information collection request (ICR) included in the Financial
Factors in Selecting Plan Investments ICR. To obtain a copy of the ICR,
contact the PRA addressee shown below or go to www.RegInfo.gov.
The Department has submitted a copy of the proposed rule to the
Office of Management and Budget (OMB) in accordance with 44 U.S.C.
3507(d) for review of its information collections. The Department and
OMB are particularly interested in comments that address the following:
Evaluate whether the collection of information is
necessary for the proper performance of the functions of the agency,
including whether the information will have practical utility;
Evaluate the accuracy of the agency's estimate of the
burden of the collection of information, including the validity of the
methodology and assumptions used;
[[Page 39124]]
Enhance the quality, utility, and clarity of the
information to be collected; and
Minimize the burden of the collection of information on
those who are to respond, including through the use of appropriate
automated, electronic, mechanical, or other technological collection
techniques or other forms of information technology (e.g., permitting
electronic submission of responses).
Comments should be sent by mail to the Office of Information and
Regulatory Affairs, Office of Management and Budget, Room 10235, New
Executive Office Building, Washington, DC 20503 and marked ``Attention:
Desk Officer for the Employee Benefits Security Administration.''
Comments can also be submitted by fax at 202-395-5806 (this is not a
toll-free number), or by email at [email protected]. OMB
requests that comments be received within 30 days of publication of the
proposed rule to ensure their consideration.
PRA Addresses: Address requests for copies of the ICR to G.
Christopher Cosby, Office of Policy and Research, U.S. Department of
Labor, Employee Benefits Security Administration, 200 Constitution
Avenue NW, Room N-5718, Washington, DC 20210. The PRA Addressee may be
reached by telephone, (202) 693-8410, or by fax, (202) 219-5333. These
are not toll-free numbers. ICRs also are available at www.RegInfo.gov
(www.reginfo.gov/public/do/PRAMain).
In prior guidance, the Department has encouraged plan fiduciaries
to appropriately document their investment activities, and the
Department believes it is common practice. The proposed rule expressly
requires only that, where a plan fiduciary determines that alternative
investments are ``economically indistinguishable,'' the fiduciary
further document 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 that two investments options which are truly
economically indistinguishable is very rare.
While the incremental burden of the proposed regulations is small,
the full burden of the requirements will be included below to allow for
evaluation of the requirements in the required information collection.
According to the most recent Form 5500 data, there are 8,870 DB
plans and 18,400 DC plans with ESG investments that are not participant
directed that could be affected by the proposed rule.\48\ While the
Department does not have data regarding the frequency of the rare event
of alternatives being indistinguishable and requiring documentation,
the Department models the burden using one percent of plans with ESG
investments as needing to provide the documentation.
---------------------------------------------------------------------------
\48\ DOL calculations based on statistics from U.S. Department
of Labor, Employee Benefits Security Administration, ``Private
Pension Plan Bulletin: Abstract of 2017 Form 5500 Annual Reports,''
(Sep. 2019), (46,698 DB plans x 19% = 8,870 DB plans; 96,860 DC
Plans x 19% = 18,400 DC plans).
---------------------------------------------------------------------------
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 89 DB plans and 61 DC plans
with ESG investments that are not participant directed will encounter
economically indistinguishable alternatives in a year.\49\
---------------------------------------------------------------------------
\49\ 8,870 DB plans * 0.01 = 89 DB plans; 18,400 DC plans * 0.01
* 0.33 = 61 DC plans.
---------------------------------------------------------------------------
2.1. Maintain Documentation
The proposed rule requires ESG plan fiduciaries to maintain
documentation if alternative investments appear to be ``economically
indistinguishable.'' While much of the 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. The Department
estimates that plan fiduciaries and clerical staff will each expend, on
average, 2 hours of labor to maintain the needed documentation. This
results in an annual burden estimate of 600 hours, with an equivalent
cost of $56,818 for DB plans and DC plans with ESG investments that are
not participant directed.\50\
---------------------------------------------------------------------------
\50\ The burden is estimated as follows: (8,870 DB plans * 0.01
* 2 hours) + (18,400 DC plans * 0.01 * 2 hours * 0.33) = 300 hours
for both a plan fiduciary and clerical staff. A labor rate of
$134.21 is used for a plan fiduciary and a labor rate of $55.14 for
clerical staff ((8,870 DB plans * 0.01 * 2 * $134.21) + (18,400 DC
plans * 0.01 * 2 hours* 0.33 * $134.21) + (8,870 DB plans * 0.01 * 2
* $55.14) + (18,400 DC plans * 0.01 * 2 hours* 0.33 * $55.14) =
$56,818.)
---------------------------------------------------------------------------
The proposal also would require individual account plan fiduciaries
to document their selections of ESG-themed funds as designated
investment alternatives for their participant-directed investment
platforms. As explained above, fiduciaries selecting investment options
for DC plans already commonly document and maintain records about their
investment choices, since that is a best practice and a potential
shield from litigation risk. Therefore, the Department assumes this
documentation requirement will impose little, if any, additional cost.
The requirement is included to confirm the need to document actions
taken and to provide a safeguard against the risk that fiduciaries will
select investment options based on non-pecuniary factors without a
proper analysis and evaluation.
These paperwork burden estimates are 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-NEW.
Affected Public: Businesses or other for-profits.
Estimated Number of Respondents: 11,470.
Estimated Number of Annual Responses: 11,470.
Frequency of Response: Occasionally.
Estimated Total Annual Burden Hours: 600.
Estimated Total Annual Burden Cost: $0.
3. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) \51\ 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 \52\ and that are likely to have a significant economic
impact on a substantial number of small entities. Unless an agency
determines that a proposal 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 an initial regulatory flexibility
analysis of the proposed rule.
---------------------------------------------------------------------------
\51\ 5 U.S.C. 601 et seq. (1980).
\52\ 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.\53\ 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
[[Page 39125]]
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
proposed 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) \54\ pursuant to
the Small Business Act.\55\ Therefore, EBSA requests comments on the
appropriateness of the size standard used in evaluating the impact of
this proposed rule on small entities.
---------------------------------------------------------------------------
\53\ The Department consulted with the Small Business
Administration before making this determination, as required by 5
U.S.C. 603(c) and 13 CFR 121.903(c).
\54\ 13 CFR 121.201.
\55\ 15 U.S.C. 631 et seq.
---------------------------------------------------------------------------
The Department has determined that this proposed rule could have a
significant impact on a substantial number of small entities.
Therefore, the Department has prepared an Initial Regulatory
Flexibility Analysis that is presented below.
3.1. Need for and Objectives of the Rule
The proposed 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 would
help ensure that fiduciaries are protecting the financial interests of
participants and beneficiaries.
3.2. Affected Small Entities
The proposed rule has documentation provisions that would affect
small ERISA-covered plans, which have fewer than 100 participants. It
also has some provisions about the improper use of non-pecuniary
factors when plan fiduciaries select and monitor investments. These
provisions would affect only plans and participants that are improperly
incorporating non-pecuniary factors into their investment decisions.
The proposed rule would affect small plans that have ESG-type
investments that are not in compliance with the proposed regulation.
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 6 percent of DC plans with participant
directed individual accounts have ESG or ESG-themed investments and
could be affected by the proposed rule. The distribution across plan
size is not available in the surveys. This represents approximately
8,870 defined benefit plans and 52,360 DC plans. It should be noted
that 83 percent of all DB plans and 88 percent of all DC are small
plans.\56\ 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.\57\ One survey found that among 401(k) plans with fewer than 50
participants, approximately 1.7 percent offered an ESG option.\58\
---------------------------------------------------------------------------
\56\ DOL calculations based on statistics from U.S. Department
of Labor, Employee Benefits Security Administration, ``Private
Pension Plan Bulletin: Abstract of 2017 Form 5500 Annual Reports,''
(Sep. 2019).
\57\ 62nd Annual Survey of Profit Sharing and 401(k) Plans, Plan
Sponsor Council of America (2019).
\58\ Id.
---------------------------------------------------------------------------
A large majority of participants in small pension plans do not have
an ESG fund in their portfolio. As previously mentioned, about 0.1
percent of total assets held by DC plans are invested in ESG funds.\59\
---------------------------------------------------------------------------
\59\ Id.
---------------------------------------------------------------------------
3.3. Impact of the Rule
While the rule is expected to affect small pension plans, it is not
likely that there would be a significant economic impact on many of
these plans. The proposed regulation provides guidance on how
fiduciaries can comply with sections 404(a)(1)(A) and 404(a)(1)(B) of
ERISA when investing plan assets. The Department believes most plans
are already fulfilling the requirements in the course of following
prior guidance. Plans would need to document selections of investments
based on non-pecuniary factors where the alternative investment options
are ``economically indistinguishable.'' The Department believes that
truly ``economically indistinguishable'' alternative investment options
should occur very rarely in practice, if at all. The Department
estimates a cost of less than $380 per affected plan for plan
fiduciaries and clerical professionals to fulfill the documentation
requirement, see Table 1.
Table 1--Documentation Requirement
----------------------------------------------------------------------------------------------------------------
Affected entity Labor rate Hours Cost
----------------------------------------------------------------------------------------------------------------
Plans: Plan Fiduciary..................................... $134.21 2 $268.42
Plans: Clerical workers................................... 55.14 2 110.28
-----------------------------------------------------
Total................................................. ................ ................ 378.70
----------------------------------------------------------------------------------------------------------------
Source: DOL calculations based on statistics from U.S. Department of Labor, Employee Benefits Security
Administration, Private Pension Plan Bulletin: Abstract of 2017 Form 5500 Annual Reports, (September 2019).
Participant directed individual account plans will need to document
their selections of ESG-themed funds as designated investment
alternatives. As described above, fiduciaries in such plans already
commonly document and maintain records about their choices of
investment funds as designated investment alternatives, since that is
the best practice and a potential shield from litigation risk.
Therefore, the Department concludes that this documentation requirement
would impose little, if any, additional cost. While the costs
associated with the rule are small, its benefits could be significant
for plans that are heavily invested in underperforming ESG funds and
would be required to change their current ESG investments in response
to the proposed rule. The Department does not have sufficient data to
estimate the number of such plans and; therefore, welcomes comments and
data that could help it make this determination.
[[Page 39126]]
3.4. Alternatives
The Department considered the following alternatives to the
proposed regulation: (1) Prohibiting plan fiduciaries from considering
ESG or similar factors; (2) prohibiting plan fiduciaries from basing
investment decisions on non-pecuniary factors and the use of non-
pecuniary factors when the alternative investment options are
economically indistinguishable; (3) requiring fiduciaries of individual
account plans to comply with paragraph (c)(1) of the proposal, which
explains a fiduciary's obligation to only focus on pecuniary factors;
and (4) applying the documentation requirement for indistinguishable
investments contained in paragraph (c)(2) of the proposal to
fiduciaries' selection of designated investment alternatives for
individual account plans. For a discussion of the Department's
rationale for not adopting these alternatives, please see Section 1.7,
Alternatives, above.
The Department believes that the approach taken in the proposal
best reflects the statutory obligations of prudence and loyalty,
appropriately ensures that fiduciaries' decisions would be guided by
the financial interests of the plans and participants to whom they owe
duties of prudence, and loyalty, and is the most efficient to apply and
enforce. Nevertheless, the Department solicits comments on other
alternatives, particularly those that would reduce the burden on small
entities.
3.5. Duplicate, Overlapping, or Relevant Federal Rules
The Department is issuing this proposal under sections 404(a)(1)(A)
and 404(a)(1)(B) of Title I under ERISA. The Department is charged with
interpreting the ERISA provisions regarding the consideration of non-
pecuniary factors in investment funds, and 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 1 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 proposal 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.\60\ 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.
---------------------------------------------------------------------------
\60\ Federalism, 64 FR 153 (Aug. 4, 1999).
---------------------------------------------------------------------------
In the Department's view, these proposed regulations would not have
federalism implications because they would 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 proposed 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.
The Department welcomes input from states regarding this
assessment.
Statutory Authority
This regulation is proposed 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 is
proposing to amend 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. 1-
2011, 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.
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 exclusive purpose of providing
benefits to participants and their beneficiaries and defraying
reasonable expenses of
[[Page 39127]]
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)(A) and 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;
(ii) Has evaluated 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 and the plan's articulated funding and investment objectives
insofar as such objectives are consistent with the provisions of Title
I of ERISA;
(iii) Has not subordinated the interests of the participants and
beneficiaries in their retirement income or financial benefits under
the plan to unrelated objectives, or sacrificed investment return or
taken on additional investment risk to promote goals unrelated to those
financial interests of the plan's participants and beneficiaries or the
purposes of the plan;
(iv) Has not otherwise acted to subordinate the interests of the
participants and beneficiaries to the fiduciary's or another's
interests and has otherwise complied with the duty of loyalty; and
(v) 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, 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;
(C) The projected return of the portfolio relative to the funding
objectives of the plan; and
(D) How the investment or investment course of action compares to
available alternative investments or investment courses of action with
regard to the factors listed in paragraphs (b)(2)(ii)(A) through (C) of
this section.
(c)(1) Consideration of Pecuniary vs. Non-Pecuniary Factors. A
fiduciary's evaluation of an investment must be focused only on
pecuniary factors. 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. Environmental,
social, corporate governance, or other similarly oriented
considerations are pecuniary factors only if they present economic
risks or opportunities that qualified investment professionals would
treat as material economic considerations under generally accepted
investment theories. The weight given to those factors should
appropriately reflect a prudent assessment of their impact on risk and
return. Fiduciaries considering environmental, social, corporate
governance, or other similarly oriented factors as pecuniary factors
are also required to 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.
(2) Economically indistinguishable alternative investments. When
alternative investments are determined to be economically
indistinguishable even after conducting the evaluation described in
paragraph (c)(1), and one of the investments is selected on the basis
of a non-pecuniary factor or factors such as environmental, social, or
corporate governance considerations (notwithstanding the requirements
of paragraph (b) and paragraph (c)(1)), the fiduciary should document
specifically why the investments were determined to be
indistinguishable and document why the selected investment was chosen
based on the purposes of the plan, diversification of investments, and
the interests of plan participants and beneficiaries in receiving
benefits from the plan.
(3) Investment Alternatives for Individual Account Plans. The
standards set forth in sections 403 and 404 of ERISA and paragraphs
(b)(1) and (b)(2) of this regulation apply to a fiduciary's selection
of an investment fund as a designated investment alternative in an
individual account plan. In the case of investment platforms for
defined contribution individual account plans, including platforms with
bundled administrative and investment services, that allow 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'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:
(i) 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;
(ii) the fiduciary documents its selection and monitoring of the
investment in accordance with paragraph (c)(3)(i) of this section; and
(iii) 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.
(d) 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
[[Page 39128]]
plan provided by or at the direction of the appointing fiduciary, if -
(1) Such information is provided for the stated purpose of
assisting the manager in the performance of the manager's investment
duties, and
(2) The manager does not know and has no reason to know that the
information is incorrect.
(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 alternative under the plan.
(3) The term ``pecuniary factor'' means 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.
(4) The term ``plan'' means an employee benefit plan to which Title
I of the Act applies.
(g) Effective date. This section shall be effective on [60 days
after date of publication of final rule].
(h) Severability. Should a court of competent jurisdiction hold any
provision(s) of this subpart to be invalid, such action will not affect
any other provision of this subpart.
Signed at Washington, DC, June 22, 2020.
Jeanne Wilson,
Acting Assistant Secretary, Employee Benefits Security Administration,
Department of Labor.
[FR Doc. 2020-13705 Filed 6-26-20; 4:15 pm]
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