On November 22, the DOL released a final rule, entitled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights” (the “Final Rule”), that represents the latest change in a decades-long regulatory tug of war affecting fiduciary duties relating to making investment decisions that reflect environmental, social, or governance (“ESG”) considerations and proxy voting. The Final Rule will become effective on January 30, 2023 and will apply to plans covered by Title I of the Employee Retirement Income Security Act (“ERISA”). It will replace the “Financial Factors in Selecting Plan Investments” and “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights" rules that became effective in 2020 (collectively, the “2020 Rule(s)”).

This article focuses on the impact of the Final Rule on ERISA plan sponsors stemming from changes to the “investment prudence duties” and “investment loyalty duties” (collectively, “Investment Duties”) that, among other things, now permit fiduciaries to consider “economic effects and climate change and other [ESG] factors” when evaluating risk and return associated with an investment or investment strategy.

If you have any questions, or if you would like more information, please feel free to contact your Pensionmark advisor or info@pensionmark.com.

Investment Duties Redefined

Under the Final Rule, the Investment Duties will allow fiduciaries to consider ESG factors but do not require them to do so (as originally proposed). To consider ESG factors, fiduciaries need not demonstrate that two similar investments are “economically indistinguishable” based solely on “pecuniary factors” as was the case in the 2020 Rule. Rather, fiduciary determinations must be “based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis” that may now include “economic effects and climate change” and other ESG factors.

Also noteworthy is the fact that the same Investment Duties apply equally to Qualified Default Investment Alternatives or QDIAs. The Final Rule removed the prohibition contained in the 2020 Rule on selecting ESG-themed investments as QDIAs.  

From a duty of loyalty perspective, the Final Rule expressly provides that fiduciaries may not “subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits … to other objectives … or take on additional investment risk to promote [unrelated] benefits or goals … .” If, however, fiduciaries prudently conclude that competing investments or investment strategies “equally serve the financial interests of the plan over the appropriate time horizon,” they are not prohibited from selecting the investment, or investment course of action, based on collateral benefits other than investment returns.” The Final Rule also dispenses with the 2020 Rule’s special requirement to retain detailed records of decisions that considered “non-pecuniary” factors in favor of “ERISA's generally applicable statutory duty to prudently document plan affairs.”

While most of the foregoing could have been reasonably anticipated (e.g., final rules commonly become more moderate than what was originally proposed as a result of the notice and comment period), there was one change that has largely been regarded as a surprise.   When it comes to participant-directed individual account plans (e.g., 401(k), 403(b), etc.), the Final Rule states that fiduciaries will “not violate the duty of loyalty … solely because the fiduciary takes into account participants’ preferences in a manner consistent with the [above-referenced duties of prudence].” The DOL notes that “if accommodating participants' preferences will lead to greater participation and higher deferral rates, it could lead to greater retirement security. Thus, considering whether an investment option aligns with participants' preferences can be relevant to furthering the purposes of the plan.”

This change is significant because many plan sponsors have struggled with balancing their fiduciary duties (under the prior rules, and, in particular, the 2020 Rule) with participants’ requests to add investments with favorable ESG-related considerations to the plan’s menu. The revised duties contained in the Final Rule allow plan sponsors the liberty to incorporate participant preferences into their decision-making process.

Summary of Key Changes

Takeaways & Action Items for Plan Sponsors

1. Educate committee members on the Final Rule.
2. Review investment policies and decision-making processes to determine whether changes need to be made to accommodate the requirements in the Final Rule. Below is a high-level framework for participant-directed plans to use as a guide for making changes to investment policies and/or processes to accommodate the Final Rule:
1. Determine whether to incorporate participants’ preferences when selecting designated investment alternatives (“DIAs”) that will be made available through the plan.

1. If so, document such preferences and how they will factor into decision-making.

1. Determine and document the plan’s investment time horizon(s).
2. Determine and document the types of DIAs (e.g., asset classes) and QDIA (e.g., age-based, risk-based or managed account).
3. Consider relevant information, including Items 2(a) – (c) above, and evaluate whether a particular investment or investment course of action is reasonably designed, as part of the menu, to further the purposes of the plan, taking into consideration the risk of loss and the opportunity for gain (or other return) associated with the investment or investment course of action compared to the opportunity for gain (or other return) associated with reasonably available alternatives with similar risks.

1. Determine whether the economic effects and climate change and other ESG factors are relevant to a risk and return analysis.

1. Confirm that the weight given to any factor appropriately reflects a reasonable assessment of its impact on risk-return.
2. In the event competing investments or investment strategies are found to equally serve the financial interests of the plan over the appropriate time horizon, fiduciaries may consider collateral benefits other than investment returns.
3. Document basis for selecting DIAs and QDIA.

1. Adopt changes to the plan’s Investment Policy Statement, monitor DIAs and QDIAs and, periodically, review the IPS to confirm criteria remain prudent.

Pensionmark Financial Group, LLC (“Pensionmark”) is an investment adviser registered under the Investment Advisers Act of 1940.  Pensionmark is affiliated through common ownership with Pensionmark Securities, LLC (member SIPC).