# Financial Factors in Selecting Plan Investments

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2020-24515

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** November 13, 2020
- **Citation:** 85 FR 72846

## Text

DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Parts 2509 and 2550
RIN 1210-AB95
Financial Factors in Selecting Plan Investments

AGENCY:

Employee Benefits Security Administration, Department of Labor.

ACTION:

Final rule.

SUMMARY:

The Department of Labor (Department) is adopting amendments to the “investment duties” regulation under Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA). The amendments require 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:

The final rule is effective on January 12, 2021.

FOR FURTHER INFORMATION CONTACT:

Jason A. DeWitt, Office of Regulations and Interpretations, Employee Benefits 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

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 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 when making decisions on investments and investment courses of action, plan fiduciaries must be focused solely on the plan's financial returns, and the interests of plan participants and beneficiaries in their benefits must be paramount.

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).

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

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).

The Department's first comprehensive guidance addressing these types of investment issues was in Interpretive Bulletin 94-1 (IB 94-1).
6

There, the term used was “economically targeted investments” (ETIs). The Department's objective in issuing IB 94-1 was to state that ETIs
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 ETIs 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.

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.

Since 1994, the Department's sub-regulatory guidance has gone through an iterative process, but the Department's emphasis on the primacy of plan participants' economic interests has stayed constant. 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 providing promised benefits 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.

8
73 FR 61734 (Oct. 17, 2008).

9
80 FR 65135 (Oct. 26, 2015).

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 IB 2015-01 had 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 the issues as material economic considerations under generally accepted investment theories. As appropriate economic considerations, they 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

10
Field Assistance Bulletin 2018-01 (Apr. 23, 2018).

11
Id.

B. Purpose of Regulatory Action

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 assets invested in sustainable funds was nearly four times larger in 2019 than in 2018.
12

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).

As ESG investing has increased, it has engendered important and substantial questions with numerous observers identifying a lack of precision and consistency in the marketplace with respect to defining ESG investments and strategies, as well as shortcomings in the rigor of the prudence and loyalty analysis by some participating 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

The use of terms such as ESG, impact investing, sustainability, and non-financial performance metrics, among others, encompass a wide variety of considerations without a common nexus and can take on different meanings to different people. In part, the confusion stems from the fact that, from its beginning, the ESG investing movement has had multiple goals, both pecuniary

and non-pecuniary.
15

Moreover, ESG funds often come with higher fees, because additional investigation and monitoring are necessary to assess an investment from an ESG perspective.
16

13
See,
e.g., OECD Business and Finance Outlook 2020
(Sept. 2020),
www.oecd.org/daf/oecd-business-and-finance-outlook-26172577.htm,
at 29 (“The review of academic and industry literature reveals a wide range of approaches and results, which are largely inconsistent with one another. The research highlights the difficulty of identifying the real impact of ESG on investment performance.”);
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; 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.

14
See,
e.g., OECD Business and Finance Outlook 2020
(Sept. 2020), at 26-33, 47-58; 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 Kölbel, & 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., Who Cares Wins: Connecting Financial Markets to a Changing World
(2004),
www.unepfi.org/fileadmin/events/2004/stocks/who_cares_wins_global_compact_2004.pdf,
at v. (“Overall goals” include “[s]tronger and more resilient financial markets” and “[c]ontribution to sustainable development”).

16
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.

The Securities and Exchange Commission (SEC) has also undertaken initiatives related to ESG. 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.
17

The SEC also solicited 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.
18

17
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.

18
See Request for Comment on Fund Names, Release No. IC-33809 (Mar. 2, 2020) (85 FR 13221 (Mar. 6, 2020)).

ESG investing raises heightened concerns under ERISA. Public companies and their investors may legitimately pursue a broad range of objectives, subject to the disclosure requirements and other requirements of the securities laws. Pension plans and other benefit plans covered by ERISA, however, are bound by statute to a narrower objective: Prudent management with an “eye single” to maximizing the funds available to pay benefits under the plan.
19

Providing a secure retirement for American workers is the paramount, and eminently worthy, “social” goal of ERISA plans; plan assets may never be enlisted in pursuit of other social or environmental objectives at the expense of ERISA's fundamental purpose of providing secure and valuable retirement benefits.

19

Donovan
v.
Bierwirth,
supra note 2, 680 F.2d at 271.

Section 404(a)(1)(A) of ERISA expressly requires that plan fiduciaries act “for the exclusive purpose of: (i) Providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan.” The Department is concerned, however, that the growing emphasis on ESG investing may prompt 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.
20

For example, the Department understands that the fund managers of some ESG investment funds offered to ERISA defined contribution plans represent that the fund is appropriate for ERISA plan investment platforms, while acknowledging in disclosure materials that the fund may perform differently, forgo investment opportunities, or accept different investment risks, in order to pursue the ESG objectives.

20
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.

This regulatory project was undertaken in part to make clear that ERISA plan fiduciaries may not subordinate return or increase risks to promote 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.
21

The duty of prudence prevents a fiduciary from choosing an investment alternative that is financially less beneficial than reasonably available alternatives. These fiduciary standards are the same no matter the investment vehicle or category.

21
See Unif. Prudent Inv. Act section 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
section 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.”).

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 use of non-pecuniary or non-financial factors over the years in sub-regulatory guidance. Accordingly, the Department intends, by this final regulation, to promulgate principles of fiduciary standards for selecting and monitoring investments, and set forth the scope of fiduciary duties surrounding non-pecuniary issues. Under the final rule, plan fiduciaries, when making decisions on investments and investment courses of action, must focus solely on the plan's financial risks and returns and keep the interests of plan participants and beneficiaries in their plan benefits 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.

The final rule recognizes that there are instances where one or more environmental, social, or governance factors 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. 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 addressing these issues in the form of a notice and comment regulation will help safeguard the interests of participants and beneficiaries in the plan benefits.

C. June 2020 Proposed Rule

In June 2020 (85 FR 39113 (June 30, 2020)), the Department published in the
Federal Register
a proposed rule to amend 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. The proposal was intended to provide regulatory guideposts for plan fiduciaries in light of recent trends involving ESG investing that the Department is concerned may lead ERISA plan fiduciaries to choose investments or investment courses of action to promote environmental, social, and other public policy goals unrelated to the interests of plan participants and beneficiaries in receiving financial benefits from the plan, and expose plan participants and beneficiaries to inappropriate investment risks or lower returns than reasonably available investment alternatives. The proposal retained the core principles in the current regulation that set forth requirements for satisfying the prudence duty under ERISA section 404(a)(1)(B) when deciding on plan investments and investment courses of action.

The proposal suggested five major additions to the investment duties regulation. First, the proposal included new regulatory text that would require plan fiduciaries to select investments and investment courses of action based on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action. Second, the proposal added an express statement that compliance with the exclusive purpose (loyalty) duty in ERISA section 404(a)(1)(A) prohibits fiduciaries from subordinating the interests of plan participants and beneficiaries in retirement income and financial benefits to non-pecuniary goals. Third, a proposed new provision required fiduciaries to consider other available investments to meet their prudence and loyalty duties under ERISA. Fourth, the proposal acknowledged that ESG factors can be pecuniary factors, 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 proposal added new regulatory text, setting forth required investment analysis and documentation requirements in the rare circumstances when fiduciaries are choosing among truly “indistinguishable” investments (related to the so-called “tie breaker rule”). The documentation requirement was intended to prevent fiduciaries from improperly finding economic equivalence and making decisions based on non-pecuniary benefits without a proper analysis and evaluation. Fiduciaries already commonly document and maintain records about their investment selections. The provision in the proposal would have made that general practice required where a fiduciary determines that alternative investment options are economically indistinguishable and where the fiduciary chooses one of the investments on the basis of a non-pecuniary factor. Fifth, the proposal added a new provision on selecting designated investment alternatives for a defined contribution individual account plan (commonly referred to as 401(k)-type plans). The proposal reiterated the Department's view that the prudence and loyalty standards set forth in ERISA apply to a fiduciary's selection of an investment alternative to be offered to plan participants and beneficiaries in a defined contribution individual account plan. The proposal described the requirements for the selection of investment alternatives for such plans that purport to pursue one or more environmental, social, and corporate governance-oriented objectives in their investment mandates or that include such parameters in the fund name.

Overall, the proposed rule was designed to assist fiduciaries in carrying out their responsibilities, while promoting the financial interests of current and future retirees. The Department acknowledged in the proposal that some plans would have to modify their processes for selecting and monitoring investments—in particular, plans whose current document and recordkeeping practices were insufficient to meet the proposal's requirements.

The Department invited interested persons to submit comments on the proposed rule. In response to this invitation, the Department received more than 1,100 written comments submitted during the open comment period, and more than 7,600 submissions made as part of six separate petitions (
i.e.,
form letters). These comments and petitions came from a variety of parties, including plan sponsors and other plan fiduciaries, individual plan participants and beneficiaries, financial services companies, academics, elected government officials, trade and industry associations, and others, both in support of and in opposition to the proposed rule. These comments were available for public review on the “Public Comments” page under the “Laws and Regulations” tab of the Department's Employee Benefits Security Administration website.
22

22
See
www.dol.gov/agencies/ebsa/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95.
The Department received some comment letters on the proposed rule that were submitted after the close of the comment period. Those late comments were not considered or posted on the Department's website.

Many comments submitted on the proposal offered general support for, or opposition to, the Department's proposal. These comments did not contain specific or detailed arguments on provisions of the proposal or otherwise include relevant, empirical information in the form of data or cited studies. As such, the Department does not separately identify or discuss these general comments in this document, although the preamble, in its entirety, addresses the reasons for undertaking this regulatory initiative and the rationales for the Department's specific regulatory choices.

Some commenters asserted that the proposal was “unsupported by substantial evidence” and was “unwarranted by the facts,” does not meet the minimum requirements of the Administrative Procedure Act, the Paperwork Reduction Act, or Executive order and Office of Management and Budget guidelines on cost-benefit analysis, and argued that the proposal could not withstand legal challenge in court. Several commenters argued for withdrawal of the proposed rule stating that the proposal neither demonstrated a compelling need for regulatory action nor demonstrated any fiduciary action that was injurious to plans. Some additionally argued that the Department had failed to employ the least burdensome method to effect any necessary change or to present any empirical data or evidence of a problem that justified the regulation. The Department, the commenters asserted, failed to provide a single example of any ERISA fiduciary allocating any investment on the basis of non-pecuniary criteria or any investigations or enforcement activity based on these concerns.

Other commenters indicated that current guidance is sufficient to enable the Department to bring enforcement actions against fiduciaries who fail to meet their responsibilities. Further, they asserted, the regulation was not proposed pursuant to either an explicit statutory mandate or evidence of an actual documented problem. Some commenters responded to the Department's observation of the growing emphasis on ESG in the marketplace by arguing that the more frequent use of the term “ESG” does not indicate any improper fiduciary decision making. Some also argued that the Department's approach is incongruent with that of other regulators who require consideration of financially material ESG factors and focus on the importance of disclosure of those factors.

With respect to the arguments of commenters concerning the Administrative Procedure Act, the Department believes that there are sufficient reasons to justify the promulgation of this final rule, including the lack of precision and consistency in the marketplace with respect to defining ESG investments and strategies, shortcomings in the rigor of the prudence and loyalty analysis by some participating in the ESG investment marketplace, and perceived variation in some aspects of the Department's past guidance on the extent a fiduciary may consider non-pecuniary factors in making investment decisions. Further, the iterative Interpretive Bulletins since 1994, followed by the Field Assistance Bulletin issued in 2018, and the number of advisory opinions and information letters historically issued on this topic demonstrate the need for notice and comment guidance issued under the Administrative Procedure Act.
23

The Department does not believe that there needs to be specific evidence of fiduciary misbehavior or demonstrated injury to plans and plan participants in order to issue a regulation addressing the application of ERISA's fiduciary duties to the issue of investing for non-pecuniary benefits. The need for this regulation was also demonstrated by some commenters who indicated their intention to make, or current practice in making, plan investment decisions based on non-pecuniary factors, rather than based on investment risk and return. For example, some commenters claimed that ERISA fiduciaries must prioritize the long-term, absolute returns for “universal owners,” and that collective investor action to manage social and environmental systems is necessary. As another example, other commenters argued that fiduciaries should be permitted to consider the potential for an investment to create jobs for workers who in turn would participate in the plan. These comments signal that the Department needs to address the use of non-pecuniary factors by fiduciaries when making decisions about ERISA plan investments and investment courses of action. Under the Department's authority to administer ERISA, the Department may promulgate rules that are preemptive in nature and is not required to wait for widespread harm to occur. The Department can ensure that demonstrated injury to plans and plan participants and beneficiaries are protected prospectively. Investing for non-pecuniary objectives raises heightened concerns under ERISA.

23
See Executive Order 13891, 84 FR 55235 (Oct. 15, 2019) promoting notice and comment regulation for guidance.

As the Department noted in the proposal, 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. However, fiduciaries of pension and other benefit plans covered by ERISA are statutorily bound to manage those plans with a singular goal of maximizing the funds available to pay benefits under the plan. Indeed, the final rule furthers the paramount goal of ERISA plans to provide a secure retirement for American workers, and states that plans may not forego investment opportunities or assume investment risk to promote other non-financial goals.
24

In response to comments stating that the current guidance is sufficient, the Department believes that there is a reasonable need for this rulemaking, for the reasons explained earlier. The Department also believes that proceeding through notice-and-comment rulemaking rather than promulgating further interpretive guidance has other benefits, including the benefit of public input and the greater stability of codified rules. Proceeding in this manner is also consistent with the principles of Executive Order 13891 and the Department's recently issued PRO Good Guidance rule, which emphasize the importance of public participation, fair notice, and compliance with the Administrative Procedure Act.
25

24
Executive Order 13868 on Promoting Energy Infrastructure and Economic Growth directed the Department to complete a review of available data filed with the Department in order to identify whether there are discernible trends with respect to plan investments in the energy sector. The order also required the Department to provide an update to the Assistant to the President for Economic Policy on any discernible trends in energy investments by such plans and to complete a review of existing Department of Labor guidance on the fiduciary responsibilities for proxy voting. Nothing in the order dealt with investing for non-pecuniary purposes. As a result, no reports related to the proposal were required by the Executive order.

25
See 85 FR 53163 (Aug. 28, 2020) (promulgating the Department's rule on promoting regulatory openness through good guidance).

Some commenters complained that the 30-day comment period was too short given the complexity of the proposed changes, the magnitude of such changes to the retirement marketplace, and the need to prepare supporting data. They stated that those challenges were exacerbated by the present COVID-19 pandemic. Many commenters requested an extension of the comment period and that the Department schedule a public hearing on the proposal and allow the public record to remain open for post-hearing comments from interested parties. The Department has considered these requests, but has determined that it is neither necessary nor appropriate to extend the public comment period, hold a public hearing, or withdraw or republish the proposed regulation. A substantial and comprehensive public comment record was developed on the proposal sufficient to substantiate promulgating a final rule. The scope and depth of the public record that has been developed itself belies arguments that a 30-day comment period was insufficient. In addition, most issues relevant to the proposal have been analyzed and reviewed by the Department and the public in the context of three separate Interpretive Bulletins issued in 1994, 2008, and 2015 and the public feedback that resulted.
26

Finally, public hearings are not required under the Department's general rulemaking authority under section 505 of ERISA, nor under the Administrative Procedure Act's procedures for rulemaking at 5 U.S.C. 553(c). In this case, a public hearing is not necessary to supplement an already comprehensive public record.

26
Further, the Department has also considered this subject in the context of specific questions submitted by stakeholders since the 1980s. See,
e.g.,
DOL Inf. Ltr to George Cox (Jan. 16, 1981); DOL Adv. Op. to Theodore R. Groom (Jan. 16, 1981); DOL Adv. Op. to Daniel E. O'Sullivan, Union Labor Life Ins. Co (Aug. 2, 1982); Ltr from Ass't Sec. Dennis Kass to Sen. Howard Metzenbuam (May 27, 1985); DOL Adv. Op to James Ray, Union Labor Life Ins. Co. (July 8, 1988); DOL Inf. Ltr. to Stuart Cohen, General Motors Corp. (May 14, 1993).

Thus, this final rulemaking follows the notice and comment process required by the Administrative Procedure Act, and fulfills the Department's mission to protect, educate, and empower retirement investors as they face important choices

in saving for retirement in their employee benefit plans. This rule is considered to be an Executive Order (E.O.) 13771 regulatory action. Details on the estimated costs of this rule can be found in the final rule's economic analysis. The Department concluded that the additions to §  2550.404a-1 (404a-1 regulation) and the rule's improvements to the Department's previous sub-regulatory guidance are appropriate and warranted. Accordingly, after consideration of the written comments received, the Department has determined to adopt the proposed regulation as modified and set forth below.

D. The Final Rule

The final regulation sets forth fiduciary standards for selecting and monitoring investments held by ERISA plans, and addresses the scope of fiduciary duties surrounding non-pecuniary issues. The final regulation contains several important changes from the proposal in response to public comments. The fact that the loyalty principles of section 404(a)(1)(A) of ERISA are now coupled with the previous prudence regulation under section 404(a)(1)(B) confirms that, in making investment decisions of any kind, ERISA requires that both the principles of loyalty and of prudence must be considered. The final rule expressly applies these principles not just to investments and investment courses of action, but also to the selection of available investment options for plan participants in individual account plans.

As more fully described below, the final rule makes five major amendments to the investment duties regulation under Title I of ERISA at 29 CFR 2550.404a-1. First, the final rule adds provisions to confirm that ERISA fiduciaries must evaluate investments and investment courses of action based solely on pecuniary factors—financial considerations that have 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 funding policy. The term “investment course of action” is defined in paragraph (f)(2) of the final rule to mean “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 investment alternative under the plan.” Second, the final rule includes an express regulatory provision stating that compliance with the exclusive purpose (loyalty) duty in ERISA section 404(a)(1)(A) prohibits fiduciaries from subordinating the interests of participants to unrelated objectives, and bars them from sacrificing investment return or taking on additional investment risk to promote non-pecuniary goals. Third, the final rule includes a provision that requires fiduciaries to consider reasonably available alternatives to meet their prudence and loyalty duties under ERISA. Fourth, new regulatory text sets forth required investment analysis and documentation requirements for those circumstances in which plan fiduciaries use non-pecuniary factors when choosing between or among investments that the fiduciary is unable to distinguish on the basis of pecuniary factors alone. The final rule includes a related documentation requirement for such decisions intended to prevent fiduciaries from improperly finding economic equivalence or making investment decisions based on non-pecuniary benefits without appropriately careful analysis and evaluation. Fifth, the final rule states that the prudence and loyalty standards set forth in ERISA apply to a fiduciary's selection of designated investment alternatives to be offered to plan participants and beneficiaries in a participant-directed individual account plan. The final rule expressly provides that, in the case of selecting investment alternatives for an individual account plan that allows plan participants and beneficiaries to choose from a broad range of investment alternatives, as defined in 29 CFR 2550.404c-1(b)(3), a fiduciary is not prohibited from considering or including an investment fund, product, or model portfolio merely because the fund, product, or model portfolio promotes, seeks, or supports one or more non-pecuniary goals, provided that the fiduciary satisfies the prudence and loyalty provisions in ERISA and the final rule, including the requirement to evaluate solely on pecuniary factors, in selecting any such investment fund, product, or model portfolio. However, the provision prohibits plans from adding any investment fund, product, or model portfolio as a qualified default investment alternative described in 29 CFR 2550.404c-5, or as a component of such an investment alternative, if the fund, product, or model portfolio's investment objectives or goals or its principal investment strategies include, consider, or indicate the use of one or more non-pecuniary factors.

The provisions of the final rule are discussed below along with relevant public comments.

1. Section 2550.404a-1(a) and (b)—General Prudence and Loyalty Investment Duties

The final 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.
27

For example, as stated in the preamble to the 1979 regulation, 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 continues to believe 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.

27
44 FR 37221, 37225 (June 26, 1979).

Paragraph (a) of the final rule is unchanged from the proposal and includes a restatement of the statutory language of the exclusive purpose requirements of ERISA section 404(a)(1)(A) and the prudence duty of ERISA section 404(a)(1)(B). The existing 404a-1 regulation already included a restatement of the prudence duties that apply to fiduciary investment decisions under ERISA section 404(a)(1)(B). The final rule thus reinforces the core principles provided in the investment duties regulation by expressly referencing the separate loyalty duty imposed on fiduciary investment decisions under ERISA section 404(a)(1)(A). In effect, paragraph (a) of this final rule amends paragraph (a) in the 1979 investment duties regulation by adding the exclusive purpose requirements to the existing duty of prudence. That application of these

prudence and loyalty requirements is context-specific and depends on the facts and circumstances as made clear by the rest of the provisions of the rule.

Some commenters asserted that the combination of prudence and loyalty in paragraph (a) of the proposal, together with the requirements of paragraph (b) as to how to satisfy those joint requirements when evaluating investments, were not simple clarifications of the existing investment duties regulation. Rather, in their view, that combination of amendments would have constituted the development of a new theory of loyalty beyond the Department's stated objective to address ESG investment developments, and which would have resulted in confusion regarding investment duties more generally. Some commenters, moreover, argued that the proposal's combination of amendments could violate established principles of statutory construction by establishing a regulation under which compliance with a single set of objective requirements would be sufficient to satisfy the requirements of both section 404(a)(1)(A)'s duty of loyalty and (B)'s duty of prudence. Unlike ERISA's duty of prudence, the duty of loyalty has not been interpreted by the courts to be an objective test requiring compliance with appropriate procedures, but has instead been measured by the subjective intent or motivation of the fiduciaries, according to the commenters. Nor have the courts extended the duty of loyalty to prohibit a fiduciary from considering implications external to the fiduciary's self-interest, so long as the fiduciary was focused on benefiting participants and beneficiaries and defraying reasonable plan expenses, according to the commenters. And finally, some commenters asserted that at least some authority interprets ERISA section 404(a)(1)(A) to permit some incidental benefits to others' interests as long as the primary purpose and effect of the action is to benefit the plan.

As to the interplay between paragraphs (a), (b), and (c) of the proposal, one commenter requested clarification that paragraph (b) of the proposal was intended to continue as a safe harbor, and was not the exclusive means for satisfying prudence. This commenter observed that the Department originally described paragraph (b) as a safe harbor in 1979 when the investment duties regulation was originally published. This commenter was concerned that the specific requirements of paragraph (c) of the proposal did not appear to constitute a safe harbor. This commenter argued that if the Department's intent is to transform paragraph (b) from a safe harbor into minimum requirements, the Department must provide specific notice of this fact and solicit comments from the public while also assessing the costs and benefits of such a change.

Some commenters also raised concerns that the Department should not have multiple prongs in the regulation variously stating that a fiduciary “should not subordinate” and “should not otherwise subordinate.” Similarly, one commenter argued that the phrase in the proposal “and has otherwise complied with the duty of loyalty” is circular because it includes compliance with the duty of loyalty as an element of complying with the duty of loyalty. Commenters argued that the addition of the phrase “the duty of loyalty” inside the definition of the duty of loyalty creates an invitation for courts to graft on additional responsibilities not included within either the Department's rule or section 404(a)(1)(A) of ERISA.

One commenter asked the Department to replace its multi-part articulation of the duty of loyalty in the proposal with a simple clarification stating that “a fiduciary may not subordinate the interests of participants and beneficiaries as retirement savers to any other interests of the participants, beneficiaries, the fiduciary itself or any other party.” This commenter also proposed eliminating paragraph (c) regarding pecuniary factors in investment decisions altogether. The commenter argued that the advantage would be an easily understood, one-part test that captures both elements of the proposal without the need for special rules for “pecuniary factors” and other rules for “non-pecuniary factors.”

Other commenters argued that the prohibition in paragraph (b) against subordinating the interest of the participants and beneficiaries to the fiduciary's or another's interest is unnecessary in light of ERISA's prohibited transaction provisions, and, moreover, would likely have unintended consequences by making many common, accepted, and generally beneficial practices suspect, such as the use of proprietary products, fee sharing, and fee aggregation.

The principles of loyalty under section 404(a)(1)(A) of ERISA prohibit a fiduciary from subordinating the interests of the participants and beneficiaries in their retirement income or other financial benefits under the plan to unrelated objectives. No commenter suggested to the contrary. Thus, the Department believes that including the duty of loyalty in a regulatory provision regarding investment activity should not be the surprise nor innovation some commenters alleged.

The Department is persuaded by the comments that there is a better way than presented in the proposal to express the view that a fiduciary engaged in investments and investment courses of action may not subordinate the interests of the plan to unrelated objectives and that the fiduciary needs to focus on the pecuniary interests of the plan in complying with its prudence obligation under the plan. The Department is persuaded by the comments that it would be preferable to retain paragraph (b) as a provision addressing only the ERISA section 404(a)(1)(B) prudence duty and revising paragraphs (c) and (d) to more specifically address the element of the duty of loyalty that requires fiduciaries to focus investment decision-making on providing financial benefits to participants under the plan and prohibits fiduciaries from subordinating the interests of participants and beneficiaries in their retirement income or financial benefits under the plan to unrelated objectives. This approach incorporates the duty of loyalty into the regulation while recognizing that the statute sets forth the duty of prudence and the duty of loyalty as separate fiduciary obligations.

Further, the Department is persuaded by the comments that the “safe harbor” nature of paragraph (b) in the original investment duties regulation should be preserved. However, the Department does not agree that its safe-harbor characterization of the 404a-1 regulation in 1979 can fairly be read to suggest an unrestricted open field. Rather, in describing the regulation as a safe harbor, the Department cautioned that it was expressing no view on whether the prudence duty could be satisfied outside of the “safe harbor” provisions in the regulation: “It should also be noted that the Department does not view compliance with the provisions of the regulation as necessarily constituting the exclusive method for satisfying the requirements of the `prudence' rule. Rather, the regulation is in the nature of a `safe harbor' provision; it is the opinion of the Department that fiduciaries who comply with the provisions of the regulation will have satisfied the requirements of the `prudence' rule,
but no opinion is expressed in the regulation as to the status of activities undertaken or performed that do not so comply.
”
28

Although there may be

distinct circumstances where some other process would be prudent, in every case, ERISA fiduciaries are required to have a soundly reasoned and supported investment decision or strategy to satisfy the ERISA prudence requirement.

28
44 FR at 37222 (June 26, 1979) (emphasis added).

As a result, proposed paragraph (b)(1) is modified in the final rule to remove the general references to the duty of loyalty under section 404(a)(1)(A) of ERISA, such as those contained in paragraphs (b)(1)(iii) and (iv) of the proposal, and to maintain its character as a safe harbor for prudent investment and investment courses of action as described in the original 1979 investment duties regulation. However, the safe harbor in paragraph (b) applies only to the duty of prudence under section 404(a)(1)(B) of ERISA. Under the final rule, the provisions set forth in paragraphs (c) and (d) are set forth as minimum requirements with respect to the aspects of the duty of loyalty addressed in those paragraphs, including the obligation to focus on pecuniary factors when making investment decisions. Thus, the final rule does not revise the current 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 return of the portfolio relative to the funding objectives of the plan. Paragraph (b)(1) of the final rule continues to provide that 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)(B) of the Act set forth in paragraph (a) 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, and (ii) has acted accordingly.

Paragraph (b)(2) of the proposal provided that for purposes of paragraph (b)(1) of the proposal, “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 composition of the portfolio with regard to diversification, the liquidity and current return of the portfolio relative to the anticipated cash flow requirements of the plan, the projected return of the portfolio relative to the funding objectives of the plan as those factors relate to such portion of the portfolio, and how the investment or investment course of action compares to available alternative investments or investment courses of action with regard to those factors listed.

Paragraph (b)(2) of the proposal was essentially the same as the provision in the 1979 investment duties regulation except for proposed paragraph (b)(2)(ii)(D) which required the consideration of how the investment or investment course of action compares to available alternative investments or investment courses of action with regard to those factors listed in paragraphs (b)(2)(ii)(A) through (C). Thus, most related comments concerned proposed paragraph (b)(2)(ii)(D). Commenters assert that this provision is unclear as to extent of the requirement to evaluate alternatives. In some cases, commenters alleged, there may be no true alternative to a particular investment, because the opportunity is so unique. In other cases, the opportunity may lapse if a thorough undertaking of all alternatives is pursued. In yet other situations, the number of potential alternatives might be so numerous that consideration of every alternative is impossible. This lack of clarity may give rise to inappropriate second-guessing in which questions are raised as to whether a particular alternative (selected with the benefit of hindsight) should have been considered. Similarly, some commenters complained that the requirement does not necessarily take into account the complexities involved in defined benefit plan investment, which varies, among other items, by plan design, participant census, the sponsor's risk tolerance and a company's cash, and whether a proposed investment adds litigation risk. Commenters also argued the proposed provision may be at odds with the ERISA section 404(c) regulation because it is unclear what “available alternative investments” means in the context of satisfying the 404(c) regulation's requirement to make available at least three investment alternatives meant to provide a broad-based selection. Further, commenters asked how to apply the obligation to consider alternative investments applies in situations where company stock is purchased for a plan through a plan provision that mandates such purchase.

Commenters were concerned that the proposed rule provides no guidance as to how the relevant alternatives would be determined and how many of those alternatives the fiduciary is to use in performing the newly required comparison. For example, one commenter posited that the proposal might be read to require a fiduciary making a decision on a diversified stock fund that falls within Morningstar's large cap growth category to compare that investment to all of the approximately 1,350 mutual funds within that category. Some commenters suggested that the Department should tell fiduciaries exactly how to conduct such an analysis to make the best prospective decision. Some expressed concern that the requirement opened fiduciaries to “20/20 hindsight” legal attacks by class action lawyers.

The Department notes that the concept of comparing available investment alternatives is not new. Interpretive Bulletins on ESG and ETI investing issued by the Department expressed the view that facts and circumstances relevant to an investment or investment course of action would, in the view of the Department, include consideration of the expected return on alternative investments with similar risks available to the plan. Specifically, the Department observed that, because every investment necessarily causes a plan to forego other investment opportunities, an investment would not be prudent if it were expected to provide a plan with a lower rate of return than available investment alternatives with commensurate degrees of risk, or were riskier than available investment alternatives with commensurate rates of return.
29

Such an analysis is similar to that required by paragraph (b)(2)(ii)(D) of the proposal. As a result, the concept of comparing investment opportunities as set forth in paragraph (b)(2)(ii)(D) cannot fairly be cast as new to the retirement investing community.

29
See 29 CFR 2509.94-1 and 2509.2015-01.

Furthermore, the proposal was not intended to require fiduciaries to “scour the market” and incur search costs on a practically infinite number of potential portfolios, nor could such a requirement be consistent with the duty

of prudence.
30

Rather, as the Department noted when it issued the 404a-1 regulation in 1979, the Department recognizes that a fiduciary should be required neither to expend unreasonable efforts in discharging his duties, nor to consider matters outside the scope of those duties. Accordingly, the regulation requires fiduciaries to give consideration to those facts and circumstances which, taking into account the scope of his investment duties, the fiduciary knows or should know are relevant to the particular investment decision involved.
31

The scope of the fiduciary's inquiry in this respect, therefore, is limited to those facts and circumstances that a prudent person having similar duties and familiar with such matters would consider relevant. That same principle applies to consideration of alternative investment opportunities.

30
See
Hecker
v.
Deere & Co.,
556 F.3d 575, 586 (7th Cir. 2009) (“nothing in ERISA requires every fiduciary to scour the market”).

31
See 44 FR at 37223 (June 26, 1979).

Accordingly, the Department has determined to keep the general concept of paragraph (b)(2)(ii)(D) in the final rule. However, we believe a better approach than the proposal is one that incorporates the concept in a way that is consistent with the Department's prior IB statements and at the same time addresses the requests of commenters for guidance as to the extent of the requirement to evaluate alternatives. The Department added new language to paragraph (b)(2)(i) to state that the consideration of risk and loss and the opportunity for gain (or other return) associated with the investment or investment courses of action should take place “compared to the opportunity for gain (or other return) associated with reasonably available alternatives with similar risks.” Under the final rule, a fiduciary is required only to compare alternatives that are reasonably available under the circumstances. The Department used the phrase “reasonably available alternatives” not only to confirm that the rule does not require fiduciaries to scour the market or to consider every possible alternative, but also to allow for the possibility that the characteristics and purposes served by a given investment or investment course of action may be sufficiently rare that a fiduciary could prudently determine, and document, that there were no other reasonably available alternatives for purpose of this comparison requirement. As a result, paragraph (b)(2) of the final rule provides that for purposes of paragraph (b)(1), “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 compared to the opportunity for gain (or other return) associated with reasonably available alternatives with similar risks, and (ii) consideration of the composition of the portfolio with regard to diversification, the liquidity and current return of the portfolio relative to the anticipated cash flow requirements of the plan, the projected return of the portfolio relative to the funding objectives of the plan as those factors relate to such portion of the portfolio, and how the investment or investment course of action compares to alternative investments or investment courses of action that were considered with regard to those factors listed.

With respect to the comments arguing that ERISA section 404(a)(1)(A) is purely a subjective motivation test, the Department does not believe that is a viable analytical approach and is concerned that such an interpretation would raise substantial feasibility questions about the application and enforcement of such a requirement. Rather, while motivation is undeniably a proper focus in applying a loyalty requirement under which fiduciary action must be based solely on the interests of participants and beneficiaries and for their “exclusive benefit,” the Department believes that establishing regulatory guideposts, like the requirement to focus on pecuniary factors in investment decision-making, is an appropriate way to establish objective criteria that help fiduciaries understand how to comply with their duty of loyalty in the context of evaluating financial factors when selecting investments or investment courses of action.

Since the scope of paragraph (b) in the final rule has been revised from the proposal to encompass only the obligations set forth in ERISA section 404(a)(1)(B), the proposal's inclusion in paragraph (b)(1)(iv) of a specific prohibition on a fiduciary subordinating the interests of participants and beneficiaries to the fiduciary's or another's interest is unnecessary. The Department further agrees that it is not necessary to have multiple provisions of the final rule contain the prohibition on “not subordinating” the interests of participants and beneficiaries. Thus, the Department eliminated paragraph (b)(1)(iv) of the proposal from the final rule, and, as described below, revised the final rule to address the Department's concerns regarding a focus in fiduciary investment activity on “pecuniary factors” through a revised provision in paragraph (c).
32

32
For similar reasons, the final rule does not carry forward the reference to the parallel exclusive purpose provision in ERISA section 403 that was in the proposal. The Department also concluded that the final rule should continue the focus of the current 404a-1 regulation on section 404 of ERISA. Section 403(c) of ERISA provides in relevant part that the assets of the plan shall never inure to the benefit of any employer and shall be held for the exclusive purpose for providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of the plan. Although similar, the text of ERISA section 403 is not identical to section 404(a)(1)(A) of ERISA, and the Department wanted to avoid any possible inference that compliance with the provisions of the final rule would also necessarily satisfy all the provisions of section 403 of ERISA.

Paragraph (b)(3) of the final rule merely moves what was paragraph (d) of the proposal to this new position in the regulatory text. This move was judged appropriate because the paragraph concerns compliance with the immediately preceding regulatory text of paragraphs (b)(1) and (2). Paragraph (d) of the proposal repeated a paragraph in the current 404a-1 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. This provision was originally part of the 1979 regulation, has remained unchanged since then, and no commenter suggested that the substance of the provision be changed. Paragraph (b)(3) of the final rule is essentially the same as the parallel provision in the original 1979 investment duties regulation.

2. Section 2550.404a-1(c)(1)—Consideration of Pecuniary Factors

Paragraph (c)(1) of the proposed rule required that a fiduciary's evaluation of an investment be focused only on pecuniary factors. The proposal expressly provided 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) also expressly acknowledged that ESG factors and other similar considerations may be pecuniary factors and 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 proposal emphasized 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 proposal further provided that 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 proposal also emphasized 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.

A number of commenters offered nearly unqualified support for the rule, and endorsed the Department's efforts in moving forward with the proposal. Although some commenters expressed concern that the rule was complex and posited possible attendant compliance costs and uncertain legal liabilities, they deemed these costs justified by the protections offered by the proposal. Commenters also shared the concern of the Department 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. They agreed that the proposal was designed 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. They stated that investments should be made based on an evaluation of whether the investments will improve the financial performance of the plan. Other commenters stated that while they support individual investors' ability to pursue ESG investments that align with their values, they support the proposal's focus on decisions made by ERISA fiduciaries on plan participants' behalf, where enhancing financial returns is the overriding legal obligation of ERISA plan fiduciaries when making investment decisions. Some commenters supported the proposal's acknowledgement that ESG factors and other similar considerations may be economic considerations and the proposal's guidance to fiduciaries regarding how to consider pecuniary ESG factors when contemplating an investment decision, such as the importance of understanding the “economic risks or opportunities” attached to such considerations and appropriately weighing pecuniary ESG factors based on “a prudent assessment of their impact on risk and return” alongside other relevant economic factors necessary to make an investment decision. These commenters said that the proposed regulation would protect plan participants by ensuring that ERISA fiduciaries are making reasoned investment decisions based on all material information, including pecuniary ESG factors, available to them. Other commenters shared DOL's concern that the growing emphasis on ESG investing may be prompting fiduciaries to make investment decisions for reasons other than maximizing return to beneficiaries. Some commenters asserted that some ESG-focused funds have a stated goal of subordinating investor return or increasing investor risk for the purpose of achieving political or social objectives, citing ESG funds' disclosures that the commenters said highlighted the potential for reduced returns, increased risks, and heightened fees in service of social goals. These commenters asserted that the proposed rule clarifies that ERISA plan fiduciaries may not invest in ESG funds when the investment strategy of the fund subordinates return or takes on additional investment risk or costs for purposes of non-pecuniary objectives.

Many commenters, however, expressed concern that the Department did not classify ESG as material financial factors that should be considered by fiduciaries in their investment evaluation and decision-making. They pointed to evidence and research that they asserted makes clear that ESG factors
are
material economic considerations that
must
be integrated into fiduciary investment decisions. Some commenters asserted that ESG integration has been evolving and growing for decades primarily to help manage investment risks and to provide a proxy for management quality, which, they argued, were both pecuniary factors. Other commenters stated that the proposed rule appeared to be based on a presumption that ESG funds commonly select portfolio constituents based on “non-pecuniary” factors, without regard to risk and return. These commenters stated that they were not aware of any fund managers that select portfolio constituents without regard to financial performance, or risk and return.

Some commenters acknowledged that the proposal expressly provided that ESG factors and other similar considerations may be pecuniary factors and economic considerations, but argued that, if the purpose of the rule is to establish a clear distinction between ESG used for risk-return assessment and ESG used for collateral benefits (
e.g.
ESG investing for moral or ethical reasons or to benefit a third party), the Department should better define ESG risk-return factors to more clearly distinguish between the permissible and impermissible uses thereof, which are the heart of this issue. Some commenters similarly argued that the proposal would cause confusion because of its failure to distinguish ESG integration and economically targeted investing. ESG integration, the commenters assert, is the consideration of ESG factors as part of prudent risk management and a strategy to take investment actions aimed at responding to those risks, whereas economically targeted investing, by comparison, is investing with the aim to provide financial as well as collateral, non-financial benefits. These commenters argued that the proposal is aimed at ETIs and problems associated with ETIs rather than ESG integration into the risk-return analysis of investments, and raised concerns that the lack of a clearer distinction between the two in the proposal will discourage proper ESG risk-return integration. Another commenter raised a similar concern, but in the specific context of selecting investment funds for individual account plans, by asking that the Department distinguish between ESG-themed investment funds, where the primary investment strategy or principal purpose is to promote impermissible collateral benefits, and those investment funds that are not primarily focused on ESG factors, but instead use one or more ESG factors as part of their overall investment analysis.

Some commenters asserted that instead of providing the needed flexibility to consider all material factors, the proposal would unnecessarily limit the discretion of the fiduciary to determine that ESG factors

may have a “material effect on the return and risk of an investment” by requiring “qualified investment professionals” to treat the factor as material economic considerations under generally accepted investment theories. They argued that the proposal, although based on generally accepted investment theories which by definition include changes to reflect an evolving financial marketplace, would still place restraints on the discretion fiduciaries need to adjust their investment practices to keep pace with the constantly changing investment landscape and emerging theories that develop alongside. For example, some commenters stated that the Department should avoid a regulatory structure that would require the Department and plan fiduciaries to referee references to “qualified investment professionals,” “material,” and “generally accepted investment theories.” The commenters expressed concern that those terms invite subjective interpretations. One commenter expressed concern that some parties will likely attempt to undermine the rule's intent with claims that ESG-focused investing is already “generally accepted.” Other commenters argued that the proposal creates a heightened level of scrutiny for investments that involve ESG-integration that do not apply to any other type of investment.

Many commenters stated that EBSA ignored academic and financial studies and papers showing that more sustainable companies and funds do not sacrifice performance compared with less sustainable peers, and in fact are somewhat more likely to outperform than to underperform. They cite, for example, a 2018 Government Accountability Office study that concluded the majority of asset managers interviewed found that incorporating ESG factors enhanced retirement plans' risk management.
33

The GAO also noted more than half of the asset managers interviewed were “incorporating ESG factors to improve the long-term performance of retirement plan portfolios.” Another commenter cited a study saying that sustainable funds provided returns in line with comparable traditional funds while reducing downside risk. During a period of extreme volatility, the commenters assert that they saw strong statistical evidence that sustainable funds are more stable. A 2015 Harvard Business School paper found that firms with strong ratings on material sustainability issues have better future performance than firms with inferior ratings on the same issues. In contrast, firms with strong ratings on immaterial issues do not outperform. Some commenters stated that numerous sophisticated investors have indicated that their ESG investments, social benefits notwithstanding, are fundamentally driven by expected financial returns, including considerations regarding long-term value, opportunity, and risk, and cited studies indicating that an ESG perspective can improve performance, including studies that purport to show, according to the commenters, that ESG-focused indexes have matched or exceeded returns of their standard counterparts, with comparable volatility. They also cited studies purporting to show that investors who screened for ESG factors could have avoided 90 percent of S&P 500 bankruptcies from 2005 to 2015 and that S&P 500 companies in the top 25 percent by ESG ratings experienced lower future earnings-per-share volatility than those in the bottom 25 percent. A commenter observed, in its view, that there was better risk-adjusted performance across “sustainable” products globally under recent market stress (including severe turmoil in the first quarter of 2020).

33
Government Accountability Office Report No. 18-398,
Retirement Plan Investing: Clearer Information on Consideration of Environmental, Social, and Governance Factors Would Be Helpful
(2018).

Representatives of the multiemployer plan community commented on the proposal's provisions requiring that the focus of fiduciaries when making investment decisions must be on pecuniary interests of the plan, and requested that the Department add a particular consideration within the meaning of “pecuniary” factor. According to these commenters, the proposal failed to consider and distinguish between the different types of defined benefit pension plans and how relevant pecuniary factors might differ between different types of ERISA plans. They asserted that there are several differences between multiemployer and single employer defined benefit pension plans relevant for purposes of this regulation: The source and nature of plan contributions; the pecuniary impact of contributions on the plan, its participants, and beneficiaries; and the consequent ability of the plan to make investments that advance, promote, and support the pecuniary interests of the plan, its participants, and beneficiaries through plan contributions. These commenters argued that, unlike single employer plans, multiemployer plans have a significant track record of being able to make investments that earn competitive risk-adjusted returns and that directly put plan participants to work, thereby generating new contributions to the plan. According to these commenters, if a given investment results in a pension fund receiving additional contributions, such contributions are as much a pecuniary factor as any gain or loss on the investment. Some commenters made a similar point with respect to defined contribution plans. They asserted that increased participation and contributions should be recognized as pecuniary factors for defined contribution plans and pointed to surveys demonstrating that including ESG investment alternatives has a positive effect on employees' interest in participating in and contributing to retirement savings plans.

Some commenters questioned the proposal's requirement to consider only pecuniary factors when ERISA investment fiduciaries routinely consider non-pecuniary interests as part of their fiduciary process. They argued, for example, that ERISA specifically provides for plan investments in qualifying employer securities. In the case of employee stock ownership plans (ESOPs), they noted that such plans are designed for investment primarily in employer securities. They said that the proposal conflicted with statutory authorization to invest in employer securities by requiring plan fiduciaries to justify the inclusion of company stock based solely on “pecuniary” factors and by comparison to “available alternative investments or investment courses of action.” Other commenters suggested that the proposal's focus on risk-return features of an investment or investment course of action would likely have unintended consequences on many common, accepted, and generally beneficial practices by rendering them suspect, such as the use of proprietary products, fee sharing, and fee aggregation. Some comments contended that investment managers and fiduciaries routinely take into consideration a variety of factors that do not necessarily have a “material effect on the risk and/or return” of a particular investment. They cited, for example, that a plan committee may consider a fund manager's brand or reputation when determining whether to include that fund in the plan's menu. A fiduciary might account for operational considerations when selecting one investment fund over another, where those operational considerations may have a bearing on the fees borne by participants or the smooth operation of the plan. A fiduciary also might decide to choose an investment regulated in

one legal regime over another because of the protection the fiduciary believes the particular regulatory regime offers, or it might find the disclosures produced by one investment provider easier for participants to understand. Another commenter noted that reasonable and necessary plan administrative expenses are commonly offset with payments or credits attributable to the plan's investment options, and asked whether the focus on risk-return characteristics would prohibit a fiduciary from considering the administrative fee offset the plan would receive when selecting an investment option. Some commenters expressed concern that the proposal also could encourage litigation by having the plaintiffs' bar second-guess whether a decision is solely for the financial benefit of participants and beneficiaries based on incidental benefits that may accrue to plan fiduciaries (even though case law and Departmental guidance have approved such benefits if they are merely incidental and flow from a fiduciary decision that satisfies ERISA's prudence and loyalty requirements).
34

One of these commenters also expressed concern about such litigation alleging that the selection of one investment over another sacrificed investment returns even if the decision was justified by the use of revenue sharing to obtain lower administrative fees.

34
See
Lockheed Corp.
v.
Spink,
517 U.S. 882 (1996);
Hughes Aircraft Co.
v.
Jacobsen,
525 U.S. 432 (1999). See also Advisory Opinion 2011-05A (noting that a fiduciary decision to use plan assets to add a wellness benefit to plan benefits under existing, supplemental or new insurance policies or contracts would not violate ERISA because the employer sponsoring the plan may receive incidental benefits, such as lower plan costs, as a result of the wellness benefits being added to the plan).

Some commenters argued that the Department's focus on risk and return was not an appropriate approach for addressing ESG considerations in decisions regarding management of plan investments. They argued that given the critical importance of overall market return, and the danger to that return from company activities that damage social and environmental systems, plan beneficiaries need protection from individual companies that focus on their own performance in ways that damage overall market return. Commenters argued that in order to protect the interest of plans and beneficiaries, plan fiduciaries must consider whether they can effectively engage with companies to limit or eliminate conduct that threatens the social and economic systems that diversified portfolios rely on over the long term. They argued that fiduciary investors must focus on and prioritize outcomes at the economy or society-wide scale, or “beta” issues such as climate change and corruption, not just on the risks and returns of individual holdings. They contended that fiduciary investment duties must prioritize the long-term, absolute returns for “universal owners,” and that collective investor action to manage social and environmental systems is needed in order to satisfy the fiduciary duties of investment trustees.

One commenter suggested that the definition of “pecuniary factor” was too narrow and recommended modifying it to mean a factor
that could reasonably be expected
to have 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(b)(1) of ERISA.

Still another commenter suggested that “appropriate investment horizon” be better defined in the definition of “pecuniary factor” to ensure that the long-term horizons for certain policy objectives are not substituted for those relating to the time-horizon of retirees.

As the Department explained in the proposal, it is the long-established view of the Department that ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits. 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. In the preamble to the proposal, the Department 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, these 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. The proposal even provided additional guidance as to when it was appropriate to consider ESG matters as pecuniary factors in making investment decisions. Thus, the proposal fundamentally accepted, rather than ignored as claimed by some commenters, the economic literature and fiduciary investment experience that showed ESG considerations may present issues of 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. Rather, the proposal sought to make clear that, from a fiduciary perspective, the relevant question is not whether a factor under consideration is “ESG”, but whether it is a pecuniary factor relevant to an evaluation of the investment or investment course of action under consideration. Nonetheless, the Department is persuaded by its review of the public comments that “ESG” terminology, although used in common parlance when discussing investments and investment strategies, is not a clear or helpful lexicon for a regulatory standard. As one commenter put it, “`ESG investing' resists precise definition.” Rather, “[r]oughly speaking, it is an umbrella term that refers to an investment strategy that emphasizes a firm's governance structure or the environmental or social impacts of the firm's products or practices.” The Department agrees that ESG terminology suffers from two distinct shortcomings as a regulatory standard. First, as the Department noted in the proposal, and many commenters agreed, various other terms have been used to describe this and related investment behaviors, such as socially responsible investing, sustainable and responsible investing, impact investing, and economically targeted investing. Moreover, the terms do not have a uniform meaning and the terminology is evolving, and the non-pecuniary goals being advocated today may not be the same as those advocated in future years. Second, by conflating unrelated environmental, social, and corporate governance factors into a single term, ESG invites a less than appropriately rigorous analytical approach in evaluating whether any given E, S, or G consideration presents a material business risk or opportunity to a company that corporate officers and directors should manage as part of the company's business plan and that qualified investment professionals would treat as economic considerations in evaluating an investment in that company. The Department also believes that adopting ESG terminology in an investment duties regulation invites the arguments, made by some commenters, that all manner of ESG considerations are always and in every case a pecuniary factor that must be

considered as such in all investment decisions, or even that ESG should be a mandatory investment strategy for prudent fiduciaries. Such positions are inconsistent with the Department's considered view and sound policy.

Thus, the final rule removes all ESG terminology from the proposed regulatory text. The Department anticipates that when a fiduciary is faced with a purported ESG factor in an investment, the regulatory requirement will be clearer and more consistent if it demands that fiduciaries focus on providing participants with the financial benefits promised under the plan and focus on whether a factor is pecuniary, rather than being required to navigate imprecise and ambiguous ESG terminology. The ERISA fiduciary duty of prudence requires portfolio-level attention to risk and return objectives reasonably suited to the purpose of the account, diversification, cost-sensitivity, documentation, and ongoing monitoring. The proposal was not intended to suggest that these principles apply other than neutrally to all investment decisions by a trustee or other fiduciary, whether in the context of a direct investment or menu construction in an individual account plan. For similar reasons, the Department declines to follow suggestions from some commenters that ESG factors are necessarily pecuniary and that the Department should specifically mandate that fiduciaries consider ESG factors as part of their investment duties.

At the time of the investment decision, fiduciaries should be focused on whether or not any given factor would materially affect the risk and/or return of the investment over an appropriate time horizon. The intent of the proposal was to address the Department's continued concern about the growing emphasis on ESG investing that seeks to achieve non-pecuniary objectives or goals that are unrelated to the interests of the plan's participants and beneficiaries in their retirement income or financial benefits under the plan, and the consequence that ERISA plan fiduciaries may be prompted to make investment decisions for purposes distinct from providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. Thus, the proposal was intended to ensure that ERISA fiduciaries comply with their investment duties in a consistent and appropriate fashion in the face of ESG-driven market developments.
35

The Department believes that the generally applicable prudence requirements in paragraph (a) of the final rule, together with a requirement in paragraphs (c) and (d) of the final rule demanding a focus on pecuniary factors and the definition of pecuniary factors in paragraph (f), are sufficient to establish an appropriate regulatory standard in this context.

35
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.

As a result, paragraph (c)(1) of the final rule retains the requirement in the proposal that fiduciary evaluation of an investment must be focused only on pecuniary factors. As in the proposal, the final rule's paragraph (c)(1) is a legal requirement and not a safe harbor. The final rule also retains the text from the proposal that expressly states that 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, but has been revised to include text from proposed paragraph (b)(1)(iii), modified slightly, that a fiduciary may not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives. Even commenters that opposed the Department's proposal generally agreed that such a provision appropriately described a fiduciary's duty of loyalty under ERISA.
36

36
The language in proposed (b)(1)(iii) referred to “unrelated objectives,” rather than “other objectives.” The Department has used “unrelated objectives” in previous sub-regulatory guidance. However, that language could be misconstrued as providing a loophole to allow fiduciaries to consider and to subordinate participants and beneficiaries' financial interests to objectives that are in any way related to the interests of participants and beneficiaries in their retirement income or financial benefits under the plan. It was not the Department's intent—and nor would it be consistent with ERISA—to allow fiduciaries to subordinate the interests of participants and beneficiaries in their retirement income or financial benefits under the plan to any other objective, and the Department has revised the language used in the final rule text to ensure that it is not misconstrued.

With respect to the provisions of paragraph (c) of the proposal that would have separately required compliance with prudence obligations set forth in paragraph (b) (
e.g.,
that the weight given to any particular pecuniary factors should appropriately reflect a prudent assessment of their impact on risk and return, and that fiduciaries considering pecuniary factors 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), the Department agrees with the observation of one commenter that identifying these requirements separately in paragraph (c)(1) and tying them to regulatory text about “environmental, social, corporate governance, or other similarly oriented factors” could be misconstrued as applying these general prudence criteria in some unique (or at least more rigorous) fashion to ESG and “other similarly oriented” investment strategies. Accordingly, in order to avoid redundant and potentially confusing regulatory requirements, the specific provisions on those obligations that were in paragraph (c) of the proposal have been eliminated from paragraph (c) of the final rule and replaced with a more general requirement that the weight given to any pecuniary factor by a fiduciary should appropriately reflect a prudent assessment of its impact on risk and return. As modified, this provision will provide fiduciaries the necessary flexibility to evaluate and consider the particular pecuniary factors relevant to a specific investment or investment course of action, while focusing paragraph (c) on the principal objective of adding to the regulation an express provision that the duty of fiduciaries is to act with an eye single toward furthering participants' “financial” rather than “nonpecuniary” benefits.

Further, the Department did not intend the reference to “generally accepted investment theories” to foreclose ERISA fiduciaries from considering emerging theories regarding prudent investment practices or otherwise freeze investment practice as of the date of the rule. Rather, the intent was to establish a regulatory guardrail against situations in which plan investment fiduciaries might be inclined to use, as one example, policy-based metrics in their assessment of the pecuniary value of an investment or investment plan that are inherently biased toward inappropriate overestimations of the pecuniary value of policy-infused investment criteria. The Department intended to communicate the idea that the fiduciary is required to have a soundly reasoned and supported investment decision or strategy to satisfy the ERISA prudence requirement. However, the Department has decided not to include this provision in the final rule, but rather to rely on the definition of pecuniary factor as the governor for investment decisions without specifically constraining the criteria that a fiduciary

could consider in making a prudent judgment. Although not retained as express regulatory text in the final rule, the Department believes that it would be consistent with ERISA and the final rule for a fiduciary to treat a given factor or consideration as pecuniary if it presents economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories. In this regard, it is based on the essence of the 1979 investment duties regulation, the conditions of which basically require the judgment of a prudent expert—and if the decision maker does not have the expertise himself, he should consult such an expert. For example, in a 1996 letter to Eugene Ludwig, Comptroller of the Currency, regarding the ERISA duty of prudence in the context of an evaluation of the prudence of derivative investments, the Department stated that among other things, the fiduciary should determine whether it possesses the requisite expertise, knowledge, and information to understand and analyze the nature of the risks and potential returns involved in a particular derivative investment. The letter pointed out that the fiduciary must determine whether the plan has adequate information and risk management systems in place given the nature, size, and complexity of the plan's investment activity, and whether the plan fiduciary has personnel who are competent to manage those systems.
37

37
See Letter to Eugene A. Ludwig from Olena Berg (March 21, 1996), and also Advisory Opinions 2002-14A and 2006-08A; and Letter to J. Mark Iwry (Oct. 23, 2014).

The Department also did not intend that the provision be read, as some commenters did, as a limitation on the ability of ERISA fiduciaries to consider all relevant factors in evaluating whether factors may have a “material effect on the return and risk of an investment.” Rather, when comparing investment or investment courses of action, including selection of designated investment alternatives in the case of participant-directed individual account plans, a fiduciary satisfies its obligations under paragraph (c)(1) by evaluating factors that are expected to result in a material difference among reasonably available alternatives with respect to risk and/or return. Thus, the final rule neither specifically prohibits nor permits the use of proprietary products, fee sharing, and fee aggregation, but requires the fiduciary to evaluate whether such practices are expected to have a material effect on risk and/or return as compared to the reasonably available alternatives. If a fiduciary were to prudently conclude that a fund manager's brand or reputation will materially affect the expected risk and/or return as funds, then such factors would be pecuniary. Similarly, to the extent that the net expenses incurred by the plan, such as for plan administration or to develop disclosures that are easier for participants to understand, are expected to materially affect the risk and return of one alternative as compared to another, such factors would be considered pecuniary. Finally, in response to some commenters, the Department did not intend to imply in the proposal that, in evaluating investments or investment courses of action, a fiduciary must always select the one with the lowest cost. Depending on the facts and circumstances, a fiduciary may conclude that a particular investment or investment course of action is prudent even though it entails higher risk or cost.

The Department, however, cautions fiduciaries against too hastily concluding that ESG-themed funds may be selected based on pecuniary factors or are not distinguishable based on pecuniary factors, thereby triggering the tie-breaking provision of paragraph (c)(2) of the final rule. A number of commenters touted the performance of ESG-themed funds for selected time periods, particularly after the widespread COVID-19 outbreak, as compared to more conventional alternatives. However, questions have been raised as to whether such performance was caused by a particular ESG strategy or merely correlated with broader economic trends unrelated to a specific ESG factor. The Department observes that many ESG-themed funds have been over-weighted in technology and underweighted in energy as compared to more conventional alternatives, which has affected certain funds' returns in recent periods. Technology assets performed relatively better during the recent pandemic, while energy markets that were already in turmoil from global excess supply declined further due to widespread decrease in demand, including due to reductions in travel. This difference in portfolio composition can affect the level of risk associated with the corresponding return and a fiduciary would need to prudently balance such considerations when comparing alternatives.

In response to the commenter who suggested that the definition of “pecuniary factor” should be modified to include a “reasonably be expected” provision, the Department has revised the definition to mean a factor that a fiduciary prudently determines is expected to have a material effect on 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(b)(1) of ERISA. The Department believes that a prudent determination incorporates a reasonableness standard of care, but has revised the definition to use terminology that is more consistent with the statutory language of ERISA section 404(a)(1)(B), which includes more than reasonableness. Thus, the final rule recognizes that the nature of the fiduciary investment judgments will necessarily involve forward-looking expectations when evaluating investment alternatives and strategies. The Department is also retaining the concept of materiality in the definition of “pecuniary factor” as it believes that fiduciaries and investment managers are generally familiar with that concept from its use in connection with both ERISA and the Federal securities laws.

With respect to the consideration of how the final rule and its emphasis on pecuniary factors would influence the selection of company stock for a plan, the Department notes first that commenters should not have concern on this issue. The basic ERISA principles governing fiduciaries have coexisted with the use of ESOPs for many years, and this rule does not disturb them. This rule is focused on principles of pecuniary and nonpecuniary investing in the broader marketplace. This rule does not have as one of its objectives any changes to the long-established use of ESOPs by companies that wish to do so.

Second and relatedly, the Department recognizes that ESOPs are typically set in most respects by the employer's settlor function, and further that they are congressionally sanctioned under a particularized statutory framework compatible with this rule. Most acquisitions of company stock and use of company stock funds in individual account plans are directed by the plan or instruments governing the plan. Investments in qualifying employer securities are explicitly authorized by statutory provisions in ERISA, and subject to specific statutory conditions that Congress enacted as elements of Federal employee benefits law. For example, there are specific provisions for employer securities in the requirements under ERISA section 101(i) related to notice of blackout periods to participants or beneficiaries under individual account plans. Section 101(m) includes special disclosure rules

for individual account plans on the right to divest employer securities with respect to any type of contribution. Section 105 on individual benefit statements requires individual account plans to include an explanation, written in a manner calculated to be understood by the average plan participant, of the importance, for the long-term retirement security of participants and beneficiaries, of a well-balanced and diversified investment portfolio, including a statement of the risk that holding more than 20 percent of a portfolio in the security of one entity (such as employer securities) may not be adequately diversified. Section 204(j) of ERISA includes special diversification requirements for certain individual account plans governing investments in employer securities. ERISA sections 404(a)(2) and 407 provide specific rules for the application of ERISA's diversification requirements to the acquisition of “qualifying employer securities.” The U.S. Supreme Court has concluded that there is no special presumption of prudence under ERISA favoring ESOP fiduciaries, stating that “the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP's holdings.”
38

Similarly, the duties of prudence and loyalty set forth in this regulation apply in the context of the pertinent provisions of ERISA. In short, the statutory provisions in ERISA, and others in the Internal Revenue Code, make clear that plan fiduciaries are permitted to invest in employer securities following the direction of a plan document with respect to acquisitions or holding of employer stock,
39

provided the fiduciary satisfies the applicable conditions in the statute, and acts prudently and loyally.

38

Dudenhoeffer,
573 U.S. at 418-419.

39
The Department has taken the position that there is a class of activities that relate to the formation, rather than the management, of plans. These activities, generally referred to as settlor functions, include decisions relating to the formation, design, and termination of plans and, except in the context of multi-employer plans, generally are not activities subject to Title I of ERISA. As such, decisions that are settlor functions would not be subject to the final rule provisions that govern fiduciary investment duties. The Department notes, however, that actions taken to implement settlor decisions may involve fiduciary activities, and, to the extent those activities involve fiduciary investment decisions, they would be subject to the provisions of this final rule. See Advisory Opinion 2001-01A; Advisory Opinion 97-03A; Letters to Kirk Maldonado from Elliot Daniel (March 2, 1987); and Letter to John Erlenborn from Dennis Kass (March 13, 1986).

With respect to the comments by the multiemployer plan community requesting that the Department adjust its definition of pecuniary factor to include increased contributions to plans as a result of investments, the Department has previously addressed this and similar issues in a number of advisory opinions and information letters.
40

Specifically, the Department has repeatedly explained that increased plan contributions and similar factors are not economic factors, but that they are the type of non-economic factor that may be considered where a fiduciary is permitted to make an investment decision on the basis of a non-pecuniary factor.
41

Increasing plan contributions and similar factors do not assist a fiduciary in determining the expected return on or riskiness of an investment, as plan contributions do not constitute a “return” on investment.

40
See,
e.g.,
DOL Inf. Ltr to George Cox (Jan. 16, 1981); DOL Adv. Op. to Theodore Groom (Jan. 16, 1981); DOL Adv. Op. to Daniel O'Sullivan, Union Labor Life Ins. Co (Aug. 2, 1982); DOL Adv. Op to James Ray, Union Labor Life Ins. Co. (July 8, 1988); DOL Inf. Ltr. to Stuart Cohen, General Motors Corp.. (May 14, 1993).

41
See,
e.g.,
DOL Inf. Ltr. to Ralph Katz (March 15, 1982) (“A decision to make an investment may not be influenced by a desire to stimulate the construction industry and generate employment, unless the investment, when judged solely on the basis of its economic value to the plan, would be equal or superior to alternative investments available to the plan.”).

The Department's position on this issue has not changed and as a result we disagree with these commenters. The potential for increased contributions to a plan as a result of an investment is not a pecuniary factor associated with the return on a particular investment. Nor may increased contributions be considered a return on an investment. In terms of determining what is or is not a pecuniary factor, the relevant performance to be measured is that of the investment in question, not future plan contributions. The purpose of plan investments under ERISA is to provide and protect retirement benefits—not to strengthen employers or unions or provide job security. Under ERISA, plans are to be operated solely in the interest of participants and beneficiaries
as participants and beneficiaries,
not in some other role or capacity, such as union members, employees, or members of some other interest group. However, the Department agrees—consistent with the advisory opinions and information letters referenced above—that an objective to increase contributions or respond to participant interest in investment options for their retirement savings are permissible factors to use in the tie-breaker provisions in paragraph (c)(2), discussed below, based on their connection to the interests of the plan and plan participants and beneficiaries.

Finally, the Department does not agree with the position that ERISA permits or requires plan fiduciaries to premise investment decisions on the idea that, as investors, they own a share of the world economy, and, therefore, that their financial interests demand that they adapt their investment-related actions to promote a theoretical benefit to the world economy that might redound, outside the plan, to the benefit of the participants in the plan.
42

The Department has acknowledged in the proposal and in this final rule that particular environmental or social factors may present material and current business risks or opportunities for specific companies (and may be reflected in potential market risk and return). But the Department cannot reconcile the approach described above with the requirements of prudence and loyalty under ERISA. On the contrary, that approach and the potential consequences of advocacy to plan fiduciaries based on that approach is one of the concerns that underlies this final rule, and illustrates why the Department considers the rule to be warranted at this time. As the Department has stated, it 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. 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.

42
See
also
supra at 83-84.

3. Section 2550.404a-1(c)(2)—Choosing Between or Among Investment Alternatives That the Plan Fiduciary Is Unable to Distinguish on the Basis of Pecuniary Factors Alone

Prior to the proposal, the Department's interpretive guidance provided that if, after an evaluation, alternative investments appear economically indistinguishable, a fiduciary may then, in effect, “break the tie” by relying on a non-pecuniary factor. The proposal carried forward this idea and paragraph (c)(2) of the proposal was designed to guide application of the “all things being equal” test by requiring fiduciaries to adequately document any such occurrences. In the preamble to the proposal, the Department noted that there are highly

correlated investments and otherwise very similar ones. The Department observed that 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, and the same investment strategy, but a different underlying asset composition. The Department explained that, even then, those two alternatives may function differently in the overall context of the fund portfolio and going forward may perform differently based on external economic trends and developments.
43

As a result, the Department expressed concern 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 it appeared that some form of ties may theoretically occur, and the Department did not have sufficient evidence to say they do not occur in fact, the Department proposed to retain a version of an “all things being equal” test. However, in the proposal, the Department specifically requested comment on the tie-breaker concept, whether true ties exist, and, if they do, how fiduciaries may appropriately break ties.

43
See Schanzenbach & Sitkoff, supra note 5, at 410 (describing a hypothetical pair of truly identical investments as a “unicorn”).

The Department also believed that using non-pecuniary factors to choose among investments merited closer scrutiny. As one commenter noted, trust fiduciary law recognizes that there are circumstances, mainly in the context of conditionally permitted conflicts of interest, that call for enhanced scrutiny of the substance of the fiduciary's decision.
44

The Department believes that relying on non-pecuniary factors to select among investments is a circumstance that similarly warrants some form of enhanced scrutiny. Thus, paragraph (c)(2) of the proposal was designed to guide application of the “all things being equal” test by requiring fiduciaries to adequately document any such occurrences. If, under proposed paragraph (c)(2) 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, the fiduciary must document why pecuniary factors were not sufficient to select the investment or investment courses of action, how the investment compares to alternative investments with respect to the factors listed in paragraphs (b)(2)(ii)(A) through (C), and how the non-pecuniary factor or factors was chosen based upon the purposes of the plan, the dive

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2020-24515. Public record. Not legal advice.