Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights

Federal RegisterDec 1, 2022

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DEPARTMENT OF LABOR

Employee Benefits Security Administration

29 CFR Part 2550

RIN 1210-AC03

Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights

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 clarify the application of ERISA's fiduciary duties of prudence and loyalty to selecting investments and investment courses of action, including selecting qualified default investment alternatives, exercising shareholder rights, such as proxy voting, and the use of written proxy voting policies and guidelines. The amendments reverse and modify certain amendments to the Investment Duties regulation adopted in 2020.

DATES:

Effective date:

This rule is effective on January 30, 2023.

Applicability dates:

See § 2550.404a-1(g) of the final rule for compliance dates for § 2550.404a-1(d)(2)(iii) and (d)(4)(ii) of the final rule.

FOR FURTHER INFORMATION CONTACT:

Fred Wong, Acting Chief of the Division of Regulations, 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:

Table of Contents

I. Background

A. General

B. The Department's Prior Non-Regulatory Guidance

1. ETI/ESG Investing

2. Exercising Shareholder Rights

C. Executive Order Review of Current Regulation

II. Purpose of Regulatory Action and Proposed Rule

A. Purpose

B. Major Provisions of Proposed Rule

III. The Final Rule

A. Executive Summary of Major Changes and Clarifications

B. Detailed Discussion of Public Comments and Final Regulation

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

2. Section 2550.404a-1(c) Investment Loyalty Duties

3. Investment Alternatives in Participant Directed Individual Account Plans Including Qualified Default Investment Alternatives

4. Section 2550.404a-1(d)—Proxy Voting and Exercise of Shareholder Rights

5. Section 2550.404a-1(e)—Definitions

6. Section 2550.404a-1(f)—Severability

7. Section 2550.404a-1(g)—Applicability Date

8. Miscellaneous

IV. Regulatory Impact Analysis

A. Executive Orders 12866 and 13563

B. Introduction and Need for Regulation

C. Affected Entities

1. Subset of Plans Affected by Proposed Modifications of Paragraphs (b) and (c) of § 2550.404a-1

2. Subset of Plans Affected by the Modifications to Paragraph (d) of § 2550.404a-1

D. Benefits

1. Benefits of Paragraphs (b) and (c)

2. Cost Savings Relating to Paragraphs (c), Relative to the Current Regulation

3. Benefits of Paragraph (d)

4. Cost Savings Relating to Paragraphs (d) and (e), Relative to the Current Regulation

E. Costs

1. Cost of Reviewing the Final Rule and Reviewing Plan Practices

2. Possible Changeover Costs

3. Cost Associated With Changes in Investment or Investment Course of Action

4. Cost Associated With Changes to the “Tiebreaker” Rule

5. Cost To Update Plan's Written Proxy Voting Policies

6. Summary

F. Transfers

G. Uncertainty

H. Alternatives

I. Conclusion

V. Paperwork Reduction Act

VI. Regulatory Flexibility Act

A. Need for and Objectives of the Rule

B. Comments

C. Affected Small Entities

1. Small Plans Affected by the Proposed Modifications of Paragraphs (b) and (c) of § 2550.404a-1

2. Subset of Plans Affected by Modifications of Paragraph (d) and (e) of § 2550.404a-1

D. Impact of the Rule

1. Cost of Reviewing the Final Rule and Reviewing Plan Practices

2. Cost To Update Written Proxy Voting Policies

3. Summary of Costs

E. Regulatory Alternatives

F. Duplicate, Overlapping, or Relevant Federal Rules

VII. Unfunded Mandates Reform Act

VIII. Federalism Statement

I. Background

A. General

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.

29 U.S.C. 1104.

29 U.S.C. 1103(c) and 1104(a).

To maximize employee pension and welfare benefits, section 404 of ERISA dictates that the focus of ERISA plan fiduciaries on the plan's financial returns and risk to beneficiaries must be paramount.

And for years, the Department's non-regulatory guidance has recognized that, under the appropriate circumstances, ERISA does not preclude fiduciaries from making investment decisions that reflect environmental, social, or governance (“ESG”) considerations, and choosing economically targeted investments (“ETIs”) selected in part for benefits in addition to the impact those considerations could have on investment return.

The Department's non-regulatory guidance has also recognized that the fiduciary act of managing employee benefit plan assets includes the management of voting rights as well as other shareholder rights connected to shares of stock, and that management of those rights, as well as shareholder engagement activities, is subject to ERISA's prudence and loyalty requirements.

Subsection B of this background section provides a complete overview of the Department's prior non-regulatory guidance.

See

Interpretive Bulletin 2015-01, 80 FR 65135 (Oct. 26, 2015).

See, e.g., id.

See, e.g.,

Interpretive Bulletin 2016-01, 81 FR 95879 (Dec. 29, 2016).

The Department's Investment Duties regulation under Title I of ERISA is codified at 29 CFR 2550.404a-1(hereinafter “current regulation” or “Investment Duties regulation,” unless otherwise stated). On June 30 and

September 4, 2020, the Department published in the

Federal Register

proposed rules to remove prior non-regulatory guidance from the CFR and to amend the Department's Investment Duties regulation. The objective was to address perceived confusion about the implications of that non-regulatory guidance with respect to ESG considerations, ETIs, shareholder rights, and proxy voting.

The preambles to the 2020 proposals expressed concern that some ERISA plan fiduciaries might be making improper investment decisions, and that plan shareholder rights were being exercised in a manner that subordinated the interests of plans and their participants and beneficiaries to unrelated objectives.

Given the persistent confusion in this area due in part to varied statements the Department had made on the subject over the years in non-regulatory guidance, the Department believed that providing further clarity on these issues in the form of a notice and comment regulation would be more helpful and permanent than another iteration of non-regulatory guidance.

See

85 FR 39113 (June 30, 2020); 85 FR 55219 (Sept. 4, 2020).

See

85 FR 39116; 85 FR 55221.

Less than six months later, on November 13, 2020, the Department published a final rule titled “Financial Factors in Selecting Plan Investments,” which adopted amendments to the Investment Duties regulation that generally require plan fiduciaries to select investments and investment courses of action based solely on consideration of “pecuniary factors.”

Among these amendments was a prohibition against adding or retaining any investment fund, product, or model portfolio as a qualified default investment alternative (QDIA) as described in 29 CFR 2550.404c-5 if the fund, product, or model portfolio includes even one non-pecuniary objective in its investment objectives or principal investment strategies. On December 16, 2020, the Department published a final rule titled “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights,” which also adopted amendments to the Investment Duties regulation to establish regulatory standards for the obligations of plan fiduciaries under ERISA when voting proxies and exercising other shareholder rights in connection with plan investments in shares of stock.

85 FR 72846 (Nov. 13, 2020).

85 FR 81658 (Dec. 16, 2020).

On January 20, 2021, the President signed Executive Order 13990 (E.O. 13990), titled “Protecting Public Health and the Environment and Restoring Science to Tackle the Climate Crisis.”

Section 1 of E.O. 13990 acknowledges the Nation's “abiding commitment to empower our workers and communities; promote and protect our public health and the environment.” Section 1 also sets forth the policy of the Administration to listen to the science; improve public health and protect our environment; bolster resilience to the impacts of climate change; and prioritize both environmental justice and the creation of the well-paying union jobs necessary to deliver on these goals. Section 2 directed agencies to review all existing regulations promulgated, issued, or adopted between January 20, 2017, and January 20, 2021, that are or may be inconsistent with, or present obstacles to, the policies set forth in section 1 of E.O. 13990. Section 2 further provided that for any such actions identified by the agencies, the heads of agencies shall, as appropriate and consistent with applicable law, consider suspending, revising, or rescinding the agency actions.

86 FR 7037 (Jan. 25, 2021). E.O. 13990 was signed eight days after the effective date of “Financial Factors in Selecting Plan Investments,” and five days after the effective date of “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.”

A Fact Sheet issued simultaneously with E.O. 13990, specifically confirmed that the Department was directed to review the final rule on “Financial Factors in Selecting Plan Investments” Available at

www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/fact-sheet-list-of-agency-actions-for-review/.

On March 10, 2021, the Department announced that it had begun a reexamination of the current regulation, consistent with E.O. 13990, the Administrative Procedure Act, and ERISA's grant of regulatory authority in section 505.

The Department also announced that, pending its review of the current regulation, the Department will not enforce the current regulation or otherwise pursue enforcement actions against any plan fiduciary based on a failure to comply with the current regulation with respect to an investment, including a QDIA, investment course of action or an exercise of shareholder rights. In announcing the enforcement policy, the Department also stated its intention to conduct significantly more stakeholder outreach to determine how to craft rules that better recognize the role that ESG integration can play in the evaluation and management of plan investments in ways that further fundamental fiduciary obligations.

29 U.S.C. 1135.

See

U.S. Department of Labor Statement Regarding Enforcement of its Final Rules on ESG Investments and Proxy Voting by Employee Benefit Plans (Mar. 10, 2021) Available at

www.dol.gov/sites/dolgov/files/ebsa/laws-and-regulations/laws/erisa/statement-on-enforcement-of-final-rules-on-esg-investments-and-proxy-voting.pdf.

Following publication of the final rules the Department heard from a wide variety of stakeholders, including asset managers, labor organizations and other plan sponsors, consumer groups, service providers and investment advisers that questioned whether the 2020 Rules properly reflect the scope of fiduciaries' duties under ERISA to act prudently and solely in the interest of plan participants and beneficiaries. The stakeholders also questioned whether the Department rushed the rulemakings unnecessarily and failed to adequately consider and address the substantial evidence submitted by public commenters on the use of environmental, social and governance considerations in improving investment value and long-term investment returns for retirement investors.

On May 20, 2021, the President signed Executive Order 14030 (E.O. 14030), titled “Executive Order on Climate-Related Financial Risk.”

The policies set forth in section 1 of E.O. 14030 include advancing acts to mitigate climate-related financial risk and actions to help safeguard the financial security of America's families, businesses, and workers from climate-related financial risk that may threaten the life savings and pensions of U.S. workers and families. Section 4 of E.O. 14030 directed the Department to consider publishing, by September 2021, for notice and comment a proposed rule to suspend, revise, or rescind “Financial Factors in Selecting Plan Investments,”

and “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.”

86 FR 27967 (May 25, 2021). E.O. 14030 was signed 128 days after the effective date of “Financial Factors in Selecting Plan Investments,” and 125 days after the effective date of “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.”

85 FR 72846 (Nov. 13, 2020).

85 FR 81658 (Dec. 16, 2020).

B. The Department's Prior Non-Regulatory Guidance

The Department has a longstanding position that ERISA fiduciaries may not sacrifice investment returns or assume greater investment risks as a means of promoting collateral social policy goals. These proscriptions flow directly from ERISA's stringent standards of prudence and loyalty under section 404(a) of the statute.

The Department has a similarly longstanding position that the fiduciary act of managing plan assets that involve shares of corporate stock includes making decisions about voting proxies and exercising shareholder rights. Over the years the Department repeatedly has issued non-regulatory

guidance to assist plan fiduciaries in understanding their obligations under ERISA to apply these principles to ETIs and ESG.

29 U.S.C. 1104(a).

1. ETI/ESG Investing

Interpretive Bulletin 94-1 (IB 94-1), published in 1994, addressed economically targeted investments (ETIs) selected, in part, for collateral benefits apart from the investment return to the plan investor.

The Department's objective in issuing IB 94-1 was to state that ETIs

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 at least commensurate to rates of return of available alternative investments, and if the ETI 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 “tiebreaker” 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 collateral considerations as the deciding factor for an investment decision. This was the Department's unchanged position for approximately three decades.

59 FR 32606 (June 23, 1994) (appeared in Code of Federal Regulations as 29 CFR 2509.94-1). Prior to issuing IB 94-1, the Department had issued a number of letters concerning a fiduciary's ability to consider the collateral effects of an investment and granted a variety of prohibited transaction exemptions to both individual plans and pooled investment vehicles involving investments that produce collateral 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. The Department also issued a number of prohibited transaction exemptions that touched on these issues.

See

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 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”).

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 collateral benefits, apart from the investment return to the employee benefit plan investor.

In 2008, the Department replaced IB 94-1 with Interpretive Bulletin 2008-01 (IB 2008-01),

and then, in 2015, the Department replaced IB 2008-01 with Interpretive Bulletin 2015-01 (IB 2015-01).

Although the Interpretive Bulletins differed from each other in tone and content to some extent, each endorsed the “all things being equal” test, while also stressing that the paramount focus of plan fiduciaries must be the plan's financial returns and providing promised benefits to participants and beneficiaries. Each Interpretive Bulletin also cautioned that fiduciaries violate ERISA if they accept reduced expected returns or greater risks to secure social, environmental, or other policy goals.

73 FR 61734 (Oct. 17, 2008).

80 FR 65135 (Oct. 26, 2015).

Additionally, 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 Field Assistance Bulletin 2018-01 (FAB 2018-01), the Department indicated that IB 2015-01 had 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, such ESG issues 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 “tiebreakers,” but “risk-return” factors affecting the economic merits of the investment.

FAB 2018-01 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.”

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.”

FAB 2018-01 (Apr. 23, 2018).

Id.

FAB 2018-01 also explained that in the case of an investment platform that allows participants and beneficiaries an opportunity to choose from a broad range of investment alternatives, a prudently selected, well managed, and properly diversified ESG-themed investment alternative could be added to the available investment options on a 401(k) plan platform without requiring the plan to remove or forgo adding other non-ESG-themed investment options to the platform.

According to the FAB, however, the selection of an investment fund as a QDIA is not analogous to a fiduciary's decision to offer participants an additional investment alternative as part of a prudently constructed lineup of investment alternatives from which participants may choose. FAB 2018-01 expressed concern that the decision to favor the fiduciary's own policy preferences in selecting an ESG-themed investment option as a QDIA for a 401(k)-type plan without regard to possibly different or competing views of plan participants and beneficiaries would raise questions about the fiduciary's compliance with ERISA's duty of loyalty.

In addition, FAB

2018-01 stated that, even if consideration of such factors could be shown to be appropriate in the selection of a QDIA for a particular plan population, the plan's fiduciaries would have to ensure compliance with the previous guidance in IB 2015-01. For example, the selection of an ESG-themed target date fund as a QDIA would not be prudent if the fund would provide a lower expected rate of return than available non-ESG alternative target date funds with commensurate degrees of risk, or if the fund would be riskier than non-ESG alternative available target date funds with commensurate rates of return.

Id.

FAB 2018-01.

2. Exercising Shareholder Rights

The Department's past non-regulatory guidance has also consistently recognized that the fiduciary act of managing employee benefit plan assets includes the management of voting rights as well as other shareholder rights connected to shares of stock, and that management of those rights, as well as shareholder engagement activities, is subject to ERISA's prudence and loyalty requirements.

The Department first issued non-regulatory guidance on proxy voting and the exercise of shareholder rights in the 1980s. For example, in 1988, the Department issued an opinion letter to Avon Products, Inc. (the Avon Letter), in which the Department took the position that the fiduciary act of managing plan assets that are shares of corporate stock includes the voting of proxies appurtenant to those shares, and that the named fiduciary of a plan has a duty to monitor decisions made and actions taken by investment managers with regard to proxy voting.

In 1994, the Department issued its first interpretive bulletin on proxy voting, Interpretive Bulletin 94-2 (IB 94-2).

IB 94-2 recognized that fiduciaries may engage in shareholder activities intended to monitor or influence corporate management if the responsible fiduciary concludes that, after taking into account the costs involved, there is a reasonable expectation that such shareholder activities (by the plan alone or together with other shareholders) will enhance the value of the plan's investment in the corporation. The Department also reiterated its view that ERISA does not permit fiduciaries, in voting proxies or exercising other shareholder rights, to subordinate the economic interests of participants and beneficiaries to unrelated objectives.

Letter to Helmuth Fandl, Chairman of the Retirement Board, Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988).

59 FR 38860 (July 29, 1994).

In October 2008, the Department replaced IB 94-2 with Interpretive Bulletin 2008-02 (IB 2008-02).

The Department's intent was to update the guidance in IB 94-2 and to reflect interpretive positions issued by the Department after 1994 on shareholder engagement and socially-directed proxy voting initiatives. IB 2008-02 stated that fiduciaries' responsibility for managing proxies includes both deciding to vote and deciding not to vote.

IB 2008-02 further stated that the fiduciary duties described at ERISA sections 404(a)(1)(A) and (B) require that, in voting proxies, the responsible fiduciary shall consider only those factors that relate to the economic value of the plan's investment and shall not subordinate the interests of the participants and beneficiaries in their retirement income to unrelated objectives. In addition, IB 2008-02 stated that votes shall only be cast in accordance with a plan's economic interests. IB 2008-02 explained that if the responsible fiduciary reasonably determines that the cost of voting (including the cost of research, if necessary, to determine how to vote) is likely to exceed the expected economic benefits of voting, the fiduciary has an obligation to refrain from voting.

The Department also reiterated in IB 2008-02 that any use of plan assets by a plan fiduciary to further political or social causes “that have no connection to enhancing the economic value of the plan's investment” through proxy voting or shareholder activism is a violation of ERISA's exclusive purpose and prudence requirements.

73 FR 61731 (Oct. 17, 2008).

73 FR 61732.

Id.

73 FR 61734.

In 2016, the Department issued Interpretive Bulletin 2016-01 (IB 2016-01), which reinstated the language of IB 94-2 with certain modifications.

IB 2016-01 reiterated and confirmed that “in voting proxies, the responsible fiduciary [must] consider those factors that may affect the value of the plan's investment and not subordinate the interests of the participants and beneficiaries in their retirement income to unrelated objectives.”

In its guidance, the Department has also stated that it rejects a construction of ERISA that would render the statute's tight limits on the use of plan assets illusory and that would permit plan fiduciaries to expend trust assets to promote a myriad of personal public policy preferences at the expense of participants' economic interests, including through shareholder engagement activities, voting proxies, or other investment policies.

81 FR 95879 (Dec. 29, 2016). In addition, the Department issued a Field Assistance Bulletin to provide guidance on IB 2016-01 on April 23, 2018.

See

FAB 2018-01, at

www.dol.gov/sites/dolgov/files/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2018-01.pdf.

81 FR 95882.

See

81 FR 95881.

C. Executive Order Review of Current Regulation

In early 2021, consistent with E.O. 13990 and E.O. 14030, the Department engaged in informal outreach to hear views from interested stakeholders on how to craft regulations that better recognize the important role that climate change and other ESG factors can play in the evaluation and management of plan investments, while continuing to uphold fundamental fiduciary obligations. The Department heard from a wide variety of stakeholders, including asset managers, labor organizations and other plan sponsors, consumer groups, service providers, and investment advisers. Many of the stakeholders expressed skepticism as to whether the current regulation properly reflects the scope of fiduciaries' duties under ERISA to act prudently and solely in the interest of plan participants and beneficiaries.

That outreach effort by the Department suggested that, rather than provide clarity, some aspects of the current regulation instead may have created further uncertainty about whether a fiduciary under ERISA may consider ESG and other factors in making investment and proxy voting decisions that the fiduciary reasonably believes will benefit the plan and its participants and beneficiaries. Many stakeholders questioned whether the Department rushed the current regulation unnecessarily and failed to adequately consider and address substantial evidence submitted by public commenters suggesting that the use of climate change and other ESG factors can improve investment value and long-term investment returns for retirement investors. The Department also heard from stakeholders that the current regulation, and investor confusion about it, including whether climate change and other ESG factors may be treated as “pecuniary” factors under the regulation, already had begun to have a chilling effect on appropriate integration of climate change and other ESG factors in investment decisions. This continued through the current non-enforcement period, including in circumstances where the current

regulation may in fact allow consideration of ESG factors.

After conducting a review of the current regulation, the Department concluded there is a reasonable basis for the concerns raised by the stakeholders. A number of public comment letters had criticized the 2020 proposed regulatory text for appearing to single out ESG investing for heightened scrutiny, which they asserted was inappropriate in light of research and investment practices suggesting that climate change and other ESG factors are material economic considerations.

In response, the Department did not include explicit references to ESG in the current regulation and furthermore acknowledged in the preamble discussion to the

Financial Factors in Selecting Plan Investments

final rulemaking that there are instances where one or more ESG factors may be properly taken into account by a fiduciary.

The preamble to the

Fiduciary Duties Regarding Proxy Voting and Shareholder Rights

final rulemaking also acknowledged academic studies and investment experience surrounding the materiality of ESG considerations in investment decisionmaking.

However, other statements in the preamble appeared to express skepticism about fiduciaries' reliance on ESG considerations. For instance, the preamble to the

Financial Factors in Selecting Plan Investments

final rulemaking asserted that ESG investing raises heightened concerns under ERISA, and cautioned fiduciaries against “too hastily” concluding that ESG-themed funds may be selected based on pecuniary factors.

Similarly, the preamble to the

Fiduciary Duties Regarding Proxy Voting and Shareholder Rights

final rulemaking expressed the view that it is likely that many environmental and social shareholder proposals have little bearing on share value or other relation to plan financial interests.

Many stakeholders indicated that the current regulation has been interpreted as putting a thumb on the scale against the consideration of ESG factors, even when those factors are financially material.

See, e.g.,

Comment # 567 at

www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00567.pdf

and Comment # 709 at

www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00709.pdf.

See

85 FR 72859 (Nov. 13, 2020) (“[T]he 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”).

85 FR 81662 (Dec. 16, 2020) (“This [Fiduciary Duties Regarding Proxy Voting and Shareholder Rights] rulemaking project, similar to the recently published final rule on ERISA fiduciaries' consideration of financial factors in investment decisions, recognizes, rather than ignores, the economic literature and fiduciary investment experience that show a particular `E,' `S,' or `G' consideration may present issues of material business risk or opportunities to a specific company that its 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.”).

85 FR 72848, 72859 (Nov. 13, 2020).

85 FR 81681 (Dec. 16, 2020).

The Department's review under the Executive orders caused it concern that, as stakeholders warned, uncertainty with respect to the current regulation may be deterring fiduciaries from taking steps that other marketplace investors would take in enhancing investment value and performance, or improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors. The Department was concerned that the current regulation created a perception that fiduciaries are at risk if they include any ESG factors in the financial evaluation of plan investments, and that they would need to have special justifications for even ordinary exercises of shareholder rights.

Based on these concerns, the Department, on October 14, 2021, published a notice of proposed rulemaking (NPRM) proposing amendments to the current regulation.

The intent of the NPRM was to address uncertainties regarding aspects of the current regulation and its preamble discussion relating to the consideration of ESG issues, including climate-related financial risk, by fiduciaries in making investment and voting decisions, and to provide further clarity that will help safeguard the interests of participants and beneficiaries in the plan benefits.

86 FR 57272 (Oct. 14, 2021).

II. Purpose of Regulatory Action and Proposed Rule

A. Purpose

Like the NPRM, the purpose of the final rule is to clarify the application of ERISA's fiduciary duties of prudence and loyalty to selecting investments and investment courses of action, including selecting QDIAs, exercising shareholder rights, such as proxy voting, and the use of written proxy voting policies and guidelines. The need for clarification comes from the chilling effect and other potential negative consequences caused by the current regulation with respect to the consideration of climate change and other ESG factors in connection with these activities. Overall, the public comments support the clarifications provided by this final rule, although some commenters challenged the stated need. The Department disagrees with commenters who asserted that any clarifications to the current regulation are unnecessary. The Department's conclusion, supported by many public commenters, is that the current regulation creates uncertainty and is having the undesirable effect of discouraging ERISA fiduciaries' consideration of climate change and other ESG factors in investment decisions, even in cases where it is in the financial interest of plans to take such considerations into account. This uncertainty may further deter fiduciaries from taking steps that other marketplace investors take in enhancing investment value and performance or improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors. Major comments are addressed in detail below in conjunction with specific provisions of the final rule.

B. Major Provisions of Proposed Rule

Consistent with the purpose of the overall rulemaking initiative, the NPRM proposed several key changes and clarifications to the current regulation, as follows:

• The NPRM proposed to delete the “pecuniary/non-pecuniary” terminology from the current regulation based on concerns that the terminology causes confusion and has a chilling effect on financially beneficial choices.

• The NPRM proposed the addition of regulatory text that would have made it clear that, when considering projected returns, a fiduciary's duty of prudence may often require an evaluation of the economic effects of climate change and other ESG factors on the particular investment or investment course of action.

• The NPRM proposed to add to the operative text of the rule three sets of examples of climate change and other ESG factors that, depending on the facts and circumstances, may be material to the risk-return analysis.

• The NPRM proposed to remove the special rules for QDIAs that apply under the current regulation. The NPRM would instead apply the same standards to QDIAs as apply to other investments.

• The NPRM proposed to modify the current rule's “tiebreaker” test, which permits fiduciaries to consider collateral benefits as tiebreakers in some circumstances. The current regulation imposes a requirement that the competing investments underlying a

tiebreaker situation be indistinguishable based on pecuniary factors alone before fiduciaries can turn to collateral factors to break a tie and imposes a special documentation requirement on the use of such factors. The NPRM proposed replacing those provisions with a standard that would have instead required the fiduciary to conclude prudently that competing investments, or competing investment courses of action, equally serve the financial interests of the plan over the appropriate time horizon. In such cases, the fiduciary is not prohibited from selecting the investment, or investment course of action, based on collateral benefits other than investment returns. The NPRM also proposed to remove the current regulation's special documentation requirements in favor of ERISA's generally applicable statutory duty to prudently document plan affairs.

• To the extent individual account plans use the tiebreaker test in the selection of a designated investment alternative, the NPRM proposed that plans must prominently disclose to the plans' participants the collateral considerations that were used as tiebreakers.

• The NPRM proposed to eliminate the statement in paragraph (e)(2)(ii) of the current regulation that “the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right,” which the Department was concerned could be misread as suggesting that plan fiduciaries should be indifferent to the exercise of their rights as shareholders, even if the cost is minimal.

• The NPRM proposed to eliminate paragraph (e)(2)(iii) of the current regulation, which sets out specific monitoring obligations with respect to use of investment managers or proxy voting firms, and to address such monitoring obligations in another provision of the regulation that more generally covers selection and monitoring obligations. The Department was concerned that the specific monitoring provision could be read as requiring some special obligations above and beyond the statutory obligations of prudence and loyalty that generally apply to monitoring the work of service providers.

• The NPRM proposed to remove the two “safe harbor” examples for proxy voting policies permissible under paragraphs (e)(3)(i)(A) and (B) of the current regulation. One of these safe harbors permitted a policy to limit voting resources to particular proposals that the fiduciary had prudently determined were substantially related to the issuer's business activities or were expected to have a material effect on the value of the investment. The other safe harbor permitted a policy of refraining from voting on proposals when the plan's holding in a single issuer relative to the plan's total investment assets was below a quantitative threshold. The Department was concerned that the safe harbors did not adequately safeguard the interests of plans and their participants and beneficiaries.

• The NPRM proposed to eliminate from the current regulation a specific requirement on maintaining records on proxy voting activities and other exercises of shareholder rights, which appeared to treat proxy voting and other exercises of shareholder rights differently from other fiduciary activities and risked creating a misperception that proxy voting and other exercises of shareholder rights are disfavored or carry greater fiduciary obligations than other fiduciary activities.

The Department invited interested persons to submit comments on the NPRM. In response to this invitation, the Department received more than 895 written comments and 21,469 petitions (

e.g.,

form letters) submitted during the open comment period. These comments and petitions (hereinafter collectively referred to as “comments” unless otherwise specified) 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 NPRM. These comments are available for public review on the Department's Employee Benefits Security Administration website.

III. The Final Rule

A. Executive Summary of Major Changes and Clarifications

The final rule generally tracks the NPRM but makes certain clarifications and changes in response to public comments. Before describing these changes, the Department emphasizes that the final rule does not change two longstanding principles. First, the final rule retains the core principle that the duties of prudence and loyalty require ERISA plan fiduciaries to focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives unrelated to the provision of benefits under the plan. Second, the fiduciary duty to manage plan assets that are shares of stock includes the management of shareholder rights appurtenant to those shares, such as the right to vote proxies. As described in further detail below in subsection B of this section III, the final rule adopts the following changes to the current regulation:

• Like the NPRM, the final rule amends the current regulation to delete the “pecuniary/non-pecuniary” terminology based on concerns that the terminology causes confusion and a chilling effect to financially beneficial choices.

• Like the NPRM, the final rule amends the current regulation to make it clear that a fiduciary's determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis and that such factors may include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action.

• Like the NPRM, the final rule amends the current regulation to remove the stricter rules for QDIAs, such that, under the final rule, the same standards apply to QDIAs as to investments generally.

• Like the NPRM, the final rule amends the current regulation's “tiebreaker” test, which permits fiduciaries to consider collateral benefits as tiebreakers in some circumstances. The current regulation imposes a requirement that competing investments be indistinguishable based on pecuniary factors alone before fiduciaries can turn to collateral factors to break a tie and imposes a special documentation requirement on the use of such factors. The final rule replaces those provisions with a standard that instead requires the fiduciary to conclude prudently that competing investments, or competing investment courses of action, equally serve the financial interests of the plan over the appropriate time horizon. In such cases, the fiduciary is not prohibited from selecting the investment, or investment course of action, based on collateral benefits other than investment returns. The final rule also removes the current regulation's special regulatory documentation requirements in favor of ERISA's generally applicable statutory duty to prudently document plan affairs.

• The final rule adds a new provision clarifying that fiduciaries do not violate

their duty of loyalty solely because they take participants' preferences into account when constructing a menu of prudent investment options for participant-directed individual account plans. If accommodating participants' preferences will lead to greater participation and higher deferral rates, as suggested by commenters, then it could lead to greater retirement security. Thus, in this way, giving consideration to whether an investment option aligns with participants' preferences can be relevant to furthering the purposes of the plan.

• Like the NPRM, the final rule amends the current regulation to eliminate the statement in paragraph (e)(2)(ii) of the current regulation that “the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right.” The final rule eliminates this provision because it may be misread as suggesting that plan fiduciaries should be indifferent to the exercise of their rights as shareholders, even if the cost is minimal.

• Like the NPRM, the final rule amends the current regulation to remove the two “safe harbor” examples for proxy voting policies permissible under paragraphs (e)(3)(i)(A) and (B) of the current regulation. One of these safe harbors permitted a policy to limit voting resources to types of proposals that the fiduciary has prudently determined are substantially related to the issuer's business activities or are expected to have a material effect on the value of the investment. The other safe harbor permitted a policy of refraining from voting on proposals or types of proposals when the plan's holding in a single issuer relative to the plan's total investment assets is below a quantitative threshold. Taken together, the Department believes the safe harbors encouraged abstention as the normal course and the Department does not support that position because it fails to recognize the importance that prudent management of shareholder rights can have in enhancing the value of plan assets or protecting plan assets from risk. Because of this failure, the Department believes these safe harbors do not adequately safeguard the interests of plans and their participants and beneficiaries.

• Like the NPRM, the final rule eliminates paragraph (e)(2)(iii) of the current regulation, which sets out specific monitoring obligations with respect to use of investment managers or proxy voting firms. The final rule instead addresses such monitoring obligations in another provision of the regulation that more generally covers selection and monitoring obligations. These amendments address concerns that the specific monitoring provision could be read as requiring special obligations above and beyond the statutory obligations of prudence and loyalty that generally apply to monitoring the work of service providers.

• Like the NPRM, the final rule amends the current regulation to eliminate from paragraph (e)(2)(ii)(E) of the current regulation a specific requirement on maintaining records on proxy voting activities and other exercises of shareholder rights. The provision is removed from the current regulation because it is widely perceived as treating proxy voting and other exercises of shareholder rights differently from other fiduciary activities and, in that respect, risks creating a misperception that proxy voting and other exercises of shareholder rights are disfavored or carry greater fiduciary obligations than other fiduciary activities.

B. Detailed Discussion of Public Comments and Final Regulation

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

(a) Paragraph (a)

Paragraph (a) of the final rule is unchanged from the NPRM and derives from the exclusive purpose requirements of ERISA section 404(a)(1)(A), and the prudence duty of ERISA section 404(a)(1)(B). The provision is also the same as paragraph (a) of the current regulation. The Department did not accept comments to expand the scope of the regulation to provide additional guidance on the duty of diversification under section 404(a)(1)(C) and the duty of impartiality under section 404(a)(1)(A) as interpreted in cases such as

Varity

Howe,

as these other duties generally are beyond the scope of this rulemaking initiative.

516 U.S. 489 (1996).

(b) Paragraph (b)

Paragraph (b) of the final rule addresses the investment prudence duties of a fiduciary under ERISA. Like the NPRM, paragraph (b) of the final rule contains four subordinate paragraphs. As discussed below, the final rule includes several changes from the proposal based on public comment, mostly in paragraphs (b)(2) and (4) of the final rule.

The NPRM did not propose any amendments to paragraph (b)(1) of the current regulation. Like the current regulation (and the 1979 Investment Duties regulation before it), paragraph (b)(1) of the NPRM provided that the requirements of section 404(a)(1)(B) of the Act set forth in paragraph (a) are satisfied with respect to a particular investment or investment course of action if the fiduciary meets two conditions. First, the fiduciary must give “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 . . . 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 second, the fiduciary must have “acted accordingly.” Except for the addition of the words “or menu” after the word “portfolio” for clarification, as explained below, paragraph (b)(1) of the final rule is unchanged from the NPRM.

(d) Paragraph (b)(2)

Paragraph (b)(2) of the NPRM addressed the “appropriate consideration” language referenced in paragraph (b)(1) of the proposal. Paragraph (b)(2) of the NPRM contained two prongs.

First, paragraph (b)(2)(i) of the NPRM provided that for purposes of paragraph (b)(1), “appropriate consideration” shall include, but is not necessarily limited to, 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. For this purpose, the plan fiduciary must take 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.

Second, paragraph (b)(2)(ii) of the NPRM provided that for purposes of paragraph (b)(1), “appropriate consideration” shall also include, but is not necessarily limited to, consideration of the composition of the portfolio with regard to diversification (paragraph (b)(2)(ii)(A)), the liquidity and current return of the portfolio relative to the anticipated cash flow requirements of the plan (paragraph (b)(2)(ii)(B)), and

the projected return of the portfolio relative to the funding objectives of the plan, which may often require the evaluation of the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action (paragraph (b)(2)(ii)(C)).

(1) Reasonably Available Alternatives

Several commenters provided views on the condition in paragraph (b)(2)(i) that a fiduciary must compare an investment or investment course of action under evaluation with reasonably available alternatives. This condition was not part of the original investment duties regulation adopted in 1979 and was added to the current regulation in 2020. The Department carried forward this condition in the 2021 NPRM and solicited comments on whether it was necessary to restate this principle of general applicability as part of this regulation.

Some commenters agreed that prudent fiduciaries should and generally do compare similar, available investments when making investment decisions. Some commenters said that because the provision is a simple restatement of a fundamental prudence tenet, its inclusion in the final rule is unnecessary. Some commenters were concerned that the term “reasonably available” is ambiguous and could make fiduciaries vulnerable to litigation challenging the reasonableness of a fiduciary's determination of the number of investments used in making the required comparison. Commenters were also concerned that the requirement imposes burdens on fiduciaries that do not necessarily have the resources to conduct research on all reasonably available alternatives. Some commenters noted that the Department did not adopt a comparative requirement in the 1979 rule and furthermore expressed concerns that the rule could be interpreted to require all fiduciaries, regardless of factors such as plan assets, to purchase and implement extensive and expensive systems to conduct the comparative analysis. One commenter suggested adding operative text that would explicitly allow for market-based comparisons using benchmarks or other market data as alternatives to the “reasonably available investment alternatives” language. One commenter cautioned that removing the provision would imply that the Department no longer believes that the marketplace is a true forum and benchmark of the investment selection process.

The Department continues to believe the requirement to compare reasonably available alternatives is commonly understood by plan fiduciaries, is uncontroversial in nature, and reflects the ordinary practice of fiduciaries in selecting investments. The Department is unpersuaded by some commenters' concerns regarding perceived ambiguity in the meaning of “reasonably available.” The scope of a fiduciary's obligation to compare an investment or investment course of action is limited to those facts and circumstances that a prudent person having similar duties and familiar with such matters would consider reasonably available. Further, the term allows 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 that there are no other reasonably available alternatives for comparative purposes. Accordingly, the final rule continues to require in paragraph (b)(2)(i) that “appropriate consideration” shall include 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. The language reflects the Department's longstanding view, articulated in Interpretive Bulletin 94-1 (and reiterated in subsequent Interpretive Bulletins) and earlier interpretive letters, that facts and circumstances relevant to an investment or investment course of action would include consideration of the expected return on alternative investments with similar risks available to the plan.

59 FR 32606 at 32607 (June 23, 1994); I.B. 2008-1, 73 FR 61734 (Oct. 17, 2008); I.B. 2015-1, 80 FR 65135 (Oct. 26, 2015);

see, e.g.,

Information Letter to Mr. Michael A. Feinberg, dated August 4, 1985; Information Letter to Mr. James Ray, dated July 8, 1988 (“It is the position of the Department that, to act prudently, a fiduciary must consider, among other factors, the availability, riskiness, and potential return of alternative investments.”).

(2) Portfolio Versus Menu

The final rule adopts minor amendments to the text in paragraph (b)(2) of the current regulation in response to commenters' requests to clarify whether and how it applies in the context of participant-directed individual account plans. Commenters observed that language in paragraph (b)(2), which was originally developed in 1979, contains certain considerations and factors that, in their view, are germane to the selection of investments for defined benefit plans but not to the selection of investments for defined contribution plans that have a set of designated investment alternatives available for participant to choose from, often referred to as a “menu.” For instance, they noted that paragraphs (b)(2)(i) and (ii) require focusing on a “portfolio,” which they believe is confusing because a participant-directed defined contribution plan's menu may include both funds that participants have chosen as investments as well as funds that have not been chosen. The commenters further noted that, in conventional investment parlance, the term “portfolio” refers to a collection of assets actually owned by an investor, whereas a menu of investment options for a participant-directed individual account plan consists of a range of designated investment alternatives that are available to participants. In addition, they questioned how to determine “anticipated cash flow requirements of the plan” in evaluating investment options for the menu of a participant-directed defined contribution plan. A commenter stated that, in its view, many of the appropriate consideration factors in paragraph (b)(2)(ii) of the NPRM seem largely irrelevant to participant-directed plans. These commenters suggested that clarification on the application of paragraph (b)(2)(ii) to the selection of investment options would be helpful for plan sponsors.

The Department appreciates the difficulties raised by commenters. Paragraph (b)(2)(ii) sets out a non-exclusive list of factors that functions as a minimum set of considerations for a fiduciary seeking to rely upon paragraph (b)(1). Failure to meet those minimum considerations would leave a fiduciary at risk of failing the standard even if, in the context of choosing investment options for a participant-directed plan, the responsible fiduciary has considered the relevant facts and circumstances surrounding its decision, including making a sound determination as described in paragraph (b)(2)(i). Accordingly, the Department is making changes to paragraph (b)(2) of the final rule. The changes clarify that the determination factors in paragraph (b)(2)(i) apply to menu construction and the factors in paragraph (b)(2)(ii) do not. Specifically, the Department is adding to paragraph (b)(2)(i) of the final rule references to an investment “menu,” and is adding an introductory clause to paragraph (b)(2)(ii) of the final rule limiting its application to employee benefit plans other than participant-directed individual account plans.

These changes do not affect the requirements of paragraph (b)(1)(i) of

the final rule, that a fiduciary must give appropriate consideration to those facts and circumstances a fiduciary knows or should know are relevant to the investment. These changes also should not be interpreted as suggesting that a fiduciary of an individual account plan is subject to a lower standard in giving appropriate consideration to the facts and circumstances surrounding a particular decision relating to an investment or investment course of action. Notwithstanding the changes to paragraph (b)(2)(ii), the Department believes that in selecting investment options for a plan menu, a fiduciary's considerations of surrounding facts and circumstances should be soundly reasoned and supported and reflect the requirements of section 404(a)(1)(B) of ERISA. The Department agrees with one commenter that, in the context of constructing a menu of investment options, the relevant analysis involves two questions: First, how does a given fund fit within the menu of funds to enable plan participants to construct an overall portfolio suitable to their circumstances? Second, how does a given fund compare to a reasonable number of alternative funds to fill the given fund's role in the overall menu?

Except for the questions described above with respect to application in the context of plan investment menus, the Department did not receive substantive comments on paragraphs (b)(2)(ii)(A) and (B) of the proposal. Those provisions are otherwise unchanged in the final rule.

(3) “May Often Require”

The Department received several comments on the language in paragraph (b)(2)(ii)(C) of the proposal which specified that consideration of the projected return of the portfolio relative to the funding objectives of the plan “may often require an evaluation of the economic effects of climate change and other environmental, social or governance factors on the particular investment or investment course of action.” This new language—the “may often require” clause—was proposed by the Department to counteract any negative perception against the consideration of climate change and other ESG factors in investment decisions caused by the current regulation. The intent behind this new clause was to clarify that plan fiduciaries may, and often should depending on the investment under consideration, consider the economic effects of climate change and other ESG factors on the investment at issue. In no way did the Department consider this proposed clause to be an expression of a novel concept. Indeed, the sentiment had been expressed in earlier non-regulatory guidance, although using different terminology.

See

Field Assistance Bulletin 2018-01 and Interpretive Bulletin 2015-01.

The Department received comments supporting and opposing this new clause. On the one hand, some commenters indicated that it helped address the chilling effect on evaluating ESG issues and served as a useful reminder to fiduciaries that ESG factors often do have an impact on investments. In the main, these commenters support the regulatory text as an express acknowledgement that climate change and other ESG factors are relevant to risk and return, and as an indication that fiduciaries should not be exposed to additional perceived or actual fiduciary liability risk under ERISA if they include such factors in their evaluation of plan investments.

On the other hand, a great many commenters, including some who concurred with the need to address the chilling effect under the current regulation, expressed a variety of concerns with this provision. Some commenters were concerned that by differentiating ESG considerations from other factors in express regulatory text, the regulation goes beyond removing the chilling effect and improperly places a thumb on the scale in favor of ESG investing. Some further cautioned that fiduciaries may treat the provisions as an effective mandate that they must consider ESG factors under all circumstances. The commenters argued that, absent guidance on when such an evaluation would not be required, plan fiduciaries would feel obligated to consider climate change and other ESG factors for every investment. Several commenters criticized the Department for, in their view, essentially favoring ESG investment strategies and overriding a fiduciary's considered judgment with respect to which investment factors or strategies to consider. Multiple commenters indicated that studies and research on investment performance involving ESG strategies show mixed results, and that a regulatory bias in favor of ESG investing is not justified. In line with this comment, some commenters questioned whether the Department presented sufficient evidence to support a position on the frequency (“may often require”) with which fiduciaries may be required to consider ESG factors, or argued that the market has already priced ESG factors into the price of any given investment.

Some commenters who criticized the new language in paragraph (b)(2)(ii)(C) stated that if the regulation takes the position that evaluating the economic effects of climate change and other ESG factors “may often” be required, then ambiguity surrounding the definition of the term ESG factors must be reduced to provide regulatory certainty. Commenters noted, however, that it would be difficult to precisely define ESG factors. Commenters also expressed concern that the language may be interpreted as effectively directing fiduciaries to take on the costs and complexity of evaluating the effects of climate change and other ESG factors, even if not otherwise prudent. In this regard, a commenter argued that there are common situations when a prudent analysis of the projected return relative to the portfolio's funding objective is unlikely to require an evaluation of the economic effects of ESG factors, such as when the objective of the applicable portion of the portfolio is to track the performance of an index. Several commenters offered alternative language to reduce the likelihood of misinterpreting the provision. Other commenters opined that the “may often require” language is largely unnecessary to address the chilling effect on consideration of ESG factors under the current regulation because of the broad language in paragraph (b)(4) of the proposal relating to the consideration of “any material factor.”

Based on the comments received, the Department has decided to modify paragraph (b)(2)(ii)(C) of the proposal by deleting the “which may often require” language altogether and consolidating the reference to “climate change and other environmental, social, or governance ESG factors” with language in paragraph (b)(4), as further modified below. The proposed language in paragraph (b)(2)(ii)(C) of the NPRM was not intended to create an effective or de facto regulatory mandate. Nor was the language intended to create an overarching regulatory bias in favor of ESG strategies. The Department is not persuaded that alternative language suggested by commenters to replace the “may often require” would be as effective in removing regulatory bias as the course chosen in the final rule. The modified version of the proposed language is intended to make it clear that climate change and other ESG factors may be relevant in a risk-return analysis of an investment and do not need to be treated differently than other relevant investment factors, without causing a perception that the

Department favors such factors in any or all cases.

As modified (and relocated to paragraph (b)(4) of the final regulation), the new text sets forth three clear principles. First, a fiduciary's determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis, using appropriate investment horizons consistent with the plan's investment objectives and taking into account the funding policy of the plan established pursuant to section 402(b)(1) of ERISA. Second, risk and return factors may include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action. Whether any particular consideration is a risk-return factor depends on the individual facts and circumstances. Third, the weight given to any factor by a fiduciary should appropriately reflect an assessment of its impact on risk and return.

In the Department's view, this principles-based approach is sufficient to address the chilling effect under the current regulation without establishing an effective mandate or explicitly favoring climate change and other ESG factors. This principles-based approach is designed to eliminate the substantial chilling effect caused by the current regulation, including its reference to “pecuniary factors.” As previously discussed, numerous commenters indicated that the current regulation puts a thumb on the scale against ESG factors, and chills fiduciaries from considering any ESG factors even when they are relevant to a risk-return analysis. The undesired effect of the current regulation is to chill and discourage fiduciaries from considering relevant investment factors that prudent investors otherwise would consider. At the same time, the final rule makes unambiguous that it is not establishing a mandate that ESG factors are relevant under every circumstance, nor is it creating an incentive for a fiduciary to put a thumb on the scale in

favor

of ESG factors. By declining to carry forward the “may often require” clause in paragraph (b)(2)(ii)(C) of the proposal, the final rule achieves appropriate regulatory neutrality and ensures that plan fiduciaries do not misinterpret the final rule as a mandate to consider the economic effects of climate change and other ESG factors under all circumstances. Instead, the final rule makes clear that a fiduciary may exercise discretion in determining, in light of the surrounding facts and circumstances, the relevance of any factor to a risk-return analysis of an investment. A fiduciary therefore remains free under the final rule to determine that an ESG-focused investment is

not

in fact prudent. Finally, nothing about the principles-based approach should be construed as overturning long established ERISA doctrine or displacing relevant common law prudent investor standards.

(e) Paragraph (b)(3)

Paragraph (b)(3) of the final rule is unchanged from the proposal and 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. The Department did not receive substantive comment on the provision, which carries forward, without change, regulatory language dating back to the 1979 Investment duties regulation.

(f) Paragraph (b)(4)

(1) Introductory Text

The introductory text of paragraph (b)(4) of the proposal provided that “a prudent fiduciary may consider any factor in the evaluation of an investment or investment course of action that, depending on the facts and circumstances, is material to the risk return analysis[.]” This introductory text was then followed by three paragraphs of specific ESG examples. Commenters were generally supportive of this provision minus the three paragraphs describing specific ESG examples. In context, many viewed paragraph (b)(4) of the NPRM as confirming the discretionary authority of fiduciaries to consider whatever factor or factors, in the reasoned judgment of the fiduciaries, are relevant to risk and return of the investment or investment course of action, including climate change and other ESG factors. Some commenters expressed the view that this introductory text (without the three paragraphs of examples), in conjunction with the removal of the so-called “pecuniary-only” terminology from the current regulation, would make significant headway in counteracting the negative perception of the consideration of climate change and other ESG factors caused by the current regulation. Paragraph (b)(4) of the final rule, therefore, retains the introductory text's focus on factors that are relevant to a risk and return analysis. Paragraph (b)(4) also retains its central recognition that relevant risk and return factors may, depending on the facts and circumstances, include the economic effects of climate change and other ESG factors. But, paragraph (b)(4) of the final rule otherwise contains substantial modifications discussed below.

(2) Three Paragraphs of ESG Examples

Comments on the list of examples in paragraph (b)(4) of the NPRM focused on both content and placement and were varied. Some commenters supported both the content (only ESG examples) and placement of the examples. In general, these commenters are of the view that the list of examples, even though limited to only ESG factors, is an appropriate corrective for what they view as the severe anti-ESG bias of the current regulation. In their view, adding the three paragraphs of ESG examples directly to the regulatory text will help to reassure fiduciaries that they will not be subject to litigation solely because of the use of such factors.

Many commenters, however, had concerns with the list of examples in paragraph (b)(4) of the NPRM and recommended their removal from the operative regulatory text. One frequently cited concern was that the list of examples in the proposal was too one-sided in favor of ESG factors. According to these commenters, the perceived regulatory bias would predictably trigger revisions by a future Administration with opposing views, effectively reducing the reliability and durability of the rule. This concern was raised by commenters who both supported and opposed the content of the examples.

Another frequently cited concern was that the list might have unintended consequences. For example, plan fiduciaries might erroneously conclude that the factors listed in the operative text are more prudent than non-listed factors. A different but possible unintended consequence mentioned several times was that some plan fiduciaries might perceive the list as a safe harbor, such that fiduciaries may believe they will be deemed to have made a prudent investment decision if they consider only the listed examples (and no others). Others suggested that, by singling out these particular examples to the exclusion of other examples, the regulation could be read

as implying that these factors were especially important when selecting an investment. Consequently, according to these commenters, at least some fiduciaries would feel obligated to document in writing their justification for not considering these example factors. Similarly, some commenters suggested that, in their view, listing in the operative text only a few of the potentially material factors that a prudent fiduciary might consider might unintentionally create a perception that the Department expects fiduciaries will take these specific factors into consideration, even where it might not be possible, practical, or prudent.

Another repeated concern of commenters was that the list of factors is unnecessary. According to these commenters, the general reference to material risk-return factors in paragraph (b)(4) of the NPRM would be sufficient to make clear that fiduciaries may consider any factor material to a risk-return analysis, including ESG factors. To these commenters, the concept of materiality provides for the determination of relevant factors on a case-by-case basis. In their view, such a principles-based approach better serves plans and provides greater flexibility for ERISA fiduciaries to consider the unique factors relevant to particular investment decisions.

Another frequently cited concern was that the examples would become stale over time. Several commenters opined that a list of specific examples of material factors that may be of particular importance now may be of less importance in the future. Thus, at a minimum, the regulation could require updates over time as risk management and investment strategies evolve.

Some commenters indicated that the list of ESG factors could be improved with additional examples. For instance, many commenters suggested that the list should be balanced by expanding the list to include non-ESG factors that may be material risk-return factors (

e.g.,

good products, compelling corporate strategy, tight cost controls). Some further suggested it would be helpful for the Department to add examples of when it is not prudent to consider ESG factors. A commenter noted that by including only ESG factors as examples, the Department risks creating a perception that fiduciaries may take only ESG factors into account. Another commenter criticized that some of the examples as proposed are broad and ambiguous, inherently subjective, and give too much flexibility to plan fiduciaries who may be inclined to use plan assets to further particular ESG goals. Some commenters further characterized the proposed examples as singling out special interests and progressive ESG priorities that have little to no impact on financial returns. Multiple commenters suggested additions of factors that seemed to fall within the broad categories of examples but were not specifically listed. Commenters also suggested the addition of factors that did not appear to fall within any of those categories.

After consideration of the comments received, the Department is persuaded that paragraph (b)(4) of the final rule should not include a list of examples. The list of examples was never intended to be exclusive; nor was it intended to define “ESG” or introduce any new conditions under the prudence safe harbor. The list of examples was merely intended to reaffirm that fiduciaries may consider ESG factors that are relevant to a risk-return analysis of the investment. The examples were intended to make clear that ESG factors may be more than mere tiebreakers, but rather financially material to the investment decision. The Department believes, however, that this point is made sufficiently clear by the general language in paragraph (b)(4) of the final rule. The primary justification for removing the examples from the operative text of the final rule is that the Department is wary of creating an apparent regulatory bias in favor of particular investments or investment strategies.

Removal of the list from paragraph (b)(4) should not be viewed as limiting a fiduciary's ability to take into account any risk and return factor that the fiduciary reasonably determines is relevant to a risk/return analysis. The Department continues to be of the view that, depending on the surrounding facts and circumstances, these may include the factors listed in paragraph (b)(4) of the proposal. Thus, depending on the surrounding circumstances, a fiduciary may reasonably conclude that climate-related factors, such as a corporation's exposure to the real and potential economic effects of climate change including exposure to the physical and transitional risks of climate change and the positive or negative effect of Government regulations and policies to mitigate climate change, can be relevant to a risk/return analysis of an investment or investment course of action. A fiduciary also may make a similar determination with respect to governance factors, such as those involving board composition, executive compensation, and transparency and accountability in corporate decisionmaking; a corporation's avoidance of criminal liability; compliance with labor, employment, environmental, tax, and other applicable laws and regulations; the corporation's progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion, and retention; investment in training to develop a skilled workforce; equal employment opportunity; and labor relations and workforce practices generally.

The foregoing examples are merely illustrative, and not intended to limit a fiduciary's discretion to identify factors that are relevant with respect to its risk/return analysis of any particular investment or investment course of action. A fiduciary may reasonably determine that a factor that seems to fall within a general category described above (

e.g.,

climate-related factors), but is not specifically identified above, nonetheless is relevant to the analysis (

e.g.,

drought). For example, depending on the facts and circumstances, relevant factors may include impact on communities in which companies operate, due diligence and practices regarding supply chain management, including environmental impact, human rights violations records, and lack of transparency or failure to meet other compliance standards. As another example, labor-relations factors, such as reduced turnover and increased productivity associated with collective bargaining, also may be relevant to a risk and return analysis.

Of course, a fiduciary's determination of relevant factors is not limited to the general categories described above. Prudent investors commonly take into account a wide range of financial circumstances and considerations, depending on the particular circumstances, such as a corporation's operating and financial history, capital structure, long-term business plans, debt load, capital expenditures, price-to-earnings ratios, operating margins, projections of future earnings, sales, inventories, accounts receivable, quality of goods and products, customer base, supply chains, barriers to entry, and a myriad of other financial factors, depending on the particular investment. This rule, as amended, does not supplant such considerations, but rather makes clear that there is no inconsistency between the appropriate consideration of ESG factors and ERISA section 404(a)(1)(B)'s standard of prudence, which requires that fiduciaries act with the “care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

(3) Consolidation of Multiple Provisions Into Paragraph (b)(4) of the Final Rule

In concert with removing the list of examples from paragraph (b)(4) of the NPRM, elements of paragraphs (b)(2)(ii)(C) and (c)(2) of the NPRM are now merged into paragraph (b)(4) of the final rule. These edits address commenters' concerns that aspects of paragraph (b)(2)(ii)(C) of the NPRM could constitute an effective or de facto mandate to always consider the effects of climate change and other ESG factors on every investment or investment course of action, that the examples in paragraph (b)(4) of the NPRM interject inappropriate regulatory bias in favor of ESG factors, and that the final rule not retreat from the principle in paragraph (c)(2) of the NPRM that fiduciaries must base investment decisions only on factors that are relevant to a risk and return analysis. The essence of paragraph (c)(2) of the NPRM was not changed when merged into paragraph (b)(4) of the final rule. As mentioned below, the merger avoids the existence of redundant concepts in multiple paragraphs and reflects that the substance of paragraph (c)(2) of the NPRM is more closely connected to ERISA's duty of prudence than the duty of loyalty.

Accordingly, paragraph (b)(4) of the final rule provides that a fiduciary's determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis, using appropriate investment horizons consistent with the plan's investment objectives and taking into account the funding policy of the plan established pursuant to section 402(b)(1) of ERISA. It further indicates that risk and return factors may include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action, and whether any particular consideration is a risk-return factor depends on the individual facts and circumstances. Finally, it provides that the weight given to any factor by a fiduciary should appropriately reflect a reasonable assessment of its impact on risk-return.

As revised, paragraph (b)(4) of the final rule subsumes core elements of paragraphs (c)(1) and (f)(3) of the current regulation. Specifically, the emphasis on risk and return factors in these two paragraphs carries forward into paragraph (b)(4) of the final rule. The current regulation's reliance on “pecuniary only” and related terminology, however, is otherwise rescinded. The framework in paragraph (b)(4) of the final rule continues to adhere to the principle, underpinning paragraphs (c)(1) and (f)(3) of the current regulation, that when selecting an investment or investment course of action plan fiduciaries must focus on relevant risk and return factors, but the Department no longer supports the current regulation's framework and terminology for advancing this principle. The Department, instead, agrees with the commenters who found the current regulation's framework and terminology confusing and susceptible to inferences of bias against the treatment of climate change and other ESG factors as potentially relevant risk and return factors. The Department intends with these edits to dispel the perception caused by the current regulation that climate change and other ESG factors are somehow presumptively suspect or unlikely to be relevant to the risk and return of an investment or investment course of action. Paragraph (b)(4) of the final recognizes that, as with other factors, climate change and other ESG factors sometimes may be relevant to a risk and return analysis and sometimes not—and when relevant, they may be weighted and factored into investment decisions alongside other relevant factors, as deemed appropriate by the plan fiduciary.

(4) Conforming Terminology—“Relevance” Versus “Material”

In addition, paragraph (b)(4) of the final rule contains a change in terminology to establish consistency with the terminology in paragraph (b)(1) of the final rule. Several commenters noted that paragraph (b)(1) of the NPRM refers to “relevant” factors but that paragraph (b)(4) of the NPRM refers to “material” factors. Noting a body of decisional and regulatory law underpinning “materiality” under Federal securities laws and accounting conventions, many of these commenters considered the NPRM's use of these different terms a source of confusion. In conjunction with proposed paragraph (b)(4)'s focus on risk and return factors, many commenters were concerned that paragraph (b)(4)'s use of “material” might be construed as circumscribing the role or authority of plan fiduciaries under ERISA's prudence standard as reflected in the use of “relevance” in paragraph (b)(1) of the NPRM.

In discussing these concerns, commenters mentioned many factors that, in their view, are relevant factors routinely considered by plan fiduciaries when selecting investments, such as brand name or reputation of the fund or fund manager, lifetime income options, style of fund (

e.g.,

growth versus value), style of fund management (passive versus active), an investment's regulatory regime, participants' understanding of the investment, participants' preferences, and other investment-related operational considerations. These commenters expressed concern that such factors may not always perfectly align with securities law or accounting concepts of materiality or directly affect the risk and return of an investment in clear or obvious ways.

In response to some of these concerns, paragraph (b)(4) of the final rule uses the word “relevant” instead of “material.”

The Department stresses, however, that under paragraph (b)(4) of the final rule, the fiduciary's investment determination must ultimately rest on factors relevant to a risk and return analysis. The Department does not undertake in this document to address specific risk and return factors, but it notes that it has previously concluded that plan contributions do not constitute a “return” on investment.

A similar change was made in paragraph (d)(2)(ii)(D) of the final regulation to appropriately align terminology in similar contexts across different paragraphs of the final regulation.

2. Section 2550.404a-1(c) Investment Loyalty Duties

(a) Removal of Pecuniary-Only Requirement—Paragraph (c)(2) of the Proposal

Paragraph (c)(2) of the NPRM modified the requirement in paragraph (c)(1) of the current regulation that a fiduciary's evaluation of an investment or investment course of action must be based “only on pecuniary factors,” which is defined at paragraph (f)(3) of the current regulation as a factor that a fiduciary prudently determines is 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. The Department used the phrase “pecuniary factors” for the first time in the 2020 regulations, and although the Department defined it in those regulations, the phrase is not found in ERISA and has no longstanding meaning in employee benefits law. The NPRM proposed to remove the “pecuniary only” formulation of the requirement and to integrate the concept of “risk/return” factors directly into paragraph (c)(2) of the NPRM. This approach was intended to address stakeholder concerns about ambiguity in the meaning and application of the

“pecuniary only” terminology of the current regulation.

A significant number of commenters supported the NPRM's proposed removal of the pecuniary-only test and related terminology. Many commenters on this issue were of the view that, rather than providing clarity, the current regulation's pecuniary-only terminology created confusion by layering an additional standard or test onto the existing fiduciary framework. That framework already unambiguously required fiduciaries to base plan investment decisions on financially relevant factors. In line with that concern, many commenters asserted that this pecuniary-only terminology chills plan fiduciaries from considering climate change and other ESG factors even where they have a material effect on the bottom line of an investment, merely because such factors also may have the effect of supporting non-financial objectives. In such “dual purpose” circumstances, the position of these commenters was that just because an investment factor or strategy may simultaneously have economic and non-economic dimensions, the non-economic dimensions do not lessen the factor or strategy's economic significance. These commenters stated that the NPRM's proposed elimination of the pecuniary-only and related terminology would make clear to fiduciaries that they are free to consider the full range of potential material risk-return factors without undue fear of regulatory second-guessing or litigation. According to these commenters, the elimination would encourage fiduciaries to take the same steps that other marketplace investors take in enhancing investment value and performance or improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors.

Some commenters opposed the NPRM's proposed changes; they emphasized the importance of basing investment decisions on only pecuniary considerations and urged the Department to retain the pecuniary factors and related terminology. These commenters generally were of the view that ERISA requires that plan fiduciaries focus solely on the economics of an investment and state that climate change and other ESG factors rarely can be harmonized with this requirement. Given that belief, these commenters were concerned that participants' retirement security will suffer as plan fiduciaries and money managers pursue agendas unrelated to the exclusive purpose of providing financial benefits to retirement plan participants and beneficiaries. In line with this concern, one commenter asserted that the insertion of non-pecuniary investment criteria in the management of pension and other such funds imposes a substantial penalty over time in terms of realized returns. One commenter questioned the consistency of permitting the consideration of non-pecuniary goals with the Supreme Court's opinion in

Fifth Third Bancorp

Dudenhoeffer,

which stressed the fiduciary's obligation to focus on retirement plan participants' financial interests.

Fifth Third Bancorp

Dudenhoeffer,

573 U.S. 409 (2014).

The Department is not persuaded to retain the current regulation's use of and reliance on the novel pecuniary-only formulation and its related terminology. The pecuniary-only requirement and related terminology unfortunately caused a great deal of confusion, and it accounts for a substantial amount of the chilling effect this rulemaking project set out to redress. These facts are manifest in the many comment letters on the NPRM. Many view the “pecuniary-only” terminology as ambiguous or decidedly prohibitive on the question of whether climate change and other ESG factors may be considered when those factors are relevant to the risk-and-return analysis. Indeed, as indicated by commenters, the current rule actually has a chilling effect that discourages fiduciaries from prudently considering climate change and other ESG factors that may be relevant to the risk-return analysis. Some commenters, in particular, asked questions about considering factors that have both economic and noneconomic components, suggesting apprehension that this would fall outside the current regulation's pecuniary-only requirement. In light of the foregoing, the Department no longer supports the use of this terminology. Rather, the Department thinks, and many commenters agree, that paragraph (c)(2) of the NPRM, subject to certain modifications discussed elsewhere in this preamble, is a more understandable formulation of ERISA's requirement that a fiduciary's evaluation of an investment or investment course of action must focus on factors that the fiduciary reasonably determines are relevant to a risk and return analysis. Removing the “based only on pecuniary factors” language (and related terminology throughout) from the current regulation will help re-establish the Department's position reflected in non-regulatory guidance as early as 2015 that climate change and other ESG factors that may be relevant in a risk-return analysis of an investment do not need to be treated differently than other relevant investment factors, even though they may possess the “dual purpose” dimensions mentioned by some commenters. Put differently, removing this novel terminology is removing the current regulation's thumb from the scale so as not to discourage fiduciaries from considering climate change and other ESG factors where relevant to the risk-return analysis.

Finally, the Department finds no merit to the argument that the final rule, either in general or in not carrying forward the pecuniary/non-pecuniary terminology, permits or requires behavior contrary to the holding in

Dudenhoeffer.

On the contrary, the central premise behind the final rule's rescission of the pecuniary/non-pecuniary distinction is that the current regulation is being perceived by plan fiduciaries and others as undermining the fundamental principle

Dudenhoeffer

expressed: fiduciaries must protect the financial benefits of plan participants and beneficiaries. In this way, the pecuniary-only requirement would effectively prohibit or encumber plan fiduciaries from managing against or taking advantage of climate change and other ESG risk factors in selecting investments, even when it is financially prudent to do so. Thus, the final rule's amendments to the current regulation, which are aimed solely at counteracting that perception, are entirely consistent with the principle articulated in

Dudenhoeffer.

Notwithstanding the foregoing, paragraph (c)(2) of the proposal has been incorporated into paragraph (b)(4) of the final rule for clarity and to avoid potentially redundant and confusing requirements. This consolidation reflects that the essence of the requirement of paragraph (c)(2) of the proposal that fiduciaries make investment decisions based on factors relevant to a risk and return analysis is inherently prudential in nature, rather than a loyalty obligation, and therefore overlaps with the requirements of paragraph (b)(4) of the proposed rule. Although including such a requirement in the regulation's loyalty provisions may help establish regulatory guideposts for fiduciaries,

that same function is fulfilled by incorporating it into the final regulation's prudence provisions at paragraph (b)(4) of the final rule.

See

85 FR 72854.

(b) Paragraph (c)(1)

Paragraph (c)(1) of the proposal restated the Department's longstanding expression of ERISA's duty of loyalty in the context of investment decisions, as also expressed in Interpretive Bulletins and associated preamble discussions. It provided that a fiduciary may not subordinate the interests of participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives and may not sacrifice investment return or take on additional investment risk to promote goals unrelated to the plan and its participants and beneficiaries. Similar language is contained in paragraph (c)(2) of the current regulation. The Department did not receive substantive comments on paragraph (c)(1) of the proposal, and it is being adopted in the final rule without change. As in the proposal and current regulation, the final rule's paragraph (c)(1) is a legal requirement and not a safe harbor.

Paragraph (c)(3) of the proposal directly rescinded the “tiebreaker” standard in paragraph (c)(2) of the current regulation and replaced it with a standard intended to align more closely with the Department's original non-regulatory guidance from nearly three decades ago, IB 94-1, which first advanced the “tiebreaker” concept. In explaining the standard in the preamble to IB 94-1, the Department stated that “a plan fiduciary may consider collateral benefits in choosing between investments that have comparable risks and rates of return.”

In contrast, the current regulation narrowly focused on whether competing investments are “indistinguishable” based on pecuniary factors alone. Under such circumstances, the current regulation permits a plan fiduciary to use a non-pecuniary factor as a deciding factor in making its investment decision, but only if the fiduciary also complies with a specific documentation requirement.

59 FR 32607 (June 23, 1994).

A number of commenters supported both the rescission of the current tiebreaker standard and the proposal's replacement standard—

i.e.,

that competing investments “equally serve” the financial interests of the plan. In their view, the proposed formulation represented a significant improvement over the current regulation, which they argued set out an unrealistically difficult and prohibitively stringent standard. Some further suggested that the standard in the current regulation is so stringent that it effectively eliminated the Department's historical tiebreaker test. For instance, according to one commenter, the current regulation's tiebreaker standard improperly limits its application, because it would only apply when a fiduciary is unable to distinguish two or more investments based on pecuniary factors alone—an occurrence that is rare and unreasonably difficult to identify, according to this commenter. In actual practice, the commenter states, a prudent fiduciary process often produces a variety of investments that are consistent with, and in the fiduciary's judgement, equally promote, the financial interests of participants and beneficiaries. According to a different commenter, the current regulation's “economically indistinguishable” standard is in practice impossible for fiduciaries to surmount, given that differences exist even among very similar investments. As put by yet another commenter, the requirement that investments be “economically indistinguishable” before a fiduciary can consider collateral factors (such as ESG factors when not relevant to risk and return) effectively subverts the fiduciary's best judgment in favor of a standard that is virtually impossible to meet. Overall, these commenters viewed the proposal's standard as tracking the Department's prior guidance more closely, and more accurately reflecting the realities of fiduciary decisionmaking. They supported adoption of the NPRM's standard without change.

Other commenters supported the proposal's rescission of the current tiebreaker standard, but raised concerns with the proposal's “equally serve” formulation. Commenters indicated that the proposal was not clear as to how to determine when investments meet the “equally serve” standard and requested further guidance. Questions presented included whether the equally-serve analysis is based on how similar investments are, or based on the potential financial effects of the investments on the plan's portfolio. One commenter suggested that the Department should recognize that investments may vary from each other but still serve the same plan purpose. Another commenter asked how small deviations in the financial effects of two investments would affect the equally serve analysis. These commenters did not believe the tiebreaker standard should require investments to be identical, and suggested clarifying language, such as a standard based on investments that serve the financial interests of the plan comparably well, or equally well.

Other commenters indicated that the “equally serve” standard appeared to imply an investment process under which a fiduciary selection process involves evaluating a group of potential investments, paring the group down to a few competing investments, and then moving on to the tiebreaker test and the selection of a single investment. Commenters opined that such a mechanical process of elimination should not be necessary if a fiduciary has already prudently determined that each investment is consistent with the plan's objectives and is reasonably designed to further the purposes of the plan. Some commenters asserted that the tiebreaker test should focus on whether investments are the result of a prudent fiduciary process rather than on an analysis of their equivalence, and suggested formulations based on “equally prudent” investments, or investments identified through a prudent process.

Some commenters supported the tiebreaker standard in the current regulation and objected to the rescission of the current standard. These commenters viewed the proposal's standard as far too lenient, and the current regulation's indistinguishability based on pecuniary factors only standard as appropriate in light of ERISA's high standard of fiduciary responsibilities. They asserted that the current regulation's provisions are a valuable curb against behavior that could otherwise lead to subordinating the interests of participants and beneficiaries in their retirement income. These commenters expressed concern that the proposal, with changes to the tiebreaker standard and related documentation provisions, would invite abuse and open the door to using pension plan assets for policy agendas, or encourage fiduciaries to advance personal policies and agendas at the expense of interests of trust beneficiaries in a secure retirement.

A number of commenters did not support inclusion of any tiebreaker provision in the regulation. Some commenters believe the tiebreaker test cannot be reconciled with ERISA's duty of loyalty, which requires that fiduciaries discharge their duties for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. Commenters also cautioned that the tiebreaker provision weakens the focus on the best financial outcome for plan participants and beneficiaries by encouraging consideration of collateral factors. In

their view, fiduciaries desiring to seek third-party benefits may, deliberately or inadvertently, be encouraged to declare ties to free themselves from the duty of loyalty. Several of these commenters did not believe a tiebreaker is necessary regardless of formulation because, in their view, ties generally do not exist, particularly in liquid financial markets. Furthermore, they argued that the purpose of an investment manager is to exploit differences among investments and to select a winner (or buy both for increased diversification in the case of ties). In their view, fiduciaries are accustomed to deliberating on such matters, including close calls, and if they are doing their job and creating an appropriate record, there should be no need for tiebreaker guidance in the rule.

Some commenters also believed that a tiebreaker test may potentially cause harm or detriment to plans. For instance, some suggested that a tiebreaker test may reduce accountability and promote complacency by allowing investment decisionmakers to adopt a “close enough” attitude and point to some reason other than financial merit to justify their decisions. In contrast, others suggested that the tiebreaker test promotes a misconception that there is a single “best” investment for a plan. Still others cautioned that the mere existence of a tiebreaker test could unintentionally signal that ESG factors cannot, on their own, be considered material to a risk-return analysis. Some also suggested that there is a chance the tiebreaker test may be overused unnecessarily in cases where the fiduciary has little doubt about the financial merits of the investment in question but where the fiduciary perceives the tiebreaker route as providing a level of protection from future allegations of disloyalty. Such overuse may lead to substantial burdens on recordkeepers in connection with the proposal's related collateral benefit disclosure requirement.

The Department is not persuaded that the tiebreaker provision should be removed from the final rule. The Department does not agree with commenters who asserted that the tiebreaker test is unnecessary or inconsistent with ERISA. Although there has been some mostly semantic variation in what constituted ties under the Department's prior non-regulatory guidance, some version of the tiebreaker test has appeared in the CFR since 1994. Consequently, since at least that time, the Department has recognized that fiduciaries may use collateral benefits to break ties between various investments. The tiebreaker test thus aligns the final rule with the settled expectations of fiduciaries and others involved in the investment of assets of employee benefits plans under ERISA, especially in the multiemployer plan context. Although some fiduciaries, by the nature of their arrangements with plans, may apply investment strategies that never require them to choose between alternatives that equally serve the plan's needs, other fiduciaries, such as those making investments outside liquid financial markets, may find the tiebreaker test useful for circumstances in which there are equally strong cases for competing investments under a risk-return analysis. In addition, although some commenters question the need for a tiebreaker test and whether ties exist, other commenters acknowledge the utility of the tiebreaker standard. For instance, some commenters argued that in the event of a tie between two investment options, the fiduciary should increase diversification by investing in both investment options. They acknowledge, however, that in not all circumstances is this appropriate, and thus, the tie will need to be broken. Under the commenter's approach, for example, the tiebreaker test provides plan fiduciaries with a solution in cases when investing in two (or more) alternatives that equally serve the financial interests of the plan, rather than one, entails additional costs (such as transactional or monitoring costs) that offset the benefits of investing in two (or more) investments rather than one.

More generally, those questioning the need for a tiebreaker test are reminded that ERISA does not specifically address a fiduciary's investment choice in circumstances where multiple investment alternatives equally serve the financial interests of the plan and thus the economic interests of the plan's participants and beneficiaries are protected by choosing either alternative. The Department is choosing to leave that decision in the hands of fiduciaries, who are charged with choosing among investment alternatives that equally serve the financial interests of the plan. Fiduciaries without a need to break a tie while selecting investments need not use the provision. This may be the case, for example, with respect to participant-directed individual account plans where adding additional investment options is not necessarily a zero-sum game, such that the fiduciary may choose only one option. Moreover, when there is a need to break a tie, there is nothing in the regulation that requires fiduciaries to look to climate change or other ESG factors to break the tie.

With respect to concerns that the tiebreaker provision might be subject to abuse or not be part of a prudent fiduciary process, we note that fiduciaries utilizing the tiebreaker provision remain subject to ERISA's prudence requirements. In addition, they also remain subject to the explicit prohibition against accepting expected reduced returns or greater risks to secure such additional benefits. The Department is of the view that these provisions, coupled with the safeguards added by ERISA's statutory prohibited transaction provisions, discussed below, sufficiently protect participants' and beneficiaries' retirement benefits in this context.

As to commenters who suggested that the existence of a tiebreaker provision implies that ESG factors are non-economic, the potential economic relevance of ESG factors is reflected in paragraph (b)(4) of the final rule, as discussed above. When such factors are relevant to a risk and return analysis, the tiebreaker test is not at issue. Put differently, as with other types of investment factors, climate change and other ESG factors sometimes may be relevant to a risk and return analysis and sometimes not—and when relevant, they may be factored into investment decisions alongside other relevant factors, as deemed appropriate by the plan fiduciary under paragraph (b)(4) of the final rule. However, when such factors are not relevant to a risk and return analysis, such factors may nevertheless be the decisive factor under the tiebreaker test, provided that the other conditions of the tiebreaker test are satisfied. The Department believes that rescission of the current regulation's tiebreaker standard and replacement with a standard more closely aligned with prior non-regulatory guidance is appropriate. The current regulation's tiebreaker standard, “unable to distinguish on the basis of pecuniary factors alone,” in practice, has meant indistinguishable in all respects, or identical. This standard is causing a great a deal of confusion, given that no two investments are the same in each and every respect. The imposition of a standard that effectively requires investments to be precisely identical therefore is both impractical and unworkable. Investments can and do differ in a wide range of attributes, but when considered in their totality, may serve the financial interests of the plan equally well. This problem was noted by the Department in 2020 when making the current regulation's tiebreaker standard, but as shown by the comments discussed above, the current

regulation has not effectively resolved this problem.

The Department believes the final rule's “equally serve” standard comports with the realities of fiduciary decisionmaking and firmly protects participant retirement benefits, since it strictly forbids the subordination of plans' and participants' financial interests to any other objective.

85 FR 72846, 62.

In response to comments requesting further guidance on the determination of whether investments equally serve the financial purposes of the plan, the Department has not made changes to the proposed standard. In the Department's view, as explained in the preamble to the proposal, investments may differ on a wide range of attributes, but when considered in their totality, serve the financial interests of the plan equally well.

Given the wide range of attributes associated with different investments, the uncertainties inherent in investing, and the practical limitations on the availability and processing of relevant data, the Department does not agree with those commenters who suggested that fiduciaries can never conclude that competing alternatives serve the financial purposes of the plan equally well. Under the final rule, investments do not need to be identical in order to equally serve the financial interests of a plan. Whether, in any particular circumstances, the tiebreaker standard is met is an inherently factual question.

86 FR 57278.

Like the NPRM, the final rule's tiebreaker provision does not define or explicitly limit the concept of “collateral benefits.” On this topic, the preamble to the NPRM specifically provided that the proposal did not place parameters on the collateral benefits that may be considered by a fiduciary to break the tie. The preamble to the NPRM explained that this position is consistent with prior nonregulatory guidance, but the preamble nevertheless solicited comments on whether more specificity should be provided in the provision. For instance, the preamble asked if the final rule should require that any collateral benefit relied upon as a tiebreaker be based upon an assessment of the shared interests or views of the participants, above and beyond their financial interests as plan participants, such as the investment's likely impact on participants' jobs or plan contribution rates. This scenario was just an example.

Some commenters opposed such limitations, both as a general idea and specifically the scenario mentioned in the preamble of the NPRM,

i.e.,

placing additional constraints in the form of requiring an assessment of the shared interests or views of the participants. Commenters stated that the Department's longstanding position prior to the 2020 amendments, going back at least to 1994, never defined or limited the concept of “collateral benefits” and that there is no history justifying a change now. Focusing on the specific scenario in the preamble to the NPRM, one commenter stated that it is not clear how a fiduciary would use information on participant views, collect such information, or even what issues should be included in such an assessment. A different commenter also focusing on this scenario stated the concern that making decisions based on a survey or estimation of participants' views unrelated to plan returns is in tension with ERISA's command that fiduciaries operate “for the exclusive purpose” of providing benefits and defraying reasonable expenses. One commenter argued that a regulatory definition is not necessary because the tiebreaker test already ensures that the investment must be prudent and serve the best interests of the participants and beneficiaries regardless of whether a collateral benefit is used. Requiring further assessment would increase costs and complexity, according to this commenter.

Other commenters had different views on this question. One commenter stated that, in its view, the tiebreaker provision is unlawful, but that if some version of it is retained in the final rule, the retained version should require that any collateral benefit relied upon as a tiebreaker be based upon an assessment of the shared interests or views of the participants, along with the consent of each participant to pursue collateral benefits with funds in their account and a delineation of the causes they support. One commenter raised the concern that, because the NPRM did not place any parameters on the collateral benefits that fiduciaries may consider, fiduciaries could be left guessing which factors would be appropriate for consideration, with the possibility that the Department's views could shift over the years.

The final rule takes the same approach as the NPRM. Some form of the tiebreaker test permitting fiduciaries to consider collateral benefits has existed for more than four decades, and the Department is not aware of plan fiduciaries struggling with the concept of permissible collateral benefits. In the Department's experience, collateral benefits have routinely involved criteria or considerations other than factors that are relevant to a risk and return analysis of the investment, such as stimulating union jobs and investing in the geographic region where participants live and work, as just a few examples. In response to requests from several commenters, the Department confirms that an investment that stimulates or maintains employment that, in turn, results in continued or increased contributions to a multiemployer plan is an example of “collateral benefits other than investment returns” under paragraph (c)(2) of the final rule. In response to the concern that, without a definition, plan fiduciaries will be forced to guess as to what constitutes a legitimate “collateral benefit” versus an impermissible collateral benefit, the Department reminds that plan fiduciaries are not required to consider collateral benefits in choosing between investments that have comparable risks and rates of return. Moreover, the statement that the final rule does not contain explicit parameters on the collateral benefits that may be considered by a fiduciary to break a tie directly responds to and addresses commenters' concerns about exceeding such parameters. Finally, while the final rule itself adds no explicit parameters on collateral benefits, ERISA's prohibited transaction provisions in section 406 remain and generally forbid collateral benefits to the extent any such benefit involves a transaction that violates those provisions.

See, e.g.,

AO 85-36A (Oct. 23, 1985) (certain investment arrangements may involve a use of plan assets for the benefit of a party in interest in violation of ERISA section 406(a)(1)(D)); Information Letter to Katz (Mar. 15, 1982) (purchase by a plan of an insurance policy pursuant to an arrangement under which it is expected that the insurance company will make a loan to a party in interest is a prohibited transaction).

(d) Paragraph (c)(2) Tiebreaker Test—Documentation

Paragraph (c)(3) of the NPRM also rescinded the current regulation's novel documentation requirement applicable to any instance of use of the tiebreaker test; instead, the proposal included a requirement that if a plan fiduciary uses the tiebreaker to select a designated investment alternative for a participant-directed individual account plan based on collateral benefits other than investment returns, “the plan fiduciary must ensure that the collateral-benefit characteristic of the fund, product, or model portfolio is prominently displayed in disclosure materials provided to participants and beneficiaries.”

A number of commenters objected to the removal of the current regulation's

documentation provision, under which a fiduciary using the tiebreaker test is required to document, among other things, its analysis in those cases where the fiduciary has concluded that pecuniary factors alone were insufficient to be the deciding factor.

The requirement was intended to “provide a safeguard against the risk that plan fiduciaries will improperly find economic equivalence and make decisions based on non-pecuniary factors without a proper analysis and evaluation.”

Some of these commenters are of the view that the tiebreaker test may be inconsistent with ERISA, as discussed above, and that a stringent documentation requirement is perhaps the best way for plan fiduciaries to contemporaneously document their decisionmaking with respect to tiebreakers and mitigate the effects of their reliance on factors that do not materially affect risk-return or directly promote retirement income.

29 CFR 2550.404a-1(c)(2) (2021).

85 FR 72862.

Other commenters supported removal of the current regulation's documentation requirement, arguing that the disclosure was formulaic, singled out one investment category, could chill fiduciaries from properly considering ESG factors, and was largely unnecessary given ERISA's general obligations. For instance, one commenter indicated that the documentation requirement has a chilling effect and is seen as suggesting that ESG investing entails extraordinary risks. Other commenters also viewed the documentation requirement as creating a stigma around considering ESG factors in investment decisions. Commenters also believed that the regulation's documentation provision is unnecessary because fiduciaries commonly document and maintain records about their investment decisions as part of their general prudence obligation. Others believed that removal of the documentation provision brings the tiebreaker standard more in line with prior non-regulatory guidance and may provide additional cost savings, which would ultimately benefit plan participants and beneficiaries. A commenter noted that some fiduciaries, even before the 2020 amendments, may have viewed tiebreaker situations as perhaps requiring enhanced documentation. This commenter requested that the Department provide further clarification regarding prudent recordkeeping if the final rule removes the current regulation's documentation requirement.

The Department is not persuaded that the current regulation's brand new documentation requirement should be retained in the tiebreaker provision. Commenters confirmed the Department's initial concern that the documentation provision in the current regulation is very likely to chill and discourage plan fiduciaries from using the tiebreaker test generally, including in cases involving the appropriate consideration of ESG factors (when such factors are not otherwise relevant to a risk and return analysis). The tiebreaker test, by its terms, applies only where competing investments equally serve the financial interests of the plan. It disallows the investment selection from sacrificing the plan's economic interests or from exposing plans to additional risk. In light of these guardrails, the Department sees no reason for a regulatory provision imposing further burdens on its use. Since the tiebreaker test only applies in cases where the competing investments equally serve the financial interests of the plan, the Department is of the view that use of the tiebreaker test should not be discouraged with additional burdens, because neither of the competing investments sacrifices the economic interests of the plan, but one of them promotes collateral benefits the other does not. In addition, the elaborateness of the current regulation's tiebreaker-specific documentation provision likely will be viewed by fiduciaries as suggesting that the Department sees tiebreakers as occurring infrequently, and the Department did not have in 2020 and does not now have sufficient information to make a judgement as to the frequency of ties. The documentation requirement also may be viewed by fiduciaries as a self-reported “red flag” that uniquely directs potential litigants' attention to tie-breaker decisions as inherently problematic, even though there is no necessary or presumed inconsistency between their use and the requirements of ERISA. The Department is wary that the potential for litigation may cause fiduciaries to consciously or unconsciously skew their investment analyses to avoid open acknowledgment of a “tie” and the requirement of specifically prescribed documentation, while still favoring investments that provide collateral benefits. The Department believes this potentially creates incentives that discourage, rather than promote, proper fiduciary activity and transparency, and further reduces the likelihood that the benefits associated with the additional documentation obligation would outweigh the associated costs.

The Department also agrees with commenters that the current regulation's prescribed documentation provisions are unnecessary given the general obligations of prudence under ERISA. The Department finds it noteworthy that no commenter provided contrary evidence demonstrating that ERISA's general obligations of prudence are deficient in protecting the interests of plan participants and beneficiaries in this context. The Department emphasizes that removal of the documentation provision from the regulation does not suggest that ERISA fiduciaries are excused from complying with ERISA's prudence obligations, or subject to a lower standard of care, with regard to documentation or otherwise. Fiduciary documentation of their investment activities already is a common practice. As explained in the preamble to the NPRM, the Department's concern with the current regulation's document provision rests on its formulaic and rigid nature. The Department believes ERISA section 404's prudence obligation sufficiently protects participants' and beneficiaries' financial interests in their plans in this regard. That obligation, which fiduciaries had prior to the 2020 amendments and will continue to have, provides that the nature and degree of the fiduciary's duty to document an investment decision depends upon the facts and circumstances particular to that decision, regardless of whether the decision is under the tiebreaker test or the type of collateral benefit at issue.

Thus, the Department believes the current regulation's specific documentation provision is not necessary and can lead to conduct contrary to the plan's interests. This includes the risk that fiduciaries will over-document or under-document their investment decisions.

Over-documentation would result in increased transaction costs for no particular benefit to plan participants.

The preamble to Interpretive Bulletin 2015-01, in relevant part, stated that, “the Department does not construe consideration of ETIs or ESG criteria as presumptively requiring additional documentation or evaluation beyond that required by fiduciary standards applicable to plan investments generally. As a general matter, the Department believes that fiduciaries responsible for investing plan assets should maintain records sufficient to demonstrate compliance with ERISA's fiduciary provisions. As with any other investments, the appropriate level of documentation would depend on the facts and circumstances.”

86 FR 57272 at 57279.

(e) Paragraph (c)(2) Tiebreaker Test—Collateral Benefit Disclosure

The NPRM contained a disclosure requirement within the tiebreaker test limited to participant-directed individual account plans. Specifically, paragraph (c)(3) of the NPRM, in relevant part, provided that if a plan fiduciary selects an investment, or investment course of action, based on collateral benefits other than investment returns, “the plan fiduciary must ensure that the collateral-benefit characteristic of the fund, product, or model portfolio is prominently displayed in disclosure materials provided to participants and beneficiaries.” This would have been a new disclosure requirement under ERISA.

The preamble to the NPRM explained the policy intent behind this proposed requirement. In relevant part, the NPRM explained that the “essential purpose of this proposed disclosure requirement is to ensure that plan participants are given sufficient information to be aware of the collateral factor or factors that tipped the scale in favor of adding the investment option to the plan menu, as opposed to its economically equivalent peers that were not.”

The Department thought the disclosure of this information would have been of potential benefit to plan participants and beneficiaries because of the possibility that “a particular plan participant or a population of plan participants does not share the same preference for a given collateral purpose as the plan fiduciary that selected the designated investment alternative for placement on the menu among the plan's other options.”

86 FR 57272, 80.

The preamble to the NPRM also provided an example of an application of this proposed requirement. The example, in relevant part, provided that “if the tiebreaking characteristic of a particular designated investment alternative were that it better aligns with the corporate ethos of the plan sponsor or that it improves the esprit de corps of the workforce, . . . then such feature or features prompting the selection of the investment must be prominently disclosed by the plan fiduciary. . . .” The NPRM believed this information “will be useful to participants and beneficiaries in deciding how to invest their plan accounts.”

Id.

The preamble to the NPRM also clarified that, in terms of compliance, the Department's intent was to provide flexibility in how plan fiduciaries would fulfill this requirement given the unknown spectrum of collateral benefits that might influence a plan fiduciary's selection. The preamble to the NPRM explained that one likely way to comply “is that the plan fiduciary could simply use the required disclosure under 29 CFR 2550.404a-5.”

That regulation, adopted in 2012, already entitles participants in participant-directed individual account plans to receive sufficient information regarding designated investment alternatives to make informed decisions about the management of their individual accounts. The information required by the 2012 rule includes information regarding the alternative's objectives or goals and the alternative's principal strategies (including a general description of the types of assets held by the investment) and principal risks. The NPRM, therefore, assumed these existing disclosures, perhaps with minor modifications or clarifications, would have been sufficient to satisfy the disclosure element of the tiebreaker provision in paragraph (c)(3) of the proposal.

Id.

As is evident from the foregoing discussion, the NPRM assumed appreciable benefits to plan participants and beneficiaries and relatively small compliance costs resulting from this proposed disclosure requirement.

The NPRM solicited comments on the overall utility of this disclosure provision, including ideas on how best to operationalize the provision considering its intended purpose balanced against costs of implementation and compliance.

86 FR 57272 at 57300 (“The Department estimates that it will take a legal professional twenty minutes on average per year to update existing disclosures for each of the 46,551 small individual account plans with participant direction that are anticipated to utilize this provision. This results in a per-plan cost of $46.14 annually relative to the pre-2020 final rule baseline.”).

(1) Support for Disclosure Requirement

The public record reflects limited support for the proposed disclosure requirement. One commenter stated that plan participants and beneficiaries should have information about collateral benefits because such information may impact participant behavior, such as whether to participate, savings rates, and asset allocations. One commenter registered its support for better disclosure to plan participants and of investment policies more generally, inclusive of sustainable investment policies and collateral benefit factors. One commenter believed the proposed requirement would protect participants and beneficiaries by ensuring that plan sponsors fully considered collateral benefits alongside financial performance. One commenter supported the proposed disclosure requirement as “reasonable,” but recommended that the Department provide plan fiduciaries with a model notice to assist compliance with this disclosure requirement. Finally, one commenter conditionally supported the proposed disclosure requirement because the commenter believed it would give plan participants needed transparency in the tiebreaking context. However, this commenter recommended that the proposed requirement, if retained, be improved with additional content requirements, including a requirement that the fiduciary disclose what specific alternative investments were considered in breaking the tie and more analysis behind the fiduciary's decisionmaking process.

(2) Concerns With Disclosure Requirement

The public record also reflects substantial concerns with the proposed disclosure requirement. In summary, these concerns are as follows. Some commenters found the content requirements of proposed disclosure requirement to be inherently ambiguous. Some found the proposed disclosure requirement to be unnecessary and the required content of the disclosure to be of no economic significance. Other commenters were concerned that the proposed disclosure requirement may undermine the purposes of other disclosure regulations promulgated by the Department aimed at helping plan participants and beneficiaries make informed investment decisions. Certain commenters expressed concerns that the proposed disclosure requirement would single out certain factors and strategies over other factors and strategies, contrary to the principle of neutrality they believe is embedded in ERISA. Other commenters were concerned that the proposed disclosure requirement could have a chilling effect on the proper use of climate change and other ESG factors. Several commenters were concerned that the proposed disclosure provision would result in unnecessary litigation. Each of these concerns is explained in detail below.

(a) Ambiguity

Some commenters found the content requirements of the proposed disclosure requirement to be inherently ambiguous. According to them, the NPRM was unclear on what “collateral-benefit characteristics” a fiduciary would be required to disclose. They

contrasted regulatory language requiring the disclosure of the collateral benefit characteristics “of the fund” with preamble language focused on the “features prompting the selection” by the fiduciary and other language referencing “improved employee morale” as the factor that “tipped the scale.” Commenters requested clarification of whether the proposed disclosure requirement was focused on an objective characteristic of the fund or the subjective reason the fiduciary selected the fund. According to the commenters, these are not necessarily the same things. Commenters said the subjective collateral benefit perceived by the plan fiduciary may be wholly different from the characteristic of the fund that would be expected to provide the collateral benefit. For example, assume that the plan sponsor is an organization whose primary mission is to tackle climate change. The plan fiduciary may decide to use the tiebreaker test to select a fund that uses ESG criteria with an environmental focus to improve the morale of its employees. In this example, the commenters stated that the regulatory text and preamble were unclear on what must be disclosed under the proposal—would it be the environmental focus of the fund's strategy or improved employee morale? Most commenters on this issue requested confirmation that the former is what the Department intended, and they asserted flaws with the NPRM's cost-benefit analysis if the latter.

(b) Unnecessary

Some commenters were of the view that the proposed disclosure requirement is unnecessary, and the required content of the disclosure is of no economic significance. The commenters stated that the Department and the Securities and Exchange Commission already have regulations in place to ensure that participants and investors have ready access to necessary investment-related information, such as principal strategies and risks, performance information, benchmarks, and fees. Commenters alleged that the content requirements of the proposed disclosure, by contrast, contained no information about the economics of the investment in question, but instead focused on information that was collateral to the economics of the investment and therefore would have no economic relevance to participant investors. Whether a participant shares the fiduciary's preference for the collateral benefit or purpose that “tipped the scale” is of no relevance to whether the investment option is economically prudent and makes economic sense to a participant. The only thing that should matter to participants, in the view of these commenters, is whether the selected investment was prudently chosen. In their view, disclosures focused on the policy or social preferences of the selecting fiduciaries will not advance intelligent investment behavior and therefore are unnecessary.

Some commenters were concerned the proposed disclosure requirement would undermine the purposes of other disclosure regulations promulgated by the Department aimed at helping plan participants and beneficiaries make informed investment decisions. These commenters pointed to existing disclosures under 29 CFR 2550.404a-5, 2550.404c-1, and 2550.404c-5 as being sufficient to enable plan participants and beneficiaries to make informed investment decisions.

These disclosures, according to the commenters, focus on what the Department has determined, through multiple notice-and-comment rulemaking projects, is the relevant investment-related information that plan participants and beneficiaries need, as investors. The proposed collateral benefit disclosure requirement, by contrast, focused on non-investment information,

i.e.,

the collateral purpose that tipped the scale—information that, by definition, is not material to risk and return. These commenters argued that not only is the proposed collateral benefit disclosure of no economic relevance, but the disclosure risks distracting participants and beneficiaries from basic and important information required under the existing regulations mentioned above. Put differently, one commenter stated that it opposes the proposed disclosure requirement because it would disproportionately emphasize one part of the fiduciary decisionmaking process over other more relevant factors in a way that could mislead participants and impact participant choices in ways that are unintended by the Department.

The disclosure requirements to which these commenters refer include: 29 CFR 2550.404a-5 (requiring disclosure of certain plan administrative and investment-related information, including fee and expense information, to participants and beneficiaries in participant-directed individual account plans (

e.g.,

401(k) plans)); 29 CFR 2550.404c-1 (requiring that participants and beneficiaries in participant-directed individual account plans are furnished specified information about the plan's investment alternatives and incidents of ownership appurtenant to such investment alternatives); and 29 CFR 2550.404c-5 (requiring that participants and beneficiaries whose plan assets may be invested, by default, into a plan's QDIA by a plan fiduciary are furnished specified investment-related information about the QDIA, the circumstances in which plan assets will be invested in a QDIA, and their ability to direct their assets to plan investment alternatives other than a QDIA).

(d) Lack of Neutrality & Chilling Effect

Commenters expressed concerns that the proposed disclosure requirement singles out certain factors over other factors, contrary to the principle of neutrality, while other commenters are concerned that the proposed disclosure requirement might have a chilling effect on the proper use of climate change and other ESG factors. Certain commenters expressed opposition to the idea of singling out any class of investment factor, including collateral benefit factors, as needing additional or stricter requirements. These commenters asserted that ERISA is, and should be, factor neutral, including with respect to collateral purposes or factors. By imposing special disclosure requirements on collateral benefits, the proposed disclosure is contrary to this principle, according to these commenters.

In line with this concern, other commenters were concerned that the proposed disclosure provision could inadvertently have a chilling effect on the proper use of climate change and other ESG factors. These commenters posited that investment strategies often simultaneously integrate multiple ESG factors into the analysis, some of which are relevant to a risk and return assessment while others are not. In these circumstances, commenters asserted that fiduciaries may avoid the investment based on ambiguity over whether it is subject to the disclosure requirement, or over disclose even when the options were selected solely for financial reasons.

(e) Litigation

Multiple commenters raised concerns that the proposed disclosure requirement would effectively act as an invitation to litigation. The very purpose of the disclosure, according to the commenters, is to draw the reader's attention to the non-financial motives of the plan fiduciary. Considering this purpose, commenters said the disclosures themselves unintendedly would serve as a signal of potential wrongdoing and as a roadmap to litigation. To altogether avoid the litigation risk, some plan sponsors and fiduciaries simply would not use the tiebreaker test even in cases when they otherwise might have been willing to use it to promote collateral purposes,

such as addressing climate change, according to commenters.

(f) Per Se Disloyalty

Other commenters raised concerns with the idea that a disclosure violation would constitute a

per se

breach of ERISA's duty of loyalty, which the commenters saw as the necessary consequence of embedding a disclosure requirement within the portion of a regulation defining ERISA's duty of loyalty. They argued that a disclosure failure does not (and should not), by itself, prove disloyalty. But as structured, that seems to be the result under the NPRM regardless of how prudent and loyal the fiduciary is when selecting the investment, the commenters asserted. These commenters observed the unconventionality of the idea that ERISA commands that if fiduciaries fail in whole or in part to disclose their motivations to participants and beneficiaries, those fiduciaries are

per se

disloyal as a result of the failure, regardless of how loyal the fiduciaries were, in fact, when selecting the investment. These commenters assert that it is a non sequitur to say that a failure to disclose the scale-tipping attributes of an investment is dispositive evidence of disloyalty, especially when the investment is prudent and serves the financial interests of the plan equally as well as a reasonable number of alternatives. To this point, the commenters note that some version of the tiebreaker test has existed for approximately forty years without a related disclosure requirement, embedded in loyalty or otherwise—and nothing in the marketplace has changed in a way that supports the new disclosure requirement. The commenters question whether the many plan fiduciaries that used the tiebreaker test in the past would now be considered disloyal because they likely never disclosed to participants the collateral benefits that broke the tie.

(g) Other Technical Concerns

In addition to the foregoing concerns, commenters raised the following technical issues with the proposed disclosure requirement. First, commenters stated that although the NPRM is clear that a collateral benefit disclosure is required only if the fiduciary uses the tiebreaker provision to select a fund, nowhere does the NPRM offer concrete guidance on when or how often the plan fiduciary must furnish this information to participants. For example, commenters requested guidance and clarification on whether a disclosure would be required only when the fund is added to the lineup, only when a participant joins the plan, annually, any time the plan or its service providers furnish any disclosure materials pertaining to the fund, or at some other interval determined solely in the judgment of the plan fiduciary based on facts and circumstances.

Second, the NPRM specifies that the collateral benefit disclosure must be “prominently” displayed in disclosure materials provided to participants. But neither the regulation nor the preamble defines the meaning of prominence for this purpose. Several commenters therefore requested guidance on how to satisfy this standard. One concern is that this standard is being construed as requiring that collateral benefit information receive more attention or prominence than other information that likely will accompany the collateral benefit information, such as investment performance, fees, strategies, risk, etc. The commenters are of the view that collateral benefit information should not be more prominent than relevant investment-related information. These commenters assert that investment success generally turns on an intelligent evaluation of performance, fees, strategies, and risk, and that mandating the elevation of collateral information over such information potentially undermines the chances of an investor's success. According to the commenters, this is particularly important, in part, because the concept of “prominence” is inherently subjective, and in part, because violations of the proposed disclosure rule are per se acts of disloyalty.

(3) Decision

Based on the foregoing concerns, and reasons similar to those underlying the decision to remove the documentation requirements from the current regulation, the final rule does not adopt the proposed collateral benefit disclosure requirement at this time. The Department is aware that the Securities and Exchange Commission (SEC) is conducting rulemaking on investment company names, addressing, among other things, “certain broad categories of investment company names that are likely to mislead investors about an investment company's investments and risks.”

The SEC also is conducting rulemaking on disclosures by mutual funds, other SEC-regulated investment companies, and SEC-regulated investment advisers designed to provide consistent standards for ESG disclosures, allowing investors to make more informed decisions, including as they compare various ESG investments.

The Department will monitor those rulemaking projects and may revisit the need for collateral benefit reporting or disclosure depending on the findings of that agency. The Department emphasizes that the decision against adopting a collateral benefit disclosure requirement in the final rule has no impact on a fiduciary's duty to prudently document the tiebreaking decisions in accordance with section 404 of ERISA.

87 FR 36594 (June 17, 2022).

87 FR 36654 (June 17, 2022).

(f) Paragraph (c)(3)—Participant Preferences

Several commenters requested clarification on whether a plan fiduciary may consider participants' policy, social, or value preferences (

i.e.,

non-financial preferences) in connection with constructing menus for defined contribution plans that permit participants to direct their own investments. Some commenters stated that, in their view, the NPRM is ambiguous on this question. Many other commenters expressed concern that the NPRM appears not to permit plan fiduciaries to consider participants' preferences or to consider them only under the tiebreaker test.

Several of these commenters stressed their view of the importance of accommodating participants' preferences in a voluntary retirement system heavily dependent on elective deferrals. These commenters, including institutional asset managers and asset custodians, assert that both increased participation and increased deferral rates follow from accommodating such preferences. They argue that participants may not use their voluntary participant-directed savings plans to save for retirement, or will leave those plans earlier, if they cannot get access to investment choices they find attractive. Consistent with this argument, many individual commenters claim they would roll their savings out of ERISA-protected plans if the plans cannot satisfactorily accommodate their preferences.

Several commenters alleged that plan fiduciaries should not have to rely solely on the tiebreaker test to consider participants' preferences. These commenters are of the view that the NPRM's tiebreaker test may be ill-suited to some methods of constructing menus for defined contribution plans because adding additional options is not necessarily a zero-sum game under these methods. To these commenters, therefore, if plan fiduciaries are unable to use the tiebreaker test because it does

not comport with how they construct defined contribution menus, they effectively have no ability under their reading of the NPRM to consider participants' preferences.

A few commenters believe that participants' preferences deserve equal treatment with risk and return factors; they believe fiduciaries should be allowed to consider and weigh participants' preferences alongside risk and return factors in a prudence analysis, giving participant's preferences such weight as the fiduciary deems appropriate, even if such preferences are not directly tied to risk or return. By contrast, a few commenters asserted that ERISA requires plan fiduciaries to focus on only pecuniary factors when selecting and retaining investments. They view participants' preferences as essentially irrelevant to menu construction.

In response to these comments, paragraph (c)(3) of the final rule provides clarification on this issue. Specifically, paragraph (c)(3) of the final rule provides that the plan fiduciary of a participant-directed individual account plan does not violate the duty of loyalty set forth in paragraph (c)(1) of the final rule solely because the fiduciary takes into account participants' preferences consistent with requirements of paragraph (b) of this section.

If accommodating participants' preferences will lead to greater participation and higher deferral rates, then it could lead to greater retirement security, as suggested by the commenters. Thus, in this way, giving consideration to whether an investment option aligns with participants' preferences can be relevant to furthering the purposes of the plan within the meaning of paragraph (b)(1) of the final rule. At the same time, however, plan fiduciaries may not add imprudent investment options to menus just because participants request or would prefer them.

See Hughes

Northwestern Univ.,

142 S. Ct. 737 (2022) (“In

Tibble,

this Court explained that, even in a defined-contribution plan where participants choose their investments, plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan's menu of options.” (citing

Tibble

Edison Int'l,

575 U.S. 523 (2015)).

The clarification in paragraph (c)(3) of the final rule does not speak to the duty of prudence. Rather, paragraph (c)(3) provides only that a fiduciary does not violate the duty of loyalty as set forth in paragraph (c)(1) of the final rule solely because the fiduciary considers participants' preferences in a manner that is consistent with paragraph (b) of the final rule. The reference to paragraph (b) in paragraph (c)(3) clarifies that the duty of prudence is independent and, as such, prudence determinations must be made consistent with paragraph (b) of the final rule. As paragraph (b)(4) of the final rule makes clear, the selection of investment options must be grounded in the fiduciary's prudent risk and return analysis.

The clarification in paragraph (c)(3) of the final rule is not novel or a change in Departmental position. The preamble to the current regulation being amended by this final rule articulated this position when explaining the meaning and mechanics of paragraph (d)(2) of that rule (entitled “Investment Alternatives for Participant-Directed Individual Account Plans”). In relevant part, that preamble stated: “Nothing in the final rule precludes a fiduciary from looking into certain types of investment alternatives in light of participant demand for those types of investments. But in deciding whether to include such investment options on a 401(k)-style menu, the fiduciary must weigh only pecuniary . . . factors.”

The relevant portion of paragraph (d)(2) of that rule, however, was incorporated into paragraphs (b) and (c)(1) of the final rule (minus the pecuniary factor terminology). The final rule restates the position as regulatory text in paragraph (c)(3), rather than as a preamble statement, to provide enhanced clarity, accessibility, and prominence, as requested by commenters.

85 FR 72846 at 72863.

The final rule declines to mandate that fiduciaries factor participants' preferences into their evaluation, selection, and retention of designated investment alternatives, and declines to mandate a uniform methodology for determining such preferences, as requested by a few commenters. Some commenters had concerns that a mandate to consider and act on participants' preferences would raise complex questions, such as how plan fiduciaries should properly solicit, weigh, implement, and monitor participants' preferences, and how plan fiduciaries should reconcile conflicting preferences of their participants (

e.g.,

some participants may oppose so-called “sin stocks” and other participants in the same plan may favor them). No commenter had persuasive answers or recommendations on these questions, and the NPRM did not propose such a mandate or suggest how to resolve such competing preferences. In addition, as some commenters noted, ERISA's fiduciary obligations could compel plan fiduciaries to disregard participants' preferences to the extent they are imprudent. Accordingly, the final rule declines to mandate that fiduciaries factor participants' preferences into their evaluation, selection, and retention of designated investment alternatives, and declines to mandate a uniform methodology for determining such preferences; the final rule, instead, leaves these questions to be decided by plan fiduciaries considering the facts and circumstances of their plan and participant population.

3. Investment Alternatives in Participant-Directed Individual Account Plans Including Qualified Default Investment Alternatives

Paragraph (d) of the current regulation contains additional rules that specifically govern fiduciaries' selection and retention of investment alternatives for participant-directed individual account plans, including qualified default investment alternatives (QDIAs). The NPRM proposes to directly rescind this paragraph. The NPRM's justification for the rescission has two dimensions. First, proposed amendments to other provisions in the section effectively merged the substance of what was paragraph (d) into these other provisions. Second, the Department no longer supports the current regulation's provisions specific to QDIAs. As structured, paragraph (d)(2)(ii) of the current regulation disallows a fund to serve as a QDIA if it, or any of its component funds in a fund-of-fund structure, has investment objectives, goals, or principal investment strategies that include, consider, or indicate the use of one or more non-pecuniary factors in its investment objectives, even if the fund is objectively economically prudent from a risk-return perspective or even best in class.

Commenters overwhelmingly supported the NPRM. A few commenters raised technical concerns regarding compliance problems and costs with paragraph (d) of the current regulation. But more globally, and fundamentally, most commenters on this issue were of the view that the provisions in paragraph (d) of the current regulation are unnecessary. This view is based, in part, on the strongly held belief, shared among a broad spectrum of commenters from various backgrounds and industries, that the legal standards under ERISA's prudence and loyalty rules should be the same for all plans, including plans with QDIAs, with respect to the selection and retention of investment alternatives.

How these standards apply to a given set of facts may, of course, differ, according to the commenters, but the base standards of prudence and loyalty should be no different for these plans, absent a statutory underpinning for a difference. Yet the current regulation, according to these commenters, unnecessarily singles out individual account plans for what the commenters view as different, special, and stricter treatment (

e.g.,

some higher level of fiduciary oversight). This special treatment is especially extreme with respect to QDIAs, according to the commenters, with some commenters equating the provisions in paragraph (d)(2)(ii) of the current regulation to an effective ban on selecting investments that consider or integrate climate change and other ESG factors, regardless of the economic merits and prudence of the investment. Many commenters disagreed that QDIAs need heightened protections beyond those specifically contained in the Department's Qualified Default Investment Alternative regulation.

Overall, these commenters agree that the provisions of paragraph (d) of the current regulation create a perception that fiduciaries of individual account plans, including plans with QDIAs, are subject to different and heightened—but unclear—standards of prudence and loyalty as compared to fiduciaries of other plans. And the primary consequence of this perception, according to the commenters, was a concern that funds may be

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