# Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2022-25783 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** December 1, 2022 - **Citation:** 87 FR 73822 ## Text 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. 1 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. 2 1 29 U.S.C. 1104. 2 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. 3 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. 4 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. 5 Subsection B of this background section provides a complete overview of the Department's prior non-regulatory guidance. 3 See Interpretive Bulletin 2015-01, 80 FR 65135 (Oct. 26, 2015). 4 See, e.g., id. 5 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. 6 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. 7 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. 6 See 85 FR 39113 (June 30, 2020); 85 FR 55219 (Sept. 4, 2020). 7 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.” 8 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. 9 8 85 FR 72846 (Nov. 13, 2020). 9 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.” 10 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. 11 10 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.” 11 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. 12 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. 13 12 29 U.S.C. 1135. 13 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.” 14 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,” 15 and “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.” 16 14 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.” 15 85 FR 72846 (Nov. 13, 2020). 16 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. 17 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. 17 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. 18 The Department's objective in issuing IB 94-1 was to state that ETIs 19 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. 18 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”). 19 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), 20 and then, in 2015, the Department replaced IB 2008-01 with Interpretive Bulletin 2015-01 (IB 2015-01). 21 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. 20 73 FR 61734 (Oct. 17, 2008). 21 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.” 22 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.” 23 22 FAB 2018-01 (Apr. 23, 2018). 23 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. 24 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. 25 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. 24 Id. 25 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. 26 In 1994, the Department issued its first interpretive bulletin on proxy voting, Interpretive Bulletin 94-2 (IB 94-2). 27 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. 26 Letter to Helmuth Fandl, Chairman of the Retirement Board, Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988). 27 59 FR 38860 (July 29, 1994). In October 2008, the Department replaced IB 94-2 with Interpretive Bulletin 2008-02 (IB 2008-02). 28 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. 29 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. 30 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. 31 28 73 FR 61731 (Oct. 17, 2008). 29 73 FR 61732. 30 Id. 31 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. 32 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.” 33 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. 34 32 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. 33 81 FR 95882. 34 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. 35 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. 36 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. 37 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. 38 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. 39 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. 35 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. 36 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”). 37 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.”). 38 85 FR 72848, 72859 (Nov. 13, 2020). 39 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. 40 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. 40 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 v. Howe, 41 as these other duties generally are beyond the scope of this rulemaking initiative. 41 516 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. (c) Paragraph (b)(1) 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. 42 42 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. 43 43 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.” 44 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. 44 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 v. Dudenhoeffer, which stressed the fiduciary's obligation to focus on retirement plan participants' financial interests. 45 45 Fifth Third Bancorp v. 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, 46 that same function is fulfilled by incorporating it into the final regulation's prudence provisions at paragraph (b)(4) of the final rule. 46 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. (c) Paragraph (c)(2)—Tie Breaker Test and Tie Breaker Standard 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.” 47 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. 47 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. 48 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. 48 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. 49 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. 49 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. 50 50 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 participan [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2022-25783. Public record. Not legal advice.