DOL’s New Rule Restricts Non-Financial (ESG) Factor Investment Consideration

The Department of Labor recently issued its final rule to clarify investment duties for plan fiduciaries under the Employee Retirement Income Security Act of 1974 (ERISA) when it comes to environmental, social, and governance (ESG) investing.

The final rule codifies the DOL’s long-held position that a fiduciary satisfies its duties of prudence and loyalty under ERISA when it has “selected investments and/or investment courses of action based solely on their pecuniary factors and not on the basis of any non-pecuniary factor.” 

It also acknowledges that non-financial (ESG) factors can be pecuniary, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories.

The final rule clarifies the investment duties regulation under Title I of ERISA as follows:

Fiduciaries must evaluate investments based only on pecuniary factors.

The final rule adds provisions to confirm that ERISA fiduciaries must evaluate investments and investment courses of action based solely on pecuniary factors—financial considerations that have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and funding policy. The term “investment course of action” is defined as “any series or program of investments or actions related to a fiduciary’s performance of the fiduciary’s investment duties, and includes the selection of an investment fund as a plan investment, or in the case of an individual account plan, a designated investment alternative under the plan.” 

In addition, the final rule includes an express regulatory provision stating that compliance with the exclusive purpose (loyalty) duty in ERISA section 404(a)(1)(A) prohibits fiduciaries from subordinating the interests of participants to unrelated objectives, and additionally it bars them from sacrificing investment return or taking on additional investment risk to promote non-pecuniary goals. 

Reasonable alternatives.

A fiduciary may only consider non-pecuniary factors in situations where the fiduciary cannot distinguish investment alternatives on a pecuniary basis alone. If this occurs, the fiduciary is permitted to use non-pecuniary factors in making a decision. While the final rule states that investments need not be identical in every respect before non-pecuniary factors are considered, a fiduciary must document the following when considering non-pecuniary factors:

  • Why pecuniary factors were insufficient to select the investment;
  • How the selected investment compares to alternatives; and
  • How the non-pecuniary factor(s) are consistent with the interests of participants and beneficiaries and their financial benefits under the plan.

Investment alternatives and QDIAs

The final rule states that the prudence and loyalty standards set forth in ERISA apply to a fiduciary’s selection of designated investment alternatives to be offered to plan participants and beneficiaries in a participant-directed individual account plan. The final rule expressly provides that, in the case of selecting investment alternatives for an individual account plan that allows plan participants and beneficiaries to choose from a broad range of investment alternatives, a fiduciary is not prohibited from considering or including an investment fund, product, or model portfolio merely because the fund, product, or model portfolio promotes, seeks, or supports one or more non-pecuniary goals, provided that the fiduciary satisfies the prudence and loyalty provisions in ERISA and the final rule, including the requirement to evaluate solely on pecuniary factors, in selecting any such investment fund, product, or model portfolio. 

However, the provision prohibits plans from adding any investment fund, product, or model portfolio as a qualified default investment alternative (QDIA) or as a component of such an investment alternative, if the fund, product, or model portfolio’s investment objectives or goals or its principal investment strategies include, consider, or indicate the use of one or more non-pecuniary factors.

Safe harbor

Under the final rule, a fiduciary will be considered to have met its duty of prudence under ERISA when the fiduciary gives “appropriate consideration” to the facts and circumstances the fiduciary knows or should know are relevant to the investment, including the role of the investment in the plan’s portfolio, and acts accordingly.

We help our clients stay on top of the legislative and regulatory changes that apply to their businesses, and we ensure that benefit plans and processes are updated to stay in compliance. To learn more, call our experienced, responsive team of ERISA attorneys today at 678-439-6236.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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