The Department of Labor (DOL) has issued a final rule to revise its existing rule regarding financial factors in selecting plan investments. We discussed the proposed rule in an earlier article, and this article provides a roadmap for fiduciaries on the final rule along with a general discussion of the core concepts under the final rule and some of the key departures from the proposed rule.
Roadmap for Fiduciaries on the Final Rule
Fiduciaries should follow these steps for selecting investments in an employee benefit plan under the final rule:
- Give “appropriate consideration” to the facts and circumstances relevant to the particular investment or investment course of action involved, including the role the investment or investment course of action plays in the plan’s investment portfolio.
- “Appropriate consideration” generally requires a determination that the particular investment or investment course of action is reasonably designed to further the purposes of the plan taking into account the following with respect to similar available alternatives:
- The risk of loss and the opportunity for gain;
- The composition of the plan’s portfolio with regard to diversification;
- The liquidity and current return of the plan’s portfolio relative to the anticipated cash flow requirements of the plan; and
- The projected return of the plan’s portfolio relative to the funding objectives of the plan.
- If the comparison indicates that an investment alternative has superior pecuniary factors, select such investment.
- If the fiduciary is unable to distinguish between investment alternatives based on pecuniary factors alone:
- Document why pecuniary factors were not sufficient to select the investment or investment course of action;
- Document how the selected investment compares to the alternative investments considering the composition of the portfolio regarding diversification, liquidity and current return of the portfolio relative to the anticipated cashflow requirements of the plan, and the projected return of the portfolio relative to the funding objectives of the plan; and
- Document how the chosen non-pecuniary factor or factors are consistent with the interests of participants and beneficiaries in their retirement income or financial benefits under the plan.
- Select the investment with the superior non-pecuniary factors.
- Do not select any investment as the plan’s qualified default investment alternative (QDIA) based on non-pecuniary factors.
General Discussion of the Final Rule
The final rule makes some key changes to the proposed rule based on public comments received by the DOL. Most importantly, the final rule does not focus on or even refer to economic, social, or governance (ESG) investments. Instead, the final rule refers only to pecuniary factors and non-pecuniary factors in defining the relevant fiduciary investment duties. In addition to this broadened focus, the final rule does the following:
- Duty of Loyalty: The final rule retains the general restatement of the duty of loyalty under section 404(a)(1)(A) of the Employee Retirement Income Security Act (ERISA) but does not include the additions to the safe harbor for meeting the duty of prudence that had been stated in the proposed rule.
- Pecuniary/Non-Pecuniary: As in the proposed rule, the final rule makes it clear that ERISA fiduciaries must evaluate investments and investment courses of action based solely on “pecuniary factors,” which are factors that the responsible fiduciary prudently determines are expected to have a material effect on risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy. The final rule prohibits fiduciaries from subordinating the interests of participants to unrelated objectives and bars them from sacrificing investment return or taking on additional investment risk to promote non-pecuniary goals.
- Tie-Breaker Rule: The final rule retains the “tie-breaker” rule with some modifications. Under the tie-breaker rule, fiduciaries may consider non-pecuniary factors to select investments, but only when the pecuniary factors for the investments are indistinguishable. In response to comments, the final rule provides what the DOL considers a more workable process for fiduciaries to apply the tie-breaker rule by documenting the steps taken to apply the rule. According to the DOL, the documentation requirements are intended to prevent fiduciaries making investment decisions based on non-pecuniary benefits without appropriately careful analysis and evaluation. Notwithstanding this more user-friendly process, the DOL continues to encourage fiduciaries to break ties using their best judgment on the basis of pecuniary factors alone.
- Investments for Individual Account Plans: The final rule provides that the same prudence and loyalty standards apply to a fiduciary’s selection of a designated investment alternative to be offered to plan participants and beneficiaries in an individual account plan (e.g., most 401(k) plans and 403(b) plans). Thus, fiduciaries must hold investments in individual account plans to the same level of scrutiny, even though the ultimate investment decision will be made by the participant or beneficiary.
- No Non-Pecuniary Factors for QDIAs: The final rule categorically prohibits fiduciaries from selecting an investment with non-pecuniary goals as a QDIA. Specifically, the final rule prohibits fiduciaries from adding or retaining any investment fund, product, or model portfolio as a QDIA, or as a component of the QDIA, if its objectives or goals or its principal investment strategies include, consider, or indicate the use of one or more non-pecuniary factors.
- No Requirement to “Scour the Marketplace”: The final rule removes a provision in the proposed rule that explicitly required fiduciaries to consider reasonably available alternatives to meet their prudence duties under ERISA. The DOL stated that the provision was removed based on comments expressing concerns that fiduciaries would have to “scour the marketplace” or look at an infinite number of possible alternatives as part of their evaluation.
The final rule is effective 60 days after the date of publication in the Federal Register and applies prospectively in its entirety to investments made and investment courses of action taken after that date. However, the final rule allows plans until April 30, 2022, to make any changes that are necessary to comply with the requirements related to the selection of a QDIA.
If you have any questions about the final rule, please contact one of the attorneys in the Employee Benefits and Executive Compensation Practice Group at Bradley.