On 30 October 2020, the Department of Labor (DOL) released its final rule “Financial Factors in Selecting Plan Investments” (Final Rule).1 Although the proposed rule aimed to regulate environmental, social, and corporate governance (ESG) investing by employee benefit plans subject to the Employee Retirement Income Security Act (ERISA),2 in the Final Rule, DOL rejected the ESG nomenclature as too unclear.3 The text of the Final Rule removes all ESG terminology, focusing instead on whether a factor is “pecuniary.”4 While this change may remove some perceived stigma for plan fiduciaries in considering ESG factors when selecting plan investments, the difference in terminology has not changed the underlying requirement that the plan fiduciary focus only on factors that make a financial impact.
Under the Final Rule, plan fiduciaries are not permitted to sacrifice investment return or take on additional investment risk to promote non-pecuniary benefits or any other non-pecuniary goals, and may not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives. Instead, a fiduciary’s evaluation of an investment or investment course of action must be based only on pecuniary factors. The weight given to any pecuniary factor by a fiduciary should appropriately reflect a prudent assessment of its impact on risk-return.5
The Final Rule defines a “pecuniary” factor to mean “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 established pursuant to section 402(b)(1) of ERISA.”6
One exception where plan fiduciary can use non-pecuniary factors remains the “tie-breaking” scenario. In the Final Rule, DOL simplified the tie-breaker test to focus on situations in which the fiduciary is unable to distinguish investment alternatives on the basis of pecuniary factors alone. In this case, the fiduciary may use non-pecuniary factors as the deciding factor.7 Addressing a concern expressed by investment managers, DOL confirmed in the Final Rule that investments are not required to be identical in each and every respect before the tie-breaker provisions become available. However, to consider non-pecuniary factors as tie-breakers, a plan fiduciary must document:
- why pecuniary factors were not sufficient to select the investment;
- how the selected investment compares to the alternative investments; and
- 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.
DOL indicated that it requires this documentation to “safeguard against the risk that fiduciaries will improperly find economic equivalence and make decisions based on non-pecuniary factors without a proper analysis and evaluation.”8 Based on its statements in the preamble to the Final Rule, DOL remains skeptical about whether investment options can ever be true “ties” based on the consideration of pecuniary factors alone.9
Changes from Proposed Rule
The Final Rule contains some changes from the proposed rule. The most relevant differences between the proposed rule and the Final Rule, and their key impacts are set out in our chart.
Product Manufacturers. While some investment products, such as mutual funds and exchange-traded funds, are not subject to ERISA, all product manufacturers should consider ERISA principles, including the Final Rule, if the investment product will be marketed to ERISA investors. If a mutual fund or exchange-traded fund integrates ESG factors into the investment process for non-financial reasons or discloses that investment…