Proposed Rule2021-22263
Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
October 14, 2021
Issuing agencies
Labor DepartmentEmployee Benefits Security Administration
Abstract
The Department of Labor (Department) in this document proposes amendments to the Investment Duties regulation under Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA), to 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.
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[Federal Register Volume 86, Number 196 (Thursday, October 14, 2021)]
[Proposed Rules]
[Pages 57272-57304]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2021-22263]
[[Page 57271]]
Vol. 86
Thursday,
No. 196
October 14, 2021
Part II
Department of Labor
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Employee Benefits Security Administration
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29 CFR Part 2550
Prudence and Loyalty in Selecting Plan Investments and Exercising
Shareholder Rights; Proposed Rule
Federal Register / Vol. 86, No. 196 / Thursday, October 14, 2021 /
Proposed Rules
[[Page 57272]]
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AC03
Prudence and Loyalty in Selecting Plan Investments and Exercising
Shareholder Rights
AGENCY: Employee Benefits Security Administration, Department of Labor.
ACTION: Proposed rule.
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SUMMARY: The Department of Labor (Department) in this document proposes
amendments to the Investment Duties regulation under Title I of the
Employee Retirement Income Security Act of 1974, as amended (ERISA), to
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.
DATES: Comments on the proposal must be submitted on or before December
13, 2021.
ADDRESSES: You may submit written comments, identified by RIN 1210-AC03
to either of the following addresses:
[ssquf] Federal eRulemaking Portal: <a href="http://www.regulations.gov">www.regulations.gov</a>. Follow the
instructions for submitting comments.
[ssquf] Mail: Office of Regulations and Interpretations, Employee
Benefits Security Administration, Room N-5655, U.S. Department of
Labor, 200 Constitution Avenue NW, Washington, DC 20210, Attention:
Prudence and Loyalty in Selecting Plan Investments and Exercising
Shareholder Rights.
Instructions: All submissions received must include the agency name
and Regulatory Identifier Number (RIN) for this rulemaking. Persons
submitting comments electronically are encouraged not to submit paper
copies. Comments will be available to the public, without charge,
online at <a href="http://www.regulations.gov">www.regulations.gov</a> and <a href="http://www.dol.gov/agencies/ebsa">www.dol.gov/agencies/ebsa</a> and at the
Public Disclosure Room, Employee Benefits Security Administration,
Suite N-1513, 200 Constitution Avenue NW, Washington, DC 20210.
Warning: Do not include any personally identifiable or confidential
business information that you do not want publicly disclosed. Comments
are public records posted on the internet as received and can be
retrieved by most internet search engines.
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 (<a href="http://www.dol.gov/ebsa">www.dol.gov/ebsa</a>).
SUPPLEMENTARY INFORMATION:
A. Background and Purpose of Regulatory Action
1. 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\
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\1\ 29 U.S.C. 1104.
\2\ 29 U.S.C. 1103(c) and 1104(a).
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For many years, the Department's non-regulatory guidance has
recognized that, under the appropriate circumstances, ERISA fiduciaries
can make investment decisions that reflect climate change and other
environmental, social, or governance (``ESG'') considerations,
including climate-related financial risk, and choose economically
targeted investments (``ETIs'') selected, in part, for benefits apart
from the investment return.\3\ 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.\4\
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\3\ See, e.g., Interpretive Bulletin 2015-01, 80 FR 65135 (Oct.
26, 2015).
\4\ See, e.g., Interpretive Bulletin 2016-01, 81 FR 95879 (Dec.
29, 2016).
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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
under Title I of ERISA at 29 CFR 2550.404a-1 (hereinafter ``current
regulation'' or ``Investment Duties regulation,'' unless otherwise
stated). The stated 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. See 85 FR
39113 (June 30, 2020); 85 FR 55219 (Sept. 4, 2020). 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. See 85 FR 39116; 85 FR 55221.
On November 13, 2020, the Department published a final rule titled
``Financial Factors in Selecting Plan Investments,'' 85 FR 72846 (Nov.
13, 2020), 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.'' The current regulation also contains 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 reflects non-pecuniary objectives 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,'' 85 FR 81658 (December
16, 2020), 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.
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,''
[[Page 57273]]
86 FR 7037 (Jan. 25, 2021). 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.\5\
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\5\ 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'' (<a href="https://www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/fact-sheet-list-of-agency-actions-for-review/">https://www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/fact-sheet-list-of-agency-actions-for-review/</a>).
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On March 10, 2021, the Department announced that it had begun a
reexamination of the current regulation, consistent with E.O. 13990 and
the Administrative Procedure Act. 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 Qualified
Default Investment Alternative, or investment course of action or with
respect to 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, while continuing to
uphold fundamental fiduciary obligations. 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).\6\
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\6\ Available at <a href="http://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">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</a>.
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On May 20, 2021, the President signed Executive Order 14030 (E.O.
14030), titled ``Executive Order on Climate-Related Financial Risk,''
86 FR 27967 (May 25, 2021). 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,'' 85 FR 72846 (Nov. 13, 2020), and ``Fiduciary Duties
Regarding Proxy Voting and Shareholder Rights,'' 85 FR 81658 (Dec. 16,
2020).
2. 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.\7\ 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 in these areas.
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\7\ 29 U.S.C. 1104(a).
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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.\8\ The Department's objective in issuing IB 94-1 was to state
that ETIs \9\ 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 ``tie-breaker''
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.
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\8\ 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'').
\9\ 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.
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In 2008, the Department replaced IB 94-1 with Interpretive Bulletin
2008-01 (IB 2008-01),\10\ and then, in 2015, the Department replaced IB
2008-01 with Interpretive Bulletin 2015-01 (IB 2015-01).\11\ Although
the Interpretive Bulletins differed 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
[[Page 57274]]
ERISA if they accept reduced expected returns or greater risks to
secure social, environmental, or other policy goals.
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\10\ 73 FR 61734 (Oct. 17, 2008).
\11\ 80 FR 65135 (Oct. 26, 2015).
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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 ``tie-breakers,'' 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.'' \12\ 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.'' \13\
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\12\ FAB 2018-01.
\13\ Id.
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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.\14\
According to the FAB, however, the selection of an investment fund as a
qualified default investment alternative (QDIA) \15\ 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.\16\ In
addition the field assistance bulletin 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.
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\14\ Id.
\15\ 29 CFR 2550.404c-5.
\16\ FAB 2018-01.
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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.\17\ In 1994, the Department issued its first interpretive
bulletin on proxy voting, Interpretive Bulletin 94-2 (IB 94-2).\18\ 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.
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\17\ Letter to Helmuth Fandl, Chairman of the Retirement Board,
Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988). Only a few
commenters on the proposal mentioned the Avon Letter, either
supporting the views taken in the letter as being consistent with
other professional codes of ethics or asserting that the proposed
rule reversed the intent of the Avon Letter by establishing a
presumption that voting proxies is a cost to be minimized and not an
asset to be prudently managed.
\18\ 59 FR 38860 (July 29, 1994).
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In October 2008, the Department replaced IB 94-2 with Interpretive
Bulletin 2008-02 (IB 2008-02).\19\ 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.\20\ 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
[[Page 57275]]
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.\21\ 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.\22\
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\19\ 73 FR 61731 (Oct. 17, 2008).
\20\ 73 FR 61732.
\21\ Id.
\22\ 73 FR 61734.
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In 2016, the Department issued Interpretive Bulletin 2016-01 (IB
2016-01), which reinstated the language of IB 94-2 with certain
modifications.\23\ 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.'' \24\ 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 myriad personal public policy preferences at the expense of
participants' economic interests, including through shareholder
engagement activities, voting proxies, or other investment
policies.\25\
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\23\ 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 <a href="http://www.dol.gov/sites/dolgov/files/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2018-01.pdf">www.dol.gov/sites/dolgov/files/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2018-01.pdf</a>.
\24\ 81 FR 95882.
\25\ See 81 FR 95881.
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3. Review of Current Regulation--the 2020 Final Rules
As noted above, 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 surrounding 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
has 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, has already had a chilling effect on appropriate
integration of climate change and other ESG factors in investment
decisions, which has continued through the current non-enforcement
period, including in circumstances that the current regulation may in
fact allow.
After conducting a further review of the current regulation, the
Department believes there is a reasonable basis for these concerns. A
number of public comment letters 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.\26\ In
response, the Department did not include explicit references to ESG in
the final 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.\27\ 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
decision-making.\28\ 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.\29\ 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.\30\ Many stakeholders have
indicated that the rules have been interpreted as putting a thumb on
the scale against the consideration of ESG factors, even when those
factors are financially material.
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\26\ See, e.g., Comment #567 at <a href="https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00567.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00567.pdf</a> and Comment #709 at <a href="https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00709.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00709.pdf</a>.
\27\ 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'').
\28\ 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.'')
\29\ 85 FR 72848, 72859 (Nov. 13, 2020).
\30\ 85 FR 81681 (Dec. 16, 2020).
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The Department is concerned that, as stakeholders warned,
uncertainty with respect to the current regulation may deter
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 often associated with climate change and other ESG factors.
The Department is concerned that the current regulation has created a
perception that fiduciaries are at risk if they include any ESG factors
in the financial evaluation of
[[Page 57276]]
plan investments, and that they may need to have special justifications
for even ordinary exercises of shareholder rights. The amendments
proposed in this document are intended 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 proxy voting
decisions, and to provide further clarity that will help safeguard the
interests of participants and beneficiaries in the plan benefits.
Accordingly, the proposal makes clear that climate change and other ESG
factors are often material and that in many instances fiduciaries to
should consider climate change and other ESG factors in the assessment
of investment risks and returns. This is discussed further below in the
Provisions of the Proposed Rule.
The Department believes that the changes proposed will improve the
current regulation and further promote retirement income security and
further retirement savings. Details on the estimated costs and benefits
of this proposed rule can be found in the proposal's economic analysis.
B. Provisions of the Proposed Rule
The proposed rule would amend the ``Investment Duties'' regulation
at 29 CFR 2550.404a-1. Although the changes to the regulation, as
described below, are limited, the entire regulation is being
republished in this proposal.
Paragraph (a) of the proposed rule includes a restatement of the
statutory language of the exclusive purpose requirements of ERISA
section 404(a)(1)(A), and the prudence duty of ERISA section
404(a)(1)(B).
1. Investment Prudence Duties
Paragraph (b) of the proposal addresses the duty of prudence under
ERISA section 404(a)(1)(B). It provides a safe harbor for prudent
investment and investment courses of action.\31\ The Department
proposes to change the title of the paragraph from ``Investment
duties'' to ``Investment prudence duties'' to more precisely reflect
the scope of the paragraph. Like the current regulation, paragraph
(b)(1) of the proposed rule provides, as a safe harbor, 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 (i) has given 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 or investment course of
action involved, 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 (ii) has
acted accordingly.
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\31\ 85 FR at 72853 (Nov. 13, 2020); see also 44 FR 37222 (June
26, 1979).
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Paragraph (b)(2) of the proposal provides that for purposes of
paragraph (b)(1), ``appropriate consideration'' shall include, but is
not necessarily limited to (i) 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, 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, and (ii)
consideration of the composition of the portfolio with regard to
diversification, the liquidity and current return of the portfolio
relative to the anticipated cash flow requirements of the plan, and the
projected return of the portfolio relative to the funding objectives of
the plan as those factors relate to such portion of the portfolio.
The Department proposes additional language in paragraph
(b)(2)(ii)(C) specifying 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 ESG factors on the particular investment or investment course of
action. Similar to paragraph (b)(4) of the proposal, this provision is
intended to counteract negative perception of the use of climate change
and other ESG factors in investment decisions caused by the 2020 Rules,
and to clarify that a fiduciary's duty of prudence may often require an
evaluation of the effect of climate change and/or government policy
changes to address climate change on investments' risks and returns.
While the additional text in paragraph (b)(2)(ii)(C) is new, its
substance is not. The Department has long acknowledged the materiality
of ESG, including climate-related financial risk, in fiduciaries'
investment decision-making and portfolio construction. In Interpretive
Bulletin 2015-01, the Department recognized there could be instances
when ESG issues present material business risk or opportunities,
stating that ``environmental, social, and governance issues may have a
direct relationship to the economic value of the plan's investment. In
these instances, such issues are not merely collateral considerations
or tie-breakers, but rather are proper components of the fiduciary's
primary analysis of the economic merits of competing investment
choices.'' \32\ In Field Assistance Bulletin 2018-01, the Department
stated that IB 2015-01 recognized that ESG issues could present
material business risk or opportunities to companies, and that a
prudent fiduciary should consider such issues when evaluating the risk
and return profiles of investment opportunities.\33\ As additional
evidence on the materiality of climate change in particular has emerged
in the intervening years, the Department believes that consideration of
the projected return of the portfolio relative to the funding
objectives of the plan not only allows but in many instances may
require an evaluation of the economic effects of climate change on the
particular investment or investment course of action.
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\32\ 80 FR 65135 (Oct. 26, 2015).
\33\ FAB 2018-01, acknowledging that the Department recognized
that ``there could be instances when otherwise collateral 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 as economic considerations under generally accepted
investment theories. In such situations, these ordinarily collateral
issues are themselves appropriate economic considerations, and thus
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 more than mere tie-breakers. To 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.''
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For example, climate change is already imposing significant
economic consequences on a wide variety of businesses as more extreme
weather damages physical assets, disrupts productivity and supply
chains, and forces adjustments to operations. Climate change is
particularly pertinent to the projected returns of pension plan
portfolios that, because of the nature of their obligations to their
participants and beneficiaries, typically have long-term investment
horizons. The effects of climate change such as sea level rise,
changing rainfall patterns, and more severe droughts, wildfires, and
flooding are expected to continue to pose a threat
[[Page 57277]]
to investments far into the future. Additionally, imminent or proposed
regulations, for example, to reduce greenhouse gas emissions in the
power sector, and other policies incentivizing a shift from carbon-
intensive investments to low-carbon investments, could significantly
lower the value of carbon-intensive investments while raising the value
of other investments. This could create a potentially serious risk for
plan participants and beneficiaries. Taking climate change into
account, such as by assessing the financial risks of investments for
which government climate policies will affect performance and account
for the risk of companies that are unprepared for the transition, can
have a beneficial effect on portfolios by reducing volatility and
mitigating the longer-term economic risks to plans' assets. While it is
not always the case, a growing body of evidence suggests a generally
positive relationship between the financial performance of investments
that address or account for climate change.\34\
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\34\ Tensie Whelan, Ulrich Atz, Tracy Van Holt, and Casey Clark,
``ESG and Financial Performance: Uncovering the Relationship by
Aggregating Evidence from 1,000 Plus Studies Published Between 2015-
2020,'' NYU Stern Center for Sustainable Business and Rockefeller
Asset Management (2021). Page 9 notes that, when assessing 59
climate change, or low carbon, studies related to financial
performance, the majority found a positive result. <a href="https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf">https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf</a>.
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Additional language in paragraph (b)(2)(i) requires consideration
of how an investment or investment course of action compares to
reasonably available alternative investments or investment courses of
action. This additional language in paragraph (b)(2)(i) of the
proposal, which is being carried forward from the current regulation,
reflects the Department's view, articulated in Interpretive Bulletin
94-1 (as well as subsequent Interpretive Bulletins) as well as 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.\35\ This provision is a statement of general
applicability and is not unique to the use of ESG factors in selecting
investments. As such, the Department expects that the provision should
be commonly understood by plan fiduciaries and uncontroversial in
nature. Comments are solicited on whether it is necessary to restate
this principle of general applicability as part of this prudence safe
harbor.
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\35\ 59 FR at 32607 (``Other facts and circumstances relevant to
an investment or investment course of action would, in the view of
the Department, include consideration of the expected return on
alternative investments with similar risks available to the plan'');
see, e.g., 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.'').
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Paragraph (b)(3) of the proposal carries forward, without change,
regulatory language dating back to the 1979 Investment Duties
regulation, 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.
Paragraph (b)(4) is a new provision that addresses uncertainty
under the current regulation as to whether a fiduciary may consider
climate change and other ESG factors in making plan-related decisions
under ERISA. This paragraph clarifies and confirms that a fiduciary may
consider any factor material to the risk-return analysis, including
climate change and other ESG factors. The intent of this new paragraph
is to establish that material climate change and other ESG factors are
no different than other ``traditional'' material risk-return factors,
and to remove any prejudice to the contrary. Thus, under ERISA, if a
fiduciary prudently concludes that a climate change or other ESG factor
is material to an investment or investment course of action under
consideration, the fiduciary can and should consider it and act
accordingly, as would be the case with respect to any material risk-
return factor. For the sake of clarity and to eliminate any doubt
caused by the current regulation, paragraph (b)(4) of the proposal
provides examples of factors, including climate change and other ESG
factors, that a fiduciary may consider in the evaluation of an
investment or investment course of action if material, including: (i)
Climate change-related factors, such as a corporation's exposure to the
real and potential economic effects of climate change, including its
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; (ii) governance factors, such as those
involving board composition, executive compensation, and transparency
and accountability in corporate decision-making, as well as a
corporation's avoidance of criminal liability and compliance with
labor, employment, environmental, tax, and other applicable laws and
regulations; and (iii) workforce practices, including the corporation's
progress on workforce diversity, inclusion, and other drivers of
employee hiring, promotion, and retention; its investment in training
to develop its workforce's skill; equal employment opportunity; and
labor relations. Paragraph (b)(4) of the proposal would not introduce
any new conditions under the prudence safe harbor in paragraph (b); its
sole purpose is to provide clarification through examples.
In the Department's view, and consistent with the comments of the
concerned stakeholders mentioned above, the examples in paragraph
(b)(4) of the proposal should eliminate unwarranted concerns about
investing in climate change or ESG funds that are economically
advantageous. If left unchanged, the rule could expose plans'
investments and portfolios to avoidable climate-change-related risks
which negatively impact performance, particularly over longer time
horizons. The examples also reflect prior non-regulatory guidance on
proxy voting, and include some examples which Interpretive Bulletin
2016-01 had previously indicated may be proper matters for fiduciary
shareholder engagement activity.\36\ To the extent such matters are
appropriate for fiduciaries to consider when exercising shareholder
rights with respect to existing plan investments, they would also be
generally appropriate for fiduciaries to consider when making
investments in the first place. The list of examples in paragraph
(b)(4) of the proposal is not exclusive and the Department solicits
comments on whether other or fewer examples would be helpful to avoid
regulatory bias.
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\36\ IB 2016-01, 81 FR 95879 (Dec. 29, 2016). See also IB 2015-
01 (recognizing that ESG factors may be relevant economic factors
considered, along with other relevant economic factors, in a prudent
evaluation of alternative investments). The Department reaffirmed
this view in FAB 2018-01.
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2. Investment Loyalty Duties
Paragraph (c) of the proposal and current regulation both address
application of the duty of loyalty under ERISA. The proposal, however,
differs in several respects from the current regulation. First, the
standard applicable to a fiduciary's evaluation of an investment or
investment course of
[[Page 57278]]
action set forth in the proposal, by cross reference to paragraph
(b)(4), includes clear text to indicate that ESG considerations,
including climate-related financial risk, are, in appropriate cases,
risk-return factors that fiduciaries should take into account when
selecting and monitoring plan investments and investment courses of
action.
Also, the proposal continues to include a ``tie-breaker'' standard,
with the proposal more closely aligning with the Department's original
non-regulatory guidance in this area, and eliminates the current
regulation's specific documentation requirements, which singled out and
created burdens specifically for investments providing collateral
benefits, which many perceived as targeting ESG investing. The proposal
makes it clear that the fiduciary is not prohibited from selecting the
investment, or investment course of action, based on collateral
benefits other than investment returns, so long as the requirements of
the proposal are met. These include, in the case of such a collateral
benefit for a designated investment alternative for an individual
account plan, the prominent display of the collateral-benefit
characteristic of the fund in disclosure materials. Further, the
fiduciary cannot accept reduced returns or greater risks to secure the
collateral-benefit.
Finally, the standards applicable to participant-directed
individual account plans contained in paragraph (d) of the current
regulation are merged into paragraph (c) of the proposal and revised
to, among other things, eliminate the current regulation's special rule
that prohibits certain investment alternatives from being used as a
QDIA.
Paragraph (c)(1) of the proposal restates the Department's
longstanding expression of a bedrock principle of ERISA's duty of
loyalty in the context of investment decisions, as expressed in
Interpretive Bulletins and associated preamble discussions. It provides
that a fiduciary may not subordinate the interests of the 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. Paragraph (c)(2) of
the current regulation contains similar language. The proposal would
move this language from paragraph (c)(2) of the current regulation to
paragraph (c)(1) to emphasize this bedrock principle encompassed within
ERISA's duty of loyalty.
Proposed paragraph (c)(2) makes two modifications to the
requirement contained in paragraph (c)(1) of the current regulation
that a fiduciary's evaluation of an investment or investment course of
action must be based 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
established pursuant to section 402(b)(1) of ERISA. The first
modification is a cross-reference to paragraph (b)(4) of the proposal
to confirm that consideration of an economically material ESG factor,
including climate-related financial risk, is consistent with ERISA's
duty of loyalty. The second modification integrates the concept of
``risk/return'' factors directly into paragraph (c)(2) rather than as
part of a separate definition of ``pecuniary'' factors. This approach
addresses stakeholder concerns about ambiguity in the meaning and
application of the ``pecuniary'' factors terminology of the current
regulation and makes paragraph (c)(2) more readable. The separate
definition of ``pecuniary factor'' in the current regulation,
therefore, is unnecessary and is not included in the proposal.
Paragraph (c)(2) of the proposal thus provides that a fiduciary's
evaluation of an investment or investment course of action must be
based on risk and return factors that the fiduciary prudently
determines are material to investment value. The proposal also
expressly states that the weight given to any factor by a fiduciary
should appropriately reflect a prudent assessment of its impact on
risk-return. Whether any particular consideration is such a factor
depends on the particular facts and circumstances. Depending on the
investment or investment course of action under consideration, relevant
factors may include such factors as the examples noted in paragraph
(b)(4) of the proposal. As noted above, those examples include: (i)
Climate change-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; (ii) governance factors, such as those
involving board composition, executive compensation, transparency and
accountability in corporate decision-making, as well as a corporation's
avoidance of criminal liability and compliance with labor, employment,
environmental, tax, and other applicable laws and regulations; (iii)
workforce practices, including the corporation's progress on workforce
diversity, inclusion, and other drivers of employee hiring, promotion,
and retention; its investment in training to develop its workforce's
skill; equal employment opportunity; and labor relations.
Paragraph (c)(3) of the proposal directly rescinds the ``tie-
breaker'' standard in paragraph (c)(2) of the current regulation and
replaces it with a standard that aligns more closely with the
Department's original non-regulatory guidance, Interpretive Bulletin
94-1, which first advanced the ``tie-breaker'' concept. Specifically,
paragraph (c)(3) of the proposal states that if, after the analysis
described in paragraph (c)(2) of the proposal, a fiduciary prudently
concludes that competing investment choices, or investment courses of
action, equally serve the financial interests of the plan, a fiduciary
can select the investment, or investment course of action, based on
collateral benefits other than investment returns.
The tie-breaker provision in paragraph (c)(2) of the current
regulation focuses on whether the competing investments are
indistinguishable based on consideration of risk and return.\37\ The
Department has concerns, however, that this formulation could be
interpreted too narrowly. For example, two investments may differ on a
wide range of attributes, yet when considered in their totality, can
serve the financial interests of the plan equally well. These
investments are not indistinguishable, but they are equally appropriate
additions to the plan's portfolio. Similarly, a fiduciary may prudently
choose an investment as a hedge against a specific risk to the
portfolio, even though the investment, when considered in isolation
from the portfolio as a whole, is riskier or less likely to generate a
significant positive return than other investments that do not serve
the same hedging function.
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\37\ But it uses a different term, ``pecuniary factor,'' to do
so.
---------------------------------------------------------------------------
Paragraph (c)(3) of the proposal, therefore, adopts a formulation
of the tie-breaker standard that is intended to be broader and applies
when choosing between competing choices or investment courses of action
that a fiduciary prudently concludes ``equally serve the financial
interests of the plan.''
[[Page 57279]]
The Department solicits comments on this approach, including whether it
is sufficiently clear and appropriate in light of investment practices
and strategies used by plan fiduciaries. The Department is also
interested in other approaches that commenters believe may better
reflect plan practices.
The proposal does not place parameters on the collateral benefits
that may be considered by a fiduciary to break the tie. The Department
believes this is consistent with prior non-regulatory guidance, but
solicits comments on whether more specificity should be provided in the
provision.\38\ For instance, should the rule require that any
collateral benefit relied upon as a tie-breaker 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?
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\38\ See, e.g., 80 FR 65135, 65137 (Oct. 26. 2015) (``The
following Interpretive Bulletin [2015-01] deals solely with the
applicability of the prudence and exclusive purpose requirements of
ERISA as applied to fiduciary decisions to invest plan assets in
ETIs, and in particular the collateral benefits they may provide
apart from a plan's performance and the interests of participants
and beneficiaries in their retirement income.'').
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Paragraph (c)(3) of the proposal also directly rescinds the current
regulation's requirement for a fiduciary to specially document its
analysis in those cases where the fiduciary has concluded that
pecuniary factors alone were insufficient to be the deciding factor. As
explained in the preamble to the current regulation, these provisions
were included in paragraph (c)(2) of the current regulation ``to
provide a safeguard against the risk that plan fiduciaries will
improperly find economic equivalence and make decisions based on non-
pecuniary factors without a proper analysis and evaluation.'' \39\
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\39\ 85 FR 72846, 72861.
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The Department, however, is concerned that singling out this one
category of investment actions for a special documentation requirement
may, in practice, chill investments based on climate change or other
ESG factors, even when those factors are directly relevant to the
financial merits of the investment decision or they are legitimately
applied as a tie-breaker. For example, stakeholders assert that the
entirety of the rulemaking process surrounding the current regulation,
including negative preamble statements regarding the economic
legitimacy of ESG investing, created a blanket perception that
fiduciaries are uniquely at risk if they include climate change or
other ESG factors in their financial evaluation of plan investments
(even when they are expected to have a material effect on risk/
return).\40\ Therefore, many stakeholders misperceive that the
consideration of climate change or other ESG factors may occur, if at
all, only in the tie-breaker context and therefore only upon
satisfaction of the documentation provisions. Consequently, even though
the current regulation does not actually use the term ``ESG,'' many
plans, plan fiduciaries, plan sponsors, and plan service providers
believe the regulation (including the tie-breaker's documentation
provisions) effectively singles out ESG investments for special
scrutiny, even when these factors are directly relevant to the risk/
return merits.
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\40\ Some point to the skepticism of ESG considerations
expressed in the preambles to the current regulation, such as a
statement cautioning fiduciaries against ``too hastily'' concluding
that ESG-themed funds may be selected based on pecuniary factors, as
discussed above. See, e.g., 85 FR 72859.
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Similarly, all ESG is not equal, and when it is not material to the
risk/return analysis, ESG still may be a legitimate collateral benefit
for consideration under a tie-breaker analysis. In these circumstances,
however, the documentation provisions in paragraph (c)(2) of the
current regulation may have a chilling effect on their use. Likewise,
the Department is concerned that the documentation provisions could
have a chilling effect on the use of the tie-breaker provision more
generally, including when ESG is not under consideration. For example,
this might occur in instances when investments are selected on the
basis of other factors that would benefit the plan and its
participants, such as investment selection taking into account
participant interest in investment options in order to increase
retirement plan savings.\41\ Contrary to the perception created during
the promulgation of the current regulation, the Department does not
view collateral benefits as being presumptively illegal, provided that
the investment at issue is otherwise selected in accordance with
ERISA's duties of prudence and loyalty.
---------------------------------------------------------------------------
\41\ 85 FR 72860.
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In addition, the Department believes that a special documentation
requirement is unnecessary given that fiduciaries are subject to a
general prudence obligation and commonly document and maintain records
about their investment selections pursuant to that obligation. Indeed,
the Department is concerned that the documentation provisions in
paragraph (c)(2) of the current regulation are too formulaic and rigid
to consistently square with ERISA's prudence requirement. While the
extent of documentation required to satisfy ERISA's general prudence
obligations would depend on the individual facts and circumstances, the
current regulation's tie-breaker provision sets out a one-size-fits-all
documentation requirement. In practice, however, prudence may require
something more, less, or different than is required under paragraph
(c)(2) of the current regulation. The current documentation provisions,
thus, could lead fiduciaries to over-documentation or under-
documentation of their investment decisions. Importantly, the
shortcoming of the documentation provisions in paragraph (c)(2) of the
current regulation could become even more significant with the proposed
broadening of the tie-breaker standard's formulation to choices or
investment courses of action that a fiduciary prudently concludes
``equally serve the financial interests of the plan,'' as discussed
above.
The Department's reconsidered view is that ERISA general prudence
obligation is sufficiently protective in this context and, unlike the
heightened documentation requirements in the current regulation, does
not tip the scale against the particular investment that offers
collateral benefits. In addition, as discussed later, as an added
measure of transparency and protection, the proposal requires in the
case of a designated investment alternative for an individual account
plan, including a QDIA, that the plan fiduciary must ensure that the
collateral-benefit characteristic of the fund, product, or model
portfolio is prominently displayed in disclosure materials provided to
participants and beneficiaries.
Finally, the Department notes that the current regulation's special
rule that prohibits certain investment alternatives from being used as
a QDIA is not carried forward in the proposal. Many stakeholders
expressed concern that funds could be excluded from treatment as QDIAs
solely because they expressly considered climate change or other ESG
factors, even though the funds were prudent based on a consideration of
their financial attributes alone. Often, QDIAs are the predominant
investment for plan participants. If a fund expressly considers climate
change or other ESG factors, is financially prudent, and meets the
protective standards set out in the Department's QDIA regulation, 29
CFR 2550.404c-5 (Fiduciary Relief for Investments in Qualified Default
[[Page 57280]]
Investment Alternatives), there appears to be no reason to foreclose
plan fiduciaries from considering the fund as a QDIA.
However, with respect to the selection of designated investment
alternatives under paragraph (c)(3) of the proposal, including QDIAs,
for the collateral benefits they create in addition to investment
return to the plan, paragraph (c)(3) adds a new requirement that the
collateral-benefit characteristic of the fund, product, or model
portfolio must be prominently displayed in disclosure materials
provided to participants and beneficiaries. For example, if the tie-
breaking characteristic of a particular designated investment
alternative were that it better aligns with the corporate ethos of the
plan sponsor or that it improves the esprit de corps of the workforce,
for instance, then such feature or features prompting the selection of
the investment must be prominently disclosed by the plan fiduciary
under paragraph (c)(3) of the proposal. The essential purpose of this
proposed disclosure requirement is to ensure that plan participants are
given sufficient information to be aware of the collateral factor or
factors that tipped the scale in favor of adding the investment option
to the plan menu, as opposed to its economically equivalent peers that
were not. It is possible, for instance, that a particular plan
participant or a population of plan participants does not share the
same preference for a given collateral purpose as the plan fiduciary
that selected the designated investment alternative for placement on
the menu among the plan's other options. The proposal intentionally
provides flexibility in how plan fiduciaries may fulfill this
requirement given the unknown spectrum of collateral benefits that
might influence a plan fiduciary's selection. One likely way, however,
is that the plan fiduciary could simply use the required disclosure
under 29 CFR 2550.404a-5.\42\ That regulation, adopted in 2012, already
entitles participants in participant-directed individual account plans
to receive sufficient information regarding designated investment
alternatives to make informed decisions with regard to the management
of their individual accounts. The information required by the 2012 rule
includes information regarding the alternative's objectives or goals
and the alternative's principal strategies (including a general
description of the types of assets held by the investment) and
principal risks. This proposal, therefore, assumes these existing
disclosures are, or perhaps with minor modifications or clarifications
could be, sufficient to satisfy the disclosure element of the tie-
breaker provision in paragraph (c)(3) of the proposal. Accordingly, the
Department believes such disclosures are already commonplace for many
regulated investment products and, in any event, that this new
disclosure will be useful to participants and beneficiaries in deciding
how to invest their plan accounts. As with the tie-breaking provision
in general, comments are solicited on the overall utility of this
disclosure provision, including ideas on how best to operationalize the
provision taking into account its intended purpose balanced against
costs of implementation and compliance.
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\42\ 29 CFR 2550.404a-5 Fiduciary Requirements for Disclosure in
Participant-directed Individual Account Plans (When the documents
and instruments governing an individual account plan provide for the
allocation of investment responsibilities to participants or
beneficiaries, the plan administrator, as defined in section 3(16)
of ERISA, must take steps to ensure, consistent with section
404(a)(1)(A) and (B) of ERISA, that such participants and
beneficiaries, on a regular and periodic basis, are made aware of
their rights and responsibilities with respect to the investment of
assets held in, or contributed to, their accounts and are provided
sufficient information regarding the plan, including fees and
expenses, and regarding designated investment alternatives,
including fees and expenses attendant thereto, to make informed
decisions with regard to the management of their individual
accounts.).
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As indicated above, under the proposal, the standards applicable to
selection of designated investment alternatives in participant-directed
individual account plans contained in paragraphs (d)(1) and (d)(2)(i)
of the current regulation are being incorporated into paragraph (c) of
the proposal. Selection of an investment fund as a designated
investment alternative under a plan is considered an ``investment
course of action'' under the proposal, and therefore is covered under
paragraph (c)(2) of the proposal. Additionally, as described above,
paragraph (c)(3) of the proposal covers selection of designated
investment alternatives for economic benefits they create in addition
to investment return to the plan.
The current regulation's special provisions on QDIAs, at paragraph
(d)(2)(ii) of the current regulation, are not being carried forward in
this proposal. The Department's justification for these provisions was
based on a perceived need for heightened protection for QDIAs given the
important role they play in facilitating retirement savings under
ERISA. The Department generally is of the view that QDIAs warrant
special treatment because plan participants have not affirmatively
directed the investment of their assets into the QDIA, but are
nevertheless dependent on the investments for long-run financial
security. Although the Department continues to believe as a general
matter that special protections may be needed in some contexts for
plans containing these investments, the Department no longer supports
the particular restrictions in paragraph (d)(2)(ii) of the current
regulation. As structured, paragraph (d)(2)(ii) of the current
regulation disallows a fund to serve as a QDIA if it, or any of its
component funds in a fund-of-fund structure, has investment objectives,
goals, or principal investment strategies that include, consider, or
indicate the use of non-pecuniary factors in its investment objectives,
even if the fund is objectively economically prudent from a risk/return
perspective or even best in class. Rather than protecting the interests
of plan participants, stakeholders therefore allege that paragraph
(d)(2)(ii) of the current regulation will only serve to harm
participants by depriving them of otherwise financially prudent options
as QDIAs. The Department agrees and, consequently, proposes to directly
rescind paragraph (d)(2)(ii) of the current regulation. The rescission
of this provision, however, does not leave participants and
beneficiaries in plans with QDIAs without protections. QDIAs would
continue to be subject to the same rules under the proposal as all
other investments, including the prohibition against subordinating the
interests of the participants and beneficiaries in their retirement
income to other objectives. QDIAs also would continue to be subject to
the separate protections of the QDIA regulation.\43\ And, finally,
participants in these plans would get the collateral benefit disclosure
under the tie-breaker test in paragraph (c)(3) of the proposal, if
applicable.
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\43\ 29 CFR 2550.404c-5.
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3. Proxy Voting and Exercise of Shareholder Rights
Paragraph (d) of the proposal contains provisions that address the
application of the duties of prudence and loyalty under ERISA to the
exercise of shareholder rights, including proxy voting. These
provisions correspond to provisions contained in paragraph (e) of the
current regulation. The proposed rule would move these provisions on
the exercise of shareholder rights from paragraph (e) of the current
regulation to paragraph (d) of the proposal for organizational
purposes.
[[Page 57281]]
(a) Major Changes to the Current Regulation
Paragraph (d) of the proposal includes four noteworthy changes from
paragraph (e) of the current regulation. They are highlighted below
followed by a technical overview of paragraph (d) of the proposal in
its entirety.
First, the proposal would 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 exercise of shareholder rights is important to ensuring
management accountability to the shareholders that own the company.\44\
Accordingly, the Department is concerned that the statement could be
misread as suggesting that plan fiduciaries should be indifferent to
the exercise of their rights as shareholders, particularly in
circumstances where the cost is minimal as is typical of voting
proxies. In general, fiduciaries should take their rights as
shareholders seriously, and conscientiously exercise those rights to
protect the interests of plan participants. Paragraph (d) of the
proposal sets forth standards for compliance with ERISA's duties when
making decisions on the exercise of shareholder rights and proxy
voting.
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\44\ See, e.g., Comment #262 at <a href="https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00262.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00262.pdf</a>; Comment #209 at <a href="https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00209.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00209.pdf</a>.
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The proposed removal of the statement, however, does not mean that
fiduciaries must always vote proxies or engage in shareholder activism.
The Department's longstanding view of ERISA is that proxies should be
voted as part of the process of managing the plan's investment in
company stock unless a responsible plan fiduciary determines voting
proxies may not be in the plan's best interest (e.g., if there are
significant costs or efforts associated with voting).\45\ Voting
proxies are a crucial lever in ensuring that shareholders' interests,
as the company's owners, are protected.\46\ Moreover, abstaining from a
vote is not a neutral act, which has no bearing on the outcome of the
matter put to the shareholders for vote, but rather, depending on the
relevant voting standard under state law and the company's governing
documents, could determine whether a particular matter or proposal is
approved.\47\ Prudent fiduciaries should take steps to ensure that the
cost and effort associated with voting a proxy is commensurate with the
significance of an issue to the plan's financial interests. The
solution to proxy-voting costs is not total abstention, but is,
instead, for the fiduciary to be prudent in incurring expenses to make
proxy decisions and, wherever possible, to rely on efficient structures
(e.g., proxy voting guidelines, proxy advisers/managers that act on
behalf of large aggregates of investors, etc.).
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\45\ 81 FR 95881.
\46\ See, e.g., Comment #290 at <a href="https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00290.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00290.pdf</a>; Comment #288 at <a href="https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00288.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00288.pdf</a>; Comment #142 at <a href="https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00142.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB91/00142.pdf</a>.
\47\ For example, an abstention would generally have the legal
effect of an ``against'' vote if the voting standard for a proposal
is the affirmative vote of the majority of the shares present and
entitled to vote or the majority of the outstanding shares.
Similarly, the failure of a shareholder who holds its shares in
``street name'' to provide voting instructions to its broker-dealer
would generally have the legal effect of an ``against'' vote for a
matter where the voting standard is the majority of the outstanding
shares.
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Second, the proposal streamlines the regulation by eliminating a
provision in the current regulation (paragraph (e)(2)(iii)) that sets
out specific monitoring obligations where the authority to vote proxies
or exercise shareholder rights has been delegated to an investment
manager or where a proxy voting firm performs advisory services as to
voting proxies. Instead, the regulation addresses such monitoring
obligations in another provision that more generally covers selection
and monitoring obligations (paragraph (d)(2)(ii)(E) of the proposal).
The revised text does not represent a change in the Department's view
or requirements under the current regulation. Rather, the Department
believes that, as previously expressed in Interpretive Bulletin 2016-
01,\48\ the general prudence and loyalty duties under ERISA section
404(a)(1) already impose a monitoring requirement. Accordingly, the
Department is concerned that the specific provision in the current
regulation may 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.
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\48\ 81 FR 95882-3.
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Third, the proposal revises the provision of the current regulation
that addresses proxy voting policies, paragraph (e)(3)(i) of the
current regulation, by removing the two ``safe harbor'' examples for
proxy voting policies that would be permissible under the provisions of
the current regulation. The Department continues to believe, as it
stated in Interpretive Bulletin 2016-1, that the maintenance by an
employee benefit plan of a statement of investment policy designed to
further the purposes of the plan and its funding policy is consistent
with the fiduciary obligations set forth in section 404(a)(1)(A) and
(B) of ERISA, and that since the act of managing plan assets that are
shares of corporate stock includes the voting of proxies appurtenant to
those shares, a statement of proxy voting policy is an important part
of any comprehensive statement of investment policy.\49\ The Department
also continues to believe that proxy voting policies can help
fiduciaries reduce costs and compliance burden. However, the Department
recognizes that, because the examples in the current regulation are
characterized as safe harbors, they may become widely adopted by plan
fiduciaries. It therefore is crucial for the Department to have
confidence that the safe harbors adequately safeguard the interests of
plans and their participants and beneficiaries. Based on its outreach
to interested stakeholders, the Department is not confident that the
safe harbors are necessary or helpful for that purpose, and,
accordingly, does not believe it is appropriate to include them in the
proposal. Rather, the Department specifically solicits comments on
those safe harbor provisions to assist the Department in its review of
the proposed regulation.
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\49\ 81 FR 95883.
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Fourth, the proposal would eliminate the requirement in paragraph
(e)(2)(ii)(E) of the current regulation that, when deciding whether to
exercise shareholder rights and when exercising shareholder rights,
plan fiduciaries must maintain records on proxy voting activities and
other exercises of shareholder rights. The proposal would remove this
provision from the current regulation because, in context, it appears
to treat proxy voting and other exercises of shareholder rights
differently from other fiduciary activities and may create a
misperception that proxy voting and other exercises of shareholder
rights are disfavored or carry greater fiduciary obligations, and
therefore greater potential liability, than other fiduciary activities.
Such a misperception may potentially chill plan fiduciaries from
exercising their rights, or result in excessive expenditures as
fiduciaries
[[Page 57282]]
over-document their efforts. Removal of the requirement is intended to
address this concern.
The first and third of these proposed changes (to paragraphs
(e)(2)(ii) and (e)(3)(i)(A) and (B), respectively) would be direct
rescissions of provisions in the current regulation. The intent of
these to-be-rescinded provisions was to offer plan fiduciaries two
examples of policies they might adopt to efficiently discharge their
responsibilities under section 404 of ERISA with respect to voting
proxies.\50\ The Department continues to be supportive of the concept
of policies that promote the efficient discharge of proxy voting
responsibilities. In light of stakeholder feedback, however, the
Department is concerned that these provisions will not achieve this
objective. To the contrary, the Department believes that the ``no
vote'' statement in paragraph (e)(2)(ii) of the current regulation and
the two safe harbors in paragraph (e)(3)(i) of the current regulation,
in combination, may be construed as little more than regulatory
permission for plans to broadly abstain from proxy voting without
properly considering their interests as shareholders and without legal
repercussions. Moreover, the Department is concerned about the
application of the safe harbors individually. In particular, the
Department is concerned that fiduciaries may take too much comfort in
the safe harbor in paragraph (e)(3)(i)(A) of the current regulation.
This safe harbor vaguely overlaps with the general standard that
precedes it and, to that extent, provides illusory safe harbor
protection to plan fiduciaries. In addition, the safe harbor in
paragraph (e)(3)(i)(B) of the current regulation appears to be subject
to practical drawbacks that substantially erode its actual utility. In
particular, stakeholders assert that the multiple investment managers
of sub-portfolios of certain ERISA look-through investment vehicles
lack the information necessary to calculate the requisite threshold
across the sub-portfolios, at the plan level. Even if these managers
are able to ascertain a particular plan's proportional interest in the
sub-portfolios, the managers do not know the plan's total investment
assets, according to the stakeholders. For these reasons, the
Department is proposing to rescind these particular provisions.
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\50\ 85 FR 81672.
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(b) Technical Overview of Paragraph (d) of the Proposal
Paragraph (d)(1) of the proposal, like paragraph (e)(1) of the
current regulation and prior Interpretive Bulletins, provides that 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.
Paragraph (d)(2)(i) of the proposal provides that when deciding
whether to exercise shareholder rights and when exercising such rights,
including the voting of proxies, fiduciaries must carry out their
duties prudently and solely in the interests of the participants and
beneficiaries and for the exclusive purpose of providing benefits to
participants and beneficiaries and defraying the reasonable expenses of
administering the plan.
Paragraph (d)(2)(ii) of the proposal sets forth specific standards
for fiduciaries to meet when deciding whether to exercise shareholder
rights and when exercising shareholder rights. In particular, a
fiduciary must act solely in accordance with the economic interest of
the plan and its participants and beneficiaries (paragraph
(d)(2)(ii)(A)) and consider any costs involved (paragraph
(d)(2)(ii)(B)). Additionally, the proposal expressly provides that a
fiduciary must not subordinate the interests of the participants and
beneficiaries in their retirement income or financial benefits under
the plan to benefits or goals unrelated to those financial interests of
the plan's participants and beneficiaries (paragraph (d)(2)(ii)(C)).
Furthermore, a fiduciary must evaluate material facts that form the
basis for any particular proxy vote or other exercise of shareholder
rights (paragraph (d)(2)(ii)(D)). Paragraph (d)(2)(ii)(E) of the
proposal additionally requires that a fiduciary must exercise prudence
and diligence in the selection and monitoring of persons, if any,
chosen to exercise shareholder rights or otherwise to advise on or
assist with exercises of shareholder rights, such as providing research
and analysis, recommendations regarding proxy votes, administrative
services with voting proxies, and recordkeeping and reporting services.
This provision (paragraph (d)(2)(ii)(E)) is broader than the current
regulation and covers obligations related to monitoring service
providers such as investment managers and proxy advisory firms that are
addressed in paragraph (e)(2)(iii) of the current regulation. These
provisions (paragraphs (d)(2)(ii)(A) through (E)) are intended to
confirm and restate what the prudence and loyalty obligations of ERISA
section 404(a)(1)(A) and (B) would require in these areas. The
Department specifically invites comments on whether these provisions
are necessary and whether they may be read as creating special duties
and requirements beyond what ERISA section 404(a)(1)(B) would demand.
We note that, as discussed above, paragraph (d)(2)(ii) does not carry
forward the current regulation's specific requirement (paragraph
(e)(2)(ii)(E)) for maintenance of records on proxy voting activities
and other exercise of shareholder rights.
Paragraph (d)(2)(iii) of the proposal states that a fiduciary may
not adopt a practice of following the recommendations of a proxy
advisory firm or other service provider without a determination that
such firm or service provider's proxy voting guidelines are consistent
with the fiduciary's obligations described in provisions of the
regulation. This provision of the current regulation was intended to
address specific concerns involving fiduciaries' use of proxy advisory
firms and similar service providers, including use of automatic voting
mechanisms relying on proxy advisory firms.\51\ The Department invites
comments on whether this provision is necessary given the more general
requirement in paragraph (d)(2)(ii)(E) of the proposal that fiduciaries
must exercise prudence and diligence in the selection and monitoring of
persons, if any, selected to exercise shareholder rights or otherwise
advise on or assist with exercises of shareholder rights.
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\51\ See 85 FR 81668 (Dec. 16, 2020).
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Paragraph (d)(3)(i) of the proposal provides that in deciding
whether to vote a proxy pursuant to paragraphs (d)(2)(i) and (ii) of
the proposal, fiduciaries may adopt proxy voting policies providing
that the authority to vote a proxy shall be exercised pursuant to
specific parameters prudently designed to serve the plan's interest in
providing benefits to participants and their beneficiaries and
defraying reasonable expenses of administering the plan. As discussed
above, this provision is not carrying forward the two ``safe harbor''
proxy voting policies contained in the current regulation. The
Department is concerned that the policies described in the current
regulation may effectively encourage adoption of proxy voting policies
that may be biased against the exercise of a plan's voting rights.
Paragraph (d)(3)(ii) of the proposal requires plan fiduciaries to
periodically review proxy voting policies adopted pursuant to the
regulation. Paragraph (d)(3)(iii) further provides that no proxy voting
policies adopted pursuant to paragraph (d)(3)(i) of the proposal shall
[[Page 57283]]
preclude submitting a proxy vote when the fiduciary prudently
determines that the matter being voted upon is expected to have a
material effect on the value of the investment or the investment
performance of the plan's portfolio (or investment performance of
assets under management in the case of an investment manager) after
taking into account the costs involved, or refraining from voting when
the fiduciary prudently determines that the matter being voted upon is
not expected to have such a material effect after taking into account
the costs involved. This provision in the proposal recognizes that,
depending on the circumstances, a fiduciary may conclude that the best
interests of the plan and its participant and beneficiaries would not
be served by following the plan's proxy voting policies in a particular
case. In such cases, paragraph (d)(3)(iii) of the proposal ensures that
a fiduciary will have the needed flexibility to deviate from those
policies and take a different approach.
Paragraphs (d)(4)(i) and (ii) of the proposal, like paragraphs
(e)(4)(i) and (ii) of the current regulation, reflect longstanding
positions expressed in the Department's prior Interpretive Bulletins.
Paragraph (d)(4)(i)(A) of the proposal states that the responsibility
for exercising shareholder rights lies exclusively with the plan
trustee except to the extent that either the trustee is subject to the
directions of a named fiduciary pursuant to ERISA section 403(a)(1); or
the power to manage, acquire, or dispose of the relevant assets has
been delegated by a named fiduciary to one or more investment managers
pursuant to ERISA section 403(a)(2). Paragraph (d)(4)(ii)(B) of the
proposal states that where the authority to manage plan assets has been
delegated to an investment manager pursuant to ERISA section 403(a)(2),
the investment manager has exclusive authority to vote proxies or
exercise other shareholder rights appurtenant to such plan assets in
accordance with this section, except to the extent the plan, trust
document, or investment management agreement expressly provides that
the responsible named fiduciary has reserved to itself (or to another
named fiduciary so authorized by the plan document) the right to direct
a plan trustee regarding the exercise or management of some or all of
such shareholder rights.
Paragraph (d)(4)(ii) of the proposal describes obligations of an
investment manager of a pooled investment vehicle that holds assets of
more than one employee benefit plan. The provision provides that an
investment manager of such a pooled investment vehicle may be subject
to an investment policy statement that conflicts with the policy of
another plan. Furthermore, it provides that compliance with ERISA
section 404(a)(1)(D) requires the investment manager to reconcile,
insofar as possible, the conflicting policies (assuming compliance with
each policy would be consistent with ERISA section 404(a)(1)(D)).\52\
The provision further states that, in the case of proxy voting, to the
extent permitted by applicable law, the investment manager must vote
(or abstain from voting) the relevant proxies to reflect such policies
in proportion to each plan's economic interest in the pooled investment
vehicle. Such an investment manager may, however, develop an investment
policy statement consistent with Title I of ERISA and the regulation,
and require participating plans to accept the investment manager's
investment policy statement, including any proxy voting policy, before
they are allowed to invest. In such cases, a fiduciary must assess
whether the investment manager's investment policy statement and proxy
voting policy are consistent with Title I of ERISA and the regulation
before deciding to retain the investment manager.
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\52\ Section 404(a)(1)(D) of ERISA provides that a fiduciary
must discharge its duties with respect to the plan in accordance
with the documents and instruments governing the plan insofar as
such documents are consistent with the provisions of title I and
title IV of ERISA. Under section 404(a)(1)(D), a fiduciary to whom
an investment policy applies would be required to comply with such
policy unless, for example, it would be imprudent to do so in a
given instance.
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Paragraph (d)(4)(ii) of the proposal is identical to paragraph
(e)(4)(ii) of the current regulation. Although the provision in the
current regulation, and thus the proposal uses different language than
prior Interpretive Bulletins in describing the obligations of
investment managers to pooled investment funds, as explained in the
preamble to the Fiduciary Duties Regarding Proxy Voting and Shareholder
Rights final rule, the objective was to clarify the requirement and not
fundamentally alter that guidance.\53\ The Department solicits comments
on whether this provision would be clearer if revised to conform more
closely to the prior Interpretive Bulletins.
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\53\ 85 FR 81675.
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Finally, paragraph (d)(5) of the proposal provides that the
regulation does not apply to voting, tender, and similar rights with
respect to shares of stock that, pursuant to the terms of an individual
account plan, are passed through to participants and beneficiaries with
accounts holding such shares.
4. Miscellaneous
Paragraph (e) defines the terms used in the proposal. The terms and
definitions do not include a definition of ``pecuniary factors''
because the proposal does not rely on that term.
Under paragraph (e)(1) of the proposal, ``investment duties'' means
any duties imposed upon, or assumed or undertaken by, a person in
connection with the investment of plan assets which make or will make
such person a fiduciary of an employee benefit plan or which are
performed by such person as a fiduciary of an employee benefit plan as
defined in section 3(21)(A)(i) or (ii) of ERISA. Paragraph (e)(2)
defines the term ``investment course of action'' 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.
Paragraph (e)(3) defines ``plan'' to mean an employee benefit plan to
which Title I of ERISA applies. Finally, under paragraph (e)(4) of the
proposal, the term ``designated investment alternative'' means any
investment alternative designated by the plan into which participants
and beneficiaries may direct the investment of assets held in, or
contributed to, their individual accounts. The provision further
provides that the term ``designated investment alternative'' shall not
include ``brokerage windows,'' ``self-directed brokerage accounts,'' or
similar plan arrangements that enable participants and beneficiaries to
select investments beyond those designated by the plan.
Paragraph (f) of the proposal, like paragraph (h) of the current
regulation, provides that if any provision of the regulation is held to
be invalid or unenforceable by its terms, or as applied to any person
or circumstance, or stayed pending further agency action, the provision
shall be construed so as to continue to give the maximum effect to the
provision permitted by law, unless such holding shall be one of
invalidity or unenforceability, in which event the provision shall be
severable from this section and shall not affect the remainder thereof.
Finally, this proposed regulation does not undermine serious
reliance interests on the part of fiduciaries selecting investments and
investment courses of action and exercising shareholder rights. Nor
does it upend a longstanding view of the agency on the standards
governing the selection of investments
[[Page 57284]]
and investment courses of action or the exercise of shareholder rights,
including the voting of proxies. It instead addresses new policies
included in a recently promulgated regulation. Further, the Department
stayed its enforcement of the regulation immediately after its
effective date and before its full applicability. Consequently, the
Department concludes serious reliance on the 2020 rule is unlikely, and
certainly would not overwhelm the Department's good reasons for this
change.
C. Request for Public Comments
The Department invites comments from interested persons on all
facets of the proposed rule. Commenters are free to express their views
not only on the specific provisions of the proposal as set forth in
this document, but on any issues germane to the subject matter of the
proposal. Comments should be submitted in accordance with the
instructions at the beginning of this document.
D. Regulatory Impact Analysis
This section of the preamble analyzes the regulatory impact of
proposed amendments to 29 CFR 2550.404a-1. As explained earlier in this
preamble, the proposed amendments would clarify the legal standard
imposed by sections 404(a)(1)(A) and 404(a)(1)(B) of ERISA with respect
to the selection of a plan investment or, in the case of an ERISA
section 404(c) plan or other individual account plan, a designated
investment alternative under the plan, and with respect to the exercise
of shareholder rights, including proxy voting.
The primary benefit of the proposal is clarification of legal
standards and the prevention of confusion to plan fiduciaries that
otherwise might persist as a result of certain provisions in the
current regulation that are the subject of the proposed amendments. The
Department has heard from stakeholders that the current regulation, and
investor confusion about it, has already had a chilling effect on
appropriate integration of climate change and other ESG factors in
investment decisions, including in circumstances that the current
regulation may in fact allow. Based on stakeholder feedback, the
Department has concerns that aspects of the current regulation could
deter plan fiduciaries from: (a) Taking into account climate change and
other ESG factors when they are material to a risk-return analysis; (b)
engaging in proxy voting and other exercises of shareholder rights when
doing so is in the plan's best interest; and (c) choosing QDIAs that
include climate change and other ESG factors in their investments. If
these concerns with the current regulation are correct, and left
unaddressed, the current regulation could continue to have (a) a
negative impact on plans' financial performance as they avoid
materially sound investments or integration of climate change and other
ESG considerations that are often material in investment analysis, (b)
a negative impact on plans' financial performance as they shy away from
economically relevant considerations in voting and from exercising
shareholder rights on material issues, and (c) broader negative
economic/societal impacts (e.g., negative impacts on climate change, on
workers' productivity and engagement, and on corporate managers'
accountability). The proposal's clarification of the relevant legal
standards is intended to address these negative impacts.
Other benefits of the proposal consist of costs savings associated
with revisions and improvements to the current regulation, for example,
the elimination of the current regulation's special documentation
provisions, elimination of its proxy voting safe harbors, clarification
of its tie-breaker standard, and the clarification of its standards
governing QDIAs. All benefits of the proposal are discussed below in
Section 1.3. As discussed in Section 1.4 below, the proposal would also
impose some modest additional costs. For example, some plans will incur
costs to review the rule to ensure compliance. But, the costs of the
proposal are expected to be relatively small, in part because the
Department assumes most plan fiduciaries are complying with the pre-
2020 interpretive bulletins (specifically Interpretive Bulletin 2016-1
and 2015-1), which the proposal tracks. Overall, the Department
estimates that the proposal's benefits justify its costs.
The Department has examined the effects of this proposal as
required by Executive Order 12866,\54\ Executive Order 13563,\55\ the
Congressional Review Act,\56\ the Paperwork Reduction Act of 1995,\57\
the Regulatory Flexibility Act,\58\ section 202 of the Unfunded
Mandates Reform Act of 1995,\59\ and Executive Order 13132.\60\
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\54\ Regulatory Planning and Review, 58 FR 51735 (Oct. 4, 1993).
\55\ Improving Regulation and Regulatory Review, 76 FR 3821
(Jan. 21, 2011).
\56\ 5 U.S.C. 804(2) (1996).
\57\ 44 U.S.C. 3506(c)(2)(A) (1995).
\58\ 5 U.S.C. 601 et seq. (1980).
\59\ 2 U.S.C. 1501 et seq. (1995).
\60\ Federalism, 64 FR 43255 (Aug. 10, 1999).
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1. Executive Orders 12866 and 13563
Executive Orders 12866 and 13563 direct agencies to assess all
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits (including potential economic, environmental, public
health, and safety effects; distributive impacts; and equity).
Executive Order 13563 emphasizes the importance of quantifying costs
and benefits, reducing costs, harmonizing rules, and promoting
flexibility.
Under Executive Order 12866, ``significant'' regulatory actions are
subject to review by the Office of Management and Budget (OMB). Section
3(f) of the Executive order defines a ``significant regulatory action''
as an action that is likely to result in a rule (1) having an annual
effect on the economy of $100 million or more, or adversely and
materially affecting a sector of the economy, productivity,
competition, jobs, the environment, public health or safety, or state,
local, or tribal governments or communities (also referred to as
``economically significant''); (2) creating a serious inconsistency or
otherwise interfering with an action taken or planned by another
agency; (3) materially altering the budgetary impacts of entitlement
grants, user fees, or loan programs or the rights and obligations of
recipients thereof; or (4) raising novel legal or policy issues arising
out of legal mandates, the President's priorities, or the principles
set forth in the Executive order. The Department and OMB have
determined that this proposed rule is significant within the meaning of
section 3(f)(4) of Executive Order 12866, under which rules are
significant if they ``[r]aise novel legal or policy issues arising out
of legal mandates [or] the President's priorities.'' The Department and
OMB also treat the regulation as economically significant within the
meaning of section 3(f)(1) of that Executive order. Given the large
scale of investments held by covered plans, approximately $12.2
trillion, we assume that changes in investment decisions and/or plan
performance are likely to be economically significant under the
Executive order.\61\ Therefore, the Department provides an assessment
of the potential costs, benefits, and
[[Page 57285]]
transfers associated with the proposal below.
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\61\ EBSA projected ERISA covered pension, welfare, and total
assets based on the 2018 Form 5500 filings with the U.S. Department
of Labor (DOL), reported SIMPLE assets from the Investment Company
Institute (ICI) Report: The U.S. Retirement Market, First Quarter
2021, and the Federal Reserve Board's Financial Accounts of the
United States Z1 June 10, 2021.
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1.1. Introduction and Need for Regulation
In late 2020, the Department published two final rules dealing with
the selection of plan investments and the exercise of shareholder
rights, including proxy voting. The Department published those rules to
provide clarity and certainty to plan fiduciaries regarding their legal
duties under ERISA section 404 in connection with making plan
investments and for exercising shareholder rights. The Department was
also concerned that some investment products may be marketed to ERISA
fiduciaries on the basis of purported benefits and goals unrelated to
financial performance. Before issuing the rules, the Department had
periodically considered and issued guidance pertaining to the
application of ERISA's fiduciary rules to plan investment decisions
that are based, in whole or part, on factors unrelated to financial
performance. Confusion with respect to these factors persisted, perhaps
due in part to varied statements the Department had made on the subject
over the years in non-regulatory guidance. Accordingly, the 2020 rules
were intended to interpret ERISA and provide clarity and certainty
regarding the scope of fiduciary duties surrounding such issues.
Responses to the 2020 rules, however, suggest that the new rules
may have inadvertently caused more confusion than clarity. Many
interested stakeholders have told the Department that the terms and
tone of the final rules and preambles have increased concerns and
uncertainty about the extent to which plan fiduciaries may consider
climate change and other ESG factors in their investment decisions, and
that the final rules have chilling effects contrary to the interests of
participants and beneficiaries. Consequently, on March 10, 2021, the
Department announced that it would stay enforcement of the 2020 rules
pending a complete review of the matter. Subsequently, on May 20, 2021,
the President issued Executive Order 14030, entitled ``Executive Order
on Climate-Related Financial Risk.'' Section 4 of the Executive order
directs the Department to consider suspending, revising, or rescinding
any rules from the prior administration that would have barred plan
fiduciaries (and their investment-firm service providers) from
considering climate change and other ESG factors in their investment
decisions related to workers' pensions.\62\ In light of the foregoing,
the Department concluded that additional notice and comment rulemaking
was necessary to safeguard the interests of participants and
beneficiaries in their retirement and welfare plan benefits.
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\62\ See White House Fact Sheet titled FACT SHEET: President
Biden Directs Agencies to Analyze and Mitigate the Risk Climate
Change Poses to Homeowners and Consumers, Businesses and Workers,
and the Financial System and Federal Government Itself (May 20,
2021) (stating, ``The Executive Order directs the Labor Secretary to
consider suspending, revising, or rescinding any rules from the
prior administration that would have barred investment firms from
considering environmental, social and governance factors, including
climate-related risks, in their investment decisions related to
workers' pensions.'').
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The baseline for purposes of the analysis in this section is a
future in which the current regulation is implemented. However,
immediately after its effective date in January but before its full
applicability date, the Department stayed enforcement of the current
regulation pursuant the March 10 non-enforcement policy.\63\ The
Department assumes that this stay, in conjunction with the President's
Executive order in January, prevented plans from incurring sunk-costs.
Comments are requested on the accuracy of this assumption.
Specifically, how many plans, if any, had already incurred costs to
comply with the current regulation between its January effective date
and the March stay, and what was the magnitude of the costs incurred?
Commenters are encouraged to be as specific as possible in responding
to this solicitation and to support their comments with data when
possible.
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\63\ 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 <a href="http://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">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</a>.
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1.2. Affected Entities
The clarifications in the proposal would affect subsets of ERISA-
covered plans and their participants and beneficiaries. The subset of
plans affected by the proposed modifications of paragraphs (c) of Sec.
2550.404a-1 include those plans whose fiduciaries consider or will
begin considering climate change and other ESG factors when selecting
investments and the participants in those plans. Another subset of
affected plans include ERISA-covered plans (pension, health, and other
welfare) that hold shares of corporate stock. This subset of plans
would be affected by the proposed modifications to paragraph (d)
(relating to proxy voting) of Sec. 2550.404a-1. Some plans would be in
both subsets, some in only one subset, and some in neither. There is
substantial uncertainty on the number and size of the affected plans.
Moreover, if the Department had not immediately stayed enforcement of
the 2020 rules, the class of affected entities could have looked
somewhat different.
a. Subset of Plans Affected by Proposed Modifications of Paragraph (c)
of Sec. 2550.404a-1
The best data on affected plans comes from surveys of ESG investing
by plans. The plans affected by the proposed modifications of paragraph
(c) of Sec. 2550.404a-1 consist of those ERISA-covered plans whose
fiduciaries consider or will begin considering climate change and other
ESG factors when selecting investments and the participants in those
plans. A challenge in relying on survey data, however, is that one
cannot readily determine how much of the ESG investing is driven by
material risk-return factors as opposed to non-risk-return or
collateral factors.\64\
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\64\ See Max Schanzenbach & Robert Sitkoff, Reconciling
Fiduciary Duty and Social Conscience: The Law and Economics of ESG
Investing by a Trustee, 72 Stan. L. Rev. 381 (2020) (distinguishing
between ``collateral benefits ESG'' investing--defined as ``ESG
investing for moral or ethical reasons or to benefit a third
party''--which is not permissible under ERISA, and ``risk-return
ESG'' investing, which is).
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The Department estimates as a lower bound that approximately 11
percent of retirement plans, or 78,300 plans, would be affected by
paragraph (c) of the proposal.
This estimate of the share of retirement plans already considering
ESG factors is derived from combining estimates of 9 percent for
participant-directed defined contribution plans and 19 percent for
other plans, weighted to reflect the relative prevalence of these types
of retirement plans. These estimates are drawn from survey findings and
administrative data. According to the Plan Sponsor Council of America,
about 3 percent of 401(k) and/or profit sharing plans offered at least
one ESG-themed investment option in 2019.\65\ Vanguard's 2018
administrative data suggest that approximately 9 percent of DC plans
offered one or more ``socially responsible'' domestic equity fund
options.\66\ In a comment letter, Fidelity Investments reported that
14.5 percent of corporate DC plans with fewer than 50 participants
offered an ESG option, and that the figure is higher for large
[[Page 57286]]
plans with at least 1,000 participants. Considering these three sources
together, the Department uses the median figure of 9 percent for its
estimate of the share of participant-directed individual account plans
that have at least one ESG-themed designated investment alternative.
This represents 53,000 participant-directed individual account
plans.\67\ To estimate ESG investing by other types of retirement
plans, the Department looked at surveys that included many defined
benefit plans as well as some defined contribution plans. According to
a 2018 survey by the NEPC, approximately 12 percent of private pension
plans have adopted ESG investing.\68\ Another survey, conducted by the
Callan Institute in 2019, found that about 19 percent of private sector
pension plans consider ESG factors in investment decisions.\69\ Since
the Callan Institute survey included a greater share of defined benefit
plans, the Department draws upon its finding and assumes that 19
percent of defined benefit plans and nonparticipant-directed defined
contribution plans use ESG investing, which represents 25,300
plans.\70\ The total number of affected plans is approximately 78,300,
which is 11 percent of all pension plans.\71\
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\65\ 63rd Annual Survey of Profit Sharing and 401(k) Plans, Plan
Sponsor Council of America (2020).
\66\ How America Saves 2019, Vanguard (June 2019), <a href="https://pressroom.vanguard.com/nonindexed/Research-How-America-Saves-2019-Report.pdf">https://pressroom.vanguard.com/nonindexed/Research-How-America-Saves-2019-Report.pdf</a>.
\67\ DOL calculations are based on statistics from Private
Pension Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports,
Employee Benefits Security Administration (2020), Table A1, <a href="https://www.dol.gov/sites/dolgov/files/EBSA/researchers/statistics/retirement-bulletins/private-pension-plan-bulletins-abstract-2018.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/researchers/statistics/retirement-bulletins/private-pension-plan-bulletins-abstract-2018.pdf</a>. This estimate is calculated as 9% x 588,499 401(k) type
plans = 52,965 rounded to 53,000.
\68\ Brad Smith & Kelly Regan, NEPC ESG Survey: A Profile of
Corporate & Healthcare Plan Decisionmakers' Perspectives, NEPC (Jul.
11, 2018), <a href="https://cdn2.hubspot.net/hubfs/2529352/files/2018%2007%20NEPC%20ESG%20Survey%20Results%20.pdf?t=1532123276859">https://cdn2.hubspot.net/hubfs/2529352/files/2018%2007%20NEPC%20ESG%20Survey%20Results%20.pdf?t=1532123276859</a>.
\69\ 2019 ESG Survey, Callan Institute (2019), <a href="http://www.callan.com/wp-content/uploads/2019/09/2019-ESG-Survey.pdf">www.callan.com/wp-content/uploads/2019/09/2019-ESG-Survey.pdf</a>.
\70\ DOL calculations are based on statistics from Private
Pension Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports,
Employee Benefits Security Administration (2020), Table A1, <a href="https://www.dol.gov/sites/dolgov/files/EBSA/researchers/statistics/retirement-bulletins/private-pension-plan-bulletins-abstract-2018.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/researchers/statistics/retirement-bulletins/private-pension-plan-bulletins-abstract-2018.pdf</a>. This estimate is calculated as 19% x (721,876 pension
plans-588,499 401(k) type plans) = 25,342 rounded to 25,300.
\71\ DOL calculations are based on statistics from Private
Pension Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports,
Employee Benefits Security Administration (2020), Table A1, <a href="https://www.dol.gov/sites/dolgov/files/EBSA/researchers/statistics/retirement-bulletins/private-pension-plan-bulletins-abstract-2018.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/researchers/statistics/retirement-bulletins/private-pension-plan-bulletins-abstract-2018.pdf</a>. This estimate is calculated as 52,965 participant-directed
individual account plans + 25,342 defined benefit and
nonparticipant-directed defined contribution plans = 78,307 plans
rounded to 78,300. 78,307 affected pension plans / 721,876 total
pension plans = 10.8% rounded to 11%.
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An estimate of 11 percent is our best approximation of the share of
plans that were using ESG factors under the prior non-regulatory
guidance. The Department anticipates that all plans using ESG factors
would be affected in some way by the proposal. The estimate is a lower
bound because it is likely that more plans will start to consider ESG
factors, including climate-related financial risk, as a result of the
new rule, as is already evidenced by the growing consideration of
climate-related financial risk and ESG factors by investors through
entities such as the Task Force on Climate-Related Financial
Disclosure.\72\ Furthermore, ESG factors are becoming more mainstream
for the investment community. Morningstar data shows that between 2015
and 2020, assets under management in sustainable funds increased by
more than four times.\73\ This growth may well carry over to ERISA
plans and participants.
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\72\ See additional studies on the growing body of evidence for
value creation from ESG investing here: CFA Institute, ``Climate
Change Analysis in the Investment Process,'' (2020) <a href="https://www.cfainstitute.org/en/research/industry-research/climate-change-analysis">https://www.cfainstitute.org/en/research/industry-research/climate-change-analysis</a>. A growing number of investors are also participating in
the Task Force on Climate-Related Financial Disclosure and the
Taskforce on Nature-related Financial Disclosures.
\73\ Morningstar, ``Sustainable Funds U.S. Landscape Report:
More Funds, More Flows, and Impressive Returns in 2020,'' (February
10, 2021), <a href="https://www.morningstar.com/lp/sustainable-funds-landscape-report">https://www.morningstar.com/lp/sustainable-funds-landscape-report</a>.
---------------------------------------------------------------------------
These statistics do not reflect, however, the proportion of plan
assets actually invested in ESG options. One recent survey indicates
that the average DC plan has less than 0.1 percent of its assets
invested in ESG funds.\74\
---------------------------------------------------------------------------
\74\ 63rd Annual Survey of Profit Sharing and 401(k) Plans, Plan
Sponsor Council of America (2020).
---------------------------------------------------------------------------
b. Subset of Plans Affected by Proposed Modifications of Paragraph (e)
of Sec. 2550.404a-1
The proposal, at paragraph (d), would codify longstanding
principles of prudence and loyalty applicable to the exercise of
shareholder rights, including proxy voting, the use of written proxy
voting policies and guidelines, and the selection and monitoring of
proxy advisory firms. In particular, paragraph (d) of the proposal
would adopt the Department's longstanding position, which was first
issued in guidance in the 1980s, that the fiduciary act of managing
plan assets includes the management of voting rights (as well as other
shareholder rights) appurtenant to shares of stock. Paragraph (d) of
the proposal also would eliminate the two safe harbors in paragraphs
(e)(3)(i)(A) and (B) of Sec. 2550.404a-1.
Under paragraph (d) of the proposal, when deciding whether to
exercise shareholder rights and when exercising such rights, including
the voting of proxies, fiduciaries must carry out their duties
prudently and solely in the interests of the participants and
beneficiaries and for the exclusive purpose of providing benefit to
participants and beneficiaries and defraying the reasonable expenses of
administering the plan. Nevertheless, because affected parties will or
could be impacted by the proposal should it become a final rule (for
example, at minimum they will have to review the proposed regulation
for compliance), an assessment of affected parties follows, but the
Department considers the number of affected parties to be an upper
bound.
Paragraph (d) of the proposal would affect ERISA-covered pension,
health, and other welfare plans that hold shares of corporate stock. It
would affect plans with respect to stocks that they hold directly, as
well as with respect to stocks they hold through ERISA-covered
intermediaries, such as common trusts, master trusts, pooled separate
accounts, and 103-12 investment entities. Paragraph (d) would not
affect plans with respect to stock held through registered investment
companies, because it would not apply to such funds' internal
management of such underlying investments. Paragraph (d) of the
proposal also would not apply to voting, tender, and similar rights
with respect to securities that are passed through pursuant to the
terms of an individual account plan to participants and beneficiaries
with accounts holding such securities.
ERISA-covered plans annually report data on their asset holdings.
However, only plans that file the Form 5500 schedule H report their
stock holdings as a separate line item (see Table 1). Most of these
plans filing schedule H have 100 or more participants (large
plans).\75\ Additionally, all plans with employer stock report their
holdings on either schedule H or schedule I. However, schedule I lacks
the specificity to determine if small plans hold employer stock or
other employer securities. Approximately 27,000 defined contribution
plans and 5,000 defined benefit plans, with approximately 84 million
participants, file the schedule H and report holding common stocks or
are an Employee Stock Ownership Plan (ESOP). Additionally, 573 health
and other welfare plans file the schedule H and report holding common
stocks either
[[Page 57287]]
directly or indirectly. In total, pension plans and welfare plans
filing schedule H hold approximately $1.7 trillion in common stock
value. Common stocks constitute about 25 percent of total assets of
those pension plans that are not ESOPs and hold common stock. Out of
the 25,400 pension plans that hold common stock and are not ESOPs,
about 20,000 plans hold common stock through an ERISA-covered
intermediary and approximately 3,500 plans hold common stock directly.
A smaller number of plans hold stock both directly and indirectly.\76\
In total, information is available on approximately 32,000 pension
plans, welfare plans, and ESOPs that hold either common stock or
employer stock.
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\75\ 431 plans with less than 100 participants filed the Form
5500 schedule H and reported holding common stock.
\76\ DOL estimates from the 2018 Form 5500 Pension Research
Files.
Table 1--Number of Pension and Welfare Plans Reporting Holding Common Stocks or ESOP by Type of Plan, 2018 a
----------------------------------------------------------------------------------------------------------------
Common stock (no employer Defined Defined Total pension Total all
securities) benefit contribution plans Welfare plans plans
----------------------------------------------------------------------------------------------------------------
Direct Holdings Only........... 1,272 2,286 3,558 569 4,127
Indirect Holdings Only......... 2,792 17,591 20,383 3 20,386
Both Direct and Indirect....... 941 586 1,527 1 1,528
--------------------------------------------------------------------------------
Total...................... 5,005 20,463 25,468 573 26,041
----------------------------------------------------------------------------------------------------------------
ESOP (No Common Stock)......... .............. 5,809 5,809 .............. 5,809
Common Stock and ESOP.......... .............. 591 591 .............. 591
--------------------------------------------------------------------------------
Total All Plans Holding 5,005 26,863 31,868 573 32,441
Stocks....................
----------------------------------------------------------------------------------------------------------------
\a\ DOL calculations from the 2018 Form 5500 Pension Research Files.
There are approximately 629,000 small pension plans that hold
assets, and some may invest in stock.\77\ Given that fewer than 1
percent of small plans file a Schedule H, there is minimal data
available about small plans' stock holdings. While the majority of
participants and assets are in large plans, most plans are small plans.
The Department lacks sufficient data to estimate the number of small
plans that hold stock, but it assumes that small plans are
significantly less likely to hold stock than larger plans. Many small
plans may hold stock only through mutual funds, and consequently would
not be significantly affected by paragraph (d) of this proposal. The
Department asks for comments on the impacts on small plans holding
stock only through mutual funds. For purposes of illustrating the
number of small plans that could be affected, the Department
preliminarily assumes that five percent of small plans, or 31,470 small
pension plans, hold stock. The Department requests comments on this
assumption.
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\77\ The Form 5500 does not require these plans to categorize
the assets as common stock, so the Department does not know if they
hold stock.
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The combined effect of these assumptions is an estimate of 63,911
plans, large and small, that would be affected by the proposed
amendments pertaining to proxy voting.
While paragraph (d) of this proposed rule would directly affect
ERISA-covered plans that possess the relevant shareholder rights, the
activities covered under paragraph (d) would be carried out by
responsible fiduciaries on plans' behalf. Many plans hire asset
managers to carry out fiduciary asset management functions, including
proxy voting. In 2018, large ERISA plans reportedly used approximately
17,800 different service providers, some of whom provide services
related to the exercise of plans' shareholder rights.\78\ Such service
providers include trustees, trust companies, banks, investment
advisers, investment managers, and proxy advisory firms.\79\ Asset
managers hired as fiduciaries to carry out proxy voting functions would
be subject to the proposal to the same extent as a plan trustee or
named fiduciary. The proposal could indirectly affect proxy advisory
firms to the extent that plan fiduciaries opt for customized
recommendations about which particular proxy proposals to vote or how
they should cast their vote. Plans' preferences for proxy advice
services moreover could shift to prioritize services offering more
rigorous and impartial recommendations. These effects may be more
muted, however, if recent rule amendments by the Securities and
Exchange Commission (SEC) enhance the transparency, accuracy, and
completeness of the information provided to clients of proxy voting
firms in connection with proxy voting decisions.\80\
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\78\ One commenter pointed out that in a proprietary survey of
the largest pension funds and defined contribution plans,
approximately 92 percent of the respondents indicated that they have
formally delegated proxy voting responsibilities to another named
fiduciary (e.g., an Investment Manager), and approximately 42
percent of respondents engage a proxy advisory firm (directly or
indirectly) to help with voting some or all proxies.
\79\ DOL estimates are derived from the 2018 Form 5500 Schedule
C.
\80\ In September 2019, the SEC issued an interpretation and
guidance addressing the application of the proxy rules to proxy
voting advice businesses. Commission Interpretation and Guidance
Regarding the Applicability of the Proxy Rules to Proxy Voting
Advice, 84 FR 47416 (Sept. 10, 2019) (``2019 Interpretation and
Guidance''). In July of 2020, The SEC adopted amendments to 17 CFR
240.14a-1(l), 240.14a-2(b), and 240. 14a-9 (Rules 14a-1(l), 14a-
2(b), and 14a-9) concerning proxy voting advice. See Exemptions from
the Proxy Rules for Proxy Voting Advice, 85 FR 55082 (Sept. 3, 2020)
(``2020 Rule Amendments''). On June 1, 2021, SEC Chair Gary Gensler
directed SEC staff to consider whether to recommend further
regulatory action regarding proxy voting advice. In particular, SEC
staff are to consider whether to recommend that the SEC revisit its
2020 codification of the definition of solicitation as encompassing
proxy voting advice, the 2019 Interpretation and Guidance regarding
that definition, and the conditions on exemptions from the
information and filing requirements in the 2020 Rule Amendments,
among other matters.
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1.3. Benefits
The proposed amendments would clarify the legal standard imposed by
sections 404(a)(1)(A) and 404(a)(1)(B) of ERISA with respect to the
selection of a plan investment or investment course of action, and to
the exercise of shareholder rights, including proxy voting. As
indicated above, a significant benefit of the proposal is that it
clearly permits plan fiduciaries to consider climate change and other
ESG factors that are often material, and to exercise shareholder rights
that may enhance the value of plan investments. As discussed above, the
Department is concerned that
[[Page 57288]]
the current rule discouraged plan fiduciaries from such considerations
and activities, even when financially material to the plan.
Stakeholders told the Department that the current regulation has
already had a chilling effect on appropriate integration of material
climate change and other ESG factors in investment decisions. Acting on
material climate change and other ESG factors in these contexts, and in
a manner consistent with the proposal, will redound, in the first
instance, to employee benefit plans covered by ERISA and their
participants and beneficiaries, and secondarily, to society more
broadly but without any detriment to the participants and beneficiaries
in ERISA plans. The Department anticipates that the resulting benefits
will be appreciable.
Paragraph (b) of the proposal addresses ERISA section
404(a)(1)(B)'s duty of prudence and clarifies how that duty applies to
a fiduciary's consideration of an investment or investment course of
action. Paragraphs (b)(1)-(3) of the proposal carry forward much of the
same regulatory language that has been in place since 1979. The
preservation of settled law should avoid the imposition of new costs.
Paragraph (b)(2)(ii)(C) adds that a prudent fiduciary's consideration
of the projected return of a portfolio relative to the funding
objectives of a plan may often require an evaluation of the economic
effects of climate change on the particular investment or investment
course of action. Similar to paragraph (b)(4) of the proposal, this new
provision is intended to counteract the negative perception regarding
the use of climate change and other ESG factors, including climate-
related financial risk, in investment decisions caused by the 2020
Rules, and to clarify that a fiduciary's duty of prudence may require
an evaluation of the effect of climate change and/or government policy
changes to address climate change on investments' risks and returns.
Paragraph (b)(4), which complements paragraph (b)(2)(ii)(C), is a
new provision that addresses uncertainty under the current regulation
as to whether a fiduciary may consider climate change and other ESG
factors in making plan-related decisions under ERISA. This paragraph
clarifies and confirms that a fiduciary may consider any factor that is
material to the risk-return analysis, including climate change and
other ESG factors. The intent of this new paragraph is to establish
through examples that material climate change and other ESG factors are
no different than other ``traditional'' material risk-return factors
and to remove prejudice to the contrary. Thus, under ERISA, if a
fiduciary prudently concludes climate change and other ESG factors are
material to an investment or investment course of action under
consideration, the fiduciary can and should consider them and act
accordingly, as would be the case with respect to any material risk-
return factor. For the sake of clarity and to eliminate any doubt
caused by the current regulation, paragraph (b)(4) of the proposal
provides examples of factors, including climate change and other ESG
factors, that a fiduciary may consider in the evaluation of an
investment or investment course of action if material, including: (i)
Climate change-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; (ii) governance factors, such as those
involving board composition, executive compensation, transparency and
accountability in corporate decision-making, as well as a corporation's
avoidance of criminal liability and compliance with labor, employment,
environmental, tax, and other applicable laws and regulations; and
(iii) workforce practices, including the corporation's progress on
workforce diversity, inclusion, and other drivers of employee hiring,
promotion, and retention; its investment in training to develop its
workforce's skill; equal employment opportunity; and labor relations.
Much of the anticipated economic benefits under this proposal
derive from the examples in paragraph (b)(4) and the clarity they
provide to plan fiduciaries. In the Department's view, and consistent
with the comments of the concerned stakeholders mentioned above, the
examples in paragraph (b)(4) of the proposal should go a long way to
overcoming unwarranted concerns about investing in climate-change-
focused or ESG-sensitive funds that are economically advantageous to
plans.
Paragraph (c)(1) of the proposal addresses the application of the
duty of loyalty under ERISA as applied to a fiduciary's consideration
of an investment or investment course of action. The primary benefit of
this provision to plan participants and beneficiaries is that it
clarifies in no uncertain terms that a plan 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 benefits or goals unrelated to
the interests of participants and beneficiaries in their retirement
income or financial benefits under the plan. By ensuring that plan
fiduciaries may not sacrifice investment returns or take on additional
investment risk to promote unrelated goals, this provision (paragraph
(c)(1)) is expected to lead to increased investment returns over the
long run, which would accrue to participants and sponsors of ERISA-
covered plans. Over the years, the Department has stated this bedrock
principle of loyalty many times in non-regulatory guidance and this
proposal, like the current regulation, would incorporate the principle
directly into title 29 of the Code of Federal Regulations. This
incorporation would result in a higher degree of permanency and
certainty for plan fiduciaries, relative to periodic restatements in
non-regulatory guidance, and as such is considered a benefit.
Paragraph (c)(2) of the proposal directly supports paragraph (c)(1)
of the proposal by giving fiduciaries concrete direction by restating
the longstanding principle that a fiduciary's evaluation of an
investment or investment course of action must be based on risk and
return factors that the fiduciary prudently determines are material to
investment value, based on an appropriate investment horizon consistent
with the plan's investment objectives and taking into account the
funding policy of the plan. When plan fiduciaries follow this
directive, they can be certain that they have not subordinated the
interests of participants and beneficiaries of the plan to goals
unrelated to the provision of retirement income or financial benefits
under the plan. Plan fiduciaries and plan participants will benefit
from this simple and clear directive.
Paragraph (c)(2), importantly, cross references paragraph (b)(4) of
the proposal to clarify that a fiduciary is not disloyal under ERISA
if, after a prudent analytical process, the fiduciary determines
climate change or other ESG factors are relevant to the risk-return
analysis of a particular investment or investment course of action.
Paragraphs (c)(2) and (b)(4) of the proposal, combined, thus would lay
to rest any remaining ambiguity or uncertainty, resulting from the
Department's prior guidance or the current regulation, regarding
whether these factors are impermissible tools for a plan fiduciary to
use when selecting an investment or investment course of action.
Removing this uncertainty is considered a primary
[[Page 57289]]
benefit of this proposal, as is the requirement that the plan fiduciary
only use these tools when prudently determining they are relevant to
the risk-return analysis, or as tie-breakers when competing investment
alternatives would equally serve the plans' interests. The Department
has recognized that fiduciaries can appropriately consider material ESG
factors multiple times over the years in various preambles and non-
regulatory guidance documents.\81\ Despite that repeated recognition,
many stakeholders continue to have confusion or doubt on the matter.
Paragraph (c)(2) of the proposal would clearly redress any lingering
uncertainty by explicitly acknowledging that a fiduciary may consider
any factors in the evaluation of an investment or investment course of
action that are material to the risk-return analysis, including climate
change and other ESG factors.
---------------------------------------------------------------------------
\81\ See, e.g., 85 FR 72857, 80 FR 65136.
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As described above, paragraph (c)(3) of the proposal would replace
the tie-breaker provision in the current regulation with a formulation
that is intended to be broader. In relevant part paragraph (c)(3)
provides that, if, after the analysis in paragraph (c)(2) of the
proposal, a fiduciary prudently concludes that competing investments or
investment courses of action equally serve the financial interests of
the plan over the appropriate time horizon, the fiduciary is not
prohibited from selecting the investment, or investment course of
action, based on collateral benefits other than investment returns.
Paragraph (c)(3) also would not carry forward the documentation
requirements contained in paragraphs (c)(2)(i) through (iii) of the
current regulation, which stakeholders identified as potentially
burdensome and effectively singles out climate change and other ESG
investments for special scrutiny. Regardless of the frequency of ties,
stakeholders point to these particularized documentation provisions as
casting an unnecessarily negative shadow on investments or investment
courses of action that are otherwise prudent. Paragraph (c)(3) of the
proposal thus permits fiduciaries to take into account an investment's
potential collateral effects, including potential increases in plan
contributions, to break a tie. This, too, is considered a benefit of
the proposal.
The clarifications provided by paragraphs (b) and (c) of this
proposal relate to the appropriate use of climate change and other ESG
factors by plan fiduciaries in selecting investments or investment
courses of action. Reflective of the significant economic impacts of
climate change to date across various sectors of the economy, the
Department believes it is often appropriate to treat climate change as
a material risk-return factor in the assessment of investments. As
noted in a U.S. Commodity Futures Trading Commission (CFTC) report in
2020: ``Climate change is already impacting or is anticipated to impact
nearly every facet of the economy, including infrastructure,
agriculture, residential and commercial property, as well as human
health and labor productivity . . . Risks include disorderly price
adjustments in various asset classes, with possible spillovers into
different parts of the financial system, as well as potential
disruption of the proper functioning of financial markets.'' \82\ The
CFTC report states: ``[c]limate change could pose systemic risks to the
U.S. financial system . . . [and that] the United States and financial
regulators should . . . confirm the appropriateness of making
investment decisions using climate-related factors in retirement and
pension plans covered by [ERISA] as well as non-ERISA managed
situations where there is fiduciary duty.'' \83\ A Government
Accountability Office Report to Congress in 2021 noted the exposure
risk of retirement investment plans specifically to climate change,\84\
and it is estimated that there is approximately $970 billion in value
at risk due to climate change for the world's 500 largest
companies.\85\ According to a Federal Reserve Board report in 2020,
``[c]limate change, which increases the likelihood of dislocations and
disruptions in the economy, is likely to increase financial shocks and
financial system vulnerabilities that could further amplify these
shocks.'' \86\ The report further states: ``Opacity of exposures and
heterogeneous beliefs of market participants about exposures to climate
risks can lead to mispricing of assets and the risk of downward price
shocks.'' \87\ BlackRock describes the repercussions of these broad
market events on investors, stating: ``[i]nvestors are increasingly . .
. recognizing that climate risk is investment risk . . . [and that]
these questions are driving a profound reassessment of risk and asset
values.'' \88\ It further states: ``And because capital markets pull
future risk forward, we will see changes in capital allocation more
quickly than we see changes to the climate itself. In the near future--
and sooner than most anticipate--there will be a significant
reallocation of capital.'' \89\ Several pension funds have already
divested from certain investments in part in response to climate-
related risk. Both the New York City Employees' Retirement System and
the New York City Teachers' Retirement System, for example, have
committed to divesting away from fossil fuel-related investments.\90\
---------------------------------------------------------------------------
\82\ Climate-Related Market Risk Subcommittee, ``Managing
Climate Risk in the U.S. Financial System'' Washington, DC: U.S.
Commodity Futures Trading Commission, Market Risk Advisory Committee
(2020) <a href="https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf">https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf</a>.
\83\ Id.
\84\ U.S. Government Accountability Office, ``Retirement
Savings: Federal Workers' Portfolios Should Be Evaluated For
Possible Financial Risks Related to Climate Change'' (2021) <a href="https://www.gao.gov/assets/gao-21-327.pdf">https://www.gao.gov/assets/gao-21-327.pdf</a>.
\85\ ``Global Climate Change Analysis 2018,'' CDP (June 2019).
\86\ Board of Governors of the Federal Reserve System,
``Financial Stability Report,'' (November 2020) <a href="https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf">https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf</a>.
\87\ Id.
\88\ BlackRock, ``A Fundamental Reshaping of Finance,'' Larry
Fink's 2020 Letter to CEOs. <a href="https://www.blackrock.com/us/individual/larry-fink-ceo-letter">https://www.blackrock.com/us/individual/larry-fink-ceo-letter</a>.
\89\ Id.
\90\ Ross Kerber and Kanishka Singh, ``NYC pension funds vote to
divest $4 billion from fossil fuels,'' (January 25, 2021) <a href="https://www.reuters.com/article/us-usa-new-york-fossil-fuels-pensions/nyc-pension-funds-vote-to-divest-4-billion-from-fossil-fuels-idUSKBN29U23Q">https://www.reuters.com/article/us-usa-new-york-fossil-fuels-pensions/nyc-pension-funds-vote-to-divest-4-billion-from-fossil-fuels-idUSKBN29U23Q</a>.
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There is a breadth of literature that provides evidence for the
materiality of climate change as a driver of risk-adjusted returns.
These risks are often referred to in two broad categories: physical
risk and transition risk. Physical risk captures the financial impacts
associated with a rise in extreme weather events and a changing
climate--both chronic and acute. The literature maintains that these
risks can be especially material for long duration assets and grow in
severity the more that climate mitigation and adaptation are
neglected.\91\ We are already seeing significant economic costs as a
result of warming, and a certain amount of additional warming is
guaranteed based on the greenhouse gas pollution already in the
atmosphere.\92\ This implies that
[[Page 57290]]
the physical risks of climate change to our economy and to investments
will persist. A 2019 report from BlackRock notes that the physical risk
of extreme weather poses growing risks that are underpriced in certain
sectors and asset classes.\93\ Additionally, S&P Trucost found that
almost 60 percent of the companies in the S&P500 index hold assets that
were at high risk to the physical effects of climate change.\94\
---------------------------------------------------------------------------
\91\ Climate-Related Market Risk Subcommittee, ``Managing
Climate Risk in the U.S. Financial System,'' U.S. Commodity Futures
Trading Commission, Market Risk Advisory Committee (2020).
\92\ Renee Cho, ``How Climate Change Impacts the Economy,''
(June 20, 2019) <a href="https://news.climate.columbia.edu/2019/06/20/climate-change-economy-impacts/">https://news.climate.columbia.edu/2019/06/20/climate-change-economy-impacts/</a> Celso Brunetti, Benjamin Dennis,
Dylan Gates, Diana Hancock, David Ignell, Elizabeth K. Kiser,
Gurubala Kotta, Anna Kovner, Richard J. Rosen, and Nicholas K.
Tabor, ``Climate Change and Financial Stability,'' FEDS Notes.
Washington: Board of Governors of the Federal Reserve System, March
19, 2021, <a href="https://doi.org/10.17016/2380-7172.2893">https://doi.org/10.17016/2380-7172.2893</a>.
\93\ BlackRock Investment Institute, ``Getting Physical:
Assessing Climate Risks,'' (2019) <a href="https://www.blackrock.com/us/individual/insights/blackrock-investment-institute/physical-climate-risks">https://www.blackrock.com/us/individual/insights/blackrock-investment-institute/physical-climate-risks</a>.
\94\ S&P Trucost Limited, Understanding Climate Risk at the
Asset Level: The Interplay of Transition and Physical Risks (2019)
<a href="https://www.spglobal.com/_division_assets/images/special-editorial/understanding-climate-risk-at-the-asset-level/sp-trucost-interplay-of-transition-and-physical-risk-report-05a.pdf">https://www.spglobal.com/_division_assets/images/special-editorial/understanding-climate-risk-at-the-asset-level/sp-trucost-interplay-of-transition-and-physical-risk-report-05a.pdf</a>.
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Additionally, existing government policies and increasingly
ambitious national and international greenhouse reduction goals will
continue to create significant transition risk for investments.
Transition risk reflects the risks that carbon-dependent businesses
lose profitability and market share as government policies and new
technology drive the transition to a carbon-neutral economy. Studies
assess the value of global financial assets at risk from climate change
to be in the range of $2.5 trillion to $4.2 trillion, including
transition risks and other impacts from climate change.\95\ A 2016
report found that the total value of assets in an average U.S. public
pension portfolio could be 6 percent lower by 2050 than under a
business-as-usual scenario due largely to transition risks associated
with climate change.\96\
---------------------------------------------------------------------------
\95\ EY, ``Climate Change: The Investment Perspective,'' (2016)
<a href="https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/banking-and-capital-markets/ey-climate-change-and-investment.pdf">https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/banking-and-capital-markets/ey-climate-change-and-investment.pdf</a>.
\96\ Mercer and Center for International Environmental Law,
``Trillion-Dollar Transformation: A Guide to Climate Change
Investment Risk Management for US Public Defined Benefit Trustees''
(October 2016).
---------------------------------------------------------------------------
It is worth noting that climate change also represents a
substantial investment opportunity, with research suggesting that
investment in climate change mitigation will produce increasingly
attractive yields.\97\ Addressing transition risks can present
opportunities to identify companies and investments that are
strategically positioning themselves to succeed in the transition.
Gradual, yet meaningful, shifts in investor preferences toward
sustainability and the growing recognition that climate risk is
investment risk may lead to a long-term reallocation of capital that
will have a self-fulfilling impact on risk and return.
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\97\ Channell, Curmi, Nguyen, Prior, Syme, Jansen, Rahbari,
Morse, Kleinman, Kruger, ``Energy Darwinism II'', Citi, August 2015,
(copyright) 2015. Citigroup5``World Energy Investment Outlook'',
International Energy Agency, June 2014, (copyright) 2014 OECD/IEA.
---------------------------------------------------------------------------
Given this substantial body of evidence, the Department welcomes
comments on whether fiduciaries should consider climate change as
presumptively material in their assessment of investment risks and
returns, if adopted. If yes, comments also are welcome on the proper
evidentiary bases to rebut such a presumption. The Department also
welcomes comments on the extent to which climate-related financial risk
is not already incorporated into market pricing.
Other ESG issues can often be material in the assessment of
investment risks and returns. This is not to say that ESG factors are
material in every instance, or that funds that use ESG screens can be
expected to outperform other funds on a systematic basis. While there
is a growing body of literature on a wide range of ESG investing
generally outside of ERISA, its findings vary. Outside the ERISA
context, investors may choose to invest in funds that promote
collateral objectives, and even choose to sacrifice return or increase
risk to achieve those objectives. Such conduct, however, would be
impermissible for ERISA plan fiduciaries, who cannot sacrifice return
or increase risk for the purpose of promoting collateral goals
unrelated to the economic interests of plan participants in their
benefits. The Department requests comments specifically addressing any
evidence on the financial materiality of ESG factors in various
investment contexts.
The body of research evaluating ESG investing as a whole shows ESG
investing has financial benefits, although the literature overall has
varied findings. In a large meta-study of peer-reviewed articles
published between 2015 and 2020, Whelan et al. (2021) find that most
studies show that ESG investing has positive effects on financial
performance.\98\ Some specific studies have shown that ESG investing
outperforms conventional investing. Verheyden, Eccles, and Feiner's
research analyzes stock portfolios that used negative screening \99\ to
exclude operating companies with poor ESG records from the
portfolios.\100\ The study finds that negative screening tends to
increase a stock portfolio's annual performance by 0.16 percent.
Similarly, Kempf and Osthoff's research, which examines stocks in the
S&P 500 and the Domini 400 Social Index (renamed as the MSCI KLD 400
Social Index in 2010), finds that it is financially beneficial for
investors to positively screen their portfolios.\101\ Additionally,
Ito, Managi, and Matsuda's research finds that socially responsible
funds outperformed conventional funds in the European Union and United
States.\102\ Additional studies found a positive relationship between
ESG investing and firms' market valuation.\103\
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\98\ Tensie Whelan, Ulrich Atz, Tracy Van Holt, and Casey Clark,
``ESG and Financial Performance: Uncovering the Relationship by
Aggregating Evidence from 1,000 Plus Studies Published Between 2015-
2020,'' NYU Stern Center for Sustainable Business and Rockefeller
Asset Management (2021). <a href="https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf">https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf</a>.
\99\ Negative screening refers to the exclusion of certain
sectors, companies, or practices from a fund or portfolio based on
ESG criteria.
\100\ Tim Verheyden, Robert G. Eccles, and Andreas Feiner, ESG
for all? The Impact of ESG Screening on Return, Risk, and
Diversification. 28 Journal of Applied Corporate Finance 2 (2016).
\101\ Alexander Kempf and Peer Osthoff, The Effect of Socially
Responsible Investing on Portfolio Performance, 13 European
Financial Management 5 (2007).
\102\ Yutaka Ito, Shunsuke Managi, and Akimi Matsuda,
Performances of Socially Responsible Investment and Environmentally
Friendly Funds, 64 Journal of the Operational Research Society 11
(2013).
\103\ De Villiers and Ana Marques, Corporate Social
Responsibility, Country-Level Predispositions, and the Consequences
of Choosing a Level of Disclosure, Accounting and Business Research,
Taylor & Francis Journals, Vol. 46(2) (2016). Dhaliwal, Dan, Suresh
Radhakrishnan, Albert Tsang, and Yong George Yang, Nonfinancial
Disclosure and Analyst Forecast Accuracy: International Evidence on
Corporate Social Responsibility Disclosure, The Accounting Review
Vol. 87(3) (2012). Godfrey, Paul C., Craig B. Merrill, and Jared M.
Hansen, The Relationship between Corporate Social Responsibility and
Shareholder Value: An Empirical Test of the Risk Management
Hypothesis, Strategic Management Journal, Vol. 30(4) (2009). Guidry,
Ronald. and Patten, Dennis, Market Reactions to the
First[hyphen]Time Issuance of Corporate Sustainability Reports:
Evidence that Quality Matters, Sustainability Accounting, Management
and Policy Journal, Vol. 1(1) (2010). Marsat,Sylvain and Benjamin
Williams, CSR and Market Valuation: International Evidence, Bankers
Markets & Investors: an Academic & Professional Review, Groupe
Banque, Vol. 123 (2013). Marvelskemper, Laura and Daniel Streit,
Enhancing Market Valuation of ESG Performance: Is Integrated
Reporting Keeping its Promise? Business Strategy and the
Environment, Wiley Blackwell, Vol. 26(4) (2017). Sharfman, Mark and
Chitru Fernando, Environmental Risk Management and the Cost of
Capital. Strategic Management Journal, Vol. 29(6) (2008).
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In contrast, however, other studies have found that ESG investing
has resulted in lower returns than conventional investing. For example,
Winegarden shows that over ten years, a portfolio of ESG funds has a
return that is 43.9 percent lower than if it had
[[Page 57291]]
been invested in an S&P 500 index fund.\104\ Trinks and Scholten's
research, which examines socially responsible investment funds, finds
that a screened market portfolio significantly underperforms an
unscreened market portfolio.\105\ Ferruz, Mu[ntilde]oz, and Vicente's
research, which examines U.S. mutual funds, finds that a portfolio of
mutual funds that implements negative screening underperforms a
portfolio of conventionally matched pairs.\106\ Likewise, Ciciretti,
Dal[ograve], and Dam's research, which analyzes a global sample of
operating companies, finds that companies that score poorly in terms of
ESG indicators have higher expected returns.\107\ Marsat and Williams'
research has very similar findings.\108\ Operating companies with
better ESG scores according to MSCI had lower market valuation. The
reviewed studies in this paragraph may not be completely representative
of ERISA investment outcomes. The studies generally do not limit their
focus to investments by ERISA plan fiduciaries. ERISA fiduciaries must
focus on financial materiality with undivided loyalty. Thus, to the
extent a study analyzes investments that fail to meet these fiduciary
standards, it will likely observe investment outcomes that have a
weaker performance.
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\104\ Wayne Winegarden, Environmental, Social, and Governance
(ESG) Investing: An Evaluation of the Evidence. Pacific Research
Institute (2019).
\105\ Pieter Jan Trinks and Bert Scholtens, The Opportunity Cost
of Negative Screening in Socially Responsible Investing, 140 Journal
of Business Ethics 2 (2017).
\106\ Luis Ferruz, Fernando Mu[ntilde]oz, and Ruth Vicente,
Effect of Positive Screens on Financial Performance: Evidence from
Ethical Mutual Fund Industry (2012).
\107\ Rocco Ciciretti, Ambrogio Dal[ograve], and Lammertjan Dam,
The Contributions of Betas versus Characteristics to the ESG Premium
(2019).
\108\ Sylvain Marsat and Benjamin Williams, CSR and Market
Valuation: International Evidence. Bankers, Markets & Investors: An
Academic & Professional Review, Groupe Banque (2013).
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Furthermore, there are many studies with mixed or inconclusive
results. Goldreyer and Diltz's research, which examines 49 socially
responsible mutual funds, finds that employing positive social screens
does not affect the investment performance of mutual funds.\109\
Similarly, Renneboog, Ter Horst, and Zhang's research, which analyzes
global socially responsible mutual funds, finds that the risk-adjusted
returns of socially responsible mutual funds are not statistically
different from conventional funds.\110\ Bello's research, which
examines 126 mutual funds, finds that the long-run investment
performance is not statistically different between conventional and
socially responsible funds.\111\ Likewise, Ferruz, Mu[ntilde]oz, and
Vicente's research finds that a portfolio of mutual funds that
implement positive screening \112\ performs equally well as a portfolio
of conventionally matched pairs.\113\ Finally, Humphrey and Tan's
research, which examines socially responsible investment funds, finds
no evidence of negative screening affecting the risks or returns of
portfolios.\114\
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\109\ Elizabeth Goldreyer and David Diltz, The Performance of
Socially Responsible Mutual Funds: Incorporating Sociopolitical
Information in Portfolio Selection, 25 Managerial Finance 1 (1999).
\110\ Luc Renneboog, Jenke Ter Horst, and Chendi Zhang, The
Price of Ethics and Stakeholder Governance: The Performance of
Socially Responsible Mutual Funds, 14 Journal of Corporate Finance 3
(2008).
\111\ Zakri Bello, Socially responsible investing and portfolio
diversification, 28 Journal of Financial Research 1 (2005).
\112\ Positive screening refers to including certain sectors and
companies that meets the criteria of non-financial objectives.
\113\ Ferruz, Mu[ntilde]oz, and Vicente, Effect of Positive
Screens on Financial Performance (2012).
\114\ Jacquelyn Humphrey and David Tan, Does It Really Hurt to
be Responsible?, 122 Journal of Business Ethics 3 (2014).
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Many compelling studies show the material financial benefits of
diverse and inclusive workplaces. There are three main vectors across
which a company's diversity and inclusion practices can have a
financially material impact on their business: Employee recruitment and
retention, performance and productivity, and litigation. Examples of
this material impact are outlined below:
Employee Recruitment and Retention
<bullet> In a survey of 2,745 respondents, the job site Glassdoor
found that 76% of employees and job seekers overall look at workforce
diversity when evaluating an offer.\115\
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\115\ ``What Job Seekers Really Think About Your Diversity and
Inclusion Stats,'' Glassdoor (July 12, 2021) <a href="https://www.glassdoor.com/employers/blog/diversity/">https://www.glassdoor.com/employers/blog/diversity/</a>. ``Glassdoor's Diversity
and Inclusion Workplace Survey,'' (updated September 30, 2020),
<a href="https://www.glassdoor.com/blog/glassdoors-diversity-and-inclusion-workplace-survey/">https://www.glassdoor.com/blog/glassdoors-diversity-and-inclusion-workplace-survey/</a>.
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<bullet> It costs firms an estimated $64 billion per year from
losing and replacing over 2 million American professionals and managers
who leave their jobs each year due to unfairness and
discrimination.\116\
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\116\ Level Playing Field Institute, ``The Cost of Employee
Turnover Due Solely to Unfairness in the Workplace'' (2007).
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<bullet> To replace a departing employee costs somewhere between
$5,000 and $10,000 for an hourly worker, and between $75,000 and
$211,000 for an executive making $100,000 per year.\117\
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\117\ Gail Robinson and Kathleen Dechant, ``Building a business
case for diversity,'' Academy of Management Executive 11 (3) (1997):
21-31.
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Performance and Productivity
<bullet> Empirical evidence finds that an increase of 10 percentage
points in the representation of female directors on a company board is
associated with 6% more patents and 7% more citations for a given
amount of R&D spending.\118\
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\118\ ``Female board representation, corporate innovation and
firm performance.'' Jie Chen, Woon Sau Leung and Kevin P. Evans
(2018).
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<bullet> A study of 171 German, Swiss, and Austrian companies shows
a clear relationship between the diversity of companies' management
teams and the revenues they get from innovative products and
services.\119\
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\119\ Rocio Lorenzo, Nicole Voigt, Karin Schetelig, Annika
Zawadzki, Isabelle Welpe, and Prisca Brosi, ``The Mix that Matters:
Innovation through Diversity,'' BCG (2017).
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<bullet> Research finds that socially different group members do
more than simply introduce new viewpoints or approaches. In the study,
diverse groups outperformed more homogeneous groups not because of an
influx of new ideas, but because diversity triggered more careful
information processing that is absent in homogeneous groups.\120\
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\120\ ``Better Decisions through Diversity,'' Kellogg School of
Management (2010).
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<bullet> When employees think their organization is committed to,
and supportive of diversity and they feel included, employees report
better business performance in terms of ability to innovate, (83%
uplift) responsiveness to changing customer needs (31% uplift) and team
collaboration (42% uplift).\121\
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\121\ ``Waiter, is that inclusion in my soup? A new recipe to
improve business performance,'' Deloitte (2013).
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<bullet> Publicly traded companies with 2D diversity (exhibiting
both inherent and acquired diversity) were 70% more likely to capture a
new market, 75% more likely to see ideas actually become productized,
and 158% more likely to understand their target end-users and innovate
effectively if one or more members on the team represent the user's
demographic.\122\
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\122\ Sylvia Ann Hewlett, Melinda Marshall, Laura Sherbin, and
Tara Gonsalves, ``Innovation, Diversity, and Market Growth,'' Center
for Talent Innovation (2013).
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<bullet> Companies in the top-quartile for gender diversity on
executive teams were 21% more likely to outperform on profitability.
Companies in the top-quartile for ethnic/cultural diversity on
executive teams were 33% more likely to have industry-leading
profitability.\123\
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\123\ Vivian Hunt, Sara Prince, Sundiatu Dixon-Fyle, Lareina Ye,
``Delivering through Diversity,'' McKinsey & Company (January 2018).
---------------------------------------------------------------------------
<bullet> A study on 366 public companies found that those in the
top quartile for ethnic and racial diversity in
[[Page 57292]]
management were 35% more likely to have financial returns above the
median for their industry in their country, and those in the top
quartile for gender diversity were 15% more likely to have returns
above the median for their industry in their country.\124\
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\124\ Vivian Hunt, Dennis Layton, and Sara Prince, ``Why
diversity matters,'' McKinsey & Company (2015).
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Litigation
<bullet> The U.S. Equal Employment Opportunity Commission (EEOC)
received 67,448 charges of workplace discrimination in Fiscal Year (FY)
2020. The agency secured $439.2 million for victims of discrimination
in the private sector and state and local government workplaces through
voluntary resolutions and litigation.\125\
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\125\ ``EEOC Releases Fiscal Year 2020 Enforcement and
Litigation Data,'' (2021).
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Other Cross-Cutting Studies
<bullet> A meta-analysis on 7,939 business units in 36 companies
further confirms that higher employee satisfaction levels are
associated with higher profitability, higher customer satisfaction, and
lower employee turnover.\126\
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\126\ James K. Harter, Frank L. Schmidt, and Theodore L. Hayes,
``Business-Unit-Level Relationship Between Employee Satisfaction,
Employee Engagement, and Business Outcomes: A Meta-Analysis.''
Journal of Applied Psychology 87(2) (2002) 268-279.
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<bullet> One study found that companies reporting high levels of
racial diversity brought in nearly 15 times more sales revenue on
average than those with low levels of racial diversity. Companies with
high rates reported an average of 35,000 customers compared to 22,700
average customers among those companies with low rates of racial
diversity.\127\
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\127\ Cedric Herring, ``Does Diversity Pay? Race, Gender, and
the Business Case for Diversity,'' American Sociological Review
(2009).
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<bullet> Diversity management is strongly linked to both work group
performance and job satisfaction, and people of color see benefits from
diversity management above and beyond those experienced by white
employees.\128\
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\128\ David Pitts, ``Diversity Management, Job Satisfaction, and
Performance: Evidence from U.S. Federal Agencies,'' Public
Administration Review (2009).
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<bullet> In a 6-month research study, found evidence that a growing
number of companies known for their hard-nosed approach to business--
such as Gap Inc., PayPal, and Cigna--have found new sources of growth
and profit by driving equitable outcomes for employees, customers, and
communities of color.\129\
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\129\ Angela Glover Blackwell, Mark Kramer, Lalitha
Vaidyanathan, Lakshmi Iyer, and Josh Kirschenbaum, ``The Competitive
Advantage of Racial Equity,'' FSG and PolicyLink, (2018).
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Paragraph (d) of the proposal contains the provisions addressing
the application of the prudence and exclusive benefit purpose duties to
the exercise of shareholder rights, including proxy voting, the use of
written proxy voting guidelines, and the selection and monitoring of
proxy advisory firms. Proposed paragraph (d) would benefit plans by
providing improved guidance regarding these activities. As discussed
above, non-regulatory guidance that the Department has previously
issued over the years may have led to a misunderstanding among some
that fiduciaries are required to vote on all proxies presented to them
or, conversely, that they may not vote proxies unless they first
perform a cost-benefit analysis and quantify net benefits. Although the
current regulation sought to address the first misunderstanding (i.e.,
that fiduciaries are required to vote on all proxies) with express
language, the Department is concerned that the language used may
effectively reinstate the second misunderstanding by suggesting that
fiduciaries need special justification to vote proxies at all.
We believe that the principles-based approach retained in paragraph
(d) of the proposal would address these misunderstandings and clarify
that neither extreme is always required. Instead, plan fiduciaries,
after an evaluation of material facts that form the basis for any
particular proxy vote or other exercise of shareholder rights, must
make a reasoned judgment both in deciding whether to exercise
shareholder rights and when actually exercising such rights. In making
this judgment, plan fiduciaries must act solely in accordance with the
economic interest of the plan, must consider any costs involved, and
must never subordinate the interests of participants in their
retirement benefits to unrelated goals. This proposal's clarifications
may lead to more proxy voting in comparison to the current regulation,
which is beneficial because it ensures that shareholders' interests as
the company's owners are protected and, by extension, that the
interests of participants and beneficiaries in plans that are
shareholders are also protected. While the Department is confident that
the proposal would promote, rather than deter, responsible proxy
voting, particularly as compared to the current regulation, it is less
certain that it will result in any increase in proxy voting as compared
to the pre-regulatory guidance, which took a similar approach. The
Department invites comments on the question.
Preserving flexibility, paragraph (d) of the proposal carries
forward core elements of the provision from the current regulation that
allows a plan to have written proxy voting policies that govern
decisions on when to vote or not vote categories or types of proposals,
subject to the aforementioned principles. With the ability for plans to
adopt policies to govern the decision whether to vote on a matter or
class of matters, plan fiduciaries will be better positioned to
conserve plan assets by establishing specific parameters designed to
serve the plan's interests.
Cost Savings Relative to the Current Regulation
Paragraph (d) of the proposal would eliminate the recordkeeping
requirement in paragraph (e)(2)(ii)(E) of the current regulation which
provides that, when deciding whether to exercise shareholder rights and
when exercising shareholder rights, plan fiduciaries must maintain
records on proxy voting activities and other exercises of shareholder
rights. The change is expected to produce a cost savings of $6.05
million per year relative to the current regulation. The proposal also
would revise the provision of the current regulation that addresses
proxy voting policies, paragraph (e)(3)(i) of the current regulation,
by removing the two ``safe harbor'' examples for proxy voting policies
that would be permissible under the provisions of the current
regulation. This revision reduces the burden related to proxy voting
policies and procedures and voting by $13.3 million in the first year
relative to the current regulation.\130\ The proposal also would
eliminate the current regulation's requirement for a fiduciary to
specially document consideration of benefits in addition to investment
return under the tie-breaker rule. This proposed elimination would save
an estimated $122,000 annually.\131\ Finally, the
[[Page 57293]]
proposal also would eliminate the requirement and the related
disruption caused by the requirement that under no circumstances may
any investment fund, product, or model portfolio be added as, or as a
component of, a QDIA if its investment objectives or goals or its
principal investment strategies include, consider, or indicate the use
of one or more non-pecuniary factors.
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\130\ In the 2020 final rule published on December 16, it was
estimated that a legal professional would expend, on average, two
hours to update policies and procedures for each of the estimated
63,911 plans affected by the rule, resulting in an annual burden
estimate of 127,822 hours in the first year, with an equivalent cost
of $17,691,809. In the proposal, the Department estimates that it
will take a legal professional just thirty minutes to update
policies and procedures for each of the estimated 63,911 plans
affected by the rule, resulting in a cost of $4,422,961. This
results in a cost savings of $13,268,857. 85 FR 81658.
\131\ In the 2020 final rule published on November 13, it was
estimated that that plan fiduciaries and clerical staff would each
expend, on average, two hours of labor to maintain the needed
documentation, resulting in an annual burden estimate of 1,290 hours
annually, with an equivalent cost of $122,115 for DB plans and DC
plans with ESG investments. This requirement has been eliminated in
the proposal. 85 FR 72846.
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1.4. Costs
By reversing aspects of the current regulation, this proposal would
facilitate certain changes by plan fiduciaries in their investment
behavior, including changes in asset management strategies such as
proxy voting, that these plan fiduciaries otherwise likely would not
take under the current regulation. The precise impact of this proposal
on such behavior is uncertain. Therefore, a precise quantification of
all costs similarly is not possible. Despite this, some impact is
predictable and these costs are quantified below. Regardless of these
limitations, to the extent that the proposal changes behavior, its
benefits are expected to outweigh the costs. Overall, the costs of the
proposal are expected to be relatively small, in part because the
Department assumes most plan fiduciaries are complying with the pre-
2020 interpretive bulletins (specifically Interpretive Bulletin 2016-1
and 2015-1), which the proposal tracks to a very large extent. Known
incremental costs of the proposal would be minimal on a per-plan basis.
(a) Cost of Reviewing NPRM and Reviewing Plan Practices
Plans, plan fiduciaries, and their service providers would incur
costs to read the proposal and evaluate how it would impact current
documents and practices. With respect to the investment duties of a
plan fiduciary when selecting an investment or investment course of
action, as set forth in paragraphs (a)-(c) of the proposal, the
Department estimates that 78,307 plans have exposure to investments
selected using ESG factors, consisting of 25,342 defined benefit
pension plans and 52,965 participant-directed individual account
plans.\132\ Fiduciaries of each of these types of plans will need to
spend time reviewing the proposal, evaluating how it might affect their
investment practices, and what would be needed to implement any
necessary changes. The Department estimates that this review process
will require a lawyer to spend approximately four hours to complete,
resulting in a cost burden of approximately $43.4 million.\133\ The
Department believes that these processes will likely be performed by a
service provider for most plans that likely oversee multiple plans.
Therefore, the Department's estimate likely is an upper bound, because
it is based on the number of affected plans, without regard to the
likely shared expense incurred by service providers that service
multiple plans. The Department does not have data that would allow it
to estimate the number of service providers acting in such a capacity
for these plans.
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\132\ DOL calculations are based on statistics from Private
Pension Plan Bulletin: Abstract of 2018 Form 5500 Annual Reports,
Employee Benefits Security Administration (2020), <a href="https://www.dol.gov/sites/dolgov/files/EBSA/researchers/statistics/retirement-bulletins/private-pension-plan-bulletins-abstract-2018.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/researchers/statistics/retirement-bulletins/private-pension-plan-bulletins-abstract-2018.pdf</a>. (52,965 + 25,342) = 78,307
\133\ The Department estimated that there are 78,307 plans that
will need to ensure compliance with the proposed rule's ESG
components. The burden is estimated as follows: 78,307 plans * 4
hours = 313,228 hours. A labor rate of $138.41 is used for a lawyer.
The cost burden is estimated as follows: 78,307 plans * 4 hours *
$138.41S = $43,353,887. Labor rates are based on DOL estimates from
Labor Cost Inputs Used in the Employee Benefits Security
Administration, Office of Policy and Research's Regulatory Impact
Analyses and Paperwork Reduction Act Burden Calculation, Employee
Benefits Security Administration (June 2019), <a href="http://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf">www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf</a>.
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Similarly, plans will need to spend time reviewing paragraph (d) of
the proposal, evaluating how it affects their proxy voting practices,
and implementing any necessary changes. The Department estimates that
this review process will require a lawyer on average to spend
approximately four hours to complete, resulting in a cost burden of
approximately $35.4 million.\134\ The Department believes that these
processes will likely be performed for most plans by a service provider
that likely oversees multiple plans. Therefore, the Department's
estimate likely represents an upper bound, because it is based on the
number of affected plans. The Department does not have sufficient data
that would allow it to estimate the number of service providers acting
in such a capacity for these plans.
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\134\ The burden is estimated as follows: 63,911 plans * 4 hours
= 255,644 hours. A labor rate of $138.41 is used for a lawyer. The
cost burden is estimated as follows: 63,911 plans * 4 hours *
$138.41 = $35,383,617.
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(b) Possible Changeover Costs
If existing plan investments are replaced due to the proposal, the
replacement may involve some short-term costs. Some plans may change
investments or investment courses of action to begin acquiring or to
acquire more ESG integrated assets in light of the clarification in
paragraph (c)(2) of the proposal. In the Department's view, this would
be net beneficial because compliant acquisitions of this type would be
done with the aim of improving (by reducing) the plan's ESG-related
financial risk. Thus, even if there are short-term costs associated
with changed investment practices, the benefits to the plan of reduced
ESG-related financial risk are expected to exceed these costs over
time. The Department lacks data to estimate the likely size of this
impact at this time and, therefore, solicits comments on the topic.
(c) Costs of Paragraphs (c)(1) and (2)
Paragraphs (c)(1) and (2) of the proposal address the application
of the duty of loyalty under ERISA as applied to a fiduciary's
consideration of an investment or investment course of action.
Paragraph (c)(1) provides that a fiduciary may not subordinate the
interests of the 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 benefits or goals unrelated to interests of the
participants and beneficiaries in their retirement income or financial
benefits under the plan. Paragraph (c)(2) provides that a fiduciary's
evaluation of an investment or investment course of action must be
based on risk and return factors that the fiduciary prudently
determines are material to investment value, 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. These proposed provisions would
require a fiduciary to perform an evaluation, including a rigorous
analysis of risk-return factors, and they provide direction on what to
include in that evaluation. Regardless of these proposed provisions, it
is the Department's view that many plan fiduciaries already undertake
such evaluations as part of their investment selection decision-making
process, including documentation of their decisions, process, and
reasoning. The Department does not intend to increase fiduciaries'
burden of care attendant to such consideration; therefore, no
additional costs are estimated for these requirements.
[[Page 57294]]
(d) Cost of Tie-Breaker
The proposal, at paragraph (c)(3), carries forward a more flexible
version of the tie-breaker concept than is in the current regulation;
the carried-forward version is comparable to and commensurate with the
formulation previously expressed in Interpretive Bulletin 2015-1 (and
first explained in Interpretive Bulletin 94-1). The proposal's tie-
breaker provision is relevant and operable only once a prudent
fiduciary determines that competing alternative investments equally
serve the financial interests of the plan. In these circumstances, the
plan fiduciary may focus on the collateral benefits of an investment or
investment course of action to decide the outcome.
The tie-breaker test in paragraph (c)(3) of the proposal would
impose minimal costs on plans. The provision implies analysis and
documentation requirements, but the proposal attributes no costs to
these requirements primarily because plans already carry out these
activities as part of their process for selecting investments. Put
differently, the Department's regulatory impact analysis assumes that
the analytics and documentation requirements of the tie-breaker
provision, and associated costs, are subsumed in the analytics and
documentation requirements of the risk-return analysis required by
paragraphs (c)(1) and (2) of the proposal. The analysis of risk-return
factors under paragraphs (c)(1) and (2) of the proposal in the first
instance would necessarily reveal any collateral benefits of an
investment or investment course of action, which may then be used later
on to break a tie pursuant to paragraph (c)(3) of the proposal. In this
sense, paragraph (c)(3) of the proposal thus imposes no distinct
process, and therefore no material additional costs, apart from a
plan's ordinary investment selection process.
Some potential costs, however, are expected with respect to the
requirement in paragraph (c)(3) to inform plan participants of the
collateral benefits that influenced the selection of the investment or
investment course of action, when such investment or investment course
of action constitutes a designated investment alternative under a
participant-directed individual account plan. These costs are expected
to be minimal because disclosure regulations adopted in 2012 already
entitle participants in participant-directed individual account plans
to receive sufficient information regarding designated investment
alternatives to make informed decisions with regard to the management
of their individual accounts. The information required by the 2012 rule
includes information regarding the alternative's objectives or goals
and the alternative's principal strategies (including a general
description of the types of assets held by the investment) and
principal risks. See 29 CFR 2550.404a-5. This proposal, therefore,
assumes these existing disclosures are, or perhaps with minor
modifications or clarifications could be, sufficient to satisfy the
disclosure element of the tie-breaker provision in paragraph (c)(3) of
the proposal. The Department estimates that it will take a legal
professional twenty minutes on average per year to update existing
disclosures to meet this requirement. If each of the approximately
53,000 participated-directed individual account plans estimated to have
at least one ESG-themed designated investment alternative used the tie-
breaker provision in paragraph (c)(3) of the proposal, the result would
be a cost of approximately $2.4 million.\135\ This estimate likely is
overstated because each such plan is unlikely to use the tie-breaker
provision and because the ongoing costs of the disclosure requirement
in paragraph (c)(3) of the proposal would be approximately zero absent
changes to an affected designated investment alternative. At the same
time, this estimate likely is understated to the extent that more plans
use ESG criteria in the future and to the extent such plans have
multiple designated investment options subject to paragraph (c)(3) of
the proposed rule. Comments are solicited on this topic.
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\135\ The burden is estimated as follows: 52,965 individual
account plans * 20 minutes = 17,655 hours. A labor rate of $138.41
is used for a legal professional: (17,655 hours * $138.41 =
$2,443,629).
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(e) Cost To Update Plan's Written Proxy Voting Policies
Paragraph (d)(3)(i) of the proposal provides that, for purposes of
deciding whether to vote a proxy, plan fiduciaries may adopt proxy
voting policies as long as the policies are prudently designed to serve
the plan's interests in providing benefits to participants and their
beneficiaries and defraying reasonable expenses of administering the
plan. Paragraph (d)(3)(ii), in turn provides that plan fiduciaries
shall periodically review these proxy voting policies.
The Department estimates that these provisions of the proposal
could impose additional costs because such policies will need to be
reviewed on an initial basis. However, the Department believes that the
proposal largely comports with industry practice for ERISA fiduciaries.
Therefore, the Department estimates that on average, it will take a
legal professional just thirty minutes to update policies and
procedures for each of the estimated 63,911 plans affected by the rule.
This results in a cost of $4.4 million in the first year relative to
the current rule.\136\ The requirement in paragraph (d)(3)(ii) to
periodically review proxy voting policies already is required for
fiduciaries to meet their obligations under ERISA; therefore, the
Department does not expect that plans will incur additional cost
associated with the periodic review.
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\136\ The burden is estimated as follows: 63,911 plans * 0.5
hour = 31,955.5. A labor rate of $138.41 is used for a legal
professional: (33,955.5 * $138.41 = $4,422,961).
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1.5. Transfers
The proposal could result in some transfers. If some portion of
proposed rule-induced increases in returns would be associated with
transactions in which other parties experience decreased returns of
equal magnitude, then this portion of the proposal's impact would, from
a societal perspective, be appropriately categorized as a transfer. For
example, the outcome of a proxy vote capping executive compensation at
a certain level could limit the income of executives while redounding
to the benefit of the company's shareholders (and thus participants and
beneficiaries of a plan invested in that company).
Transfers could also arise as a result of substantially greater
confidence on the part of fiduciaries that they may consider any
material factor in their risk-return analysis going forward, including
climate change and other ESG factors. As discussed previously, the
Department has heard from stakeholders that the current regulation has
already had a chilling effect on appropriate integration of material
climate change and other ESG factors into investment decisions.
Although the current regulation acknowledges that climate change and
other ESG factors can in some instances be taken into account by a
fiduciary, it also includes multiple statements that have been
interpreted as putting a thumb on the scale against their
consideration. This conflicting guidance may have disincentivized
fiduciar
[…truncated; see source link]Indexed from Federal Register on October 14, 2021.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.