Rule2022-25783
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
December 1, 2022
Effective
January 30, 2023
Issuing agencies
Labor DepartmentEmployee Benefits Security Administration
Abstract
The Department of Labor (Department) is adopting amendments to the Investment Duties regulation under Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA). The amendments clarify the application of ERISA's fiduciary duties of prudence and loyalty to selecting investments and investment courses of action, including selecting qualified default investment alternatives, exercising shareholder rights, such as proxy voting, and the use of written proxy voting policies and guidelines. The amendments reverse and modify certain amendments to the Investment Duties regulation adopted in 2020.
Full Text
<html>
<head>
<title>Federal Register, Volume 87 Issue 230 (Thursday, December 1, 2022)</title>
</head>
<body><pre>
[Federal Register Volume 87, Number 230 (Thursday, December 1, 2022)]
[Rules and Regulations]
[Pages 73822-73886]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-25783]
[[Page 73821]]
Vol. 87
Thursday,
No. 230
December 1, 2022
Part II
Department of Labor
-----------------------------------------------------------------------
Employee Benefits Security Administration
29 CFR Part 2550
Prudence and Loyalty in Selecting Plan Investments and Exercising
Shareholder Rights; Final Rule
Federal Register / Vol. 87 , No. 230 / Thursday, December 1, 2022 /
Rules and Regulations
[[Page 73822]]
-----------------------------------------------------------------------
DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AC03
Prudence and Loyalty in Selecting Plan Investments and Exercising
Shareholder Rights
AGENCY: Employee Benefits Security Administration, Department of Labor.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Department of Labor (Department) is adopting amendments to
the Investment Duties regulation under Title I of the Employee
Retirement Income Security Act of 1974, as amended (ERISA). The
amendments clarify the application of ERISA's fiduciary duties of
prudence and loyalty to selecting investments and investment courses of
action, including selecting qualified default investment alternatives,
exercising shareholder rights, such as proxy voting, and the use of
written proxy voting policies and guidelines. The amendments reverse
and modify certain amendments to the Investment Duties regulation
adopted in 2020.
DATES:
Effective date: This rule is effective on January 30, 2023.
Applicability dates: See Sec. 2550.404a-1(g) of the final rule for
compliance dates for Sec. 2550.404a-1(d)(2)(iii) and (d)(4)(ii) of the
final rule.
FOR FURTHER INFORMATION CONTACT: Fred Wong, Acting Chief of the
Division of Regulations, Office of Regulations and Interpretations,
Employee Benefits Security Administration, (202) 693-8500. This is not
a toll-free number.
Customer Service Information: Individuals interested in obtaining
information from the Department of Labor concerning ERISA and employee
benefit plans may call the Employee Benefits Security Administration
(EBSA) Toll-Free Hotline, at 1-866-444-EBSA (3272) or visit the
Department of Labor's website (<a href="http://www.dol.gov/ebsa">www.dol.gov/ebsa</a>).
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. General
B. The Department's Prior Non-Regulatory Guidance
1. ETI/ESG Investing
2. Exercising Shareholder Rights
C. Executive Order Review of Current Regulation
II. Purpose of Regulatory Action and Proposed Rule
A. Purpose
B. Major Provisions of Proposed Rule
III. The Final Rule
A. Executive Summary of Major Changes and Clarifications
B. Detailed Discussion of Public Comments and Final Regulation
1. Section 2550.404a-1(a) and (b)--General and Investment
Prudence Duties
2. Section 2550.404a-1(c) Investment Loyalty Duties
3. Investment Alternatives in Participant Directed Individual
Account Plans Including Qualified Default Investment Alternatives
4. Section 2550.404a-1(d)--Proxy Voting and Exercise of
Shareholder Rights
5. Section 2550.404a-1(e)--Definitions
6. Section 2550.404a-1(f)--Severability
7. Section 2550.404a-1(g)--Applicability Date
8. Miscellaneous
IV. Regulatory Impact Analysis
A. Executive Orders 12866 and 13563
B. Introduction and Need for Regulation
C. Affected Entities
1. Subset of Plans Affected by Proposed Modifications of
Paragraphs (b) and (c) of Sec. 2550.404a-1
2. Subset of Plans Affected by the Modifications to Paragraph
(d) of Sec. 2550.404a-1
D. Benefits
1. Benefits of Paragraphs (b) and (c)
2. Cost Savings Relating to Paragraphs (c), Relative to the
Current Regulation
3. Benefits of Paragraph (d)
4. Cost Savings Relating to Paragraphs (d) and (e), Relative to
the Current Regulation
E. Costs
1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
2. Possible Changeover Costs
3. Cost Associated With Changes in Investment or Investment
Course of Action
4. Cost Associated With Changes to the ``Tiebreaker'' Rule
5. Cost To Update Plan's Written Proxy Voting Policies
6. Summary
F. Transfers
G. Uncertainty
H. Alternatives
I. Conclusion
V. Paperwork Reduction Act
VI. Regulatory Flexibility Act
A. Need for and Objectives of the Rule
B. Comments
C. Affected Small Entities
1. Small Plans Affected by the Proposed Modifications of
Paragraphs (b) and (c) of Sec. 2550.404a-1
2. Subset of Plans Affected by Modifications of Paragraph (d)
and (e) of Sec. 2550.404a-1
D. Impact of the Rule
1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
2. Cost To Update Written Proxy Voting Policies
3. Summary of Costs
E. Regulatory Alternatives
F. Duplicate, Overlapping, or Relevant Federal Rules
VII. Unfunded Mandates Reform Act
VIII. Federalism Statement
I. Background
A. General
Title I of the Employee Retirement Income Security Act of 1974
(ERISA) establishes minimum standards that govern the operation of
private-sector employee benefit plans, including fiduciary
responsibility rules. Section 404 of ERISA, in part, requires that plan
fiduciaries act prudently and diversify plan investments so as to
minimize the risk of large losses, unless under the circumstances it is
clearly prudent not to do so.\1\ Sections 403(c) and 404(a) also
require fiduciaries to act solely in the interest of the plan's
participants and beneficiaries, and for the exclusive purpose of
providing benefits to participants and beneficiaries and defraying
reasonable expenses of administering the plan.\2\
---------------------------------------------------------------------------
\1\ 29 U.S.C. 1104.
\2\ 29 U.S.C. 1103(c) and 1104(a).
---------------------------------------------------------------------------
To maximize employee pension and welfare benefits, section 404 of
ERISA dictates that the focus of ERISA plan fiduciaries on the plan's
financial returns and risk to beneficiaries must be paramount.\3\ And
for years, the Department's non-regulatory guidance has recognized
that, under the appropriate circumstances, ERISA does not preclude
fiduciaries from making investment decisions that reflect
environmental, social, or governance (``ESG'') considerations, and
choosing economically targeted investments (``ETIs'') selected in part
for benefits in addition to the impact those considerations could have
on investment return.\4\ The Department's non-regulatory guidance has
also recognized that the fiduciary act of managing employee benefit
plan assets includes the management of voting rights as well as other
shareholder rights connected to shares of stock, and that management of
those rights, as well as shareholder engagement activities, is subject
to ERISA's prudence and loyalty requirements.\5\ Subsection B of this
background section provides a complete overview of the Department's
prior non-regulatory guidance.
---------------------------------------------------------------------------
\3\ See Interpretive Bulletin 2015-01, 80 FR 65135 (Oct. 26,
2015).
\4\ See, e.g., id.
\5\ See, e.g., Interpretive Bulletin 2016-01, 81 FR 95879 (Dec.
29, 2016).
---------------------------------------------------------------------------
The Department's Investment Duties regulation under Title I of
ERISA is codified at 29 CFR 2550.404a-1(hereinafter ``current
regulation'' or ``Investment Duties regulation,'' unless otherwise
stated). On June 30 and
[[Page 73823]]
September 4, 2020, the Department published in the Federal Register
proposed rules to remove prior non-regulatory guidance from the CFR and
to amend the Department's Investment Duties regulation. The objective
was to address perceived confusion about the implications of that non-
regulatory guidance with respect to ESG considerations, ETIs,
shareholder rights, and proxy voting.\6\ The preambles to the 2020
proposals expressed concern that some ERISA plan fiduciaries might be
making improper investment decisions, and that plan shareholder rights
were being exercised in a manner that subordinated the interests of
plans and their participants and beneficiaries to unrelated
objectives.\7\ Given the persistent confusion in this area due in part
to varied statements the Department had made on the subject over the
years in non-regulatory guidance, the Department believed that
providing further clarity on these issues in the form of a notice and
comment regulation would be more helpful and permanent than another
iteration of non-regulatory guidance.
---------------------------------------------------------------------------
\6\ See 85 FR 39113 (June 30, 2020); 85 FR 55219 (Sept. 4,
2020).
\7\ See 85 FR 39116; 85 FR 55221.
---------------------------------------------------------------------------
Less than six months later, on November 13, 2020, the Department
published a final rule titled ``Financial Factors in Selecting Plan
Investments,'' which adopted amendments to the Investment Duties
regulation that generally require plan fiduciaries to select
investments and investment courses of action based solely on
consideration of ``pecuniary factors.'' \8\ Among these amendments was
a prohibition against adding or retaining any investment fund, product,
or model portfolio as a qualified default investment alternative (QDIA)
as described in 29 CFR 2550.404c-5 if the fund, product, or model
portfolio includes even one non-pecuniary objective in its investment
objectives or principal investment strategies. On December 16, 2020,
the Department published a final rule titled ``Fiduciary Duties
Regarding Proxy Voting and Shareholder Rights,'' which also adopted
amendments to the Investment Duties regulation to establish regulatory
standards for the obligations of plan fiduciaries under ERISA when
voting proxies and exercising other shareholder rights in connection
with plan investments in shares of stock.\9\
---------------------------------------------------------------------------
\8\ 85 FR 72846 (Nov. 13, 2020).
\9\ 85 FR 81658 (Dec. 16, 2020).
---------------------------------------------------------------------------
On January 20, 2021, the President signed Executive Order 13990
(E.O. 13990), titled ``Protecting Public Health and the Environment and
Restoring Science to Tackle the Climate Crisis.'' \10\ Section 1 of
E.O. 13990 acknowledges the Nation's ``abiding commitment to empower
our workers and communities; promote and protect our public health and
the environment.'' Section 1 also sets forth the policy of the
Administration to listen to the science; improve public health and
protect our environment; bolster resilience to the impacts of climate
change; and prioritize both environmental justice and the creation of
the well-paying union jobs necessary to deliver on these goals. Section
2 directed agencies to review all existing regulations promulgated,
issued, or adopted between January 20, 2017, and January 20, 2021, that
are or may be inconsistent with, or present obstacles to, the policies
set forth in section 1 of E.O. 13990. Section 2 further provided that
for any such actions identified by the agencies, the heads of agencies
shall, as appropriate and consistent with applicable law, consider
suspending, revising, or rescinding the agency actions.\11\
---------------------------------------------------------------------------
\10\ 86 FR 7037 (Jan. 25, 2021). E.O. 13990 was signed eight
days after the effective date of ``Financial Factors in Selecting
Plan Investments,'' and five days after the effective date of
``Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.''
\11\ A Fact Sheet issued simultaneously with E.O. 13990,
specifically confirmed that the Department was directed to review
the final rule on ``Financial Factors in Selecting Plan
Investments'' Available at <a href="http://www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/fact-sheet-list-of-agency-actions-for-review/">www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/fact-sheet-list-of-agency-actions-for-review/</a>.
---------------------------------------------------------------------------
On March 10, 2021, the Department announced that it had begun a
reexamination of the current regulation, consistent with E.O. 13990,
the Administrative Procedure Act, and ERISA's grant of regulatory
authority in section 505.\12\ The Department also announced that,
pending its review of the current regulation, the Department will not
enforce the current regulation or otherwise pursue enforcement actions
against any plan fiduciary based on a failure to comply with the
current regulation with respect to an investment, including a QDIA,
investment course of action or an exercise of shareholder rights. In
announcing the enforcement policy, the Department also stated its
intention to conduct significantly more stakeholder outreach to
determine how to craft rules that better recognize the role that ESG
integration can play in the evaluation and management of plan
investments in ways that further fundamental fiduciary obligations.\13\
---------------------------------------------------------------------------
\12\ 29 U.S.C. 1135.
\13\ See U.S. Department of Labor Statement Regarding
Enforcement of its Final Rules on ESG Investments and Proxy Voting
by Employee Benefit Plans (Mar. 10, 2021) Available at <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>. Following publication of the final rules the Department
heard from a wide variety of stakeholders, including asset managers,
labor organizations and other plan sponsors, consumer groups,
service providers and investment advisers that questioned whether
the 2020 Rules properly reflect the scope of fiduciaries' duties
under ERISA to act prudently and solely in the interest of plan
participants and beneficiaries. The stakeholders also questioned
whether the Department rushed the rulemakings unnecessarily and
failed to adequately consider and address the substantial evidence
submitted by public commenters on the use of environmental, social
and governance considerations in improving investment value and
long-term investment returns for retirement investors.
---------------------------------------------------------------------------
On May 20, 2021, the President signed Executive Order 14030 (E.O.
14030), titled ``Executive Order on Climate-Related Financial Risk.''
\14\ The policies set forth in section 1 of E.O. 14030 include
advancing acts to mitigate climate-related financial risk and actions
to help safeguard the financial security of America's families,
businesses, and workers from climate-related financial risk that may
threaten the life savings and pensions of U.S. workers and families.
Section 4 of E.O. 14030 directed the Department to consider publishing,
by September 2021, for notice and comment a proposed rule to suspend,
revise, or rescind ``Financial Factors in Selecting Plan Investments,''
\15\ and ``Fiduciary Duties Regarding Proxy Voting and Shareholder
Rights.'' \16\
---------------------------------------------------------------------------
\14\ 86 FR 27967 (May 25, 2021). E.O. 14030 was signed 128 days
after the effective date of ``Financial Factors in Selecting Plan
Investments,'' and 125 days after the effective date of ``Fiduciary
Duties Regarding Proxy Voting and Shareholder Rights.''
\15\ 85 FR 72846 (Nov. 13, 2020).
\16\ 85 FR 81658 (Dec. 16, 2020).
---------------------------------------------------------------------------
B. The Department's Prior Non-Regulatory Guidance
The Department has a longstanding position that ERISA fiduciaries
may not sacrifice investment returns or assume greater investment risks
as a means of promoting collateral social policy goals. These
proscriptions flow directly from ERISA's stringent standards of
prudence and loyalty under section 404(a) of the statute.\17\ The
Department has a similarly longstanding position that the fiduciary act
of managing plan assets that involve shares of corporate stock includes
making decisions about voting proxies and exercising shareholder
rights. Over the years the Department repeatedly has issued non-
regulatory
[[Page 73824]]
guidance to assist plan fiduciaries in understanding their obligations
under ERISA to apply these principles to ETIs and ESG.
---------------------------------------------------------------------------
\17\ 29 U.S.C. 1104(a).
---------------------------------------------------------------------------
1. ETI/ESG Investing
Interpretive Bulletin 94-1 (IB 94-1), published in 1994, addressed
economically targeted investments (ETIs) selected, in part, for
collateral benefits apart from the investment return to the plan
investor.\18\ The Department's objective in issuing IB 94-1 was to
state that ETIs \19\ are not inherently incompatible with ERISA's
fiduciary obligations. The preamble to IB 94-1 explained that the
requirements of sections 403 and 404 of ERISA do not prevent plan
fiduciaries from investing plan assets in ETIs if the investment has an
expected rate of return at least commensurate to rates of return of
available alternative investments, and if the ETI is otherwise an
appropriate investment for the plan in terms of such factors as
diversification and the investment policy of the plan. Some
commentators have referred to this as the ``all things being equal''
test or the ``tiebreaker'' standard. The Department stated in the
preamble to IB 94-1 that when competing investments serve the plan's
economic interests equally well, plan fiduciaries can use such
collateral considerations as the deciding factor for an investment
decision. This was the Department's unchanged position for
approximately three decades.
---------------------------------------------------------------------------
\18\ 59 FR 32606 (June 23, 1994) (appeared in Code of Federal
Regulations as 29 CFR 2509.94-1). Prior to issuing IB 94-1, the
Department had issued a number of letters concerning a fiduciary's
ability to consider the collateral effects of an investment and
granted a variety of prohibited transaction exemptions to both
individual plans and pooled investment vehicles involving
investments that produce collateral benefits. See Advisory Opinions
80-33A, 85-36A and 88-16A; Information Letters to Mr. George Cox,
dated Jan. 16, 1981; to Mr. Theodore Groom, dated Jan. 16, 1981; to
The Trustees of the Twin City Carpenters and Joiners Pension Plan,
dated May 19, 1981; to Mr. William Chadwick, dated July 21, 1982; to
Mr. Daniel O'Sullivan, dated Aug. 2, 1982; to Mr. Ralph Katz, dated
Mar. 15, 1982; to Mr. William Ecklund, dated Dec. 18, 1985, and Jan.
16, 1986; to Mr. Reed Larson, dated July 14, 1986; to Mr. James Ray,
dated July 8, 1988; to the Honorable Jack Kemp, dated Nov. 23, 1990;
and to Mr. Stuart Cohen, dated May 14, 1993. The Department also
issued a number of prohibited transaction exemptions that touched on
these issues. See PTE 76-1, part B, concerning construction loans by
multiemployer plans; PTE 84-25, issued to the Pacific Coast Roofers
Pension Plan; PTE 85-58, issued to the Northwestern Ohio Building
Trades and Employer Construction Industry Investment Plan; PTE 87-
20, issued to the Racine Construction Industry Pension Fund; PTE 87-
70, issued to the Dayton Area Building and Construction Industry
Investment Plan; PTE 88-96, issued to the Real Estate for American
Labor A Balcor Group Trust; PTE 89-37, issued to the Union Bank; and
PTE 93-16, issued to the Toledo Roofers Local No. 134 Pension Plan
and Trust, et al. In addition, one of the first directors of the
Department's benefits office authored an article on this topic in
1980. See Ian D. Lanoff, The Social Investment of Private Pension
Plan Assets: May It Be Done Lawfully Under ERISA?, 31 Labor L.J.
387, 391-92 (1980) (stating that ``[t]he Labor Department has
concluded that economic considerations are the only ones which can
be taken into account in determining which investments are
consistent with ERISA standards,'' and warning that fiduciaries who
exclude investment options for non-economic reasons would be
``acting at their peril'').
\19\ IB 94-1 used the terms ETI and economically targeted
investments to broadly refer to any investment or investment course
of action that is selected, in part, for its expected collateral
benefits, apart from the investment return to the employee benefit
plan investor.
---------------------------------------------------------------------------
In 2008, the Department replaced IB 94-1 with Interpretive Bulletin
2008-01 (IB 2008-01),\20\ and then, in 2015, the Department replaced IB
2008-01 with Interpretive Bulletin 2015-01 (IB 2015-01).\21\ Although
the Interpretive Bulletins differed from each other in tone and content
to some extent, each endorsed the ``all things being equal'' test,
while also stressing that the paramount focus of plan fiduciaries must
be the plan's financial returns and providing promised benefits to
participants and beneficiaries. Each Interpretive Bulletin also
cautioned that fiduciaries violate ERISA if they accept reduced
expected returns or greater risks to secure social, environmental, or
other policy goals.
---------------------------------------------------------------------------
\20\ 73 FR 61734 (Oct. 17, 2008).
\21\ 80 FR 65135 (Oct. 26, 2015).
---------------------------------------------------------------------------
Additionally, the preamble to IB 2015-01 explained that if a
fiduciary prudently determines that an investment is appropriate based
solely on economic considerations, including those that may derive from
ESG factors, the fiduciary may make the investment without regard to
any collateral benefits the investment may also promote. In Field
Assistance Bulletin 2018-01 (FAB 2018-01), the Department indicated
that IB 2015-01 had recognized that there could be instances when ESG
issues present material business risk or opportunities to companies
that company officers and directors need to manage as part of the
company's business plan, and that qualified investment professionals
would treat the issues as material economic considerations under
generally accepted investment theories. As appropriate economic
considerations, such ESG issues should be considered by a prudent
fiduciary along with other relevant economic factors to evaluate the
risk and return profiles of alternative investments. In other words, in
these instances, the factors are not ``tiebreakers,'' but ``risk-
return'' factors affecting the economic merits of the investment.
FAB 2018-01 cautioned, however, that ``[t]o the extent ESG factors,
in fact, involve business risks or opportunities that are properly
treated as economic considerations themselves in evaluating alternative
investments, the weight given to those factors should also be
appropriate to the relative level of risk and return involved compared
to other relevant economic factors.'' \22\ The Department further
emphasized in FAB 2018-01 that fiduciaries ``must not too readily treat
ESG factors as economically relevant to the particular investment
choices at issue when making a decision,'' as ``[i]t does not
ineluctably follow from the fact that an investment promotes ESG
factors, or that it arguably promotes positive general market trends or
industry growth, that the investment is a prudent choice for retirement
or other investors.'' Rather, ERISA fiduciaries must always put first
the economic interests of the plan in providing retirement benefits,
and ``[a] fiduciary's evaluation of the economics of an investment
should be focused on financial factors that have a material effect on
the return and risk of an investment based on appropriate investment
horizons consistent with the plan's articulated funding and investment
objectives.'' \23\
---------------------------------------------------------------------------
\22\ FAB 2018-01 (Apr. 23, 2018).
\23\ Id.
---------------------------------------------------------------------------
FAB 2018-01 also explained that in the case of an investment
platform that allows participants and beneficiaries an opportunity to
choose from a broad range of investment alternatives, a prudently
selected, well managed, and properly diversified ESG-themed investment
alternative could be added to the available investment options on a
401(k) plan platform without requiring the plan to remove or forgo
adding other non-ESG-themed investment options to the platform.\24\
According to the FAB, however, the selection of an investment fund as a
QDIA is not analogous to a fiduciary's decision to offer participants
an additional investment alternative as part of a prudently constructed
lineup of investment alternatives from which participants may choose.
FAB 2018-01 expressed concern that the decision to favor the
fiduciary's own policy preferences in selecting an ESG-themed
investment option as a QDIA for a 401(k)-type plan without regard to
possibly different or competing views of plan participants and
beneficiaries would raise questions about the fiduciary's compliance
with ERISA's duty of loyalty.\25\ In addition, FAB
[[Page 73825]]
2018-01 stated that, even if consideration of such factors could be
shown to be appropriate in the selection of a QDIA for a particular
plan population, the plan's fiduciaries would have to ensure compliance
with the previous guidance in IB 2015-01. For example, the selection of
an ESG-themed target date fund as a QDIA would not be prudent if the
fund would provide a lower expected rate of return than available non-
ESG alternative target date funds with commensurate degrees of risk, or
if the fund would be riskier than non-ESG alternative available target
date funds with commensurate rates of return.
---------------------------------------------------------------------------
\24\ Id.
\25\ FAB 2018-01.
---------------------------------------------------------------------------
2. Exercising Shareholder Rights
The Department's past non-regulatory guidance has also consistently
recognized that the fiduciary act of managing employee benefit plan
assets includes the management of voting rights as well as other
shareholder rights connected to shares of stock, and that management of
those rights, as well as shareholder engagement activities, is subject
to ERISA's prudence and loyalty requirements.
The Department first issued non-regulatory guidance on proxy voting
and the exercise of shareholder rights in the 1980s. For example, in
1988, the Department issued an opinion letter to Avon Products, Inc.
(the Avon Letter), in which the Department took the position that the
fiduciary act of managing plan assets that are shares of corporate
stock includes the voting of proxies appurtenant to those shares, and
that the named fiduciary of a plan has a duty to monitor decisions made
and actions taken by investment managers with regard to proxy
voting.\26\ In 1994, the Department issued its first interpretive
bulletin on proxy voting, Interpretive Bulletin 94-2 (IB 94-2).\27\ IB
94-2 recognized that fiduciaries may engage in shareholder activities
intended to monitor or influence corporate management if the
responsible fiduciary concludes that, after taking into account the
costs involved, there is a reasonable expectation that such shareholder
activities (by the plan alone or together with other shareholders) will
enhance the value of the plan's investment in the corporation. The
Department also reiterated its view that ERISA does not permit
fiduciaries, in voting proxies or exercising other shareholder rights,
to subordinate the economic interests of participants and beneficiaries
to unrelated objectives.
---------------------------------------------------------------------------
\26\ Letter to Helmuth Fandl, Chairman of the Retirement Board,
Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988).
\27\ 59 FR 38860 (July 29, 1994).
---------------------------------------------------------------------------
In October 2008, the Department replaced IB 94-2 with Interpretive
Bulletin 2008-02 (IB 2008-02).\28\ The Department's intent was to
update the guidance in IB 94-2 and to reflect interpretive positions
issued by the Department after 1994 on shareholder engagement and
socially-directed proxy voting initiatives. IB 2008-02 stated that
fiduciaries' responsibility for managing proxies includes both deciding
to vote and deciding not to vote.\29\ IB 2008-02 further stated that
the fiduciary duties described at ERISA sections 404(a)(1)(A) and (B)
require that, in voting proxies, the responsible fiduciary shall
consider only those factors that relate to the economic value of the
plan's investment and shall not subordinate the interests of the
participants and beneficiaries in their retirement income to unrelated
objectives. In addition, IB 2008-02 stated that votes shall only be
cast in accordance with a plan's economic interests. IB 2008-02
explained that if the responsible fiduciary reasonably determines that
the cost of voting (including the cost of research, if necessary, to
determine how to vote) is likely to exceed the expected economic
benefits of voting, the fiduciary has an obligation to refrain from
voting.\30\ The Department also reiterated in IB 2008-02 that any use
of plan assets by a plan fiduciary to further political or social
causes ``that have no connection to enhancing the economic value of the
plan's investment'' through proxy voting or shareholder activism is a
violation of ERISA's exclusive purpose and prudence requirements.\31\
---------------------------------------------------------------------------
\28\ 73 FR 61731 (Oct. 17, 2008).
\29\ 73 FR 61732.
\30\ Id.
\31\ 73 FR 61734.
---------------------------------------------------------------------------
In 2016, the Department issued Interpretive Bulletin 2016-01 (IB
2016-01), which reinstated the language of IB 94-2 with certain
modifications.\32\ IB 2016-01 reiterated and confirmed that ``in voting
proxies, the responsible fiduciary [must] consider those factors that
may affect the value of the plan's investment and not subordinate the
interests of the participants and beneficiaries in their retirement
income to unrelated objectives.'' \33\ In its guidance, the Department
has also stated that it rejects a construction of ERISA that would
render the statute's tight limits on the use of plan assets illusory
and that would permit plan fiduciaries to expend trust assets to
promote a myriad of personal public policy preferences at the expense
of participants' economic interests, including through shareholder
engagement activities, voting proxies, or other investment
policies.\34\
---------------------------------------------------------------------------
\32\ 81 FR 95879 (Dec. 29, 2016). In addition, the Department
issued a Field Assistance Bulletin to provide guidance on IB 2016-01
on April 23, 2018. See FAB 2018-01, at <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>.
\33\ 81 FR 95882.
\34\ See 81 FR 95881.
---------------------------------------------------------------------------
C. Executive Order Review of Current Regulation
In early 2021, consistent with E.O. 13990 and E.O. 14030, the
Department engaged in informal outreach to hear views from interested
stakeholders on how to craft regulations that better recognize the
important role that climate change and other ESG factors can play in
the evaluation and management of plan investments, while continuing to
uphold fundamental fiduciary obligations. The Department heard from a
wide variety of stakeholders, including asset managers, labor
organizations and other plan sponsors, consumer groups, service
providers, and investment advisers. Many of the stakeholders expressed
skepticism as to whether the current regulation properly reflects the
scope of fiduciaries' duties under ERISA to act prudently and solely in
the interest of plan participants and beneficiaries.
That outreach effort by the Department suggested that, rather than
provide clarity, some aspects of the current regulation instead may
have created further uncertainty about whether a fiduciary under ERISA
may consider ESG and other factors in making investment and proxy
voting decisions that the fiduciary reasonably believes will benefit
the plan and its participants and beneficiaries. Many stakeholders
questioned whether the Department rushed the current regulation
unnecessarily and failed to adequately consider and address substantial
evidence submitted by public commenters suggesting that the use of
climate change and other ESG factors can improve investment value and
long-term investment returns for retirement investors. The Department
also heard from stakeholders that the current regulation, and investor
confusion about it, including whether climate change and other ESG
factors may be treated as ``pecuniary'' factors under the regulation,
already had begun to have a chilling effect on appropriate integration
of climate change and other ESG factors in investment decisions. This
continued through the current non-enforcement period, including in
circumstances where the current
[[Page 73826]]
regulation may in fact allow consideration of ESG factors.
After conducting a review of the current regulation, the Department
concluded there is a reasonable basis for the concerns raised by the
stakeholders. A number of public comment letters had criticized the
2020 proposed regulatory text for appearing to single out ESG investing
for heightened scrutiny, which they asserted was inappropriate in light
of research and investment practices suggesting that climate change and
other ESG factors are material economic considerations.\35\ In
response, the Department did not include explicit references to ESG in
the current regulation and furthermore acknowledged in the preamble
discussion to the Financial Factors in Selecting Plan Investments final
rulemaking that there are instances where one or more ESG factors may
be properly taken into account by a fiduciary.\36\ The preamble to the
Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final
rulemaking also acknowledged academic studies and investment experience
surrounding the materiality of ESG considerations in investment
decisionmaking.\37\ However, other statements in the preamble appeared
to express skepticism about fiduciaries' reliance on ESG
considerations. For instance, the preamble to the Financial Factors in
Selecting Plan Investments final rulemaking asserted that ESG investing
raises heightened concerns under ERISA, and cautioned fiduciaries
against ``too hastily'' concluding that ESG-themed funds may be
selected based on pecuniary factors.\38\ Similarly, the preamble to the
Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final
rulemaking expressed the view that it is likely that many environmental
and social shareholder proposals have little bearing on share value or
other relation to plan financial interests.\39\ Many stakeholders
indicated that the current regulation has been interpreted as putting a
thumb on the scale against the consideration of ESG factors, even when
those factors are financially material.
---------------------------------------------------------------------------
\35\ See, e.g., Comment # 567 at <a href="http://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00567.pdf">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="http://www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00709.pdf">www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00709.pdf</a>.
\36\ See 85 FR 72859 (Nov. 13, 2020) (``[T]he Department
believes that it would be consistent with ERISA and the final rule
for a fiduciary to treat a given factor or consideration as
pecuniary if it presents economic risks or opportunities that
qualified investment professionals would treat as material economic
considerations under generally accepted investment theories'').
\37\ 85 FR 81662 (Dec. 16, 2020) (``This [Fiduciary Duties
Regarding Proxy Voting and Shareholder Rights] rulemaking project,
similar to the recently published final rule on ERISA fiduciaries'
consideration of financial factors in investment decisions,
recognizes, rather than ignores, the economic literature and
fiduciary investment experience that show a particular `E,' `S,' or
`G' consideration may present issues of material business risk or
opportunities to a specific company that its officers and directors
need to manage as part of the company's business plan and that
qualified investment professionals would treat as economic
considerations under generally accepted investment theories.'').
\38\ 85 FR 72848, 72859 (Nov. 13, 2020).
\39\ 85 FR 81681 (Dec. 16, 2020).
---------------------------------------------------------------------------
The Department's review under the Executive orders caused it
concern that, as stakeholders warned, uncertainty with respect to the
current regulation may be deterring fiduciaries from taking steps that
other marketplace investors would take in enhancing investment value
and performance, or improving investment portfolio resilience against
the potential financial risks and impacts associated with climate
change and other ESG factors. The Department was concerned that the
current regulation created a perception that fiduciaries are at risk if
they include any ESG factors in the financial evaluation of plan
investments, and that they would need to have special justifications
for even ordinary exercises of shareholder rights.
Based on these concerns, the Department, on October 14, 2021,
published a notice of proposed rulemaking (NPRM) proposing amendments
to the current regulation.\40\ The intent of the NPRM was to address
uncertainties regarding aspects of the current regulation and its
preamble discussion relating to the consideration of ESG issues,
including climate-related financial risk, by fiduciaries in making
investment and voting decisions, and to provide further clarity that
will help safeguard the interests of participants and beneficiaries in
the plan benefits.
---------------------------------------------------------------------------
\40\ 86 FR 57272 (Oct. 14, 2021).
---------------------------------------------------------------------------
II. Purpose of Regulatory Action and Proposed Rule
A. Purpose
Like the NPRM, the purpose of the final rule is to clarify the
application of ERISA's fiduciary duties of prudence and loyalty to
selecting investments and investment courses of action, including
selecting QDIAs, exercising shareholder rights, such as proxy voting,
and the use of written proxy voting policies and guidelines. The need
for clarification comes from the chilling effect and other potential
negative consequences caused by the current regulation with respect to
the consideration of climate change and other ESG factors in connection
with these activities. Overall, the public comments support the
clarifications provided by this final rule, although some commenters
challenged the stated need. The Department disagrees with commenters
who asserted that any clarifications to the current regulation are
unnecessary. The Department's conclusion, supported by many public
commenters, is that the current regulation creates uncertainty and is
having the undesirable effect of discouraging ERISA fiduciaries'
consideration of climate change and other ESG factors in investment
decisions, even in cases where it is in the financial interest of plans
to take such considerations into account. This uncertainty may further
deter fiduciaries from taking steps that other marketplace investors
take in enhancing investment value and performance or improving
investment portfolio resilience against the potential financial risks
and impacts associated with climate change and other ESG factors. Major
comments are addressed in detail below in conjunction with specific
provisions of the final rule.
B. Major Provisions of Proposed Rule
Consistent with the purpose of the overall rulemaking initiative,
the NPRM proposed several key changes and clarifications to the current
regulation, as follows:
<bullet> The NPRM proposed to delete the ``pecuniary/non-
pecuniary'' terminology from the current regulation based on concerns
that the terminology causes confusion and has a chilling effect on
financially beneficial choices.
<bullet> The NPRM proposed the addition of regulatory text that
would have made it clear that, when considering projected returns, a
fiduciary's duty of prudence may often require an evaluation of the
economic effects of climate change and other ESG factors on the
particular investment or investment course of action.
<bullet> The NPRM proposed to add to the operative text of the rule
three sets of examples of climate change and other ESG factors that,
depending on the facts and circumstances, may be material to the risk-
return analysis.
<bullet> The NPRM proposed to remove the special rules for QDIAs
that apply under the current regulation. The NPRM would instead apply
the same standards to QDIAs as apply to other investments.
<bullet> The NPRM proposed to modify the current rule's
``tiebreaker'' test, which permits fiduciaries to consider collateral
benefits as tiebreakers in some circumstances. The current regulation
imposes a requirement that the competing investments underlying a
[[Page 73827]]
tiebreaker situation be indistinguishable based on pecuniary factors
alone before fiduciaries can turn to collateral factors to break a tie
and imposes a special documentation requirement on the use of such
factors. The NPRM proposed replacing those provisions with a standard
that would have instead required the fiduciary to conclude prudently
that competing investments, or competing investment courses of action,
equally serve the financial interests of the plan over the appropriate
time horizon. In such cases, the fiduciary is not prohibited from
selecting the investment, or investment course of action, based on
collateral benefits other than investment returns. The NPRM also
proposed to remove the current regulation's special documentation
requirements in favor of ERISA's generally applicable statutory duty to
prudently document plan affairs.
<bullet> To the extent individual account plans use the tiebreaker
test in the selection of a designated investment alternative, the NPRM
proposed that plans must prominently disclose to the plans'
participants the collateral considerations that were used as
tiebreakers.
<bullet> The NPRM proposed to eliminate the statement in paragraph
(e)(2)(ii) of the current regulation that ``the fiduciary duty to
manage shareholder rights appurtenant to shares of stock does not
require the voting of every proxy or the exercise of every shareholder
right,'' which the Department was concerned could be misread as
suggesting that plan fiduciaries should be indifferent to the exercise
of their rights as shareholders, even if the cost is minimal.
<bullet> The NPRM proposed to eliminate paragraph (e)(2)(iii) of
the current regulation, which sets out specific monitoring obligations
with respect to use of investment managers or proxy voting firms, and
to address such monitoring obligations in another provision of the
regulation that more generally covers selection and monitoring
obligations. The Department was concerned that the specific monitoring
provision could be read as requiring some special obligations above and
beyond the statutory obligations of prudence and loyalty that generally
apply to monitoring the work of service providers.
<bullet> The NPRM proposed to remove the two ``safe harbor''
examples for proxy voting policies permissible under paragraphs
(e)(3)(i)(A) and (B) of the current regulation. One of these safe
harbors permitted a policy to limit voting resources to particular
proposals that the fiduciary had prudently determined were
substantially related to the issuer's business activities or were
expected to have a material effect on the value of the investment. The
other safe harbor permitted a policy of refraining from voting on
proposals when the plan's holding in a single issuer relative to the
plan's total investment assets was below a quantitative threshold. The
Department was concerned that the safe harbors did not adequately
safeguard the interests of plans and their participants and
beneficiaries.
<bullet> The NPRM proposed to eliminate from the current regulation
a specific requirement on maintaining records on proxy voting
activities and other exercises of shareholder rights, which appeared to
treat proxy voting and other exercises of shareholder rights
differently from other fiduciary activities and risked creating a
misperception that proxy voting and other exercises of shareholder
rights are disfavored or carry greater fiduciary obligations than other
fiduciary activities.
The Department invited interested persons to submit comments on the
NPRM. In response to this invitation, the Department received more than
895 written comments and 21,469 petitions (e.g., form letters)
submitted during the open comment period. These comments and petitions
(hereinafter collectively referred to as ``comments'' unless otherwise
specified) came from a variety of parties, including plan sponsors and
other plan fiduciaries, individual plan participants and beneficiaries,
financial services companies, academics, elected government officials,
trade and industry associations, and others, both in support of and in
opposition to the NPRM. These comments are available for public review
on the Department's Employee Benefits Security Administration website.
III. The Final Rule
A. Executive Summary of Major Changes and Clarifications
The final rule generally tracks the NPRM but makes certain
clarifications and changes in response to public comments. Before
describing these changes, the Department emphasizes that the final rule
does not change two longstanding principles. First, the final rule
retains the core principle that the duties of prudence and loyalty
require ERISA plan fiduciaries to focus on relevant risk-return factors
and not subordinate the interests of participants and beneficiaries
(such as by sacrificing investment returns or taking on additional
investment risk) to objectives unrelated to the provision of benefits
under the plan. Second, the fiduciary duty to manage plan assets that
are shares of stock includes the management of shareholder rights
appurtenant to those shares, such as the right to vote proxies. As
described in further detail below in subsection B of this section III,
the final rule adopts the following changes to the current regulation:
<bullet> Like the NPRM, the final rule amends the current
regulation to delete the ``pecuniary/non-pecuniary'' terminology based
on concerns that the terminology causes confusion and a chilling effect
to financially beneficial choices.
<bullet> Like the NPRM, the final rule amends the current
regulation to make it clear that a fiduciary's determination with
respect to an investment or investment course of action must be based
on factors that the fiduciary reasonably determines are relevant to a
risk and return analysis and that such factors may include the economic
effects of climate change and other environmental, social, or
governance factors on the particular investment or investment course of
action.
<bullet> Like the NPRM, the final rule amends the current
regulation to remove the stricter rules for QDIAs, such that, under the
final rule, the same standards apply to QDIAs as to investments
generally.
<bullet> Like the NPRM, the final rule amends the current
regulation's ``tiebreaker'' test, which permits fiduciaries to consider
collateral benefits as tiebreakers in some circumstances. The current
regulation imposes a requirement that competing investments be
indistinguishable based on pecuniary factors alone before fiduciaries
can turn to collateral factors to break a tie and imposes a special
documentation requirement on the use of such factors. The final rule
replaces those provisions with a standard that instead requires the
fiduciary to conclude prudently that competing investments, or
competing investment courses of action, equally serve the financial
interests of the plan over the appropriate time horizon. In such cases,
the fiduciary is not prohibited from selecting the investment, or
investment course of action, based on collateral benefits other than
investment returns. The final rule also removes the current
regulation's special regulatory documentation requirements in favor of
ERISA's generally applicable statutory duty to prudently document plan
affairs.
<bullet> The final rule adds a new provision clarifying that
fiduciaries do not violate
[[Page 73828]]
their duty of loyalty solely because they take participants'
preferences into account when constructing a menu of prudent investment
options for participant-directed individual account plans. If
accommodating participants' preferences will lead to greater
participation and higher deferral rates, as suggested by commenters,
then it could lead to greater retirement security. Thus, in this way,
giving consideration to whether an investment option aligns with
participants' preferences can be relevant to furthering the purposes of
the plan.
<bullet> Like the NPRM, the final rule amends the current
regulation to eliminate the statement in paragraph (e)(2)(ii) of the
current regulation that ``the fiduciary duty to manage shareholder
rights appurtenant to shares of stock does not require the voting of
every proxy or the exercise of every shareholder right.'' The final
rule eliminates this provision because it may be misread as suggesting
that plan fiduciaries should be indifferent to the exercise of their
rights as shareholders, even if the cost is minimal.
<bullet> Like the NPRM, the final rule amends the current
regulation to remove the two ``safe harbor'' examples for proxy voting
policies permissible under paragraphs (e)(3)(i)(A) and (B) of the
current regulation. One of these safe harbors permitted a policy to
limit voting resources to types of proposals that the fiduciary has
prudently determined are substantially related to the issuer's business
activities or are expected to have a material effect on the value of
the investment. The other safe harbor permitted a policy of refraining
from voting on proposals or types of proposals when the plan's holding
in a single issuer relative to the plan's total investment assets is
below a quantitative threshold. Taken together, the Department believes
the safe harbors encouraged abstention as the normal course and the
Department does not support that position because it fails to recognize
the importance that prudent management of shareholder rights can have
in enhancing the value of plan assets or protecting plan assets from
risk. Because of this failure, the Department believes these safe
harbors do not adequately safeguard the interests of plans and their
participants and beneficiaries.
<bullet> Like the NPRM, the final rule eliminates paragraph
(e)(2)(iii) of the current regulation, which sets out specific
monitoring obligations with respect to use of investment managers or
proxy voting firms. The final rule instead addresses such monitoring
obligations in another provision of the regulation that more generally
covers selection and monitoring obligations. These amendments address
concerns that the specific monitoring provision could be read as
requiring special obligations above and beyond the statutory
obligations of prudence and loyalty that generally apply to monitoring
the work of service providers.
<bullet> Like the NPRM, the final rule amends the current
regulation to eliminate from paragraph (e)(2)(ii)(E) of the current
regulation a specific requirement on maintaining records on proxy
voting activities and other exercises of shareholder rights. The
provision is removed from the current regulation because it is widely
perceived as treating proxy voting and other exercises of shareholder
rights differently from other fiduciary activities and, in that
respect, risks creating a misperception that proxy voting and other
exercises of shareholder rights are disfavored or carry greater
fiduciary obligations than other fiduciary activities.
B. Detailed Discussion of Public Comments and Final Regulation
1. Section 2550.404a-1(a) and (b)--General and Investment Prudence
Duties
(a) Paragraph (a)
Paragraph (a) of the final rule is unchanged from the NPRM and
derives from the exclusive purpose requirements of ERISA section
404(a)(1)(A), and the prudence duty of ERISA section 404(a)(1)(B). The
provision is also the same as paragraph (a) of the current regulation.
The Department did not accept comments to expand the scope of the
regulation to provide additional guidance on the duty of
diversification under section 404(a)(1)(C) and the duty of impartiality
under section 404(a)(1)(A) as interpreted in cases such as Varity v.
Howe,\41\ as these other duties generally are beyond the scope of this
rulemaking initiative.
---------------------------------------------------------------------------
\41\ 516 U.S. 489 (1996).
---------------------------------------------------------------------------
(b) Paragraph (b)
Paragraph (b) of the final rule addresses the investment prudence
duties of a fiduciary under ERISA. Like the NPRM, paragraph (b) of the
final rule contains four subordinate paragraphs. As discussed below,
the final rule includes several changes from the proposal based on
public comment, mostly in paragraphs (b)(2) and (4) of the final rule.
(c) Paragraph (b)(1)
The NPRM did not propose any amendments to paragraph (b)(1) of the
current regulation. Like the current regulation (and the 1979
Investment Duties regulation before it), paragraph (b)(1) of the NPRM
provided that the requirements of section 404(a)(1)(B) of the Act set
forth in paragraph (a) are satisfied with respect to a particular
investment or investment course of action if the fiduciary meets two
conditions. First, the fiduciary must give ``appropriate consideration
to those facts and circumstances that, given the scope of such
fiduciary's investment duties, the fiduciary knows or should know are
relevant to the particular investment . . . including the role the
investment or investment course of action plays in that portion of the
plan's investment portfolio with respect to which the fiduciary has
investment duties.'' And second, the fiduciary must have ``acted
accordingly.'' Except for the addition of the words ``or menu'' after
the word ``portfolio'' for clarification, as explained below, paragraph
(b)(1) of the final rule is unchanged from the NPRM.
(d) Paragraph (b)(2)
Paragraph (b)(2) of the NPRM addressed the ``appropriate
consideration'' language referenced in paragraph (b)(1) of the
proposal. Paragraph (b)(2) of the NPRM contained two prongs.
First, paragraph (b)(2)(i) of the NPRM provided that for purposes
of paragraph (b)(1), ``appropriate consideration'' shall include, but
is not necessarily limited to, a determination by the fiduciary that
the particular investment or investment course of action is reasonably
designed, as part of the portfolio (or, where applicable, that portion
of the plan portfolio with respect to which the fiduciary has
investment duties), to further the purposes of the plan. For this
purpose, the plan fiduciary must take into consideration the risk of
loss and the opportunity for gain (or other return) associated with the
investment or investment course of action compared to the opportunity
for gain (or other return) associated with reasonably available
alternatives with similar risks.
Second, paragraph (b)(2)(ii) of the NPRM provided that for purposes
of paragraph (b)(1), ``appropriate consideration'' shall also include,
but is not necessarily limited to, consideration of the composition of
the portfolio with regard to diversification (paragraph (b)(2)(ii)(A)),
the liquidity and current return of the portfolio relative to the
anticipated cash flow requirements of the plan (paragraph
(b)(2)(ii)(B)), and
[[Page 73829]]
the projected return of the portfolio relative to the funding
objectives of the plan, which may often require the evaluation of the
economic effects of climate change and other environmental, social, or
governance factors on the particular investment or investment course of
action (paragraph (b)(2)(ii)(C)).
(1) Reasonably Available Alternatives
Several commenters provided views on the condition in paragraph
(b)(2)(i) that a fiduciary must compare an investment or investment
course of action under evaluation with reasonably available
alternatives. This condition was not part of the original investment
duties regulation adopted in 1979 and was added to the current
regulation in 2020. The Department carried forward this condition in
the 2021 NPRM and solicited comments on whether it was necessary to
restate this principle of general applicability as part of this
regulation.
Some commenters agreed that prudent fiduciaries should and
generally do compare similar, available investments when making
investment decisions. Some commenters said that because the provision
is a simple restatement of a fundamental prudence tenet, its inclusion
in the final rule is unnecessary. Some commenters were concerned that
the term ``reasonably available'' is ambiguous and could make
fiduciaries vulnerable to litigation challenging the reasonableness of
a fiduciary's determination of the number of investments used in making
the required comparison. Commenters were also concerned that the
requirement imposes burdens on fiduciaries that do not necessarily have
the resources to conduct research on all reasonably available
alternatives. Some commenters noted that the Department did not adopt a
comparative requirement in the 1979 rule and furthermore expressed
concerns that the rule could be interpreted to require all fiduciaries,
regardless of factors such as plan assets, to purchase and implement
extensive and expensive systems to conduct the comparative analysis.
One commenter suggested adding operative text that would explicitly
allow for market-based comparisons using benchmarks or other market
data as alternatives to the ``reasonably available investment
alternatives'' language. One commenter cautioned that removing the
provision would imply that the Department no longer believes that the
marketplace is a true forum and benchmark of the investment selection
process.
The Department continues to believe the requirement to compare
reasonably available alternatives is commonly understood by plan
fiduciaries, is uncontroversial in nature, and reflects the ordinary
practice of fiduciaries in selecting investments. The Department is
unpersuaded by some commenters' concerns regarding perceived ambiguity
in the meaning of ``reasonably available.'' The scope of a fiduciary's
obligation to compare an investment or investment course of action is
limited to those facts and circumstances that a prudent person having
similar duties and familiar with such matters would consider reasonably
available. Further, the term allows for the possibility that the
characteristics and purposes served by a given investment or investment
course of action may be sufficiently rare that a fiduciary could
prudently determine that there are no other reasonably available
alternatives for comparative purposes. Accordingly, the final rule
continues to require in paragraph (b)(2)(i) that ``appropriate
consideration'' shall include taking into consideration the risk of
loss and the opportunity for gain (or other return) associated with the
investment or investment course of action compared to the opportunity
for gain (or other return) associated with reasonably available
alternatives with similar risks. The language reflects the Department's
longstanding view, articulated in Interpretive Bulletin 94-1 (and
reiterated in subsequent Interpretive Bulletins) and earlier
interpretive letters, that facts and circumstances relevant to an
investment or investment course of action would include consideration
of the expected return on alternative investments with similar risks
available to the plan.\42\
---------------------------------------------------------------------------
\42\ 59 FR 32606 at 32607 (June 23, 1994); I.B. 2008-1, 73 FR
61734 (Oct. 17, 2008); I.B. 2015-1, 80 FR 65135 (Oct. 26, 2015);
see, e.g., Information Letter to Mr. Michael A. Feinberg, dated
August 4, 1985; Information Letter to Mr. James Ray, dated July 8,
1988 (``It is the position of the Department that, to act prudently,
a fiduciary must consider, among other factors, the availability,
riskiness, and potential return of alternative investments.'').
---------------------------------------------------------------------------
(2) Portfolio Versus Menu
The final rule adopts minor amendments to the text in paragraph
(b)(2) of the current regulation in response to commenters' requests to
clarify whether and how it applies in the context of participant-
directed individual account plans. Commenters observed that language in
paragraph (b)(2), which was originally developed in 1979, contains
certain considerations and factors that, in their view, are germane to
the selection of investments for defined benefit plans but not to the
selection of investments for defined contribution plans that have a set
of designated investment alternatives available for participant to
choose from, often referred to as a ``menu.'' For instance, they noted
that paragraphs (b)(2)(i) and (ii) require focusing on a ``portfolio,''
which they believe is confusing because a participant-directed defined
contribution plan's menu may include both funds that participants have
chosen as investments as well as funds that have not been chosen. The
commenters further noted that, in conventional investment parlance, the
term ``portfolio'' refers to a collection of assets actually owned by
an investor, whereas a menu of investment options for a participant-
directed individual account plan consists of a range of designated
investment alternatives that are available to participants. In
addition, they questioned how to determine ``anticipated cash flow
requirements of the plan'' in evaluating investment options for the
menu of a participant-directed defined contribution plan. A commenter
stated that, in its view, many of the appropriate consideration factors
in paragraph (b)(2)(ii) of the NPRM seem largely irrelevant to
participant-directed plans. These commenters suggested that
clarification on the application of paragraph (b)(2)(ii) to the
selection of investment options would be helpful for plan sponsors.
The Department appreciates the difficulties raised by commenters.
Paragraph (b)(2)(ii) sets out a non-exclusive list of factors that
functions as a minimum set of considerations for a fiduciary seeking to
rely upon paragraph (b)(1). Failure to meet those minimum
considerations would leave a fiduciary at risk of failing the standard
even if, in the context of choosing investment options for a
participant-directed plan, the responsible fiduciary has considered the
relevant facts and circumstances surrounding its decision, including
making a sound determination as described in paragraph (b)(2)(i).
Accordingly, the Department is making changes to paragraph (b)(2) of
the final rule. The changes clarify that the determination factors in
paragraph (b)(2)(i) apply to menu construction and the factors in
paragraph (b)(2)(ii) do not. Specifically, the Department is adding to
paragraph (b)(2)(i) of the final rule references to an investment
``menu,'' and is adding an introductory clause to paragraph (b)(2)(ii)
of the final rule limiting its application to employee benefit plans
other than participant-directed individual account plans.
These changes do not affect the requirements of paragraph (b)(1)(i)
of
[[Page 73830]]
the final rule, that a fiduciary must give appropriate consideration to
those facts and circumstances a fiduciary knows or should know are
relevant to the investment. These changes also should not be
interpreted as suggesting that a fiduciary of an individual account
plan is subject to a lower standard in giving appropriate consideration
to the facts and circumstances surrounding a particular decision
relating to an investment or investment course of action.
Notwithstanding the changes to paragraph (b)(2)(ii), the Department
believes that in selecting investment options for a plan menu, a
fiduciary's considerations of surrounding facts and circumstances
should be soundly reasoned and supported and reflect the requirements
of section 404(a)(1)(B) of ERISA. The Department agrees with one
commenter that, in the context of constructing a menu of investment
options, the relevant analysis involves two questions: First, how does
a given fund fit within the menu of funds to enable plan participants
to construct an overall portfolio suitable to their circumstances?
Second, how does a given fund compare to a reasonable number of
alternative funds to fill the given fund's role in the overall menu?
Except for the questions described above with respect to
application in the context of plan investment menus, the Department did
not receive substantive comments on paragraphs (b)(2)(ii)(A) and (B) of
the proposal. Those provisions are otherwise unchanged in the final
rule.
(3) ``May Often Require''
The Department received several comments on the language in
paragraph (b)(2)(ii)(C) of the proposal which specified that
consideration of the projected return of the portfolio relative to the
funding objectives of the plan ``may often require an evaluation of the
economic effects of climate change and other environmental, social or
governance factors on the particular investment or investment course of
action.'' This new language--the ``may often require'' clause--was
proposed by the Department to counteract any negative perception
against the consideration of climate change and other ESG factors in
investment decisions caused by the current regulation. The intent
behind this new clause was to clarify that plan fiduciaries may, and
often should depending on the investment under consideration, consider
the economic effects of climate change and other ESG factors on the
investment at issue. In no way did the Department consider this
proposed clause to be an expression of a novel concept. Indeed, the
sentiment had been expressed in earlier non-regulatory guidance,
although using different terminology.\43\
---------------------------------------------------------------------------
\43\ See Field Assistance Bulletin 2018-01 and Interpretive
Bulletin 2015-01.
---------------------------------------------------------------------------
The Department received comments supporting and opposing this new
clause. On the one hand, some commenters indicated that it helped
address the chilling effect on evaluating ESG issues and served as a
useful reminder to fiduciaries that ESG factors often do have an impact
on investments. In the main, these commenters support the regulatory
text as an express acknowledgement that climate change and other ESG
factors are relevant to risk and return, and as an indication that
fiduciaries should not be exposed to additional perceived or actual
fiduciary liability risk under ERISA if they include such factors in
their evaluation of plan investments.
On the other hand, a great many commenters, including some who
concurred with the need to address the chilling effect under the
current regulation, expressed a variety of concerns with this
provision. Some commenters were concerned that by differentiating ESG
considerations from other factors in express regulatory text, the
regulation goes beyond removing the chilling effect and improperly
places a thumb on the scale in favor of ESG investing. Some further
cautioned that fiduciaries may treat the provisions as an effective
mandate that they must consider ESG factors under all circumstances.
The commenters argued that, absent guidance on when such an evaluation
would not be required, plan fiduciaries would feel obligated to
consider climate change and other ESG factors for every investment.
Several commenters criticized the Department for, in their view,
essentially favoring ESG investment strategies and overriding a
fiduciary's considered judgment with respect to which investment
factors or strategies to consider. Multiple commenters indicated that
studies and research on investment performance involving ESG strategies
show mixed results, and that a regulatory bias in favor of ESG
investing is not justified. In line with this comment, some commenters
questioned whether the Department presented sufficient evidence to
support a position on the frequency (``may often require'') with which
fiduciaries may be required to consider ESG factors, or argued that the
market has already priced ESG factors into the price of any given
investment.
Some commenters who criticized the new language in paragraph
(b)(2)(ii)(C) stated that if the regulation takes the position that
evaluating the economic effects of climate change and other ESG factors
``may often'' be required, then ambiguity surrounding the definition of
the term ESG factors must be reduced to provide regulatory certainty.
Commenters noted, however, that it would be difficult to precisely
define ESG factors. Commenters also expressed concern that the language
may be interpreted as effectively directing fiduciaries to take on the
costs and complexity of evaluating the effects of climate change and
other ESG factors, even if not otherwise prudent. In this regard, a
commenter argued that there are common situations when a prudent
analysis of the projected return relative to the portfolio's funding
objective is unlikely to require an evaluation of the economic effects
of ESG factors, such as when the objective of the applicable portion of
the portfolio is to track the performance of an index. Several
commenters offered alternative language to reduce the likelihood of
misinterpreting the provision. Other commenters opined that the ``may
often require'' language is largely unnecessary to address the chilling
effect on consideration of ESG factors under the current regulation
because of the broad language in paragraph (b)(4) of the proposal
relating to the consideration of ``any material factor.''
Based on the comments received, the Department has decided to
modify paragraph (b)(2)(ii)(C) of the proposal by deleting the ``which
may often require'' language altogether and consolidating the reference
to ``climate change and other environmental, social, or governance ESG
factors'' with language in paragraph (b)(4), as further modified below.
The proposed language in paragraph (b)(2)(ii)(C) of the NPRM was not
intended to create an effective or de facto regulatory mandate. Nor was
the language intended to create an overarching regulatory bias in favor
of ESG strategies. The Department is not persuaded that alternative
language suggested by commenters to replace the ``may often require''
would be as effective in removing regulatory bias as the course chosen
in the final rule. The modified version of the proposed language is
intended to make it clear that climate change and other ESG factors may
be relevant in a risk-return analysis of an investment and do not need
to be treated differently than other relevant investment factors,
without causing a perception that the
[[Page 73831]]
Department favors such factors in any or all cases.
As modified (and relocated to paragraph (b)(4) of the final
regulation), the new text sets forth three clear principles. First, a
fiduciary's determination with respect to an investment or investment
course of action must be based on factors that the fiduciary reasonably
determines are relevant to a risk and return analysis, using
appropriate investment horizons consistent with the plan's investment
objectives and taking into account the funding policy of the plan
established pursuant to section 402(b)(1) of ERISA. Second, risk and
return factors may include the economic effects of climate change and
other environmental, social, or governance factors on the particular
investment or investment course of action. Whether any particular
consideration is a risk-return factor depends on the individual facts
and circumstances. Third, the weight given to any factor by a fiduciary
should appropriately reflect an assessment of its impact on risk and
return.
In the Department's view, this principles-based approach is
sufficient to address the chilling effect under the current regulation
without establishing an effective mandate or explicitly favoring
climate change and other ESG factors. This principles-based approach is
designed to eliminate the substantial chilling effect caused by the
current regulation, including its reference to ``pecuniary factors.''
As previously discussed, numerous commenters indicated that the current
regulation puts a thumb on the scale against ESG factors, and chills
fiduciaries from considering any ESG factors even when they are
relevant to a risk-return analysis. The undesired effect of the current
regulation is to chill and discourage fiduciaries from considering
relevant investment factors that prudent investors otherwise would
consider. At the same time, the final rule makes unambiguous that it is
not establishing a mandate that ESG factors are relevant under every
circumstance, nor is it creating an incentive for a fiduciary to put a
thumb on the scale in favor of ESG factors. By declining to carry
forward the ``may often require'' clause in paragraph (b)(2)(ii)(C) of
the proposal, the final rule achieves appropriate regulatory neutrality
and ensures that plan fiduciaries do not misinterpret the final rule as
a mandate to consider the economic effects of climate change and other
ESG factors under all circumstances. Instead, the final rule makes
clear that a fiduciary may exercise discretion in determining, in light
of the surrounding facts and circumstances, the relevance of any factor
to a risk-return analysis of an investment. A fiduciary therefore
remains free under the final rule to determine that an ESG-focused
investment is not in fact prudent. Finally, nothing about the
principles-based approach should be construed as overturning long
established ERISA doctrine or displacing relevant common law prudent
investor standards.
(e) Paragraph (b)(3)
Paragraph (b)(3) of the final rule is unchanged from the proposal
and states that an investment manager appointed pursuant to the
provisions of section 402(c)(3) of the Act to manage all or part of the
assets of a plan may, for purposes of compliance with the provisions of
paragraphs (b)(1) and (2) of the proposal, rely on, and act upon the
basis of, information pertaining to the plan provided by or at the
direction of the appointing fiduciary, if such information is provided
for the stated purpose of assisting the manager in the performance of
the manager's investment duties, and the manager does not know and has
no reason to know that the information is incorrect. The Department did
not receive substantive comment on the provision, which carries
forward, without change, regulatory language dating back to the 1979
Investment duties regulation.
(f) Paragraph (b)(4)
(1) Introductory Text
The introductory text of paragraph (b)(4) of the proposal provided
that ``a prudent fiduciary may consider any factor in the evaluation of
an investment or investment course of action that, depending on the
facts and circumstances, is material to the risk return analysis[.]''
This introductory text was then followed by three paragraphs of
specific ESG examples. Commenters were generally supportive of this
provision minus the three paragraphs describing specific ESG examples.
In context, many viewed paragraph (b)(4) of the NPRM as confirming the
discretionary authority of fiduciaries to consider whatever factor or
factors, in the reasoned judgment of the fiduciaries, are relevant to
risk and return of the investment or investment course of action,
including climate change and other ESG factors. Some commenters
expressed the view that this introductory text (without the three
paragraphs of examples), in conjunction with the removal of the so-
called ``pecuniary-only'' terminology from the current regulation,
would make significant headway in counteracting the negative perception
of the consideration of climate change and other ESG factors caused by
the current regulation. Paragraph (b)(4) of the final rule, therefore,
retains the introductory text's focus on factors that are relevant to a
risk and return analysis. Paragraph (b)(4) also retains its central
recognition that relevant risk and return factors may, depending on the
facts and circumstances, include the economic effects of climate change
and other ESG factors. But, paragraph (b)(4) of the final rule
otherwise contains substantial modifications discussed below.
(2) Three Paragraphs of ESG Examples
Comments on the list of examples in paragraph (b)(4) of the NPRM
focused on both content and placement and were varied. Some commenters
supported both the content (only ESG examples) and placement of the
examples. In general, these commenters are of the view that the list of
examples, even though limited to only ESG factors, is an appropriate
corrective for what they view as the severe anti-ESG bias of the
current regulation. In their view, adding the three paragraphs of ESG
examples directly to the regulatory text will help to reassure
fiduciaries that they will not be subject to litigation solely because
of the use of such factors.
Many commenters, however, had concerns with the list of examples in
paragraph (b)(4) of the NPRM and recommended their removal from the
operative regulatory text. One frequently cited concern was that the
list of examples in the proposal was too one-sided in favor of ESG
factors. According to these commenters, the perceived regulatory bias
would predictably trigger revisions by a future Administration with
opposing views, effectively reducing the reliability and durability of
the rule. This concern was raised by commenters who both supported and
opposed the content of the examples.
Another frequently cited concern was that the list might have
unintended consequences. For example, plan fiduciaries might
erroneously conclude that the factors listed in the operative text are
more prudent than non-listed factors. A different but possible
unintended consequence mentioned several times was that some plan
fiduciaries might perceive the list as a safe harbor, such that
fiduciaries may believe they will be deemed to have made a prudent
investment decision if they consider only the listed examples (and no
others). Others suggested that, by singling out these particular
examples to the exclusion of other examples, the regulation could be
read
[[Page 73832]]
as implying that these factors were especially important when selecting
an investment. Consequently, according to these commenters, at least
some fiduciaries would feel obligated to document in writing their
justification for not considering these example factors. Similarly,
some commenters suggested that, in their view, listing in the operative
text only a few of the potentially material factors that a prudent
fiduciary might consider might unintentionally create a perception that
the Department expects fiduciaries will take these specific factors
into consideration, even where it might not be possible, practical, or
prudent.
Another repeated concern of commenters was that the list of factors
is unnecessary. According to these commenters, the general reference to
material risk-return factors in paragraph (b)(4) of the NPRM would be
sufficient to make clear that fiduciaries may consider any factor
material to a risk-return analysis, including ESG factors. To these
commenters, the concept of materiality provides for the determination
of relevant factors on a case-by-case basis. In their view, such a
principles-based approach better serves plans and provides greater
flexibility for ERISA fiduciaries to consider the unique factors
relevant to particular investment decisions.
Another frequently cited concern was that the examples would become
stale over time. Several commenters opined that a list of specific
examples of material factors that may be of particular importance now
may be of less importance in the future. Thus, at a minimum, the
regulation could require updates over time as risk management and
investment strategies evolve.
Some commenters indicated that the list of ESG factors could be
improved with additional examples. For instance, many commenters
suggested that the list should be balanced by expanding the list to
include non-ESG factors that may be material risk-return factors (e.g.,
good products, compelling corporate strategy, tight cost controls).
Some further suggested it would be helpful for the Department to add
examples of when it is not prudent to consider ESG factors. A commenter
noted that by including only ESG factors as examples, the Department
risks creating a perception that fiduciaries may take only ESG factors
into account. Another commenter criticized that some of the examples as
proposed are broad and ambiguous, inherently subjective, and give too
much flexibility to plan fiduciaries who may be inclined to use plan
assets to further particular ESG goals. Some commenters further
characterized the proposed examples as singling out special interests
and progressive ESG priorities that have little to no impact on
financial returns. Multiple commenters suggested additions of factors
that seemed to fall within the broad categories of examples but were
not specifically listed. Commenters also suggested the addition of
factors that did not appear to fall within any of those categories.
After consideration of the comments received, the Department is
persuaded that paragraph (b)(4) of the final rule should not include a
list of examples. The list of examples was never intended to be
exclusive; nor was it intended to define ``ESG'' or introduce any new
conditions under the prudence safe harbor. The list of examples was
merely intended to reaffirm that fiduciaries may consider ESG factors
that are relevant to a risk-return analysis of the investment. The
examples were intended to make clear that ESG factors may be more than
mere tiebreakers, but rather financially material to the investment
decision. The Department believes, however, that this point is made
sufficiently clear by the general language in paragraph (b)(4) of the
final rule. The primary justification for removing the examples from
the operative text of the final rule is that the Department is wary of
creating an apparent regulatory bias in favor of particular investments
or investment strategies.
Removal of the list from paragraph (b)(4) should not be viewed as
limiting a fiduciary's ability to take into account any risk and return
factor that the fiduciary reasonably determines is relevant to a risk/
return analysis. The Department continues to be of the view that,
depending on the surrounding facts and circumstances, these may include
the factors listed in paragraph (b)(4) of the proposal. Thus, depending
on the surrounding circumstances, a fiduciary may reasonably conclude
that climate-related factors, such as a corporation's exposure to the
real and potential economic effects of climate change including
exposure to the physical and transitional risks of climate change and
the positive or negative effect of Government regulations and policies
to mitigate climate change, can be relevant to a risk/return analysis
of an investment or investment course of action. A fiduciary also may
make a similar determination with respect to governance factors, such
as those involving board composition, executive compensation, and
transparency and accountability in corporate decisionmaking; a
corporation's avoidance of criminal liability; compliance with labor,
employment, environmental, tax, and other applicable laws and
regulations; the corporation's progress on workforce diversity,
inclusion, and other drivers of employee hiring, promotion, and
retention; investment in training to develop a skilled workforce; equal
employment opportunity; and labor relations and workforce practices
generally.
The foregoing examples are merely illustrative, and not intended to
limit a fiduciary's discretion to identify factors that are relevant
with respect to its risk/return analysis of any particular investment
or investment course of action. A fiduciary may reasonably determine
that a factor that seems to fall within a general category described
above (e.g., climate-related factors), but is not specifically
identified above, nonetheless is relevant to the analysis (e.g.,
drought). For example, depending on the facts and circumstances,
relevant factors may include impact on communities in which companies
operate, due diligence and practices regarding supply chain management,
including environmental impact, human rights violations records, and
lack of transparency or failure to meet other compliance standards. As
another example, labor-relations factors, such as reduced turnover and
increased productivity associated with collective bargaining, also may
be relevant to a risk and return analysis.
Of course, a fiduciary's determination of relevant factors is not
limited to the general categories described above. Prudent investors
commonly take into account a wide range of financial circumstances and
considerations, depending on the particular circumstances, such as a
corporation's operating and financial history, capital structure, long-
term business plans, debt load, capital expenditures, price-to-earnings
ratios, operating margins, projections of future earnings, sales,
inventories, accounts receivable, quality of goods and products,
customer base, supply chains, barriers to entry, and a myriad of other
financial factors, depending on the particular investment. This rule,
as amended, does not supplant such considerations, but rather makes
clear that there is no inconsistency between the appropriate
consideration of ESG factors and ERISA section 404(a)(1)(B)'s standard
of prudence, which requires that fiduciaries act with the ``care,
skill, prudence, and diligence under the circumstances then prevailing
that a prudent man acting in a like capacity and familiar with such
matters would use in the conduct of an enterprise of a like character
and with like aims.''
[[Page 73833]]
(3) Consolidation of Multiple Provisions Into Paragraph (b)(4) of the
Final Rule
In concert with removing the list of examples from paragraph (b)(4)
of the NPRM, elements of paragraphs (b)(2)(ii)(C) and (c)(2) of the
NPRM are now merged into paragraph (b)(4) of the final rule. These
edits address commenters' concerns that aspects of paragraph
(b)(2)(ii)(C) of the NPRM could constitute an effective or de facto
mandate to always consider the effects of climate change and other ESG
factors on every investment or investment course of action, that the
examples in paragraph (b)(4) of the NPRM interject inappropriate
regulatory bias in favor of ESG factors, and that the final rule not
retreat from the principle in paragraph (c)(2) of the NPRM that
fiduciaries must base investment decisions only on factors that are
relevant to a risk and return analysis. The essence of paragraph (c)(2)
of the NPRM was not changed when merged into paragraph (b)(4) of the
final rule. As mentioned below, the merger avoids the existence of
redundant concepts in multiple paragraphs and reflects that the
substance of paragraph (c)(2) of the NPRM is more closely connected to
ERISA's duty of prudence than the duty of loyalty.
Accordingly, paragraph (b)(4) of the final rule provides that a
fiduciary's determination with respect to an investment or investment
course of action must be based on factors that the fiduciary reasonably
determines are relevant to a risk and return analysis, using
appropriate investment horizons consistent with the plan's investment
objectives and taking into account the funding policy of the plan
established pursuant to section 402(b)(1) of ERISA. It further
indicates that risk and return factors may include the economic effects
of climate change and other environmental, social, or governance
factors on the particular investment or investment course of action,
and whether any particular consideration is a risk-return factor
depends on the individual facts and circumstances. Finally, it provides
that the weight given to any factor by a fiduciary should appropriately
reflect a reasonable assessment of its impact on risk-return.
As revised, paragraph (b)(4) of the final rule subsumes core
elements of paragraphs (c)(1) and (f)(3) of the current regulation.
Specifically, the emphasis on risk and return factors in these two
paragraphs carries forward into paragraph (b)(4) of the final rule. The
current regulation's reliance on ``pecuniary only'' and related
terminology, however, is otherwise rescinded. The framework in
paragraph (b)(4) of the final rule continues to adhere to the
principle, underpinning paragraphs (c)(1) and (f)(3) of the current
regulation, that when selecting an investment or investment course of
action plan fiduciaries must focus on relevant risk and return factors,
but the Department no longer supports the current regulation's
framework and terminology for advancing this principle. The Department,
instead, agrees with the commenters who found the current regulation's
framework and terminology confusing and susceptible to inferences of
bias against the treatment of climate change and other ESG factors as
potentially relevant risk and return factors. The Department intends
with these edits to dispel the perception caused by the current
regulation that climate change and other ESG factors are somehow
presumptively suspect or unlikely to be relevant to the risk and return
of an investment or investment course of action. Paragraph (b)(4) of
the final recognizes that, as with other factors, climate change and
other ESG factors sometimes may be relevant to a risk and return
analysis and sometimes not--and when relevant, they may be weighted and
factored into investment decisions alongside other relevant factors, as
deemed appropriate by the plan fiduciary.
(4) Conforming Terminology--``Relevance'' Versus ``Material''
In addition, paragraph (b)(4) of the final rule contains a change
in terminology to establish consistency with the terminology in
paragraph (b)(1) of the final rule. Several commenters noted that
paragraph (b)(1) of the NPRM refers to ``relevant'' factors but that
paragraph (b)(4) of the NPRM refers to ``material'' factors. Noting a
body of decisional and regulatory law underpinning ``materiality''
under Federal securities laws and accounting conventions, many of these
commenters considered the NPRM's use of these different terms a source
of confusion. In conjunction with proposed paragraph (b)(4)'s focus on
risk and return factors, many commenters were concerned that paragraph
(b)(4)'s use of ``material'' might be construed as circumscribing the
role or authority of plan fiduciaries under ERISA's prudence standard
as reflected in the use of ``relevance'' in paragraph (b)(1) of the
NPRM.
In discussing these concerns, commenters mentioned many factors
that, in their view, are relevant factors routinely considered by plan
fiduciaries when selecting investments, such as brand name or
reputation of the fund or fund manager, lifetime income options, style
of fund (e.g., growth versus value), style of fund management (passive
versus active), an investment's regulatory regime, participants'
understanding of the investment, participants' preferences, and other
investment-related operational considerations. These commenters
expressed concern that such factors may not always perfectly align with
securities law or accounting concepts of materiality or directly affect
the risk and return of an investment in clear or obvious ways.
In response to some of these concerns, paragraph (b)(4) of the
final rule uses the word ``relevant'' instead of ``material.'' \44\ The
Department stresses, however, that under paragraph (b)(4) of the final
rule, the fiduciary's investment determination must ultimately rest on
factors relevant to a risk and return analysis. The Department does not
undertake in this document to address specific risk and return factors,
but it notes that it has previously concluded that plan contributions
do not constitute a ``return'' on investment.
---------------------------------------------------------------------------
\44\ A similar change was made in paragraph (d)(2)(ii)(D) of the
final regulation to appropriately align terminology in similar
contexts across different paragraphs of the final regulation.
---------------------------------------------------------------------------
2. Section 2550.404a-1(c) Investment Loyalty Duties
(a) Removal of Pecuniary-Only Requirement--Paragraph (c)(2) of the
Proposal
Paragraph (c)(2) of the NPRM modified the requirement in paragraph
(c)(1) of the current regulation that a fiduciary's evaluation of an
investment or investment course of action must be based ``only on
pecuniary factors,'' which is defined at paragraph (f)(3) of the
current regulation as a factor that a fiduciary prudently determines is
expected to have a material effect on the risk and/or return of an
investment based on appropriate investment horizons consistent with the
plan's investment objectives and the funding policy. The Department
used the phrase ``pecuniary factors'' for the first time in the 2020
regulations, and although the Department defined it in those
regulations, the phrase is not found in ERISA and has no longstanding
meaning in employee benefits law. The NPRM proposed to remove the
``pecuniary only'' formulation of the requirement and to integrate the
concept of ``risk/return'' factors directly into paragraph (c)(2) of
the NPRM. This approach was intended to address stakeholder concerns
about ambiguity in the meaning and application of the
[[Page 73834]]
``pecuniary only'' terminology of the current regulation.
A significant number of commenters supported the NPRM's proposed
removal of the pecuniary-only test and related terminology. Many
commenters on this issue were of the view that, rather than providing
clarity, the current regulation's pecuniary-only terminology created
confusion by layering an additional standard or test onto the existing
fiduciary framework. That framework already unambiguously required
fiduciaries to base plan investment decisions on financially relevant
factors. In line with that concern, many commenters asserted that this
pecuniary-only terminology chills plan fiduciaries from considering
climate change and other ESG factors even where they have a material
effect on the bottom line of an investment, merely because such factors
also may have the effect of supporting non-financial objectives. In
such ``dual purpose'' circumstances, the position of these commenters
was that just because an investment factor or strategy may
simultaneously have economic and non-economic dimensions, the non-
economic dimensions do not lessen the factor or strategy's economic
significance. These commenters stated that the NPRM's proposed
elimination of the pecuniary-only and related terminology would make
clear to fiduciaries that they are free to consider the full range of
potential material risk-return factors without undue fear of regulatory
second-guessing or litigation. According to these commenters, the
elimination would encourage fiduciaries to take the same steps that
other marketplace investors take in enhancing investment value and
performance or improving investment portfolio resilience against the
potential financial risks and impacts associated with climate change
and other ESG factors.
Some commenters opposed the NPRM's proposed changes; they
emphasized the importance of basing investment decisions on only
pecuniary considerations and urged the Department to retain the
pecuniary factors and related terminology. These commenters generally
were of the view that ERISA requires that plan fiduciaries focus solely
on the economics of an investment and state that climate change and
other ESG factors rarely can be harmonized with this requirement. Given
that belief, these commenters were concerned that participants'
retirement security will suffer as plan fiduciaries and money managers
pursue agendas unrelated to the exclusive purpose of providing
financial benefits to retirement plan participants and beneficiaries.
In line with this concern, one commenter asserted that the insertion of
non-pecuniary investment criteria in the management of pension and
other such funds imposes a substantial penalty over time in terms of
realized returns. One commenter questioned the consistency of
permitting the consideration of non-pecuniary goals with the Supreme
Court's opinion in Fifth Third Bancorp v. Dudenhoeffer, which stressed
the fiduciary's obligation to focus on retirement plan participants'
financial interests.\45\
---------------------------------------------------------------------------
\45\ Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014).
---------------------------------------------------------------------------
The Department is not persuaded to retain the current regulation's
use of and reliance on the novel pecuniary-only formulation and its
related terminology. The pecuniary-only requirement and related
terminology unfortunately caused a great deal of confusion, and it
accounts for a substantial amount of the chilling effect this
rulemaking project set out to redress. These facts are manifest in the
many comment letters on the NPRM. Many view the ``pecuniary-only''
terminology as ambiguous or decidedly prohibitive on the question of
whether climate change and other ESG factors may be considered when
those factors are relevant to the risk-and-return analysis. Indeed, as
indicated by commenters, the current rule actually has a chilling
effect that discourages fiduciaries from prudently considering climate
change and other ESG factors that may be relevant to the risk-return
analysis. Some commenters, in particular, asked questions about
considering factors that have both economic and noneconomic components,
suggesting apprehension that this would fall outside the current
regulation's pecuniary-only requirement. In light of the foregoing, the
Department no longer supports the use of this terminology. Rather, the
Department thinks, and many commenters agree, that paragraph (c)(2) of
the NPRM, subject to certain modifications discussed elsewhere in this
preamble, is a more understandable formulation of ERISA's requirement
that a fiduciary's evaluation of an investment or investment course of
action must focus on factors that the fiduciary reasonably determines
are relevant to a risk and return analysis. Removing the ``based only
on pecuniary factors'' language (and related terminology throughout)
from the current regulation will help re-establish the Department's
position reflected in non-regulatory guidance as early as 2015 that
climate change and other ESG factors that may be relevant in a risk-
return analysis of an investment do not need to be treated differently
than other relevant investment factors, even though they may possess
the ``dual purpose'' dimensions mentioned by some commenters. Put
differently, removing this novel terminology is removing the current
regulation's thumb from the scale so as not to discourage fiduciaries
from considering climate change and other ESG factors where relevant to
the risk-return analysis.
Finally, the Department finds no merit to the argument that the
final rule, either in general or in not carrying forward the pecuniary/
non-pecuniary terminology, permits or requires behavior contrary to the
holding in Dudenhoeffer. On the contrary, the central premise behind
the final rule's rescission of the pecuniary/non-pecuniary distinction
is that the current regulation is being perceived by plan fiduciaries
and others as undermining the fundamental principle Dudenhoeffer
expressed: fiduciaries must protect the financial benefits of plan
participants and beneficiaries. In this way, the pecuniary-only
requirement would effectively prohibit or encumber plan fiduciaries
from managing against or taking advantage of climate change and other
ESG risk factors in selecting investments, even when it is financially
prudent to do so. Thus, the final rule's amendments to the current
regulation, which are aimed solely at counteracting that perception,
are entirely consistent with the principle articulated in Dudenhoeffer.
Notwithstanding the foregoing, paragraph (c)(2) of the proposal has
been incorporated into paragraph (b)(4) of the final rule for clarity
and to avoid potentially redundant and confusing requirements. This
consolidation reflects that the essence of the requirement of paragraph
(c)(2) of the proposal that fiduciaries make investment decisions based
on factors relevant to a risk and return analysis is inherently
prudential in nature, rather than a loyalty obligation, and therefore
overlaps with the requirements of paragraph (b)(4) of the proposed
rule. Although including such a requirement in the regulation's loyalty
provisions may help establish regulatory guideposts for
fiduciaries,\46\ that same function is fulfilled by incorporating it
into the final regulation's prudence provisions at paragraph (b)(4) of
the final rule.
---------------------------------------------------------------------------
\46\ See 85 FR 72854.
---------------------------------------------------------------------------
[[Page 73835]]
(b) Paragraph (c)(1)
Paragraph (c)(1) of the proposal restated the Department's
longstanding expression of ERISA's duty of loyalty in the context of
investment decisions, as also expressed in Interpretive Bulletins and
associated preamble discussions. It provided that a fiduciary may not
subordinate the interests of participants and beneficiaries in their
retirement income or financial benefits under the plan to other
objectives and may not sacrifice investment return or take on
additional investment risk to promote goals unrelated to the plan and
its participants and beneficiaries. Similar language is contained in
paragraph (c)(2) of the current regulation. The Department did not
receive substantive comments on paragraph (c)(1) of the proposal, and
it is being adopted in the final rule without change. As in the
proposal and current regulation, the final rule's paragraph (c)(1) is a
legal requirement and not a safe harbor.
(c) Paragraph (c)(2)--Tie Breaker Test and Tie Breaker Standard
Paragraph (c)(3) of the proposal directly rescinded the
``tiebreaker'' standard in paragraph (c)(2) of the current regulation
and replaced it with a standard intended to align more closely with the
Department's original non-regulatory guidance from nearly three decades
ago, IB 94-1, which first advanced the ``tiebreaker'' concept. In
explaining the standard in the preamble to IB 94-1, the Department
stated that ``a plan fiduciary may consider collateral benefits in
choosing between investments that have comparable risks and rates of
return.'' \47\ In contrast, the current regulation narrowly focused on
whether competing investments are ``indistinguishable'' based on
pecuniary factors alone. Under such circumstances, the current
regulation permits a plan fiduciary to use a non-pecuniary factor as a
deciding factor in making its investment decision, but only if the
fiduciary also complies with a specific documentation requirement.
---------------------------------------------------------------------------
\47\ 59 FR 32607 (June 23, 1994).
---------------------------------------------------------------------------
A number of commenters supported both the rescission of the current
tiebreaker standard and the proposal's replacement standard--i.e., that
competing investments ``equally serve'' the financial interests of the
plan. In their view, the proposed formulation represented a significant
improvement over the current regulation, which they argued set out an
unrealistically difficult and prohibitively stringent standard. Some
further suggested that the standard in the current regulation is so
stringent that it effectively eliminated the Department's historical
tiebreaker test. For instance, according to one commenter, the current
regulation's tiebreaker standard improperly limits its application,
because it would only apply when a fiduciary is unable to distinguish
two or more investments based on pecuniary factors alone--an occurrence
that is rare and unreasonably difficult to identify, according to this
commenter. In actual practice, the commenter states, a prudent
fiduciary process often produces a variety of investments that are
consistent with, and in the fiduciary's judgement, equally promote, the
financial interests of participants and beneficiaries. According to a
different commenter, the current regulation's ``economically
indistinguishable'' standard is in practice impossible for fiduciaries
to surmount, given that differences exist even among very similar
investments. As put by yet another commenter, the requirement that
investments be ``economically indistinguishable'' before a fiduciary
can consider collateral factors (such as ESG factors when not relevant
to risk and return) effectively subverts the fiduciary's best judgment
in favor of a standard that is virtually impossible to meet. Overall,
these commenters viewed the proposal's standard as tracking the
Department's prior guidance more closely, and more accurately
reflecting the realities of fiduciary decisionmaking. They supported
adoption of the NPRM's standard without change.
Other commenters supported the proposal's rescission of the current
tiebreaker standard, but raised concerns with the proposal's ``equally
serve'' formulation. Commenters indicated that the proposal was not
clear as to how to determine when investments meet the ``equally
serve'' standard and requested further guidance. Questions presented
included whether the equally-serve analysis is based on how similar
investments are, or based on the potential financial effects of the
investments on the plan's portfolio. One commenter suggested that the
Department should recognize that investments may vary from each other
but still serve the same plan purpose. Another commenter asked how
small deviations in the financial effects of two investments would
affect the equally serve analysis. These commenters did not believe the
tiebreaker standard should require investments to be identical, and
suggested clarifying language, such as a standard based on investments
that serve the financial interests of the plan comparably well, or
equally well.
Other commenters indicated that the ``equally serve'' standard
appeared to imply an investment process under which a fiduciary
selection process involves evaluating a group of potential investments,
paring the group down to a few competing investments, and then moving
on to the tiebreaker test and the selection of a single investment.
Commenters opined that such a mechanical process of elimination should
not be necessary if a fiduciary has already prudently determined that
each investment is consistent with the plan's objectives and is
reasonably designed to further the purposes of the plan. Some
commenters asserted that the tiebreaker test should focus on whether
investments are the result of a prudent fiduciary process rather than
on an analysis of their equivalence, and suggested formulations based
on ``equally prudent'' investments, or investments identified through a
prudent process.
Some commenters supported the tiebreaker standard in the current
regulation and objected to the rescission of the current standard.
These commenters viewed the proposal's standard as far too lenient, and
the current regulation's indistinguishability based on pecuniary
factors only standard as appropriate in light of ERISA's high standard
of fiduciary responsibilities. They asserted that the current
regulation's provisions are a valuable curb against behavior that could
otherwise lead to subordinating the interests of participants and
beneficiaries in their retirement income. These commenters expressed
concern that the proposal, with changes to the tiebreaker standard and
related documentation provisions, would invite abuse and open the door
to using pension plan assets for policy agendas, or encourage
fiduciaries to advance personal policies and agendas at the expense of
interests of trust beneficiaries in a secure retirement.
A number of commenters did not support inclusion of any tiebreaker
provision in the regulation. Some commenters believe the tiebreaker
test cannot be reconciled with ERISA's duty of loyalty, which requires
that fiduciaries discharge their duties for the exclusive purpose of
providing benefits to participants and beneficiaries and defraying
reasonable expenses of administering the plan. Commenters also
cautioned that the tiebreaker provision weakens the focus on the best
financial outcome for plan participants and beneficiaries by
encouraging consideration of collateral factors. In
[[Page 73836]]
their view, fiduciaries desiring to seek third-party benefits may,
deliberately or inadvertently, be encouraged to declare ties to free
themselves from the duty of loyalty. Several of these commenters did
not believe a tiebreaker is necessary regardless of formulation
because, in their view, ties generally do not exist, particularly in
liquid financial markets. Furthermore, they argued that the purpose of
an investment manager is to exploit differences among investments and
to select a winner (or buy both for increased diversification in the
case of ties). In their view, fiduciaries are accustomed to
deliberating on such matters, including close calls, and if they are
doing their job and creating an appropriate record, there should be no
need for tiebreaker guidance in the rule.
Some commenters also believed that a tiebreaker test may
potentially cause harm or detriment to plans. For instance, some
suggested that a tiebreaker test may reduce accountability and promote
complacency by allowing investment decisionmakers to adopt a ``close
enough'' attitude and point to some reason other than financial merit
to justify their decisions. In contrast, others suggested that the
tiebreaker test promotes a misconception that there is a single
``best'' investment for a plan. Still others cautioned that the mere
existence of a tiebreaker test could unintentionally signal that ESG
factors cannot, on their own, be considered material to a risk-return
analysis. Some also suggested that there is a chance the tiebreaker
test may be overused unnecessarily in cases where the fiduciary has
little doubt about the financial merits of the investment in question
but where the fiduciary perceives the tiebreaker route as providing a
level of protection from future allegations of disloyalty. Such overuse
may lead to substantial burdens on recordkeepers in connection with the
proposal's related collateral benefit disclosure requirement.
The Department is not persuaded that the tiebreaker provision
should be removed from the final rule. The Department does not agree
with commenters who asserted that the tiebreaker test is unnecessary or
inconsistent with ERISA. Although there has been some mostly semantic
variation in what constituted ties under the Department's prior non-
regulatory guidance, some version of the tiebreaker test has appeared
in the CFR since 1994. Consequently, since at least that time, the
Department has recognized that fiduciaries may use collateral benefits
to break ties between various investments. The tiebreaker test thus
aligns the final rule with the settled expectations of fiduciaries and
others involved in the investment of assets of employee benefits plans
under ERISA, especially in the multiemployer plan context. Although
some fiduciaries, by the nature of their arrangements with plans, may
apply investment strategies that never require them to choose between
alternatives that equally serve the plan's needs, other fiduciaries,
such as those making investments outside liquid financial markets, may
find the tiebreaker test useful for circumstances in which there are
equally strong cases for competing investments under a risk-return
analysis. In addition, although some commenters question the need for a
tiebreaker test and whether ties exist, other commenters acknowledge
the utility of the tiebreaker standard. For instance, some commenters
argued that in the event of a tie between two investment options, the
fiduciary should increase diversification by investing in both
investment options. They acknowledge, however, that in not all
circumstances is this appropriate, and thus, the tie will need to be
broken. Under the commenter's approach, for example, the tiebreaker
test provides plan fiduciaries with a solution in cases when investing
in two (or more) alternatives that equally serve the financial
interests of the plan, rather than one, entails additional costs (such
as transactional or monitoring costs) that offset the benefits of
investing in two (or more) investments rather than one.
More generally, those questioning the need for a tiebreaker test
are reminded that ERISA does not specifically address a fiduciary's
investment choice in circumstances where multiple investment
alternatives equally serve the financial interests of the plan and thus
the economic interests of the plan's participants and beneficiaries are
protected by choosing either alternative. The Department is choosing to
leave that decision in the hands of fiduciaries, who are charged with
choosing among investment alternatives that equally serve the financial
interests of the plan. Fiduciaries without a need to break a tie while
selecting investments need not use the provision. This may be the case,
for example, with respect to participant-directed individual account
plans where adding additional investment options is not necessarily a
zero-sum game, such that the fiduciary may choose only one option.
Moreover, when there is a need to break a tie, there is nothing in the
regulation that requires fiduciaries to look to climate change or other
ESG factors to break the tie.
With respect to concerns that the tiebreaker provision might be
subject to abuse or not be part of a prudent fiduciary process, we note
that fiduciaries utilizing the tiebreaker provision remain subject to
ERISA's prudence requirements. In addition, they also remain subject to
the explicit prohibition against accepting expected reduced returns or
greater risks to secure such additional benefits. The Department is of
the view that these provisions, coupled with the safeguards added by
ERISA's statutory prohibited transaction provisions, discussed below,
sufficiently protect participants' and beneficiaries' retirement
benefits in this context.
As to commenters who suggested that the existence of a tiebreaker
provision implies that ESG factors are non-economic, the potential
economic relevance of ESG factors is reflected in paragraph (b)(4) of
the final rule, as discussed above. When such factors are relevant to a
risk and return analysis, the tiebreaker test is not at issue. Put
differently, as with other types of investment factors, climate change
and other ESG factors sometimes may be relevant to a risk and return
analysis and sometimes not--and when relevant, they may be factored
into investment decisions alongside other relevant factors, as deemed
appropriate by the plan fiduciary under paragraph (b)(4) of the final
rule. However, when such factors are not relevant to a risk and return
analysis, such factors may nevertheless be the decisive factor under
the tiebreaker test, provided that the other conditions of the
tiebreaker test are satisfied. The Department believes that rescission
of the current regulation's tiebreaker standard and replacement with a
standard more closely aligned with prior non-regulatory guidance is
appropriate. The current regulation's tiebreaker standard, ``unable to
distinguish on the basis of pecuniary factors alone,'' in practice, has
meant indistinguishable in all respects, or identical. This standard is
causing a great a deal of confusion, given that no two investments are
the same in each and every respect. The imposition of a standard that
effectively requires investments to be precisely identical therefore is
both impractical and unworkable. Investments can and do differ in a
wide range of attributes, but when considered in their totality, may
serve the financial interests of the plan equally well. This problem
was noted by the Department in 2020 when making the current
regulation's tiebreaker standard, but as shown by the comments
discussed above, the current
[[Page 73837]]
regulation has not effectively resolved this problem.\48\ The
Department believes the final rule's ``equally serve'' standard
comports with the realities of fiduciary decisionmaking and firmly
protects participant retirement benefits, since it strictly forbids the
subordination of plans' and participants' financial interests to any
other objective.
---------------------------------------------------------------------------
\48\ 85 FR 72846, 62.
---------------------------------------------------------------------------
In response to comments requesting further guidance on the
determination of whether investments equally serve the financial
purposes of the plan, the Department has not made changes to the
proposed standard. In the Department's view, as explained in the
preamble to the proposal, investments may differ on a wide range of
attributes, but when considered in their totality, serve the financial
interests of the plan equally well.\49\ Given the wide range of
attributes associated with different investments, the uncertainties
inherent in investing, and the practical limitations on the
availability and processing of relevant data, the Department does not
agree with those commenters who suggested that fiduciaries can never
conclude that competing alternatives serve the financial purposes of
the plan equally well. Under the final rule, investments do not need to
be identical in order to equally serve the financial interests of a
plan. Whether, in any particular circumstances, the tiebreaker standard
is met is an inherently factual question.
---------------------------------------------------------------------------
\49\ 86 FR 57278.
---------------------------------------------------------------------------
Like the NPRM, the final rule's tiebreaker provision does not
define or explicitly limit the concept of ``collateral benefits.'' On
this topic, the preamble to the NPRM specifically provided that the
proposal did not place parameters on the collateral benefits that may
be considered by a fiduciary to break the tie. The preamble to the NPRM
explained that this position is consistent with prior nonregulatory
guidance, but the preamble nevertheless solicited comments on whether
more specificity should be provided in the provision. For instance, the
preamble asked if the final rule should require that any collateral
benefit relied upon as a tiebreaker be based upon an assessment of the
shared interests or views of the participants, above and beyond their
financial interests as plan participants, such as the investment's
likely impact on participants' jobs or plan contribution rates. This
scenario was just an example.
Some commenters opposed such limitations, both as a general idea
and specifically the scenario mentioned in the preamble of the NPRM,
i.e., placing additional constraints in the form of requiring an
assessment of the shared interests or views of the participants.
Commenters stated that the Department's longstanding position prior to
the 2020 amendments, going back at least to 1994, never defined or
limited the concept of ``collateral benefits'' and that there is no
history justifying a change now. Focusing on the specific scenario in
the preamble to the NPRM, one commenter stated that it is not clear how
a fiduciary would use information on participant views, collect such
information, or even what issues should be included in such an
assessment. A different commenter also focusing on this scenario stated
the concern that making decisions based on a survey or estimation of
participants' views unrelated to plan returns is in tension with
ERISA's command that fiduciaries operate ``for the exclusive purpose''
of providing benefits and defraying reasonable expenses. One commenter
argued that a regulatory definition is not necessary because the
tiebreaker test already ensures that the investment must be prudent and
serve the best interests of the participants and beneficiaries
regardless of whether a collateral benefit is used. Requiring further
assessment would increase costs and complexity, according to this
commenter.
Other commenters had different views on this question. One
commenter stated that, in its view, the tiebreaker provision is
unlawful, but that if some version of it is retained in the final rule,
the retained version should require that any collateral benefit relied
upon as a tiebreaker be based upon an assessment of the shared
interests or views of the participants, along with the consent of each
participant to pursue collateral benefits with funds in their account
and a delineation of the causes they support. One commenter raised the
concern that, because the NPRM did not place any parameters on the
collateral benefits that fiduciaries may consider, fiduciaries could be
left guessing which factors would be appropriate for consideration,
with the possibility that the Department's views could shift over the
years.
The final rule takes the same approach as the NPRM. Some form of
the tiebreaker test permitting fiduciaries to consider collateral
benefits has existed for more than four decades, and the Department is
not aware of plan fiduciaries struggling with the concept of
permissible collateral benefits. In the Department's experience,
collateral benefits have routinely involved criteria or considerations
other than factors that are relevant to a risk and return analysis of
the investment, such as stimulating union jobs and investing in the
geographic region where participants live and work, as just a few
examples. In response to requests from several commenters, the
Department confirms that an investment that stimulates or maintains
employment that, in turn, results in continued or increased
contributions to a multiemployer plan is an example of ``collateral
benefits other than investment returns'' under paragraph (c)(2) of the
final rule. In response to the concern that, without a definition, plan
fiduciaries will be forced to guess as to what constitutes a legitimate
``collateral benefit'' versus an impermissible collateral benefit, the
Department reminds that plan fiduciaries are not required to consider
collateral benefits in choosing between investments that have
comparable risks and rates of return. Moreover, the statement that the
final rule does not contain explicit parameters on the collateral
benefits that may be considered by a fiduciary to break a tie directly
responds to and addresses commenters' concerns about exceeding such
parameters. Finally, while the final rule itself adds no explicit
parameters on collateral benefits, ERISA's prohibited transaction
provisions in section 406 remain and generally forbid collateral
benefits to the extent any such benefit involves a transaction that
violates those provisions.\50\
---------------------------------------------------------------------------
\50\ See, e.g., AO 85-36A (Oct. 23, 1985) (certain investment
arrangements may involve a use of plan assets for the benefit of a
party in interest in violation of ERISA section 406(a)(1)(D));
Information Letter to Katz (Mar. 15, 1982) (purchase by a plan of an
insurance policy pursuant to an arrangement under which it is
expected that the insurance company will make a loan to a party in
interest is a prohibited transaction).
---------------------------------------------------------------------------
(d) Paragraph (c)(2) Tiebreaker Test--Documentation
Paragraph (c)(3) of the NPRM also rescinded the current
regulation's novel documentation requirement applicable to any instance
of use of the tiebreaker test; instead, the proposal included a
requirement that if a plan fiduciary uses the tiebreaker to select a
designated investment alternative for a participant-directed individual
account plan based on collateral benefits other than investment
returns, ``the plan fiduciary must ensure that the collateral-benefit
characteristic of the fund, product, or model portfolio is prominently
displayed in disclosure materials provided to participants and
beneficiaries.''
A number of commenters objected to the removal of the current
regulation's
[[Page 73838]]
documentation provision, under which a fiduciary using the tiebreaker
test is required to document, among other things, its analysis in those
cases where the fiduciary has concluded that pecuniary factors alone
were insufficient to be the deciding factor.\51\ The requirement was
intended 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.'' \52\ Some of these commenters are of the view that the
tiebreaker test may be inconsistent with ERISA, as discussed above, and
that a stringent documentation requirement is perhaps the best way for
plan fiduciaries to contemporaneously document their decisionmaking
with respect to tiebreakers and mitigate the effects of their reliance
on factors that do not materially affect risk-return or directly
promote retirement income.
---------------------------------------------------------------------------
\51\ 29 CFR 2550.404a-1(c)(2) (2021).
\52\ 85 FR 72862.
---------------------------------------------------------------------------
Other commenters supported removal of the current regulation's
documentation requirement, arguing that the disclosure was formulaic,
singled out one investment category, could chill fiduciaries from
properly considering ESG factors, and was largely unnecessary given
ERISA's general obligations. For instance, one commenter indicated that
the documentation requirement has a chilling effect and is seen as
suggesting that ESG investing entails extraordinary risks. Other
commenters also viewed the documentation requirement as creating a
stigma around considering ESG factors in investment decisions.
Commenters also believed that the regulation's documentation provision
is unnecessary because fiduciaries commonly document and maintain
records about their investment decisions as part of their general
prudence obligation. Others believed that removal of the documentation
provision brings the tiebreaker standard more in line with prior non-
regulatory guidance and may provide additional cost savings, which
would ultimately benefit plan participants and beneficiaries. A
commenter noted that some fiduciaries, even before the 2020 amendments,
may have viewed tiebreaker situations as perhaps requiring enhanced
documentation. This commenter requested that the Department provide
further clarification regarding prudent recordkeeping if the final rule
removes the current regulation's documentation requirement.
The Department is not persuaded that the current regulation's brand
new documentation requirement should be retained in the tiebreaker
provision. Commenters confirmed the Department's initial concern that
the documentation provision in the current regulation is very likely to
chill and discourage plan fiduciaries from using the tiebreaker test
generally, including in cases involving the appropriate consideration
of ESG factors (when such factors are not otherwise relevant to a risk
and return analysis). The tiebreaker test, by its terms, applies only
where competing investments equally serve the financial interests of
the plan. It disallows the investment selection from sacrificing the
plan's economic interests or from exposing plans to additional risk. In
light of these guardrails, the Department sees no reason for a
regulatory provision imposing further burdens on its use. Since the
tiebreaker test only applies in cases where the competing investments
equally serve the financial interests of the plan, the Department is of
the view that use of the tiebreaker test should not be discouraged with
additional burdens, because neither of the competing investments
sacrifices the economic interests of the plan, but one of them promotes
collateral benefits the other does not. In addition, the elaborateness
of the current regulation's tiebreaker-specific documentation provision
likely will be viewed by fiduciaries as suggesting that the Department
sees tiebreakers as occurring infrequently, and the Department did not
have in 2020 and does not now have sufficient information to make a
judgement as to the frequency of ties. The documentation requirement
also may be viewed by fiduciaries as a self-reported ``red flag'' that
uniquely directs potential litigants' attention to tie-breaker
decisions as inherently problematic, even though there is no necessary
or presumed inconsistency between their use and the requirements of
ERISA. The Department is wary that the potential for litigation may
cause fiduciaries to consciously or unconsciously skew their investment
analyses to avoid open acknowledgment of a ``tie'' and the requirement
of specifically prescribed documentation, while still favoring
investments that provide collateral benefits. The Department believes
this potentially creates incentives that discourage, rather than
promote, proper fiduciary activity and transparency, and further
reduces the likelihood that the benefits associated with the additional
documentation obligation would outweigh the associated costs.
The Department also agrees with commenters that the current
regulation's prescribed documentation provisions are unnecessary given
the general obligations of prudence under ERISA. The Department finds
it noteworthy that no commenter provided contrary evidence
demonstrating that ERISA's general obligations of prudence are
deficient in protecting the interests of plan participants and
beneficiaries in this context. The Department emphasizes that removal
of the documentation provision from the regulation does not suggest
that ERISA fiduciaries are excused from complying with ERISA's prudence
obligations, or subject to a lower standard of care, with regard to
documentation or otherwise. Fiduciary documentation of their investment
activities already is a common practice. As explained in the preamble
to the NPRM, the Department's concern with the current regulation's
document provision rests on its formulaic and rigid nature. The
Department believes ERISA section 404's prudence obligation
sufficiently protects participants' and beneficiaries' financial
interests in their plans in this regard. That obligation, which
fiduciaries had prior to the 2020 amendments and will continue to have,
provides that the nature and degree of the fiduciary's duty to document
an investment decision depends upon the facts and circumstances
particular to that decision, regardless of whether the decision is
under the tiebreaker test or the type of collateral benefit at
issue.\53\ Thus, the Department believes the current regulation's
specific documentation provision is not necessary and can lead to
conduct contrary to the plan's interests. This includes the risk that
fiduciaries will over-document or under-document their investment
decisions.\54\ Over-documentation would result in increased transaction
costs for no particular benefit to plan participants.
---------------------------------------------------------------------------
\53\ The preamble to Interpretive Bulletin 2015-01, in relevant
part, stated that, ``the Department does not construe consideration
of ETIs or ESG criteria as presumptively requiring additional
documentation or evaluation beyond that required by fiduciary
standards applicable to plan investments generally. As a general
matter, the Department believes that fiduciaries responsible for
investing plan assets should maintain records sufficient to
demonstrate compliance with ERISA's fiduciary provisions. As with
any other investments, the appropriate level of documentation would
depend on the facts and circumstances.''
\54\ 86 FR 57272 at 57279.
---------------------------------------------------------------------------
[[Page 73839]]
(e) Paragraph (c)(2) Tiebreaker Test--Collateral Benefit Disclosure
The NPRM contained a disclosure requirement within the tiebreaker
test limited to participant-directed individual account plans.
Specifically, paragraph (c)(3) of the NPRM, in relevant part, provided
that if a plan fiduciary selects an investment, or investment course of
action, based on collateral benefits other than investment returns,
``the plan fiduciary must ensure that the collateral-benefit
characteristic of the fund, product, or model portfolio is prominently
displayed in disclosure materials provided to participants and
beneficiaries.'' This would have been a new disclosure requirement
under ERISA.
The preamble to the NPRM explained the policy intent behind this
proposed requirement. In relevant part, the NPRM explained that 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.'' \55\ The Department
thought the disclosure of this information would have been of potential
benefit to plan participants and beneficiaries because of the
possibility 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.''
---------------------------------------------------------------------------
\55\ 86 FR 57272, 80.
---------------------------------------------------------------------------
The preamble to the NPRM also provided an example of an application
of this proposed requirement. The example, in relevant part, provided
that ``if the tiebreaking 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, . . . then such feature or features prompting the
selection of the investment must be prominently disclosed by the plan
fiduciary. . . .'' The NPRM believed this information ``will be useful
to participants and beneficiaries in deciding how to invest their plan
accounts.'' \56\
---------------------------------------------------------------------------
\56\ Id.
---------------------------------------------------------------------------
The preamble to the NPRM also clarified that, in terms of
compliance, the Department's intent was to provide flexibility in how
plan fiduciaries would fulfill this requirement given the unknown
spectrum of collateral benefits that might influence a plan fiduciary's
selection. The preamble to the NPRM explained that one likely way to
comply ``is that the plan fiduciary could simply use the required
disclosure under 29 CFR 2550.404a-5.'' \57\ 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 about 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. The NPRM, therefore, assumed these existing
disclosures, perhaps with minor modifications or clarifications, would
have been sufficient to satisfy the disclosure element of the
tiebreaker provision in paragraph (c)(3) of the proposal.
---------------------------------------------------------------------------
\57\ Id.
---------------------------------------------------------------------------
As is evident from the foregoing discussion, the NPRM assumed
appreciable benefits to plan participants and beneficiaries and
relatively small compliance costs resulting from this proposed
disclosure requirement.\58\ The NPRM solicited comments on the overall
utility of this disclosure provision, including ideas on how best to
operationalize the provision considering its intended purpose balanced
against costs of implementation and compliance.
---------------------------------------------------------------------------
\58\ 86 FR 57272 at 57300 (``The Department estimates that it
will take a legal professional twenty minutes on average per year to
update existing disclosures for each of the 46,551 small individual
account plans with participant direction that are anticipated to
utilize this provision. This results in a per-plan cost of $46.14
annually relative to the pre-2020 final rule baseline.'').
---------------------------------------------------------------------------
(1) Support for Disclosure Requirement
The public record reflects limited support for the proposed
disclosure requirement. One commenter stated that plan participants and
beneficiaries should have information about collateral benefits because
such information may impact participant behavior, such as whether to
participate, savings rates, and asset allocations. One commenter
registered its support for better disclosure to plan participants and
of investment policies more generally, inclusive of sustainable
investment policies and collateral benefit factors. One commenter
believed the proposed requirement would protect participants and
beneficiaries by ensuring that plan sponsors fully considered
collateral benefits alongside financial performance. One commenter
supported the proposed disclosure requirement as ``reasonable,'' but
recommended that the Department provide plan fiduciaries with a model
notice to assist compliance with this disclosure requirement. Finally,
one commenter conditionally supported the proposed disclosure
requirement because the commenter believed it would give plan
participants needed transparency in the tiebreaking context. However,
this commenter recommended that the proposed requirement, if retained,
be improved with additional content requirements, including a
requirement that the fiduciary disclose what specific alternative
investments were considered in breaking the tie and more analysis
behind the fiduciary's decisionmaking process.
(2) Concerns With Disclosure Requirement
The public record also reflects substantial concerns with the
proposed disclosure requirement. In summary, these concerns are as
follows. Some commenters found the content requirements of proposed
disclosure requirement to be inherently ambiguous. Some found the
proposed disclosure requirement to be unnecessary and the required
content of the disclosure to be of no economic significance. Other
commenters were concerned that the proposed disclosure requirement may
undermine the purposes of other disclosure regulations promulgated by
the Department aimed at helping plan participants and beneficiaries
make informed investment decisions. Certain commenters expressed
concerns that the proposed disclosure requirement would single out
certain factors and strategies over other factors and strategies,
contrary to the principle of neutrality they believe is embedded in
ERISA. Other commenters were concerned that the proposed disclosure
requirement could have a chilling effect on the proper use of climate
change and other ESG factors. Several commenters were concerned that
the proposed disclosure provision would result in unnecessary
litigation. Each of these concerns is explained in detail below.
(a) Ambiguity
Some commenters found the content requirements of the proposed
disclosure requirement to be inherently ambiguous. According to them,
the NPRM was unclear on what ``collateral-benefit characteristics'' a
fiduciary would be required to disclose. They
[[Page 73840]]
contrasted regulatory language requiring the disclosure of the
collateral benefit characteristics ``of the fund'' with preamble
language focused on the ``features prompting the selection'' by the
fiduciary and other language referencing ``improved employee morale''
as the factor that ``tipped the scale.'' Commenters requested
clarification of whether the proposed disclosure requirement was
focused on an objective characteristic of the fund or the subjective
reason the fiduciary selected the fund. According to the commenters,
these are not necessarily the same things. Commenters said the
subjective collateral benefit perceived by the plan fiduciary may be
wholly different from the characteristic of the fund that would be
expected to provide the collateral benefit. For example, assume that
the plan sponsor is an organization whose primary mission is to tackle
climate change. The plan fiduciary may decide to use the tiebreaker
test to select a fund that uses ESG criteria with an environmental
focus to improve the morale of its employees. In this example, the
commenters stated that the regulatory text and preamble were unclear on
what must be disclosed under the proposal--would it be the
environmental focus of the fund's strategy or improved employee morale?
Most commenters on this issue requested confirmation that the former is
what the Department intended, and they asserted flaws with the NPRM's
cost-benefit analysis if the latter.
(b) Unnecessary
Some commenters were of the view that the proposed disclosure
requirement is unnecessary, and the required content of the disclosure
is of no economic significance. The commenters stated that the
Department and the Securities and Exchange Commission already have
regulations in place to ensure that participants and investors have
ready access to necessary investment-related information, such as
principal strategies and risks, performance information, benchmarks,
and fees. Commenters alleged that the content requirements of the
proposed disclosure, by contrast, contained no information about the
economics of the investment in question, but instead focused on
information that was collateral to the economics of the investment and
therefore would have no economic relevance to participant investors.
Whether a participant shares the fiduciary's preference for the
collateral benefit or purpose that ``tipped the scale'' is of no
relevance to whether the investment option is economically prudent and
makes economic sense to a participant. The only thing that should
matter to participants, in the view of these commenters, is whether the
selected investment was prudently chosen. In their view, disclosures
focused on the policy or social preferences of the selecting
fiduciaries will not advance intelligent investment behavior and
therefore are unnecessary.
(c) Interference With Existing Disclosure Regulations
Some commenters were concerned the proposed disclosure requirement
would undermine the purposes of other disclosure regulations
promulgated by the Department aimed at helping plan participants and
beneficiaries make informed investment decisions. These commenters
pointed to existing disclosures under 29 CFR 2550.404a-5, 2550.404c-1,
and 2550.404c-5 as being sufficient to enable plan participants and
beneficiaries to make informed investment decisions.\59\ These
disclosures, according to the commenters, focus on what the Department
has determined, through multiple notice-and-comment rulemaking
projects, is the relevant investment-related information that plan
participants and beneficiaries need, as investors. The proposed
collateral benefit disclosure requirement, by contrast, focused on non-
investment information, i.e., the collateral purpose that tipped the
scale--information that, by definition, is not material to risk and
return. These commenters argued that not only is the proposed
collateral benefit disclosure of no economic relevance, but the
disclosure risks distracting participants and beneficiaries from basic
and important information required under the existing regulations
mentioned above. Put differently, one commenter stated that it opposes
the proposed disclosure requirement because it would disproportionately
emphasize one part of the fiduciary decisionmaking process over other
more relevant factors in a way that could mislead participants and
impact participant choices in ways that are unintended by the
Department.
---------------------------------------------------------------------------
\59\ The disclosure requirements to which these commenters refer
include: 29 CFR 2550.404a-5 (requiring disclosure of certain plan
administrative and investment-related information, including fee and
expense information, to participants and beneficiaries in
participant-directed individual account plans (e.g., 401(k) plans));
29 CFR 2550.404c-1 (requiring that participants and beneficiaries in
participant-directed individual account plans are furnished
specified information about the plan's investment alternatives and
incidents of ownership appurtenant to such investment alternatives);
and 29 CFR 2550.404c-5 (requiring that participants and
beneficiaries whose plan assets may be invested, by default, into a
plan's QDIA by a plan fiduciary are furnished specified investment-
related information about the QDIA, the circumstances in which plan
assets will be invested in a QDIA, and their ability to direct their
assets to plan investment alternatives other than a QDIA).
---------------------------------------------------------------------------
(d) Lack of Neutrality & Chilling Effect
Commenters expressed concerns that the proposed disclosure
requirement singles out certain factors over other factors, contrary to
the principle of neutrality, while other commenters are concerned that
the proposed disclosure requirement might have a chilling effect on the
proper use of climate change and other ESG factors. Certain commenters
expressed opposition to the idea of singling out any class of
investment factor, including collateral benefit factors, as needing
additional or stricter requirements. These commenters asserted that
ERISA is, and should be, factor neutral, including with respect to
collateral purposes or factors. By imposing special disclosure
requirements on collateral benefits, the proposed disclosure is
contrary to this principle, according to these commenters.
In line with this concern, other commenters were concerned that the
proposed disclosure provision could inadvertently have a chilling
effect on the proper use of climate change and other ESG factors. These
commenters posited that investment strategies often simultaneously
integrate multiple ESG factors into the analysis, some of which are
relevant to a risk and return assessment while others are not. In these
circumstances, commenters asserted that fiduciaries may avoid the
investment based on ambiguity over whether it is subject to the
disclosure requirement, or over disclose even when the options were
selected solely for financial reasons.
(e) Litigation
Multiple commenters raised concerns that the proposed disclosure
requirement would effectively act as an invitation to litigation. The
very purpose of the disclosure, according to the commenters, is to draw
the reader's attention to the non-financial motives of the plan
fiduciary. Considering this purpose, commenters said the disclosures
themselves unintendedly would serve as a signal of potential wrongdoing
and as a roadmap to litigation. To altogether avoid the litigation
risk, some plan sponsors and fiduciaries simply would not use the
tiebreaker test even in cases when they otherwise might have been
willing to use it to promote collateral purposes,
[[Page 73841]]
such as addressing climate change, according to commenters.
(f) Per Se Disloyalty
Other commenters raised concerns with the idea that a disclosure
violation would constitute a per se breach of ERISA's duty of loyalty,
which the commenters saw as the necessary consequence of embedding a
disclosure requirement within the portion of a regulation defining
ERISA's duty of loyalty. They argued that a disclosure failure does not
(and should not), by itself, prove disloyalty. But as structured, that
seems to be the result under the NPRM regardless of how prudent and
loyal the fiduciary is when selecting the investment, the commenters
asserted. These commenters observed the unconventionality of the idea
that ERISA commands that if fiduciaries fail in whole or in part to
disclose their motivations to participants and beneficiaries, those
fiduciaries are per se disloyal as a result of the failure, regardless
of how loyal the fiduciaries were, in fact, when selecting the
investment. These commenters assert that it is a non sequitur to say
that a failure to disclose the scale-tipping attributes of an
investment is dispositive evidence of disloyalty, especially when the
investment is prudent and serves the financial interests of the plan
equally as well as a reasonable number of alternatives. To this point,
the commenters note that some version of the tiebreaker test has
existed for approximately forty years without a related disclosure
requirement, embedded in loyalty or otherwise--and nothing in the
marketplace has changed in a way that supports the new disclosure
requirement. The commenters question whether the many plan fiduciaries
that used the tiebreaker test in the past would now be considered
disloyal because they likely never disclosed to participants the
collateral benefits that broke the tie.
(g) Other Technical Concerns
In addition to the foregoing concerns, commenters raised the
following technical issues with the proposed disclosure requirement.
First, commenters stated that although the NPRM is clear that a
collateral benefit disclosure is required only if the fiduciary uses
the tiebreaker provision to select a fund, nowhere does the NPRM offer
concrete guidance on when or how often the plan fiduciary must furnish
this information to participants. For example, commenters requested
guidance and clarification on whether a disclosure would be required
only when the fund is added to the lineup, only when a participant
joins the plan, annually, any time the plan or its service providers
furnish any disclosure materials pertaining to the fund, or at some
other interval determined solely in the judgment of the plan fiduciary
based on facts and circumstances.
Second, the NPRM specifies that the collateral benefit disclosure
must be ``prominently'' displayed in disclosure materials provided to
participants. But neither the regulation nor the preamble defines the
meaning of prominence for this purpose. Several commenters therefore
requested guidance on how to satisfy this standard. One concern is that
this standard is being construed as requiring that collateral benefit
information receive more attention or prominence than other information
that likely will accompany the collateral benefit information, such as
investment performance, fees, strategies, risk, etc. The commenters are
of the view that collateral benefit information should not be more
prominent than relevant investment-related information. These
commenters assert that investment success generally turns on an
intelligent evaluation of performance, fees, strategies, and risk, and
that mandating the elevation of collateral information over such
information potentially undermines the chances of an investor's
success. According to the commenters, this is particularly important,
in part, because the concept of ``prominence'' is inherently
subjective, and in part, because violations of the proposed disclosure
rule are per se acts of disloyalty.
(3) Decision
Based on the foregoing concerns, and reasons similar to those
underlying the decision to remove the documentation requirements from
the current regulation, the final rule does not adopt the proposed
collateral benefit disclosure requirement at this time. The Department
is aware that the Securities and Exchange Commission (SEC) is
conducting rulemaking on investment company names, addressing, among
other things, ``certain broad categories of investment company names
that are likely to mislead investors about an investment company's
investments and risks.'' \60\ The SEC also is conducting rulemaking on
disclosures by mutual funds, other SEC-regulated investment companies,
and SEC-regulated investment advisers designed to provide consistent
standards for ESG disclosures, allowing investors to make more informed
decisions, including as they compare various ESG investments.\61\ The
Department will monitor those rulemaking projects and may revisit the
need for collateral benefit reporting or disclosure depending on the
findings of that agency. The Department emphasizes that the decision
against adopting a collateral benefit disclosure requirement in the
final rule has no impact on a fiduciary's duty to prudently document
the tiebreaking decisions in accordance with section 404 of ERISA.
---------------------------------------------------------------------------
\60\ 87 FR 36594 (June 17, 2022).
\61\ 87 FR 36654 (June 17, 2022).
---------------------------------------------------------------------------
(f) Paragraph (c)(3)--Participant Preferences
Several commenters requested clarification on whether a plan
fiduciary may consider participants' policy, social, or value
preferences (i.e., non-financial preferences) in connection with
constructing menus for defined contribution plans that permit
participants to direct their own investments. Some commenters stated
that, in their view, the NPRM is ambiguous on this question. Many other
commenters expressed concern that the NPRM appears not to permit plan
fiduciaries to consider participants' preferences or to consider them
only under the tiebreaker test.
Several of these commenters stressed their view of the importance
of accommodating participants' preferences in a voluntary retirement
system heavily dependent on elective deferrals. These commenters,
including institutional asset managers and asset custodians, assert
that both increased participation and increased deferral rates follow
from accommodating such preferences. They argue that participants may
not use their voluntary participant-directed savings plans to save for
retirement, or will leave those plans earlier, if they cannot get
access to investment choices they find attractive. Consistent with this
argument, many individual commenters claim they would roll their
savings out of ERISA-protected plans if the plans cannot satisfactorily
accommodate their preferences.
Several commenters alleged that plan fiduciaries should not have to
rely solely on the tiebreaker test to consider participants'
preferences. These commenters are of the view that the NPRM's
tiebreaker test may be ill-suited to some methods of constructing menus
for defined contribution plans because adding additional options is not
necessarily a zero-sum game under these methods. To these commenters,
therefore, if plan fiduciaries are unable to use the tiebreaker test
because it does
[[Page 73842]]
not comport with how they construct defined contribution menus, they
effectively have no ability under their reading of the NPRM to consider
participants' preferences.
A few commenters believe that participants' preferences deserve
equal treatment with risk and return factors; they believe fiduciaries
should be allowed to consider and weigh participants' preferences
alongside risk and return factors in a prudence analysis, giving
participant's preferences such weight as the fiduciary deems
appropriate, even if such preferences are not directly tied to risk or
return. By contrast, a few commenters asserted that ERISA requires plan
fiduciaries to focus on only pecuniary factors when selecting and
retaining investments. They view participants' preferences as
essentially irrelevant to menu construction.
In response to these comments, paragraph (c)(3) of the final rule
provides clarification on this issue. Specifically, paragraph (c)(3) of
the final rule provides that the plan fiduciary of a participant-
directed individual account plan does not violate the duty of loyalty
set forth in paragraph (c)(1) of the final rule solely because the
fiduciary takes into account participants' preferences consistent with
requirements of paragraph (b) of this section.
If accommodating participants' preferences will lead to greater
participation and higher deferral rates, then it could lead to greater
retirement security, as suggested by the commenters. Thus, in this way,
giving consideration to whether an investment option aligns with
participants' preferences can be relevant to furthering the purposes of
the plan within the meaning of paragraph (b)(1) of the final rule. At
the same time, however, plan fiduciaries may not add imprudent
investment options to menus just because participants request or would
prefer them.\62\
---------------------------------------------------------------------------
\62\ See Hughes v. Northwestern Univ., 142 S. Ct. 737 (2022)
(``In Tibble, this Court explained that, even in a defined-
contribution plan where participants choose their investments, plan
fiduciaries are required to conduct their own independent evaluation
to determine which investments may be prudently included in the
plan's menu of options.'' (citing Tibble v. Edison Int'l, 575 U.S.
523 (2015)).
---------------------------------------------------------------------------
The clarification in paragraph (c)(3) of the final rule does not
speak to the duty of prudence. Rather, paragraph (c)(3) provides only
that a fiduciary does not violate the duty of loyalty as set forth in
paragraph (c)(1) of the final rule solely because the fiduciary
considers participants' preferences in a manner that is consistent with
paragraph (b) of the final rule. The reference to paragraph (b) in
paragraph (c)(3) clarifies that the duty of prudence is independent
and, as such, prudence determinations must be made consistent with
paragraph (b) of the final rule. As paragraph (b)(4) of the final rule
makes clear, the selection of investment options must be grounded in
the fiduciary's prudent risk and return analysis.
The clarification in paragraph (c)(3) of the final rule is not
novel or a change in Departmental position. The preamble to the current
regulation being amended by this final rule articulated this position
when explaining the meaning and mechanics of paragraph (d)(2) of that
rule (entitled ``Investment Alternatives for Participant-Directed
Individual Account Plans''). In relevant part, that preamble stated:
``Nothing in the final rule precludes a fiduciary from looking into
certain types of investment alternatives in light of participant demand
for those types of investments. But in deciding whether to include such
investment options on a 401(k)-style menu, the fiduciary must weigh
only pecuniary . . . factors.'' \63\ The relevant portion of paragraph
(d)(2) of that rule, however, was incorporated into paragraphs (b) and
(c)(1) of the final rule (minus the pecuniary factor terminology). The
final rule restates the position as regulatory text in paragraph
(c)(3), rather than as a preamble statement, to provide enhanced
clarity, accessibility, and prominence, as requested by commenters.
---------------------------------------------------------------------------
\63\ 85 FR 72846 at 72863.
---------------------------------------------------------------------------
The final rule declines to mandate that fiduciaries factor
participants' preferences into their evaluation, selection, and
retention of designated investment alternatives, and declines to
mandate a uniform methodology for determining such preferences, as
requested by a few commenters. Some commenters had concerns that a
mandate to consider and act on participants' preferences would raise
complex questions, such as how plan fiduciaries should properly
solicit, weigh, implement, and monitor participants' preferences, and
how plan fiduciaries should reconcile conflicting preferences of their
participants (e.g., some participants may oppose so-called ``sin
stocks'' and other participants in the same plan may favor them). No
commenter had persuasive answers or recommendations on these questions,
and the NPRM did not propose such a mandate or suggest how to resolve
such competing preferences. In addition, as some commenters noted,
ERISA's fiduciary obligations could compel plan fiduciaries to
disregard participants' preferences to the extent they are imprudent.
Accordingly, the final rule declines to mandate that fiduciaries factor
participants' preferences into their evaluation, selection, and
retention of designated investment alternatives, and declines to
mandate a uniform methodology for determining such preferences; the
final rule, instead, leaves these questions to be decided by plan
fiduciaries considering the facts and circumstances of their plan and
participant population.
3. Investment Alternatives in Participant-Directed Individual Account
Plans Including Qualified Default Investment Alternatives
Paragraph (d) of the current regulation contains additional rules
that specifically govern fiduciaries' selection and retention of
investment alternatives for participant-directed individual account
plans, including qualified default investment alternatives (QDIAs). The
NPRM proposes to directly rescind this paragraph. The NPRM's
justification for the rescission has two dimensions. First, proposed
amendments to other provisions in the section effectively merged the
substance of what was paragraph (d) into these other provisions.
Second, the Department no longer supports the current regulation's
provisions specific to QDIAs. 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 one or more 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.
Commenters overwhelmingly supported the NPRM. A few commenters
raised technical concerns regarding compliance problems and costs with
paragraph (d) of the current regulation. But more globally, and
fundamentally, most commenters on this issue were of the view that the
provisions in paragraph (d) of the current regulation are unnecessary.
This view is based, in part, on the strongly held belief, shared among
a broad spectrum of commenters from various backgrounds and industries,
that the legal standards under ERISA's prudence and loyalty rules
should be the same for all plans, including plans with QDIAs, with
respect to the selection and retention of investment alternatives.
[[Page 73843]]
How these standards apply to a given set of facts may, of course,
differ, according to the commenters, but the base standards of prudence
and loyalty should be no different for these plans, absent a statutory
underpinning for a difference. Yet the current regulation, according to
these commenters, unnecessarily singles out individual account plans
for what the commenters view as different, special, and stricter
treatment (e.g., some higher level of fiduciary oversight). This
special treatment is especially extreme with respect to QDIAs,
according to the commenters, with some commenters equating the
provisions in paragraph (d)(2)(ii) of the current regulation to an
effective ban on selecting investments that consider or integrate
climate change and other ESG factors, regardless of the economic merits
and prudence of the investment. Many commenters disagreed that QDIAs
need heightened protections beyond those specifically contained in the
Department's Qualified Default Investment Alternative regulation.\64\
Overall, these commenters agree that the provisions of paragraph (d) of
the current regulation create a perception that fiduciaries of
individual account plans, including plans with QDIAs, are subject to
different and heightened--but unclear--standards of prudence and
loyalty as compared to fiduciaries of other plans. And the primary
consequence of this perception, according to the commenters, was a
concern that funds may be excluded from selection as QDIAs solely
because they expressly considered climate change or other ESG factors,
even though the funds are prudent based on a consideration of their
financial attributes alone.
---------------------------------------------------------------------------
\64\ 29 CFR 2550.404c-5.
---------------------------------------------------------------------------
Some commenters opposed the NPRM's proposed changes to paragraph
(d) of the current regulation. In the main, these commenters oppose all
aspects of the NPRM, not just the NPRM's proposed deletion of paragraph
(d) of the current regulation, but their expressed concerns with the
proposed elimination of paragraph (d) are mainly limited to QDIAs. One
of these commenters, for instance, stated that, because the proposal
would allow a QDIA that states, as one of its investment objectives, a
goal other than financial return, this part of the proposal, in the
view of this commenter, is a per se violation of ERISA's exclusive
purpose rule as interpreted by the Supreme Court in Dudenhoeffer.\65\ A
different commenter, noting that individual account plans shift the
risk of investment loss to participants, asserted that this shift in
risk justifies enhanced--not reduced--protections for participants that
are defaulted into QDIAs. This risk is compounded, according to this
commenter, by the fact that defaulted employees are an increasingly
larger percentage of the universe, and they tend not to opt out of the
default investment. In line with the concerns of this commenter, two
other commenters asserted that, to the extent ESG investing is
acceptable at all, it should never be allowed in the case of QDIAs.
Even if active investors are given the prerogative to align their
investments with their beliefs, inattentive defaulted investors should
never, according to these commenters, be forced to accept the social
investment preferences of their plan fiduciaries or burdened with the
obligation of having to actively recognize that the default option is
misaligned with the investors' desires for higher returns (or contrary
social values) and opt out.
---------------------------------------------------------------------------
\65\ Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014).
---------------------------------------------------------------------------
The Department was not persuaded by these objections and the final
regulation retains this aspect of the NPRM, meaning that the final
regulation does not contain the set of special rules for participant-
directed individual account plans, including plans with QDIAs, codified
in paragraph (d) of the current regulation. The first part of paragraph
(d) of the current regulation (paragraphs (d)(1) and (d)(2)(i)) was
eliminated because the essential principles of this part were merged
into paragraphs (b) and (c) of the final rule.
As to the second part of paragraph (d) of the current regulation,
i.e., the part containing special provisions for QDIAs (paragraph
(d)(2)(ii) of the current), 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 specific 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.
The Department agrees with the many commenters asserting that,
rather than protecting the interests of plan participants, paragraph
(d)(2)(ii) of the current regulation will only serve to harm
participants. It would, as the commenters notice, effectively preclude
fiduciaries from considering QDIAs that include ESG strategies, even
where they were otherwise prudent or economically superior to competing
options. The Department sees no reason to deprive participants of such
options. Consequently, the final rule directly rescinds 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 legal standards under the final rule as all other investments,
including the prohibition against subordinating the interests of
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.\66\ The Department finds no merit
to the argument that the final rule, either in general or in not
carrying forward paragraph (d) of the current regulation in specific,
sanctions behavior contrary to the holding in Dudenhoeffer. On the
contrary, as already stated, the central premise behind the final
rule's amendments to the current regulation is that the current
regulation is being perceived by plan fiduciaries and others as an
impediment to protecting the financial benefits of plan participants
and beneficiaries by prohibiting or encumbering plan fiduciaries from
managing against or taking advantage of climate change and other ESG
risk factors in selecting investments. Thus, in this way, the final
rule's rescission of the special provision for QDIAs is entirely
consistent with the principle articulated in Dudenhoeffer.
---------------------------------------------------------------------------
\66\ 29 CFR 2550.404c-5.
---------------------------------------------------------------------------
4. Section 2550.404a-1(d)--Proxy Voting and Exercise of Shareholder
Rights
Paragraph (d) of the final rule addresses the application of the
duties of prudence and loyalty under ERISA section 404(a) to the
exercise of shareholder rights, including proxy voting. As discussed
below, the final rule includes several minor changes from the proposal
based on public comment.
[[Page 73844]]
(a) Paragraph (d)(1)
Paragraph (d)(1) of the final rule is unchanged from the proposal
and 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. A
commenter requested that the Department limit paragraph (d) to only
proxy voting. The commenter noted that while the provisions cover both
proxy voting and the exercise of shareholder rights, most of the
substantive provisions relate only to proxy voting. The commenter
further opined that other shareholder rights do not necessarily share
the same objectives as those of proxy voting in connection with stock
ownership. Moreover, according to the commenter, decisions on corporate
actions like stock splits, tender offers, exchange offers on bond
issues, and mergers and acquisitions are generally not governed by
proxy voting policies or undertaken with advice from proxy advisors.
For these reasons, the commenter expressed the view that exercise of
shareholder rights should not be coupled with proxy voting in the
regulation. The Department is not persuaded to make the suggested
change. The exercise of shareholder rights has been part of the
Department's prior guidance since at least the first Interpretive
Bulletin in 1994. The Department believes that the exercise of
shareholder rights to monitor or influence management, which may occur
in lieu of, or in connection with, formal proxy proposals is no less
important to fiduciary management of the investment asset as proxy
voting and accordingly should be covered by the final rule.
(b) Paragraph (d)(2)
(1) Paragraph (d)(2)(i)
Paragraph (d)(2)(i) of the proposal provided 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)(i) was proposed without
modification from paragraph (e)(2)(i) of the current regulation and is
adopted without change.
(2) Paragraph (d)(2)(ii)
Paragraph (d)(2)(ii) of the proposal set forth specific standards
for fiduciaries to meet when deciding whether to exercise shareholder
rights and when exercising shareholder rights. It provided that 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)). Paragraph (d)(2)(ii) further required that a fiduciary
must not subordinate the interests of the participants and
beneficiaries in their retirement income or financial benefits under
the plan to any other objective, or promote benefits or goals unrelated
to the financial interests of the plan's participants and beneficiaries
(paragraph (d)(2)(ii)(C)). The proposal additionally provided that 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)). Finally, paragraph (d)(2)(ii)(E) of the
proposal provided that a fiduciary 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, such as providing research and
analysis, recommendations regarding proxy votes, administrative
services with voting proxies, and recordkeeping and reporting services.
Paragraph (d)(2)(ii) of the proposal was based on paragraph
(e)(2)(ii) of the current regulation but proposed three significant
changes. First, paragraph (d)(2)(ii) of the proposal directly rescinded
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.'' Second, proposed paragraph (d)(2)(ii) did
not carry forward the current regulation's specific requirement at
paragraph (e)(2)(ii)(E) 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. Third, paragraph (d)(2)(ii)(E) of the
proposal broadened the corresponding provision in the current
regulation (paragraph (e)(2)(ii)(F)) in connection with a proposed
streamlining of fiduciary selection and monitoring obligations under
the current regulation. Specifically, paragraphs (e)(2)(ii)(F) and
(e)(2)(iii) of the current regulation both address fiduciary monitoring
obligations, with paragraph (e)(2)(ii)(F) covering selection and
monitoring of persons selected to advise or otherwise assist with the
exercise of shareholder rights, and paragraph (e)(2)(iii) sets out
specific monitoring obligations where the authority to vote proxies or
exercise shareholder rights has been delegated to an investment manager
or a proxy voting firm. The NPRM proposed streamlining this approach by
eliminating paragraph (e)(2)(iii) and covering selection and monitoring
obligations in a single more general provision (paragraph (d)(2)(ii)(E)
of the proposal). Although based on paragraph (e)(2)(ii)(F) of the
current regulation, paragraph (d)(2)(ii)(E) of the proposal was
broader, and covered 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.
(a) Rescission of ``Does Not Require Voting Every Proxy'' Language From
Paragraph (e)(2)(ii) of the Current Regulation
The Department proposed to rescind 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'' out of a concern 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. Such indifference
could leave plan investments unprotected, as the exercise of
shareholder rights is important to ensuring management accountability
to the shareholders that own the company. Furthermore, abstaining from
a vote is not a neutral act that has no bearing on the outcome of a
particular matter put to shareholders for vote; rather, depending on
the relevant voting standard under state law and the company's
governing documents, abstention could determine whether a particular
matter or proposal is approved.
Commenters expressed a range of views with respect to the
rescission of the ``does not require voting every proxy'' language.
Multiple commenters supported the rescission, and agreed with the
Department's concerns that the language promotes indifference in
managing proxy voting rights. A commenter furthermore cautioned that
the language misleadingly signaled to fiduciaries that proxy voting is
costly and unimportant. Some commenters expressed the view that the
exercise of
[[Page 73845]]
shareholder rights is key to management accountability and paying
attention to governance is as important as financial performance. Other
commenters similarly supported rescission based on the view that
exercise of shareholder rights, including through proxy voting, is an
important tool for managing risk. Some commenters also indicated that
the ``does not require voting every proxy'' language is not necessary
in the current regulation because fiduciaries have never believed that
ERISA required them to vote all proxies. In particular, commenters
pointed to prior non-regulatory guidance which clearly indicated, in
the context of foreign stock, that ERISA does not require fiduciaries
to vote all proxies.\67\
---------------------------------------------------------------------------
\67\ IB 94-2, 59 FR 38864; IB 2016-01, 81 FR 95882.
---------------------------------------------------------------------------
Some commenters did not indicate support or opposition to
rescission of the ``not required to vote every proxy'' language, but
they cautioned that removal of the language could be misread as
indicating that the Department believes that ERISA requires fiduciaries
to vote every proxy. These commenters requested confirmation of the
Department's view.
Other commenters opposed the rescission and viewed the NPRM as
creating a presumption that all proxies should be voted. A commenter
stated that many small plans abstain from proxy votes because
performing the required due diligence would be inordinately expensive.
Several commenters criticized that a presumption that all proxies
should be voted will lead fiduciaries to further rely on proxy advisory
firms, which they view as potentially harmful to plans because,
according to these commenters, proxy advisory firms have conflicts of
interest and base their votes on noneconomic ESG policy-driven goals.
Some commenters also opposed the rescission because they believe
language in the regulation was necessary because some fund managers
believed they were obliged to vote proxies on all matters, which
resulted either in the fund managers employing significant assets to
explore the issues implicated in the matters, or in their relying on
proxy advisory services to decide for them how to vote.
After considering the comments, the Department has decided to
rescind the ``not required to vote every proxy'' language as proposed.
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., in cases when
voting proxies may involve exceptional costs or unusual requirements,
such as in the case of voting proxies on shares of certain foreign
corporations).\68\ This position recognizes the importance that prudent
management of shareholder rights can have in enhancing the value of
plan assets or protecting plan assets from risk. However, as explained
in the preamble to the NPRM, the removal of the language is not meant
to indicate that fiduciaries must always vote proxies or engage in
shareholder activism.\69\ 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 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 advisors/managers that
act on behalf of large aggregates of investors, etc.). With regard to
commenters' concerns about fiduciaries' reliance on proxy advisory
firms, the Department notes that, as discussed below, the final rule
retains requirements relating to the prudent selection and monitoring
of services providers to advise or assist with the exercise of
shareholder rights. In order to satisfy that provision, fiduciaries
would be expected to assess the qualifications of the provider, the
quality of services offered, and the reasonableness of fees charged in
light of the services provided. A fiduciary's process also should be
designed to avoid self-dealing, conflicts of interest or other improper
influence.\70\ Fiduciaries additionally should take steps to ensure
they are fully informed of potential conflicts of proxy advisory firms
and the steps such firms have taken to address them.\71\ To the extent
relevant, fiduciaries should review the proxy voting policies and proxy
voting guidelines and the implementing activities of the person being
selected. If a fiduciary determines that the recommendations and other
activities of such person are not being carried out in a manner
consistent with those policies and/or guidelines, then the fiduciary
should take appropriate action in response. The Department further
notes that in 2020, the U.S. Securities and Exchange Commission adopted
final rules that were intended to help ensure that investors who use
proxy voting advice receive more transparent, accurate, and complete
information on which to make their voting decisions.\72\ Information
required to be provided pursuant to those final rules also may be
useful to responsible plan fiduciaries relying on recommendations from
proxy advisory firms.
---------------------------------------------------------------------------
\68\ 81 FR 95879, 81 (``The essential point of IB 94-2, however,
was to articulate a general principle that a fiduciary's obligation
to manage plan assets prudently extends to proxy voting. As such, IB
94-2 properly read was meant to express the view that proxies should
be voted as part of the process of managing the plan's investment in
company stock unless a responsible plan fiduciary determined that
the time and costs associated with voting proxies with respect to
certain types of proposals or issuers may not be in the plan's best
interest.''). See also IB 94-2, 59 FR 38861, 63 (July 29, 1994)
(``The fiduciary obligations of prudence and loyalty to plan
participants and beneficiaries require the responsible fiduciary to
vote proxies on Issues that may affect the value of the plan's
investment. Although the same principles apply for proxies
appurtenant to shares of foreign corporations, the Department
recognizes that in voting such proxies, plans may, in some cases,
incur additional costs. Thus, a fiduciary should consider whether
the plan's vote, either by itself or together with the votes of
other shareholders, is expected to have an effect on the value of
the plan's investment that will outweigh the cost of voting.
Moreover, a fiduciary, in deciding whether to purchase shares of a
foreign corporation, should consider whether the difficulty and
expense in voting the shares is reflected in their market price.'').
\69\ 86 FR 57281.
\70\ See 85 FR 81669; see also Department of Labor Information
Letter to Diana Orantes Ceresi (Feb. 19, 1998).
\71\ See ``Selecting and Monitoring Pension Consultants--Tips
for Plan Fiduciaries'' <a href="https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/our-activities/resource-center/fact-sheets/selecting-and-monitoring-pension-consultants.pdf">https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/our-activities/resource-center/fact-sheets/selecting-and-monitoring-pension-consultants.pdf</a>.
\72\ See Exemptions from the Proxy Rules for Proxy Voting
Advice, Release No. 34-89372 (July 22, 2020), 85 FR 55082 (Sept. 3,
2020). In July 2022, the SEC amended these final rules. See 87 FR
43168 (July 19, 2022).
---------------------------------------------------------------------------
(b) Removal of Specific Recordkeeping Requirement From Paragraph
(e)(2)(ii)(E) of the Current Regulation
The Department proposed to 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 Department was concerned
that the provision appeared to treat proxy voting and other exercises
of shareholder rights differently from other fiduciary activities and
might 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 could be harmful to plans,
as it could potentially chill plan fiduciaries from exercising their
right or result in
[[Page 73846]]
excessive expenditures as fiduciaries over-document their efforts.
Some commenters supported removal of the recordkeeping provision,
echoing the Department's concerns stated in the preamble to the NPRM.
Several commenters believed there was no need to single out proxy
voting for special recordkeeping requirements. Some commenters
criticized the recordkeeping requirement as creating a misperception
that exercising shareholder rights carry a greater fiduciary obligation
than other fiduciary activities and a heightened burden when exercised,
which might cause fiduciaries to shy away from exercising shareholder
rights or incur unnecessary compliance expenses when doing so. A
commenter criticized the specific recordkeeping requirement as creating
a new barrier and extra expense, without justification. Several
commenters were of the view that the general framework of ERISA is
sufficient to govern the recordkeeping requirements for proxy voting.
Other commenters opposed removal of the documentation requirement
and suggested that it be retained in the regulation. A commenter
indicated that removing the documentation provision deprives
participants and beneficiaries of information they may use to evaluate
whether fiduciaries are acting in their best interest for their
exclusive benefit. Another commenter similarly suggested that
eliminating the requirement impedes the ability of participants to
monitor plan fiduciaries. Another commenter further opined that
enhanced documentation would help to ensure that ERISA plan proxies are
being voted only in a manner that is in the articulable financial
interest of plan beneficiaries.
The Department is not persuaded by commenters to retain the
specific recordkeeping provision. The Department does not disagree with
the need for proper documentation of fiduciary activity. To the
contrary, in previous guidance on proxy voting, the Department
indicated that section 404(a)(1)(B) requires proper documentation both
of the activities of the investment manager and of the named fiduciary
of the plan in monitoring the activities of the investment manager.\73\
Specifically, with respect to proxy voting, this would require the
investment manager or other responsible fiduciary to keep accurate
records as to the voting of proxies. It is the Department's view that
in order for the named fiduciary to carry out the fiduciary's
responsibilities under ERISA section 404(a), the fiduciary must be able
to review periodically not only the voting procedure pursuant to which
the investment manager votes the proxies appurtenant to plan-owned
stock, but also the actions taken in individual situations so that a
determination can be made whether the investment manager is fulfilling
their fiduciary obligations in a manner which justifies the
continuation of the management appointment. In context, however, the
Department takes note of, and to a large extent agrees with, the
commenters' concern that the current regulation could be viewed by some
as treating 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.
Because this misperception could be harmful to plans, as it could
potentially chill plan fiduciaries from exercising their rights or
result in excessive expenditures as fiduciaries over-document their
efforts, the Department has concluded it is appropriate to rescind this
provision in the current regulation.
---------------------------------------------------------------------------
\73\ See Letter to Helmuth Fandl, Chairman of the Retirement
Board, Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988) (``[I]t is
the opinion of the Department that section 404(a)(1)(B) requires
proper documentation of the activities of the investment manager and
of the named fiduciary of the plan in monitoring the activities of
the investment manager. Specifically, with respect to proxy voting,
this would require the investment manager or other responsible
fiduciary to keep accurate records as to the voting of proxies.'');
see also Interpretive Bulletin IB 94-2 (July 29, 1994) 59 FR 38860,
63 (``It is the view of the Department that compliance with the duty
to monitor necessitates proper documentation of the activities that
are subject to monitoring. Thus, the investment manager or other
responsible fiduciary would be required to maintain accurate records
as to proxy voting. Moreover, if the named fiduciary is to be able
to carry out its responsibilities under ERISA Sec. 404(a) in
determining whether the investment manager is fulfilling its
fiduciary obligations in investing plans assets in a manner that
justifies the continuation of the management appointment, the proxy
voting records must enable the named fiduciary to review not only
the investment manager's voting procedure with respect to plan-owned
stock, but also to review the actions taken in individual proxy
voting situations.'').
---------------------------------------------------------------------------
(c) Removal of Specific Monitoring Requirement From Paragraph
(e)(2)(iii) of the Current Regulation
As discussed above, the Department proposed to eliminate paragraph
(e)(2)(iii) of the current regulation, which set out specific
monitoring obligations where the authority to vote proxies or exercise
shareholder rights has been delegated to an investment manager or proxy
voting firm and proposed to broaden another provision of the regulation
that more generally covers selection and monitoring obligations
(paragraph (d)(2)(ii)(E) of the proposal). The Department was concerned
that the more specific provision relating to providers of certain
proxy-related services could be read as creating special monitoring
obligations above and beyond the statutory obligations of prudence and
loyalty that generally apply to monitoring service providers. In this
regard, the Department noted that it had previously indicated in
Interpretive Bulletin 2016-01 that the general prudence and loyalty
duties under ERISA section 404(a)(1) require a fiduciary to monitor
decisions made and actions taken by an investment manager with regard
to proxy voting decisions. In addition, the Department had previously
indicated that in adopting paragraph (e)(2)(iii) of the current
regulation it did not intend to create a higher standard for a
fiduciary's monitoring of an investment manager's proxy voting
activities than would ordinarily apply under ERISA with respect to the
monitoring of any other fiduciary or fiduciary activity.\74\
---------------------------------------------------------------------------
\74\ 85 FR 81670 (``The Department did not intend to create a
higher standard for a fiduciary's monitoring of an investment
manager's proxy voting activities than would ordinarily apply under
ERISA with respect to the monitoring of any other fiduciary or
fiduciary activity. Thus, the Department has revised the provision
in th
[…truncated; see source link]Indexed from Federal Register on December 1, 2022.
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.