July 31, 2020

DOL Keeps Its “Social Distance” from 401(k) Plan Investments in Environmental, Social and Governance Funds

On June 30, 2020, the U. S. Department of Labor (“DOL”) published a proposed rule (see also related Notice of Proposed Rulemaking) that would throw cold water on the idea of “social investing” in retirement plans, including 401(k) plans. In particular, by emphasizing that ERISA requires plan fiduciaries to select investments and investment courses of action based solely on financial considerations, and by adding new analysis and documentation requirements in some cases, the proposed rule would add new disincentives to the use of mutual funds driven largely by environmental, social and governance (“ESG”) factors.

Background. ERISA requires that retirement plan fiduciaries manage plans solely in the interest of participants and beneficiaries, and for the exclusive purpose of providing benefits and paying plan expenses. (See our articles entitled “401(k) ERISA’s Duty of Care and Liability” and “401(k) Fiduciary and Non-Fiduciary Functions” for a general discussion on ERISA fiduciary duty.) In particular, the investment of plan assets (including investment choices made directly by 401(k) plan participants and beneficiaries from a pre-selected menu of funds) must meet ERISA’s high standards of care and prudence. In general, this means that investment decisions must be based solely on financial considerations, taking into account appropriate economic conditions and factors, to evaluate the risk and return profiles of different investments.

In 1994, the DOL formally stated that “economically targeted investments” (ETIs) could be consistent with ERISA’s fiduciary obligations, but that fiduciaries must confirm that an ETI has an expected rate of return that corresponds to the rates of return for available alternative investments with similar risk characteristics. The DOL revised its viewpoint in 2008 and again in 2015, cautioning that fiduciaries violate ERISA if they accept expected reduced returns or greater risks to secure social, environmental, or other public policy goals; but also stating that, if a fiduciary prudently determines that an investment is appropriate based solely on economic considerations — including those that may derive from ESG factors – then the fiduciary may make the investment without regard to any collateral benefits the investment might also promote.

COMMENT: Practitioners have almost universally interpreted the DOL’s recent positions as being generally permissive towards endorsing the use of ESG and other “socially responsible” funds – provided that the investments are “appropriate for the plan and economically and financially equivalent with respect to the plan’s investment objectives, return, risk and other financial attributes as competing investment choices.” With this new proposal, however, many commentators see the DOL as turning its back on this long-held view.

Highlights of the New Proposed Rule

NOTE: The text of the proposal is highly technical in nature. The following is meant as a high-level, general overview of the major provisions applicable to 401(k) plans, and is not intended as an exhaustive analysis of the proposed rule or of ERISA investments generally.

Generally stated, the new proposed rule, if finalized in its present form, would add five new provisions to the existing DOL regulations that govern ERISA investment duties:

  • New text would codify the DOL’s 1994, 2008 and 2015 past pronouncements (see “Background,” above) mandating that plan fiduciaries select investments based on financial considerations relevant to the risk-adjusted economic value of a particular investment.
  • A new provision stating that compliance with ERISA’s exclusive purpose duty (the duty of loyalty) prohibits fiduciaries from subordinating the interests of plan participants and beneficiaries to “non-pecuniary goals.”
  • A new provision that requires fiduciaries, in order to meet their ERISA prudence and loyalty duties, to consider available investments other than ESGs in furthering the purposes of the plan.
  • The proposed rule would impose new analysis and documentation requirements in certain circumstances where fiduciaries must choose between “economically indistinguishable” investments” (“tie-breaker” situations).
  • A new provision appliable solely to selecting “designated investment alternatives” for 401(k) plans would effectively prohibit a plan from using an ESG fund as the plan’s qualified default investment fund.

Postscript. The DOL recognizes that some plans might have to modify their processes for selecting and monitoring investments, and that the proposed rule may impose costs on plans whose current documentation and recordkeeping are insufficient to meet the new requirements. Nevertheless, the DOL believes that, overall, the proposed rule would assist fiduciaries in carrying out their ERISA responsibilities, while also promoting the financial interests of retirees.

Effective Date. If finalized in its present form, the proposed PTE would become effective 60 days after the date of its publication in the Federal Register.

The information and content contained in this blog post are for general informational purposes only, and does not, and is not intended to, constitute legal advice. As always, for specific questions concerning your 401(k) retirement plan, or for help in operating your plan during the current COVID-19 crisis, please consult your own ERISA attorney or professional advisor.

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