DOL Amends Investment Duties Rule for Selecting Investments

New guidance for fiduciaries of ERISA plans around environmental, social and governance (ESG) investing

On October 30, 2020, the Department of Labor (DOL) released a final rule that amends DOL Regulation Section 2550.404a-1 covering investment duties for ERISA plans. The final rule codifies fiduciary standards for the selection and monitoring of plan investments, as well as provides guidance for fiduciaries of ERISA plans around environmental, social and governance (ESG) investing. 

In general, the final regulation requires the fiduciary to evaluate investments based solely on “pecuniary” factors (e.g., financial, economic, monetary, etc.).

Plans Impacted: Employee benefit plans subject to the Employee Retirement Income Security Act (ERISA). An “employee benefit pension plan” is subject to Title I of ERISA unless it meets one of the following exceptions:

• A 401(a), 401(k), 403(b) or 457(b) plan of a governmental employer (including a public school);
• A Top Hat 457(b) plan of a nonprofit organization;
• A 401(a), 401(k), and 403(b) plans of a church or church-related entity unless the plan administrator has irrevocablyelected into ERISA for that plan;
• A 403(b) plan of nongovernmental/non-church 501(c)(3) organization that meet the non-ERISA regulatory safe harborrules; and
• IRAs that do not have employer contributions or employer active involvement.

Effective Dates: Final rule is effective 60 days after publication in the Federal Register with regard to all investments and investment courses of action taken after that date. However, if a plan has selected an investment fund that has one or more non-pecuniary factors incorporated in its objectives or goals or its principal investment strategies as that plan’s Qualified Default Investment Alternative (QDIA), the plan must modify its QDIA to comply with the new final rule no later than April 30, 2022.

Background

  • The amendments made in the final rule follow a June 2020 release of proposed rules, amending the investment duties regulation, in which DOL notes, “Confusion with respect to ESG investing issues persists, potentially generated in part by the different iterations of sub-regulatory guidance from the Department.” The DOL also expressed concerns that ESG trends suggest that fiduciaries may be making investment decisions for reasons other than what is required under the fiduciary requirement of loyalty, i.e., decisions based on objectives other than fiduciary obligations to maintain the plan for the exclusive purpose of providing benefits to participants and beneficiaries, and to defray reasonable expenses of administering the plan. The DOL also notes that ESG funds may often carry higher fees, or that participants may be offered funds with lower returns or higher investment risks in order to pursue ESG objectives as a result.
  • Over 1,100 written comments from the public were received by the DOL during the 30-day comment period prior to the publication of the final rule.

Important changes to the original investment duties regulation released in 1979:

  • Restates the fiduciary Duty of Loyalty to the original regulation. This rule provides that decisions are made for the exclusive purpose of providing benefits that are associated with participants and beneficiaries, and for defraying the costs of reasonable plan administrative expenses.
  • While the original Duty of Prudence Safe Harbor was retained, the final rule expands the meaning of giving “appropriate consideration” to certain facts and circumstances. Such consideration should include a comparison of “the opportunity for gain (or other return) associated with other investments with similar risks.” The DOL clarifies that fiduciaries need only include investments that are reasonably available.
  • The final regulation requires a fiduciary to evaluate investments based solely on “pecuniary” factors (e.g., financial, economic, monetary, etc.), subject to the “tie breaker test” explained below. Accordingly, a fiduciary may not make the interests of participants and beneficiaries, regarding their retirement benefits, secondary to other objectives. The fiduciary may not take on additional risk, or sacrifice investment return to meet other “non-pecuniary” objectives.
  • The final regulation defines “pecuniary factor” as a factor that a fiduciary determines will have a material effect on the risk and/or return of an investment based on the investment horizons consistent with the plan’s funding and investment policy.
  • The final regulation includes a “tie breaker” test for situations where the fiduciary cannot distinguish between investments on a pecuniary basis only. Here non-pecuniary factors may be used, however certain important documentation and other requirements apply.
  • Removal of ESG terminology. The proposed rule included ESG related terminology and instead focuses on whether a factor is “pecuniary.” DOL is of the opinion that such terms are not helpful, as indicated in the regulation, do not have a uniform meaning and may interfere with fiduciaries’ analysis.
  • The regulation includes special rules for investment funds in a participant directed defined contribution plan. The rule provides that duties of prudence and loyalty apply to the selection and monitoring of Default Investment Alternatives (DIA). If the rules are followed, then a plan fiduciary may include a fund, product or model portfolio as a DIA, even though it may promote or support “non-pecuniary” goals. However, DOL notes that the DIA rules are legal requirements not a safe harbor.
    • Note that the new rules do not require divesting or ceasing investments in existing DIAs (even if non-pecuniary factors were considered in choosing the DIA), however, the new final rule does apply to decisions made after the effective date (i.e., ongoing monitoring).
  • Special restriction on Qualified Default Investment Alternatives (QDIA). The above rules for DIAs above notwithstanding, the final rule provides that an investment fund, product or model portfolio may not be treated as a QDIA if its investment goals or principle investment strategies “include, consider, or indicate the use of one or more non-pecuniary strategies.”

This article is meant only as a high level summary of some of the key points contained in the final regulation. Plan sponsors should review the final regulation with the plan’s attorney to determine impact of these changes on the sponsor’s retirement plan.

 

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Any tax discussion contained in this communication was not intended or written to be used, and cannot be used by the recipient or any other person, for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person. Any tax
discussion contained in this communication was written to support the promotion or marketing of the transactions or matter discussed herein. Any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.

Neither Voya Financial® or its affiliated companies or representatives offer legal or tax advice. Please seek the advice of a tax attorney or tax advisor prior to making a tax-related insurance/investment decision. 11/2020


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