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July 7, 2020

Stroock Special Bulletin

By: David C. Olstein, Austin S. Lilling, Abbey L. Keppler, Bruce D. Gallant

On June 30, 2020, the Department of Labor (“DOL”) published in the Federal Register a proposed regulation (the “Proposed Regulation”) that would amend a current regulation addressing how plan fiduciaries may satisfy their obligations under Title I of the Employment Retirement Income Security Act of 1974 (as amended, “ERISA”) in connection with the investment of plan assets (the “Investment Duties Regulation”). The Proposed Regulation would codify prior DOL sub-regulatory guidance that ERISA plan fiduciaries are required to make investment decisions based on financial considerations and not environmental, social and corporate governance (“ESG”) or other “non-pecuniary” objectives.[1] The DOL was prompted to issue the Proposed Regulation due to its concern “that the growing emphasis on ESG investing may be prompting ERISA plan fiduciaries to make investment decisions for purposes distinct from benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan.”[2] Comments on the Proposed Regulation are due by July 30, 2020, and the amendments will become effective 60 days after publication of a final rule.

Prior DOL Guidance on ESG Investments

In the preamble to the Proposed Regulation, the DOL reviewed its prior guidance with respect to ESG investing, noting a common theme that the “paramount focus of plan fiduciaries must be the plan’s financial returns and risk to participants and beneficiaries.”[3] The DOL first comprehensively addressed ESG investments (then referred to as “economically targeted investments”) in Interpretive Bulletin 94-1(“IB 94-1”).[4] The DOL explained that its objective in issuing IB 94-1 was to confirm that economically targeted investments were “not inherently incompatible with ERISA’s fiduciary obligations,” provided that such investments had “an expected rate of return commensurate to rates of return of available alternative investments with similar investment characteristics. . . .”[5] Under IB 94-1, plan fiduciaries could consider non-pecuniary factors only when choosing between investments with comparable risks and rates of return.[6]  In subsequent guidance, the DOL confirmed that ESG factors may also be considered to the extent they have an economic component, but cautioned that such factors should only be treated as economically relevant if they would be treated as material economic considerations under generally accepted investment theories.[7]

Proposed Changes to Investment Duties Regulation

The Investment Duties Regulation, issued in 1979, provides that an ERISA plan fiduciary will satisfy its duty of prudence in connection with the selection of plan investments by giving “appropriate consideration” to those factors that “the fiduciary knows or should know are relevant to the particular investment” and acts accordingly.  Under the Investment Duties Regulation, such factors include, but are not be limited to:

  • the diversification of the plan’s investment portfolio;
  • the liquidity and current return of the plan’s investment portfolio relative to the plan’s anticipated cash flow requirements; and
  • the projected return of the plan’s investment portfolio relative to the plan’s funding objectives.

The Proposed Regulation would supplement the Investment Duties Regulation by incorporating provisions addressing ERISA’s requirement that a plan fiduciary discharge his duties solely in the interests of plan participants and beneficiaries and for the exclusive purpose of providing benefits and defraying reasonable administrative expenses. 

The Proposed Regulation provides that a plan fiduciary’s evaluation of an investment must be based solely on pecuniary factors and that a fiduciary may not sacrifice investment returns or accept additional risk in order to promote a public policy, political or other non-pecuniary goal.  The term “pecuniary factor” is defined in the Proposed Regulation as “a factor that has a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy established pursuant to section 402(a)(1) of ERISA.”[8]  The Proposed Regulation specifies that ESG factors “are pecuniary factors only if they present economic risks or opportunities that would be treated as material economic considerations under generally accepted investment theories,” and that such factors must be weighted in a manner that “appropriately reflect[s] a prudent assessment of their impact on risk and return.”[9]

Consistent with prior DOL guidance, the Proposed Regulation permits a plan fiduciary to consider non-pecuniary factors as tie breakers when choosing between alternative investments that are economically indistinguishable.  However, the DOL emphasized in the preamble to the Proposed Regulation that such ties should rarely, if ever, occur.  Moreover, the Proposed Regulation provides that when a plan fiduciary determines that two investment alternatives are economically indistinguishable and selects an investment on the basis of ESG or other non-pecuniary factors, “the fiduciary should document specifically why the investments were determined to be indistinguishable and why the selected investment was chosen based on the purposes of the plan, diversification of investments and the interests of plan participants and beneficiaries. . . .”[10]

The Proposed Regulation also addresses the selection of an ESG investment by a fiduciary as an investment alternative in a participant-directed individual account plan, such as a 401(k) plan. The Proposed Regulation states that a plan fiduciary may include on the investment platform for such a plan “one or more prudently selected, well managed, and properly diversified investment alternatives” that include ESG factors in their investment mandate, provided that:

  • the fiduciary uses only objective risk-return criteria in selecting and monitoring all investment alternatives for the plan, including any ESG investment alternatives;
  • the fiduciary documents its reliance on objective risk-return criteria in selecting and monitoring ESG investment alternatives; and
  • any selected ESG investment alternative is not added as, and is not included as a component of, a qualified default investment alternative.

Impact of the Proposed Regulation

In the preamble to the Proposed Regulation, the DOL estimated that 19% of private sector defined benefit plans (approximately 8,870) and non-participant directed defined contribution plans (approximately 18,400) have adopted ESG investing and would be impacted by the Proposed Regulation.  In discussing the impact of the Proposed Regulation on such plans, the DOL noted that the documentation requirements with respect to investments selected over economically indistinguishable alternatives based on non-pecuniary factors could be burdensome, but that such circumstances would rarely arise.  The DOL estimated that six percent of participant-directed individual account plans (approximately 33,690) had at least one ESG-themed investment alternative.  While noting that the potential replacement of investment alternatives in such plans might lead to disruption, the DOL asserted that such a disruption should be no greater than when plan fiduciaries routinely change designated investment alternatives. In addition, the DOL anticipated that the Proposed Regulation’s documentation requirements for the selecting and monitoring ESG investment alternatives would impose few if any additional costs because such activities are already commonly documented by plan fiduciaries “as a best practice and potential shield from litigation risk.”[11]

Request for Comments

In addition to general comments on all facets of the Proposed Regulation, the DOL is specifically seeking comments on the following matters: 

  • the frequency with which plan fiduciaries find two investments to be “economically indistinguishable,” and the process plan fiduciaries use in this situation;
  • whether the provision allowing for consideration of non-pecuniary factors where two investments are determined to be economically indistinguishable should be retained in some form or should instead be abandoned as inconsistent with the fiduciary requirements under ERISA;
  • whether the provisions governing the selection of ESG investment alternatives in participant-directed individual account plans should expressly incorporate provisions governing the  selection of ESG investments for non-participant directed plans;
  • the DOL’s assumptions describing the prevalence of ESG investing among ERISA plans, including their use as qualified default investment alternatives;
  • the costs and benefits that would be associated with the Proposed Regulation; and
  • whether any transition or applicability date provisions should be added for any of the provisions of the Proposed Regulation.

If you have any questions on the foregoing, please feel free to reach out to us or your regular Stroock contact. We will continue to monitor all developments and guidance with respect to the Proposed Regulation and with respect to ERISA plan investments generally.



For More Information

David C. Olstein

Austin S. Lilling

Abbey L. Keppler

Bruce D. Gallant

[1] Proposed Rule on Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 39,113 (June 30, 2020).

[2] 85 Fed. Reg. at 39,116.

[3] Id. at 39,114.

[4] 29 CFR § 2509.94-1 (superseded by Interpretive Bulletin 2008-01 and Interpretive Bulletin 2015-01).

[5] 85 Fed. Reg. at 39,114.

[6] Preamble to Interpretive Bulletin 94-1, 59 Fed. Reg. 32,606, 32,607 (June 23, 1994).

[7] See Interpretive Bulletin 2015-1 (codified at 29 CFR § 2509.2015-1); Field Assistance Bulletin 2018-01 (April 23, 2018).

[8] Proposed Regulation, 29 CFR § 2550.404a-1(f)(3).

[9] Id. at § 2550.404a-1(c)(1).

[10] Id. at § 2550.404a-1(c)(2).

[11] 85 Fed. Reg. at 39,122.

This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome.