DOL Issues Final Rule on Financial Factors in Selecting Plan Investments
The Department of Labor (DOL) issued its final rule providing guidance to plan sponsors on the financial factors to consider when evaluating plan investments. This is a follow-up to its proposed environmental, social, and governance (ESG) rule released four months ago.
(Estimated reading time: 3 min 49 sec)
In the final rule, entitled “Financial Factors in Selecting Plan Investments,” the DOL modified the ESG rule, most notably removing references to ESG and instead focusing on pecuniary versus non-pecuniary factors. The DOL claimed the decision to forego the use of the term ESG was due to the lack of a commonly accepted definition of the term, either individually (E, S, or G) or collectively. That said, the DOL noted in both the proposed rule and the preamble to the final rule that ESG factors can be pecuniary.
There are aspects of this final rule’s preamble, which provides a review and response to comments received and insight on the DOL’s thinking, and the rule itself that apply differently to defined contribution plans, defined benefit plans, multi-employer plans (e.g., union plans), and plans sponsored by religious organizations subject to ERISA. It is important for plan sponsors to incorporate applicable elements of the document into their fiduciary training and review it with their ERISA legal counsel to assess the impact to their specific ERISA-governed plan.
Highlights of the final rule include:
- The rule expands on the duty of prudence to require the consideration of different alternatives (review of multiple, similar types of options) in making investment selections. However, the DOL does not expect plan sponsors to “scour the marketplace” for all available alternatives, so this expansion of duty will likely not have an effect on fiduciaries already following sound processes for considering multiple options in investment manager selection (e.g., conducting a manager search process to select a new investment option).
- Rather than discussing ESG considerations specifically, the final rule states that investments must be evaluated based solely on pecuniary factors—i.e., factors that have a material impact on the risk and return of an investment based on a time horizon that is consistent with the plan’s objectives and funding policy—and that participants’ interests cannot be subordinated for non-pecuniary goals.
- The final rule does address the so-called “tiebreaker” rule in which non-pecuniary considerations could be used to break ties between investments that cannot be distinguished from one another based on pecuniary factors. The DOL removed the “economically indistinguishable” language that was in the proposed rule as the bar for tiebreakers in response to commenters deeming it too onerous. The final rule stipulates a three-step documentation process that a plan fiduciary must follow in the case of tiebreakers.
- Specific to DC plans, the DOL delineates between selecting investment options for a plan lineup versus selecting the qualified default investment alternative (QDIA). In the case of an investment option that is not a QDIA, the DOL permits the selection of funds or products that support non-pecuniary goals as long as 1) the option is one of a number that a participant can choose between in a lineup and 2) the evaluation of the fund or product is based solely on pecuniary attributes (i.e., a standard fiduciary assessment of an investment including its risk and return characteristics).
- Plan sponsors are not able to select QDIAs that have as a main objective or investment strategy the inclusion or consideration of non-pecuniary factors. The bottom line is that the DOL is differentiating between QDIAs, which participants can be defaulted into by definition, from other plan options. The DOL calculated that non-compliant target date fund series are a tiny portion of the target date fund market.
- The rule does not address accessing funds via the brokerage window that may include or support non-pecuniary factors.
Timing: All future fiduciary decisions including fund monitoring must reflect the final rule, as of 60 days after the rule is published in the Federal Register. However, QDIA compliance with the new rule must only be completed by April 30, 2022, to give sufficient time for fund changes for any plans that may require them.
A fact sheet for the final rule can be found here:
The final rule itself, including the preamble, can be found here:
The final rule starts on page 142.
Bottom line: The DOL’s new rule on a fiduciary’s investment duties for investment selection and monitoring is underpinned by the principles 1) that these decisions should be based on evaluating pecuniary factors such as risk-return characteristics of an investment; 2) that ESG factors are pecuniary in some cases; and 3) that ERISA fiduciaries should focus solely on the interests of plan participants and beneficiaries and should not subordinate their interests to further other goals.