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Under final rule, 401(k) fiduciaries should be careful about green investing

published in McAfee & Taft ERISALINC | November 2, 2020

Earlier this year, the U.S. Department of Labor issued a proposed rule on environmental, social, corporate governance, or other similarly-oriented considerations (collectively, “ESG”) related to the investments in ERISA plans.  The Department appears to have issued the proposed rule out of a concern about the growing emphasis on ESG investing and the potential for some investment products to be marketed to ERISA fiduciaries on the basis of purported benefits and goals unrelated to financial performance.

After receiving a number of comments on the proposed rule, the DOL issued its final rule this past Friday.  The final rule provides that ERISA plan fiduciaries must select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.  ERISA fiduciaries can never sacrifice investment returns, take on additional investment risk, or pay higher fees to promote non-pecuniary benefits or goals (including ESG goals).

The final rule states that it makes five changes to the applicable regulation under ERISA:

  1. Evaluate investments based solely on pecuniary factors.  The rule adds provisions to confirm that ERISA fiduciaries must evaluate investments and investment courses of action based solely on pecuniary factors – that is, financial considerations that 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 funding policy.
  2. Can’t sacrifice returns to promote non-pecuniary goals.  The rule includes an express regulatory provision stating that compliance with the exclusive purpose (loyalty) duty in ERISA prohibits fiduciaries from subordinating the interests of participants to unrelated objectives, and bars them from sacrificing investment return or taking on additional investment risk to promote non-pecuniary goals.
  3. Consider reasonably available alternatives.  The rule includes a provision that requires fiduciaries to consider reasonably available alternatives to meet their prudence and loyalty duties under ERISA.
  4. All things being equal.  The rule sets forth required investment analysis and documentation requirements for those circumstances in which plan fiduciaries use non-pecuniary factors when choosing between or among investments that the fiduciary is unable to distinguish on the basis of pecuniary factors alone.
  5. Might be okay to include fund with non-pecuniary goals, IF. . . .  The final rule expressly provides that, in the case of selecting investment alternatives for an individual account plan that allows plan participants and beneficiaries to choose from a broad range of investment alternatives, a fiduciary is not prohibited from considering or including an investment fund, product, or model portfolio merely because the fund, product, or model portfolio promotes, seeks, or supports one or more non-pecuniary goals, provided that the fiduciary satisfies the prudence and loyalty provisions in ERISA and the final rule, including the requirement to evaluate solely on pecuniary factors, in selecting any such investment fund, product, or model portfolio. However, the provision prohibits plans from adding any investment fund, product, or model portfolio as a qualified default investment alternative, or as a component of such an investment alternative, if the fund, product, or model portfolio’s investment objectives or goals or its principal investment strategies include, consider, or indicate the use of one or more non-pecuniary factors.