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Final DOL Rule Imposes Fiduciary Limitations on Social Investing

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The DOL recently issued a final rule (“Rule”) providing guidance on the long-standing issue of whether ERISA fiduciaries are permitted to consider non-pecuniary factors while making investments (or selecting investment funds) that promote one or more environmental, social or corporate governance goals (so called “ESG Investments”).  The preamble to the Rule acknowledges that ERISA fiduciaries must act solely in the interest of plan participants/beneficiaries and that courts have consistently interpreted this interest to refer to pecuniary, rather than non-pecuniary benefits.

Prior DOL ESG Investment guidance also required ERISA fiduciaries to place financial returns over other non-financial goals and prohibited a fiduciary from subordinating the interests of participants/beneficiaries in their retirement income to “unrelated objectives.”  However, the DOL previously stated that, when comparing ESG and non-ESG investments, if the financial returns were comparable, it was not a breach of fiduciary duty to select the ESG Investment.  This was known as the DOL’s “all things being equal” test or the “tie-breaker” standard.

In the preamble to the Rule, the DOL acknowledges that ESG Investments have grown in popularity and that some ERISA fiduciaries have placed a greater emphasis on non-pecuniary factors while investing.  Additionally, the DOL is worried that ESG Investments are being actively marketed to ERISA plans even though marketing materials acknowledge the funds may perform differently because of these non-pecuniary goals.   The Preamble boldly states that:

Providing a secure retirement for American workers is the paramount, and eminently worthy, “social” goal of ERISA plans; plan assets may never be enlisted in pursuit of other social or environmental objectives at the expense of ERISA’s fundamental purpose of providing secure and valuable retirement benefits.”

Although the Rule takes a step back from the guidance issued in the DOL’s proposed rule issued a few months ago, the Rule makes the following five changes to ERISA’s investment duty regulation:

  • ERISA fiduciaries must evaluate investments based solely on pecuniary factors (i.e., financial considerations that have a material effect on risk and/or return based on appropriate investment horizons);
  • ERISA fiduciaries are prohibited from subordinating the interests of participants to unrelated objectives, and they may not sacrifice investment return or take on additional risk to promote non-pecuniary goals;
  • ERISA fiduciaries must consider reasonably available alternatives to meet their ERISA prudence and loyalty duties;
  • ERISA fiduciaries must satisfy analysis and documentation requirements for those circumstances in which they use non-pecuniary factors when choosing among investments in those “all things being equal” situations; and
  • ERISA fiduciaries of participant-directed individual account plans are not prohibited from including an investment fund that promotes non-pecuniary goals so long as a fiduciary’s decision satisfies ERISA’s prudence and loyalty standards, including the requirement to evaluate the investment fund based solely on pecuniary factors.

This final Rule will become effective on December 29, 2020 (60 days from October 30, 2020, the date the DOL published the Rule).