Department of Labor Swiftly Finalizes Rule on Consideration of Only Pecuniary (not ESG) Factors in Investment Decisions

On October 30, 2020, the U.S. Department of Labor (DOL) issued its final rule, which amends its 1979 investment duties regulation under the Employee Retirement Income Security Act of 1974, as amended (ERISA), to set forth strict rules requiring plan fiduciaries to consider only pecuniary factors in making investment decisions. This rule was proposed on June 23, 2020, and generated a significant response, under which the DOL received more than 1,100 written comments and more than 7,600 submissions in the form of six form letters.

The proposed rule related to consideration of environmental, social, and governance (ESG) factors in making investment decisions. The preamble to the final rule indicates that the DOL believes that the term ESG “is not a clear or helpful lexicon for a regulatory standard” and, as a result, eliminated that term from the final rule. Instead, the final rule requires plan fiduciaries to consider only “pecuniary factors” in making investment decisions. According to the DOL, plan fiduciaries “must never sacrifice investment returns, take on additional investment risk, or pay higher fees to promote non-pecuniary benefits or goals.”

Definition of “Pecuniary Factor”

The final rule defines the term “pecuniary factor” as “a factor that a fiduciary prudently determines is expected to 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 the funding policy established pursuant to section 402(b)(1) of ERISA.”

The preamble to the final rule acknowledges that ESG factors “will present an economic business risk or opportunity that corporate officers, directors, and qualified investment professionals would appropriately treat as material economic considerations under generally accepted investment theories.” Examples provided in the preamble include a company’s improper disposal of hazardous waste and dysfunctional corporate governance.

List of Amendments to the Investment Duties Regulations

The final rule amends the ERISA investment duties regulation set forth in 29 CFR 2550.404a-1 t

1. confirm that ERISA fiduciaries must evaluate investments and “investment courses of action” based solely on pecuniary factors
   • The term “investment course of action” is defined as “any series or program of investments or actions related to a fiduciary’s performance of the fiduciary’s investment duties, and includes the selection of an investment fund as a plan investment, or in the case of an individual account plan, a designated investment alternative under the plan.”
2. state that compliance with the exclusive purpose requirement in ERISA prohibits fiduciaries from subordinating the interests of participants to unrelated objectives and bars plan fiduciaries from sacrificing investment return or taking on additional investment risk to promote non-pecuniary goals
3. require fiduciaries to consider reasonably available alternatives with similar risks to meet their prudence and loyalty duties under ERISA
   • The DOL explained, in the preamble to the final rule, that this provision does not require fiduciaries to consider every possible alternative.
4. set 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. clarify that the prudence and loyalty standards set forth in ERISA apply to a fiduciary’s selection of designated investment alternatives to be offered to plan participants and beneficiaries in a participant-directed individual account plan

When Non-Pecuniary Factors Can Be Considered

As referenced in item 4 above, the final rule indicates that a plan fiduciary may use non-pecuniary factors as a deciding factor in making an investment decision where the plan fiduciary is considering several investment opportunities and is unable to distinguish these alternatives solely on the basis of pecuniary factors. To support the use of the non-pecuniary factors in this situation, the fiduciary must document

• why pecuniary factors were not sufficient to select the investment
• how the selected investment compares to the alternative investments with regard to certain specified investment consideration factors set forth in the final rule
• how the chosen non-pecuniary factor or factors are consistent with the interests of participants and beneficiaries under the plan

Impact on the Selection of Designated Investment Alternatives for Individual Account Plans

The final rule states that a fiduciary is not prohibited from considering or including an investment option as a designated investment alternative in a self-directed defined contribution plan solely because that option promotes or supports non-pecuniary goals, provided that the fiduciary satisfies certain specified investment consideration factors set forth in the final rule in selecting and retaining such investment option. The final rule indicates, however, that the qualified default investment alternative (QDIA) used by the plan may not have, as its investment objectives or goals, the use of non-pecuniary factors.

Effective Date

The amendments to the final rule become effective 60 days after the final regulation is published in the Federal Register and apply to all investments after that date. A special exception provides that plans have until April 30, 2022, to make any changes to QDIAs available under individual account plans if necessary to comply with the new rule.