DOL Final Rule for Financial Factors in Selecting Plan Investments
Employee Benefits Update
Date: December 03, 2020
On October 30, the Department of Labor (DOL) released a final rule (“Rule”) governing a fiduciary’s investment duties under ERISA. The DOL’s stated purpose in adopting the Rule is to confirm that plan fiduciaries must select plan investments solely based on considerations that impact the investments’ economic value. Unlike the proposed rule released in June, the Rule discards explicit reference to environmental, social and corporate governance due to the inability to precisely define such factors and to avoid unduly narrowing the Rule’s overriding goals.
As further explained herein, the Rule clarifies that plan fiduciaries must base their investment decisions solely on pecuniary factors – those that have a material effect on an investment’s risk and return based on appropriate time horizons consistent with the plan’s investment objectives and funding policy.
ERISA generally requires that plan fiduciaries act prudently and diversify plan investments to minimize the risk of large losses. Additionally, plan fiduciaries must act solely in the interest of plan participants and beneficiaries for the exclusive purpose of providing benefits to plan participants and beneficiaries and to defray reasonable plan administrative expenses. Therefore, the selection of investment options to serve non-pecuniary interests raises fiduciary concerns under ERISA. The Rule seeks to resolve the uncertainty created by seemingly conflicting prior DOL guidance regarding what role non-pecuniary factors may serve in the selection of plan investments and to provide a clear outline for fiduciaries moving forward.
The Rule is generally consistent with the proposed rule, stating that a plan fiduciary must never subordinate plan participants’ and beneficiaries’ pecuniary interests to achieve non-pecuniary goals; rather, the fiduciary must evaluate investments based solely on pecuniary factors and avoid additional investment risk to promote non-pecuniary objectives or goals. The Rule defines a pecuniary factor as one “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 Rule, however, recognizes that in rare circumstances a plan fiduciary may be unable to distinguish between two investments based solely on pecuniary factors. In that event, the Rule provides that a fiduciary may use non-pecuniary factors to make an investment decision provided the fiduciary documents:
- why pecuniary factors were insufficient to select the investment or course of action,
- how the investment that was selected compares to alternative investments in terms of composition for diversification, liquidity and current returns relative to the plan’s cash flow needs, and projected return relative to funding objectives, and
- how the non-pecuniary factors used to select the investment are consistent with participants’ or beneficiaries’ interests under the plan.
The Rule also provides that when selecting designated investment alternatives for participant-directed individual account plans, a fiduciary is not prohibited from including an investment option that supports a non-pecuniary goal, as long as he or she has satisfied the duties of loyalty and prudence under ERISA and the decision is based solely on pecuniary factors or satisfies the “tie breaker” standards discussed above. The Rule, however, prohibits a fiduciary from selecting a designated investment alternative to serve as a plan’s qualified default investment alternative (QDIA) if the investment’s objectives, goals or principal investment strategies include, consider or indicate use of one or more non-pecuniary factors.
Finally, the Rule clarifies that a fiduciary need not “scour the market” or incur costs to evaluate an infinite number of investments to meet the duty of prudence, but should consider the facts and circumstances that he or she knows or should know are relevant to the particular investment decision. A fiduciary has met his or her burden by having considered investment alternatives reasonably available under the circumstances.
Although in many aspects the Rule is similar to the proposed rule, it provides clarification on the use of pecuniary and non-pecuniary factors in determining a plan’s investment lineup as well as when and how non-pecuniary factors may be considered. A plan fiduciary should consider the Rule and ERISA’s duties of loyalty and prudence when reviewing a plan’s current investment options and ensure they are consistent with the Rule or make necessary changes to bring the investment lineup into compliance. The fiduciary should also review and update, as necessary, the plan’s investment policy statement to ensure consistency with the Rule’s dictates.
Finally, plan fiduciaries and other interested stakeholders should stay tuned for further developments. It would not be surprising to see the Rule revisited after the Biden administration’s political appointees are in place at the DOL.
The Rule will be effective on January 12, 2021, which is 60 days after its publication in the Federal Register. However, there is an extended transition period for plans to bring their QDIAs into compliance with the Rule on or before April 30, 2022.
FOR MORE INFORMATION
For more information, please contact:
Julia Ann Love
Edward C. Redder
Mark G. Kroboth
or any member of our Employee Benefits & Executive Compensation group.
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