U.S. Department of Labor Issues Final Regulations Regarding Selecting Plan Investments:

On November 22, 2022, the U.S. Department of Labor (“DOL”) published final regulations addressing the application of ERISA’s fiduciary duties of prudence and loyalty to selecting investments and investment courses of action. This involves selecting qualified default investment alternatives, exercising shareholder rights such as proxy voting, and the use of written proxy voting policies and guidelines. (The shareholder rights and proxy voting rules only apply to plans that hold individual stocks as plan investments. Given that a significant majority of defined contribution plans do not invest in individual stocks, this article will focus exclusively on this new guidance’s investment selection rules.)

The DOL initially states that “Over the last approximately 40 years, the [DOL] has periodically considered how ERISA’s fiduciary duties of prudence and loyalty apply to plan investments that promote environmental, social, or governance [“ESG”] goals. In its interpretive guidance during this period, the [DOL] has consistently recognized that ERISA does not prohibit fiduciaries from making investment decisions that reflect ESG considerations, depending on the circumstances.” 

Overall, the final regulation retains a DOL core principle.  Namely, ERISA’s duties of prudence and loyalty require plan fiduciaries to focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries to objectives that are unrelated to the provision of plan benefits. More specifically, under the final regulation:

  • A fiduciary’s duty of prudence must be based on factors that he or she reasonably determines are relevant to a risk and return analysis, and such factors may include the economic effects of climate change and other ESG considerations on the particular investment.
  • Standards applied to qualified default investment alternatives (“QDIAs”) are no different from those applied to other investments. Thus, when selecting a QDIA, a plan fiduciary must focus on relevant risk and return factors and not subordinate the interests of participants and beneficiaries to objectives unrelated to the provision of plan benefits.
  • When considering competing investments, a fiduciary must prudently conclude that the competing investments equally serve the plan’s financial interests over the appropriate time horizon. In such cases, as a “tiebreaker” in choosing one of those competing investments over the other, the fiduciary can select the investment based on “collateral benefits” (i.e., ESG factors).
  • A fiduciary does not violate the duty of loyalty solely because he or she takes participants’ non-financial preferences into account when constructing a menu of prudent investment options for participant-directed individual account plans. A fiduciary cannot accept reduced returns or greater risks in order to secure collateral benefits, however.