[Federal Register Volume 87, Number 230 (Thursday, December 1, 2022)]
[Rules and Regulations]
[Pages 73822-73886]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-25783]
[[Page 73821]]
Vol. 87
Thursday,
No. 230
December 1, 2022
Part II
Department of Labor
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Employee Benefits Security Administration
29 CFR Part 2550
Prudence and Loyalty in Selecting Plan Investments and Exercising
Shareholder Rights; Final Rule
Federal Register / Vol. 87 , No. 230 / Thursday, December 1, 2022 /
Rules and Regulations
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
RIN 1210-AC03
Prudence and Loyalty in Selecting Plan Investments and Exercising
Shareholder Rights
AGENCY: Employee Benefits Security Administration, Department of Labor.
ACTION: Final rule.
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SUMMARY: The Department of Labor (Department) is adopting amendments to
the Investment Duties regulation under Title I of the Employee
Retirement Income Security Act of 1974, as amended (ERISA). The
amendments clarify the application of ERISA's fiduciary duties of
prudence and loyalty to selecting investments and investment courses of
action, including selecting qualified default investment alternatives,
exercising shareholder rights, such as proxy voting, and the use of
written proxy voting policies and guidelines. The amendments reverse
and modify certain amendments to the Investment Duties regulation
adopted in 2020.
DATES:
Effective date: This rule is effective on January 30, 2023.
Applicability dates: See Sec. 2550.404a-1(g) of the final rule for
compliance dates for Sec. 2550.404a-1(d)(2)(iii) and (d)(4)(ii) of the
final rule.
FOR FURTHER INFORMATION CONTACT: Fred Wong, Acting Chief of the
Division of Regulations, Office of Regulations and Interpretations,
Employee Benefits Security Administration, (202) 693-8500. This is not
a toll-free number.
Customer Service Information: Individuals interested in obtaining
information from the Department of Labor concerning ERISA and employee
benefit plans may call the Employee Benefits Security Administration
(EBSA) Toll-Free Hotline, at 1-866-444-EBSA (3272) or visit the
Department of Labor's website (www.dol.gov/ebsa).
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. General
B. The Department's Prior Non-Regulatory Guidance
1. ETI/ESG Investing
2. Exercising Shareholder Rights
C. Executive Order Review of Current Regulation
II. Purpose of Regulatory Action and Proposed Rule
A. Purpose
B. Major Provisions of Proposed Rule
III. The Final Rule
A. Executive Summary of Major Changes and Clarifications
B. Detailed Discussion of Public Comments and Final Regulation
1. Section 2550.404a-1(a) and (b)--General and Investment
Prudence Duties
2. Section 2550.404a-1(c) Investment Loyalty Duties
3. Investment Alternatives in Participant Directed Individual
Account Plans Including Qualified Default Investment Alternatives
4. Section 2550.404a-1(d)--Proxy Voting and Exercise of
Shareholder Rights
5. Section 2550.404a-1(e)--Definitions
6. Section 2550.404a-1(f)--Severability
7. Section 2550.404a-1(g)--Applicability Date
8. Miscellaneous
IV. Regulatory Impact Analysis
A. Executive Orders 12866 and 13563
B. Introduction and Need for Regulation
C. Affected Entities
1. Subset of Plans Affected by Proposed Modifications of
Paragraphs (b) and (c) of Sec. 2550.404a-1
2. Subset of Plans Affected by the Modifications to Paragraph
(d) of Sec. 2550.404a-1
D. Benefits
1. Benefits of Paragraphs (b) and (c)
2. Cost Savings Relating to Paragraphs (c), Relative to the
Current Regulation
3. Benefits of Paragraph (d)
4. Cost Savings Relating to Paragraphs (d) and (e), Relative to
the Current Regulation
E. Costs
1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
2. Possible Changeover Costs
3. Cost Associated With Changes in Investment or Investment
Course of Action
4. Cost Associated With Changes to the ``Tiebreaker'' Rule
5. Cost To Update Plan's Written Proxy Voting Policies
6. Summary
F. Transfers
G. Uncertainty
H. Alternatives
I. Conclusion
V. Paperwork Reduction Act
VI. Regulatory Flexibility Act
A. Need for and Objectives of the Rule
B. Comments
C. Affected Small Entities
1. Small Plans Affected by the Proposed Modifications of
Paragraphs (b) and (c) of Sec. 2550.404a-1
2. Subset of Plans Affected by Modifications of Paragraph (d)
and (e) of Sec. 2550.404a-1
D. Impact of the Rule
1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
2. Cost To Update Written Proxy Voting Policies
3. Summary of Costs
E. Regulatory Alternatives
F. Duplicate, Overlapping, or Relevant Federal Rules
VII. Unfunded Mandates Reform Act
VIII. Federalism Statement
I. Background
A. General
Title I of the Employee Retirement Income Security Act of 1974
(ERISA) establishes minimum standards that govern the operation of
private-sector employee benefit plans, including fiduciary
responsibility rules. Section 404 of ERISA, in part, requires that plan
fiduciaries act prudently and diversify plan investments so as to
minimize the risk of large losses, unless under the circumstances it is
clearly prudent not to do so.\1\ Sections 403(c) and 404(a) also
require fiduciaries to act solely in the interest of the plan's
participants and beneficiaries, and for the exclusive purpose of
providing benefits to participants and beneficiaries and defraying
reasonable expenses of administering the plan.\2\
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\1\ 29 U.S.C. 1104.
\2\ 29 U.S.C. 1103(c) and 1104(a).
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To maximize employee pension and welfare benefits, section 404 of
ERISA dictates that the focus of ERISA plan fiduciaries on the plan's
financial returns and risk to beneficiaries must be paramount.\3\ And
for years, the Department's non-regulatory guidance has recognized
that, under the appropriate circumstances, ERISA does not preclude
fiduciaries from making investment decisions that reflect
environmental, social, or governance (``ESG'') considerations, and
choosing economically targeted investments (``ETIs'') selected in part
for benefits in addition to the impact those considerations could have
on investment return.\4\ The Department's non-regulatory guidance has
also recognized that the fiduciary act of managing employee benefit
plan assets includes the management of voting rights as well as other
shareholder rights connected to shares of stock, and that management of
those rights, as well as shareholder engagement activities, is subject
to ERISA's prudence and loyalty requirements.\5\ Subsection B of this
background section provides a complete overview of the Department's
prior non-regulatory guidance.
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\3\ See Interpretive Bulletin 2015-01, 80 FR 65135 (Oct. 26,
2015).
\4\ See, e.g., id.
\5\ See, e.g., Interpretive Bulletin 2016-01, 81 FR 95879 (Dec.
29, 2016).
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The Department's Investment Duties regulation under Title I of
ERISA is codified at 29 CFR 2550.404a-1(hereinafter ``current
regulation'' or ``Investment Duties regulation,'' unless otherwise
stated). On June 30 and
[[Page 73823]]
September 4, 2020, the Department published in the Federal Register
proposed rules to remove prior non-regulatory guidance from the CFR and
to amend the Department's Investment Duties regulation. The objective
was to address perceived confusion about the implications of that non-
regulatory guidance with respect to ESG considerations, ETIs,
shareholder rights, and proxy voting.\6\ The preambles to the 2020
proposals expressed concern that some ERISA plan fiduciaries might be
making improper investment decisions, and that plan shareholder rights
were being exercised in a manner that subordinated the interests of
plans and their participants and beneficiaries to unrelated
objectives.\7\ Given the persistent confusion in this area due in part
to varied statements the Department had made on the subject over the
years in non-regulatory guidance, the Department believed that
providing further clarity on these issues in the form of a notice and
comment regulation would be more helpful and permanent than another
iteration of non-regulatory guidance.
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\6\ See 85 FR 39113 (June 30, 2020); 85 FR 55219 (Sept. 4,
2020).
\7\ See 85 FR 39116; 85 FR 55221.
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Less than six months later, on November 13, 2020, the Department
published a final rule titled ``Financial Factors in Selecting Plan
Investments,'' which adopted amendments to the Investment Duties
regulation that generally require plan fiduciaries to select
investments and investment courses of action based solely on
consideration of ``pecuniary factors.'' \8\ Among these amendments was
a prohibition against adding or retaining any investment fund, product,
or model portfolio as a qualified default investment alternative (QDIA)
as described in 29 CFR 2550.404c-5 if the fund, product, or model
portfolio includes even one non-pecuniary objective in its investment
objectives or principal investment strategies. On December 16, 2020,
the Department published a final rule titled ``Fiduciary Duties
Regarding Proxy Voting and Shareholder Rights,'' which also adopted
amendments to the Investment Duties regulation to establish regulatory
standards for the obligations of plan fiduciaries under ERISA when
voting proxies and exercising other shareholder rights in connection
with plan investments in shares of stock.\9\
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\8\ 85 FR 72846 (Nov. 13, 2020).
\9\ 85 FR 81658 (Dec. 16, 2020).
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On January 20, 2021, the President signed Executive Order 13990
(E.O. 13990), titled ``Protecting Public Health and the Environment and
Restoring Science to Tackle the Climate Crisis.'' \10\ Section 1 of
E.O. 13990 acknowledges the Nation's ``abiding commitment to empower
our workers and communities; promote and protect our public health and
the environment.'' Section 1 also sets forth the policy of the
Administration to listen to the science; improve public health and
protect our environment; bolster resilience to the impacts of climate
change; and prioritize both environmental justice and the creation of
the well-paying union jobs necessary to deliver on these goals. Section
2 directed agencies to review all existing regulations promulgated,
issued, or adopted between January 20, 2017, and January 20, 2021, that
are or may be inconsistent with, or present obstacles to, the policies
set forth in section 1 of E.O. 13990. Section 2 further provided that
for any such actions identified by the agencies, the heads of agencies
shall, as appropriate and consistent with applicable law, consider
suspending, revising, or rescinding the agency actions.\11\
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\10\ 86 FR 7037 (Jan. 25, 2021). E.O. 13990 was signed eight
days after the effective date of ``Financial Factors in Selecting
Plan Investments,'' and five days after the effective date of
``Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.''
\11\ A Fact Sheet issued simultaneously with E.O. 13990,
specifically confirmed that the Department was directed to review
the final rule on ``Financial Factors in Selecting Plan
Investments'' Available at www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/fact-sheet-list-of-agency-actions-for-review/.
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On March 10, 2021, the Department announced that it had begun a
reexamination of the current regulation, consistent with E.O. 13990,
the Administrative Procedure Act, and ERISA's grant of regulatory
authority in section 505.\12\ The Department also announced that,
pending its review of the current regulation, the Department will not
enforce the current regulation or otherwise pursue enforcement actions
against any plan fiduciary based on a failure to comply with the
current regulation with respect to an investment, including a QDIA,
investment course of action or an exercise of shareholder rights. In
announcing the enforcement policy, the Department also stated its
intention to conduct significantly more stakeholder outreach to
determine how to craft rules that better recognize the role that ESG
integration can play in the evaluation and management of plan
investments in ways that further fundamental fiduciary obligations.\13\
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\12\ 29 U.S.C. 1135.
\13\ See U.S. Department of Labor Statement Regarding
Enforcement of its Final Rules on ESG Investments and Proxy Voting
by Employee Benefit Plans (Mar. 10, 2021) Available at www.dol.gov/sites/dolgov/files/ebsa/laws-and-regulations/laws/erisa/statement-on-enforcement-of-final-rules-on-esg-investments-and-proxy-voting.pdf. Following publication of the final rules the Department
heard from a wide variety of stakeholders, including asset managers,
labor organizations and other plan sponsors, consumer groups,
service providers and investment advisers that questioned whether
the 2020 Rules properly reflect the scope of fiduciaries' duties
under ERISA to act prudently and solely in the interest of plan
participants and beneficiaries. The stakeholders also questioned
whether the Department rushed the rulemakings unnecessarily and
failed to adequately consider and address the substantial evidence
submitted by public commenters on the use of environmental, social
and governance considerations in improving investment value and
long-term investment returns for retirement investors.
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On May 20, 2021, the President signed Executive Order 14030 (E.O.
14030), titled ``Executive Order on Climate-Related Financial Risk.''
\14\ The policies set forth in section 1 of E.O. 14030 include
advancing acts to mitigate climate-related financial risk and actions
to help safeguard the financial security of America's families,
businesses, and workers from climate-related financial risk that may
threaten the life savings and pensions of U.S. workers and families.
Section 4 of E.O. 14030 directed the Department to consider publishing,
by September 2021, for notice and comment a proposed rule to suspend,
revise, or rescind ``Financial Factors in Selecting Plan Investments,''
\15\ and ``Fiduciary Duties Regarding Proxy Voting and Shareholder
Rights.'' \16\
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\14\ 86 FR 27967 (May 25, 2021). E.O. 14030 was signed 128 days
after the effective date of ``Financial Factors in Selecting Plan
Investments,'' and 125 days after the effective date of ``Fiduciary
Duties Regarding Proxy Voting and Shareholder Rights.''
\15\ 85 FR 72846 (Nov. 13, 2020).
\16\ 85 FR 81658 (Dec. 16, 2020).
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B. The Department's Prior Non-Regulatory Guidance
The Department has a longstanding position that ERISA fiduciaries
may not sacrifice investment returns or assume greater investment risks
as a means of promoting collateral social policy goals. These
proscriptions flow directly from ERISA's stringent standards of
prudence and loyalty under section 404(a) of the statute.\17\ The
Department has a similarly longstanding position that the fiduciary act
of managing plan assets that involve shares of corporate stock includes
making decisions about voting proxies and exercising shareholder
rights. Over the years the Department repeatedly has issued non-
regulatory
[[Page 73824]]
guidance to assist plan fiduciaries in understanding their obligations
under ERISA to apply these principles to ETIs and ESG.
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\17\ 29 U.S.C. 1104(a).
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1. ETI/ESG Investing
Interpretive Bulletin 94-1 (IB 94-1), published in 1994, addressed
economically targeted investments (ETIs) selected, in part, for
collateral benefits apart from the investment return to the plan
investor.\18\ The Department's objective in issuing IB 94-1 was to
state that ETIs \19\ are not inherently incompatible with ERISA's
fiduciary obligations. The preamble to IB 94-1 explained that the
requirements of sections 403 and 404 of ERISA do not prevent plan
fiduciaries from investing plan assets in ETIs if the investment has an
expected rate of return at least commensurate to rates of return of
available alternative investments, and if the ETI is otherwise an
appropriate investment for the plan in terms of such factors as
diversification and the investment policy of the plan. Some
commentators have referred to this as the ``all things being equal''
test or the ``tiebreaker'' standard. The Department stated in the
preamble to IB 94-1 that when competing investments serve the plan's
economic interests equally well, plan fiduciaries can use such
collateral considerations as the deciding factor for an investment
decision. This was the Department's unchanged position for
approximately three decades.
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\18\ 59 FR 32606 (June 23, 1994) (appeared in Code of Federal
Regulations as 29 CFR 2509.94-1). Prior to issuing IB 94-1, the
Department had issued a number of letters concerning a fiduciary's
ability to consider the collateral effects of an investment and
granted a variety of prohibited transaction exemptions to both
individual plans and pooled investment vehicles involving
investments that produce collateral benefits. See Advisory Opinions
80-33A, 85-36A and 88-16A; Information Letters to Mr. George Cox,
dated Jan. 16, 1981; to Mr. Theodore Groom, dated Jan. 16, 1981; to
The Trustees of the Twin City Carpenters and Joiners Pension Plan,
dated May 19, 1981; to Mr. William Chadwick, dated July 21, 1982; to
Mr. Daniel O'Sullivan, dated Aug. 2, 1982; to Mr. Ralph Katz, dated
Mar. 15, 1982; to Mr. William Ecklund, dated Dec. 18, 1985, and Jan.
16, 1986; to Mr. Reed Larson, dated July 14, 1986; to Mr. James Ray,
dated July 8, 1988; to the Honorable Jack Kemp, dated Nov. 23, 1990;
and to Mr. Stuart Cohen, dated May 14, 1993. The Department also
issued a number of prohibited transaction exemptions that touched on
these issues. See PTE 76-1, part B, concerning construction loans by
multiemployer plans; PTE 84-25, issued to the Pacific Coast Roofers
Pension Plan; PTE 85-58, issued to the Northwestern Ohio Building
Trades and Employer Construction Industry Investment Plan; PTE 87-
20, issued to the Racine Construction Industry Pension Fund; PTE 87-
70, issued to the Dayton Area Building and Construction Industry
Investment Plan; PTE 88-96, issued to the Real Estate for American
Labor A Balcor Group Trust; PTE 89-37, issued to the Union Bank; and
PTE 93-16, issued to the Toledo Roofers Local No. 134 Pension Plan
and Trust, et al. In addition, one of the first directors of the
Department's benefits office authored an article on this topic in
1980. See Ian D. Lanoff, The Social Investment of Private Pension
Plan Assets: May It Be Done Lawfully Under ERISA?, 31 Labor L.J.
387, 391-92 (1980) (stating that ``[t]he Labor Department has
concluded that economic considerations are the only ones which can
be taken into account in determining which investments are
consistent with ERISA standards,'' and warning that fiduciaries who
exclude investment options for non-economic reasons would be
``acting at their peril'').
\19\ IB 94-1 used the terms ETI and economically targeted
investments to broadly refer to any investment or investment course
of action that is selected, in part, for its expected collateral
benefits, apart from the investment return to the employee benefit
plan investor.
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In 2008, the Department replaced IB 94-1 with Interpretive Bulletin
2008-01 (IB 2008-01),\20\ and then, in 2015, the Department replaced IB
2008-01 with Interpretive Bulletin 2015-01 (IB 2015-01).\21\ Although
the Interpretive Bulletins differed from each other in tone and content
to some extent, each endorsed the ``all things being equal'' test,
while also stressing that the paramount focus of plan fiduciaries must
be the plan's financial returns and providing promised benefits to
participants and beneficiaries. Each Interpretive Bulletin also
cautioned that fiduciaries violate ERISA if they accept reduced
expected returns or greater risks to secure social, environmental, or
other policy goals.
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\20\ 73 FR 61734 (Oct. 17, 2008).
\21\ 80 FR 65135 (Oct. 26, 2015).
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Additionally, the preamble to IB 2015-01 explained that if a
fiduciary prudently determines that an investment is appropriate based
solely on economic considerations, including those that may derive from
ESG factors, the fiduciary may make the investment without regard to
any collateral benefits the investment may also promote. In Field
Assistance Bulletin 2018-01 (FAB 2018-01), the Department indicated
that IB 2015-01 had recognized that there could be instances when ESG
issues present material business risk or opportunities to companies
that company officers and directors need to manage as part of the
company's business plan, and that qualified investment professionals
would treat the issues as material economic considerations under
generally accepted investment theories. As appropriate economic
considerations, such ESG issues should be considered by a prudent
fiduciary along with other relevant economic factors to evaluate the
risk and return profiles of alternative investments. In other words, in
these instances, the factors are not ``tiebreakers,'' but ``risk-
return'' factors affecting the economic merits of the investment.
FAB 2018-01 cautioned, however, that ``[t]o the extent ESG factors,
in fact, involve business risks or opportunities that are properly
treated as economic considerations themselves in evaluating alternative
investments, the weight given to those factors should also be
appropriate to the relative level of risk and return involved compared
to other relevant economic factors.'' \22\ The Department further
emphasized in FAB 2018-01 that fiduciaries ``must not too readily treat
ESG factors as economically relevant to the particular investment
choices at issue when making a decision,'' as ``[i]t does not
ineluctably follow from the fact that an investment promotes ESG
factors, or that it arguably promotes positive general market trends or
industry growth, that the investment is a prudent choice for retirement
or other investors.'' Rather, ERISA fiduciaries must always put first
the economic interests of the plan in providing retirement benefits,
and ``[a] fiduciary's evaluation of the economics of an investment
should be focused on financial factors that have a material effect on
the return and risk of an investment based on appropriate investment
horizons consistent with the plan's articulated funding and investment
objectives.'' \23\
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\22\ FAB 2018-01 (Apr. 23, 2018).
\23\ Id.
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FAB 2018-01 also explained that in the case of an investment
platform that allows participants and beneficiaries an opportunity to
choose from a broad range of investment alternatives, a prudently
selected, well managed, and properly diversified ESG-themed investment
alternative could be added to the available investment options on a
401(k) plan platform without requiring the plan to remove or forgo
adding other non-ESG-themed investment options to the platform.\24\
According to the FAB, however, the selection of an investment fund as a
QDIA is not analogous to a fiduciary's decision to offer participants
an additional investment alternative as part of a prudently constructed
lineup of investment alternatives from which participants may choose.
FAB 2018-01 expressed concern that the decision to favor the
fiduciary's own policy preferences in selecting an ESG-themed
investment option as a QDIA for a 401(k)-type plan without regard to
possibly different or competing views of plan participants and
beneficiaries would raise questions about the fiduciary's compliance
with ERISA's duty of loyalty.\25\ In addition, FAB
[[Page 73825]]
2018-01 stated that, even if consideration of such factors could be
shown to be appropriate in the selection of a QDIA for a particular
plan population, the plan's fiduciaries would have to ensure compliance
with the previous guidance in IB 2015-01. For example, the selection of
an ESG-themed target date fund as a QDIA would not be prudent if the
fund would provide a lower expected rate of return than available non-
ESG alternative target date funds with commensurate degrees of risk, or
if the fund would be riskier than non-ESG alternative available target
date funds with commensurate rates of return.
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\24\ Id.
\25\ FAB 2018-01.
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2. Exercising Shareholder Rights
The Department's past non-regulatory guidance has also consistently
recognized that the fiduciary act of managing employee benefit plan
assets includes the management of voting rights as well as other
shareholder rights connected to shares of stock, and that management of
those rights, as well as shareholder engagement activities, is subject
to ERISA's prudence and loyalty requirements.
The Department first issued non-regulatory guidance on proxy voting
and the exercise of shareholder rights in the 1980s. For example, in
1988, the Department issued an opinion letter to Avon Products, Inc.
(the Avon Letter), in which the Department took the position that the
fiduciary act of managing plan assets that are shares of corporate
stock includes the voting of proxies appurtenant to those shares, and
that the named fiduciary of a plan has a duty to monitor decisions made
and actions taken by investment managers with regard to proxy
voting.\26\ In 1994, the Department issued its first interpretive
bulletin on proxy voting, Interpretive Bulletin 94-2 (IB 94-2).\27\ IB
94-2 recognized that fiduciaries may engage in shareholder activities
intended to monitor or influence corporate management if the
responsible fiduciary concludes that, after taking into account the
costs involved, there is a reasonable expectation that such shareholder
activities (by the plan alone or together with other shareholders) will
enhance the value of the plan's investment in the corporation. The
Department also reiterated its view that ERISA does not permit
fiduciaries, in voting proxies or exercising other shareholder rights,
to subordinate the economic interests of participants and beneficiaries
to unrelated objectives.
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\26\ Letter to Helmuth Fandl, Chairman of the Retirement Board,
Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988).
\27\ 59 FR 38860 (July 29, 1994).
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In October 2008, the Department replaced IB 94-2 with Interpretive
Bulletin 2008-02 (IB 2008-02).\28\ The Department's intent was to
update the guidance in IB 94-2 and to reflect interpretive positions
issued by the Department after 1994 on shareholder engagement and
socially-directed proxy voting initiatives. IB 2008-02 stated that
fiduciaries' responsibility for managing proxies includes both deciding
to vote and deciding not to vote.\29\ IB 2008-02 further stated that
the fiduciary duties described at ERISA sections 404(a)(1)(A) and (B)
require that, in voting proxies, the responsible fiduciary shall
consider only those factors that relate to the economic value of the
plan's investment and shall not subordinate the interests of the
participants and beneficiaries in their retirement income to unrelated
objectives. In addition, IB 2008-02 stated that votes shall only be
cast in accordance with a plan's economic interests. IB 2008-02
explained that if the responsible fiduciary reasonably determines that
the cost of voting (including the cost of research, if necessary, to
determine how to vote) is likely to exceed the expected economic
benefits of voting, the fiduciary has an obligation to refrain from
voting.\30\ The Department also reiterated in IB 2008-02 that any use
of plan assets by a plan fiduciary to further political or social
causes ``that have no connection to enhancing the economic value of the
plan's investment'' through proxy voting or shareholder activism is a
violation of ERISA's exclusive purpose and prudence requirements.\31\
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\28\ 73 FR 61731 (Oct. 17, 2008).
\29\ 73 FR 61732.
\30\ Id.
\31\ 73 FR 61734.
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In 2016, the Department issued Interpretive Bulletin 2016-01 (IB
2016-01), which reinstated the language of IB 94-2 with certain
modifications.\32\ IB 2016-01 reiterated and confirmed that ``in voting
proxies, the responsible fiduciary [must] consider those factors that
may affect the value of the plan's investment and not subordinate the
interests of the participants and beneficiaries in their retirement
income to unrelated objectives.'' \33\ In its guidance, the Department
has also stated that it rejects a construction of ERISA that would
render the statute's tight limits on the use of plan assets illusory
and that would permit plan fiduciaries to expend trust assets to
promote a myriad of personal public policy preferences at the expense
of participants' economic interests, including through shareholder
engagement activities, voting proxies, or other investment
policies.\34\
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\32\ 81 FR 95879 (Dec. 29, 2016). In addition, the Department
issued a Field Assistance Bulletin to provide guidance on IB 2016-01
on April 23, 2018. See FAB 2018-01, at www.dol.gov/sites/dolgov/files/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2018-01.pdf.
\33\ 81 FR 95882.
\34\ See 81 FR 95881.
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C. Executive Order Review of Current Regulation
In early 2021, consistent with E.O. 13990 and E.O. 14030, the
Department engaged in informal outreach to hear views from interested
stakeholders on how to craft regulations that better recognize the
important role that climate change and other ESG factors can play in
the evaluation and management of plan investments, while continuing to
uphold fundamental fiduciary obligations. The Department heard from a
wide variety of stakeholders, including asset managers, labor
organizations and other plan sponsors, consumer groups, service
providers, and investment advisers. Many of the stakeholders expressed
skepticism as to whether the current regulation properly reflects the
scope of fiduciaries' duties under ERISA to act prudently and solely in
the interest of plan participants and beneficiaries.
That outreach effort by the Department suggested that, rather than
provide clarity, some aspects of the current regulation instead may
have created further uncertainty about whether a fiduciary under ERISA
may consider ESG and other factors in making investment and proxy
voting decisions that the fiduciary reasonably believes will benefit
the plan and its participants and beneficiaries. Many stakeholders
questioned whether the Department rushed the current regulation
unnecessarily and failed to adequately consider and address substantial
evidence submitted by public commenters suggesting that the use of
climate change and other ESG factors can improve investment value and
long-term investment returns for retirement investors. The Department
also heard from stakeholders that the current regulation, and investor
confusion about it, including whether climate change and other ESG
factors may be treated as ``pecuniary'' factors under the regulation,
already had begun to have a chilling effect on appropriate integration
of climate change and other ESG factors in investment decisions. This
continued through the current non-enforcement period, including in
circumstances where the current
[[Page 73826]]
regulation may in fact allow consideration of ESG factors.
After conducting a review of the current regulation, the Department
concluded there is a reasonable basis for the concerns raised by the
stakeholders. A number of public comment letters had criticized the
2020 proposed regulatory text for appearing to single out ESG investing
for heightened scrutiny, which they asserted was inappropriate in light
of research and investment practices suggesting that climate change and
other ESG factors are material economic considerations.\35\ In
response, the Department did not include explicit references to ESG in
the current regulation and furthermore acknowledged in the preamble
discussion to the Financial Factors in Selecting Plan Investments final
rulemaking that there are instances where one or more ESG factors may
be properly taken into account by a fiduciary.\36\ The preamble to the
Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final
rulemaking also acknowledged academic studies and investment experience
surrounding the materiality of ESG considerations in investment
decisionmaking.\37\ However, other statements in the preamble appeared
to express skepticism about fiduciaries' reliance on ESG
considerations. For instance, the preamble to the Financial Factors in
Selecting Plan Investments final rulemaking asserted that ESG investing
raises heightened concerns under ERISA, and cautioned fiduciaries
against ``too hastily'' concluding that ESG-themed funds may be
selected based on pecuniary factors.\38\ Similarly, the preamble to the
Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final
rulemaking expressed the view that it is likely that many environmental
and social shareholder proposals have little bearing on share value or
other relation to plan financial interests.\39\ Many stakeholders
indicated that the current regulation has been interpreted as putting a
thumb on the scale against the consideration of ESG factors, even when
those factors are financially material.
---------------------------------------------------------------------------
\35\ See, e.g., Comment # 567 at www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00567.pdf and Comment # 709 at www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00709.pdf.
\36\ See 85 FR 72859 (Nov. 13, 2020) (``[T]he Department
believes that it would be consistent with ERISA and the final rule
for a fiduciary to treat a given factor or consideration as
pecuniary if it presents economic risks or opportunities that
qualified investment professionals would treat as material economic
considerations under generally accepted investment theories'').
\37\ 85 FR 81662 (Dec. 16, 2020) (``This [Fiduciary Duties
Regarding Proxy Voting and Shareholder Rights] rulemaking project,
similar to the recently published final rule on ERISA fiduciaries'
consideration of financial factors in investment decisions,
recognizes, rather than ignores, the economic literature and
fiduciary investment experience that show a particular `E,' `S,' or
`G' consideration may present issues of material business risk or
opportunities to a specific company that its officers and directors
need to manage as part of the company's business plan and that
qualified investment professionals would treat as economic
considerations under generally accepted investment theories.'').
\38\ 85 FR 72848, 72859 (Nov. 13, 2020).
\39\ 85 FR 81681 (Dec. 16, 2020).
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The Department's review under the Executive orders caused it
concern that, as stakeholders warned, uncertainty with respect to the
current regulation may be deterring fiduciaries from taking steps that
other marketplace investors would take in enhancing investment value
and performance, or improving investment portfolio resilience against
the potential financial risks and impacts associated with climate
change and other ESG factors. The Department was concerned that the
current regulation created a perception that fiduciaries are at risk if
they include any ESG factors in the financial evaluation of plan
investments, and that they would need to have special justifications
for even ordinary exercises of shareholder rights.
Based on these concerns, the Department, on October 14, 2021,
published a notice of proposed rulemaking (NPRM) proposing amendments
to the current regulation.\40\ The intent of the NPRM was to address
uncertainties regarding aspects of the current regulation and its
preamble discussion relating to the consideration of ESG issues,
including climate-related financial risk, by fiduciaries in making
investment and voting decisions, and to provide further clarity that
will help safeguard the interests of participants and beneficiaries in
the plan benefits.
---------------------------------------------------------------------------
\40\ 86 FR 57272 (Oct. 14, 2021).
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II. Purpose of Regulatory Action and Proposed Rule
A. Purpose
Like the NPRM, the purpose of the final rule is to clarify the
application of ERISA's fiduciary duties of prudence and loyalty to
selecting investments and investment courses of action, including
selecting QDIAs, exercising shareholder rights, such as proxy voting,
and the use of written proxy voting policies and guidelines. The need
for clarification comes from the chilling effect and other potential
negative consequences caused by the current regulation with respect to
the consideration of climate change and other ESG factors in connection
with these activities. Overall, the public comments support the
clarifications provided by this final rule, although some commenters
challenged the stated need. The Department disagrees with commenters
who asserted that any clarifications to the current regulation are
unnecessary. The Department's conclusion, supported by many public
commenters, is that the current regulation creates uncertainty and is
having the undesirable effect of discouraging ERISA fiduciaries'
consideration of climate change and other ESG factors in investment
decisions, even in cases where it is in the financial interest of plans
to take such considerations into account. This uncertainty may further
deter fiduciaries from taking steps that other marketplace investors
take in enhancing investment value and performance or improving
investment portfolio resilience against the potential financial risks
and impacts associated with climate change and other ESG factors. Major
comments are addressed in detail below in conjunction with specific
provisions of the final rule.
B. Major Provisions of Proposed Rule
Consistent with the purpose of the overall rulemaking initiative,
the NPRM proposed several key changes and clarifications to the current
regulation, as follows:
The NPRM proposed to delete the ``pecuniary/non-
pecuniary'' terminology from the current regulation based on concerns
that the terminology causes confusion and has a chilling effect on
financially beneficial choices.
The NPRM proposed the addition of regulatory text that
would have made it clear that, when considering projected returns, a
fiduciary's duty of prudence may often require an evaluation of the
economic effects of climate change and other ESG factors on the
particular investment or investment course of action.
The NPRM proposed to add to the operative text of the rule
three sets of examples of climate change and other ESG factors that,
depending on the facts and circumstances, may be material to the risk-
return analysis.
The NPRM proposed to remove the special rules for QDIAs
that apply under the current regulation. The NPRM would instead apply
the same standards to QDIAs as apply to other investments.
The NPRM proposed to modify the current rule's
``tiebreaker'' test, which permits fiduciaries to consider collateral
benefits as tiebreakers in some circumstances. The current regulation
imposes a requirement that the competing investments underlying a
[[Page 73827]]
tiebreaker situation be indistinguishable based on pecuniary factors
alone before fiduciaries can turn to collateral factors to break a tie
and imposes a special documentation requirement on the use of such
factors. The NPRM proposed replacing those provisions with a standard
that would have instead required the fiduciary to conclude prudently
that competing investments, or competing investment courses of action,
equally serve the financial interests of the plan over the appropriate
time horizon. In such cases, the fiduciary is not prohibited from
selecting the investment, or investment course of action, based on
collateral benefits other than investment returns. The NPRM also
proposed to remove the current regulation's special documentation
requirements in favor of ERISA's generally applicable statutory duty to
prudently document plan affairs.
To the extent individual account plans use the tiebreaker
test in the selection of a designated investment alternative, the NPRM
proposed that plans must prominently disclose to the plans'
participants the collateral considerations that were used as
tiebreakers.
The NPRM proposed to eliminate the statement in paragraph
(e)(2)(ii) of the current regulation that ``the fiduciary duty to
manage shareholder rights appurtenant to shares of stock does not
require the voting of every proxy or the exercise of every shareholder
right,'' which the Department was concerned could be misread as
suggesting that plan fiduciaries should be indifferent to the exercise
of their rights as shareholders, even if the cost is minimal.
The NPRM proposed to eliminate paragraph (e)(2)(iii) of
the current regulation, which sets out specific monitoring obligations
with respect to use of investment managers or proxy voting firms, and
to address such monitoring obligations in another provision of the
regulation that more generally covers selection and monitoring
obligations. The Department was concerned that the specific monitoring
provision could be read as requiring some special obligations above and
beyond the statutory obligations of prudence and loyalty that generally
apply to monitoring the work of service providers.
The NPRM proposed to remove the two ``safe harbor''
examples for proxy voting policies permissible under paragraphs
(e)(3)(i)(A) and (B) of the current regulation. One of these safe
harbors permitted a policy to limit voting resources to particular
proposals that the fiduciary had prudently determined were
substantially related to the issuer's business activities or were
expected to have a material effect on the value of the investment. The
other safe harbor permitted a policy of refraining from voting on
proposals when the plan's holding in a single issuer relative to the
plan's total investment assets was below a quantitative threshold. The
Department was concerned that the safe harbors did not adequately
safeguard the interests of plans and their participants and
beneficiaries.
The NPRM proposed to eliminate from the current regulation
a specific requirement on maintaining records on proxy voting
activities and other exercises of shareholder rights, which appeared to
treat proxy voting and other exercises of shareholder rights
differently from other fiduciary activities and risked creating a
misperception that proxy voting and other exercises of shareholder
rights are disfavored or carry greater fiduciary obligations than other
fiduciary activities.
The Department invited interested persons to submit comments on the
NPRM. In response to this invitation, the Department received more than
895 written comments and 21,469 petitions (e.g., form letters)
submitted during the open comment period. These comments and petitions
(hereinafter collectively referred to as ``comments'' unless otherwise
specified) came from a variety of parties, including plan sponsors and
other plan fiduciaries, individual plan participants and beneficiaries,
financial services companies, academics, elected government officials,
trade and industry associations, and others, both in support of and in
opposition to the NPRM. These comments are available for public review
on the Department's Employee Benefits Security Administration website.
III. The Final Rule
A. Executive Summary of Major Changes and Clarifications
The final rule generally tracks the NPRM but makes certain
clarifications and changes in response to public comments. Before
describing these changes, the Department emphasizes that the final rule
does not change two longstanding principles. First, the final rule
retains the core principle that the duties of prudence and loyalty
require ERISA plan fiduciaries to focus on relevant risk-return factors
and not subordinate the interests of participants and beneficiaries
(such as by sacrificing investment returns or taking on additional
investment risk) to objectives unrelated to the provision of benefits
under the plan. Second, the fiduciary duty to manage plan assets that
are shares of stock includes the management of shareholder rights
appurtenant to those shares, such as the right to vote proxies. As
described in further detail below in subsection B of this section III,
the final rule adopts the following changes to the current regulation:
Like the NPRM, the final rule amends the current
regulation to delete the ``pecuniary/non-pecuniary'' terminology based
on concerns that the terminology causes confusion and a chilling effect
to financially beneficial choices.
Like the NPRM, the final rule amends the current
regulation to make it clear that a fiduciary's determination with
respect to an investment or investment course of action must be based
on factors that the fiduciary reasonably determines are relevant to a
risk and return analysis and that such factors may include the economic
effects of climate change and other environmental, social, or
governance factors on the particular investment or investment course of
action.
Like the NPRM, the final rule amends the current
regulation to remove the stricter rules for QDIAs, such that, under the
final rule, the same standards apply to QDIAs as to investments
generally.
Like the NPRM, the final rule amends the current
regulation's ``tiebreaker'' test, which permits fiduciaries to consider
collateral benefits as tiebreakers in some circumstances. The current
regulation imposes a requirement that competing investments be
indistinguishable based on pecuniary factors alone before fiduciaries
can turn to collateral factors to break a tie and imposes a special
documentation requirement on the use of such factors. The final rule
replaces those provisions with a standard that instead requires the
fiduciary to conclude prudently that competing investments, or
competing investment courses of action, equally serve the financial
interests of the plan over the appropriate time horizon. In such cases,
the fiduciary is not prohibited from selecting the investment, or
investment course of action, based on collateral benefits other than
investment returns. The final rule also removes the current
regulation's special regulatory documentation requirements in favor of
ERISA's generally applicable statutory duty to prudently document plan
affairs.
The final rule adds a new provision clarifying that
fiduciaries do not violate
[[Page 73828]]
their duty of loyalty solely because they take participants'
preferences into account when constructing a menu of prudent investment
options for participant-directed individual account plans. If
accommodating participants' preferences will lead to greater
participation and higher deferral rates, as suggested by commenters,
then it could lead to greater retirement security. Thus, in this way,
giving consideration to whether an investment option aligns with
participants' preferences can be relevant to furthering the purposes of
the plan.
Like the NPRM, the final rule amends the current
regulation to eliminate the statement in paragraph (e)(2)(ii) of the
current regulation that ``the fiduciary duty to manage shareholder
rights appurtenant to shares of stock does not require the voting of
every proxy or the exercise of every shareholder right.'' The final
rule eliminates this provision because it may be misread as suggesting
that plan fiduciaries should be indifferent to the exercise of their
rights as shareholders, even if the cost is minimal.
Like the NPRM, the final rule amends the current
regulation to remove the two ``safe harbor'' examples for proxy voting
policies permissible under paragraphs (e)(3)(i)(A) and (B) of the
current regulation. One of these safe harbors permitted a policy to
limit voting resources to types of proposals that the fiduciary has
prudently determined are substantially related to the issuer's business
activities or are expected to have a material effect on the value of
the investment. The other safe harbor permitted a policy of refraining
from voting on proposals or types of proposals when the plan's holding
in a single issuer relative to the plan's total investment assets is
below a quantitative threshold. Taken together, the Department believes
the safe harbors encouraged abstention as the normal course and the
Department does not support that position because it fails to recognize
the importance that prudent management of shareholder rights can have
in enhancing the value of plan assets or protecting plan assets from
risk. Because of this failure, the Department believes these safe
harbors do not adequately safeguard the interests of plans and their
participants and beneficiaries.
Like the NPRM, the final rule eliminates paragraph
(e)(2)(iii) of the current regulation, which sets out specific
monitoring obligations with respect to use of investment managers or
proxy voting firms. The final rule instead addresses such monitoring
obligations in another provision of the regulation that more generally
covers selection and monitoring obligations. These amendments address
concerns that the specific monitoring provision could be read as
requiring special obligations above and beyond the statutory
obligations of prudence and loyalty that generally apply to monitoring
the work of service providers.
Like the NPRM, the final rule amends the current
regulation to eliminate from paragraph (e)(2)(ii)(E) of the current
regulation a specific requirement on maintaining records on proxy
voting activities and other exercises of shareholder rights. The
provision is removed from the current regulation because it is widely
perceived as treating proxy voting and other exercises of shareholder
rights differently from other fiduciary activities and, in that
respect, risks creating a misperception that proxy voting and other
exercises of shareholder rights are disfavored or carry greater
fiduciary obligations than other fiduciary activities.
B. Detailed Discussion of Public Comments and Final Regulation
1. Section 2550.404a-1(a) and (b)--General and Investment Prudence
Duties
(a) Paragraph (a)
Paragraph (a) of the final rule is unchanged from the NPRM and
derives from the exclusive purpose requirements of ERISA section
404(a)(1)(A), and the prudence duty of ERISA section 404(a)(1)(B). The
provision is also the same as paragraph (a) of the current regulation.
The Department did not accept comments to expand the scope of the
regulation to provide additional guidance on the duty of
diversification under section 404(a)(1)(C) and the duty of impartiality
under section 404(a)(1)(A) as interpreted in cases such as Varity v.
Howe,\41\ as these other duties generally are beyond the scope of this
rulemaking initiative.
---------------------------------------------------------------------------
\41\ 516 U.S. 489 (1996).
---------------------------------------------------------------------------
(b) Paragraph (b)
Paragraph (b) of the final rule addresses the investment prudence
duties of a fiduciary under ERISA. Like the NPRM, paragraph (b) of the
final rule contains four subordinate paragraphs. As discussed below,
the final rule includes several changes from the proposal based on
public comment, mostly in paragraphs (b)(2) and (4) of the final rule.
(c) Paragraph (b)(1)
The NPRM did not propose any amendments to paragraph (b)(1) of the
current regulation. Like the current regulation (and the 1979
Investment Duties regulation before it), paragraph (b)(1) of the NPRM
provided that the requirements of section 404(a)(1)(B) of the Act set
forth in paragraph (a) are satisfied with respect to a particular
investment or investment course of action if the fiduciary meets two
conditions. First, the fiduciary must give ``appropriate consideration
to those facts and circumstances that, given the scope of such
fiduciary's investment duties, the fiduciary knows or should know are
relevant to the particular investment . . . including the role the
investment or investment course of action plays in that portion of the
plan's investment portfolio with respect to which the fiduciary has
investment duties.'' And second, the fiduciary must have ``acted
accordingly.'' Except for the addition of the words ``or menu'' after
the word ``portfolio'' for clarification, as explained below, paragraph
(b)(1) of the final rule is unchanged from the NPRM.
(d) Paragraph (b)(2)
Paragraph (b)(2) of the NPRM addressed the ``appropriate
consideration'' language referenced in paragraph (b)(1) of the
proposal. Paragraph (b)(2) of the NPRM contained two prongs.
First, paragraph (b)(2)(i) of the NPRM provided that for purposes
of paragraph (b)(1), ``appropriate consideration'' shall include, but
is not necessarily limited to, a determination by the fiduciary that
the particular investment or investment course of action is reasonably
designed, as part of the portfolio (or, where applicable, that portion
of the plan portfolio with respect to which the fiduciary has
investment duties), to further the purposes of the plan. For this
purpose, the plan fiduciary must take into consideration the risk of
loss and the opportunity for gain (or other return) associated with the
investment or investment course of action compared to the opportunity
for gain (or other return) associated with reasonably available
alternatives with similar risks.
Second, paragraph (b)(2)(ii) of the NPRM provided that for purposes
of paragraph (b)(1), ``appropriate consideration'' shall also include,
but is not necessarily limited to, consideration of the composition of
the portfolio with regard to diversification (paragraph (b)(2)(ii)(A)),
the liquidity and current return of the portfolio relative to the
anticipated cash flow requirements of the plan (paragraph
(b)(2)(ii)(B)), and
[[Page 73829]]
the projected return of the portfolio relative to the funding
objectives of the plan, which may often require the evaluation of the
economic effects of climate change and other environmental, social, or
governance factors on the particular investment or investment course of
action (paragraph (b)(2)(ii)(C)).
(1) Reasonably Available Alternatives
Several commenters provided views on the condition in paragraph
(b)(2)(i) that a fiduciary must compare an investment or investment
course of action under evaluation with reasonably available
alternatives. This condition was not part of the original investment
duties regulation adopted in 1979 and was added to the current
regulation in 2020. The Department carried forward this condition in
the 2021 NPRM and solicited comments on whether it was necessary to
restate this principle of general applicability as part of this
regulation.
Some commenters agreed that prudent fiduciaries should and
generally do compare similar, available investments when making
investment decisions. Some commenters said that because the provision
is a simple restatement of a fundamental prudence tenet, its inclusion
in the final rule is unnecessary. Some commenters were concerned that
the term ``reasonably available'' is ambiguous and could make
fiduciaries vulnerable to litigation challenging the reasonableness of
a fiduciary's determination of the number of investments used in making
the required comparison. Commenters were also concerned that the
requirement imposes burdens on fiduciaries that do not necessarily have
the resources to conduct research on all reasonably available
alternatives. Some commenters noted that the Department did not adopt a
comparative requirement in the 1979 rule and furthermore expressed
concerns that the rule could be interpreted to require all fiduciaries,
regardless of factors such as plan assets, to purchase and implement
extensive and expensive systems to conduct the comparative analysis.
One commenter suggested adding operative text that would explicitly
allow for market-based comparisons using benchmarks or other market
data as alternatives to the ``reasonably available investment
alternatives'' language. One commenter cautioned that removing the
provision would imply that the Department no longer believes that the
marketplace is a true forum and benchmark of the investment selection
process.
The Department continues to believe the requirement to compare
reasonably available alternatives is commonly understood by plan
fiduciaries, is uncontroversial in nature, and reflects the ordinary
practice of fiduciaries in selecting investments. The Department is
unpersuaded by some commenters' concerns regarding perceived ambiguity
in the meaning of ``reasonably available.'' The scope of a fiduciary's
obligation to compare an investment or investment course of action is
limited to those facts and circumstances that a prudent person having
similar duties and familiar with such matters would consider reasonably
available. Further, the term allows for the possibility that the
characteristics and purposes served by a given investment or investment
course of action may be sufficiently rare that a fiduciary could
prudently determine that there are no other reasonably available
alternatives for comparative purposes. Accordingly, the final rule
continues to require in paragraph (b)(2)(i) that ``appropriate
consideration'' shall include taking into consideration the risk of
loss and the opportunity for gain (or other return) associated with the
investment or investment course of action compared to the opportunity
for gain (or other return) associated with reasonably available
alternatives with similar risks. The language reflects the Department's
longstanding view, articulated in Interpretive Bulletin 94-1 (and
reiterated in subsequent Interpretive Bulletins) and earlier
interpretive letters, that facts and circumstances relevant to an
investment or investment course of action would include consideration
of the expected return on alternative investments with similar risks
available to the plan.\42\
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\42\ 59 FR 32606 at 32607 (June 23, 1994); I.B. 2008-1, 73 FR
61734 (Oct. 17, 2008); I.B. 2015-1, 80 FR 65135 (Oct. 26, 2015);
see, e.g., Information Letter to Mr. Michael A. Feinberg, dated
August 4, 1985; Information Letter to Mr. James Ray, dated July 8,
1988 (``It is the position of the Department that, to act prudently,
a fiduciary must consider, among other factors, the availability,
riskiness, and potential return of alternative investments.'').
---------------------------------------------------------------------------
(2) Portfolio Versus Menu
The final rule adopts minor amendments to the text in paragraph
(b)(2) of the current regulation in response to commenters' requests to
clarify whether and how it applies in the context of participant-
directed individual account plans. Commenters observed that language in
paragraph (b)(2), which was originally developed in 1979, contains
certain considerations and factors that, in their view, are germane to
the selection of investments for defined benefit plans but not to the
selection of investments for defined contribution plans that have a set
of designated investment alternatives available for participant to
choose from, often referred to as a ``menu.'' For instance, they noted
that paragraphs (b)(2)(i) and (ii) require focusing on a ``portfolio,''
which they believe is confusing because a participant-directed defined
contribution plan's menu may include both funds that participants have
chosen as investments as well as funds that have not been chosen. The
commenters further noted that, in conventional investment parlance, the
term ``portfolio'' refers to a collection of assets actually owned by
an investor, whereas a menu of investment options for a participant-
directed individual account plan consists of a range of designated
investment alternatives that are available to participants. In
addition, they questioned how to determine ``anticipated cash flow
requirements of the plan'' in evaluating investment options for the
menu of a participant-directed defined contribution plan. A commenter
stated that, in its view, many of the appropriate consideration factors
in paragraph (b)(2)(ii) of the NPRM seem largely irrelevant to
participant-directed plans. These commenters suggested that
clarification on the application of paragraph (b)(2)(ii) to the
selection of investment options would be helpful for plan sponsors.
The Department appreciates the difficulties raised by commenters.
Paragraph (b)(2)(ii) sets out a non-exclusive list of factors that
functions as a minimum set of considerations for a fiduciary seeking to
rely upon paragraph (b)(1). Failure to meet those minimum
considerations would leave a fiduciary at risk of failing the standard
even if, in the context of choosing investment options for a
participant-directed plan, the responsible fiduciary has considered the
relevant facts and circumstances surrounding its decision, including
making a sound determination as described in paragraph (b)(2)(i).
Accordingly, the Department is making changes to paragraph (b)(2) of
the final rule. The changes clarify that the determination factors in
paragraph (b)(2)(i) apply to menu construction and the factors in
paragraph (b)(2)(ii) do not. Specifically, the Department is adding to
paragraph (b)(2)(i) of the final rule references to an investment
``menu,'' and is adding an introductory clause to paragraph (b)(2)(ii)
of the final rule limiting its application to employee benefit plans
other than participant-directed individual account plans.
These changes do not affect the requirements of paragraph (b)(1)(i)
of
[[Page 73830]]
the final rule, that a fiduciary must give appropriate consideration to
those facts and circumstances a fiduciary knows or should know are
relevant to the investment. These changes also should not be
interpreted as suggesting that a fiduciary of an individual account
plan is subject to a lower standard in giving appropriate consideration
to the facts and circumstances surrounding a particular decision
relating to an investment or investment course of action.
Notwithstanding the changes to paragraph (b)(2)(ii), the Department
believes that in selecting investment options for a plan menu, a
fiduciary's considerations of surrounding facts and circumstances
should be soundly reasoned and supported and reflect the requirements
of section 404(a)(1)(B) of ERISA. The Department agrees with one
commenter that, in the context of constructing a menu of investment
options, the relevant analysis involves two questions: First, how does
a given fund fit within the menu of funds to enable plan participants
to construct an overall portfolio suitable to their circumstances?
Second, how does a given fund compare to a reasonable number of
alternative funds to fill the given fund's role in the overall menu?
Except for the questions described above with respect to
application in the context of plan investment menus, the Department did
not receive substantive comments on paragraphs (b)(2)(ii)(A) and (B) of
the proposal. Those provisions are otherwise unchanged in the final
rule.
(3) ``May Often Require''
The Department received several comments on the language in
paragraph (b)(2)(ii)(C) of the proposal which specified that
consideration of the projected return of the portfolio relative to the
funding objectives of the plan ``may often require an evaluation of the
economic effects of climate change and other environmental, social or
governance factors on the particular investment or investment course of
action.'' This new language--the ``may often require'' clause--was
proposed by the Department to counteract any negative perception
against the consideration of climate change and other ESG factors in
investment decisions caused by the current regulation. The intent
behind this new clause was to clarify that plan fiduciaries may, and
often should depending on the investment under consideration, consider
the economic effects of climate change and other ESG factors on the
investment at issue. In no way did the Department consider this
proposed clause to be an expression of a novel concept. Indeed, the
sentiment had been expressed in earlier non-regulatory guidance,
although using different terminology.\43\
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\43\ See Field Assistance Bulletin 2018-01 and Interpretive
Bulletin 2015-01.
---------------------------------------------------------------------------
The Department received comments supporting and opposing this new
clause. On the one hand, some commenters indicated that it helped
address the chilling effect on evaluating ESG issues and served as a
useful reminder to fiduciaries that ESG factors often do have an impact
on investments. In the main, these commenters support the regulatory
text as an express acknowledgement that climate change and other ESG
factors are relevant to risk and return, and as an indication that
fiduciaries should not be exposed to additional perceived or actual
fiduciary liability risk under ERISA if they include such factors in
their evaluation of plan investments.
On the other hand, a great many commenters, including some who
concurred with the need to address the chilling effect under the
current regulation, expressed a variety of concerns with this
provision. Some commenters were concerned that by differentiating ESG
considerations from other factors in express regulatory text, the
regulation goes beyond removing the chilling effect and improperly
places a thumb on the scale in favor of ESG investing. Some further
cautioned that fiduciaries may treat the provisions as an effective
mandate that they must consider ESG factors under all circumstances.
The commenters argued that, absent guidance on when such an evaluation
would not be required, plan fiduciaries would feel obligated to
consider climate change and other ESG factors for every investment.
Several commenters criticized the Department for, in their view,
essentially favoring ESG investment strategies and overriding a
fiduciary's considered judgment with respect to which investment
factors or strategies to consider. Multiple commenters indicated that
studies and research on investment performance involving ESG strategies
show mixed results, and that a regulatory bias in favor of ESG
investing is not justified. In line with this comment, some commenters
questioned whether the Department presented sufficient evidence to
support a position on the frequency (``may often require'') with which
fiduciaries may be required to consider ESG factors, or argued that the
market has already priced ESG factors into the price of any given
investment.
Some commenters who criticized the new language in paragraph
(b)(2)(ii)(C) stated that if the regulation takes the position that
evaluating the economic effects of climate change and other ESG factors
``may often'' be required, then ambiguity surrounding the definition of
the term ESG factors must be reduced to provide regulatory certainty.
Commenters noted, however, that it would be difficult to precisely
define ESG factors. Commenters also expressed concern that the language
may be interpreted as effectively directing fiduciaries to take on the
costs and complexity of evaluating the effects of climate change and
other ESG factors, even if not otherwise prudent. In this regard, a
commenter argued that there are common situations when a prudent
analysis of the projected return relative to the portfolio's funding
objective is unlikely to require an evaluation of the economic effects
of ESG factors, such as when the objective of the applicable portion of
the portfolio is to track the performance of an index. Several
commenters offered alternative language to reduce the likelihood of
misinterpreting the provision. Other commenters opined that the ``may
often require'' language is largely unnecessary to address the chilling
effect on consideration of ESG factors under the current regulation
because of the broad language in paragraph (b)(4) of the proposal
relating to the consideration of ``any material factor.''
Based on the comments received, the Department has decided to
modify paragraph (b)(2)(ii)(C) of the proposal by deleting the ``which
may often require'' language altogether and consolidating the reference
to ``climate change and other environmental, social, or governance ESG
factors'' with language in paragraph (b)(4), as further modified below.
The proposed language in paragraph (b)(2)(ii)(C) of the NPRM was not
intended to create an effective or de facto regulatory mandate. Nor was
the language intended to create an overarching regulatory bias in favor
of ESG strategies. The Department is not persuaded that alternative
language suggested by commenters to replace the ``may often require''
would be as effective in removing regulatory bias as the course chosen
in the final rule. The modified version of the proposed language is
intended to make it clear that climate change and other ESG factors may
be relevant in a risk-return analysis of an investment and do not need
to be treated differently than other relevant investment factors,
without causing a perception that the
[[Page 73831]]
Department favors such factors in any or all cases.
As modified (and relocated to paragraph (b)(4) of the final
regulation), the new text sets forth three clear principles. First, a
fiduciary's determination with respect to an investment or investment
course of action must be based on factors that the fiduciary reasonably
determines are relevant to a risk and return analysis, using
appropriate investment horizons consistent with the plan's investment
objectives and taking into account the funding policy of the plan
established pursuant to section 402(b)(1) of ERISA. Second, risk and
return factors may include the economic effects of climate change and
other environmental, social, or governance factors on the particular
investment or investment course of action. Whether any particular
consideration is a risk-return factor depends on the individual facts
and circumstances. Third, the weight given to any factor by a fiduciary
should appropriately reflect an assessment of its impact on risk and
return.
In the Department's view, this principles-based approach is
sufficient to address the chilling effect under the current regulation
without establishing an effective mandate or explicitly favoring
climate change and other ESG factors. This principles-based approach is
designed to eliminate the substantial chilling effect caused by the
current regulation, including its reference to ``pecuniary factors.''
As previously discussed, numerous commenters indicated that the current
regulation puts a thumb on the scale against ESG factors, and chills
fiduciaries from considering any ESG factors even when they are
relevant to a risk-return analysis. The undesired effect of the current
regulation is to chill and discourage fiduciaries from considering
relevant investment factors that prudent investors otherwise would
consider. At the same time, the final rule makes unambiguous that it is
not establishing a mandate that ESG factors are relevant under every
circumstance, nor is it creating an incentive for a fiduciary to put a
thumb on the scale in favor of ESG factors. By declining to carry
forward the ``may often require'' clause in paragraph (b)(2)(ii)(C) of
the proposal, the final rule achieves appropriate regulatory neutrality
and ensures that plan fiduciaries do not misinterpret the final rule as
a mandate to consider the economic effects of climate change and other
ESG factors under all circumstances. Instead, the final rule makes
clear that a fiduciary may exercise discretion in determining, in light
of the surrounding facts and circumstances, the relevance of any factor
to a risk-return analysis of an investment. A fiduciary therefore
remains free under the final rule to determine that an ESG-focused
investment is not in fact prudent. Finally, nothing about the
principles-based approach should be construed as overturning long
established ERISA doctrine or displacing relevant common law prudent
investor standards.
(e) Paragraph (b)(3)
Paragraph (b)(3) of the final rule is unchanged from the proposal
and states that an investment manager appointed pursuant to the
provisions of section 402(c)(3) of the Act to manage all or part of the
assets of a plan may, for purposes of compliance with the provisions of
paragraphs (b)(1) and (2) of the proposal, rely on, and act upon the
basis of, information pertaining to the plan provided by or at the
direction of the appointing fiduciary, if such information is provided
for the stated purpose of assisting the manager in the performance of
the manager's investment duties, and the manager does not know and has
no reason to know that the information is incorrect. The Department did
not receive substantive comment on the provision, which carries
forward, without change, regulatory language dating back to the 1979
Investment duties regulation.
(f) Paragraph (b)(4)
(1) Introductory Text
The introductory text of paragraph (b)(4) of the proposal provided
that ``a prudent fiduciary may consider any factor in the evaluation of
an investment or investment course of action that, depending on the
facts and circumstances, is material to the risk return analysis[.]''
This introductory text was then followed by three paragraphs of
specific ESG examples. Commenters were generally supportive of this
provision minus the three paragraphs describing specific ESG examples.
In context, many viewed paragraph (b)(4) of the NPRM as confirming the
discretionary authority of fiduciaries to consider whatever factor or
factors, in the reasoned judgment of the fiduciaries, are relevant to
risk and return of the investment or investment course of action,
including climate change and other ESG factors. Some commenters
expressed the view that this introductory text (without the three
paragraphs of examples), in conjunction with the removal of the so-
called ``pecuniary-only'' terminology from the current regulation,
would make significant headway in counteracting the negative perception
of the consideration of climate change and other ESG factors caused by
the current regulation. Paragraph (b)(4) of the final rule, therefore,
retains the introductory text's focus on factors that are relevant to a
risk and return analysis. Paragraph (b)(4) also retains its central
recognition that relevant risk and return factors may, depending on the
facts and circumstances, include the economic effects of climate change
and other ESG factors. But, paragraph (b)(4) of the final rule
otherwise contains substantial modifications discussed below.
(2) Three Paragraphs of ESG Examples
Comments on the list of examples in paragraph (b)(4) of the NPRM
focused on both content and placement and were varied. Some commenters
supported both the content (only ESG examples) and placement of the
examples. In general, these commenters are of the view that the list of
examples, even though limited to only ESG factors, is an appropriate
corrective for what they view as the severe anti-ESG bias of the
current regulation. In their view, adding the three paragraphs of ESG
examples directly to the regulatory text will help to reassure
fiduciaries that they will not be subject to litigation solely because
of the use of such factors.
Many commenters, however, had concerns with the list of examples in
paragraph (b)(4) of the NPRM and recommended their removal from the
operative regulatory text. One frequently cited concern was that the
list of examples in the proposal was too one-sided in favor of ESG
factors. According to these commenters, the perceived regulatory bias
would predictably trigger revisions by a future Administration with
opposing views, effectively reducing the reliability and durability of
the rule. This concern was raised by commenters who both supported and
opposed the content of the examples.
Another frequently cited concern was that the list might have
unintended consequences. For example, plan fiduciaries might
erroneously conclude that the factors listed in the operative text are
more prudent than non-listed factors. A different but possible
unintended consequence mentioned several times was that some plan
fiduciaries might perceive the list as a safe harbor, such that
fiduciaries may believe they will be deemed to have made a prudent
investment decision if they consider only the listed examples (and no
others). Others suggested that, by singling out these particular
examples to the exclusion of other examples, the regulation could be
read
[[Page 73832]]
as implying that these factors were especially important when selecting
an investment. Consequently, according to these commenters, at least
some fiduciaries would feel obligated to document in writing their
justification for not considering these example factors. Similarly,
some commenters suggested that, in their view, listing in the operative
text only a few of the potentially material factors that a prudent
fiduciary might consider might unintentionally create a perception that
the Department expects fiduciaries will take these specific factors
into consideration, even where it might not be possible, practical, or
prudent.
Another repeated concern of commenters was that the list of factors
is unnecessary. According to these commenters, the general reference to
material risk-return factors in paragraph (b)(4) of the NPRM would be
sufficient to make clear that fiduciaries may consider any factor
material to a risk-return analysis, including ESG factors. To these
commenters, the concept of materiality provides for the determination
of relevant factors on a case-by-case basis. In their view, such a
principles-based approach better serves plans and provides greater
flexibility for ERISA fiduciaries to consider the unique factors
relevant to particular investment decisions.
Another frequently cited concern was that the examples would become
stale over time. Several commenters opined that a list of specific
examples of material factors that may be of particular importance now
may be of less importance in the future. Thus, at a minimum, the
regulation could require updates over time as risk management and
investment strategies evolve.
Some commenters indicated that the list of ESG factors could be
improved with additional examples. For instance, many commenters
suggested that the list should be balanced by expanding the list to
include non-ESG factors that may be material risk-return factors (e.g.,
good products, compelling corporate strategy, tight cost controls).
Some further suggested it would be helpful for the Department to add
examples of when it is not prudent to consider ESG factors. A commenter
noted that by including only ESG factors as examples, the Department
risks creating a perception that fiduciaries may take only ESG factors
into account. Another commenter criticized that some of the examples as
proposed are broad and ambiguous, inherently subjective, and give too
much flexibility to plan fiduciaries who may be inclined to use plan
assets to further particular ESG goals. Some commenters further
characterized the proposed examples as singling out special interests
and progressive ESG priorities that have little to no impact on
financial returns. Multiple commenters suggested additions of factors
that seemed to fall within the broad categories of examples but were
not specifically listed. Commenters also suggested the addition of
factors that did not appear to fall within any of those categories.
After consideration of the comments received, the Department is
persuaded that paragraph (b)(4) of the final rule should not include a
list of examples. The list of examples was never intended to be
exclusive; nor was it intended to define ``ESG'' or introduce any new
conditions under the prudence safe harbor. The list of examples was
merely intended to reaffirm that fiduciaries may consider ESG factors
that are relevant to a risk-return analysis of the investment. The
examples were intended to make clear that ESG factors may be more than
mere tiebreakers, but rather financially material to the investment
decision. The Department believes, however, that this point is made
sufficiently clear by the general language in paragraph (b)(4) of the
final rule. The primary justification for removing the examples from
the operative text of the final rule is that the Department is wary of
creating an apparent regulatory bias in favor of particular investments
or investment strategies.
Removal of the list from paragraph (b)(4) should not be viewed as
limiting a fiduciary's ability to take into account any risk and return
factor that the fiduciary reasonably determines is relevant to a risk/
return analysis. The Department continues to be of the view that,
depending on the surrounding facts and circumstances, these may include
the factors listed in paragraph (b)(4) of the proposal. Thus, depending
on the surrounding circumstances, a fiduciary may reasonably conclude
that climate-related factors, such as a corporation's exposure to the
real and potential economic effects of climate change including
exposure to the physical and transitional risks of climate change and
the positive or negative effect of Government regulations and policies
to mitigate climate change, can be relevant to a risk/return analysis
of an investment or investment course of action. A fiduciary also may
make a similar determination with respect to governance factors, such
as those involving board composition, executive compensation, and
transparency and accountability in corporate decisionmaking; a
corporation's avoidance of criminal liability; compliance with labor,
employment, environmental, tax, and other applicable laws and
regulations; the corporation's progress on workforce diversity,
inclusion, and other drivers of employee hiring, promotion, and
retention; investment in training to develop a skilled workforce; equal
employment opportunity; and labor relations and workforce practices
generally.
The foregoing examples are merely illustrative, and not intended to
limit a fiduciary's discretion to identify factors that are relevant
with respect to its risk/return analysis of any particular investment
or investment course of action. A fiduciary may reasonably determine
that a factor that seems to fall within a general category described
above (e.g., climate-related factors), but is not specifically
identified above, nonetheless is relevant to the analysis (e.g.,
drought). For example, depending on the facts and circumstances,
relevant factors may include impact on communities in which companies
operate, due diligence and practices regarding supply chain management,
including environmental impact, human rights violations records, and
lack of transparency or failure to meet other compliance standards. As
another example, labor-relations factors, such as reduced turnover and
increased productivity associated with collective bargaining, also may
be relevant to a risk and return analysis.
Of course, a fiduciary's determination of relevant factors is not
limited to the general categories described above. Prudent investors
commonly take into account a wide range of financial circumstances and
considerations, depending on the particular circumstances, such as a
corporation's operating and financial history, capital structure, long-
term business plans, debt load, capital expenditures, price-to-earnings
ratios, operating margins, projections of future earnings, sales,
inventories, accounts receivable, quality of goods and products,
customer base, supply chains, barriers to entry, and a myriad of other
financial factors, depending on the particular investment. This rule,
as amended, does not supplant such considerations, but rather makes
clear that there is no inconsistency between the appropriate
consideration of ESG factors and ERISA section 404(a)(1)(B)'s standard
of prudence, which requires that fiduciaries act with the ``care,
skill, prudence, and diligence under the circumstances then prevailing
that a prudent man acting in a like capacity and familiar with such
matters would use in the conduct of an enterprise of a like character
and with like aims.''
[[Page 73833]]
(3) Consolidation of Multiple Provisions Into Paragraph (b)(4) of the
Final Rule
In concert with removing the list of examples from paragraph (b)(4)
of the NPRM, elements of paragraphs (b)(2)(ii)(C) and (c)(2) of the
NPRM are now merged into paragraph (b)(4) of the final rule. These
edits address commenters' concerns that aspects of paragraph
(b)(2)(ii)(C) of the NPRM could constitute an effective or de facto
mandate to always consider the effects of climate change and other ESG
factors on every investment or investment course of action, that the
examples in paragraph (b)(4) of the NPRM interject inappropriate
regulatory bias in favor of ESG factors, and that the final rule not
retreat from the principle in paragraph (c)(2) of the NPRM that
fiduciaries must base investment decisions only on factors that are
relevant to a risk and return analysis. The essence of paragraph (c)(2)
of the NPRM was not changed when merged into paragraph (b)(4) of the
final rule. As mentioned below, the merger avoids the existence of
redundant concepts in multiple paragraphs and reflects that the
substance of paragraph (c)(2) of the NPRM is more closely connected to
ERISA's duty of prudence than the duty of loyalty.
Accordingly, paragraph (b)(4) of the final rule provides that a
fiduciary's determination with respect to an investment or investment
course of action must be based on factors that the fiduciary reasonably
determines are relevant to a risk and return analysis, using
appropriate investment horizons consistent with the plan's investment
objectives and taking into account the funding policy of the plan
established pursuant to section 402(b)(1) of ERISA. It further
indicates that risk and return factors may include the economic effects
of climate change and other environmental, social, or governance
factors on the particular investment or investment course of action,
and whether any particular consideration is a risk-return factor
depends on the individual facts and circumstances. Finally, it provides
that the weight given to any factor by a fiduciary should appropriately
reflect a reasonable assessment of its impact on risk-return.
As revised, paragraph (b)(4) of the final rule subsumes core
elements of paragraphs (c)(1) and (f)(3) of the current regulation.
Specifically, the emphasis on risk and return factors in these two
paragraphs carries forward into paragraph (b)(4) of the final rule. The
current regulation's reliance on ``pecuniary only'' and related
terminology, however, is otherwise rescinded. The framework in
paragraph (b)(4) of the final rule continues to adhere to the
principle, underpinning paragraphs (c)(1) and (f)(3) of the current
regulation, that when selecting an investment or investment course of
action plan fiduciaries must focus on relevant risk and return factors,
but the Department no longer supports the current regulation's
framework and terminology for advancing this principle. The Department,
instead, agrees with the commenters who found the current regulation's
framework and terminology confusing and susceptible to inferences of
bias against the treatment of climate change and other ESG factors as
potentially relevant risk and return factors. The Department intends
with these edits to dispel the perception caused by the current
regulation that climate change and other ESG factors are somehow
presumptively suspect or unlikely to be relevant to the risk and return
of an investment or investment course of action. Paragraph (b)(4) of
the final recognizes that, as with other factors, climate change and
other ESG factors sometimes may be relevant to a risk and return
analysis and sometimes not--and when relevant, they may be weighted and
factored into investment decisions alongside other relevant factors, as
deemed appropriate by the plan fiduciary.
(4) Conforming Terminology--``Relevance'' Versus ``Material''
In addition, paragraph (b)(4) of the final rule contains a change
in terminology to establish consistency with the terminology in
paragraph (b)(1) of the final rule. Several commenters noted that
paragraph (b)(1) of the NPRM refers to ``relevant'' factors but that
paragraph (b)(4) of the NPRM refers to ``material'' factors. Noting a
body of decisional and regulatory law underpinning ``materiality''
under Federal securities laws and accounting conventions, many of these
commenters considered the NPRM's use of these different terms a source
of confusion. In conjunction with proposed paragraph (b)(4)'s focus on
risk and return factors, many commenters were concerned that paragraph
(b)(4)'s use of ``material'' might be construed as circumscribing the
role or authority of plan fiduciaries under ERISA's prudence standard
as reflected in the use of ``relevance'' in paragraph (b)(1) of the
NPRM.
In discussing these concerns, commenters mentioned many factors
that, in their view, are relevant factors routinely considered by plan
fiduciaries when selecting investments, such as brand name or
reputation of the fund or fund manager, lifetime income options, style
of fund (e.g., growth versus value), style of fund management (passive
versus active), an investment's regulatory regime, participants'
understanding of the investment, participants' preferences, and other
investment-related operational considerations. These commenters
expressed concern that such factors may not always perfectly align with
securities law or accounting concepts of materiality or directly affect
the risk and return of an investment in clear or obvious ways.
In response to some of these concerns, paragraph (b)(4) of the
final rule uses the word ``relevant'' instead of ``material.'' \44\ The
Department stresses, however, that under paragraph (b)(4) of the final
rule, the fiduciary's investment determination must ultimately rest on
factors relevant to a risk and return analysis. The Department does not
undertake in this document to address specific risk and return factors,
but it notes that it has previously concluded that plan contributions
do not constitute a ``return'' on investment.
---------------------------------------------------------------------------
\44\ A similar change was made in paragraph (d)(2)(ii)(D) of the
final regulation to appropriately align terminology in similar
contexts across different paragraphs of the final regulation.
---------------------------------------------------------------------------
2. Section 2550.404a-1(c) Investment Loyalty Duties
(a) Removal of Pecuniary-Only Requirement--Paragraph (c)(2) of the
Proposal
Paragraph (c)(2) of the NPRM modified the requirement in paragraph
(c)(1) of the current regulation that a fiduciary's evaluation of an
investment or investment course of action must be based ``only on
pecuniary factors,'' which is defined at paragraph (f)(3) of the
current regulation 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. The Department
used the phrase ``pecuniary factors'' for the first time in the 2020
regulations, and although the Department defined it in those
regulations, the phrase is not found in ERISA and has no longstanding
meaning in employee benefits law. The NPRM proposed to remove the
``pecuniary only'' formulation of the requirement and to integrate the
concept of ``risk/return'' factors directly into paragraph (c)(2) of
the NPRM. This approach was intended to address stakeholder concerns
about ambiguity in the meaning and application of the
[[Page 73834]]
``pecuniary only'' terminology of the current regulation.
A significant number of commenters supported the NPRM's proposed
removal of the pecuniary-only test and related terminology. Many
commenters on this issue were of the view that, rather than providing
clarity, the current regulation's pecuniary-only terminology created
confusion by layering an additional standard or test onto the existing
fiduciary framework. That framework already unambiguously required
fiduciaries to base plan investment decisions on financially relevant
factors. In line with that concern, many commenters asserted that this
pecuniary-only terminology chills plan fiduciaries from considering
climate change and other ESG factors even where they have a material
effect on the bottom line of an investment, merely because such factors
also may have the effect of supporting non-financial objectives. In
such ``dual purpose'' circumstances, the position of these commenters
was that just because an investment factor or strategy may
simultaneously have economic and non-economic dimensions, the non-
economic dimensions do not lessen the factor or strategy's economic
significance. These commenters stated that the NPRM's proposed
elimination of the pecuniary-only and related terminology would make
clear to fiduciaries that they are free to consider the full range of
potential material risk-return factors without undue fear of regulatory
second-guessing or litigation. According to these commenters, the
elimination would encourage fiduciaries to take the same steps that
other marketplace investors take in enhancing investment value and
performance or improving investment portfolio resilience against the
potential financial risks and impacts associated with climate change
and other ESG factors.
Some commenters opposed the NPRM's proposed changes; they
emphasized the importance of basing investment decisions on only
pecuniary considerations and urged the Department to retain the
pecuniary factors and related terminology. These commenters generally
were of the view that ERISA requires that plan fiduciaries focus solely
on the economics of an investment and state that climate change and
other ESG factors rarely can be harmonized with this requirement. Given
that belief, these commenters were concerned that participants'
retirement security will suffer as plan fiduciaries and money managers
pursue agendas unrelated to the exclusive purpose of providing
financial benefits to retirement plan participants and beneficiaries.
In line with this concern, one commenter asserted that the insertion of
non-pecuniary investment criteria in the management of pension and
other such funds imposes a substantial penalty over time in terms of
realized returns. One commenter questioned the consistency of
permitting the consideration of non-pecuniary goals with the Supreme
Court's opinion in Fifth Third Bancorp v. Dudenhoeffer, which stressed
the fiduciary's obligation to focus on retirement plan participants'
financial interests.\45\
---------------------------------------------------------------------------
\45\ Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014).
---------------------------------------------------------------------------
The Department is not persuaded to retain the current regulation's
use of and reliance on the novel pecuniary-only formulation and its
related terminology. The pecuniary-only requirement and related
terminology unfortunately caused a great deal of confusion, and it
accounts for a substantial amount of the chilling effect this
rulemaking project set out to redress. These facts are manifest in the
many comment letters on the NPRM. Many view the ``pecuniary-only''
terminology as ambiguous or decidedly prohibitive on the question of
whether climate change and other ESG factors may be considered when
those factors are relevant to the risk-and-return analysis. Indeed, as
indicated by commenters, the current rule actually has a chilling
effect that discourages fiduciaries from prudently considering climate
change and other ESG factors that may be relevant to the risk-return
analysis. Some commenters, in particular, asked questions about
considering factors that have both economic and noneconomic components,
suggesting apprehension that this would fall outside the current
regulation's pecuniary-only requirement. In light of the foregoing, the
Department no longer supports the use of this terminology. Rather, the
Department thinks, and many commenters agree, that paragraph (c)(2) of
the NPRM, subject to certain modifications discussed elsewhere in this
preamble, is a more understandable formulation of ERISA's requirement
that a fiduciary's evaluation of an investment or investment course of
action must focus on factors that the fiduciary reasonably determines
are relevant to a risk and return analysis. Removing the ``based only
on pecuniary factors'' language (and related terminology throughout)
from the current regulation will help re-establish the Department's
position reflected in non-regulatory guidance as early as 2015 that
climate change and other ESG factors that may be relevant in a risk-
return analysis of an investment do not need to be treated differently
than other relevant investment factors, even though they may possess
the ``dual purpose'' dimensions mentioned by some commenters. Put
differently, removing this novel terminology is removing the current
regulation's thumb from the scale so as not to discourage fiduciaries
from considering climate change and other ESG factors where relevant to
the risk-return analysis.
Finally, the Department finds no merit to the argument that the
final rule, either in general or in not carrying forward the pecuniary/
non-pecuniary terminology, permits or requires behavior contrary to the
holding in Dudenhoeffer. On the contrary, the central premise behind
the final rule's rescission of the pecuniary/non-pecuniary distinction
is that the current regulation is being perceived by plan fiduciaries
and others as undermining the fundamental principle Dudenhoeffer
expressed: fiduciaries must protect the financial benefits of plan
participants and beneficiaries. In this way, the pecuniary-only
requirement would effectively prohibit or encumber plan fiduciaries
from managing against or taking advantage of climate change and other
ESG risk factors in selecting investments, even when it is financially
prudent to do so. Thus, the final rule's amendments to the current
regulation, which are aimed solely at counteracting that perception,
are entirely consistent with the principle articulated in Dudenhoeffer.
Notwithstanding the foregoing, paragraph (c)(2) of the proposal has
been incorporated into paragraph (b)(4) of the final rule for clarity
and to avoid potentially redundant and confusing requirements. This
consolidation reflects that the essence of the requirement of paragraph
(c)(2) of the proposal that fiduciaries make investment decisions based
on factors relevant to a risk and return analysis is inherently
prudential in nature, rather than a loyalty obligation, and therefore
overlaps with the requirements of paragraph (b)(4) of the proposed
rule. Although including such a requirement in the regulation's loyalty
provisions may help establish regulatory guideposts for
fiduciaries,\46\ that same function is fulfilled by incorporating it
into the final regulation's prudence provisions at paragraph (b)(4) of
the final rule.
---------------------------------------------------------------------------
\46\ See 85 FR 72854.
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[[Page 73835]]
(b) Paragraph (c)(1)
Paragraph (c)(1) of the proposal restated the Department's
longstanding expression of ERISA's duty of loyalty in the context of
investment decisions, as also expressed in Interpretive Bulletins and
associated preamble discussions. It provided that a fiduciary may not
subordinate the interests of participants and beneficiaries in their
retirement income or financial benefits under the plan to other
objectives and may not sacrifice investment return or take on
additional investment risk to promote goals unrelated to the plan and
its participants and beneficiaries. Similar language is contained in
paragraph (c)(2) of the current regulation. The Department did not
receive substantive comments on paragraph (c)(1) of the proposal, and
it is being adopted in the final rule without change. As in the
proposal and current regulation, the final rule's paragraph (c)(1) is a
legal requirement and not a safe harbor.
(c) Paragraph (c)(2)--Tie Breaker Test and Tie Breaker Standard
Paragraph (c)(3) of the proposal directly rescinded the
``tiebreaker'' standard in paragraph (c)(2) of the current regulation
and replaced it with a standard intended to align more closely with the
Department's original non-regulatory guidance from nearly three decades
ago, IB 94-1, which first advanced the ``tiebreaker'' concept. In
explaining the standard in the preamble to IB 94-1, the Department
stated that ``a plan fiduciary may consider collateral benefits in
choosing between investments that have comparable risks and rates of
return.'' \47\ In contrast, the current regulation narrowly focused on
whether competing investments are ``indistinguishable'' based on
pecuniary factors alone. Under such circumstances, the current
regulation permits a plan fiduciary to use a non-pecuniary factor as a
deciding factor in making its investment decision, but only if the
fiduciary also complies with a specific documentation requirement.
---------------------------------------------------------------------------
\47\ 59 FR 32607 (June 23, 1994).
---------------------------------------------------------------------------
A number of commenters supported both the rescission of the current
tiebreaker standard and the proposal's replacement standard--i.e., that
competing investments ``equally serve'' the financial interests of the
plan. In their view, the proposed formulation represented a significant
improvement over the current regulation, which they argued set out an
unrealistically difficult and prohibitively stringent standard. Some
further suggested that the standard in the current regulation is so
stringent that it effectively eliminated the Department's historical
tiebreaker test. For instance, according to one commenter, the current
regulation's tiebreaker standard improperly limits its application,
because it would only apply when a fiduciary is unable to distinguish
two or more investments based on pecuniary factors alone--an occurrence
that is rare and unreasonably difficult to identify, according to this
commenter. In actual practice, the commenter states, a prudent
fiduciary process often produces a variety of investments that are
consistent with, and in the fiduciary's judgement, equally promote, the
financial interests of participants and beneficiaries. According to a
different commenter, the current regulation's ``economically
indistinguishable'' standard is in practice impossible for fiduciaries
to surmount, given that differences exist even among very similar
investments. As put by yet another commenter, the requirement that
investments be ``economically indistinguishable'' before a fiduciary
can consider collateral factors (such as ESG factors when not relevant
to risk and return) effectively subverts the fiduciary's best judgment
in favor of a standard that is virtually impossible to meet. Overall,
these commenters viewed the proposal's standard as tracking the
Department's prior guidance more closely, and more accurately
reflecting the realities of fiduciary decisionmaking. They supported
adoption of the NPRM's standard without change.
Other commenters supported the proposal's rescission of the current
tiebreaker standard, but raised concerns with the proposal's ``equally
serve'' formulation. Commenters indicated that the proposal was not
clear as to how to determine when investments meet the ``equally
serve'' standard and requested further guidance. Questions presented
included whether the equally-serve analysis is based on how similar
investments are, or based on the potential financial effects of the
investments on the plan's portfolio. One commenter suggested that the
Department should recognize that investments may vary from each other
but still serve the same plan purpose. Another commenter asked how
small deviations in the financial effects of two investments would
affect the equally serve analysis. These commenters did not believe the
tiebreaker standard should require investments to be identical, and
suggested clarifying language, such as a standard based on investments
that serve the financial interests of the plan comparably well, or
equally well.
Other commenters indicated that the ``equally serve'' standard
appeared to imply an investment process under which a fiduciary
selection process involves evaluating a group of potential investments,
paring the group down to a few competing investments, and then moving
on to the tiebreaker test and the selection of a single investment.
Commenters opined that such a mechanical process of elimination should
not be necessary if a fiduciary has already prudently determined that
each investment is consistent with the plan's objectives and is
reasonably designed to further the purposes of the plan. Some
commenters asserted that the tiebreaker test should focus on whether
investments are the result of a prudent fiduciary process rather than
on an analysis of their equivalence, and suggested formulations based
on ``equally prudent'' investments, or investments identified through a
prudent process.
Some commenters supported the tiebreaker standard in the current
regulation and objected to the rescission of the current standard.
These commenters viewed the proposal's standard as far too lenient, and
the current regulation's indistinguishability based on pecuniary
factors only standard as appropriate in light of ERISA's high standard
of fiduciary responsibilities. They asserted that the current
regulation's provisions are a valuable curb against behavior that could
otherwise lead to subordinating the interests of participants and
beneficiaries in their retirement income. These commenters expressed
concern that the proposal, with changes to the tiebreaker standard and
related documentation provisions, would invite abuse and open the door
to using pension plan assets for policy agendas, or encourage
fiduciaries to advance personal policies and agendas at the expense of
interests of trust beneficiaries in a secure retirement.
A number of commenters did not support inclusion of any tiebreaker
provision in the regulation. Some commenters believe the tiebreaker
test cannot be reconciled with ERISA's duty of loyalty, which requires
that fiduciaries discharge their duties for the exclusive purpose of
providing benefits to participants and beneficiaries and defraying
reasonable expenses of administering the plan. Commenters also
cautioned that the tiebreaker provision weakens the focus on the best
financial outcome for plan participants and beneficiaries by
encouraging consideration of collateral factors. In
[[Page 73836]]
their view, fiduciaries desiring to seek third-party benefits may,
deliberately or inadvertently, be encouraged to declare ties to free
themselves from the duty of loyalty. Several of these commenters did
not believe a tiebreaker is necessary regardless of formulation
because, in their view, ties generally do not exist, particularly in
liquid financial markets. Furthermore, they argued that the purpose of
an investment manager is to exploit differences among investments and
to select a winner (or buy both for increased diversification in the
case of ties). In their view, fiduciaries are accustomed to
deliberating on such matters, including close calls, and if they are
doing their job and creating an appropriate record, there should be no
need for tiebreaker guidance in the rule.
Some commenters also believed that a tiebreaker test may
potentially cause harm or detriment to plans. For instance, some
suggested that a tiebreaker test may reduce accountability and promote
complacency by allowing investment decisionmakers to adopt a ``close
enough'' attitude and point to some reason other than financial merit
to justify their decisions. In contrast, others suggested that the
tiebreaker test promotes a misconception that there is a single
``best'' investment for a plan. Still others cautioned that the mere
existence of a tiebreaker test could unintentionally signal that ESG
factors cannot, on their own, be considered material to a risk-return
analysis. Some also suggested that there is a chance the tiebreaker
test may be overused unnecessarily in cases where the fiduciary has
little doubt about the financial merits of the investment in question
but where the fiduciary perceives the tiebreaker route as providing a
level of protection from future allegations of disloyalty. Such overuse
may lead to substantial burdens on recordkeepers in connection with the
proposal's related collateral benefit disclosure requirement.
The Department is not persuaded that the tiebreaker provision
should be removed from the final rule. The Department does not agree
with commenters who asserted that the tiebreaker test is unnecessary or
inconsistent with ERISA. Although there has been some mostly semantic
variation in what constituted ties under the Department's prior non-
regulatory guidance, some version of the tiebreaker test has appeared
in the CFR since 1994. Consequently, since at least that time, the
Department has recognized that fiduciaries may use collateral benefits
to break ties between various investments. The tiebreaker test thus
aligns the final rule with the settled expectations of fiduciaries and
others involved in the investment of assets of employee benefits plans
under ERISA, especially in the multiemployer plan context. Although
some fiduciaries, by the nature of their arrangements with plans, may
apply investment strategies that never require them to choose between
alternatives that equally serve the plan's needs, other fiduciaries,
such as those making investments outside liquid financial markets, may
find the tiebreaker test useful for circumstances in which there are
equally strong cases for competing investments under a risk-return
analysis. In addition, although some commenters question the need for a
tiebreaker test and whether ties exist, other commenters acknowledge
the utility of the tiebreaker standard. For instance, some commenters
argued that in the event of a tie between two investment options, the
fiduciary should increase diversification by investing in both
investment options. They acknowledge, however, that in not all
circumstances is this appropriate, and thus, the tie will need to be
broken. Under the commenter's approach, for example, the tiebreaker
test provides plan fiduciaries with a solution in cases when investing
in two (or more) alternatives that equally serve the financial
interests of the plan, rather than one, entails additional costs (such
as transactional or monitoring costs) that offset the benefits of
investing in two (or more) investments rather than one.
More generally, those questioning the need for a tiebreaker test
are reminded that ERISA does not specifically address a fiduciary's
investment choice in circumstances where multiple investment
alternatives equally serve the financial interests of the plan and thus
the economic interests of the plan's participants and beneficiaries are
protected by choosing either alternative. The Department is choosing to
leave that decision in the hands of fiduciaries, who are charged with
choosing among investment alternatives that equally serve the financial
interests of the plan. Fiduciaries without a need to break a tie while
selecting investments need not use the provision. This may be the case,
for example, with respect to participant-directed individual account
plans where adding additional investment options is not necessarily a
zero-sum game, such that the fiduciary may choose only one option.
Moreover, when there is a need to break a tie, there is nothing in the
regulation that requires fiduciaries to look to climate change or other
ESG factors to break the tie.
With respect to concerns that the tiebreaker provision might be
subject to abuse or not be part of a prudent fiduciary process, we note
that fiduciaries utilizing the tiebreaker provision remain subject to
ERISA's prudence requirements. In addition, they also remain subject to
the explicit prohibition against accepting expected reduced returns or
greater risks to secure such additional benefits. The Department is of
the view that these provisions, coupled with the safeguards added by
ERISA's statutory prohibited transaction provisions, discussed below,
sufficiently protect participants' and beneficiaries' retirement
benefits in this context.
As to commenters who suggested that the existence of a tiebreaker
provision implies that ESG factors are non-economic, the potential
economic relevance of ESG factors is reflected in paragraph (b)(4) of
the final rule, as discussed above. When such factors are relevant to a
risk and return analysis, the tiebreaker test is not at issue. Put
differently, as with other types of investment factors, climate change
and other ESG factors sometimes may be relevant to a risk and return
analysis and sometimes not--and when relevant, they may be factored
into investment decisions alongside other relevant factors, as deemed
appropriate by the plan fiduciary under paragraph (b)(4) of the final
rule. However, when such factors are not relevant to a risk and return
analysis, such factors may nevertheless be the decisive factor under
the tiebreaker test, provided that the other conditions of the
tiebreaker test are satisfied. The Department believes that rescission
of the current regulation's tiebreaker standard and replacement with a
standard more closely aligned with prior non-regulatory guidance is
appropriate. The current regulation's tiebreaker standard, ``unable to
distinguish on the basis of pecuniary factors alone,'' in practice, has
meant indistinguishable in all respects, or identical. This standard is
causing a great a deal of confusion, given that no two investments are
the same in each and every respect. The imposition of a standard that
effectively requires investments to be precisely identical therefore is
both impractical and unworkable. Investments can and do differ in a
wide range of attributes, but when considered in their totality, may
serve the financial interests of the plan equally well. This problem
was noted by the Department in 2020 when making the current
regulation's tiebreaker standard, but as shown by the comments
discussed above, the current
[[Page 73837]]
regulation has not effectively resolved this problem.\48\ The
Department believes the final rule's ``equally serve'' standard
comports with the realities of fiduciary decisionmaking and firmly
protects participant retirement benefits, since it strictly forbids the
subordination of plans' and participants' financial interests to any
other objective.
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\48\ 85 FR 72846, 62.
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In response to comments requesting further guidance on the
determination of whether investments equally serve the financial
purposes of the plan, the Department has not made changes to the
proposed standard. In the Department's view, as explained in the
preamble to the proposal, investments may differ on a wide range of
attributes, but when considered in their totality, serve the financial
interests of the plan equally well.\49\ Given the wide range of
attributes associated with different investments, the uncertainties
inherent in investing, and the practical limitations on the
availability and processing of relevant data, the Department does not
agree with those commenters who suggested that fiduciaries can never
conclude that competing alternatives serve the financial purposes of
the plan equally well. Under the final rule, investments do not need to
be identical in order to equally serve the financial interests of a
plan. Whether, in any particular circumstances, the tiebreaker standard
is met is an inherently factual question.
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\49\ 86 FR 57278.
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Like the NPRM, the final rule's tiebreaker provision does not
define or explicitly limit the concept of ``collateral benefits.'' On
this topic, the preamble to the NPRM specifically provided that the
proposal did not place parameters on the collateral benefits that may
be considered by a fiduciary to break the tie. The preamble to the NPRM
explained that this position is consistent with prior nonregulatory
guidance, but the preamble nevertheless solicited comments on whether
more specificity should be provided in the provision. For instance, the
preamble asked if the final rule should require that any collateral
benefit relied upon as a tiebreaker be based upon an assessment of the
shared interests or views of the participants, above and beyond their
financial interests as plan participants, such as the investment's
likely impact on participants' jobs or plan contribution rates. This
scenario was just an example.
Some commenters opposed such limitations, both as a general idea
and specifically the scenario mentioned in the preamble of the NPRM,
i.e., placing additional constraints in the form of requiring an
assessment of the shared interests or views of the participants.
Commenters stated that the Department's longstanding position prior to
the 2020 amendments, going back at least to 1994, never defined or
limited the concept of ``collateral benefits'' and that there is no
history justifying a change now. Focusing on the specific scenario in
the preamble to the NPRM, one commenter stated that it is not clear how
a fiduciary would use information on participant views, collect such
information, or even what issues should be included in such an
assessment. A different commenter also focusing on this scenario stated
the concern that making decisions based on a survey or estimation of
participants' views unrelated to plan returns is in tension with
ERISA's command that fiduciaries operate ``for the exclusive purpose''
of providing benefits and defraying reasonable expenses. One commenter
argued that a regulatory definition is not necessary because the
tiebreaker test already ensures that the investment must be prudent and
serve the best interests of the participants and beneficiaries
regardless of whether a collateral benefit is used. Requiring further
assessment would increase costs and complexity, according to this
commenter.
Other commenters had different views on this question. One
commenter stated that, in its view, the tiebreaker provision is
unlawful, but that if some version of it is retained in the final rule,
the retained version should require that any collateral benefit relied
upon as a tiebreaker be based upon an assessment of the shared
interests or views of the participants, along with the consent of each
participant to pursue collateral benefits with funds in their account
and a delineation of the causes they support. One commenter raised the
concern that, because the NPRM did not place any parameters on the
collateral benefits that fiduciaries may consider, fiduciaries could be
left guessing which factors would be appropriate for consideration,
with the possibility that the Department's views could shift over the
years.
The final rule takes the same approach as the NPRM. Some form of
the tiebreaker test permitting fiduciaries to consider collateral
benefits has existed for more than four decades, and the Department is
not aware of plan fiduciaries struggling with the concept of
permissible collateral benefits. In the Department's experience,
collateral benefits have routinely involved criteria or considerations
other than factors that are relevant to a risk and return analysis of
the investment, such as stimulating union jobs and investing in the
geographic region where participants live and work, as just a few
examples. In response to requests from several commenters, the
Department confirms that an investment that stimulates or maintains
employment that, in turn, results in continued or increased
contributions to a multiemployer plan is an example of ``collateral
benefits other than investment returns'' under paragraph (c)(2) of the
final rule. In response to the concern that, without a definition, plan
fiduciaries will be forced to guess as to what constitutes a legitimate
``collateral benefit'' versus an impermissible collateral benefit, the
Department reminds that plan fiduciaries are not required to consider
collateral benefits in choosing between investments that have
comparable risks and rates of return. Moreover, the statement that the
final rule does not contain explicit parameters on the collateral
benefits that may be considered by a fiduciary to break a tie directly
responds to and addresses commenters' concerns about exceeding such
parameters. Finally, while the final rule itself adds no explicit
parameters on collateral benefits, ERISA's prohibited transaction
provisions in section 406 remain and generally forbid collateral
benefits to the extent any such benefit involves a transaction that
violates those provisions.\50\
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\50\ See, e.g., AO 85-36A (Oct. 23, 1985) (certain investment
arrangements may involve a use of plan assets for the benefit of a
party in interest in violation of ERISA section 406(a)(1)(D));
Information Letter to Katz (Mar. 15, 1982) (purchase by a plan of an
insurance policy pursuant to an arrangement under which it is
expected that the insurance company will make a loan to a party in
interest is a prohibited transaction).
---------------------------------------------------------------------------
(d) Paragraph (c)(2) Tiebreaker Test--Documentation
Paragraph (c)(3) of the NPRM also rescinded the current
regulation's novel documentation requirement applicable to any instance
of use of the tiebreaker test; instead, the proposal included a
requirement that if a plan fiduciary uses the tiebreaker to select a
designated investment alternative for a participant-directed individual
account plan based on collateral benefits other than investment
returns, ``the plan fiduciary must ensure that the collateral-benefit
characteristic of the fund, product, or model portfolio is prominently
displayed in disclosure materials provided to participants and
beneficiaries.''
A number of commenters objected to the removal of the current
regulation's
[[Page 73838]]
documentation provision, under which a fiduciary using the tiebreaker
test is required to document, among other things, its analysis in those
cases where the fiduciary has concluded that pecuniary factors alone
were insufficient to be the deciding factor.\51\ The requirement was
intended to ``provide a safeguard against the risk that plan
fiduciaries will improperly find economic equivalence and make
decisions based on non-pecuniary factors without a proper analysis and
evaluation.'' \52\ Some of these commenters are of the view that the
tiebreaker test may be inconsistent with ERISA, as discussed above, and
that a stringent documentation requirement is perhaps the best way for
plan fiduciaries to contemporaneously document their decisionmaking
with respect to tiebreakers and mitigate the effects of their reliance
on factors that do not materially affect risk-return or directly
promote retirement income.
---------------------------------------------------------------------------
\51\ 29 CFR 2550.404a-1(c)(2) (2021).
\52\ 85 FR 72862.
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Other commenters supported removal of the current regulation's
documentation requirement, arguing that the disclosure was formulaic,
singled out one investment category, could chill fiduciaries from
properly considering ESG factors, and was largely unnecessary given
ERISA's general obligations. For instance, one commenter indicated that
the documentation requirement has a chilling effect and is seen as
suggesting that ESG investing entails extraordinary risks. Other
commenters also viewed the documentation requirement as creating a
stigma around considering ESG factors in investment decisions.
Commenters also believed that the regulation's documentation provision
is unnecessary because fiduciaries commonly document and maintain
records about their investment decisions as part of their general
prudence obligation. Others believed that removal of the documentation
provision brings the tiebreaker standard more in line with prior non-
regulatory guidance and may provide additional cost savings, which
would ultimately benefit plan participants and beneficiaries. A
commenter noted that some fiduciaries, even before the 2020 amendments,
may have viewed tiebreaker situations as perhaps requiring enhanced
documentation. This commenter requested that the Department provide
further clarification regarding prudent recordkeeping if the final rule
removes the current regulation's documentation requirement.
The Department is not persuaded that the current regulation's brand
new documentation requirement should be retained in the tiebreaker
provision. Commenters confirmed the Department's initial concern that
the documentation provision in the current regulation is very likely to
chill and discourage plan fiduciaries from using the tiebreaker test
generally, including in cases involving the appropriate consideration
of ESG factors (when such factors are not otherwise relevant to a risk
and return analysis). The tiebreaker test, by its terms, applies only
where competing investments equally serve the financial interests of
the plan. It disallows the investment selection from sacrificing the
plan's economic interests or from exposing plans to additional risk. In
light of these guardrails, the Department sees no reason for a
regulatory provision imposing further burdens on its use. Since the
tiebreaker test only applies in cases where the competing investments
equally serve the financial interests of the plan, the Department is of
the view that use of the tiebreaker test should not be discouraged with
additional burdens, because neither of the competing investments
sacrifices the economic interests of the plan, but one of them promotes
collateral benefits the other does not. In addition, the elaborateness
of the current regulation's tiebreaker-specific documentation provision
likely will be viewed by fiduciaries as suggesting that the Department
sees tiebreakers as occurring infrequently, and the Department did not
have in 2020 and does not now have sufficient information to make a
judgement as to the frequency of ties. The documentation requirement
also may be viewed by fiduciaries as a self-reported ``red flag'' that
uniquely directs potential litigants' attention to tie-breaker
decisions as inherently problematic, even though there is no necessary
or presumed inconsistency between their use and the requirements of
ERISA. The Department is wary that the potential for litigation may
cause fiduciaries to consciously or unconsciously skew their investment
analyses to avoid open acknowledgment of a ``tie'' and the requirement
of specifically prescribed documentation, while still favoring
investments that provide collateral benefits. The Department believes
this potentially creates incentives that discourage, rather than
promote, proper fiduciary activity and transparency, and further
reduces the likelihood that the benefits associated with the additional
documentation obligation would outweigh the associated costs.
The Department also agrees with commenters that the current
regulation's prescribed documentation provisions are unnecessary given
the general obligations of prudence under ERISA. The Department finds
it noteworthy that no commenter provided contrary evidence
demonstrating that ERISA's general obligations of prudence are
deficient in protecting the interests of plan participants and
beneficiaries in this context. The Department emphasizes that removal
of the documentation provision from the regulation does not suggest
that ERISA fiduciaries are excused from complying with ERISA's prudence
obligations, or subject to a lower standard of care, with regard to
documentation or otherwise. Fiduciary documentation of their investment
activities already is a common practice. As explained in the preamble
to the NPRM, the Department's concern with the current regulation's
document provision rests on its formulaic and rigid nature. The
Department believes ERISA section 404's prudence obligation
sufficiently protects participants' and beneficiaries' financial
interests in their plans in this regard. That obligation, which
fiduciaries had prior to the 2020 amendments and will continue to have,
provides that the nature and degree of the fiduciary's duty to document
an investment decision depends upon the facts and circumstances
particular to that decision, regardless of whether the decision is
under the tiebreaker test or the type of collateral benefit at
issue.\53\ Thus, the Department believes the current regulation's
specific documentation provision is not necessary and can lead to
conduct contrary to the plan's interests. This includes the risk that
fiduciaries will over-document or under-document their investment
decisions.\54\ Over-documentation would result in increased transaction
costs for no particular benefit to plan participants.
---------------------------------------------------------------------------
\53\ The preamble to Interpretive Bulletin 2015-01, in relevant
part, stated that, ``the Department does not construe consideration
of ETIs or ESG criteria as presumptively requiring additional
documentation or evaluation beyond that required by fiduciary
standards applicable to plan investments generally. As a general
matter, the Department believes that fiduciaries responsible for
investing plan assets should maintain records sufficient to
demonstrate compliance with ERISA's fiduciary provisions. As with
any other investments, the appropriate level of documentation would
depend on the facts and circumstances.''
\54\ 86 FR 57272 at 57279.
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[[Page 73839]]
(e) Paragraph (c)(2) Tiebreaker Test--Collateral Benefit Disclosure
The NPRM contained a disclosure requirement within the tiebreaker
test limited to participant-directed individual account plans.
Specifically, paragraph (c)(3) of the NPRM, in relevant part, provided
that if a plan fiduciary selects an investment, or investment course of
action, based on collateral benefits other than investment returns,
``the plan fiduciary must ensure that the collateral-benefit
characteristic of the fund, product, or model portfolio is prominently
displayed in disclosure materials provided to participants and
beneficiaries.'' This would have been a new disclosure requirement
under ERISA.
The preamble to the NPRM explained the policy intent behind this
proposed requirement. In relevant part, the NPRM explained that the
``essential purpose of this proposed disclosure requirement is to
ensure that plan participants are given sufficient information to be
aware of the collateral factor or factors that tipped the scale in
favor of adding the investment option to the plan menu, as opposed to
its economically equivalent peers that were not.'' \55\ The Department
thought the disclosure of this information would have been of potential
benefit to plan participants and beneficiaries because of the
possibility that ``a particular plan participant or a population of
plan participants does not share the same preference for a given
collateral purpose as the plan fiduciary that selected the designated
investment alternative for placement on the menu among the plan's other
options.''
---------------------------------------------------------------------------
\55\ 86 FR 57272, 80.
---------------------------------------------------------------------------
The preamble to the NPRM also provided an example of an application
of this proposed requirement. The example, in relevant part, provided
that ``if the tiebreaking characteristic of a particular designated
investment alternative were that it better aligns with the corporate
ethos of the plan sponsor or that it improves the esprit de corps of
the workforce, . . . then such feature or features prompting the
selection of the investment must be prominently disclosed by the plan
fiduciary. . . .'' The NPRM believed this information ``will be useful
to participants and beneficiaries in deciding how to invest their plan
accounts.'' \56\
---------------------------------------------------------------------------
\56\ Id.
---------------------------------------------------------------------------
The preamble to the NPRM also clarified that, in terms of
compliance, the Department's intent was to provide flexibility in how
plan fiduciaries would fulfill this requirement given the unknown
spectrum of collateral benefits that might influence a plan fiduciary's
selection. The preamble to the NPRM explained that one likely way to
comply ``is that the plan fiduciary could simply use the required
disclosure under 29 CFR 2550.404a-5.'' \57\ That regulation, adopted in
2012, already entitles participants in participant-directed individual
account plans to receive sufficient information regarding designated
investment alternatives to make informed decisions about the management
of their individual accounts. The information required by the 2012 rule
includes information regarding the alternative's objectives or goals
and the alternative's principal strategies (including a general
description of the types of assets held by the investment) and
principal risks. The NPRM, therefore, assumed these existing
disclosures, perhaps with minor modifications or clarifications, would
have been sufficient to satisfy the disclosure element of the
tiebreaker provision in paragraph (c)(3) of the proposal.
---------------------------------------------------------------------------
\57\ Id.
---------------------------------------------------------------------------
As is evident from the foregoing discussion, the NPRM assumed
appreciable benefits to plan participants and beneficiaries and
relatively small compliance costs resulting from this proposed
disclosure requirement.\58\ The NPRM solicited comments on the overall
utility of this disclosure provision, including ideas on how best to
operationalize the provision considering its intended purpose balanced
against costs of implementation and compliance.
---------------------------------------------------------------------------
\58\ 86 FR 57272 at 57300 (``The Department estimates that it
will take a legal professional twenty minutes on average per year to
update existing disclosures for each of the 46,551 small individual
account plans with participant direction that are anticipated to
utilize this provision. This results in a per-plan cost of $46.14
annually relative to the pre-2020 final rule baseline.'').
---------------------------------------------------------------------------
(1) Support for Disclosure Requirement
The public record reflects limited support for the proposed
disclosure requirement. One commenter stated that plan participants and
beneficiaries should have information about collateral benefits because
such information may impact participant behavior, such as whether to
participate, savings rates, and asset allocations. One commenter
registered its support for better disclosure to plan participants and
of investment policies more generally, inclusive of sustainable
investment policies and collateral benefit factors. One commenter
believed the proposed requirement would protect participants and
beneficiaries by ensuring that plan sponsors fully considered
collateral benefits alongside financial performance. One commenter
supported the proposed disclosure requirement as ``reasonable,'' but
recommended that the Department provide plan fiduciaries with a model
notice to assist compliance with this disclosure requirement. Finally,
one commenter conditionally supported the proposed disclosure
requirement because the commenter believed it would give plan
participants needed transparency in the tiebreaking context. However,
this commenter recommended that the proposed requirement, if retained,
be improved with additional content requirements, including a
requirement that the fiduciary disclose what specific alternative
investments were considered in breaking the tie and more analysis
behind the fiduciary's decisionmaking process.
(2) Concerns With Disclosure Requirement
The public record also reflects substantial concerns with the
proposed disclosure requirement. In summary, these concerns are as
follows. Some commenters found the content requirements of proposed
disclosure requirement to be inherently ambiguous. Some found the
proposed disclosure requirement to be unnecessary and the required
content of the disclosure to be of no economic significance. Other
commenters were concerned that the proposed disclosure requirement may
undermine the purposes of other disclosure regulations promulgated by
the Department aimed at helping plan participants and beneficiaries
make informed investment decisions. Certain commenters expressed
concerns that the proposed disclosure requirement would single out
certain factors and strategies over other factors and strategies,
contrary to the principle of neutrality they believe is embedded in
ERISA. Other commenters were concerned that the proposed disclosure
requirement could have a chilling effect on the proper use of climate
change and other ESG factors. Several commenters were concerned that
the proposed disclosure provision would result in unnecessary
litigation. Each of these concerns is explained in detail below.
(a) Ambiguity
Some commenters found the content requirements of the proposed
disclosure requirement to be inherently ambiguous. According to them,
the NPRM was unclear on what ``collateral-benefit characteristics'' a
fiduciary would be required to disclose. They
[[Page 73840]]
contrasted regulatory language requiring the disclosure of the
collateral benefit characteristics ``of the fund'' with preamble
language focused on the ``features prompting the selection'' by the
fiduciary and other language referencing ``improved employee morale''
as the factor that ``tipped the scale.'' Commenters requested
clarification of whether the proposed disclosure requirement was
focused on an objective characteristic of the fund or the subjective
reason the fiduciary selected the fund. According to the commenters,
these are not necessarily the same things. Commenters said the
subjective collateral benefit perceived by the plan fiduciary may be
wholly different from the characteristic of the fund that would be
expected to provide the collateral benefit. For example, assume that
the plan sponsor is an organization whose primary mission is to tackle
climate change. The plan fiduciary may decide to use the tiebreaker
test to select a fund that uses ESG criteria with an environmental
focus to improve the morale of its employees. In this example, the
commenters stated that the regulatory text and preamble were unclear on
what must be disclosed under the proposal--would it be the
environmental focus of the fund's strategy or improved employee morale?
Most commenters on this issue requested confirmation that the former is
what the Department intended, and they asserted flaws with the NPRM's
cost-benefit analysis if the latter.
(b) Unnecessary
Some commenters were of the view that the proposed disclosure
requirement is unnecessary, and the required content of the disclosure
is of no economic significance. The commenters stated that the
Department and the Securities and Exchange Commission already have
regulations in place to ensure that participants and investors have
ready access to necessary investment-related information, such as
principal strategies and risks, performance information, benchmarks,
and fees. Commenters alleged that the content requirements of the
proposed disclosure, by contrast, contained no information about the
economics of the investment in question, but instead focused on
information that was collateral to the economics of the investment and
therefore would have no economic relevance to participant investors.
Whether a participant shares the fiduciary's preference for the
collateral benefit or purpose that ``tipped the scale'' is of no
relevance to whether the investment option is economically prudent and
makes economic sense to a participant. The only thing that should
matter to participants, in the view of these commenters, is whether the
selected investment was prudently chosen. In their view, disclosures
focused on the policy or social preferences of the selecting
fiduciaries will not advance intelligent investment behavior and
therefore are unnecessary.
(c) Interference With Existing Disclosure Regulations
Some commenters were concerned the proposed disclosure requirement
would undermine the purposes of other disclosure regulations
promulgated by the Department aimed at helping plan participants and
beneficiaries make informed investment decisions. These commenters
pointed to existing disclosures under 29 CFR 2550.404a-5, 2550.404c-1,
and 2550.404c-5 as being sufficient to enable plan participants and
beneficiaries to make informed investment decisions.\59\ These
disclosures, according to the commenters, focus on what the Department
has determined, through multiple notice-and-comment rulemaking
projects, is the relevant investment-related information that plan
participants and beneficiaries need, as investors. The proposed
collateral benefit disclosure requirement, by contrast, focused on non-
investment information, i.e., the collateral purpose that tipped the
scale--information that, by definition, is not material to risk and
return. These commenters argued that not only is the proposed
collateral benefit disclosure of no economic relevance, but the
disclosure risks distracting participants and beneficiaries from basic
and important information required under the existing regulations
mentioned above. Put differently, one commenter stated that it opposes
the proposed disclosure requirement because it would disproportionately
emphasize one part of the fiduciary decisionmaking process over other
more relevant factors in a way that could mislead participants and
impact participant choices in ways that are unintended by the
Department.
---------------------------------------------------------------------------
\59\ The disclosure requirements to which these commenters refer
include: 29 CFR 2550.404a-5 (requiring disclosure of certain plan
administrative and investment-related information, including fee and
expense information, to participants and beneficiaries in
participant-directed individual account plans (e.g., 401(k) plans));
29 CFR 2550.404c-1 (requiring that participants and beneficiaries in
participant-directed individual account plans are furnished
specified information about the plan's investment alternatives and
incidents of ownership appurtenant to such investment alternatives);
and 29 CFR 2550.404c-5 (requiring that participants and
beneficiaries whose plan assets may be invested, by default, into a
plan's QDIA by a plan fiduciary are furnished specified investment-
related information about the QDIA, the circumstances in which plan
assets will be invested in a QDIA, and their ability to direct their
assets to plan investment alternatives other than a QDIA).
---------------------------------------------------------------------------
(d) Lack of Neutrality & Chilling Effect
Commenters expressed concerns that the proposed disclosure
requirement singles out certain factors over other factors, contrary to
the principle of neutrality, while other commenters are concerned that
the proposed disclosure requirement might have a chilling effect on the
proper use of climate change and other ESG factors. Certain commenters
expressed opposition to the idea of singling out any class of
investment factor, including collateral benefit factors, as needing
additional or stricter requirements. These commenters asserted that
ERISA is, and should be, factor neutral, including with respect to
collateral purposes or factors. By imposing special disclosure
requirements on collateral benefits, the proposed disclosure is
contrary to this principle, according to these commenters.
In line with this concern, other commenters were concerned that the
proposed disclosure provision could inadvertently have a chilling
effect on the proper use of climate change and other ESG factors. These
commenters posited that investment strategies often simultaneously
integrate multiple ESG factors into the analysis, some of which are
relevant to a risk and return assessment while others are not. In these
circumstances, commenters asserted that fiduciaries may avoid the
investment based on ambiguity over whether it is subject to the
disclosure requirement, or over disclose even when the options were
selected solely for financial reasons.
(e) Litigation
Multiple commenters raised concerns that the proposed disclosure
requirement would effectively act as an invitation to litigation. The
very purpose of the disclosure, according to the commenters, is to draw
the reader's attention to the non-financial motives of the plan
fiduciary. Considering this purpose, commenters said the disclosures
themselves unintendedly would serve as a signal of potential wrongdoing
and as a roadmap to litigation. To altogether avoid the litigation
risk, some plan sponsors and fiduciaries simply would not use the
tiebreaker test even in cases when they otherwise might have been
willing to use it to promote collateral purposes,
[[Page 73841]]
such as addressing climate change, according to commenters.
(f) Per Se Disloyalty
Other commenters raised concerns with the idea that a disclosure
violation would constitute a per se breach of ERISA's duty of loyalty,
which the commenters saw as the necessary consequence of embedding a
disclosure requirement within the portion of a regulation defining
ERISA's duty of loyalty. They argued that a disclosure failure does not
(and should not), by itself, prove disloyalty. But as structured, that
seems to be the result under the NPRM regardless of how prudent and
loyal the fiduciary is when selecting the investment, the commenters
asserted. These commenters observed the unconventionality of the idea
that ERISA commands that if fiduciaries fail in whole or in part to
disclose their motivations to participants and beneficiaries, those
fiduciaries are per se disloyal as a result of the failure, regardless
of how loyal the fiduciaries were, in fact, when selecting the
investment. These commenters assert that it is a non sequitur to say
that a failure to disclose the scale-tipping attributes of an
investment is dispositive evidence of disloyalty, especially when the
investment is prudent and serves the financial interests of the plan
equally as well as a reasonable number of alternatives. To this point,
the commenters note that some version of the tiebreaker test has
existed for approximately forty years without a related disclosure
requirement, embedded in loyalty or otherwise--and nothing in the
marketplace has changed in a way that supports the new disclosure
requirement. The commenters question whether the many plan fiduciaries
that used the tiebreaker test in the past would now be considered
disloyal because they likely never disclosed to participants the
collateral benefits that broke the tie.
(g) Other Technical Concerns
In addition to the foregoing concerns, commenters raised the
following technical issues with the proposed disclosure requirement.
First, commenters stated that although the NPRM is clear that a
collateral benefit disclosure is required only if the fiduciary uses
the tiebreaker provision to select a fund, nowhere does the NPRM offer
concrete guidance on when or how often the plan fiduciary must furnish
this information to participants. For example, commenters requested
guidance and clarification on whether a disclosure would be required
only when the fund is added to the lineup, only when a participant
joins the plan, annually, any time the plan or its service providers
furnish any disclosure materials pertaining to the fund, or at some
other interval determined solely in the judgment of the plan fiduciary
based on facts and circumstances.
Second, the NPRM specifies that the collateral benefit disclosure
must be ``prominently'' displayed in disclosure materials provided to
participants. But neither the regulation nor the preamble defines the
meaning of prominence for this purpose. Several commenters therefore
requested guidance on how to satisfy this standard. One concern is that
this standard is being construed as requiring that collateral benefit
information receive more attention or prominence than other information
that likely will accompany the collateral benefit information, such as
investment performance, fees, strategies, risk, etc. The commenters are
of the view that collateral benefit information should not be more
prominent than relevant investment-related information. These
commenters assert that investment success generally turns on an
intelligent evaluation of performance, fees, strategies, and risk, and
that mandating the elevation of collateral information over such
information potentially undermines the chances of an investor's
success. According to the commenters, this is particularly important,
in part, because the concept of ``prominence'' is inherently
subjective, and in part, because violations of the proposed disclosure
rule are per se acts of disloyalty.
(3) Decision
Based on the foregoing concerns, and reasons similar to those
underlying the decision to remove the documentation requirements from
the current regulation, the final rule does not adopt the proposed
collateral benefit disclosure requirement at this time. The Department
is aware that the Securities and Exchange Commission (SEC) is
conducting rulemaking on investment company names, addressing, among
other things, ``certain broad categories of investment company names
that are likely to mislead investors about an investment company's
investments and risks.'' \60\ The SEC also is conducting rulemaking on
disclosures by mutual funds, other SEC-regulated investment companies,
and SEC-regulated investment advisers designed to provide consistent
standards for ESG disclosures, allowing investors to make more informed
decisions, including as they compare various ESG investments.\61\ The
Department will monitor those rulemaking projects and may revisit the
need for collateral benefit reporting or disclosure depending on the
findings of that agency. The Department emphasizes that the decision
against adopting a collateral benefit disclosure requirement in the
final rule has no impact on a fiduciary's duty to prudently document
the tiebreaking decisions in accordance with section 404 of ERISA.
---------------------------------------------------------------------------
\60\ 87 FR 36594 (June 17, 2022).
\61\ 87 FR 36654 (June 17, 2022).
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(f) Paragraph (c)(3)--Participant Preferences
Several commenters requested clarification on whether a plan
fiduciary may consider participants' policy, social, or value
preferences (i.e., non-financial preferences) in connection with
constructing menus for defined contribution plans that permit
participants to direct their own investments. Some commenters stated
that, in their view, the NPRM is ambiguous on this question. Many other
commenters expressed concern that the NPRM appears not to permit plan
fiduciaries to consider participants' preferences or to consider them
only under the tiebreaker test.
Several of these commenters stressed their view of the importance
of accommodating participants' preferences in a voluntary retirement
system heavily dependent on elective deferrals. These commenters,
including institutional asset managers and asset custodians, assert
that both increased participation and increased deferral rates follow
from accommodating such preferences. They argue that participants may
not use their voluntary participant-directed savings plans to save for
retirement, or will leave those plans earlier, if they cannot get
access to investment choices they find attractive. Consistent with this
argument, many individual commenters claim they would roll their
savings out of ERISA-protected plans if the plans cannot satisfactorily
accommodate their preferences.
Several commenters alleged that plan fiduciaries should not have to
rely solely on the tiebreaker test to consider participants'
preferences. These commenters are of the view that the NPRM's
tiebreaker test may be ill-suited to some methods of constructing menus
for defined contribution plans because adding additional options is not
necessarily a zero-sum game under these methods. To these commenters,
therefore, if plan fiduciaries are unable to use the tiebreaker test
because it does
[[Page 73842]]
not comport with how they construct defined contribution menus, they
effectively have no ability under their reading of the NPRM to consider
participants' preferences.
A few commenters believe that participants' preferences deserve
equal treatment with risk and return factors; they believe fiduciaries
should be allowed to consider and weigh participants' preferences
alongside risk and return factors in a prudence analysis, giving
participant's preferences such weight as the fiduciary deems
appropriate, even if such preferences are not directly tied to risk or
return. By contrast, a few commenters asserted that ERISA requires plan
fiduciaries to focus on only pecuniary factors when selecting and
retaining investments. They view participants' preferences as
essentially irrelevant to menu construction.
In response to these comments, paragraph (c)(3) of the final rule
provides clarification on this issue. Specifically, paragraph (c)(3) of
the final rule provides that the plan fiduciary of a participant-
directed individual account plan does not violate the duty of loyalty
set forth in paragraph (c)(1) of the final rule solely because the
fiduciary takes into account participants' preferences consistent with
requirements of paragraph (b) of this section.
If accommodating participants' preferences will lead to greater
participation and higher deferral rates, then it could lead to greater
retirement security, as suggested by the commenters. Thus, in this way,
giving consideration to whether an investment option aligns with
participants' preferences can be relevant to furthering the purposes of
the plan within the meaning of paragraph (b)(1) of the final rule. At
the same time, however, plan fiduciaries may not add imprudent
investment options to menus just because participants request or would
prefer them.\62\
---------------------------------------------------------------------------
\62\ See Hughes v. Northwestern Univ., 142 S. Ct. 737 (2022)
(``In Tibble, this Court explained that, even in a defined-
contribution plan where participants choose their investments, plan
fiduciaries are required to conduct their own independent evaluation
to determine which investments may be prudently included in the
plan's menu of options.'' (citing Tibble v. Edison Int'l, 575 U.S.
523 (2015)).
---------------------------------------------------------------------------
The clarification in paragraph (c)(3) of the final rule does not
speak to the duty of prudence. Rather, paragraph (c)(3) provides only
that a fiduciary does not violate the duty of loyalty as set forth in
paragraph (c)(1) of the final rule solely because the fiduciary
considers participants' preferences in a manner that is consistent with
paragraph (b) of the final rule. The reference to paragraph (b) in
paragraph (c)(3) clarifies that the duty of prudence is independent
and, as such, prudence determinations must be made consistent with
paragraph (b) of the final rule. As paragraph (b)(4) of the final rule
makes clear, the selection of investment options must be grounded in
the fiduciary's prudent risk and return analysis.
The clarification in paragraph (c)(3) of the final rule is not
novel or a change in Departmental position. The preamble to the current
regulation being amended by this final rule articulated this position
when explaining the meaning and mechanics of paragraph (d)(2) of that
rule (entitled ``Investment Alternatives for Participant-Directed
Individual Account Plans''). In relevant part, that preamble stated:
``Nothing in the final rule precludes a fiduciary from looking into
certain types of investment alternatives in light of participant demand
for those types of investments. But in deciding whether to include such
investment options on a 401(k)-style menu, the fiduciary must weigh
only pecuniary . . . factors.'' \63\ The relevant portion of paragraph
(d)(2) of that rule, however, was incorporated into paragraphs (b) and
(c)(1) of the final rule (minus the pecuniary factor terminology). The
final rule restates the position as regulatory text in paragraph
(c)(3), rather than as a preamble statement, to provide enhanced
clarity, accessibility, and prominence, as requested by commenters.
---------------------------------------------------------------------------
\63\ 85 FR 72846 at 72863.
---------------------------------------------------------------------------
The final rule declines to mandate that fiduciaries factor
participants' preferences into their evaluation, selection, and
retention of designated investment alternatives, and declines to
mandate a uniform methodology for determining such preferences, as
requested by a few commenters. Some commenters had concerns that a
mandate to consider and act on participants' preferences would raise
complex questions, such as how plan fiduciaries should properly
solicit, weigh, implement, and monitor participants' preferences, and
how plan fiduciaries should reconcile conflicting preferences of their
participants (e.g., some participants may oppose so-called ``sin
stocks'' and other participants in the same plan may favor them). No
commenter had persuasive answers or recommendations on these questions,
and the NPRM did not propose such a mandate or suggest how to resolve
such competing preferences. In addition, as some commenters noted,
ERISA's fiduciary obligations could compel plan fiduciaries to
disregard participants' preferences to the extent they are imprudent.
Accordingly, the final rule declines to mandate that fiduciaries factor
participants' preferences into their evaluation, selection, and
retention of designated investment alternatives, and declines to
mandate a uniform methodology for determining such preferences; the
final rule, instead, leaves these questions to be decided by plan
fiduciaries considering the facts and circumstances of their plan and
participant population.
3. Investment Alternatives in Participant-Directed Individual Account
Plans Including Qualified Default Investment Alternatives
Paragraph (d) of the current regulation contains additional rules
that specifically govern fiduciaries' selection and retention of
investment alternatives for participant-directed individual account
plans, including qualified default investment alternatives (QDIAs). The
NPRM proposes to directly rescind this paragraph. The NPRM's
justification for the rescission has two dimensions. First, proposed
amendments to other provisions in the section effectively merged the
substance of what was paragraph (d) into these other provisions.
Second, the Department no longer supports the current regulation's
provisions specific to QDIAs. As structured, paragraph (d)(2)(ii) of
the current regulation disallows a fund to serve as a QDIA if it, or
any of its component funds in a fund-of-fund structure, has investment
objectives, goals, or principal investment strategies that include,
consider, or indicate the use of one or more non-pecuniary factors in
its investment objectives, even if the fund is objectively economically
prudent from a risk-return perspective or even best in class.
Commenters overwhelmingly supported the NPRM. A few commenters
raised technical concerns regarding compliance problems and costs with
paragraph (d) of the current regulation. But more globally, and
fundamentally, most commenters on this issue were of the view that the
provisions in paragraph (d) of the current regulation are unnecessary.
This view is based, in part, on the strongly held belief, shared among
a broad spectrum of commenters from various backgrounds and industries,
that the legal standards under ERISA's prudence and loyalty rules
should be the same for all plans, including plans with QDIAs, with
respect to the selection and retention of investment alternatives.
[[Page 73843]]
How these standards apply to a given set of facts may, of course,
differ, according to the commenters, but the base standards of prudence
and loyalty should be no different for these plans, absent a statutory
underpinning for a difference. Yet the current regulation, according to
these commenters, unnecessarily singles out individual account plans
for what the commenters view as different, special, and stricter
treatment (e.g., some higher level of fiduciary oversight). This
special treatment is especially extreme with respect to QDIAs,
according to the commenters, with some commenters equating the
provisions in paragraph (d)(2)(ii) of the current regulation to an
effective ban on selecting investments that consider or integrate
climate change and other ESG factors, regardless of the economic merits
and prudence of the investment. Many commenters disagreed that QDIAs
need heightened protections beyond those specifically contained in the
Department's Qualified Default Investment Alternative regulation.\64\
Overall, these commenters agree that the provisions of paragraph (d) of
the current regulation create a perception that fiduciaries of
individual account plans, including plans with QDIAs, are subject to
different and heightened--but unclear--standards of prudence and
loyalty as compared to fiduciaries of other plans. And the primary
consequence of this perception, according to the commenters, was a
concern that funds may be excluded from selection as QDIAs solely
because they expressly considered climate change or other ESG factors,
even though the funds are prudent based on a consideration of their
financial attributes alone.
---------------------------------------------------------------------------
\64\ 29 CFR 2550.404c-5.
---------------------------------------------------------------------------
Some commenters opposed the NPRM's proposed changes to paragraph
(d) of the current regulation. In the main, these commenters oppose all
aspects of the NPRM, not just the NPRM's proposed deletion of paragraph
(d) of the current regulation, but their expressed concerns with the
proposed elimination of paragraph (d) are mainly limited to QDIAs. One
of these commenters, for instance, stated that, because the proposal
would allow a QDIA that states, as one of its investment objectives, a
goal other than financial return, this part of the proposal, in the
view of this commenter, is a per se violation of ERISA's exclusive
purpose rule as interpreted by the Supreme Court in Dudenhoeffer.\65\ A
different commenter, noting that individual account plans shift the
risk of investment loss to participants, asserted that this shift in
risk justifies enhanced--not reduced--protections for participants that
are defaulted into QDIAs. This risk is compounded, according to this
commenter, by the fact that defaulted employees are an increasingly
larger percentage of the universe, and they tend not to opt out of the
default investment. In line with the concerns of this commenter, two
other commenters asserted that, to the extent ESG investing is
acceptable at all, it should never be allowed in the case of QDIAs.
Even if active investors are given the prerogative to align their
investments with their beliefs, inattentive defaulted investors should
never, according to these commenters, be forced to accept the social
investment preferences of their plan fiduciaries or burdened with the
obligation of having to actively recognize that the default option is
misaligned with the investors' desires for higher returns (or contrary
social values) and opt out.
---------------------------------------------------------------------------
\65\ Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014).
---------------------------------------------------------------------------
The Department was not persuaded by these objections and the final
regulation retains this aspect of the NPRM, meaning that the final
regulation does not contain the set of special rules for participant-
directed individual account plans, including plans with QDIAs, codified
in paragraph (d) of the current regulation. The first part of paragraph
(d) of the current regulation (paragraphs (d)(1) and (d)(2)(i)) was
eliminated because the essential principles of this part were merged
into paragraphs (b) and (c) of the final rule.
As to the second part of paragraph (d) of the current regulation,
i.e., the part containing special provisions for QDIAs (paragraph
(d)(2)(ii) of the current), the Department generally is of the view
that QDIAs warrant special treatment because plan participants have not
affirmatively directed the investment of their assets into the QDIA but
are nevertheless dependent on the investments for long-run financial
security. Although the Department continues to believe as a general
matter that special protections may be needed in some contexts for
plans containing these investments, the Department no longer supports
the specific restrictions in paragraph (d)(2)(ii) of the current
regulation. As structured, paragraph (d)(2)(ii) of the current
regulation disallows a fund to serve as a QDIA if it, or any of its
component funds in a fund-of-fund structure, has investment objectives,
goals, or principal investment strategies that include, consider, or
indicate the use of non-pecuniary factors in its investment objectives,
even if the fund is objectively economically prudent from a risk-return
perspective or even best in class.
The Department agrees with the many commenters asserting that,
rather than protecting the interests of plan participants, paragraph
(d)(2)(ii) of the current regulation will only serve to harm
participants. It would, as the commenters notice, effectively preclude
fiduciaries from considering QDIAs that include ESG strategies, even
where they were otherwise prudent or economically superior to competing
options. The Department sees no reason to deprive participants of such
options. Consequently, the final rule directly rescinds paragraph
(d)(2)(ii) of the current regulation. The rescission of this provision,
however, does not leave participants and beneficiaries in plans with
QDIAs without protections. QDIAs would continue to be subject to the
same legal standards under the final rule as all other investments,
including the prohibition against subordinating the interests of
participants and beneficiaries in their retirement income to other
objectives. QDIAs also would continue to be subject to the separate
protections of the QDIA regulation.\66\ The Department finds no merit
to the argument that the final rule, either in general or in not
carrying forward paragraph (d) of the current regulation in specific,
sanctions behavior contrary to the holding in Dudenhoeffer. On the
contrary, as already stated, the central premise behind the final
rule's amendments to the current regulation is that the current
regulation is being perceived by plan fiduciaries and others as an
impediment to protecting the financial benefits of plan participants
and beneficiaries by prohibiting or encumbering plan fiduciaries from
managing against or taking advantage of climate change and other ESG
risk factors in selecting investments. Thus, in this way, the final
rule's rescission of the special provision for QDIAs is entirely
consistent with the principle articulated in Dudenhoeffer.
---------------------------------------------------------------------------
\66\ 29 CFR 2550.404c-5.
---------------------------------------------------------------------------
4. Section 2550.404a-1(d)--Proxy Voting and Exercise of Shareholder
Rights
Paragraph (d) of the final rule addresses the application of the
duties of prudence and loyalty under ERISA section 404(a) to the
exercise of shareholder rights, including proxy voting. As discussed
below, the final rule includes several minor changes from the proposal
based on public comment.
[[Page 73844]]
(a) Paragraph (d)(1)
Paragraph (d)(1) of the final rule is unchanged from the proposal
and provides that the fiduciary duty to manage plan assets that are
shares of stock includes the management of shareholder rights
appurtenant to those shares, such as the right to vote proxies. A
commenter requested that the Department limit paragraph (d) to only
proxy voting. The commenter noted that while the provisions cover both
proxy voting and the exercise of shareholder rights, most of the
substantive provisions relate only to proxy voting. The commenter
further opined that other shareholder rights do not necessarily share
the same objectives as those of proxy voting in connection with stock
ownership. Moreover, according to the commenter, decisions on corporate
actions like stock splits, tender offers, exchange offers on bond
issues, and mergers and acquisitions are generally not governed by
proxy voting policies or undertaken with advice from proxy advisors.
For these reasons, the commenter expressed the view that exercise of
shareholder rights should not be coupled with proxy voting in the
regulation. The Department is not persuaded to make the suggested
change. The exercise of shareholder rights has been part of the
Department's prior guidance since at least the first Interpretive
Bulletin in 1994. The Department believes that the exercise of
shareholder rights to monitor or influence management, which may occur
in lieu of, or in connection with, formal proxy proposals is no less
important to fiduciary management of the investment asset as proxy
voting and accordingly should be covered by the final rule.
(b) Paragraph (d)(2)
(1) Paragraph (d)(2)(i)
Paragraph (d)(2)(i) of the proposal provided that when deciding
whether to exercise shareholder rights and when exercising such rights,
including the voting of proxies, fiduciaries must carry out their
duties prudently and solely in the interests of the participants and
beneficiaries and for the exclusive purpose of providing benefits to
participants and beneficiaries and defraying the reasonable expenses of
administering the plan. Paragraph (d)(2)(i) was proposed without
modification from paragraph (e)(2)(i) of the current regulation and is
adopted without change.
(2) Paragraph (d)(2)(ii)
Paragraph (d)(2)(ii) of the proposal set forth specific standards
for fiduciaries to meet when deciding whether to exercise shareholder
rights and when exercising shareholder rights. It provided that a
fiduciary must act solely in accordance with the economic interest of
the plan and its participants and beneficiaries (paragraph
(d)(2)(ii)(A)) and consider any costs involved (paragraph
(d)(2)(ii)(B)). Paragraph (d)(2)(ii) further required that a fiduciary
must not subordinate the interests of the participants and
beneficiaries in their retirement income or financial benefits under
the plan to any other objective, or promote benefits or goals unrelated
to the financial interests of the plan's participants and beneficiaries
(paragraph (d)(2)(ii)(C)). The proposal additionally provided that a
fiduciary must evaluate material facts that form the basis for any
particular proxy vote or other exercise of shareholder rights
(paragraph (d)(2)(ii)(D)). Finally, paragraph (d)(2)(ii)(E) of the
proposal provided that a fiduciary must exercise prudence and diligence
in the selection and monitoring of persons, if any, selected to
exercise shareholder rights or otherwise advise on or assist with
exercises of shareholder rights, such as providing research and
analysis, recommendations regarding proxy votes, administrative
services with voting proxies, and recordkeeping and reporting services.
Paragraph (d)(2)(ii) of the proposal was based on paragraph
(e)(2)(ii) of the current regulation but proposed three significant
changes. First, paragraph (d)(2)(ii) of the proposal directly rescinded
the statement in paragraph (e)(2)(ii) of the current regulation that
``the fiduciary duty to manage shareholder rights appurtenant to shares
of stock does not require the voting of every proxy or the exercise of
every shareholder right.'' Second, proposed paragraph (d)(2)(ii) did
not carry forward the current regulation's specific requirement at
paragraph (e)(2)(ii)(E) that, when deciding whether to exercise
shareholder rights and when exercising shareholder rights, plan
fiduciaries must maintain records on proxy voting activities and other
exercises of shareholder rights. Third, paragraph (d)(2)(ii)(E) of the
proposal broadened the corresponding provision in the current
regulation (paragraph (e)(2)(ii)(F)) in connection with a proposed
streamlining of fiduciary selection and monitoring obligations under
the current regulation. Specifically, paragraphs (e)(2)(ii)(F) and
(e)(2)(iii) of the current regulation both address fiduciary monitoring
obligations, with paragraph (e)(2)(ii)(F) covering selection and
monitoring of persons selected to advise or otherwise assist with the
exercise of shareholder rights, and paragraph (e)(2)(iii) sets out
specific monitoring obligations where the authority to vote proxies or
exercise shareholder rights has been delegated to an investment manager
or a proxy voting firm. The NPRM proposed streamlining this approach by
eliminating paragraph (e)(2)(iii) and covering selection and monitoring
obligations in a single more general provision (paragraph (d)(2)(ii)(E)
of the proposal). Although based on paragraph (e)(2)(ii)(F) of the
current regulation, paragraph (d)(2)(ii)(E) of the proposal was
broader, and covered obligations related to monitoring service
providers such as investment managers and proxy advisory firms that are
addressed in paragraph (e)(2)(iii) of the current regulation.
(a) Rescission of ``Does Not Require Voting Every Proxy'' Language From
Paragraph (e)(2)(ii) of the Current Regulation
The Department proposed to rescind the statement in paragraph
(e)(2)(ii) of the current regulation that ``the fiduciary duty to
manage shareholder rights appurtenant to shares of stock does not
require the voting of every proxy or the exercise of every shareholder
right'' out of a concern that the statement could be misread as
suggesting that plan fiduciaries should be indifferent to the exercise
of their rights as shareholders, particularly in circumstances where
the cost is minimal as is typical of voting proxies. Such indifference
could leave plan investments unprotected, as the exercise of
shareholder rights is important to ensuring management accountability
to the shareholders that own the company. Furthermore, abstaining from
a vote is not a neutral act that has no bearing on the outcome of a
particular matter put to shareholders for vote; rather, depending on
the relevant voting standard under state law and the company's
governing documents, abstention could determine whether a particular
matter or proposal is approved.
Commenters expressed a range of views with respect to the
rescission of the ``does not require voting every proxy'' language.
Multiple commenters supported the rescission, and agreed with the
Department's concerns that the language promotes indifference in
managing proxy voting rights. A commenter furthermore cautioned that
the language misleadingly signaled to fiduciaries that proxy voting is
costly and unimportant. Some commenters expressed the view that the
exercise of
[[Page 73845]]
shareholder rights is key to management accountability and paying
attention to governance is as important as financial performance. Other
commenters similarly supported rescission based on the view that
exercise of shareholder rights, including through proxy voting, is an
important tool for managing risk. Some commenters also indicated that
the ``does not require voting every proxy'' language is not necessary
in the current regulation because fiduciaries have never believed that
ERISA required them to vote all proxies. In particular, commenters
pointed to prior non-regulatory guidance which clearly indicated, in
the context of foreign stock, that ERISA does not require fiduciaries
to vote all proxies.\67\
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\67\ IB 94-2, 59 FR 38864; IB 2016-01, 81 FR 95882.
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Some commenters did not indicate support or opposition to
rescission of the ``not required to vote every proxy'' language, but
they cautioned that removal of the language could be misread as
indicating that the Department believes that ERISA requires fiduciaries
to vote every proxy. These commenters requested confirmation of the
Department's view.
Other commenters opposed the rescission and viewed the NPRM as
creating a presumption that all proxies should be voted. A commenter
stated that many small plans abstain from proxy votes because
performing the required due diligence would be inordinately expensive.
Several commenters criticized that a presumption that all proxies
should be voted will lead fiduciaries to further rely on proxy advisory
firms, which they view as potentially harmful to plans because,
according to these commenters, proxy advisory firms have conflicts of
interest and base their votes on noneconomic ESG policy-driven goals.
Some commenters also opposed the rescission because they believe
language in the regulation was necessary because some fund managers
believed they were obliged to vote proxies on all matters, which
resulted either in the fund managers employing significant assets to
explore the issues implicated in the matters, or in their relying on
proxy advisory services to decide for them how to vote.
After considering the comments, the Department has decided to
rescind the ``not required to vote every proxy'' language as proposed.
The Department's longstanding view of ERISA is that proxies should be
voted as part of the process of managing the plan's investment in
company stock unless a responsible plan fiduciary determines voting
proxies may not be in the plan's best interest (e.g., in cases when
voting proxies may involve exceptional costs or unusual requirements,
such as in the case of voting proxies on shares of certain foreign
corporations).\68\ This position recognizes the importance that prudent
management of shareholder rights can have in enhancing the value of
plan assets or protecting plan assets from risk. However, as explained
in the preamble to the NPRM, the removal of the language is not meant
to indicate that fiduciaries must always vote proxies or engage in
shareholder activism.\69\ Prudent fiduciaries should take steps to
ensure that the cost and effort associated with voting a proxy is
commensurate with the significance of an issue to the plan's financial
interests. The solution to proxy-voting costs is not abstention, but
is, instead, for the fiduciary to be prudent in incurring expenses to
make proxy decisions and, wherever possible, to rely on efficient
structures (e.g., proxy voting guidelines, proxy advisors/managers that
act on behalf of large aggregates of investors, etc.). With regard to
commenters' concerns about fiduciaries' reliance on proxy advisory
firms, the Department notes that, as discussed below, the final rule
retains requirements relating to the prudent selection and monitoring
of services providers to advise or assist with the exercise of
shareholder rights. In order to satisfy that provision, fiduciaries
would be expected to assess the qualifications of the provider, the
quality of services offered, and the reasonableness of fees charged in
light of the services provided. A fiduciary's process also should be
designed to avoid self-dealing, conflicts of interest or other improper
influence.\70\ Fiduciaries additionally should take steps to ensure
they are fully informed of potential conflicts of proxy advisory firms
and the steps such firms have taken to address them.\71\ To the extent
relevant, fiduciaries should review the proxy voting policies and proxy
voting guidelines and the implementing activities of the person being
selected. If a fiduciary determines that the recommendations and other
activities of such person are not being carried out in a manner
consistent with those policies and/or guidelines, then the fiduciary
should take appropriate action in response. The Department further
notes that in 2020, the U.S. Securities and Exchange Commission adopted
final rules that were intended to help ensure that investors who use
proxy voting advice receive more transparent, accurate, and complete
information on which to make their voting decisions.\72\ Information
required to be provided pursuant to those final rules also may be
useful to responsible plan fiduciaries relying on recommendations from
proxy advisory firms.
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\68\ 81 FR 95879, 81 (``The essential point of IB 94-2, however,
was to articulate a general principle that a fiduciary's obligation
to manage plan assets prudently extends to proxy voting. As such, IB
94-2 properly read was meant to express the view that proxies should
be voted as part of the process of managing the plan's investment in
company stock unless a responsible plan fiduciary determined that
the time and costs associated with voting proxies with respect to
certain types of proposals or issuers may not be in the plan's best
interest.''). See also IB 94-2, 59 FR 38861, 63 (July 29, 1994)
(``The fiduciary obligations of prudence and loyalty to plan
participants and beneficiaries require the responsible fiduciary to
vote proxies on Issues that may affect the value of the plan's
investment. Although the same principles apply for proxies
appurtenant to shares of foreign corporations, the Department
recognizes that in voting such proxies, plans may, in some cases,
incur additional costs. Thus, a fiduciary should consider whether
the plan's vote, either by itself or together with the votes of
other shareholders, is expected to have an effect on the value of
the plan's investment that will outweigh the cost of voting.
Moreover, a fiduciary, in deciding whether to purchase shares of a
foreign corporation, should consider whether the difficulty and
expense in voting the shares is reflected in their market price.'').
\69\ 86 FR 57281.
\70\ See 85 FR 81669; see also Department of Labor Information
Letter to Diana Orantes Ceresi (Feb. 19, 1998).
\71\ See ``Selecting and Monitoring Pension Consultants--Tips
for Plan Fiduciaries'' https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/our-activities/resource-center/fact-sheets/selecting-and-monitoring-pension-consultants.pdf.
\72\ See Exemptions from the Proxy Rules for Proxy Voting
Advice, Release No. 34-89372 (July 22, 2020), 85 FR 55082 (Sept. 3,
2020). In July 2022, the SEC amended these final rules. See 87 FR
43168 (July 19, 2022).
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(b) Removal of Specific Recordkeeping Requirement From Paragraph
(e)(2)(ii)(E) of the Current Regulation
The Department proposed to eliminate the requirement in paragraph
(e)(2)(ii)(E) of the current regulation that, when deciding whether to
exercise shareholder rights and when exercising shareholder rights,
plan fiduciaries must maintain records on proxy voting activities and
other exercises of shareholder rights. The Department was concerned
that the provision appeared to treat proxy voting and other exercises
of shareholder rights differently from other fiduciary activities and
might create a misperception that proxy voting and other exercises of
shareholder rights are disfavored or carry greater fiduciary
obligations, and therefore greater potential liability, than other
fiduciary activities. Such a misperception could be harmful to plans,
as it could potentially chill plan fiduciaries from exercising their
right or result in
[[Page 73846]]
excessive expenditures as fiduciaries over-document their efforts.
Some commenters supported removal of the recordkeeping provision,
echoing the Department's concerns stated in the preamble to the NPRM.
Several commenters believed there was no need to single out proxy
voting for special recordkeeping requirements. Some commenters
criticized the recordkeeping requirement as creating a misperception
that exercising shareholder rights carry a greater fiduciary obligation
than other fiduciary activities and a heightened burden when exercised,
which might cause fiduciaries to shy away from exercising shareholder
rights or incur unnecessary compliance expenses when doing so. A
commenter criticized the specific recordkeeping requirement as creating
a new barrier and extra expense, without justification. Several
commenters were of the view that the general framework of ERISA is
sufficient to govern the recordkeeping requirements for proxy voting.
Other commenters opposed removal of the documentation requirement
and suggested that it be retained in the regulation. A commenter
indicated that removing the documentation provision deprives
participants and beneficiaries of information they may use to evaluate
whether fiduciaries are acting in their best interest for their
exclusive benefit. Another commenter similarly suggested that
eliminating the requirement impedes the ability of participants to
monitor plan fiduciaries. Another commenter further opined that
enhanced documentation would help to ensure that ERISA plan proxies are
being voted only in a manner that is in the articulable financial
interest of plan beneficiaries.
The Department is not persuaded by commenters to retain the
specific recordkeeping provision. The Department does not disagree with
the need for proper documentation of fiduciary activity. To the
contrary, in previous guidance on proxy voting, the Department
indicated that section 404(a)(1)(B) requires proper documentation both
of the activities of the investment manager and of the named fiduciary
of the plan in monitoring the activities of the investment manager.\73\
Specifically, with respect to proxy voting, this would require the
investment manager or other responsible fiduciary to keep accurate
records as to the voting of proxies. It is the Department's view that
in order for the named fiduciary to carry out the fiduciary's
responsibilities under ERISA section 404(a), the fiduciary must be able
to review periodically not only the voting procedure pursuant to which
the investment manager votes the proxies appurtenant to plan-owned
stock, but also the actions taken in individual situations so that a
determination can be made whether the investment manager is fulfilling
their fiduciary obligations in a manner which justifies the
continuation of the management appointment. In context, however, the
Department takes note of, and to a large extent agrees with, the
commenters' concern that the current regulation could be viewed by some
as treating proxy voting and other exercises of shareholder rights
differently from other fiduciary activities and may create a
misperception that proxy voting and other exercises of shareholder
rights are disfavored or carry greater fiduciary obligations, and
therefore greater potential liability, than other fiduciary activities.
Because this misperception could be harmful to plans, as it could
potentially chill plan fiduciaries from exercising their rights or
result in excessive expenditures as fiduciaries over-document their
efforts, the Department has concluded it is appropriate to rescind this
provision in the current regulation.
---------------------------------------------------------------------------
\73\ See Letter to Helmuth Fandl, Chairman of the Retirement
Board, Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988) (``[I]t is
the opinion of the Department that section 404(a)(1)(B) requires
proper documentation of the activities of the investment manager and
of the named fiduciary of the plan in monitoring the activities of
the investment manager. Specifically, with respect to proxy voting,
this would require the investment manager or other responsible
fiduciary to keep accurate records as to the voting of proxies.'');
see also Interpretive Bulletin IB 94-2 (July 29, 1994) 59 FR 38860,
63 (``It is the view of the Department that compliance with the duty
to monitor necessitates proper documentation of the activities that
are subject to monitoring. Thus, the investment manager or other
responsible fiduciary would be required to maintain accurate records
as to proxy voting. Moreover, if the named fiduciary is to be able
to carry out its responsibilities under ERISA Sec. 404(a) in
determining whether the investment manager is fulfilling its
fiduciary obligations in investing plans assets in a manner that
justifies the continuation of the management appointment, the proxy
voting records must enable the named fiduciary to review not only
the investment manager's voting procedure with respect to plan-owned
stock, but also to review the actions taken in individual proxy
voting situations.'').
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(c) Removal of Specific Monitoring Requirement From Paragraph
(e)(2)(iii) of the Current Regulation
As discussed above, the Department proposed to eliminate paragraph
(e)(2)(iii) of the current regulation, which set out specific
monitoring obligations where the authority to vote proxies or exercise
shareholder rights has been delegated to an investment manager or proxy
voting firm and proposed to broaden another provision of the regulation
that more generally covers selection and monitoring obligations
(paragraph (d)(2)(ii)(E) of the proposal). The Department was concerned
that the more specific provision relating to providers of certain
proxy-related services could be read as creating special monitoring
obligations above and beyond the statutory obligations of prudence and
loyalty that generally apply to monitoring service providers. In this
regard, the Department noted that it had previously indicated in
Interpretive Bulletin 2016-01 that the general prudence and loyalty
duties under ERISA section 404(a)(1) require a fiduciary to monitor
decisions made and actions taken by an investment manager with regard
to proxy voting decisions. In addition, the Department had previously
indicated that in adopting paragraph (e)(2)(iii) of the current
regulation it did not intend to create a higher standard for a
fiduciary's monitoring of an investment manager's proxy voting
activities than would ordinarily apply under ERISA with respect to the
monitoring of any other fiduciary or fiduciary activity.\74\
---------------------------------------------------------------------------
\74\ 85 FR 81670 (``The Department did not intend to create a
higher standard for a fiduciary's monitoring of an investment
manager's proxy voting activities than would ordinarily apply under
ERISA with respect to the monitoring of any other fiduciary or
fiduciary activity. Thus, the Department has revised the provision
in the final rule to eliminate the requirement for documentation of
the rationale for proxy voting decisions, and instead replaced it
with a more general monitoring obligation.'').
---------------------------------------------------------------------------
Some commenters agreed with the Department's proposed elimination
of paragraph (e)(2)(iii) of the current regulation. One commenter
opined that the specific monitoring requirement in that provision
largely duplicated the general obligation in current paragraph
(e)(2)(ii)(F), which the commenter viewed as redundant and suggestive
that monitoring proxy-related services demand more rigor than required
to monitor other service providers. Other commenters similarly observed
that the current regulation's specific monitoring requirement may have
created an impression that there are special obligations above and
beyond the statutory obligations of prudence and loyalty that generally
apply to monitoring service providers with respect to proxy voting.
Some commenters noted that ERISA's general prudence and loyalty duties
already impose a monitoring requirement on fiduciaries, and further
expressed the view that monitoring service providers with respect to
proxy voting is no different from other fiduciary obligations and
should be subject to the
[[Page 73847]]
same standards. A commenter asserted that there is no basis for
heightened monitoring responsibilities when a fiduciary uses the
services of a proxy advisory firm, and specifically disagreed with
assertions contained in the preamble to the 2020 rule that proxy
advisors are prone to factual and/or analytic errors.
Other commenters opposed the elimination of the specific monitoring
requirement. A commenter viewed it as reasonable and justified to
single out delegated voting authority as particularly deserving of due
diligence and prudent monitoring. This commenter believed it
appropriate for the regulation to remind fiduciaries of their
obligations. Another commenter suggested that the specific monitoring
requirement was necessary to protect plan participants. According to
the commenter, proxy advisory firms are insufficiently staffed and
otherwise ill-suited to conduct the sort of research required under
fiduciary law, and demonstrate a history of advising on self-interested
and politically motivated grounds instead of on purely financial
interests. In this commenter's view, when fund managers rely on the
recommendations of these firms, they may commit a violation of their
duty of care. Another commenter cautioned that removal of the specific
monitoring requirement may create confusion because it would remove the
detailed standards fiduciaries must follow when monitoring the proxy
voting of investment managers and proxy advisory firms.
The Department is not persuaded by the public comments to retain
the specific monitoring provision in paragraph (e)(2)(iii) of the
current regulation. Despite the Department's explicit indication,
described above, that paragraph (e)(2)(iii) of the current regulation
was not intended to create a higher standard in monitoring proxy voting
activities of parties delegated such responsibilities, commenters
continue to express concerns that paragraph (e)(2)(iii) of the current
regulation suggests such heightened obligations. The Department
believes it appropriate to resolve lingering doubts by eliminating
paragraph (e)(2)(iii) of the current regulation, and broadening
paragraph (d)(2)(ii)(E) of the final rule, which sets forth general
selection and monitoring obligations, to additionally cover selection
and monitoring of any person selected to exercise shareholder rights.
The Department believes paragraph (d)(2)(ii)(E) is sufficient to remind
fiduciaries of their responsibilities in selecting and monitoring
persons selected to exercise shareholder rights, and is sufficient to
protect the interests of plan participants and beneficiaries. With
respect to concerns that removal of paragraph (e)(2)(iii) of the
current regulation would eliminate detailed standards that fiduciaries
must follow in monitoring the proxy voting of investment managers and
proxy advisory firms, the Department notes that paragraph (e)(2)(iii)
of the current regulation merely references monitoring activities
relating to shareholder rights for consistency with the regulation. In
the Department's view, a fiduciary's obligations with respect to
monitoring a service provider would include measures to ascertain the
service provider's compliance with ERISA and the terms of the plan.
(d) Provisions of Paragraph (d)(2)(ii) of the Final Rule
Paragraph (d)(2)(ii) of the final rule, like the NPRM and the
current regulation, sets forth specific standards for fiduciaries to
meet when deciding whether to exercise shareholder rights and when
exercising shareholder rights. The requirements in paragraphs
(d)(2)(ii)(A) through (E) of the final rule are intended to confirm and
restate what the prudence and loyalty obligations of ERISA section
404(a)(1)(A) and (B) would require in this context. Paragraph
(d)(2)(ii)(A) of the final rule is the same as proposed except for a
change in cross-reference to paragraph (b)(4). It provides that a
fiduciary must act solely in accordance with the economic interest of
the plan and its participants and beneficiaries, in a manner consistent
with paragraph (b)(4) of the final rule. A commenter requested
confirmation of statements in prior non-regulatory guidance that in
deciding whether to vote a proxy the fiduciary should determine whether
``the plan's vote, either by itself or together with the votes of other
shareholders, is expected to have an effect on the value of the plan's
investment that warrants the additional cost of voting.'' \75\ In the
commenter's view, without such confirmation, the ``solely in the
interest'' requirement of paragraph (d)(2)(ii)(A) may limit plan voting
where a plan holds a relatively small investment that, on its own,
might not affect the outcome of a vote. In response, the Department
confirms that in making decisions regarding the exercise of a plan's
shareholder rights, a fiduciary's analysis may include consideration of
the effects of the plan's exercise, either by itself or together with
the exercise of rights of other shareholders.
---------------------------------------------------------------------------
\75\ Interpretive Bulletin 2016-01, 81 FR 95882 at 95883.
---------------------------------------------------------------------------
Paragraph (d)(2)(ii)(B) of the final rule is adopted as proposed.
It requires that when deciding whether to exercise shareholder rights
and when exercising shareholder rights, a fiduciary must consider any
costs involved. The Department received no comments on this provision.
Paragraph (d)(2)(ii)(C) of the proposal provided that a fiduciary
must not subordinate the interests of the participants and
beneficiaries in their retirement income or financial benefits under
the plan to any other objective, or promote benefits or goals unrelated
to those financial interests of the plan's participants and
beneficiaries. A commenter suggested deleting the clause ``or promote
benefits or goals unrelated to those of financial interests of the
plan's participants and beneficiaries'' from paragraph (d)(2)(ii)(C).
The commenter reasoned that where a particular exercise of a
shareholder right would not directly affect shareholder value, the
language could be read to prohibit such exercise. Another commenter
with the same request explained that the deletion would clarify that
fiduciaries are not required to undertake a burdensome economic
analysis before voting proxies. This commenter opined that in some
cases, it may be even less expensive to cast the vote than speculate
whether the vote in question ``promotes'' benefits or goals unrelated
to those financial interests of the plan's participants and
beneficiaries. Both commenters opined that voting under these
circumstances would be allowed under a tiebreaker standard. Other
commenters raised concerns regarding increased potential for litigation
more generally and requested that the Department factor that potential
into all decisions under the final regulation; in this context, that
concern might present as a dispute over whether and the extent to which
any particular vote was an affirmative ``promotion'' of an
impermissible goal as opposed to a vote on a matter the outcome of
which might confer an ancillary benefit on a stakeholder other than the
plan.
The Department was persuaded by the commenters' suggestion to
remove the clause from paragraph (d)(2)(ii)(C). On review, the
Department has concluded that the clause at issue serves no independent
function, in terms of adding protections to plan participants, that is
not already served by paragraph (d)(2)(ii)(A) (requirement to act
``solely in accordance with the economic interests of the plan'') and
the first clause of paragraph (d)(2)(ii)(C)
[[Page 73848]]
(requirement ``not to subordinate the interests of participant and
beneficiaries in their retirement income or financial benefits under
the plan to any other objectives'') of the final rule. In addition to
being unnecessary, as pointed out by the commenters, the clause is
easily misconstrued as suggesting or implying an affirmative duty on
plan fiduciaries, above and beyond those duties contained in the other
two paragraphs already mentioned, that requires the fiduciaries to do
something further to investigate and ensure that their votes or other
exercises do not promote objectives or goals unrelated the financial
interests of the plan, or perform an analysis of each vote's benefit.
The Department sees no reason to impose such additional duties, with
their attendant costs and potential for litigation, when the other two
provisions mentioned are fully adequate to protect the interests of
plan participants.
The purpose of the clause was to ensure that a fiduciary does not
exercise proxy voting and other shareholder rights with the goal of
advancing nonpecuniary goals unrelated to the financial interests of
the plan's participants and beneficiaries so long as it does not result
in increased costs to the plan or a decrease in value of the
investment.\76\ This clause thus dovetailed with a longstanding
position of the Department that ERISA prohibits plan fiduciaries from
expending trust assets to promote myriad public policy preferences.\77\
The final rule's removal of the clause at issue does not constitute a
rejection of this principle. However, with respect to the concern that
the fiduciary must determine that an exercise of shareholder rights
would directly affect shareholder value, the Department's historical
view has been that ERISA's fiduciary obligations of prudence and
loyalty require the responsible fiduciary to vote proxies on issues
that may affect the value of the plan's investment.\78\ With respect to
the commenters referring to the tiebreaker test, although that test is
not applicable in this context, the Department further notes that when
a plan fiduciary exercises voting authority, a violation of paragraph
(d)(2)(ii)(C) of the final rule would not occur merely because
stakeholders other than the plan would potentially benefit along with
the investing plan.
---------------------------------------------------------------------------
\76\ 85 FR 816658, 67 (Dec. 16, 2020).
\77\ 81 FR 95879, 81 (Dec. 29, 2016) (preamble to IB 2016-01)
(``The Department has rejected a construction of ERISA that would
render ERISA's tight limits on the use of plan assets illusory and
that would permit plan fiduciaries to expend trust assets to promote
myriad public policy preferences. Rather, plan fiduciaries may not
increase expenses, sacrifice investment returns, or reduce the
security of plan benefits in order to promote collateral goals.'');
Advisory Opinion Nos. 2008-05A (June 27, 2008) and 2007-07A (Dec.
21, 2007).
\78\ See Interpretive Bulletin 94-2, 59 FR 38860; Interpretive
Bulletin 2016-01, 81 FR 95879.
---------------------------------------------------------------------------
Paragraph (d)(2)(ii)(D) of the final rule requires that when
deciding whether to exercise shareholder rights and when exercising
shareholder rights, a fiduciary must evaluate relevant facts that form
the basis for any particular proxy vote or other exercise of
shareholder rights. The provision is the same as proposed, except that
the Department has substituted the term ``relevant'' for ``material''
for purposes of consistency throughout the regulation, as discussed
above.
Paragraph (d)(2)(ii)(E) of the final rule is being adopted as
proposed, and requires that a fiduciary must exercise prudence and
diligence in the selection and monitoring of persons, if any, chosen to
exercise shareholder rights or otherwise to advise on or assist with
exercises of shareholder rights, such as providing research and
analysis, recommendations regarding proxy votes, administrative
services with voting proxies, and recordkeeping and reporting services.
As discussed above, this provision covered obligations that were set
forth in paragraphs (e)(2)(ii)(F) and (e)(2)(iii) of the current
regulation. The provision is essentially a restatement of the general
fiduciary obligations that apply to the selection and monitoring of
plan service providers, articulated in the context of fiduciary and
other service providers that exercise shareholder rights, or advise or
assist with exercises of shareholder rights.
A commenter requested that the Department delete the list of
services--``research and analysis, recommendations regarding proxy
votes, administrative services with voting proxies, and recordkeeping
and reporting services''--from the provision. The commenter was
concerned that codifying an itemized list of duties that, according to
the commenter, fiduciaries routinely delegate to investment managers
and proxy voting firms may cause confusion or uncertainty over
regulatory expectations regarding any delegation of these fiduciary
responsibilities to a third party. The Department has not accepted this
comment, and notes that this paragraph is focused on fiduciary duties
of prudence and loyalty under ERISA section 404(a)(1)(A) and (B) in the
selection and monitoring of particular service providers, and is not
attempting to limit in any way the types of services that a plan or
plan fiduciary may utilize in connection with exercising shareholder
rights.
Another commenter requested that the Department clarify that
fiduciaries are not required to monitor every proxy vote or second-
guess other fiduciaries' specific proxy voting decisions, unless the
fiduciary knows or should know the designated fiduciary is violating
ERISA with their proxy voting procedures. Whether a fiduciary has
complied with its obligations under paragraph (d)(2)(ii)(E) depends on
the surrounding circumstances. The Department does not believe that a
fiduciary would generally be required to monitor each vote or second-
guess other fiduciaries' decisions. To the extent applicable, a
fiduciary would be expected to review the proxy voting policies and/or
proxy voting guidelines and the implementing activities of the person
being selected to exercise votes. If a fiduciary determines that the
activities of such person are not being carried out in a manner
consistent with those policies and/or guidelines, then the fiduciary
will be expected to take appropriate action in response.\79\
---------------------------------------------------------------------------
\79\ See 85 FR 81669.
---------------------------------------------------------------------------
(3) Paragraph (d)(2)(iii)
Paragraph (d)(2)(iii) of the proposal stated that a fiduciary may
not adopt a practice of following the recommendations of a proxy
advisory firm or other service provider without a determination that
such firm or service provider's proxy voting guidelines are consistent
with the fiduciary's obligations described in provisions of the
regulation. This provision was based on paragraph (e)(2)(iv) of the
current regulation, which was intended to address specific concerns
involving fiduciaries' use of proxy advisory firms and similar service
providers, including use of automatic voting mechanisms relying on
proxy advisory firms.
Some commenters viewed paragraph (d)(2)(iii) as largely unnecessary
because, in their view, a fiduciary's review of a service provider's
proxy voting guidelines would already be required as part of the
fiduciary's compliance with ERISA's prudence and loyalty requirements
in the selection of a service provider. Some commenters moreover
cautioned that paragraph (d)(2)(iii) could be construed as suggesting
that monitoring proxy-related services demands more rigor than required
to monitor other service providers. A commenter noted that the
provision requires a specific determination when a fiduciary ``adopts a
practice of following the recommendations of a proxy advisory firm or
other service provider,'' and thus
[[Page 73849]]
would establish an additional vague and heightened burden that is
unnecessary and a potential deterrent to informed, responsible
shareholder engagement.
Other commenters viewed the provisions as necessary. One commenter
opined that it is crucial that ERISA fiduciaries have a full
understanding of the proxy advisory firm's guidelines and
recommendations before relying on their advice. In this commenter's
view, robo-voting presents clear risks to participants given proxy
advisory firms' one-size-fits-all policies. Another commenter expressed
the view that evaluation of climate risks is extremely difficult, and
criticizes proxy advisors as not being particularly well-suited to
perform climate analysis. Furthermore, as described above, a number of
other commenters expressed concerns about proxy advisory firms'
conflicts and quality of services.
In proposing paragraph (d)(2)(iii), the Department did not propose
to make any changes to requirements contained in the corresponding
provision of the current regulation, paragraph (e)(2)(iii). The
Department is not persuaded that any of the requirements should be
eliminated or otherwise modified. We note that paragraph (d)(2)(iii)
deals with a fiduciary's process for making proxy voting decisions
(i.e., the reliance on recommendations or advice from a service
provider) and does not touch on the fiduciary's obligations with regard
to the selection and monitoring of the service providers used. The
provision relates to oversight obligations of fiduciaries that
essentially automatically rely on a service provider in carrying out
the fiduciary's own obligations.\80\ We do not believe that potential
misunderstandings as to fiduciary monitoring obligations with respect
to providers of proxy-related services, which is addressed in paragraph
(d)(2)(ii)(E) of the final rule, is sufficient to justify modification
or elimination of paragraph (d)(2)(iii). As a result, paragraph
(d)(2)(iii) is being adopted without change.
---------------------------------------------------------------------------
\80\ 85 FR 81671.
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(c) Paragraph (d)(3)
In recognition of the appropriateness of ERISA fiduciaries'
adoption of proxy voting policies to help them more cost effectively
comply with their obligations under ERISA and the regulation, paragraph
(d)(3) of the proposal carried forward from the current regulation
general provisions relating to the adoption of proxy voting policies.
The proposal did not, however, carry forward from the current
regulation two ``safe harbor'' policies that could be used for
satisfying the fiduciary responsibilities under ERISA with respect to
decisions whether to vote. The first permitted a policy of limiting
voting resources to particular types of proposals that the fiduciary
has prudently determined are substantially related to the issuer's
business activities or are expected to have a material effect on the
value of the investment. The second permitted a policy of not voting on
proposals or particular types of proposals when the plan's holding in a
single issuer relative to the plan's total investment assets is below a
quantitative threshold that the fiduciary prudently determines,
considering its percentage ownership of the issuer and other relevant
factors, is sufficiently small that the matter being voted upon is not
expected to have a material effect on the investment performance of the
plan's portfolio. The Department proposed rescinding these safe harbors
because it lacked confidence that they were necessary or helpful in
safeguarding the interests of plan participants and beneficiaries. The
Department also was concerned that, in conjunction with other
provisions in the current regulation, the safe harbors could be
construed as regulatory permission for plans to broadly abstain from
proxy voting without properly considering their interests as
shareholders.
(1) Rescission of Safe Harbors From Paragraphs (e)(3)(i)(A) and (B) of
the Current Regulation
The Department received a range of comments on the proposed
rescission of the safe harbor policies. Some commenters agree with the
Department's general concern that, by their nature safe harbors can
invite adoption, which makes it important that the safe harbors be in
participants' best interest. In this regard, some commenters generally
asserted that the safe harbors may encourage fiduciaries to limit their
proxy voting in ways that harm participants and beneficiaries. Also,
without identifying a particular safe harbor, some commenters asserted
that the proxy voting rule adopted in 2020 provided no justification as
to how the safe harbors were consistent with ERISA's duties of loyalty
and prudence. Another commenter opined that because a decision by an
ERISA plan to not vote effectively cedes voting power to other
shareholders, it should only be permitted on a case-by-case basis
rather than pursuant to a general safe harbor to refrain from voting.
One commenter opined that neither safe harbor was particularly helpful,
and there is little evidence that a material number of fiduciaries are
currently relying on them. Another commenter cautioned that the safe
harbor provisions could be interpreted as best-practice and encourage
shareholders to follow those examples, instead of their established
practices in line with stated investment policies and obligations under
ERISA.
Commenters also raised specific concerns on the safe harbors. With
respect to the first safe harbor, a commenter expressed the view that a
policy to vote only particular types of proposals, depending on the
scope of the policy, may be too limited to capture all relevant
proposals. Another commenter criticized the first safe harbor as being
based on an unsupported premise that certain types of proxy votes are
not substantially related to the issuer's business activities or are
expected to have a material effect on the value of the investment. The
commenter noted that many of the topics that corporate law permits
shareholders to have a say on--e.g., election of directors or
ratification of auditors--play an important risk mitigation role, and
asserted that these types of issues are often prophylactic and do not
readily lend themselves to an analysis of whether they will lead to a
material effect on the value of a plan investment. The commenter
cautioned that the first safe harbor encouraged fiduciaries to pass on
these and other proxy matters, and thus created a genuine risk to plan
participants' long-term interests.
With respect to the second safe harbor, a commenter expressed
concern that a policy to refrain from voting unless the plan holds a
concentrated position in a company suggests that diversified investors,
such as plan fiduciaries, should not have a voice in corporate
decisions. Another commenter asserted that the second safe harbor was
never fully explained or substantiated, and viewed it as being premised
on the notion that not voting at most, or perhaps all, meetings a plan
would be entitled to vote at would be in the best interest of
participants.
Other commenters neither supported nor opposed elimination of the
safe harbors, but emphasized that proxy voting policies in general are
useful to fiduciaries in making proxy voting decisions. One commenter
requested confirmation from the Department that removal of the safe
harbors from the regulation would not preclude, and should not be
interpreted as discouraging, the adoption of such policies in
appropriate circumstances. The commenter indicated that for many types
of investment strategies, limiting voting resources, for example, to
those
[[Page 73850]]
matters that are expected to have a material effect on the value of the
investment is the prudent course of action. According to the commenter,
in other cases adopting a policy to refrain from voting on proposals,
or particular types of proposals, based on a prudently determined
quantitative threshold could be in the best interest of plan
participants and beneficiaries.
Other commenters opposed rescission of the safe harbors. A
commenter stated that the safe harbors appropriately recognized
instances in which proxy voting would not be expected to have economic
effect. The commenter cautioned that without the safe harbors,
fiduciaries find the path of least resistance in hiring proxy advisory
firm to vote all proxies, which would result in promoting ESG policies
and raising a variety of concerns regarding proxy advisory firms, as
discussed above.
After considering the public comments, the Department is not
persuaded to retain the safe harbors. Taken together, they encourage
abstention as the normal course. Regulatory safe harbors tend to be
widely adopted and the Department no longer believes it should be
promoting abstention with these safe harbors. The Department has never
taken the position that ERISA requires fiduciaries to cast a proxy vote
on every ballot item. Thus, it follows that abstention or not voting on
a matter or matters may be appropriate and not a violation of ERISA,
from the Department's perspective. Voting rights, however, are a type
of plan asset and, in the Department's view, an important tool to
protect the plan's investment. The Department's longstanding view of
ERISA is that proxies should be voted as part of the process of
managing the plan's investment in company stock unless a responsible
plan fiduciary determines voting proxies may not be in the plan's best
interest (e.g., in cases when voting proxies may involve out of the
ordinary costs or unusual requirements, such as in the case of voting
proxies on shares of certain foreign corporations).\81\ This position
recognizes the importance that prudent management of shareholder rights
can have in enhancing the value of plan assets or protecting plan
assets from risk. Finally, as to commenters' concerns about reliance on
proxy advisory firms and quality of their services, the final rule also
retains requirements relating to the prudent selection and monitoring
of service providers to advise or assist with the exercise of
shareholder rights.
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\81\ 81 FR 95879, 81.
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(2) Provisions of Paragraph (d)(3) of the Final Rule
Paragraph (d)(3)(i) of the proposal provided that in deciding
whether to vote a proxy pursuant to paragraphs (d)(2)(i) and (ii) of
the proposal, fiduciaries may adopt proxy voting policies providing
that the authority to vote a proxy shall be exercised pursuant to
specific parameters prudently designed to serve the plan's interest in
providing benefits to participants and their beneficiaries and
defraying reasonable expenses of administering the plan. Proposed
paragraph (d)(3)(i) was based on paragraph (e)(3)(i) of the current
regulation, but as discussed above did not retain the current
regulation's two safe harbor proxy voting policies. Several commenters
expressed general support for the Department's recognition of the
usefulness of proxy voting policies to fiduciaries. However, the
Department did not receive substantive comment on this provision of the
proposal, and it is being adopted without substantive modification.\82\
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\82\ Paragraph (d)(3)(iii) of the final rule uses the term
``significant effect on the value of the investment'' rather than
``material'' effect. No substantive change is intended by the
revision as the Department believes that ``significant'' is
generally the same as the adjective ``material'' in this context.
The Department recognized this similarity in the preamble to the
current regulation, but erroneously concluded then that the term
``material'' would be more familiar and helpful to ERISA plan
fiduciaries. 85 FR 81658, 72 (December 16, 2020). However, as
discussed above at section B1.(f) (4) of this preamble, commenters
on the NPRM did not agree that the word ``material'' is a helpful
term in this regulatory section because of its varied uses and
meanings under accounting conventions, Federal securities laws, and
other regulatory regimes. Compare note 44 (in other contexts, the
final regulation substitutes ``material'' with ``relevant,'' but
that adjective does not work well here where the focus is on the
size of the impact of one thing on another thing as opposed to the
closeness of connection between two things).
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Paragraphs (d)(3)(ii) of the proposal required plan fiduciaries to
periodically review proxy voting policies adopted pursuant to the
regulation. The Department received no comments on this provision of
the proposal, and it is being adopted without modification.
Paragraph (d)(3)(iii) of the proposal related to the effect of
proxy voting policies adopted pursuant to the regulation, and provided
that no proxy voting policies adopted pursuant to paragraph (d)(3)(i)
shall preclude submitting a proxy vote when the fiduciary prudently
determines that the matter being voted upon is expected to have a
material effect on the value of the investment or the investment
performance of the plan's portfolio (or investment performance of
assets under management in the case of an investment manager) after
taking into account the costs involved, or refraining from voting when
the fiduciary prudently determines that the matter being voted upon is
not expected to have such a material effect after taking into account
the costs involved. This provision recognized that, depending on the
circumstances, a fiduciary may conclude that the best interests of the
plan and its participant and beneficiaries would not be served by
following the plan's proxy voting policies in a particular case. In
such cases, paragraph (d)(3)(iii) of the proposal ensured that a
fiduciary have the needed flexibility to deviate from those policies
and take a different approach. The Department received no substantive
comments on this provision of the proposal, and it is being adopted
without modification. One commenter requested clarification that
fiduciaries are not required by this provision to conduct an analysis
of each proxy vote to determine whether a fiduciary needs to deviate
from the proxy voting policies. The commenter misapprehends the nature
of the provision. The provision does not speak, directly or indirectly,
to voting frequency or establish obligations with respect to the
question of whether or how often plan fiduciaries should be voting
proxies. The provision seeks to ensure that plan fiduciaries may safely
deviate from the generally governing written instruments as may be
needed from time-to-time in circumstances when doing so is in the best
economic interest of plan participants. In this way, the provision
shields a fiduciary from liability to the extent that a fiduciary
deviates from written policies based on the fiduciary's conclusion that
a different approach in a particular case is in the economic interests
of the plan considering the facts and circumstances.
(d) Paragraph (d)(4)
Paragraphs (d)(4)(i) and (ii) of the proposal, like paragraphs
(e)(4)(i) and (ii) of the current regulation, reflect longstanding
positions expressed in the Department's prior Interpretive Bulletins.
(1) Paragraph (d)(4)(i)
Paragraph (d)(4)(i)(A) of the proposal stated that the
responsibility for exercising shareholder rights lies exclusively with
the plan trustee except to the extent that either the trustee is
subject to the directions of a named fiduciary pursuant to ERISA
section 403(a)(1), or the power to manage,
[[Page 73851]]
acquire, or dispose of the relevant assets has been delegated by a
named fiduciary to one or more investment managers pursuant to ERISA
section 403(a)(2). Paragraph (d)(4)(i)(B) of the proposal stated that
where the authority to manage plan assets has been delegated to an
investment manager pursuant to ERISA section 403(a)(2), the investment
manager has exclusive authority to vote proxies or exercise other
shareholder rights appurtenant to such plan assets in accordance with
this section, except to the extent the plan, trust document, or
investment management agreement expressly provides that the responsible
named fiduciary has reserved to itself (or to another named fiduciary
so authorized by the plan document) the right to direct a plan trustee
regarding the exercise or management of some or all of such shareholder
rights.
A commenter indicated that an increasing number of ERISA plan
fiduciaries may choose to retain the ability to instruct the plan's
trustee or investment manager to implement a proxy voting policy chosen
by the plan fiduciary. The commenter requested that the Department add
to paragraph (d)(4)(i)(B) language stating that a named fiduciary may
direct an investment manager regarding the exercise or management of
shareholder rights. The Department declines to adopt this commenter's
request. In the Avon Letter, discussed above, the Department cautioned
that ERISA contains no provision that would relieve an investment
manager of fiduciary liability for any decision it made at the
direction of another person. The commenter did not indicate whether it
was requesting a reconsideration of this aspect of the Avon Letter, or
guidance on different issues or arrangements than considered in the
Avon Letter. In any event, an evaluation of issues related to the
direction of a fiduciary investment manager by another person
implicates provisions of ERISA, including sections 402, 403, and 405,
that are beyond the scope of this rulemaking.
(2) Paragraph (d)(4)(ii)
Paragraph (d)(4)(ii) of the proposal described obligations of an
investment manager of a pooled investment vehicle that holds assets of
more than one employee benefit plan. The provision provides that an
investment manager of such a pooled investment vehicle may be subject
to an investment policy statement that conflicts with the policy of
another plan. Furthermore, it provided that compliance with ERISA
section 404(a)(1)(D) requires the investment manager to reconcile,
insofar as possible, the conflicting policies (assuming compliance with
each policy would be consistent with ERISA section 404(a)(1)(D)).\83\
The provision further stated that, in the case of proxy voting, to the
extent permitted by applicable law, the investment manager must vote
(or abstain from voting) the relevant proxies to reflect such policies
in proportion to each plan's economic interest in the pooled investment
vehicle. The provision further provided that such an investment manager
may, however, develop an investment policy statement consistent with
Title I of ERISA and the regulation, and require participating plans to
accept the investment manager's investment policy statement, including
any proxy voting policy, before they are allowed to invest. In such
cases, a fiduciary must assess whether the investment manager's
investment policy statement and proxy voting policy are consistent with
Title I of ERISA and the regulation before deciding to retain the
investment manager.
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\83\ Section 404(a)(1)(D) of ERISA provides that a fiduciary
must discharge its duties with respect to the plan in accordance
with the documents and instruments governing the plan insofar as
such documents are consistent with the provisions of title I and
title IV of ERISA. Under section 404(a)(1)(D), a fiduciary to whom
an investment policy applies would be required to comply with such
policy unless, for example, it would be imprudent to do so in a
given instance.
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The Department received a number of comments indicating generally
that investment managers of pooled funds would face operational
challenges in reconciling conflicting proxy voting policies of
investing plans and voting in a proportional manner, as described in
the beginning of proposed paragraph (d)(4)(ii). Commenters indicated
that because of these challenges, most investment managers of pooled
investments require investing plans to accept the investment manager's
policy, which is also contemplated in the latter portions of proposed
paragraph (d)(4)(ii). Some commenters suggested that paragraph
(d)(4)(ii) could be improved by placing more emphasis on the current
common practices that do not require proportional voting (i.e., where
investment managers require plans' acceptance of the managers' proxy
voting policies prior to investment), and less emphasis on arrangements
that require proportional voting, which these commenters believe is
rare.
Some commenters requested that the Department broaden proposed
paragraph (d)(4)(ii). One commenter requested modification to address
the possibility that the responsible named fiduciary may choose to
retain the authority to vote proxies or to direct an investment manager
regarding the voting of proxies appurtenant to those plan assets that
are invested in a pooled investment vehicle. Other commenters requested
that the Department extend the provision to separately-managed accounts
that are managed by investment managers. This suggestion appears to be
based on the common practice of investment managers in single-plan
separate account arrangements requiring that plans accept the managers'
proxy voting policy prior to investing.
Some commenters requested that the final rule address circumstances
where investment managers have not obtained consent from participating
plans accepting the manager's investment policy and proxy voting policy
prior to initial investment. Commenters requested that the Department
allow an investment manager to rely on a ``negative consent''
procedure, such as by sending a written notice stating that plans will
be deemed to have accepted the investment manager's investment policy
and proxy voting policy if they continue investing with the investment
manager after receiving the notice.
Another commenter suggested that the Department eliminate proposed
paragraph (d)(4)(ii) in its entirety and revise proposed paragraph
(d)(4)(i)(B) to explicitly cover investment managers for pooled
investment vehicles that hold plan assets. According to the commenter,
proposed paragraph (d)(4)(ii) could result in conflicting or
misinterpreted regulatory expectations. Similar to commenters discussed
above, this commenter explained that paragraph (d)(4)(ii) does not
reflect current industry standard practice followed by investment
managers for collective investment funds and other pooled investment
vehicles that hold ERISA plan assets. In particular, it stated that it
was not aware of any collective investment fund or other pooled
investment vehicles that did not have their own investment objectives,
guidelines, and/or policies that must be accepted as a condition for
investment. The commenter further suggested that if a national bank
trustee of a collective investment fund, in managing the fund's
portfolio, attempts ``to reconcile, insofar as possible, the
conflicting [investment] policies [of plans],'' this may inevitably
favor some plans over others. The commenter raised the question as to
whether this may be inconsistent with Office of the Comptroller of the
Currency expectations regarding that bank's treatment of participants
in a pooled investment fund.
The Department is not persuaded to remove paragraph (d)(4)(ii) from
the
[[Page 73852]]
final rule or make the language changes requested by commenters.
Paragraph (d)(4)(ii) of the proposal is identical to paragraph
(e)(4)(ii) of the current regulation, and also is similar to guidance
relating to pooled investment vehicles that has been consistently part
of the Department's prior Interpretive Bulletins since 1994. A number
of the issues raised with respect to paragraph (d)(4)(ii) of the
proposal, particularly relating to difficulties with proportional
voting and industry common practices to avoid being subject to
proportional voting, were also raised by commenters with respect to
paragraph (e)(4)(ii) of the current regulation but not accepted by the
Department. As with the current regulation, the Department declines to
reorder the provisions within paragraph (d)(4)(ii) of the final rule
solely to put more emphasis on the exception to the proportional voting
provision. The Department does not interpret the public comments as
saying that paragraph (d)(4)(ii) of the NPRM is unworkable, but rather
that the popularity of the exception justifies a reorganization of the
constituent parts of the paragraph to elevate the prominence of the
exception to match common industry practice. The organizational
structure of paragraph (d)(4)(ii) of the final rule intentionally
begins with the general requirement and is followed by the exception to
that requirement--a structure which has been in place for approximately
four decades. The Department believes this structure to be sound and
logical notwithstanding the current popularity of the exception. In
addition, with respect to the commenters' more fundamental suggestions
including eliminating paragraph (d)(4)(ii) in its entirety, the NPRM
narrowly solicited comments on whether the provision in question should
be revised to conform more closely to the Department's prior
guidance.\84\ These more fundamental suggestions are well beyond the
scope of the solicitation in the NPRM because, if adopted, they would
cause paragraph (d)(4)(ii) of the final to diverge substantially from
the prior guidance. Also, as discussed above, issues relating to a
named fiduciary's direction of an investment manager with respect to
voting decisions implicate provisions of ERISA beyond the scope of this
rulemaking. Although the Department declines to extend paragraph
(d)(4)(ii) of the final rule to include managers of separately managed
accounts, we note that there is nothing in ERISA that precludes an
investment manager from requiring a plan fiduciary to accept the
investment manager's proxy voting policies before agreeing to become a
plan investment manager. With regard to requests for approval of
``negative consent'' procedure for adoption of proxy policies by plans
with current investments in a pooled investment vehicle, the Department
believes the later applicability date of paragraph (d)(4)(ii) should
alleviate commenters' concerns.
---------------------------------------------------------------------------
\84\ 86 FR 57283.
---------------------------------------------------------------------------
(e) Paragraph (d)(5)
Paragraph (d)(5) of the NPRM provided that the regulation does not
apply to voting, tender, and similar rights with respect to shares of
stock that, pursuant to the terms of an individual account plan, are
passed through to participants and beneficiaries with accounts holding
such shares. The Department did not receive comments on this provision,
which is being adopted as proposed. Despite this exclusion,
participants and beneficiaries are not without ERISA's protections. The
Department stresses that plan trustees and other fiduciaries must
comply with ERISA's general statutory duties of prudence and loyalty
provisions with respect to the pass through of votes to plan
participants and beneficiaries. In doing so, however, plan fiduciaries
may continue to rely on the Department's prior guidance with respect to
such participant-directed voting, including 29 CFR 2550.404c-1
(implementing ERISA section 404(c)(1) to participant-directed pass-
through voting) and interpretive letters.\85\
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\85\ See, e.g., Letter from Deputy Assistant Secretary Lebowitz
to Thobin Elrod (Feb. 23, 1989); Letter from Assistant Secretary
Berg to Ian Lanoff (Sept. 28, 1995).
---------------------------------------------------------------------------
5. Section 2550.404a-1(e)--Definitions
Paragraph (e) of the final rule provides definitions and is
unchanged from the proposal and current regulation. Under paragraph
(e)(1) of the final rule, ``investment duties'' means any duties
imposed upon, or assumed or undertaken by, a person in connection with
the investment of plan assets which make or will make such person a
fiduciary of an employee benefit plan or which are performed by such
person as a fiduciary of an employee benefit plan as defined in section
3(21)(A)(i) or (ii) of ERISA. Paragraph (e)(2) defines the term
``investment course of action'' 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. Paragraph (e)(3)
defines ``plan'' to mean an employee benefit plan to which Title I of
ERISA applies. Finally, under paragraph (e)(4) of the final rule, the
term ``designated investment alternative'' means any investment
alternative designated by the plan into which participants and
beneficiaries may direct the investment of assets held in, or
contributed to, their individual accounts. The provision further
provides that the term ``designated investment alternative'' shall not
include ``brokerage windows,'' ``self-directed brokerage accounts,'' or
similar plan arrangements that enable participants and beneficiaries to
select investments beyond those designated by the plan.
6. Section 2550.404a-1(f)--Severability
Paragraph (f) of the final rule, like paragraph (f) of the proposal
and paragraph (h) of the current regulation, provides that should a
court of competent jurisdiction hold any provision of the rule invalid,
such action will not affect any other provision. Including a
severability clause describes the Department's intent that any legal
infirmity found with part of the final rule should not affect any other
part of the rule.
7. Section 2550.404a-1(g)--Applicability Date
The proposed rule did not include an applicability date provision.
Some commenters requested that the Department provide a prospective
applicability date for all recent changes to the regulation (including
both changes made in 2020 as well as amendments to the current
regulation made today by the final rule) that is no earlier than the
date that would be one year after the Department's publication of this
final rule in the Federal Register. The commenters indicated that plan
sponsors, investment managers, proxy advisory firms, and other
fiduciaries need adequate time to, as necessary, review and modify
their policies, procedures, and practices to conform to the final
rule's requirements.
Some commenters also specifically suggested a need for transition
relief or a delayed applicability date with respect to the proxy voting
provisions. One commenter requested that the Department retain and
extend the delayed applicability date of certain requirements of the
regulation as set forth in paragraph (g)(3) of the current regulation.
In general, that provision delayed until January 31, 2022, the
applicability of the requirements of paragraphs (e)(2)(ii)(D)
(evaluation of
[[Page 73853]]
material facts that form the basis of a vote), (e)(2)(ii)(E)
(maintenance of proxy voting records), (e)(2)(iv) (prohibition against
adopting practice of following proxy advisory firm recommendations
without determination that firm's voting guidelines consistent with
requirements of regulation), and (e)(4)(ii) (responsibilities of
investment managers to pooled investment vehicles holding plan assets)
of the current regulation.\86\ The commenter noted that investment
managers to pooled investment vehicles may have delayed their
implementation efforts due to the announcement in March 2021 of the
Department's enforcement policy. Others pointed to difficulties faced
by investment managers in assuring that investing plans had adequately
adopted manager's proxy voting policies as required under paragraph
(d)(4)(ii).
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\86\ Fiduciaries that are investment advisers registered with
the SEC were not able to take advantage of the delayed applicability
of paragraphs (e)(2)(ii)(D) and (E). See 85 FR 81676.
---------------------------------------------------------------------------
After consideration of the comments, the Department has decided to
provide a general applicability date of 60 days after publication in
the Federal Register, but to delay applicability of certain provisions
of the final rule's proxy voting provisions until 1 year after the date
of publication. The Department is persuaded that a delayed
applicability of paragraph (d)(4)(ii) of the final rule is appropriate
as it gives fiduciaries of plans invested in pooled investment vehicles
additional time for reviewing any proxy voting policies of the
investment vehicle's investment manager; and also provides investment
managers additional time to determine whether investing plans have
adequately adopted their proxy voting policies, as well as assessing
and reconciling, insofar as possible, any conflicting policies. The
Department also believes it appropriate to delay application of
paragraph (d)(2)(iii) to give additional time to plan fiduciaries to
review proxy voting guidelines of proxy advisory firms and make any
necessary changes in their arrangements with such firms. The Department
is providing for a delay of one year as requested by commenters. The
Department's March 10, 2021, enforcement statement continues to apply
with respect to paragraphs (d)(2)(iii) and (d)(4)(ii) until the delayed
applicability date.
Thus, paragraph (g)(1) provides that except for paragraphs
(d)(2)(iii) and (d)(4)(ii), the final rule will apply in its entirety
to all investments made and investment courses of action taken after
January 30, 2023. Paragraph (g)(2) provides that paragraphs (d)(2)(iii)
and (d)(4)(ii) of the final rule will apply on December 1, 2023.
8. Miscellaneous
(a) Constitutional Concerns
A few commenters argue that the proposed rule violates the U.S.
Constitution. These commenters contend that the proposal is
unconstitutional because permitting fiduciaries to base their
investment decisions on any non-pecuniary factors cannot be consistent
with ERISA and thus rewrites the statute, which is the sole
responsibility of Congress. As a result, they argue that the Department
violates the separation of powers imposed by the Constitution.
The Department does not agree that the final rule rewrites ERISA or
violates the Constitution. Congress has given the Secretary of Labor
authority to promulgate regulations that interpret and fill up the
details in the fiduciary duties under ERISA section 404, including the
duties of prudence and loyalty.\87\ The Department here interprets
those duties to protect plan participants' financial benefits and
strictly prohibits any other goal from subordinating their interests in
those benefits. Nothing in the final rule permits a fiduciary, outside
of a tiebreaker situation, to base investment decisions on factors
irrelevant to a risk and return analysis. The Secretary has maintained
these fundamental interpretive principles in its guidance, referenced
earlier in this preamble, since 1980 and its first comprehensive
guidance in 1994. Moreover, the principles stated in the proposed and
final rule, including the tiebreaker, were fundamental aspects of that
guidance.
---------------------------------------------------------------------------
\87\ See 29 U.S.C. 1135 (providing that ``the Secretary may
prescribe such regulations as he finds necessary or appropriate to
carry out the provisions of this subchapter'').
---------------------------------------------------------------------------
(b) Administrative Procedure Act
In addition, some commenters asserted that the proposed rule was
arbitrary and capricious and thus violated the Administrative Procedure
Act (APA). The Department is of the view that the final rule comports
with the APA.
Several commenters claimed that the NPRM did not engage in reasoned
decision-making, did not look at all aspects of the problem, and did
not properly consider the costs to participants and beneficiaries.
These commenters, for instance, characterized the NPRM as arbitrarily
and capriciously focused on clarifying that ERISA permits ESG
considerations in plan investments at the expense of protecting
participants from ESG investing ``run amok'' or violations of ERISA's
duty of loyalty. One commenter contended that the NPRM was more a
political action taken because of the popularity of ESG investing
rather than a reflection of the current administration's concern about
a problem to be addressed. Another commenter espoused that the
Department's real agenda was to encourage ESG investing. Yet another
asserted that the only reason this rule was being promulgated was
because of an Executive order.\88\ And another commenter contended that
it could not give input on the Department's view of how its rule
promotes retiree welfare, because, the commenter states, the agency
gives no reasoning on this point.
---------------------------------------------------------------------------
\88\ E.O. 14030, 86 FR 27967 (May 25, 2021).
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The Department disagrees with these contentions. The final rule
repeatedly emphasizes that the Department's purpose is to remedy the
chilling effect of certain aspects of the 2020 rule and preamble on the
consideration of ESG factors. As stated above, the final rule allows
such factors to influence investment decisions only when relevant to a
risk and return analysis or when used as a tiebreaker. By tying the
final rule to the statutory language and to the fact that ESG factors
may, in some circumstances, affect both returns and risk, the
Department has engaged in the essence of reasoned decisionmaking.
Moreover, the fact that ESG investing has increased in popularity is
another reason why fiduciaries need a clarifying rule and why the
Department is promulgating one. This would be the case even if the
President had never issued Executive Orders 13990 and 14030. The final
rule also emphatically addresses potential loyalty breaches by
forbidding subordination of participants' financial benefits under the
plan to ESG or any other goal and, likewise, by prohibiting fiduciaries
from sacrificing investment return or taking on additional investment
risk to promote benefits or goals unrelated to interests of
participants and beneficiaries in their retirement or financial
benefits under the plan.
A few commenters stated that the NPRM effectively placed a ``heavy
thumb'' on the scale in favor of ESG factors and ignored other options,
such as a policy statement or interpretive guidance. At least one
commenter also claimed that the NPRM was trying to address a problem
that does not exist. The Department has explained its reasons for
amending the current regulation, including the chilling effect
[[Page 73854]]
caused by, for example, its explicit documentation requirements for
investments and the exercising of shareholder rights, and its
restrictions on QDIAs, as discussed earlier in this preamble. The
Department determined and received confirmation in public comments that
features such as these, combined with the overall chilling tone of the
current regulation (including its preamble) as it relates to
financially beneficial ESG considerations, rendered interpretive
guidance under the current regulation insufficient. Rather than placing
a thumb on the scale, the final rule removes the current regulation's
thumb against ESG strategies. It does this by simply clarifying that
ESG factors may be relevant to a risk and return analysis to the same
extent as any other relevant factor.
Many commenters expressed concerns that the NPRM language, as one
put it, ``imposes a de facto mandate'' on retirement plan fiduciaries
to consider ESG factors and declares that such a presumption would be
arbitrary and capricious. The commenters referenced paragraph
(b)(2)(ii)(C) of the NPRM stating that the consideration of the
projected return of the portfolio relative to the plan's funding
objectives ``may often require'' an evaluation of the economic effects
of climate change and other ESG factors. As explained earlier in this
preamble, in response to these comments, the Department recognizes that
the language as drafted created a misimpression of its intent and has
modified the provision to eliminate the ``may often require'' language
altogether.
At least three commenters took issue with the NPRM's use of the
term ``ESG''. They contended that the NPRM failed to define ``ESG''
factors and that the term ``ESG'' was too imprecise to serve as a basis
for a regulatory standard. Commenters, citing to the November 2020
preamble statement that the term ``was not a clear or helpful lexicon
for a regulatory standard,'' claimed the Department changed its
position without acknowledging it. One commenter contended that a more
precise definition was especially important given the perceived ``de
facto mandate'' in the NPRM. Use of the term ESG in the NPRM was not
intended to create a regulatory mandate or standard for compliance, and
as stated above, the ``may often require'' provision has been removed
in the final rule. Rather, it was the Department's intent to clarify
that ESG factors are no different than other non-ESG relevant risk-
return factors. Consequently, the final rule does not define ESG
because the precision of terminology is less important than the
Department's fundamental premise that fiduciaries may consider ESG
factors--irrespective of the definition of the term ``ESG''--when they
are relevant to a risk-return analysis to the same extent as any other
relevant factor.
One commenter expressed an opinion about the Department's position
on negative screening which the commenter defines as excluding certain
types of investments from a portfolio based on non-economic or non-
pecuniary reasons. The commenter states that the NPRM, if adopted,
would change a Departmental position against negative screening,
without considering a serious reliance interest on the prior position.
The commenter is correct that when promulgating a change in policy, the
Department must consider serious reliance interests in a prior policy.
The Department never has posited, however, that ERISA imposes a blanket
bar against all forms of exclusionary investments. The two Department
of Labor (DOL) letters the commenter cites comport. They state that the
exclusionary investment first required ``an economic analysis of
economic consequences'' of the exclusion,\89\ or put another way, a
``consideration of the economic and financial merit.'' \90\ Both the
NPRM and the final rule are fully consistent and in fact reinforce the
position in these letters. Further, as stated in the preamble of the
NPRM, the Department long has acknowledged, since the publication of
those letters, the potential risk and return attributes of ESG criteria
in fiduciary investment decisionmaking and portfolio construction.
Thus, there is no change of position in this regard and no reliance
interest on any former position to address.
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\89\ Letter to the Honorable Howard M. Metzenbaum from Assistant
Secretary Dennis Kass (May 27, 1986).
\90\ Letter to Daniel O'Sullivan from Jeffrey Clayton (Aug. 2,
1982).
---------------------------------------------------------------------------
Another commenter stated that the Department has not acknowledged
or considered the cost of the risk of ``channeling'' plan assets into
ESG investments given the concerns of misrepresentation highlighted by
staff of Division of Examinations of the SEC in its April 2021 Risk
Alert on ESG investing. The commenter concluded that the Department's
NPRM, if adopted, would be arbitrary and capricious, in part, because
of its failure to acknowledge the profound effect of the risk of
misrepresentation. This final rule is not intended to channel assets
into any particular type of investment. Rather, the intent of the final
rule is simply to remove barriers to the fiduciary's consideration of
all financially relevant factors, which may include ESG, as part of a
prudent and loyal process of investment decisionmaking. The Department
anticipates that fiduciaries will give careful consideration in a
meaningful comparison and selection process of ESG investments just as
they do with any other type of investment.
The Department also disagrees with the comment that it prejudged
the outcome of this rule. Offering a proposed solution to a problem is
the foundation of notice and comment rulemaking. Under the APA,
policymakers are required to solicit comments on the problem and its
proposed solution and to adequately review those comments in the
development of the final rule. The changes made to the NPRM in this
final rule demonstrate that the Department has not prejudged the rule's
outcome. Substantive changes in response to public comments include the
elimination of the language that the evaluation of investments ``may
often require'' consideration of ESG factors, the elimination of the
list of ESG examples from the regulatory text, and removal of the
collateral benefit disclosure requirement.
Some commenters added that the Department failed to identify which
investors the 2020 rule confused and did not produce data showing that
consideration of ESG factors will sustain or increase plan returns--
returns one commenter called ``phantom benefits.'' As amply explained
in both the NPRM preamble and here, and as reflected by the
Department's longstanding Investment Duties regulation, ensuring that
determinations are based on relevant risk and return factors, which may
include the economic effects of climate change and other ESG factors,
will serve the retirement participants and beneficiaries' financial
interests. The Department believes, and many commenters confirmed, the
current regulation causes an unwanted chilling effect on the use of
climate change and other ESG factors, and therefore is a barrier to
that consideration. The Department is not required to produce a record
of extensive and detailed data showing the extent to which ESG
considerations will grow retirement accounts. The final rule does not
require fiduciaries to consider ESG factors to a different extent than
any other factors that the fiduciary reasonably determines are relevant
to a risk and return analysis. Nor does the APA require the Department
to specifically identify investors who were confused by or chilled by
the current regulation. As
[[Page 73855]]
previously stated, many commenters--whose identity is public--indicated
this concern.
Multiple commenters also questioned the quantitative support for
the Department's position. For instance, some commenters contended that
the Department's claims about climate change were unsubstantiated. The
Department believes it has made reasonable efforts to quantify all
aspects of the final rule, and their potential effects, for which data
is available. The Department also notes that efforts have been made to
qualitatively address those areas where the Department is unable to
adequately derive quantitative assessments. Further, the preamble to
this final rule (as well as the proposed rule) adequately cites to
research supporting the Department's views. Responses to these and
related additional comments are discussed later in the Regulatory
Impact Analysis (RIA) section of this preamble.
Finally, one commenter asserts Chevron deference does not apply to
the NPRM because, if adopted, it would be a ``major question'' in the
sense that it would constitute a ``decision of vast political and
economic significance'' and ``in the realm of climate.'' The final rule
does not represent one of the rare ``extraordinary cases'' for which
the major questions doctrine compels a ``different approach'' to
analyzing agency authority.\91\ Indeed, far from representing a
``transformative expansion in [the agency's] regulatory authority,''
\92\ the Department has for decades issued guidance addressing how
fiduciaries, compliant with ERISA's prudence and loyalty duties, may or
may not incorporate various factors into investment and shareholder
rights decisions. And even if the major questions doctrine did apply,
Congress has provided clear authorization to issue the final rule,
including by authorizing the Secretary to ``prescribe such regulations
as he finds necessary or appropriate to carry out the provisions of''
the subchapter encompassing fiduciary responsibilities.\93\
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\91\ West Virginia v. EPA, 142 S. Ct. 2587, 2608 (2022) (quoting
FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 159 (2000)).
\92\ Id. (quoting Utility Air Regul. Grp. v. EPA, 573 U.S. 302,
324 (2014)).
\93\ 29 U.S.C. 1135.
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Finally, as stated in the NPRM, this final rule does not undermine
serious reliance interests on the part of fiduciaries selecting
investments and investment courses of action or exercising shareholder
rights.\94\ This final rule does not upend longstanding standards
governing the selection of investments and investment courses of action
or the exercise of shareholder rights. Instead, it addresses new
policies included in a recently promulgated regulation. Further, the
Department stayed its enforcement of the current regulation shortly
after its effective date and before all portions were applicable.
Consequently, the Department concludes any serious reliance interest in
the changes introduced by the current regulation in 2020 is unlikely
and does not outweigh the Department's good reasons for change.
---------------------------------------------------------------------------
\94\ 85 FR 57272, 57283 (Oct. 14, 2021).
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IV. Regulatory Impact Analysis
This section of the preamble analyzes the regulatory impact of the
final rule in 29 CFR 2550.404a-1. As explained earlier in this
preamble, the final rule clarifies the legal standard imposed by
sections 404(a)(1)(A) and 404(a)(1)(B) of ERISA with respect to the
selection of a plan investment or, in the case of an ERISA section
404(c) plan or other individual account plan, a designated investment
alternative under the plan, and with respect to the exercise of
shareholder rights, including proxy voting.
The primary benefit of the final rule is to clarify legal standards
and prevent confusion among stakeholders. The Department has heard from
stakeholders that the current regulation, and investor confusion
related to the regulation, has had a chilling effect on appropriate use
of climate change and other ESG factors in investment decisions, even
in circumstances allowed by the current regulation. Based on
stakeholder feedback, the Department has determined that aspects of the
current regulation could deter plan fiduciaries from: (a) taking into
account climate change and other ESG factors when they are relevant to
a risk and return analysis, and (b) engaging in proxy voting and other
exercises of shareholder rights when doing so is in the plan's best
interest. If these concerns with the current regulation were left
unaddressed, the regulation would have (a) a negative impact on plans'
financial performance as they avoid using climate change and other ESG
considerations in investment analysis even when directly relevant to
the financial merits of the investment, and (b) a negative impact on
plans' financial performance as they shy away from proxy votes and
shareholder engagement activities that are economically relevant. The
final rule's clarification of the relevant legal standards is intended
to address these negative impacts.
The final rule provides cost savings by eliminating the current
regulation's special documentation provisions pertaining to the
tiebreaker and eliminating its proxy voting safe harbors. In the impact
analysis for the current regulation, the Department had estimated that
these provisions would impose a regulatory burden. Other benefits
include clarifying the tiebreaker standard and clarifying the standards
governing QDIAs. All benefits of the amendments are discussed below in
section IV.D. As discussed in section IV.E, the final rule will impose
costs; however, the costs are expected to be relatively small. Overall,
the Department anticipates that the final rule's benefits justify its
costs.
The Department has examined the effects of this final rule as
required by Executive Order 12866,\95\ Executive Order 13563,\96\ the
Congressional Review Act,\97\ the Paperwork Reduction Act of 1995,\98\
the Regulatory Flexibility Act,\99\ section 202 of the Unfunded
Mandates Reform Act of 1995,\100\ and Executive Order 13132.\101\
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\95\ Regulatory Planning and Review, 58 FR 51735 (Oct. 4, 1993).
\96\ Improving Regulation and Regulatory Review, 76 FR 3821
(Jan. 21, 2011).
\97\ 5 U.S.C. 804(2) (1996).
\98\ 44 U.S.C. 3506(c)(2)(A) (1995).
\99\ 5 U.S.C. 601 et seq. (1980).
\100\ 2 U.S.C. 1501 et seq. (1995).
\101\ Federalism, 64 FR 43255 (Aug. 10, 1999).
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A. Executive Orders 12866 and 13563
Executive Orders 12866 and 13563 direct agencies to assess all
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits (including potential economic, environmental, public
health, and safety effects; distributive impacts; and equity).
Executive Order 13563 emphasizes the importance of quantifying costs
and benefits, reducing costs, harmonizing rules, and promoting
flexibility.
Under Executive Order 12866, ``significant'' regulatory actions are
subject to review by the Office of Management and Budget (OMB). Section
3(f) of the Executive order defines a ``significant regulatory action''
as an action that is likely to result in a rule (1) having an annual
effect on the economy of $100 million or more, or adversely and
materially affecting a sector of the economy, productivity,
competition, jobs, the environment, public health or safety, or state,
local, or tribal governments or communities (also referred to as
``economically significant''); (2) creating a serious inconsistency or
otherwise interfering with an action taken or planned by
[[Page 73856]]
another agency; (3) materially altering the budgetary impacts of
entitlement grants, user fees, or loan programs or the rights and
obligations of recipients thereof; or (4) raising novel legal or policy
issues arising out of legal mandates, the President's priorities, or
the principles set forth in the Executive order. OMB has determined
that this final rule is economically significant within the meaning of
section 3(f)(1) of Executive Order 12866. Given the large scale of
investments held by covered plans, approximately $12.0 trillion,
changes in investment decisions and/or plan performance may result in
changes in returns in excess of $100 million in a given year.\102\
Therefore, below the Department provides an assessment of the potential
costs, benefits, and transfers associated with the final rule.
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\102\ EBSA projected ERISA covered pension, welfare, and total
assets based on the 2020 Form 5500 filings with the U.S. Department
of Labor (DOL), reported SIMPLE assets from the Investment Company
Institute (ICI) Report: The U.S. Retirement Market, Second Quarter
2022, and the Federal Reserve Board's Financial Accounts of the
United States Z1 September 9, 2022.
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B. Introduction and Need for Regulation
In late 2020, the Department published two final rules dealing with
the selection of plan investments and the exercise of shareholder
rights, including proxy voting. The Department intended to provide
clarity and certainty to plan fiduciaries regarding their legal duties
under ERISA section 404 in connection with making plan investments and
for exercising shareholder rights. The Department was also concerned
that some investment products may be marketed to ERISA fiduciaries
based on purported benefits and goals unrelated to financial
performance.
Before issuing the 2020 regulation, the Department had periodically
issued guidance pertaining to the application of ERISA's fiduciary
rules to plan investment decisions that are based, in whole or part, on
factors unrelated to financial performance. This nonregulatory guidance
consisted of varied statements that led to confusion. Accordingly, the
2020 regulation was intended to provide clarity and certainty regarding
the scope of fiduciary duties surrounding such issues.
Responses to the 2020 rules, however, suggest that they may have
inadvertently caused more confusion than clarity. Many stakeholders
told the Department that the terms and tone of the final rules and
preambles increased concerns and uncertainty about the extent to which
plan fiduciaries may consider climate change and other ESG factors in
their investment decisions, and that the 2020 rules had chilling
effects that would tend to deter consideration of ESG factors and that
were contrary to the interests of participants and beneficiaries.
Consequently, on March 10, 2021, the Department announced that it would
stay enforcement of the 2020 rules pending a complete review of the
matter. Subsequently, on May 20, 2021, the President issued Executive
Order 14030, entitled ``Executive Order on Climate-Related Financial
Risk.'' Section 4 of the Executive order directs the Department to
consider suspending, revising, or rescinding any rules from the prior
administration that would have barred plan fiduciaries (and their
investment-firm service providers) from considering climate change and
other ESG factors in their investment decisions related to workers'
pensions.\103\ In light of the foregoing confusion among stakeholders,
the Department concluded that additional notice and comment rulemaking
was necessary to safeguard the interests of participants and
beneficiaries in their retirement and welfare plan benefits.
---------------------------------------------------------------------------
\103\ See White House Fact Sheet titled FACT SHEET: President
Biden Directs Agencies to Analyze and Mitigate the Risk Climate
Change Poses to Homeowners and Consumers, Businesses and Workers,
and the Financial System and Federal Government Itself (May 20,
2021) (stating, ``The Executive Order directs the Labor Secretary to
consider suspending, revising, or rescinding any rules from the
prior administration that would have barred investment firms from
considering environmental, social and governance factors, including
climate-related risks, in their investment decisions related to
workers' pensions.'').
---------------------------------------------------------------------------
The baseline for purposes of the analysis is a future in which the
current regulations are implemented. The baseline does not take into
account the fact that the Department stayed enforcement of the current
regulations pursuant to the March 10, 2021, enforcement policy, which
was after their effective date in January 2021 but before their full
applicability date.\104\
---------------------------------------------------------------------------
\104\ U.S. Department of Labor Statement Regarding Enforcement
of its Final Rules on ESG Investments and Proxy Voting by Employee
Benefit Plans (Mar. 10, 2021), available at www.dol.gov/sites/dolgov/files/ebsa/laws-and-regulations/laws/erisa/statement-on-enforcement-of-final-rules-on-esg-investments-and-proxy-voting.pdf.
---------------------------------------------------------------------------
C. Affected Entities
The clarifications in the final rule will affect subsets of ERISA-
covered plans and their participants and beneficiaries. The subset of
plans affected by the proposed modifications of paragraphs (b) and (c)
of Sec. 2550.404a-1 include those plans whose fiduciaries consider or
will begin considering climate change and other ESG factors when
selecting investments and the participants in those plans. Based on the
sources below, the Department estimates that about 20 percent of plans
will be affected by this final rule.
Another subset of affected plans includes ERISA-covered plans
(pension, health, and other welfare) that hold shares of corporate
stock. This subset of plans will be affected by the proposed
modifications to paragraph (d) (relating to proxy voting) of Sec.
2550.404a-1. Some plans will be in both subsets, some in only one
subset, and some in neither. There is substantial uncertainty about the
number and size of affected plans.
1. Subset of Plans Affected by Proposed Modifications of Paragraphs (b)
and (c) of Sec. 2550.404a-1
The Department estimates that 20 percent of plans, both defined
contribution (DC) and defined benefit (DB), will be affected by the
proposed modifications of paragraphs (b) and (c) of Sec. 2550.404a-1
because their fiduciaries consider or will begin considering climate
change or other ESG factors when selecting investments. The
administrative data and surveys relied upon for this estimate are
discussed below.
According to a survey by the NEPC, LLC (2018), approximately 12
percent of private pension plans (both DB and DC) have adopted ESG
investing.\105\ A survey conducted by the Callan Institute (2021),
which included a greater share of DB plans, found that about 20 percent
of private sector pension plans consider ESG factors in investment
decisions.\106\ In a comment letter on the NPRM, Morningstar estimates
that approximately 36 percent of large plans (with at least 100
participants) use ESG information to consider their investments. Their
analysis is based on whether a fund's prospectus references considering
ESG information when selecting securities. It includes both DB and DC
plans.
---------------------------------------------------------------------------
\105\ Brad Smith and Kelly Regan, NEPC ESG Survey: A Profile of
Corporate & Healthcare Plan Decisionmakers' Perspectives, NEPC (Jul.
11, 2018), https://cdn2.hubspot.net/hubfs/2529352/files/2018%2007%20NEPC%20ESG%20Survey%20Results%20.pdf.
\106\ 2021 ESG Survey, Callan Institute (2021), https://www.callan.com/e508ca6d-4014-4c99-b0aa-9fb15170bb18.
---------------------------------------------------------------------------
To focus on ESG investing by participant-directed defined
contribution plans, the Department draws from several sources.
According to the Plan Sponsor Council of America (PSCA, 2021), about 5
percent of 401(k) and/or profit-sharing ERISA plans offered at least
one ESG-themed
[[Page 73857]]
investment option in 2020.\107\ The PSCA survey was cited by several
commenters on the NPRM. NEPC (2022) surveyed DC plans, the vast
majority of which were in the private sector, and found that 6 percent
of DC plans in 2020 had at least one fund labeled as ``socially
responsible'' or ``ESG.'' \108\ Vanguard's administrative data for 2021
indicated that approximately 13 percent of DC plans offered one or more
``socially responsible'' funds.\109\ Moreover, about 30 percent of
participants were offered at least one ``socially responsible'' fund,
and of those participants, 6 percent were using these funds. In a
comment letter received on the 2020 NPRM Financial Factors in Selecting
Plan Investments, Fidelity Investments reported that approximately 14.5
percent of corporate DC plans with fewer than 50 participants offered
an ESG option, and that the figure is higher for large plans with at
least 1,000 participants.
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\107\ 64th Annual Survey of Profit Sharing and 401(k) Plans,
Plan Sponsor Council of America (2021).
\108\ NEPC 2021 Defined Contribution Plan Trends and Fee Survey
Results, NEPC (February 2022).
\109\ How America Saves 2022, Vanguard (June 2022), https://institutional.vanguard.com/content/dam/inst/vanguard-has/insights-pdfs/22_TL_HAS_FullReport_2022.pdf.
---------------------------------------------------------------------------
While survey and administrative data is the best information
available, it is not perfect. For instance, a plan fiduciary responding
to a survey likely bases their answer on whether the plan offers an
investment with a name indicating it is a ``sustainable'' fund or with
advertising emphasizing that it pursues ESG. If the plan offers a fund
that does not have these characteristics, even if the asset manager
factors in ESG information, the plan fiduciary may not be aware of this
and would respond to a survey by saying the plan does not consider any
ESG factors. To the degree this situation occurs, it would lead to
survey data that underestimate the consideration of ESG factors.
It is also likely that ESG investing will increase in the future.
Many of the sources above show increases in ESG investing in recent
years, and a trend towards ESG investing has also been observed in the
wider universe of all investors. A study from Morningstar (2021) shows
that between 2018 and 2020, assets under management in sustainable
funds increased over three hundred percent.\110\ Additionally, U.S. SIF
(2020) estimates that U.S.-domiciled assets under management using
sustainable investing strategies reached $17.1 trillion at the start of
2020, an increase of 42 percent since 2018.\111\ The Deloitte Center
for Financial Services (2020) estimates that assets under management
with mandates related to ESG factors could comprise half of all
professionally managed investments in the U.S. by 2025. This study also
finds investment managers are likely to launch up to 200 new ESG funds
by 2023, more than double the activity in the previous three
years.\112\
---------------------------------------------------------------------------
\110\ Morningstar, ``Sustainable Funds U.S. Landscape Report:
More Funds, More Flows, and Impressive Returns in 2020'' (February
10, 2021), https://www.morningstar.com/lp/sustainable-funds-landscape-report.
\111\ US SIF, ``US SIF Trends Report Executive Summary: Report
on US Sustainable and Impact Investing Trends 2020,'' https://www.ussif.org/files/US%20SIF%20Trends%20Report%202020%20Executive%20Summary.pdf.
\112\ Sean Collins and Kristen Sullivan, ``Advancing
Environmental, Social, and Governance Investing: A Holistic approach
for Investment Management Firms'' (February 2020), https://www2.deloitte.com/us/en/insights/industry/financial-services/esg-investing-performance.html.
---------------------------------------------------------------------------
The Department received several comments and resources exploring
the perception of ESG investing from investors. A survey of individual
investors by the Morgan Stanley Institute for Sustainable Investing
(2019) finds that 85 percent of investors overall, and 95 percent of
millennial investors, are interested in sustainable investing. About 88
percent of all surveyed investors are ``very'' or ``somewhat''
interested in pursuing sustainable investing in 401(k) plans.\113\ A
survey of consumers between ages 45 and 75 by Schroders (2021) found
that 90 percent said that ``they invested in ESG options when they were
aware of their availability in their DC plan.'' Of those who said their
plans did not offer ESG investment options or did not know, 69 percent
said they would increase their overall contribution rate if they were
offered an ESG option.\114\ A survey conducted by CNBC (2021) finds
that ``about one-third of millennials often or exclusively use
investments that take ESG factors into account, compared to 19 percent
of Gen Z, 16 percent of Gen X, and 2 percent of Baby Boomers.'' \115\ A
study by Natixis finds that ``7 in 10 individual investors believe it
is important to make a positive social impact through their
investments.'' \116\
---------------------------------------------------------------------------
\113\ Morgan Stanley Institute for Sustainable Investing,
``Sustainable Signals: Individual Investor Interest Driven by
Impact, Conviction, and Choice'' (2019), https://www.morganstanley.com/pub/content/dam/msdotcom/infographics/sustainable-investing/Sustainable_Signals_Individual_Investor_White_Paper_Final.pdf.
\114\ Schroders, ``Schroders US Retirement Survey Results--
2021,'' https://www.schroders.com/en/us/defined-contribution/dc/retirement-survey-2021.
\115\ Alicia Adamczyk, ``Millennials Spurred Growth in
Sustainable Investing for Years. Now All Generations are Interested
in ESG Options,'' CNBC (May 2021), https://www.cnbc.com/2021/05/21/millennials-spurred-growth-in-esg-investing-now-all-ages-are-on-board.html.
\116\ Natixis, ``ESG Investing Survey: Investors Want the Best
of Both Worlds,'' (2019), https://www.im.natixis.com/us/research/esg-investing-report-2019.
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These studies suggest that investor demand for ESG is strong and is
poised to increase, given the preferences of younger investors. Taking
into account likely future growth, the Department's best estimate of
the share of plans that will be affected by the final rule is 20
percent. This is an increase from the 11 percent estimate in the NPRM;
the Department increased the estimate based on updated data, comment
letters, and to account for future growth. This is an overall estimate,
and it is unclear how the share affected may vary between DB and DC
plans. An estimate of 20 percent of plans means that approximately
149,300 plans will be affected.\117\ The Department estimates that more
than 28.5 million participants belong to plans that will be
affected.\118\ The proportion of plan assets actually invested in ESG
options, however, may be much less than 20 percent; the PSCA survey
indicates that the average participant-directed DC plan has
approximately 0.03 percent of its assets invested in ESG funds in
2020.\119\
---------------------------------------------------------------------------
\117\ This estimate is calculated as: 20% x 746,610 pension
plans = 149,322 pension plans, rounded to 149,300. (Source Private
Pension Plan Bulletin: Abstract of 2020 Form 5500 Annual Reports,
Employee Benefits Security Administration (2022; forthcoming), Table
B1.)
\118\ Id. This estimate is calculated as: 20% x 142.3 = 28.5
million total participants.
\119\ 64th Annual Survey of Profit Sharing and 401(k) Plans,
Plan Sponsor Council of America (2021).
---------------------------------------------------------------------------
2. Subset of Plans Affected by the Modifications to Paragraph (d) of
Sec. 2550.404a-1
The final rule, at paragraph (d), will codify longstanding
principles of prudence and loyalty applicable to the exercise of
shareholder rights, including proxy voting, the use of written proxy
voting policies and guidelines, and the selection and monitoring of
proxy advisory firms. In particular, paragraph (d) of the final rule
will adopt the Department's longstanding position, which was first
issued in guidance in the 1980s, that the fiduciary act of managing
plan assets includes the management of voting rights (as well as other
shareholder rights) appurtenant to shares of stock. Paragraph (d) of
the final rule also eliminates the two safe harbors from paragraphs
(d)(3)(i)(A) and (B) of Sec. 2550.404a-1.
Under paragraph (d) of the final rule, when deciding whether to
exercise shareholder rights and how to exercise
[[Page 73858]]
such rights, including the voting of proxies, fiduciaries must carry
out their duties prudently and solely in the interests of the
participants and beneficiaries and for the exclusive purpose of
providing benefit to participants and beneficiaries and defraying the
reasonable expenses of administering the plan. An assessment of
affected parties follows, but the Department believes that the estimate
of affected plans is likely an overestimate.
Paragraph (d) of the final rule will affect ERISA-covered pension,
health, and other welfare plans that hold shares of corporate stock. It
will affect plans with respect to stocks that they hold directly, as
well as with respect to stocks they hold through ERISA-covered
intermediaries, such as common trusts, master trusts, pooled separate
accounts, and 103-12 investment entities. Paragraph (d) will not affect
plans with respect to stock held through registered investment
companies, such as mutual funds, because it will not apply to such
funds' internal management of such underlying investments. Paragraph
(d) of the final rule also will not apply to voting, tender, and
similar rights with respect to securities that are passed through
pursuant to the terms of an individual account plan to participants and
beneficiaries with accounts holding such securities.
ERISA-covered plans annually report data on their asset holdings.
However, only plans that file the Form 5500 schedule H report their
stock holdings as a separate line item (see Table 1). Most plans filing
schedule H have 100 or more participants (large plans).\120\ All plans
with employer stock report their holdings on either schedule H or
schedule I. However, schedule I lacks the specificity to determine if
small plans hold employer stock or other employer securities.
Approximately 25,900 defined contribution plans and 4,600 defined
benefit plans, with approximately 83.6 million participants, filed the
schedule H in 2020 and report holding common stocks or are an Employee
Stock Ownership Plan (ESOP). Additionally, 518 health and other welfare
plans file the schedule H and report holding common stocks either
directly or indirectly. In total, pension plans and welfare plans
filing schedule H hold approximately $2.4 trillion in common stock
value. Common stocks constitute about 28 percent of total assets of
those pension plans that are not ESOPs and hold common stock. Out of
the 24,100 pension plans that hold common stock and are not ESOPs,
about 19,300 plans hold common stock through an ERISA-covered
intermediary and approximately 3,300 plans hold common stock directly.
A smaller number of plans hold stock both directly and indirectly.\121\
In total, information is available on approximately 30,500 pension
plans, welfare plans, and ESOPs that hold either common stock or
employer stock.
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\120\ 487 plans with less than 100 participants filed the Form
5500 schedule H and reported holding common stock.
\121\ DOL estimates from the 2020 Form 5500 Pension Research
Files.
Table 1--Number of Pension and Welfare Plans Reporting Holding Common Stocks or ESOP by Type of Plan, 2020 a
----------------------------------------------------------------------------------------------------------------
Common stock (no employer Defined Defined Total pension Total all
securities) benefit contribution plans Welfare plans plans
----------------------------------------------------------------------------------------------------------------
Direct Holdings Only............ 1,059 2,228 3,288 517 3,805
Indirect Holdings Only.......... 2,649 16,691 19,340 .............. 19,340
Both Direct and Indirect........ 849 645 1,494 1 1,495
-------------------------------------------------------------------------------
Total....................... 4,558 19,564 24,122 518 24,640
----------------------------------------------------------------------------------------------------------------
ESOP (No Common Stock).......... .............. 5,809 5,809 .............. 5,809
Common Stock and ESOP........... .............. 574 574 .............. 574
-------------------------------------------------------------------------------
Total All Plans Holding 4,558 25,947 30,505 518 31,023
Stocks.....................
----------------------------------------------------------------------------------------------------------------
\a\ DOL calculations from the 2020 Form 5500 Pension Research Files.
There are approximately 652,900 small pension plans that hold
assets that could be invested in stock.\122\ Given that fewer than 1
percent of small plans file a Schedule H, there is minimal data
available about small plans' stock holdings. While most participants
and assets are in large plans, most plans are small plans. The
Department lacks sufficient data to estimate the number of small plans
that hold stock, but the Department expects that many small plans are
only exposed to stock through mutual funds and consequently will not be
significantly affected by paragraph (d) of the final rule. For purposes
of estimating the number of small plans that will be affected, the
Department assumes that five percent of small plans, or approximately
32,600 small pension plans, hold stock.\123\ In the NPRM, the
Department solicited comments on the impact of small plans holding
stock only through mutual funds and on the assumption that five percent
of small plans hold stock. No comments were received in response to
either inquiry.
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\122\ The Form 5500 does not require these plans to categorize
the assets as common stock, so the Department does not know if they
hold stock. (Source Private Pension Plan Bulletin: Abstract of 2020
Form 5500 Annual Reports, Employee Benefits Security Administration
(2022; forthcoming), Table B1.)
\123\ This estimate is calculated as 652,935 pension plans x 5%
= 32,647 plans, rounded to 32,600. To assess the reasonableness of
the five percent estimate, the Department looked at the number of
pension plans filing the 2020 Form 5500, just above the threshold
(100 participants) for needing to file the schedule H. Common stock
or employer stock in an ESOP was held by eight percent of pension
plans with 100 participants up to 109 participants. Common stock or
employer stock in an ESOP was held by twelve percent of pension
plans with 110 participants up to 119 participants. While both
percentages are above five percent, the percentage falls as the plan
size decreases, suggesting that five percent is a reasonable
estimate of the percent of small plans holding common stock or
employer stock in an ESOP.
---------------------------------------------------------------------------
The combined effect of these assumptions is an estimate of 63,700
plans, large and small, that will be affected by the final rule
pertaining to proxy voting.\124\
---------------------------------------------------------------------------
\124\ This estimate is calculated as 30,505 large pension plans
holding common stock or employer stock + 518 large health or welfare
plans holding common stock or employer stock + 32,647 small pension
plans holding stock = 63,670 plans rounded to 63,700.
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While paragraph (d) of this final rule will directly affect ERISA-
covered plans that possess the relevant shareholder rights, the
activities covered under paragraph (d) will be carried out by
responsible fiduciaries on plans' behalf.
[[Page 73859]]
Many plans hire asset managers to carry out fiduciary asset management
functions, including proxy voting. The Department estimates that large
ERISA plans use approximately 17,600 different service providers, some
of whom provide services related to the exercise of plans' shareholder
rights.\125\ Such service providers include trustees, trust companies,
banks, investment advisers, investment managers, and proxy advisory
firms.\126\ Asset managers hired as fiduciaries to carry out proxy
voting functions will be subject to the final rule to the same extent
as a plan trustee or named fiduciary. The final rule could indirectly
affect proxy advisory firms to the extent that plan fiduciaries opt for
customized recommendations about which proxy proposals to vote or how
they should cast their vote. Plans' preferences for proxy advice
services moreover could shift to prioritize services offering more
rigorous and impartial recommendations. These effects may be more
muted, however; recent rule amendments by the Securities and Exchange
Commission (SEC) may enhance the transparency, accuracy, and
completeness of the information provided to clients of proxy advisory
firms in connection with proxy voting decisions.\127\
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\125\ DOL estimates are derived from the historical Form 5500
Schedule C data. This value reflects the number of entities that
have ever been reported with the service codes associated with
trustees (individual, bank, trust company, or similar financial
institution), plan investment advisory, or investment management.
\126\ A commenter on the proposal for the 2020 rule shared
results from a proprietary survey of the largest pension funds and
defined contribution plans. The survey finds that approximately 92
percent of the respondents indicated that they have formally
delegated proxy voting responsibilities to another named fiduciary
and approximately 42 percent of respondents engage a proxy advisory
firm (directly or indirectly) to help with voting some or all
proxies.
\127\ In September 2019, the SEC issued an interpretation and
guidance addressing the application of the proxy rules to proxy
voting advice businesses. (See 84 FR 47416). In July of 2020, the
SEC adopted amendments to 17 CFR 240.14a-1(l), 240.14a-2(b), and
240.14a-9 concerning proxy voting advice (the ``2020 Rule
Amendments''). (See 85 FR 55082) On June 1, 2021, SEC Chair Gary
Gensler directed SEC staff to consider whether to recommend further
regulatory action regarding proxy voting advice. SEC staff were
asked to consider whether to recommend that the SEC revisit its 2020
codification of the definition of solicitation as encompassing proxy
voting advice, the 2019 Interpretation and Guidance regarding that
definition, and the conditions on exemptions from the information
and filing requirements in the 2020 Rule Amendments, among other
matters. In July, 2022, the SEC adopted final amendments that, among
other things, rescinded certain conditions that were adopted in the
2020 Rule Amendments to the availability of certain exemptions from
the information and filing requirements of the Federal proxy rules
for proxy advisory firms. (See 87 FR 43168)
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D. Benefits
The final rule will clarify the legal standard imposed by sections
404(a)(1)(A) and 404(a)(1)(B) of ERISA with respect to the selection of
a plan investment or investment course of action, and the exercise of
shareholder rights, including proxy voting. As indicated above, the
final rule will benefit plans by making clear that plan fiduciaries are
permitted to consider risk and return ESG factors and to exercise
shareholder rights that may enhance the value of plan investments. The
Department is concerned that the current regulation dissuades plan
fiduciaries from such considerations and activities even when they are
financially relevant to the plan. Prior to the NPRM, stakeholders told
the Department that the current regulation had already had a chilling
effect on appropriate use of ESG factors in investment decisions.
Acting on relevant ESG factors in a manner consistent with the final
rule will redound to the benefit of employee benefit plans,
participants, and beneficiaries covered by ERISA. The public provided
many comments about the proposal and cited many studies and reports
which have helped the Department to assess what the effects of the rule
will be. The literature examined by the Department generally shows that
the consideration of ESG factors can be beneficial to investing in many
circumstances. The Department anticipates that the benefits of this
final rule will be significant.
1. Benefits of Paragraphs (b) and (c)
Paragraph (b) of the final rule addresses ERISA section
404(a)(1)(B)'s duty of prudence and clarifies how that duty applies to
a fiduciary's consideration of an investment or investment course of
action. Paragraphs (b)(1) through (3) of the final rule carry forward
much of the same regulatory language that has been in place since 1979.
The preservation of settled law should minimize new costs attributable
to the final rule.
Paragraph (b)(4) addresses uncertainty under the current regulation
as to whether a fiduciary may consider ESG factors in making investment
decisions under ERISA. This paragraph clarifies that when selecting an
investment or investment course of action plan fiduciaries must base
their determination on factors that the fiduciary reasonably determines
are relevant to a risk and return analysis. Paragraph (b)(4) further
clarifies that risk and return factors may, depending on particular
facts and circumstances, include the economic effects of climate change
and other ESG factors. The intent of this paragraph is to establish
that ESG factors that may be relevant in a risk-return analysis of an
investment do not need to be treated differently than other relevant
investment factors, and to remove prejudice to the contrary contained
in the current regulation. When relevant to a risk and return analysis
of an investment, ESG factors may be weighted and factored into
investment decisions alongside other relevant factors, as prudently
determined by the fiduciary.
For the sake of clarity and to eliminate any doubt caused by the
current regulation, the preamble further explains paragraph (b)(4) by
providing examples of factors that may be relevant to a fiduciary's
risk and return analysis depending on the particular facts and
circumstances. For example, such factors may include: (i) climate
change-related factors, such as a corporation's exposure to the real
and potential economic effects of climate change, including exposure to
the physical and transitional risks of climate change and the positive
or negative effects of government regulations and policies related to
climate change; (ii) governance factors, such as those involving board
composition, executive compensation, transparency and accountability in
corporate decision-making, as well as a corporation's avoidance of
criminal liability and compliance with labor, employment,
environmental, tax, and other applicable laws and regulations; and
(iii) workforce practices, including the corporation's progress on
workforce diversity, inclusion, and other drivers of employee hiring,
promotion, and retention; its investment in training to develop its
workforce's skill; equal employment opportunity; and labor relations.
To its list of examples in section III.B.1.(f)(2) of this preamble
the Department added other examples to emphasize that the examples are
merely illustrative, and not intended to limit a fiduciary's discretion
to identify factors that are relevant to its risk/return analysis of
any particular investment or investment course of action. This
expansion of examples is intended to avoid regulatory bias and not
favor particular investments or investment strategies. As paragraph
(b)(4) explicitly states, whether any particular factor is relevant to
a risk and return analysis depends upon the individual facts and
circumstances.
Paragraph (c)(1) of the final rule addresses the application of the
duty of loyalty under ERISA as applied to a fiduciary's consideration
of an
[[Page 73860]]
investment or investment course of action. The primary benefit of this
provision to plan participants and beneficiaries is that it clarifies
in no uncertain terms that a plan fiduciary may not subordinate the
interests of participants and beneficiaries in their retirement income
or financial benefits under the plan to other objectives, and may not
sacrifice investment return or take on additional investment risk to
promote benefits or goals unrelated to the interests of participants
and beneficiaries in their retirement income or financial benefits
under the plan. By ensuring that plan fiduciaries may not sacrifice
investment returns or take on additional investment risk to promote
unrelated goals, paragraph (c)(1) protects the investment returns that
accrue to participants and sponsors of ERISA-covered plans. Over the
years, the Department has stated this bedrock principle of loyalty many
times in non-regulatory guidance, and this final rule, like the current
regulation, incorporates the principle directly into title 29 of the
Code of Federal Regulations. This incorporation will result in a higher
degree of permanency and certainty for plan fiduciaries, relative to
periodic restatements in non-regulatory guidance, and as such is
considered a benefit.
Much of the anticipated economic benefits under this final rule is
derived from paragraph (b)(4) of the final rule and the examples
earlier in section III.B.1.(f)(2) of this preamble and the clarity they
provide to plan fiduciaries. In the Department's view, and consistent
with the comments of the concerned stakeholders mentioned above, the
examples in the preamble should overcome unwarranted concerns about
investing in ESG-themed funds that are economically advantageous to
plans. Removing this uncertainty is considered a primary benefit of
this final rule.
Two comments on the proposal argued against the Department's
assertion that the current regulation has had a chilling effect. One
argued that the Department did not articulate what confusion it had
created, while the other said the Department had failed to demonstrate
that it had a negative impact.
However, many comments on the NPRM agreed with the Department's
assessment of the impact of the 2020 rule, noting the 2020 rule created
confusion on whether ERISA fiduciaries should incorporate ESG factors
into their decision-making and that this confusion created a chilling
effect. One comment states that the 2020 rule had introduced
``significant uncertainty'' and ``potential legal liability'' for
fiduciaries making investment decisions. Some of the commenters assert
that the documentation requirement in the 2020 rule could chill
investments in ESG assets. According to Lipton (2020), under the 2020
rule it would be harder for 401(k) plans to offer ESG investment
options and fewer plan participants would have access to these
options.\128\ According to the United Nations Principles for
Responsible Investment, the uncertainty in how considerations of ESG
factors fall within the legal standard of ERISA has precluded plan
fiduciaries from considering ESG factors within their investment
analysis.\129\ Avoiding the chilling effects described by these
comments and reports will be a benefit to participants and
beneficiaries.
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\128\ Martin Lipton, ``DOL Proposes New Rules Regulating ESG
Investments,'' Harvard Law School Forum on Corporate Governance
(2020), https://corpgov.law.harvard.edu/2020/07/07/dol-proposes-new-rules-regulating-esg-investments/.
\129\ Rory Sullivan, Will Martindale, Elodie Feller, and Anna
Bordon, ``Fiduciary Duty in the 21st Century,'' United Nations
Principles for Responsible Investment, https://www.unpri.org/download?ac=1378.
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As described in the preamble, paragraph (c)(2) of the final rule
will replace the tiebreaker provision in the current regulation with a
formulation that is intended to be broader. Paragraph (c)(2) provides
that if a fiduciary prudently concludes that competing investments or
investment courses of action equally serve the financial interests of
the plan over the appropriate time horizon, the fiduciary is not
prohibited from selecting the investment, or investment course of
action, based on collateral benefits other than investment returns.
Paragraph (c)(2) of the final rule will not carry forward the
documentation requirements contained in paragraphs (c)(2)(i) through
(iii) of the current regulation.
Commenters said these requirements are burdensome and have the
effect of singling out ESG investments for special scrutiny.
Stakeholders point to these special, heightened documentation
provisions as casting an unnecessarily negative shadow on investments
or investment courses of action that are prudent. Paragraph (c)(2) of
the final rule permits fiduciaries to take into account an investment's
potential collateral benefits, including potential increases in plan
contributions, to break a tie. The Department received several comments
citing research that increased access to ESG investment could increase
contributions to retirement plans. Avoiding unnecessarily burdensome
documentation and clarifying the extent to which fiduciaries may factor
in collateral benefits to break ties are benefits of the final rule.
Several commenters supported the proposed changes to the
tiebreaker. One commenter noted that under the current rule,
fiduciaries may only consider the collateral benefit between two
investments if the fiduciaries are unable to distinguish between two
investments based on pecuniary factors. However, it may be unclear
under what circumstances, if any, two investment courses of action
would meet the current rule's standard. The proposed rule recognizes
that competing investments can equally serve the financial interests of
the plan. However, several commenters expressed that the proposed
provisions were still too narrow, while other commenters argued that
the tiebreaker should be eliminated altogether. One commenter argued
that the test was obsolete and additional tests or documentation would
increase costs for plan participants and beneficiaries without a
corresponding benefit.
Paragraph (c)(3) of the final rule confirms that plan fiduciaries
do not violate the paragraph (c)(1) duty of loyalty solely because they
take participant preferences into consideration. Plan fiduciaries must
ensure that consideration of participant preferences is consistent with
the requirements in paragraph (b). This clarification may lead to
investment options that are more aligned with employee preferences and
that, accordingly, result in increased contributions to the plan and
greater retirement savings.
Commenters on the NPRM supported the idea that reflecting
participant preferences in investment options has a positive effect on
participation and retirement savings, including comments from
institutional asset managers and asset custodians. This is supported by
a survey conducted by Schroders (2021) of consumers between ages 45 and
75, finding that 69 percent of participants, who said their plans did
not offer ESG investment options or did not know, would increase their
overall contribution rate if an ESG option was offered.\130\ Commenters
also suggested that not considering participant preferences may be
detrimental to retirement savings. A few of the commenters argued that
participants may not utilize ERISA plans that do not offer investments
reflective of their
[[Page 73861]]
values, resulting in some individuals foregoing saving for retirement
or choosing to save outside of a qualified plan.
---------------------------------------------------------------------------
\130\ Schroders, ``Schroders US Retirement Survey Results--
2021,'' https://www.schroders.com/en/us/defined-contribution/dc/retirement-survey-2021.
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The current regulation prohibits fiduciaries from adding or
retaining any investment fund, product, or model portfolio as a
qualified default investment alternative (QDIA) as described in 29 CFR
2550.404c-5 if the fund, product, or model portfolio reflects non-
pecuniary objectives in its investment objectives or principal
investment strategies. The final rule amends the current regulation to
remove the stricter rules for QDIAs, such that, under the final rule,
the same standards apply to QDIAs as to investments generally. The
Department expects to see an increase in the number of QDIAs that are
ESG funds. This will affect many participants since a large and growing
share of plans use automatic enrollment. For example, Vanguard
administrative data shows that 70 percent of participants in 2021 were
in plans with automatic enrollment.\131\ It is difficult to obtain data
on how many of these participants' accounts were invested in a QDIA.
---------------------------------------------------------------------------
\131\ How America Saves 2022, Vanguard, 2022.
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The clarifications provided by paragraphs (b) and (c) of this final
rule relate to the appropriate use of ESG factors by plan fiduciaries
in selecting investments or investment courses of action. Outside the
ERISA context, investors may choose to invest in funds that promote
collateral objectives, and even choose to sacrifice return or increase
risk to achieve those objectives. Such conduct, however, would be
impermissible for ERISA plan fiduciaries, who cannot sacrifice return
or increase risk for the purpose of promoting collateral goals
unrelated to the economic interests of plan participants in their
benefits.
In the proposal, the Department requested comment on the financial
materiality of ESG factors in various investment contexts. In the
analysis below, the Department has considered and taken into account
the comments received and the resources referenced by commenters as
well as other resources that came to its attention. The studies and
reports often examine investing circumstances that are outside of ERISA
and may not apply to an ERISA context. Several comments on the NPRM
criticized the Department's survey of the literature. For example, one
commenter asserted that there was an oversampling of studies showing
better returns from ESG investing, compared to literature showing lower
returns. The comparison between the various studies cited is difficult,
however, as studies differ between whether they consider corporate or
investment performance, which benchmarks are considered, the time
horizon studied, and how ESG is incorporated into the company or
investment strategy. The Department has reviewed the literature
received from commenters and summarized the findings.
(a) Challenges of Determining the Relationship Between Performance and
ESG Factors
The primary types of ESG portfolio management are integration,
negative screening, and positive screening. Integration incorporates
ESG factors into the investment analysis and decisions. Screening
filters investments based on ESG-related preferences. Negative
screening excludes investments based on the investment's sector,
issuer, activity, or other ESG criteria; positive screening includes
investments based on similar characteristics. Positive screening is
often referred to as ``best-in-class'' investing.\132\
---------------------------------------------------------------------------
\132\ United Nations Principles for Responsible Investment, ``An
Introduction to Responsible Investment: Screening'' (May 2020),
https://www.unpri.org/an-introduction-to-responsible-investment/an-introduction-to-responsible-investment-screening/5834.article.
---------------------------------------------------------------------------
The Royal Bank of Canada (RBC, 2019) outlines the challenges of
comparing studies on ESG. This report divides the research literature
on socially responsible investment (SRI) into four categories: index
comparison, mutual fund comparison, hypothetical portfolios, and
company performance. In their review, they find that research comparing
equity SRI and non-SRI indices generally find that equity SRI indices
do not underperform traditional indices, with much of the literature
finding that SRI indices outperformed traditional indices. However,
mutual fund comparison studies prove difficult to compare because of
the variety of funds and investment strategies considered as SRI,
resulting in mixed and inconclusive results from this type of study.
Similarly, hypothetical portfolio studies may use different techniques
to incorporate ESG, making it difficult to compare results.\133\
---------------------------------------------------------------------------
\133\ RBC Global Asset Management, ``Does socially responsible
investing hurt investment returns?'' (2019), https://www.rbcgam.com/documents/en/articles/does-socially-responsible-investing-hurt-investment-returns.pdf.
---------------------------------------------------------------------------
Other research has pointed to the lack of a standardized definition
for ESG as a cause of mixed conclusions on the benefits of ESG. For
instance, Lioui and Tarelli (2022) analyze ESG data from three vendors,
comparing the properties of their ESG factors. They find that the
different factor construction methodologies can contribute to the mixed
evidence on the ESG performance in the literature and that disagreement
across data vendors has substantial implications for the performances
of ESG factors.\134\ Similarly, Cornell, and Damodaran (2020) review
ESG literature and note that while there is evidence that ``being
good'' benefits a company's operating performance, the literature's
findings are sensitive to how ESG is defined and profitability is
measured.\135\
---------------------------------------------------------------------------
\134\ Abraham Lioui and Andrea Tarelli, ``Chasing the ESG
Factor,'' Journal of Banking and Finance, forthcoming (March 2022),
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3878314.
\135\ Bradford Cornell and Aswath Damodaran, ``Valuing ESG:
Doing Good or Sounding Good?'' The Journal of Impact and ESG
Investing, Fall 2020, 1(1). https://jesg.pm-research.com/content/1/1/76.
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Likewise, the comments on the proposal are mixed in their
assessment on the relationship between ESG performance and corporate or
investment performance. Several comments note that ESG factors are
financially material for financial returns. For example, a comment
notes that firms with strong ratings on material sustainability issues
have better performance than firms with inferior ratings. One commenter
states that ESG-focused companies in the MSCI ACWI Index saw higher
returns, stronger earnings, and higher dividends. Another commenter
notes that the iShares ESG Aware MSCI USA ETF outperformed the S&P 500
index by five percentage points from the beginning of 2020 to the
second quarter of 2021. Still another commenter notes that ignoring the
entire category of information and analysis that comprises ESG factors
could be deemed an abrogation of a fiduciary's responsibility to
consider all relevant information when assessing the risk and return of
an investment opportunity.
Conversely, several commenters assert that ESG factors are not
relevant for financial returns and may be detrimental to returns and
retirement savings. For instance, one commenter remarks that the time
horizon associated with ESG risks often surpasses the time horizon of
retirement investors. Other commenters note that ESG return premiums
are due to larger weights placed on technology stocks, which have
experienced increased value but also present increased risk. A
commenter asserts that the claim in the NPRM that the proposal would
lead to increased investment returns is unsubstantiated.
[[Page 73862]]
(b) Meta-Studies
The body of research evaluating ESG investing shows ESG investing
can have financial benefits, although the literature overall has varied
findings. In a meta-analysis of over 1,000 studies published between
2015 and 2020, Whelan et al. (2021) report that of the studies
concerning corporate performance--focusing on measurements such as
return on equity, return on assets, and stock price for an individual
firm--58 percent find a positive relationship between corporate
financial performance and ESG, while 13 percent find a neutral
relationship, 21 percent find a mixed relationship, and 8 percent find
a negative relationship. For the studies concerning investment
performance--focusing on risk-adjusted return measurements for a
portfolio of stocks--33 percent find a positive relationship between
investment performance and ESG, 26 percent find a neutral impact, 28
percent find mixed results, and 14 percent find negative results.\136\
They found similar results when focusing only on studies about climate
change and financial performance. Clark, Feiner, and Vieha (2014)
conduct a meta-study analyzing more than 200 studies, 45 of which
looked at operational performance, and showed that 88 percent of these
studies found that ESG practices lead to better operational
performance. Additionally, 41 of the operational performance studies
review the relationship between sustainability and financial market
performance, of which 80 percent show that stock price performance of
companies is positively influenced by good sustainability
practices.\137\ Friede et al. (2015) find in their meta-study that only
10.0 percent of studies found a negative ESG performance relationship,
while 47.9 percent of vote-count studies \138\ and 62.6 percent of
meta-studies \139\ show positive findings.\140\
---------------------------------------------------------------------------
\136\ Tenise Whelan, Ulrich Atz, Tracy Van Holt, and Casey
Clark, ``ESG and Financial Performance: Uncovering the Relationship
by Aggregating Evidence from 1,000 Plus Studies Published Between
2015 and 2020,'' Journal of Sustainable Finance & Investment (2021).
https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf.
\137\ Gordon Clark, Andreas Feiner, and Michael Viehs, ``From
the Stockholder to the Stakeholder: How Sustainability Can Drive
Financial Outperformance,'' University of Oxford and Arabesque
Partner (2014), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2508281.
\138\ A ``vote count study'' in this context is a review study
which counts the number of primary studies with significant
positive, negative, and non-significant results and ``votes'' the
category with the highest share as winner.
\139\ A ``meta-study'' in this context is a review study which
directly imports effect sizes and sample sizes of primary studies to
compute a summary effect across all primary studies.
\140\ In this study, the authors analyze 60 review studies on
ESG performance, encompassing the finding of 2,250 unique underlying
studies. (See Gunnar Friede, Michael Lewis, Alexander Bassen, and
Timo Busch. ``ESG & Corporate Financial Performance: Mapping the
global landscape.'' DWS, University of Hamburg (December 2015).
https://download.dws.com/download?elib-assetguid=2c2023f453ef4284be4430003b0fbeee.)
---------------------------------------------------------------------------
(c) Association Between ESG Investing and Performance
Ito, Managi, and Matsuda (2013) find that socially responsible
funds outperformed conventional funds in the European Union and United
States.\141\ The Morgan Stanley Institute for Sustainable Investing
(2019) compared the performance of sustainable funds to traditional
funds between 2004 and 2018 and found that sustainable funds provided
returns in line with comparable traditional funds such that the
returns, net of fees, were not statistically significantly
different.\142\ Morningstar (2022) finds that of trailing three- and
five-year periods, 44 percent of sustainable funds, as defined by
Morningstar, ranked in the top quartile of their respective
categories.\143\ Curtis, Fisch, and Robertson (2021) measures ESG
orientation of mutual fund portfolios from four rating providers to
analyze returns of ESG funds between 2018 and 2019. They find that ESG
funds did not perform worse in terms of either raw or risk-adjusted
returns.\144\
---------------------------------------------------------------------------
\141\ Yutaka Ito, Shunsuke Managi, and Akimi Matsuda,
``Performances of Socially Responsible Investment and
Environmentally Friendly Funds,'' 64 Journal of the Operational
Research Society 11 (2013).
\142\ Morgan Stanley Institute for Sustainable Investing,
``Sustainable Reality: Analyzing Risk and Returns of sustainable
Funds,'' https://www.morganstanley.com/pub/content/dam/msdotcom/ideas/sustainable-investing-offers-financial-performance-lowered-risk/Sustainable_Reality_Analyzing_Risk_and_Returns_of_Sustainable_Funds.pdf.
\143\ Morningstar Manager Research, ``Sustainable U.S. Landscape
Report. 2021: Another Year of Broken Records'' (January 2022),
https://assets.contentstack.io/v3/assets/blt4eb669caa7dc65b2/blta4326c09c190e82b/62100fefcf85c1619ad897b2/U.S._Sustainable_Funds_Landscape_2022.pdf.
\144\ In this study, the authors identify ESG funds based on
their fund names. (See Quinn Curtis, Jill Fisch, and Adriana
Robertson, ``Do ESG Funds Deliver on Their Promises?'' Michigan Law
Review, Vol. 120(3) (2021), https://repository.law.umich.edu/cgi/
viewcontent.cgi?params=/context/mlr/article/7846/
&path_info=#:~:text=We%20find%20that%20ESG%20funds,increasing%20costs
%20or%20reducing%20returns.)
---------------------------------------------------------------------------
In contrast, other studies have found that ESG investing has
resulted in lower returns than conventional investing. For example,
Winegarden (2019) shows that over ten years, a portfolio of ESG funds
has a net return that is 43.9 percent lower than if it had been
invested in an S&P 500 index fund.\145\ One commenter criticizes the
Winegarden report, saying that the study does not isolate how
incorporation of ESG data affects performance. Trinks and Scholten
(2017) examine socially responsible investment funds and find that a
market portfolio based on negative screening significantly
underperforms an unscreened market portfolio.\146\ Ferruz,
Mu[ntilde]oz, and Vicente (2012) find that a portfolio of mutual funds
that implements negative screening \147\ underperforms a portfolio of
conventionally matched pairs.\148\ Ciciretti, Dal[ograve], and Dam
(2019) analyze a global sample of operating companies and find that
companies that score poorly on ESG indicators have higher expected
returns.\149\
---------------------------------------------------------------------------
\145\ Wayne Winegarden, ``Environmental, Social, and Governance
(ESG) Investing: An Evaluation of the Evidence,'' Pacific Research
Institute (2019), https://www.pacificresearch.org/wp-content/uploads/2019/05/ESG_Funds_F_web.pdf.
\146\ Pieter Jan Trinks and Bert Scholtens, ``The Opportunity
Cost of Negative Screening in Socially Responsible Investing''
Journal of Business Ethics 140, 193-208 (2017).
\147\ The authors describe a negative screening strategy as one
that ``removes stocks'' that do not align with the socially
responsible ideology from a portfolio. Comparatively, a positive
screening strategy ``selects stocks'' that align with the socially
responsible ideology for a portfolio.
\148\ Luis Ferruz, Fernando Mu[ntilde]oz, and Ruth Vicente,
``Effect of Positive Screens on Financial Performance: Evidence from
Ethical Mutual Fund Industry'' (2012), https://www.efmaefm.org/0efmameetings/efma%20annual%20meetings/2012-Barcelona/papers/EFMA2012_0183_fullpaper.pdf.
\149\ Rocco Ciciretti, Ambrogio Dal[ograve], and Lammertjan Dam,
``The Contributions of Betas versus Characteristics to the ESG
Premium,'' (2019).
---------------------------------------------------------------------------
Furthermore, there are many studies with inconclusive results.
Goldreyer and Diltz (1999) find that employing positive social screens
does not affect the investment performance of mutual funds, based on
analysis of 49 socially responsible mutual funds.\150\ Similarly,
Renneboog, Ter Horst, and Zhang (2008) find that the risk-adjusted
returns of socially responsible mutual funds are not statistically
different from conventional funds when analyzing a sample of global
socially responsible mutual funds.\151\ Research by Bello
[[Page 73863]]
(2005), which examines 126 mutual funds, finds that the long-run
investment performance is not statistically different between
conventional and socially responsible funds.\152\ Likewise, Ferruz,
Mu[ntilde]oz, and Vicente (2012) finds that a portfolio of mutual funds
that implement positive screening performs equally well as a comparable
conventional mutual funds, matched based on fund age, size, risk
factors.\153\ Humphrey and Tan (2014), which examines socially
responsible investment funds, finds no evidence of negative screening
affecting the risks or returns of portfolios.\154\
---------------------------------------------------------------------------
\150\ Elizabeth Goldreyer and David Diltz, ``The Performance of
Socially Responsible Mutual Funds: Incorporating Sociopolitical
Information in Portfolio Selection,'' 25 Managerial Finance 1
(1999).
\151\ Luc Renneboog, Jenke Ter Horst, and Chendi Zhang, ``The
Price of Ethics and Stakeholder Governance: The Performance of
Socially Responsible Mutual Funds'', 14 Journal of Corporate Finance
3 (2008).
\152\ Zakri Bello, ``Socially Responsible Investing and
Portfolio Diversification,'' 28 Journal of Financial Research 1
(2005).
\153\ Ferruz, Mu[ntilde]oz, and Vicente, ``Effect of Positive
Screens on Financial Performance,'' 2012.
\154\ Jacquelyn Humphrey and David Tan, ``Does It Really Hurt to
be Responsible?'', 122 Journal of Business Ethics 3 (2014).
---------------------------------------------------------------------------
Marsat and Williams (2020) uses the Markowitz Portfolio
optimization model, the direct application of modern portfolio theory,
to create the ``best complete portfolio'' by allocating to the optimal
risky portfolio and the risk-free asset. It does so assuming that
investors are risk averse and that, given equal returns, an investor
would prefer the one with less risk. Backtesting various constructed
portfolios over the past 10 years, the study did not observe a
correlation between high ESG scores and financial returns. The study
observes a wide range of performance depending on the provider of ESG
data.\155\
---------------------------------------------------------------------------
\155\ Organisation for Economic Co-operation and Development
(OECD). ``ESG Investing: Practices, Progress and Challenges''
(2020). https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf.
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A few of the studies referenced in the comments discussed the
performance of ESG funds during the COVID-19 pandemic. Whieldon and
Clark (2021) look at the performance of 26 ESG exchange traded funds
(ETFs) and mutual funds with more than $250 million in assets between
March of 2020 and 2021 and found that 19 of the 26 funds outperformed
the S&P 500.\156\ The Morgan Stanley Institute for Sustainable
Investing (2020) finds that, three out of four sustainable equity funds
beat their Morningstar category average. The authors posit that the
performance of sustainable funds in 2020 demonstrates that investing
strategies that manage material ESG risks can produce good returns in
an uncertain economic environment. The study finds that between January
and June of 2020, domestic sustainable equity funds outperformed their
traditional peers by a median of 3.9 percentage points.\157\
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\156\ Esther Whieldon and Robert Clark, ``ESG Funds Beat Out S&P
500 in 1st Year of COVID-19; How 1 Fund Shot to the Top,'' S&P
Global Market Intelligence (2021), https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/esg-funds-beat-out-s-p-500-in-1st-year-of-covid-19-how-1-fund-shot-to-the-top-63224550.
\157\ Morgan Stanley Institute for Sustainable Investing,
``Sustainable Reality: 2020 Update,'' Morgan Stanley (2020), https://www.morganstanley.com/content/dam/msdotcom/en/assets/pdfs/3190436-20-09-15_Sustainable-Reality-2020-update_Final-Revised.pdf.
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(d) Fees
Some commenters expressed concern that higher fees associated with
ESG investments will result in lower returns and retirement savings.
The Department recognizes that ESG investing requires information
collection and research that will incur costs. For instance, a 2020
study estimates that, globally, investment managers would spend $745
million in 2020 on ESG information.\158\
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\158\ Sean Collins and Kristen Sullivan, ``Advancing ESG
Investing: a Holistic Approach for Investment Management Firms,''
Harvard Law School Forum on Corporate Governance (March 2020),
https://corpgov.law.harvard.edu/2020/03/11/advancing-esg-investing-a-holistic-approach-for-investment-management-firms/.
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The findings in the literature discussing fees on ESG funds were
mixed. Morningstar (2020) finds that sustainable funds have higher
asset-weighted average expense ratios (0.61 percent) than their
traditional peers (0.41 percent).\159\ According to Wursthorn (2021),
at the end of 2020, the average fee for ESG funds was 0.20 percent,
compared to 0.14 percent for standard ETFs that invest in U.S. large-
cap stocks.\160\ Winegarden (2019) analyzes 30 ESG funds that have
either existed for more than 10 years or have outperformed the S&P 500
over a short-term timeframe and finds that the average expense ratio
was 0.69 percent for the 30 ESG funds, compared to an expense ratio of
0.09 percent for a S&P 500 index fund.\161\ Conversely, a study
conducted by Curtis, Fisch, and Robertson (2021) found that when
controlling for whether a fund is an actively managed fund or an index
fund, as well as net assets by fund manager, fund, and class, there is
not a statistically significant difference between the fees of ESG
funds and the fees that would be expected given fund
characteristics.\162\
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\159\ Morningstar, ``2020 U.S. Fund Fee Study: Fees Keep
Falling'' (August 2021), https://www.morningstar.com/content/dam/marketing/shared/pdfs/Research/annual-us-fund-fee-study-updated.pdf.
\160\ Michael Wursthorn, ``Tidal Wave of ESG Funds Brings Profit
to Wall Street,'' Wall Street Journal (March 2021), https://www.wsj.com/articles/tidal-wave-of-esg-funds-brings-profit-to-wall-street-11615887004.
\161\ Winegarden, ``Environmental, Social, and Governance (ESG)
Investing,'' 2019.
\162\ Curtis, Fisch, and Robertson, ``Do ESG Funds Deliver on
Their Promises?'' 2021.
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There has been some reduction in sustainable funds fees.
Morningstar (2020) finds that the average fee charged by sustainable
funds fell 27 percent between 2011 and 2021 and that this decline in
average fees has been driven by the rise of low-fee sustainable index
mutual funds and ETFs.\163\
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\163\ Morningstar, ``2020 U.S. Fund Fee Study: Fees Keep
Falling,'' Morningstar (2020), https://assets.contentstack.io/v3/assets/blt4eb669caa7dc65b2/blt0b2eed63bfb1eb8b/619f8bf6224a1b121d540f7e/annual-us-fund-fee-study-updated.pdf.
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The studies of ESG investment performance discussed in this
document generally take fees into account.
(e) Sectoral Bias
Some of the literature addresses the role of sectoral biases within
ESG investing. A study by Morningstar (2021) finds that between
November 2020 and March 2021, a rally in energy prices may have
hampered sustainable equity fund returns.\164\ Hale (2020) notes that
the performance of sustainable funds during the first quarter of 2020
was helped by having less exposure to energy stocks and a larger
exposure to technology stocks than the comparable market indices. The
study estimates that U.S. `sustainable index funds' energy-sector
under-weightings contributed an average of 0.43 percent to their
outperformance of the S&P 500 during this period. Information
technology was the quarter's best-performing sector, and sustainable
funds generally had a higher proportion of assets invested in the
sector than broad market indices. The study estimates information
technology contributed an average of 0.21 percent to the funds'
outperformance of the S&P 500. Nevertheless, the author posits that
``the biggest reason for their outperformance is that sustainable funds
appear to have benefited from selecting stocks with better ESG
credentials.'' \165\ Bruno, Esakia, and Goltz (2021) addresses
sectorial bias in general, finding that over representation of the
technology sector increases ESG performance. The study finds that when
[[Page 73864]]
the sectoral weights of portfolios are rebalanced to more closely
resemble the overall sectoral composition of the market, ESG strategies
``consistently deliver zero alpha.'' \166\ However, Lefkovitz (2021)
refutes the claims that ESG performance is entirely due to sectorial
bias, observing that companies with a sustainable competitive advantage
have often experienced lower volatility. The author posits that while
sectoral bias contributes to the performance of ESG strategies,
security selection also contributes to the outperformance.\167\
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\164\ Morningstar Manager Research, ``Sustainable U.S. Landscape
Report. 2021: Another Year of Broken Records'' (Jan. 2022), https://assets.contentstack.io/v3/assets/blt4eb669caa7dc65b2/blta4326c09c190e82b/62100fefcf85c1619ad897b2/U.S._Sustainable_Funds_Landscape_2022.pdf.
\165\ Jon Hale, ``Sustainable Funds Weather the First Quarter
Better than Conventional Funds,'' Morningstar (April 2020), https://www.morningstar.com/articles/976361/sustainable-funds-weather-the-first-guarter-better-thanconventional-funds.
\166\ Giovanni Bruno, Mikheil Esakia, and Felix Goltz, ``
`Honey, I Shrunk the ESG Alpha': Risk-Adjusting ESG Portfolio
Returns'' (April 2021), https://cdn.ihsmarkit.com/www/pdf/0521/Honey-I-Shrunk-the-ESG-Alpha.pdf.
\167\ Dan Lefkovitz, ``Morningstar's ESG Indexes have
Outperformed and Protected on the Downside'' (February 2021),
https://www.morningstar.com/insights/2021/02/08/morningstars-esg-indexes-have-outperformed-and-protected-on-the-downside.
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Conversely, Brav, and Heaton (2021) compare the returns of high-
carbon assets and low-carbon assets. The study found that, for firms
included in the S&P 500, the average return for the energy sector in
2021 was 64.8 percent, compared to an average return of 28.7 percent
for all companies not in the energy sector. Similarly, for firms
included in the Russell 3000, the average return for the energy sector
was 74.4 percent, compared to an average return of 25.5 percent for all
companies not in the energy sector. The authors state that the
transition to a low-carbon economy may fail and investors should not
avoid high-carbon assets.\168\
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\168\ Alon Brav and J.B. Heaton, ``Brown Assets for the Prudent
Investor,'' Harvard Business Law Review (2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3895887.
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(f) Investment Screening
As discussed above, one of the ESG investment strategies used is
investment screening. One commenter noted that many of the studies
cited by the Department in the proposal finding ESG underperformance
focus on the implications of negative screening or a socially
responsible investing lens. The commenter notes that most of the
studies cited by the Department showing ESG as beneficial to returns
focus on ESG as a means to maximize risk-adjusted returns. The
commenter further notes that most plan sponsors, except for those
relying on the tiebreaker test, would rely on a modern, financially
material ESG lens to select investments. Similarly, one commenter
called integrated ESG analysis a tool in the modern investment toolkit
to be used alongside traditional fundamental analysis, valuation
assessment, or quantitative analysis. For instance, one asset manager
with more than $50 billion assets under management commented that they
seek to generate superior, risk-adjusted investment returns by
investing in assets they believe are better positioned to seize
opportunities and mitigate risks associated with the transition to a
more sustainable economy. Another commenter noted that the
``digitalization of the economy and pioneering research has helped
generate awareness of critical issues that were previously not
considered significant for investors, including, but not limited to,
climate change, data privacy and social justice issues.'' The commenter
notes that the drawdowns and the risks associated with these ESG issues
are factors that financial markets and ERISA fiduciaries must consider
when making business, investment and voting decisions.
Several studies have specifically addressed the ESG investment
strategy of screening. For instance, the U.S. Commodity Futures
Tradition Commission (2020) refutes the historical view that ESG
investing is a values-driven activity inconsistent with fiduciary duty.
The study notes that this view ``ignore[s] the evolution of a wide
range of financial ESG factors and strategies, as well as the
proposition that impact investing may yield additional returns.'' \169\
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\169\ U.S. Commodity Futures Trading Commission, ``Managing
Climate Risk in the U.S. Financial System'' (2020), https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
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Verheyden, Eccles, and Feiner (2016) analyze stock portfolios that
were selected using ESG screening.\170\ The study finds that screening
tends to increase a stock portfolio's annual performance by 0.16
percent. Similarly, Kempf, and Osthoff (2007) examine stocks in the S&P
500 and the Domini 400 Social Index (renamed as the MSCI KLD 400 Social
Index in 2010) and find that it is financially beneficial for investors
to positively screen their portfolios.\171\ A study from Morningstar
(2021), looking at the performance of 69 ESG-screened Morningstar
indices, finds that 75 percent ``outperformed their broad market
equivalents in 2020'', 88 percent outperformed between 2015 and 2020,
and 91 percent ``lost less than their broad market equivalents during
down markets over the past five years, including the bear market in the
first quarter of 2020.'' \172\
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\170\ Tim Verheyden, Robert G. Eccles, and Andreas Feiner, ``ESG
for All? The Impact of ESG Screening on Return, Risk, and
Diversification,'' 28 Journal of Applied Corporate Finance 2 (2016).
\171\ Alexander Kempf and Peer Osthoff, The Effect of Socially
Responsible Investing on Portfolio Performance, 13 European
Financial Management 5 (2007).
\172\ Dan Lefkovitz, ``Morningstar's ESG Indexes have
Outperformed and Protected on the Downside'' (February 2021),
https://www.morningstar.com/insights/2021/02/08/morningstars-esg-indexes-have-outperformed-and-protected-on-the-downside.
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Trinks and Scholtens (2017) explores the effect of negative
screening stocks related to abortion, adult entertainment, alcohol,
animal testing, contraceptives, controversial weapons, fur, gambling,
genetic engineering, meat, nuclear power, pork, embryonic stem cells,
and tobacco has on investment returns. Looking at a sample of 1,763
stocks between 1991 and 2013, the authors note that negative screens
decrease the investment universe and limit the ability to diversify.
The study finds that there is an opportunity cost in negative screening
of ``refraining from investing in controversial firms.'' The study
finds that screened portfolios underperformed the unscreened portfolio
and notes that there ``can be a trade-off between values and beliefs
and financial returns.'' \173\ AQR Capital Management warns that the
performance of a constrained portfolio will always ex-ante be less than
or equal to an unconstrained portfolio.\174\ Similarly, Cornell and
Damodaran (2020) present a theoretical framework demonstrating that
adding an ESG constraint to investing increases expected returns is
counter intuitive, as a constrained optimum can, at best, match an
unconstrained one, and most of the time, the constraint will create a
cost.\175\ Sharfman (2021) argues that ``screening techniques based on
non-financial factors lead to an increased probability that the big
winners in the stock market will be excluded from or underweighted in
an investment portfolio.'' Based on this premise, the author concludes
that screening will result in lower expected risk-adjusted returns,
relative to a benchmark index.\176\
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\173\ Trinks and Scholtens, ``The Opportunity Cost of Negative
Screening in Socially Responsible Investing,'' 2017.
\174\ Cliff Asness, ``Virtue Is Its Own Reward: Or, One Man's
Ceiling Is Another Man's Floor,'' AQR Capital (May 2017), https://www.aqr.com/Insights/Perspectives/Virtue-is-its-Own-Reward-Or-One-Mans-Ceiling-is-Another-Mans-Floor.
\175\ Cornell and Damodaran, ``Valuing ESG,'' 2020.
\176\ Bernard Sharfman, ``ESG Investing Under ERISA.'' Yale
Journal on Regulation Bulletin, Vol. 38 (March 2021). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3809129.
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[[Page 73865]]
(g) ESG Factors and Risk
In addition to performance, the ESG literature also addresses the
relationship between ESG factors and risk. Common ESG factors are also
common risk factors, for both companies and investors. As such, ESG
integration inherently serves as a risk management function. For
instance, the E in ESG may include risks from climate change,
deforestation, or water scarcity. The S may consider risk associated
with data protection and privacy, employee engagement, or labor
standards within a supply chain. The G may address issues with bribery
and corruption, board and executive compensation, and whistleblower
protections.\177\ Each of these factors has direct connections to the
profitability and resilience of an investment, but as pointed out by
Kumar et al. (2016), may also be relevant with respect to the
reputation, political, and regulatory risk faced by the
investment.\178\ As a reference to the magnitude of risks associated
with ESG factors, a study by Schroders (2019) estimates that the
negative externalities of listed companies equate to almost half of
their combined earnings. The authors posit that these economic costs
will become tangible in the future, affecting financial cost and
income.\179\
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\177\ CFA Institute, ``The Rise of ESG Investing: What is
Sustainable Investing?'' https://interactive.cfainstitute.org/ESG-guide/what-is-sustainable-investing-238UB-188048.html.
\178\ Ashwin Kumar, Camille Smith, Leila Badis, Nan Wang, Paz
Amroxy, and Rodrigo Tavres, ``ESG Factors and Risk-Adjusted
Performance: A New Quantitative Model,'' Journal of Sustainable
Finance & Investment (2016) Vol. 6, No. 4, 292-300.
\179\ Schroders, ``SustainEx'' (April 2019), https://www.schroders.com/en/sysglobalassets/digital/insights/2019/pdfs/sustainability/sustainex/sustainex-short.pdf.
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This was confirmed by several commenters. Some commenters on the
NPRM state that ESG funds have lower downside risk or lower systematic
volatility. One commenter noted that ESG consideration is a form of
risk mitigation that can confer an investment edge and that neglecting
ESG-related risk can impact a company's competitive advantage and
diminish long-term economic gains. Another commenter noted that ESG
factors should be treated no differently than other risk and return
factors, as appropriate for a given industry and investment timeframe.
Several studies have found that the consideration of ESG factors in
investment processes can mitigate risk. For instance, a meta study by
Clark et al. (2014) observes that most of the studies (90 percent)
addressing the relationship between sustainability standards and the
cost of capital show that incorporating sustainability standards is
associated with a lower cost of equity or cost of debt.\180\ This
finding suggests that incorporating sustainable standards is associated
with lower risk. The consensus of the relationship between ESG factors
and risk has also been confirmed by more recent studies. Campagna,
Spellman, and Mishra (2020) find that higher ESG performance is
associated with lower volatility.\181\ The Morgan Stanley Institute for
Sustainable Investing (2019) shows that when comparing downside
deviation,\182\ sustainable funds were less risky. On average the
distribution of downside deviation for sustainable funds was 20.0
percent less than what traditional fund investors experienced in the
same period.\183\
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\180\ This meta study analyzes more than 200 studies, of which
29 discuss the cost of capital. (See Clark, Feiner, and Viehs,
``From the Stockholder to the Stakeholder,'' 2014.
\181\ This study looks at the relationship between ESG ratings
and returns for 534 securities, with a market cap exceeding $250
million, between 2013 and 2019. (See Anthony Campagna, G. Kevin
Spellman, and Subodh Mishra, ``ESG Matters,'' Harvard Law School
Forum on Corporate Governance (2020), https://corpgov.law.harvard.edu/2020/01/14/esg-matters/.)
\182\ Downside deviation is a risk measurement that focuses on
returns below a minimum threshold. (See Mark Jahn, ``Downside
Deviation,'' Investopedia (2022), https://www.investopedia.com/
terms/d/downside-
deviation.asp#:~:text=Downside%20deviation%20is%20a%20measure,measure
%20of%20risk%2Dadjusted%20return.)
\183\ This study compares the performance of sustainable funds
to traditional funds between 2004 and 2018 using Morningstar data on
ETF and open-ended mutual funds. Funds considered to be ESG-focused
are defined as those that prioritize investments based on multiple
screens for numerous ESG factors and a variety of strategies. (See
Morgan Stanley Institute for Sustainable Investing, ``Sustainable
Reality: Analyzing Risk and Returns of sustainable Funds'' (2019),
https://www.morganstanley.com/pub/content/dam/msdotcom/ideas/sustainable-investing-offers-financial-performance-lowered-risk/Sustainable_Reality_Analyzing_Risk_and_Returns_of_Sustainable_Funds.pdf.)
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Surveys of the investment industry and investors indicate that the
application of ESG factors in risk-management is a common practice. In
an investigation performed by the Government Accountability Office
(GAO) (2020), 12 of 14 interviewed institutional investors seek
information on ESG to better understand risks that could affect company
financial performance over time, and five of seven public pension funds
seek ESG information to enhance their understanding of risks that could
affect a companies' value over time.\184\ Similarly, survey data
reported by Natixis (2018) observes that 46 percent of institutional
investors implementing ESG say that the analysis of ESG-related factors
is ``as important to their investment process as traditional
fundamental analysis'' and that 56 percent of institutional investors
believe incorporating ESG mitigates governance and social risks.\185\
According to a survey conducted by FTSE Russell (2021), 64 percent of
asset owners implementing or evaluating sustainability in portfolios
cite risk as a motivator.\186\
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\184\ GAO, ``Report to the Honorable Mark Warner U.S. Senate:
Disclosure of Environmental, Social, and Governance Factors and
Options to Enhance Them'' (July 2020), https://www.gao.gov/assets/gao-20-530.pdf.
\185\ Natixis Investment Managers, ``Looking for the Best of
Both Worlds'' (2019), https://www.im.natixis.com/us/resources/esg-investing-survey-2019.
\186\ FTSE Russell, ``Sustainable Investment Is Now Standard
According to Global Asset Owner Survey'' (October 2021), https://www.ftserussell.com/press/sustainable-investment-now-standard-according-global-asset-owner-survey.
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The Department agrees that considering relevant ESG factors plays
an important role in mitigating risks in the portfolios of ERISA plan
participants and beneficiaries.
(h) Market Pricing of ESG Risks
In the proposal, the Department also welcomed comments on the
extent to which climate-related financial risk is not already
incorporated into market pricing. The Department received two comments
that argued that climate risks are not yet fully reflected in asset
prices. Conversely, another commenter criticized that the proposal's
regulatory impact analysis did not provide a rational basis for the
contention that climate change and other ESG factors are not already
priced into the market. This commenter argued that if climate change
and ESG factors are already priced into the market, then further
consideration would not result in investment gains.
Commenters also referenced literature exploring market pricing. For
instance, Brest, Gilson, and Wolfson (2018) argue that if ESG ratings
and investments in ESG affect productivity, then they should already be
reflected in stock prices.\187\ However, Condon (2021) identifies
several sources of mispricing pertaining to climate risks, including
limited asset-level data, reliance on outdated risk assessments,
misaligned incentives, and regulatory distortions within the market.
Although the efficient market hypothesis posits that arbitrageurs would
exploit mispriced assets until the assets are no longer
[[Page 73866]]
mispriced, the author acknowledges that the role of arbitrage in the
real world is limited by imperfect information, heterogeneous
expectations about the future, and uncertainty about when climate-
related risks will occur.\188\ Brav and Heaton (2021) notes that
research in this area is difficult, as the theories rely on expected
returns, while researchers only have access to realized returns. The
authors note, ``When researchers study average, realized returns, it is
always uncertain whether the realized price reflected one of the
possible price realizations that investors anticipated at the
probability they assigned it, or whether that price reflected a change
in the underlying probability distribution.'' \189\
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\187\ Paul Brest, Ronald Gilson, and Mark Wolfson, ``How
Investors Can (and Can't) Create Social Value,'' Columbia Law School
Scholarship Archive (2018), https://scholarship.law.columbia.edu/cgi/viewcontent.cgi?article=3099&context=faculty_scholarship.
\188\ Madison Condon, ``Market Myopia's Climate Bubble,'' 1 Utah
Law Review 63 (2022), Boston University School of Law Research Paper
(February 2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3782675.
\189\ Alon Brav and J.B. Heaton, ``Brown Assets for the Prudent
Investor,'' Harvard Business Law Review (2021). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3895887.
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(i) Literature on Environmental Factors
Reflective of the significant economic impacts of climate change to
date across various sectors of the economy, the Department believes it
can be as appropriate to treat climate change as a relevant factor in
assessing the risks and returns of investments as any other relevant
factor a prudent fiduciary would consider.
In the proposal, the Department requested comments on whether
fiduciaries should consider climate change as presumptively material in
their assessment of investment risks and returns, if adopted. The
Department received numerous comments specifically addressing the
materiality of climate change and environmental risks. Some of the
commenters note that while climate change risks are often considered
strategic and regulatory, they are also operational risks. One
commenter notes that the physical and transition impacts from climate
change are already materially affecting public companies and financial
institutions. Another commenter notes that weak control of
environmental activities, such as pollution, over-consumption of raw
materials, or lack of recycling, can lead to volatile or lower
financial margins or returns to investors. A few commenters note that
climate-related financial risks are especially relevant to retirement
investors, who invest over decades and are often universal owners with
exposure to many at-risk sectors.
There is a breadth of literature that provides evidence for the
materiality of climate change as a driver of risk-adjusted returns.
These risks are often referred to in two broad categories: physical
risk and transition risk. Physical risk captures the financial impacts
associated with a rise in extreme weather events and a changing
climate, both chronic and acute. The literature maintains that these
risks can be especially material for long duration assets and grow in
severity the more that climate mitigation and adaptation are neglected.
We are already seeing significant economic costs as a result of
warming, and a certain amount of additional warming is guaranteed based
on the greenhouse gas pollution already in the atmosphere.\190\ This
implies that the physical risks of climate change to our economy and to
investments will persist. A 2019 report from BlackRock notes that the
physical risk of extreme weather poses growing risks that are
underpriced in certain sectors and asset classes.\191\ Additionally,
S&P Trucost found that almost 60 percent of the companies in the S&P500
index hold assets that were at high risk to the physical effects of
climate change.\192\ The Treasury Financial Stability Oversight Council
(2021) provides a sense of the magnitude of the effect, noting that in
2020, there were 22 weather and climate disasters with damages
exceeding a billion dollars, resulting in a combined $95 billion in
damages.\193\ The report asserted that weather and climate disasters
may result in credit and market risks, associated with loss of income,
defaults, changes in the value of assets, liquidity risks, operational
risks, and legal risks.\194\
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\190\ Renee Cho, ``How Climate Change Impacts the Economy''
(June 20, 2019), https://news.climate.columbia.edu/2019/06/20/climate-change-economy-impacts/. Celso Brunetti, Benjamin Dennis,
Dylan Gates, Diana Hancock, David Ignell, Elizabeth K. Kiser,
Gurubala Kotta, Anna Kovner, Richard J. Rosen, and Nicholas K.
Tabor, ``Climate Change and Financial Stability,'' FEDS Notes.
Washington: Board of Governors of the Federal Reserve System, March
19, 2021, https://doi.org/10.17016/2380-7172.2893.
\191\ BlackRock Investment Institute, ``Getting Physical:
Assessing Climate Risks'' (2019), https://www.blackrock.com/us/individual/insights/blackrock-investment-institute/physical-climaterisks.
\192\ S&P Trucost Limited, Understanding Climate Risk at the
Asset Level: The Interplay of Transition and Physical Risks (2019),
https://www.spglobal.com/_division_assets/images/specialeditorial/understanding-climate-risk-at-the-assetlevel/sp-trucost-interplay-of-transition-andphysical-risk-report-05a.pdf.
\193\ U.S. Treasury Financial Stability Oversight Council,
``Report on Climate-Related Financial Risk: 2021'' (2021), https://home.treasury.gov/system/files/261/FSOC-Climate-Report.pdf.
\194\ Id.
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In contrast, transition risk reflects the risks that carbon-
dependent businesses lose profitability and market share as government
policies and new technology drive the transition to a carbon-neutral
economy. Existing government policies and increasingly ambitious
national and international greenhouse reduction goals will continue to
create significant transition risk for investments. Studies assess the
value of global financial assets at risk from climate change to be in
the range of $2.5 trillion to $4.2 trillion, including transition risks
and other impacts from climate change.
The U.S. Commodity Futures Trading Commission (CFTC, 2020) warns
that much of the risk associated with climate change is not priced into
the market, which increases the risk for a systemic shock. The report
notes that a ``sudden revision of market participants' perceptions
about climate risk could trigger a disorderly repricing of assets,
which could have cascading effects on portfolios and balance sheets
and, therefore, systemic implications for financial stability.'' \195\
A Federal Reserve Board report from 2020, which states ``[c]limate
change, which increases the likelihood of dislocations and disruptions
in the economy, is likely to increase financial shocks and financial
system vulnerabilities that could further amplify these shocks.'' \196\
The report continues: ``Opacity of exposures and heterogeneous beliefs
of market participants about exposures to climate risks can lead to
mispricing of assets and the risk of downward price shocks.'' \197\
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\195\ Climate-Related Market Risk Subcommittee, ``Managing
Climate Risk in the U.S. Financial System,'' U.S. Commodity Futures
Trading Commission, Market Risk Advisory Committee (2020), https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
\196\ Board of Governors of the Federal Reserve System,
``Financial Stability Report'' (November 2020), https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf.
\197\ Id.
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[[Page 73867]]
Several studies quantify the direct economic effects of climate
change. For instance, the CFTC estimates that by the end of the
century, climate change will decrease the U.S. annual GDP by 1.2
percent for every 1 degree Celsius increase and that by 2090, total
impacts from extreme heat conditions could result in more than 2
billion lost labor hours, corresponding to $160 billion (2015) in lost
wages.\198\ CFTC (2020) notes that transition risks may lead to both
stranded capital--where capital assets are at-risk from devaluation--or
stranded value--where the market-value of a project or firm is at-risk
from devaluation or otherwise negatively discounted.\199\ Mecure et al.
(2018) estimates that the stranded fossil fuel assets may result in a
discounted global wealth loss between $1 trillion and $4 trillion.\200\
Similarly, a Mercer and the Center for International Environmental Law
2016 report estimates that the coal subsector may lose as much as 84
percent of its annual return potential over the next 35 years. The
study also estimates that the annual returns for the oil and utilities
subsectors could fall by as much as 63 percent, and 39 percent,
respectively. In comparison, the study estimates that annual returns
for renewables could increase by as much 54 percent over the same
period.\201\
---------------------------------------------------------------------------
\198\ U.S. Commodity Futures Trading Commission, ``Managing
Climate Risk in the U.S. Financial System'' (2020), https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
\199\ U.S. Commodity Futures Trading Commission. ``Managing
Climate Risk in the U.S. Financial System,'' (2020). https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
\200\ J.F. Mercure, H. Pollitt, J.E. Vi[ntilde]uales, N.R.
Edwards, P.B. Holden. U. Chewpreecha, P. Salas, I. Sognnaes, A. Lam,
and F. Knobloch, ``Macroeconmic Impact of Stranded Fossil Fuel
Assets,'' Nature Climate Change 8, 588-593 (2018).
\201\ Mercer and the Center for International Environmental Law,
``Trillion-Dollar Transformation: A Guide to Climate Change
Investment Risk Management for US Public Defined Benefit Trustees''
(2016), https://static1.squarespace.com/static/569da6479cadb6436a8fecc8/t/584dcf37893fc01633e3572a/1481494366264/gl-2016-responsible-investments-a-guide-to-climate-change-investment-risk-management-for-us-public-defined-benefit-plan-trustees-mercer.pdf.
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The risks associated with climate change are also expected to have
direct implication for retirement investors. For example, Mercer and
the Center for International Environmental Law (2016) finds that the
total value of assets in an average U.S. public pension portfolio could
be 6 percent lower by 2050 than under a business-as-usual scenario due
largely to transition risks associated with climate change.\202\
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\202\ Id.
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However, it is worth noting that climate change also represents an
investment opportunity, with research suggesting that investment in
climate change mitigation will produce increasingly attractive
yields.\203\ Addressing transition risks can present opportunities to
identify investments that are strategically positioned to succeed in
the transition. Gradual shifts in investor preferences toward
sustainability and the growing recognition that climate risk is
investment risk may lead to a reallocation of capital. For instance,
Matthews, Eaton, and Benoit (2021) estimates that to meet global energy
demand and climate aspirations, annual investments in clean energy
would need to grow from $1.1 trillion in 2021 to $3.4 trillion until
2030.\204\
---------------------------------------------------------------------------
\203\ Jason Channell, Elizabeth Curmi, Phuc Nguyen, Elaine
Prior, Alastair Syme, Heath Jansen, Ebrahim Rahbari, Edward Morse,
Seth Kleinman, and Tim Kruger, ``Energy Darwinism II: Why a Low
Carbon Future Doesn't Have to Cost the Earth,'' Citi (August 2015).
https://www.citivelocity.com/citigps/energy-darwinism-ii/.
\204\ Christopher Matthews, Collin Eaton, and Faucon Benoit,
``Behind the Energy Crisis: Fossil Fuel Investment Drops, and
Renewables Aren't Ready,'' Wall Street Journal (October 2021),
https://www.proquest.com/docview/2582603911?accountid=41086.
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(j) Literature on Social Factors
The literature also has findings on the materiality of weighing
social factors in investment processes. The aforementioned meta-
analysis by Friede et al. (2015) finds that 55.1 percent of the studies
reviewed found a positive correlation between corporate financial
performance and social-focused investing.\205\ Two topics focused on in
the literature were (1) diversity and inclusion and (2) worker voice.
---------------------------------------------------------------------------
\205\ Gunnar Friede, Michael Lewis, and Alexander Bassen, Timo
Busch, ``ESG & Corporate Financial Performance: Mapping the Global
Landscape,'' Deutsche Asset & Wealth Management, University of
Hamburg (December 2015). https://download.dws.com/download?elib-assetguid=2c2023f453ef4284be4430003b0fbeee.
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(1) Diversity and Inclusion
Many studies show the material financial benefits of diverse and
inclusive workplaces. The Department received several comments noting
that diversity is material to financial performance. For instance, one
commenter notes that high staff turnover, high strike rates,
absenteeism, or death have all been linked to lower productivity and
poor-quality control. There are three main vectors across which a
company's diversity and inclusion practices that can have a financially
material impact on their business: employee recruitment and retention,
performance and productivity, and litigation.
(a) Employee Recruitment and Retention
There is evidence that corporate social responsibility affects
employee recruitment, productivity, satisfaction, and retention.\206\
While not all turnover is undesirable, turnover is costly. These costs
are both direct and indirect. Direct costs include staff time to off-
board the former employee, covering the reduced capacity with a
contingent employee or with existing staff, and the cost of
recruitment. The indirect costs include on-the-job training, employee
socialization, and productivity gaps between the new and former
employees.\207\ These costs are commonly estimated as equating to 6 to
9 months of the salary for the position (or 50 to 75 percent of the
salary) on top of the salary itself, depending on how exhaustively one
catalogues the different types of costs.\208\
---------------------------------------------------------------------------
\206\ Hong-yan Wang and Zhi-Xia Chen, ``Corporate Social
Responsibility and Job Applicant Attraction: a Moderated-Mediation
Model,'' PLOS ONE 17(3): e0260125. https://doi.org/10.1371/journal.pone.0260125. DiversityInc., ``Millennial and Gen Z
Jobseekers: An Emphasis on Social Responsibility,'' https://www.diversityincbestpractices.com/millennial-and-gen-z-jobseekers-an-emphasis-on-social-responsibility/.
\207\ David Allen, ``Retaining Talent,'' Society for Human
Resources Management Foundation (2008), https://www.shrm.org/hr-today/trends-and-forecasting/special-reports-and-expert-views/documents/retaining-talent.pdf.
\208\ Shane McFeely and Wigert, Ben, ``This Fixable Problem
Costs U.S. Businesses $1 Trillion,'' Gallup (March 2019), https://
www.gallup.com/workplace/247391/fixable-problem-costs-businesses-
trillion.aspx#:~:text=The%20cost%20of%20replacing%20an,to%20%242.6%20
million%20per%20year. John Hall, ``The Cost of Turnover Can Kill
Your Business and Make Things Less Fun,'' Forbes (May 2019), https://www.forbes.com/sites/johnhall/2019/05/09/the-cost-of-turnover-can-kill-your-business-and-make-things-less-fun/?sh=323adfac7943. Aharon
Tziner and Assa Birati, ``Assessing Employee Turnover Costs: A
Revised Approach,'' Human Resources Management Review (1996). 118-
119.
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In a survey of 2,745 respondents, the job site Glassdoor
found that 76 percent of employees and job seekers overall look at
workforce diversity when evaluating an offer.\209\
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\209\ Glassdoor, ``Diversity & Inclusion Workplace Survey''
(September 2020), https://b2b-assets.glassdoor.com/glassdoor-diversity-inclusion-workplace-survey.pdf?_gl=1*14tssal*_ga*MTY5NTI5NTgwMi4xNjYwNjUzMDY3*_ga_RC95PMVB3H*MTY2MDY1MzA2Ni4xLjEuMTY2MDY1MzA3NS41MQ.
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The Level Playing Institute (2007) estimates firms incur a
cost of $64
[[Page 73868]]
billion per year from losing and replacing over 2 million American
professionals and managers who leave their jobs each year due to
unfairness and discrimination.\210\
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\210\ Level Playing Field Institute, ``The Cost of Employee
Turnover Due Solely to Unfairness in the Workplace'' (2007).
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Robinson and Dechant (1997) estimate that replacing a
departing employee costs between $5,000 and $10,000 for an hourly
worker, and between $75,000 and $211,000 for an executive making
$100,000 per year.\211\
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\211\ Gail Robinson and Kathleen Dechant, ``Building a Business
Case for Diversity,'' Academy of Management Executive 11 (3) (1997):
21-31.
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(b) Performance and Productivity
Chen, Leung, and Evans (2018) find that increased
representation of women on corporate boards is associated with an
increase in the number of patents and citations, when controlling for
the amount of research and development spending.\212\
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\212\ Jie Chen, Woon Sau Leung, and Kevin P. Evans, ``Female
Board Representation, Corporate Innovation and Firm Performance,''
Journal of Empirical Finance 48 (September 2018): 236-254.
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Lorenzo et al. (2017) review of 171 German, Swiss, and
Austrian companies finds that management diversity has a positive and
statistically significant relationship to higher revenue from new
products and services.\213\
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\213\ Rocio Lorenzo, Nicole Voigt, Karin Schetelig, Annika
Zawadzki, Isabelle Welpe, and Prisca Brosi, ``The Mix that Matters:
Innovation through Diversity,'' BCG (2017), https://www.bcg.com/publications/2017/people-organization-leadership-talent-innovation-through-diversity-mix-that-matters.
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Phillips, Lijenquist, and Neale (2008) find that socially
different group members do more than simply introduce new viewpoints or
approaches. In the study, diverse groups outperformed more homogeneous
groups not because of an influx of new ideas, but because diversity
triggered more careful information processing that is absent in
homogeneous groups.\214\
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\214\ Katherine W. Phllips, Katie A. Lijenquist, and Margaret A.
Neale ``Is the Pain Worth the Gain? The Advantages and Liabilities
of Agreeing with Socially Distinct Newcomers,'' Personality and
Social Psychology Bulletin (December 2008), https://journals.sagepub.com/doi/abs/10.1177/0146167208328062.
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A study from Deloitte (2013) finds employee perception of
an organization's commitment to diversity and inclusion is associated
with higher levels of innovation, responsiveness to customer needs, and
team collaboration.\215\
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\215\ Deloitte, ``Waiter, Is that Inclusion in My Soup? A New
Recipe to Improve Business Performance,'' Deloitte (2013), https://www2.deloitte.com/content/dam/Deloitte/au/Documents/human-capital/deloitte-au-hc-diversity-inclusion-soup-051.
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A 2013 report released by the Center for Talent Innovation
(CTI) finds that employees at publicly traded companies that exhibit
both inherent and acquired diversity \216\ reported substantial
benefits. CTI conducted a survey and found that employees at diverse
companies were 70 percent more likely to report that they had captured
a new market, and 75 percent more likely to report that their ideas had
become productized. Employees were also as much as 158 percent more
likely to report that they believed they understood their target end-
users if one or more members on the team represent the user's
demographic.\217\
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\216\ The report defined inherent diversity to include gender,
race, age, religious background, socioeconomic background, sexual
orientation, disability, and nationality. The report defines
acquired diversity to include cultural fluency, generational
savviness, gender smarts, social media skills, cross-functional
knowledge, global mindset, military experience, and language skills.
\217\ Sylvia Ann Hewlett, Melinda Marshall, Laura Sherbin, and
Tara Gonsalves, ``Innovation, Diversity, and Market Growth,'' Center
for Talent Innovation (2013), https://coqual.org/wp-content/uploads/2020/09/31_innovationdiversityandmarketgrowth_keyfindings-1.pdf.
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Companies in the top quartile for ethnic and racial
diversity in management were 36 percent more likely to have financial
returns above the median for their industry in their country, and those
in the top quartile for gender diversity were 25 percent more likely to
have returns above the median for their industry in their country.\218\
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\218\ Vivian Hunt, Sara Prince, Sundiatu Dixon-Fyle, and Kevin
Dolan. ``Diversity Wins: How Inclusion Matters,'' McKinsey & Company
(2020). https://www.mckinsey.com/~/media/mckinsey/
featured%20insights/diversity%20and%20inclusion/
diversity%20wins%20how%20inclusion%20matters/diversity-wins-how-
inclusion-matters-vf.pdf.
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Companies in the top quartile of gender diversity or
ethnic diversity on executive teams were more likely to outperform peer
companies in the bottom quartile of diversity on executive teams, in
terms of profitability.\219\
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\219\ Ibid.
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(c) Litigation
The U.S. Equal Employment Opportunity Commission (EEOC)
received 67,448 charges of workplace discrimination in Fiscal Year (FY)
2020. The agency secured $439.2 million for victims of discrimination
in the private sector and state and local government workplaces through
voluntary resolutions and litigation.\220\
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\220\ ``EEOC Releases Fiscal Year 2020 Enforcement and
Litigation Data,'' (2021).
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(d) Studies Covering Multiple Topics
A meta-analysis on 7,939 business units in 36 companies
further confirms that higher employee satisfaction levels are
associated with higher profitability, higher customer satisfaction, and
lower employee turnover.\221\
---------------------------------------------------------------------------
\221\ James K. Harter, Frank L. Schmidt, and Theodore L. Hayes,
``Business-Unit-Level Relationship Between Employee Satisfaction,
Employee Engagement, and Business Outcomes: A Meta-Analysis,''
Journal of Applied Psychology 87(2) (2002) 268-279.
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One study found that ``companies reporting highest levels
of racial diversity brought in nearly 15 times more sales revenue on
average than those with lowest levels of racial diversity.'' It also
found that ``[c]ompanies with highest rates reported an average of
35,000 customers compared to 22,700 average customers among those
companies with lowest rates of racial diversity.'' \222\
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\222\ Cedric Herring, ``Does Diversity Pay? Race, Gender, and
the Business Case for Diversity,'' American Sociological Review
(2009).
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A study of Federal agencies finds that diversity
management is strongly linked to both work group performance and job
satisfaction, and people of color see benefits from diversity
management above and beyond those experienced by white employees.\223\
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\223\ David Pitts, ``Diversity Management, Job Satisfaction, and
Performance: Evidence from U.S. Federal Agencies,'' Public
Administration Review (2009).
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A 6-month research study ``found evidence that a growing
number of companies known for their hard-nosed approach to business--
such as Gap Inc., PayPal, and Cigna--have found new sources of growth
and profit by driving equitable outcomes for employees, customers, and
communities of color.'' \224\
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\224\ Angela Glover Blackwell, Mark Kramer, Lalitha
Vaidyanathan, Lakshmi Iyer, and Josh Kirschenbaum, ``The Competitive
Advantage of Racial Equity,'' FSG and PolicyLink (2018).
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However, some studies surveyed by the Department did not find a
statistically significant link between board diversity and corporate
financial performance. For instance:
A 2016 meta-analysis finds that the correlation between
gender diversity and corporate financial performance is either
nonexistent or very small.\225\
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\225\ Alive Eagly, ``When Passionate Advocates Meet Research on
Diversity, Does the Honest Broker Stand a Chance,'' Journal of
Social Issues, Vol. 72, No. 1 (2016). https://web.p.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=1&sid=8ad704e4-79e4-4998-827b-07473bb39c31%40redis.
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A 2021 review found that most of the literature used to
support diversity mandates on corporate boards does not identify causal
effects and that the conclusions of studies that do isolate a causal
effect are mixed.\226\
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\226\ Jonathan Klick, ``Review of the Literature on Diversity on
Corporate Boards,'' American Enterprise Institute (2021), https://www.aei.org/research-products/report/review-of-the-literature-on-diversity-on-corporate-boards/.
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[[Page 73869]]
A 2010 study did not find a statistically significant
relationship between the gender or ethnic diversity of boards and
financial performance.\227\
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\227\ David A. Carter, Frank D'Souza, Betty J. Simkins, and W.
Gary Simpson, ``The Gender and Ethnic Diversity of US Boards and
Board Committees and Firm Financial Performance,'' Corporate
Governance: An International Review 18, no. 5 (2010): 396-414,
https://wedc-online.wildapricot.org/Resources/WEDC-Documents/Women%20On%20Board/Gender%20Diversity%20and%20Boards.pdf.
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A 2015 meta-analysis from 20 studies on 3,097 companies
analyzed the relationship between female representation on corporate
boards and firm performance. The analysis found the mean-weighted
correlation between female representation and firm performance was
small and non-significant. However, the authors note that a higher
representation of females on corporate boards was also not associated
with a detrimental effect on firm financial performance.\228\
---------------------------------------------------------------------------
\228\ Jan Luca Pletzer, Romina Nikolova, Karina Karolina
Kedzior, and Sven Constantin Voelpel, ``Does Gender Matter? Female
Representation on Corporate Boards and Firm Financial Performance--A
Meta-Analysis'' (June 2015), https://journals.plos.org/plosone/article/file?id=10.1371/journal.pone.0130005&type=printable.
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One study cautions that ``the empirical connection between a single
dimension of board structure and firm performance may be too nuanced to
statistically tease out. Research that empirically links board
structure to board or firm actions is a much better method to test if a
relationship between board composition and performance exists than an
analysis that attempts to go from board structure directly to firm
performance and skips over board and firm actions.'' \229\ Another
study cautioned that when diversity is enforced by regulation, there
was no effect on performance.\230\
---------------------------------------------------------------------------
\229\ David A. Carter, Frank D'Souza, Betty J. Simkins, and W.
Gary Simpson, ``The Gender and Ethnic Diversity of US Boards and
Board Committees and Firm Financial Performance,'' Corporate
Governance: An International Review 18, no. 5 (2010): 396-414.
https://wedc-online.wildapricot.org/Resources/WEDC-Documents/Women%20On%20Board/Gender%20Diversity%20and%20Boards.pdf.
\230\ Deloitte and Nyenrode Research Program, ``Good Governance
Driving Corporate Performance? A Meta-Analysis of Academic Research
& Invitation to Engage in the Dialogue'' (December 2016).
---------------------------------------------------------------------------
(2) Worker Voice
The research literature also finds material financial benefits from
employee engagement and representation in corporate governance as
employees' voices are amplified through unions or through direct
representation on corporate boards. Similar to the literature on
diversity and inclusion, the literature focuses on the benefits of
employee retention and productivity.
Much of the literature on employee voice builds on the tradeoff
between exit and voice laid out by Hirschman (1970), in which
management becomes aware of failures either by actors, such as
employees, leaving the organization (``quitting'') or by actors
expressing dissatisfaction to management (``voicing'').\231\ A review
of theoretical and empirical research by Palladino (2021) finds that
when employees have access to voice mechanisms, such as union
representation, firms are likely to experience fewer employee
``exits.'' \232\ For example, Freeman (1980) shows empirically that the
presence of unions reduces turnover.\233\
---------------------------------------------------------------------------
\231\ Albert Hirschman, Exit, Voice, and Loyalty: Responses to
Decline in Firms, Organizations, and States, Harvard University
Press, Cambridge, Massachusetts (1970).
\232\ Lenore Palladino, ``Economic Democracy at Work: Why (and
How) Workers Should be Represented on US Corporate Boards,'' Journal
of Law and Political Economy, Vol. 1, No. 3 (2021).
\233\ Richard B. Freeman, ``The Exit-Voice Tradeoff in the Labor
Market: Unionism, Job Tenure, Quits, and Separations,'' The
Quarterly Journal of Economics, Vol. 94, No. 4 (1980), https://www.jstor.org/stable/pdf/1885662.pdf?refreqid=excelsior%3A04abe825526fefa1f141b7b509419d18&ab_segments=&origin=&acceptTC=1.
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The literature surveyed by Palladino (2021) also suggests that
unionization and worker voice improves employee productivity.\234\
Freeman and Lazear (1995) model the economic value of workers'
councils, finding that workers' councils may reduce economic
inefficiencies by decreasing information asymmetries and aligning
employer and worker incentives during difficult times. Their modeling
also finds that workers' councils with co-determination rights were
associated with increased perceptions of job security amongst workers,
aligning long-run interests of the worker and employer, and ultimately
increasing productivity.\235\ J[auml]ger et al. (2021) performed an
empirical analysis of the impact of a policy reform in Germany
affecting the degree of worker representation on corporate boards.\236\
They found that worker representation does not lower wages or reduce
capital formation.
---------------------------------------------------------------------------
\234\ Lenore Palladino, ``Economic Democracy at Work: Why (and
How) Workers Should be Represented on US Corporate Boards,'' Journal
of Law and Political Economy, Vol. 1, No. 3 (2021).
\235\ Richard Freeman and Edward Lazear, ``An Economic Analysis
of Works Councils,'' Works Councils: Consultation, Representation,
and Cooperation in Industrial Relations, University of Chicago Press
(1995), https://www.nber.org/system/files/chapters/c11555/c11555.pdf.
\236\ Simon J[auml]ger, Benjamin Schoefer, J[ouml]rg Heining,
``Labor in the Boardroom,'' Quarterly Journal of Economics, Vol.
136, Issue 2, 2021. https://doi.org/10.1093/qje/qjaa038.
---------------------------------------------------------------------------
(k) ESG Data, Ratings, and Disclosures
The research community and commenters also weighed in on the data,
ratings, and disclosures used to inform ESG investments. Surveys
conducted by Natixis Investment Managers in 2018 found that among
investment managers implementing ESG, 70 percent of institutions rely
on sustainability ratings to evaluate ESG performance, which is higher
than the percent of institutions relying on company reports (37
percent), rankings and awards (37 percent), regulatory filings (24
percent), news reports (24 percent), and non-governmental organizations
(23 percent).\237\
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\237\ Natixis Investment Managers, ``Looking for the Best of
Both Worlds'' (2019), https://www.im.natixis.com/us/resources/esg-investing-survey-2019.
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Research indicates that one of the challenges faced by investment
managers and rating agencies is that many of the company disclosures on
ESG-related issues are voluntary. Condon (2022) finds that, as of 2018,
complying companies, on average, provided less than four of the eleven
disclosure metrics recommended by the Task Force on Climate-related
Financial Disclosures. The study also finds that voluntary disclosures
are more likely to focus on transition risks than physical risks.\238\
---------------------------------------------------------------------------
\238\ Madison Condon, ``Market Myopia's Climate Bubble,'' 1 Utah
Law Review 63 (2022), Boston University School of Law Research Paper
(February 2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3782675.
---------------------------------------------------------------------------
To mitigate missing information in voluntary disclosures, ESG
rating agencies and investment professionals have begun to utilize
alternative data and artificial intelligence. These techniques allow
the industry to uncover material data that were not disclosed by the
company.\239\ For instance, Morgan Stanley Capital International (MSCI)
estimates that only 35 percent of the data inputs for the MSCI ESG
Ratings model are from voluntary disclosures.\240\ Additionally, a 2020
survey of CFA Institute members finds that 71 percent of the
participants polled agreed that alternative data reinforce
sustainability analysis and 43
[[Page 73870]]
percent expect applying artificial intelligence to sustainability
analysis will further improve the analysis.\241\
---------------------------------------------------------------------------
\239\ Sean Collins and Kristen Sullivan, ``Advancing ESG
Investing: a Holistic Approach for Investment Management Firms,''
Harvard Law School Forum on Corporate Governance (March 2020),
https://corpgov.law.harvard.edu/2020/03/11/advancing-esg-investing-a-holistic-approach-for-investment-management-firms/.
\240\ Samuel Block, ``Using Alternative Data to Spot ESG
Risks,'' MSCI (June 2019), https://www.msci.com/www/blog-posts/using-alternative-data-to-spot/01516155636.
\241\ CFA Institute. ``Future of Sustainability in Investment
Management: From Ideas to Reality.'' https://www.cfainstitute.org/-/media/documents/survey/future-of-sustainability.ashx.
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Another challenge faced by investment managers and rating agencies
is a lack of standardization in ESG terminology, which makes it
difficult to do relative comparisons or to create well-defined
categories.\242\ In a 2020 report to Congress, the GAO reviewed annual
reports, 10-K filings, proxy statements, and voluntary sustainability
reports for 32 companies and interviewed 14 large and midsized
institutional investors. The report found that the ``differences in
methods and measures companies use to disclose quantitative information
make it difficult to compare across companies.'' \243\ Similarly, the
CFA Institute notes that differing terminology, such as the same
measure being called different names or different measures sharing the
same name, makes it difficult to do relative comparisons.\244\
---------------------------------------------------------------------------
\242\ CFA Institute, ``Global ESG Disclosure Standards for
Investment Products'' (2021), https://www.cfainstitute.org/-/media/documents/ESG-standards/Global-ESG-Disclosure-Standards-for-Investment-Products.pdf.
\243\ GAO, ``Report to the Honorable Mark Warner U.S. Senate:
Disclosure of Environmental, Social, and Governance Factors and
Options to Enhance Them'' (July 2020), https://www.gao.gov/assets/gao-20-530.pdf.
\244\ CFA Institute, ``Global ESG Disclosure Standards for
Investment Products'' (2021).
---------------------------------------------------------------------------
While ESG rating agencies have improved their methods and
transparency in recent years, rating providers vary significantly in
scoring methodology, data, analyses, metric weighting, materiality, and
how missing information is accounted for.\245\ Several studies analyze
how ratings differ between agencies. For instance, Feifei and
Polychronopoulos (2020) construct four separate portfolios, two in the
United States and two in Europe, using ESG ratings data from two
providers. The study simulates portfolio performance between July 2010
and June 2018. The authors found that the two constructed portfolios
``have a performance dispersion of 70 basis points (bps) a year in
Europe (9.4 percent versus 8.7 percent) and 130 bps a year in the
United States (14.2 percent versus 12.9 percent).'' \246\ Similarly, a
2020 study from the OECD constructed portfolios using ESG scores from
different rating providers and found that risk-adjusted returns varied
significantly between different rating providers.\247\
---------------------------------------------------------------------------
\245\ OECD, ``ESG Investing: Practices, Progress and
Challenges'' (2020), https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf.
\246\ Feifei Li and Ari Polychronopoulos, ``What a Different an
ESG Ratings Provider Makes!'' Research Affiliates (January 2020),
https://www.researchaffiliates.com/content/dam/ra/documents/770-what-a-difference-an-esg-ratings-provider-makes.pdf.
\247\ OECD, ``ESG Investing: Practices, Progress and
Challenges'' (2020), https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf.
---------------------------------------------------------------------------
Berg, K[ouml]lbel, and Rigobon (2022) compared 709 ESG indicators
from different rating systems, to estimate how measurement, scope, and
weight divergence account for the differences between ESG ratings. They
find that measurement divergence accounts for 56 percent of the
difference, while scope and weight divergence account for 38 percent
and 6 percent, respectively.\248\ They caution that inconsistency with
ESG ratings sends mixed signals to companies as to which actions are
expected and will be valued by the market. They believe that the
divergence of ratings poses a challenge for empirical research, as
using one rater versus another may alter a study's results and
conclusions.
---------------------------------------------------------------------------
\248\ Florian Berg, Julian K[ouml]lbel, and Roberto Rigobon,
``Aggregate Confusion: The Divergence of ESG Ratings,'' 2022,
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533.
---------------------------------------------------------------------------
Curtis, Fisch, and Robertson (2021) find that there is substantial
heterogeneity in ESG ratings of companies but more consistency in ESG
ratings of portfolios, and that in general ESG portfolios provide a
degree of ESG characteristics.\249\ They argue this is what really
matters from an investor's point of view. They make the analogy that
the concerns with an ESG mutual fund are similar to those of a growth
mutual fund--neither has a standardized definition, but they offer
investors certain characteristics to a degree even if those
characteristics vary widely across funds and even if different ratings
providers rate them differently.
---------------------------------------------------------------------------
\249\ Curtis, Fisch, and Robertson, ``Do ESG Funds Deliver on
Their Promises?'' 2021.
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A 2021 study from MSCI finds that ESG ratings within the same
category can have low pairwise correlations, which the study attributes
to the use of different ESG metrics and weights.\250\ The study creates
a composite ESG rating based on subindustry specific weights of E, S,
and G and finds composite ratings tend to outperform any of the
individual E, S, or G ratings. The bottom quintile of E, S, G, and
composite ratings tend to have more stock drawdowns than their top
quintile, especially when it comes to large drawdowns. From 2007 to
2019, the bottom quintiles of E, S, G, and composite scores all
performed worse than their top quintile. In this longer run analysis,
E, S, and G scores had about equal effects, with the composite score
improving on all these ratings. However, the top E, S, and G scores
underperformed the bottom quintile during some time periods of their
analysis. The top quintile of the composite ESG score outperformed for
the entire time period.\251\
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\250\ MSCI's ESG ratings are based on subindustry level ratings,
selected from 37 ESG metrics. For each subindustry, metrics are
weighted based on subindustry specific weights.
\251\ MSCI ESG Research, ``Deconstructing ESG Ratings
Performance'' (2021), https://www.msci.com/our-solutions/esg-investing/deconstructing-esg-performance.
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Many commenters, academic researchers, and industry observers have
raised serious questions about the reliability of ESG ratings.
Fiduciaries use ratings as tools to synthesize large amounts of
information. Reliability concerns make it more challenging for
fiduciaries to conduct an analysis, but making decisions based on
imperfect information is not limited to ESG investing. The Department
anticipates that fiduciaries will give the same careful consideration
to the usefulness and shortcomings of data sources pertaining to ESG as
they do to any relevant data source.
(l) Summary of the Literature Reviewed
Paragraphs (b) and (c) of the final rule will reduce the
uncertainty that fiduciaries might have about considering ESG factors,
thereby permitting them to take into account the beneficial impact that
ESG can have on investing. The studies examined by the Department show
that ESG can have a beneficial impact on investing in many
circumstances. However, that impact is not universal and does not mean
that ESG investing will result in improved performance or reduced risk
in every circumstance. The current lack of standardized ratings also
makes it difficult to directly measure the full impact of ESG
strategies.
2. Cost Savings Relating to Paragraphs (c), Relative to the Current
Regulation
The current regulation expressly requires a fiduciary making an
investment decision on collateral benefits when using the tiebreaker to
document why pecuniary factors were not sufficient to select the
investment, how the selected investment compares to alternative
investments with regard to the factors listed in paragraphs
(b)(2)(ii)(A) through (C) of the current regulation, and how the chosen
non-pecuniary factors are consistent with the interests of the plan.
This provision implemented a more rigid, heightened documentation
requirement, which
[[Page 73871]]
imposed an annual cost burden of $122,115 according to the impact
analysis of the current rule. This view was also supported by
commenters, who stated that the current regulation created an extra
burden of documentation. The final rule eliminates this special
documentation requirement. The removal of this provision does not
excuse ERISA fiduciaries from the documentation required to satisfy
their general prudence obligations.
Removing the special documentation leads to a cost savings. Like in
the current regulation, the Department estimates that one percent of
plans will invoke the tiebreaker in an investment decision each year,
and the special documentation would have required two hours of labor
from both a plan fiduciary and clerical worker. Assuming an hourly
labor cost of $129.74 for a plan fiduciary and $61.01 for a clerical
worker,\252\ the Department estimates that this elimination, updated
for revised affected entity estimates, will save approximately $506,000
annually.\253\
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\252\ The Department estimates labor costs by occupation.
Estimates for total compensation are based on mean hourly wages by
occupation from the 2021 Occupational Employment Statistics and
estimates of wages and salaries as a percentage of total
compensation by occupation from the December 2021 National
Compensation Survey's Employee Cost for Employee Compensation.
Estimates for overhead costs for services are imputed from the 2020
Service Annual Survey. To estimate overhead cost on an occupational
basis, the Office of Research and Analysis (ORA) allocates total
industry overhead cost to unique occupations using a matrix of
detailed occupational employment for each North American Industry
Classification System (NAICS) industry. All values are in 2022
dollars. For more information in how the labor costs are estimated
see: Labor Cost Inputs Used in the Employee Benefits Security
Administration, Office of Policy and Research's Regulatory Impact
Analyses and Paperwork Reduction Act Burden Calculation, Employee
Benefits Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
\253\ In the 2020 final rule published on November 13, it was
estimated that that plan fiduciaries and clerical staff would each
expend, on average, two hours of labor to maintain the needed
documentation, resulting in an annual burden estimate of 1,290 hours
annually, with an equivalent cost of $122,115 for plans with ESG
investments. For the purposes of this analysis, the Department
assumes that DB plans will change investments annually, while DC
plans review their investments every three years, on average.
Updated to reflect updated estimates for affected plans and labor
costs, the Department estimates the updated costs as: (124,302 DB
plans that use ESG x 1% of plans that have ties x 2 hours x $129.74
per hour for a plan fiduciary) + (124,302 DB plans that use ESG x 1%
of plans that have ties x 2 hours x $61.01 per hour for a clerical
worker) + (25,020 DC plans that use ESG x 1% of plans that have ties
x \1/3\ of plans reviewing investments annually x 2 hours x $129.74
per hour for a plan fiduciary) + (25,020 DC plans that use ESG x 1%
of plans that have ties x \1/3\ of plans reviewing investments
annually x 2 hours x $61.01 per hour for a clerical worker) =
$506,029. This requirement has been eliminated in the finalized
rule. 85 FR 72846. (Source Private Pension Plan Bulletin: Abstract
of 2020 Form 5500 Annual Reports, Employee Benefits Security
Administration (2022; forthcoming), Table D3.)
---------------------------------------------------------------------------
3. Benefits of Paragraph (d)
Paragraph (d) of the final rule contains provisions addressing the
application of the prudence and loyalty duties to the exercise of
shareholder rights, including proxy voting, the use of written proxy
voting guidelines, and the selection and monitoring of proxy advisory
firms. The final rule's paragraph (d) will benefit plans by providing
improved guidance regarding these activities. As discussed above, non-
regulatory guidance that the Department has previously issued over the
years may have led to the misapprehension that fiduciaries are required
to participate in all proxy votes presented to them or, conversely,
that they may not participate in proxy votes unless they first perform
a formal cost-benefit analysis and quantify net benefits. Although the
current regulation sought to address the first misunderstanding (i.e.,
that fiduciaries are required to participate in all proxy votes) with
express language, the Department is concerned that the language used
may have effectively reinstated the second misunderstanding--that they
may not participate in proxy votes unless they first perform a formal
cost-benefit analysis and quantify net benefits--by suggesting that
fiduciaries need special justification to participate in proxy votes.
Several commenters stated that this misinterpretation leads some
fiduciaries to abstain from many proxy votes out of an abundance of
caution. These abstentions leave the interests of plans, participants,
and beneficiaries unrepresented in proxy votes. An increase in proxy
votes by plans will improve corporate accountability.
The Department believes that the principles-based approach retained
in paragraph (d) of the final rule will address these misunderstandings
and clarify that neither extreme is required. Instead, plan
fiduciaries, after an evaluation of relevant facts that form the basis
for any particular proxy vote or other exercise of shareholder rights,
must make a reasoned judgment both in deciding whether to exercise
shareholder rights and how to exercise such rights. In making this
judgment, plan fiduciaries must act in accordance with the economic
interest of the plan, must consider any costs involved, and must never
subordinate the interests of participants in their retirement benefits
to unrelated goals.
The clarifications offered in this final rule will lead to
increased proxy voting activity compared to the baseline. The reason is
that the final rule will address the misunderstanding that fiduciaries
need special justification to participate in proxy votes. With this
additional guidance, fiduciaries will have sufficient clarity to
participate in proxy votes unless a responsible plan fiduciary
determines it is not in the plan's best interest. The Department
believes this is beneficial because it ensures that shareholders'
interests, as a company's owners, are protected. By extension, this
means the interests of plan participants and beneficiaries as
shareholders are also protected.
Preserving flexibility, paragraph (d) of the final rule carries
forward core elements of the provision from the current regulation that
allows a plan to have written proxy voting policies that govern
decisions on when to vote on different categories or types of
proposals, subject to the aforementioned principles. With the ability
for plans to adopt policies to govern the decision whether to vote on a
matter or class of matters, plan fiduciaries will be in a better
position to conserve plan assets by establishing specific parameters
designed to serve the plan's interests.
The Department received several comments on the NPRM expressing
support for proxy voting as an essential fiduciary function. One
commenter argued that proxy voting can help reduce investment risk and
pointed to the success of shareholder resolutions in reducing hazardous
chemicals and pesticides, which could cause reputational and financial
damage to firms if improperly managed. Several commenters argued that
proxy votes can provide critical oversight of management, which can
reduce downside risk. One investment management firm commented that
they approach proxy voting with ``the consistent goal of promoting
strong corporate governance, acting in the best interest of [. . .]
shareholders and clients.'' Another commenter argued that the
Department should go further and require voting in favor of proxy votes
that align holdings with ESG metrics when in the interest of plan
participants and beneficiaries, citing the financial effects that waste
reduction efforts can have on lowering business costs. The Department
considered this suggestion, but believes that the Department's
longstanding view of ERISA with regards to proxy voting sets out a more
balanced approach. The Department believes that proxies should
[[Page 73872]]
be voted as part of the process of managing the plan's investment in
company stock unless a responsible plan fiduciary determines a proxy
vote may not be in the plan's best interest; for example, if the costs
associated with voting outweigh the expected benefits.
Commenters provided literature on the cost, benefits, and effects
of shareholder engagement and proxy voting.
(a) Changes in Levels of Proxy Voting
The Department expects that the final rule will promote, rather
than deter, responsible proxy voting compared to the 2020 rule;
however, it is less certain that it will result in any increase in
proxy voting as compared to the pre-regulatory guidance, which took a
similar approach. In the NPRM, the Department invited comments on
whether the proposed rule would increase proxy voting as compared to
the pre-regulatory guidance but did not receive any comments on the
question.
Some commenters discussed how the proposed rule would affect proxy
voting activity. For instance, one commenter noted that the proposed
rule would help support appropriate levels of proxy voting, though they
did not specify how, while recognizing that a professional advisor
across many accounts can play a practical role in alleviating the costs
and burdens of voting at the plan level. Conversely, another commenter
noted that even large funds could be ``rationally apathetic'' because
the costs of analyzing a given proxy vote and overcoming conflicts of
interest will likely outweigh the marginal benefits of a ``correct''
proxy vote. This commenter expressed that unless there are explicit
standards in place making clear that proxy voting is a fiduciary
obligation, there is a significant risk of sub-optimal proxy votes. The
Department's longstanding view of ERISA is that proxies should be voted
as part of the process of managing the plan's investment in company
stock unless a responsible plan fiduciary determines a proxy vote may
not be in the plan's best interest. We believe that this standard
highlights the importance of proxy voting, while also allowing a
fiduciary to make prudent decisions regarding the costs and benefits of
any particular proxy vote.
(b) Trends in Proxy Voting
Commenters provided literature on the state of proxy voting.
Orowitz, Kumar, and Hagel (2022) observe that by June of the 2022 proxy
season there were already 924 shareholder proposal submissions.\254\
Even though the 2022 proxy season was not complete at the time of the
study, this figure represented a 10 percent increase from 2021, when
837 shareholder proposals were submitted. There was a similar 11
percent increase between 2020 and 2021, when the number of proposals
increased from 754 to 837. Based on projections for the rest of the
year, the authors state that it is possible that 621 of these
shareholder resolutions may eventually come to a vote. This would
represent a 42 percent increase from 2021.\255\
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\254\ Hannah Orowitz, Rajeev Kumar, and Lee Ann Hagel, ``An
Early Look at the 2022 Proxy Season,'' The Harvard Law School Forum
on Corporate Governance (7 June 2022), https://corpgov.law.harvard.edu/2022/06/07/an-early-look-at-the-2022-proxy-season/.
\255\ Id.
---------------------------------------------------------------------------
Cook and Solberg (2021) examined the number of shareholder
resolutions brought to a vote regarding environmental and social
issues. The authors observed 171 votes on shareholder-sponsored
resolutions pertaining to environmental and social issues between July
1, 2020 and June 30, 2021, down from 220 votes in 2017. The study
attributes the decline in environmental and social shareholder
resolution votes to SEC regulations, which discouraged climate
shareholder resolutions. Of the 171 resolutions, however, a record 36
resolutions passed with majority support. Despite the decline in
shareholder resolutions received, average support rose to 34 percent,
which is five percentage points higher than the previous record set in
2019.\256\
---------------------------------------------------------------------------
\256\ Jackie Cook and Lauren Solberg, ``The 2021 Proxy Season in
Charts,'' Morningstar (August 2021), https://www.morningstar.com/articles/1052234/the-2021-proxy-voting-season-in-7-charts.
---------------------------------------------------------------------------
Koningsburg, Thorne, and Cahill (2021) analyzes trends across
annual general meetings in 2021. The authors find that U.S.
shareholders submitted 115 proposals related to the environment, with
74 percent of those being related to climate. This is a significant
increase from 2020, when shareholders submitted 89 environmental
resolutions, with 54 percent of those related to climate. There were 9
shareholder resolutions filed on diversity disclosure, three of which
requested public disclosure of EEO-1 data and six of which requested
enhanced reporting on diversity, equity, and inclusion data. Further,
there were eight shareholder proposals on racial equity audits. For
governance, in 2021, there was 95 percent support for re-election of
directors in the Russell 3000; however, the proportion of directors
receiving less than 80 percent support has increased in recent years.
The authors attribute the decline in support to lack of progress by the
board on climate change and diversity.\257\
---------------------------------------------------------------------------
\257\ Dan Konigsburg, Sharon Thorne, and Stephen Cahill,
``Investor Behavior in the 2021 Proxy Season,'' Harvard Law School
Forum on Corporate Governance (2021), https://corpgov.law.harvard.edu/2021/11/10/investor-behavior-in-the-2021-proxy-season/.
---------------------------------------------------------------------------
Another important facet of proxy voting is the investor's approach
to proposals by management. Shareholder resolutions are often the most
discussed aspect of proxy voting, but only make up a small share of
total proxy votes. According to ICI (2019), 98 percent of proxy
proposals at the 3,000 largest publicly traded firms were submitted by
management, with the majority of those proposals being related to
compensation, personnel, and other key business decisions. ICI also
finds investors are significantly more likely to support management
resolutions than they are shareholder resolutions. They found that 94
percent of the votes were cast in favor of proposals by management,
whereas only 34 percent of votes were cast in favor of shareholder
resolutions. This relationship also held with respect to the
recommendations of proxy advisors. Proxy advisors recommended voting in
favor of 93 percent of management proposals, but only 65 percent of
shareholder proposals.\258\
---------------------------------------------------------------------------
\258\ ``ICI Research Perspective'', ICI (2019), https://www.ici.org/system/files/attachments/per25-05.pdf.
---------------------------------------------------------------------------
(c) The Role of Proxy Advisory Firms
Several commenters weighed in on the role of proxy advisory firms.
Multiple commenters expressed concerns over the role of the proxy
advisory service industry, which they observed as being highly
concentrated. Several commenters argued that proxy advisory firms do
not have the knowledge or sufficient staff necessary to adequately
conduct the type of analysis necessary for making recommendations to
fiduciaries. One commenter went on to further express concern that
proxy advisory firms have no obligation to explain their
recommendations or provide the underlying research to back them up.
In addition to concerns over the role of proxy advisory firms,
several commenters expressed concerns regarding the potential for
conflicts of interests at these firms. If a proxy advisory firm makes
proxy voting recommendations that promote ESG it may increase their
lines of business providing ESG ratings and advising companies on how
to increase their ESG ratings.
[[Page 73873]]
Commenters primarily focused on four sections of the final rule
which they asserted would lead to increased reliance on proxy advisory
firms. First, commenters pointed to the rescission of language from
paragraph (e)(2)(ii) of the current regulation stating that ``the
fiduciary duty to manage shareholder rights appurtenant to shares of
stock does not require the voting of every proxy or the exercise of
every shareholder right.'' They believe that removing this language
will encourage higher levels of proxy voting by fiduciaries and that
fiduciaries will rely on proxy advisory services to deal with the
workload from increased proxy voting. Second, commenters stated that
removing the specific monitoring provisions from paragraph (e)(2)(ii)
of the existing regulation would reduce the effort associated with
using proxy advisory firms while simultaneously reducing accountability
and monitoring of those firms. Third, commenters stated that the
removal of specific recordkeeping requirements from paragraph
(e)(2)(ii)(E) of the current regulation would similarly make it easier
to rely on proxy advisory firms, while also impeding the ability of
participants to ensure that ERISA plan proxies are being voted in a
manner consistent with the financial interest of the plan. Finally, the
commenters point to the removal of two safe harbors from paragraphs
(e)(3)(i)(A) and (B) of the current regulation, which specified
policies of limiting voting based on voting type and holding size.
Other commenters stated that the safe harbors applied to instances in
which proxy voting would not be expected to have an economic effect.
They further expanded that without the safe harbors, fiduciaries would
participate in all proxy votes, which would require increased reliance
on proxy advisory firms.
The Department understands these concerns, and notes that
fiduciaries still have a duty under the final rule's general monitoring
provision, at paragraph (d)(2)(ii)(E) to prudently select and monitor
the provider of proxy advisory services. However, the Department did
not find it necessary to retain an additional provision to
differentiate the monitoring of a proxy advisory firm from the
monitoring of any other service providers that a fiduciary may utilize.
Additionally, section 404 (a)(1)(B) of ERISA already requires proper
documentation both of the activities of the investment manager and of
the named fiduciary of the plan in monitoring the activities of the
investment manager. This would require the investment manager or other
responsible fiduciary to keep accurate records as to the voting of
proxies, and periodically review the voting procedures and individual
votes. The Department did not find it necessary to retain additional
recordkeeping requirements beyond these that were already required of
fiduciaries. With regards to the safe harbors, the Department notes
that fiduciaries may still develop written guidelines to determine
their decisions to participate in proxy votes. The Department
reiterates its longstanding view of ERISA that proxies should be voted
unless a responsible plan fiduciary determines a proxy vote is not in
the plan's best interest.
Several commenters referenced studies discussing the role of proxy
advisory firms. A central theme in this literature was the argument
that shareholder resolutions are heavily influenced by the proxy
advisory service industry. Malenko and Shen (2016) studied the effects
of the proxy advisory industry on say-on-pay proposals from 2010 to
2011. The authors observed that negative recommendations by proxy
advisory firms reduced support for proposals by 25 percentage
points.\259\ A Timothy Doyle (2018) report also observed that certain
large institutional investors vote in line with proxy advisory firm
recommendations 80-95 percent of the time for positive recommendations,
and 50-85 percent for negative recommendations.\260\ At its most
extreme, this influence can manifest into ``robovoting'' whereby
investors follow a proxy advisory firm's voting guidance without any
independent review. Another report by Timothy Doyle (2018) finds that
175 asset managers representing more than $5 trillion in assets under
management and who voted on more than 100 shareholder resolutions voted
in line with proxy advisory firm recommendations more than 95 percent
of the time. Of these 175 asset managers, 82 voted with proxy advisory
services more than 99 percent of the time.\261\ In a similar vein, Paul
Rose (2019) found 98 investors, representing $3.2 trillion in assets
under management, voted in alignment with ISS more than 99.5 percent of
the time.\262\
---------------------------------------------------------------------------
\259\ Nadya Malenko and Yao Shen, ``The Role of Proxy Advisory
Firms: Evidence from a Regression-Discontinuity Design,'' The Review
of Financial Studies, Volume 29, Issue 12, December 2016, Pages
3394-3427, https://doi.org/10.1093/rfs/hhw070.
\260\ Timothy Doyle, ``The Conflicted Role of Proxy Advisors,''
American Council for Capital Formation (May 2018), https://accf.org/wp-content/uploads/2018/05/ACCF-The-Conflicted-Role-of-Proxy-Advisor-FINAL.pdf.
\261\ Timothy Doyle, ``The Realities of Robo-Voting,'' American
Council on Capital Formation (November 2018), https://accfcorpgov.org/wp-content/uploads/ACCF-RoboVoting-Report_11_8_FINAL.pdf.
\262\ Paul Rose, ``Robovoting and Proxy Vote Disclosure''
(November 2019). https://ssrn.com/abstract=3486322.
---------------------------------------------------------------------------
In addition to concerns over the influence of proxy advisory firms,
some literature also took issue with the quality of their
recommendations. Larcker, McCall, and Ormazabal (2015) find that
companies faced with the prospect of a negative proxy advisory service
recommendation on say-on-pay proposals will often change their
compensation programs ``in a manner consistent with the features known
to be favored by proxy advisory firms.'' The stock market reaction to
these pre-emptive changes is statistically negative.\263\
---------------------------------------------------------------------------
\263\ David F. Larcker, Allan McCall, and Gaizka Ormazabal,
``The Economic Consequences of Proxy Advisor Say-on-Pay Voting
Policies,'' Journal of Law and Economics, vol. 58, no. 1, Feb. 2015,
pp. 173-204, https://doi.org/10.2139/ssrn.2101453.
---------------------------------------------------------------------------
Some literature was more skeptical on the level of influence by the
proxy advisory service industry. Nili and Kastiel (2020) find that the
success rates of the two largest proxy advisory firms, Glass Lewis and
ISS, varies significantly from year to year.\264\ From 2005 to 2017,
the percentage of proxy fights won by the dissidents when supported by
Glass Lewis has been as low as 33 percent in 2012 and as high as 100
percent in 2010. When supported by ISS, the percentage of proxy fights
won by the dissidents has been as low as 43 percent in 2006 and as high
as 89 percent in 2014.
---------------------------------------------------------------------------
\264\ Yaron Nili and Kobi Kastiel, ``Competing for Votes,''
Wisconsin Law School Legal Studies Research Paper Series Paper, No.
1605 (2020), https://ssrn.com/abstract=3681541.
---------------------------------------------------------------------------
Similar variation was found in the percentage of proxy fights won
by management when supported by these proxy advisory firms. The authors
found that these mixed findings were consistent with the overall
corporate governance literature on proxy advisory services. In a review
of relevant literature, Larcker, Tayan, and Copland (2015), observe
that ``the empirical evidence shows that an against recommendation is
associated with a reduction in the favorable vote count by 10 percent
to 30 percent.'' \265\ Choi, Fisch, and Kahan (2010) estimate that the
negative recommendations of proxy advisory firms only shifted investor
votes by 6 to 10 percent after controlling
[[Page 73874]]
for observable factors.\266\ McCahery, Sauthner, and Starks (2015) find
that ``55 percent of institutional investors agree that proxy advisory
firms help them make more informed voting decisions,'' but concluded
that institutional investors rely on the advice of proxy advisory firms
as a complement to their decision-making, rather than a
substitute.\267\
---------------------------------------------------------------------------
\265\ David F. Larcker, Brian Tayan, and James R. Copland, ``The
Big Thumb on the Scale: An Overview of the Proxy Access Advisory
Industry,'' Harvard Law School Forum on Corporate Governance (June
14, 2018), https://corpgov.law.harvard.edu/2018/06/14/the-big-thumb-on-the-scale-an-overview-of-the-proxy-advisory-industry/.
\266\ Stephen Choi, Jill Fisch, and Marcel Kahan, ``The Power of
Proxy Advisors: Myth or Reality?'' 59 Emory Law Journal 869, 882
(2010), https://scholarlycommons.law.emory.edu/elj/vol59/iss4/2/.
\267\ Joseph A. McCahery, Zacharias Sautner, and Laura T.
Starks, ``Behind the Scenes: The Corporate Governance Preferences of
Institutional Investors,'' 71 Journal of Finance, 2905, 2928 (2016).
https://www.jstor.org/stable/44155408#metadata_info_tab_contents.
---------------------------------------------------------------------------
As stated in the preamble, the Department believes that the
solution to proxy-voting costs is for the fiduciary to be prudent in
incurring expenses to make proxy decisions and, wherever possible, to
rely on efficient structures, which may include the use of proxy
advisory services. However, paragraph (d)(2)(iii) of the final rule
states that a fiduciary may not adopt a practice of following the
recommendations of a proxy advisory firm or other service provider
without a determination that such firm or service provider's proxy
voting guidelines are consistent with the fiduciary's obligations
described in paragraphs (d)(2)(ii)(A) through (E) of this section. The
Department recognizes some commenters' continued concerns about the
role of proxy advisory firms, but this provision (in conjunction with
the general monitoring provision in paragraph (d)(2)(ii)(E), discussed
above) will protect plan participants and beneficiaries by ensuring
adequate oversight of proxy advisory firms.
(d) Costs of Proxy Voting and Shareholder Engagement and Its Effect on
Company Behavior
The effects of proxy voting and shareholder engagement on company
activity is the subject of a diverse body of literature. Much of the
research on proxy voting and shareholder engagement focuses on the
effects of proxy voting and shareholder engagement on a company's ESG
performance, which could then affect a company's financial performance.
The association between ESG and financial performance was discussed in
detail in previous sections.
Another body of research looks at the effectiveness of shareholder
resolutions as a tool to incite change. For instance, K[ouml]lbel,
Heeb, Paetzold, and Busch (2020) review five studies on shareholder
resolutions and found that 18 to 60 percent of shareholder resolutions
are successful in changing company behavior.\268\ The 18 percent
finding by Dimson, Karakas, and Li (2015) comes from the oldest sample
period (1999-2009) of the five papers, with more recent studies
suggesting higher success rates.\269\ One of the studies reviewed went
on to further demonstrate an increase in ESG ratings as a result of
these shareholder resolutions.\270\
---------------------------------------------------------------------------
\268\ Julian F. K[ouml]lbel, Florian Heeb, Falko Paetzold, and
Timo Busch, ``Can Sustainable Investing Save the World? Reviewing
the Mechanisms of Investor Impact,'' Organization & Environment,
vol. 33, no. 4, 2020, pp. 554-574, https://doi.org/10.1177/1086026620919202.
\269\ E. Dimson, O. Karakas, and X Li, ``Active Ownership,''
Review of Financial Studies, volume 28, issue 12, p. 3225-3268,
2015.
\270\ K[ouml]lbel, Heeb, Paetzold, and Busch, ``Can Sustainable
Investing Save the World?'' 2020.
---------------------------------------------------------------------------
Literature on the direct financial effects of proxy voting on stock
returns is more limited. A literature summary by Clark, Feiner, and
Viehs (2014) finds that most papers on proxy voting find inconclusive
or statistically insignificant results on the relationship to stock
returns. The authors find that the reviewed literature ``only provides
limited evidence that proxy voting is an effective tool to promote
proper ESG standards, or that it is helpful in creating superior
financial performance at investee firms.'' \271\
---------------------------------------------------------------------------
\271\ Clark, Feiner, and Viehs, ``From the Stockholder to the
Stakeholder,'' 2014.
---------------------------------------------------------------------------
Cu[ntilde]at, Gine, and Guadalupe (2012) find that companies with
successful shareholder governance proposals yielded abnormal returns--
1.3 percent higher than firms with failed proposals on the day of the
vote. Over the week of the vote, these abnormal returns accumulate to
2.4 percent. This gain in shareholder value is more pronounced
regarding anti-takeover provisions, like eliminating classified boards
and poison pills. This effect is also stronger at firms with more
concentrated ownership, more anti-takeover provisions in place, more
research and development (R&D) expenditures, and more shareholder
proposals in the past. The effect is also larger for proposals made by
institutional shareholders rather than individuals. The authors further
find that actually implementing these accepted proposals increases the
shareholder value effect to 2.8 percent.\272\
---------------------------------------------------------------------------
\272\ Cu[ntilde]at Vicente, Mireia Gine, and Maria Guadalupe,
``The Vote Is Cast: The Effect of Corporate Governance on
Shareholder Value,'' The Journal of Finance, vol. 67, no. 5, 2012,
pp. 1943-1977, https://doi.org/10.1111/j.1540-6261.2012.01776.x.
---------------------------------------------------------------------------
In summary, the literature provided leads the Department to believe
that proxy voting and shareholder engagement is increasing in its
frequency and scope. The effects of this activity are not uniformly
agreed upon in the literature, however there is evidence of proxy
voting and shareholder engagement leading to increased shareholder
value and financial returns at firms. There is also evidence of proxy
voting and shareholder engagement being able to increase a company's
ESG performance, which may have financial performance benefits that
were discussed previously. Proxy voting and shareholder engagement has
a tangible time cost, which can be reduced through the use of efficient
structures, including proxy voting guidelines, and proxy advisers/
managers that act on behalf of large aggregates of investors. Evidence
regarding the influence of these proxy advisory firms is mixed, and
varies from year to year, company to company, and topic to topic.
Accordingly, the Department stresses fiduciaries' obligation to monitor
the performance of proxy advisory firms to ensure that they are
performing their work in a way that is consistent with the plan's best
interest.
4. Cost Savings Relating to Paragraphs (d) and (e), Relative to the
Current Regulation
In the cost savings estimates below, the Department assumes an
hourly labor cost of $129.74 for a plan fiduciary and $61.01 for a
clerical worker.\273\
---------------------------------------------------------------------------
\273\ The Department estimates labor costs by occupation.
Estimates for total compensation are based on mean hourly wages by
occupation from the 2021 Occupational Employment Statistics and
estimates of wages and salaries as a percentage of total
compensation by occupation from the December 2021 National
Compensation Survey's Employee Cost for Employee Compensation.
Estimates for overhead costs for services are imputed from the 2020
Service Annual Survey. To estimate overhead cost on an occupational
basis, ORA allocates total industry overhead cost to unique
occupations using a matrix of detailed occupational employment for
each NAICS industry. All values are in 2022 dollars. For more
information in how the labor costs are estimated see: Labor Cost
Inputs Used in the Employee Benefits Security Administration, Office
of Policy and Research's Regulatory Impact Analyses and Paperwork
Reduction Act Burden Calculation, Employee Benefits Security
Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
---------------------------------------------------------------------------
Paragraph (d) of the final rule eliminates the recordkeeping
requirement in paragraph (e)(2)(ii)(E) of the current regulation which
provides that, when deciding whether to exercise shareholder rights and
when exercising shareholder rights, plan fiduciaries must maintain
records on proxy voting activities and other exercises of shareholder
rights. The change is
[[Page 73875]]
expected to produce a cost savings of $6.1 million per year relative to
the current regulation.\274\ This cost savings was confirmed by one
commenter.
---------------------------------------------------------------------------
\274\ In the 2020 final rule published on December 16, it was
estimated that a plan fiduciary and a clerical staff would expend,
on average, 30 minutes each to fulfill the recordkeeping
requirement. The burden in the 2020 rule was estimated as $6.05
million. Updated to reflect updated estimates for affected plans and
labor costs, the Department estimates the updated costs as: (63,670
plans * 0.5 hours * $129.74 per hour for a plan fiduciary) + (63,670
plans * 0.5 hours * $61.01 per hour for a clerical worker) =
$6,072,526, or $6.1 million.
---------------------------------------------------------------------------
The final rule amends the provision of the current regulation that
addresses proxy voting policies, paragraph (e)(3)(i) of the current
regulation, by removing the two ``safe harbor'' examples for proxy
voting policies that would be permissible under the provisions of the
current regulation. As discussed earlier in the preamble to this
regulation, the Department believes that the two ``safe harbor''
examples would likely become widely adopted by plan fiduciaries if
maintained. When adopting the current regulation, the Department
estimated that it would take a legal professional two hours to evaluate
and implement changes to proxy voting policies within the scope of the
safe harbors. In the final rule, without the safe harbors, the
Department estimates that it will take a legal professional 30 minutes
to update policies and procedures. This final rule thus reduces the
burden related to evaluating, updating, and implementing proxy voting
policies and procedures and voting by $11.6 million in the first year
relative to the current regulation.\275\
---------------------------------------------------------------------------
\275\ In the 2020 final rule published on December 16, it was
estimated that a legal professional would expend, on average, two
hours to update policies and procedures. The burden in the 2020 rule
was estimated as $17.2 million. Updated to reflect updated estimates
for affected plans and labor costs, the Department estimates the
updated costs for the original requirement as: 63,670 plans * 2
hours * $129.74 per hour for a plan fiduciary = $16,521,092. As
discussed in the Cost section of this analysis, the Department
estimates that it will take a legal professional just thirty minutes
to update policies and procedures for each of the estimated 63,670
plans affected by the rule, resulting in a cost of $4,877,440. This
results in a cost savings of $11,643,651, or $11.6 million. 85 FR
81658.
---------------------------------------------------------------------------
The total costs savings associated with the amendments to paragraph
(d) are estimated to be approximately $17.7 million.
E. Costs
The Department expects the amendments made by the final rule will
change plan fiduciary investment behavior; however, the overall effect
of amendments on investment behavior is largely uncertain. In the
analysis below, the Department has carefully considered the costs
associated with the amendments and quantified the costs expected to
result from the final rule, with the acknowledgment that a precise
quantification of all costs stemming from changes in behavior is not
possible. Nevertheless, the Department expects the incremental costs of
the final rule to be relatively small and the overall benefits to
outweigh the costs. As shown in the analysis below, the known
incremental costs of the proposal are expected to be minimal on a per-
plan basis.
The analysis below is based on labor cost estimates of $153.21 for
a legal professional.\276\
---------------------------------------------------------------------------
\276\ The Department estimates labor costs by occupation.
Estimates for total compensation are based on mean hourly wages by
occupation from the 2021 Occupational Employment Statistics and
estimates of wages and salaries as a percentage of total
compensation by occupation from the December 2021 National
Compensation Survey's Employee Cost for Employee Compensation.
Estimates for overhead costs for services are imputed from the 2020
Service Annual Survey. To estimate overhead cost on an occupational
basis, ORA allocates total industry overhead cost to unique
occupations using a matrix of detailed occupational employment for
each NAICS industry. All values are in 2022 dollars. For more
information in how the labor costs are estimated see: Labor Cost
Inputs Used in the Employee Benefits Security Administration, Office
of Policy and Research's Regulatory Impact Analyses and Paperwork
Reduction Act Burden Calculation, Employee Benefits Security
Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
---------------------------------------------------------------------------
1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
Plans, plan fiduciaries, and their service providers will need to
read the final rule and evaluate how it will impact their practices. To
estimate the costs associated with reviewing the amended rule, the
Department considers two sub-groups of plans: plans that consider ESG
factors in their investment process and plans that hold corporate stock
with voting rights.
The Department estimates that approximately 149,300 plans will
consider ESG factors in their investment practice and will be affected
by the finalized amendments in paragraphs (b) and (c).\277\ For each
plan, a legal professional will need to review paragraphs (b) and (c)
of the final rule, evaluate how these provisions might affect their
investment practices and assess whether the plan will need to make
changes to investment practices. The Department estimates that this
review will take a legal professional approximately four hours to
complete, resulting in an aggregate cost burden of approximately $91.5
million \278\ or a per-plan cost burden of approximately $613.\279\
---------------------------------------------------------------------------
\277\ For more information on this estimate, refer to the
discussion of affected entities in section IV.C.
\278\ The burden is estimated as follows: 149,322 plans x 4
hours = 597,288 hours. A labor rate of $153.21 is used for a legal
professional. The cost is estimated as follows: 149,322 plans x 4
hours x $153.21 = $91,510,494.
\279\ The per-plan burden is estimated as follows: $91,510,494/
149,322 plans = $612.84, rounded to $613.
---------------------------------------------------------------------------
The Department estimates that 63,670 plans hold corporate stock
with voting rights and will be affected by the finalized amendments
pertaining to proxy voting in paragraph (d). For each plan, a legal
professional will need to review paragraph (d) of the amended rule and
evaluate how it affects their proxy voting practices. The Department
estimates that this review process will require a legal professional,
on average, approximately four hours to complete, resulting in an
aggregate cost burden of approximately $39.0 million \280\ or a per-
plan cost of approximately $613.\281\
---------------------------------------------------------------------------
\280\ The burden is estimated as follows: 63,670 plans x 4 hours
= 254,680 hours. A labor rate of $153.21 is used for a lawyer. The
cost burden is estimated as follows: 63,670 plans x 4 hours x
$153.21 = $39,019,523.
\281\ The per-plan burden is estimated as follows: $39,019,523/
63,670 plans = $612.84, rounded to $613.
---------------------------------------------------------------------------
The Department believes that most plans, in both subsets discussed
above, will rely on a service provider to perform such a review and
that each service provider will likely oversee multiple plans. The
Department does not have data that would allow it to estimate the
number of service providers acting in such a capacity for these plans.
While the Department believes that this cost is likely an overestimate,
given the lack of data, the Department believes it is reasonable.
2. Possible Changeover Costs
The Department expects that some plans may change investments or
investment processes in light of the clarifications in the final rule.
For example, plans may decide to replace existing investments with ESG
investments. This may involve some short-term costs. In the
Department's view, this will be net beneficial because compliant
acquisitions of ESG assets will be done with the aim of reducing the
plan's ESG-related financial risk or improving the plan's investment
performance. Thus, even if there are short-term costs associated with
changed investment practices, the benefits to the plan of reduced ESG-
related financial risk are expected to exceed these costs over time.
The Department lacks data to estimate the likely size of this impact.
The Department solicited comments on this assumption in the NPRM but
did not receive any comments.
[[Page 73876]]
3. Cost Associated With Changes in Investment or Investment Course of
Action
Paragraphs (b) and (c)(1) of the final rule address a fiduciary's
duty of prudence and loyalty under ERISA with respect to consideration
of an investment or investment course of action. Paragraph (c)(1) of
the final rule provides that a fiduciary may not subordinate the
interests of the participants and beneficiaries in their retirement
income or financial benefits under the plan to other objectives, and
may not sacrifice investment return or take on additional investment
risk to promote benefits or goals unrelated to said interests of the
participants and beneficiaries. Paragraph (b)(4) of the final rule, in
relevant part, provides that a fiduciary's determination with respect
to an investment or investment course of action must be based on
factors that the fiduciary reasonably determines are relevant to a risk
and return analysis, using appropriate investment horizons consistent
with the plan's investment objectives and taking into account the
funding policy of the plan established pursuant to section 402(b)(1) of
ERISA. These provisions will require a fiduciary to perform an
evaluation, including a prudent analysis of risk and return factors.
These provisions provide direction on what to include in that
evaluation.
In the NPRM, the Department did not attribute a cost to these
requirements, with the understanding that many plan fiduciaries already
undertake such evaluations as part of their investment selection
decision-making process, including documentation of their decisions,
process, and reasoning. One commenter refuted this assumption, noting
that the industry lacks consistent definitions on ESG topics and
stating that evaluating ESG topics would be a manual process for plan
sponsors, requiring time and resources. Conversely, another commenter
noted that data collection costs imposed by the rule would likely be de
minimis, as the investment community is collecting ESG data independent
of the rulemaking process.
The commenters have not persuaded the Department to change its
views on this topic. Plan fiduciaries generally already undertake
deliberative evaluations as part of their investment selection
decision-making process and this final rule does not add burden to
those deliberations; but rather, the final rule clarifies that the
scope of those deliberations may include climate change and other ESG
factors within the confines of paragraphs (b)(4) and (c)(1) of the
final rule. The Department does not intend to increase fiduciaries'
burden of care attendant to such consideration; therefore, no
incremental costs are estimated for these requirements.
4. Cost Associated With Changes to the ``Tiebreaker'' Rule
The final rule, at paragraph (c)(2), implements a version of the
tiebreaker concept that is comparable to and commensurate with the
formulation previously expressed in Interpretive Bulletin 2015-1 (and
first explained in Interpretive Bulletin 94-1). The final rule's
tiebreaker provision is relevant and operable only once a prudent
fiduciary determines that competing alternative investments equally
serve the financial interests of the plan. In these circumstances, the
plan fiduciary may focus on the collateral benefits of an investment or
investment course of action to decide the outcome. This version of the
tiebreaker is more flexible than the regulation this rule replaces,
which requires that the risk and reward of competing investments be
indistinguishable before the tiebreaker can be utilized.
While the provision implies a requirement for analysis and
documentation, the Department expects that the analytics and
documentation requirements of the tiebreaker provision are subsumed in
the analytics and documentation requirements of the risk and return
analysis required by paragraphs (c)(1) and (b)(4) of the final rule.
The analysis of risk and return factors under paragraphs (c)(1) and
(b)(4) of the final rule in the first instance will necessarily reveal
any collateral benefits of an investment or investment course of
action, which may then be used to break a tie pursuant to paragraph
(c)(2) of the final rule. In this sense, paragraph (c)(2) of the final
rule thus imposes no distinct process, and therefore no significant
additional costs, apart from a plan's ordinary investment selection
process. Based on this assumption, the Department attributes no costs
to paragraph (c)(2) of the final rule.
5. Cost To Update Plan's Written Proxy Voting Policies
Paragraph (d)(3)(i) of the final rule provides that plan
fiduciaries may adopt proxy voting policies on when to vote a proxy
ballot. Such a policy must be prudently designed to serve the plan's
interests in providing benefits to participants and their beneficiaries
and to defray reasonable expenses of administering the plan. In
addition, plan fiduciaries must periodically review any such proxy
voting policies under paragraph (d)(3)(ii).
The Department estimates that 63,670 plans hold corporate stock
with voting rights and will be affected by the finalized amendments
pertaining to proxy voting in paragraph (d).\282\ For each plan, the
Department estimates that, on average, it will take a legal
professional thirty minutes to update policies and procedures,
resulting in an aggregate incremental cost of $4.9 million,\283\ or a
per-plan incremental cost of $77,\284\ in the first year relative to
the current rule.
---------------------------------------------------------------------------
\282\ For more information on this estimate, refer to the
discussion of affected entities in section IV.C.
\283\ The burden is estimated as follows: 63,670 plans x 0.5
hour = 31,835 hours. A labor rate of $153.21 is used for a legal
professional: (63,670 plans x 0.5 hour x $153.21 = $4,877,440).
\284\ The per-plan burden is estimated as follows: $4,877,440/
63,670 plans = $76.61, rounded to $77.
---------------------------------------------------------------------------
The amended paragraph (d)(3)(ii) will require plans to periodically
review proxy voting policies. However, the Department believes that the
final rule largely comports with current practice for ERISA
fiduciaries, such that plan fiduciaries already periodically review
proxy voting policies to meet their obligations under ERISA. The
Department does not expect that plans will incur additional cost
associated with the periodic review.
6. Summary
The Department estimates that the total incremental costs
associated with the final rule will be $135.4 million in the first year
with no additional costs in subsequent years. The aggregate and per-
plan costs are summarized in Table 2.
[[Page 73877]]
Table 2--Costs for Plans To Comply With the Requirements
----------------------------------------------------------------------------------------------------------------
Aggregate cost Per-plan cost
Requirement ---------------------------------------------------------------
Year 1 Year 2 Year 1 Year 2
----------------------------------------------------------------------------------------------------------------
Plans considering ESG factors when selecting investments
----------------------------------------------------------------------------------------------------------------
Review of Plan Investment Practices............. $91,510,494 $0.00 $612.84 $0.00
---------------------------------------------------------------
Total....................................... 91,510,494 0.00 612.84 0.00
----------------------------------------------------------------------------------------------------------------
Plans holding corporate stock, directly or through ERISA-covered intermediaries
----------------------------------------------------------------------------------------------------------------
Review of Proxy Voting Practices................ 39,019,523 0.00 612.84 0.00
Update Proxy Voting Policies.................... 4,877,440 0.00 76.61 0.00
---------------------------------------------------------------
Total....................................... 43,896,963 0.00 689.45 0.00
----------------------------------------------------------------------------------------------------------------
Plans that both consider ESG factors when selecting investments and hold corporate stock, directly or through
ERISA-covered intermediaries
----------------------------------------------------------------------------------------------------------------
Total....................................... 135,407,458 0 1,302.29 0.00
----------------------------------------------------------------------------------------------------------------
This cost estimate differs from the cost estimate in the NPRM in
several ways. First, paragraph (c)(3) of the NPRM included a disclosure
requirement when collateral benefits were used in a tiebreaker. The
removal of this requirement in the final rule decreased the cost
estimate. Additionally, in the NPRM, the Department estimated that 11
percent of retirement plans would be affected by paragraph (c) of the
proposal. In the final rule, in consideration of comments received on
the NPRM, this estimate was increased to 20 percent of retirement
plans. This change increased the cost estimate. Finally, this cost
estimate reflects more recent data on the number of retirement plans
and updated estimates of labor costs. The incorporation of updated data
also increased the cost estimate.
F. Transfers
The final rule will result in transfers. For instance, the final
rule may facilitate changes in plan fiduciary behavior, resulting in
transactions in which a party experiences increased returns while other
parties experience decreased returns of equal magnitude, resulting in a
transfer, due to either the selection of investments or the investment
course of action.
In particular, transfers could arise as a result of substantially
greater confidence on the part of fiduciaries that they may consider
ESG factors going forward. As discussed previously, the public record
reflects that the current regulation has already had a chilling effect
on appropriate use of relevant ESG factors in investment decisions.
Although the current regulation acknowledges that ESG factors can in
some instances be taken into account by a fiduciary, it also includes
multiple statements that have been interpreted as discouraging their
consideration. This conflicting guidance has disincentivized
fiduciaries from considering relevant ESG factors in order to minimize
potential legal liability under ERISA. Such a disincentive has a
distortionary effect on the investment of ERISA plan assets well into
the future by changing fiduciaries' investment decisions and preventing
them from considering ESG factors that they would otherwise find
economically advantageous. The Department expects the clear guidance in
this final rule to eliminate this existing market distortion.
While the effect the amendments will have on assets is discussed as
a benefit in section IV.D, this will also impact the flow of revenue to
investment entities. For example, if, because of the amendments, plan
assets are moved from Fund A to Fund B, Fund A's asset managers would
experience a decrease in revenue while Fund B's asset managers would
experience an increase in revenue. As a result, there would be a
transfer from non-ESG product providers to ESG product providers.
Similarly, there could be a transfer from companies with lower ESG
ratings to companies with higher ESG ratings. Although the Department
is unable to quantify the transfers that might result, the Department
expects the magnitude of transfers will likely exceed $100 million
annually, given that roughly $12.0 trillion is currently invested in
ERISA plan assets,\285\ and the lower bound estimate of plan assets
invested using ESG factors in 2020 is 0.03 percent.\286\
---------------------------------------------------------------------------
\285\ EBSA projected ERISA covered pension, welfare, and total
assets based on the 2020 Form 5500 filings with the U.S. Department
of Labor (DOL), reported SIMPLE assets from the Investment Company
Institute (ICI) Report: The U.S. Retirement Market, Second Quarter
2022, and the Federal Reserve Board's Financial Accounts of the
United States Z1 September 9, 2022.
\286\ 64th Annual Survey of Profit Sharing and 401(k) Plans,
Plan Sponsor Council of America (2021).
---------------------------------------------------------------------------
Similarly, transfers also could arise as a result of the proposed
changes to the proxy voting provisions in paragraph (e) of the current
regulation (relocated to paragraph (d) of the amended rule). For
instance, the current regulation may discourage plans from voting
proxies as a result of the no-vote statement in paragraph (e)(2)(ii)
and the two safe harbors in paragraphs (e)(3)(i)(A) and (B) of the
current regulation. The final rule's rescission of these provisions,
however, will increase plan proxy votes and effectively transfer some
voting power from other shareholders back to ERISA plans. A common
proxy vote where such an outcome may occur would be a vote to select a
member of the Board of Directors, resulting in a shift in power from a
losing candidate to a winning candidate. A transfer might also occur
related to a proxy vote for one company to acquire another company.
G. Uncertainty
The Department's economic assessment of the final rule's effects is
subject to uncertainty. Special areas of uncertainty are discussed
below:
A significant source of uncertainty comes from the lack of a
widely-accepted standard or definition of what ESG is. This uncertainty
was echoed by commenters. The Department received several comments
concerned with the lack of a standard definition of ESG.
[[Page 73878]]
One commenter noted that there is no way to uniformly assess or weight
the separate E, S, and G factors. Another commenter noted that because
ESG frameworks in the U.S. have been designed by the private sector and
are voluntary in nature, there is no industry-wide standard for how to
disclose information or comply under these frameworks.
In the affected-entities discussion of the regulatory impact
analysis, the Department estimates that 20 percent of plans, both
defined benefit (DB) and defined contribution (DC), consider or will
begin considering ESG factors when selecting investments and, thus,
will be affected by the final rule's amendments to paragraphs (b) and
(c) of the current regulation. As discussed in the regulatory impact
analysis, the Department referenced several sources and surveys for DB
and DC plans to arrive at this estimate. However, the range of
estimates from these resources confirms the degree of uncertainty of
how many plan fiduciaries currently consider ESG factors when selecting
investments. This is particularly true for DB plans. While there is
some survey evidence on how many DB plans factor in ESG considerations,
the surveys were based on small samples and yielded varying results.
It is also difficult to estimate the degree to which the use of ESG
factors by ERISA fiduciaries will expand in the future. The
clarification provided by this final rule may encourage more plan
fiduciaries to use ESG factors. Trends in other countries suggest that
pressure for such expansion may continue to increase.\287\ Based on
current trends, the Department believes that the use of ESG factors by
ERISA plan fiduciaries will likely increase in the future, although it
is uncertain when or by how much.
---------------------------------------------------------------------------
\287\ See generally Government Accountability Office Report No.
18-398, Retirement Plan Investing: Clearer Information on
Consideration of Environmental, Social, and Governance Factors Would
Be Helpful (May 2018), https://www.gao.gov/products/gao-18-398;
Principles for Responsible Investment, Fiduciary Duty in the 21st
Century, United Nations Environment Programme Finance Initiative
(2019), https://www.unepfi.org/wordpress/wp-content/uploads/2019/10/Fiduciary-duty-21st-century-final-report.pdf.
---------------------------------------------------------------------------
For purposes of this analysis, the Department has prepared low-,
mid-, and high-cost scenarios for costs associated with paragraphs (b)
and (c), varying by the estimated number of affected plans. As
discussed in the cost discussion, the Department's estimate of 20
percent of ERISA plans being affected by these provisions translated
into approximately 149,300 affected plans and a cost of $91.5 million.
If instead, the Department were to rely on the 5 percent estimate of
401(k) and/or profit-sharing plans offering at least one ESG themed
investment option from the Plan Sponsor Council of America \288\ and
the 12 percent estimate of private pension plans that have adopted ESG
investing from NEPC,\289\ this would result in an estimate of
approximately 46,100 affected plans and a cost of $28.2 million.\290\
Further if the Department were to rely on the 36 percent estimate of
large plans using ESG information to consider their investments
provided by commenters to all plans, this would result in an estimate
of approximately 268,800 affected plans and a cost of $164.7
million.\291\
---------------------------------------------------------------------------
\288\ 64th Annual Survey of Profit Sharing and 401(k) Plans,
Plan Sponsor Council of America (2021).
\289\ Smith and Regan, NEPC ESG Survey, 2018.
\290\ The estimate of plans is calculated as: (5% x 621,509
401(k) type plans) + (12% x 125,101 defined benefit and
nonparticipant-directed defined contribution plans) = 46,087 plans,
rounded to 46,100 plans. The cost estimate is calculated as: 46,087
plans x 4 hours = 184,348 hours. A labor rate of $153.21 is used for
a lawyer. The cost burden is estimated as follows: 46,087 plans x 4
hours x $153.21 = $28,243,957. (Source Private Pension Plan
Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee
Benefits Security Administration (2022; forthcoming), Table D3.)
\291\ The estimate of plans is calculated as: (36% x 746,610
pension plans) = 268,779 plans, rounded to 268,800 plans. The cost
estimate is calculated as: 268,779 plans x 4 hours = 1,075,116
hours. A labor rate of $153.21 is used for a lawyer. The cost burden
is estimated as follows: 268,779 plans x 4 hours x $153.21 =
$164,718,522.
---------------------------------------------------------------------------
Regarding paragraph (d) of the final rule, it is uncertain whether
the amendments would create a demand for new or different services
associated with proxy voting and if so, what alternate services or
relationships with service providers might result and how overall plan
expenses could be impacted. Similarly, it is unclear whether and to
what extent paragraph (d) of the amended rule will cause plans to
modify their securities holdings, for example, in favor of greater
mutual fund holdings (to avoid management responsibilities with respect
to holdings of individual companies).
The Department has heard from stakeholders that the current
regulation, and investor confusion about it, has already had a chilling
effect on appropriate use of ESG factors in investment decisions.
Additionally, the Department received a significant number of comments
on the impacts the current regulation has had on the appropriate use of
ESG factors in investment decisions. A larger discussion of the
comments received is included in the discussion of the benefits above.
H. Alternatives
In developing this final rule on the application of ERISA's
fiduciary duties of prudence and loyalty to selecting investments and
investment courses of action, the Department considered several
regulatory approaches to the overarching rule and its various elements.
Beyond the major alternatives discussed below, the Department
considered many other specific alternatives. For example, the
Department considered eliminating the tiebreaker test in response to
commenters' requests to do so. The Department decided against this
alternative because the tiebreaker test has been relied on by
fiduciaries for many years in making decisions about plan investments
and investment courses of action, is consistent with the fiduciary
obligations set forth in Section 404 of ERISA, and complete removal of
the provision could lead to disruptions in plan investment activity. In
addition, the Department, in response to commenters' requests,
considered amending the current regulation to explicitly provide
participants' preferences with a status equal to risk and return
factors under the final regulation, such that participants' preferences
could be considered and factored into decisions alongside risk and
return factors, and weighted as determined appropriate by the plan's
fiduciary. The Department decided against this alternative for many
reasons, but mainly because plan fiduciaries must focus on financial
benefits and fiduciaries may not add imprudent investment options to
menus based on participant preferences or requests because that would
violate ERISA's duty of prudence. Many other relatively more granular
alternatives that were considered and not accepted are discussed
throughout section III of this preamble in connection with views of the
commenters.
In order to ensure a comprehensive review, the Department examined
as an alternative leaving the current regulation in place without
change. However, as explained in more detail earlier in this document,
following informal outreach activities with a wide variety of
stakeholders, including asset managers, labor organizations and other
plan sponsors, consumer groups, service providers and investment
advisers, and after considering the significant volume of public
comment on the NPRM, the Department believes that uncertainty with
respect to the current regulation has and likely will continue to deter
fiduciaries from taking steps that other
[[Page 73879]]
marketplace investors might take to enhance investment value and
performance, or improve investment portfolio resilience against the
financial risks and impacts associated with climate change. This could
hamper fiduciaries as they attempt to discharge their responsibilities
prudently and solely in the interests of plan participants and
beneficiaries. The Department therefore did not elect this alternative.
The Department also considered rescinding the Financial Factors in
Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting
and Shareholder Rights final rules. This alternative would remove the
entire current regulation from the Code of Federal Regulations,
including provisions that reflect the original 1979 Investment Duties
regulation. The original Investment Duties regulation has been relied
on by fiduciaries for many years in making decisions about plan
investments and investment courses of action, and complete removal of
the provisions could lead to disruptions in plan investment activity.
Accordingly, the Department rejected this alternative. As discussed in
section IV.D.4, the Department quantified some costs of the current
rule related to proxy voting totaled $17.7 million in the first year
and $6.1 million in subsequent years for the current rule. Rescission
of the current rule would save this quantified amount, but these
savings would be offset by the aforementioned disruptions.
As another alternative, the Department considered revising the
current regulation by, in effect, reverting it to the original 1979
Investment Duties regulation. This would reduce the potential of
disrupting plan investment activity that would be caused by complete
rescission, as described above. However, because the Department's prior
non-regulatory guidance on ESG investing and proxy voting was removed
from the Code of Federal Regulations by the Financial Factors in
Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting
and Shareholder Rights final rules, this alternative will leave plan
fiduciaries without any guidance on the consideration of ESG issues
when relevant to plan financial interests. Similar to the first
alternative described above, this could inhibit fiduciaries from taking
steps that other marketplace investors might take in enhancing
investment value and performance, or from improving investment
portfolio resilience against the potential financial risks and impacts
associated with climate change. The Department therefore rejected this
alternative. As discussed in section IV.D.2, the Department quantified
some of the costs for the current rule related to the tiebreaker, which
totaled approximately $506,000 annually.
The Department also considered revising the current regulation by
adopting changes similar to the fiduciary responsibilities as proposed
by the European Commission.\292\ The European Commission (EC) is
amending existing rules on fiduciary duties in delegated acts for asset
management, insurance, reinsurance and investment sectors to encompass
sustainability risks such as the impact of climate change and
environmental degradation on the value of investments. Specifically,
the EC has added the requirement that fiduciaries must proactively
solicit client's sustainability preferences, in addition to existing
requirements that a fiduciary obtain information about the client's
investment knowledge and experience, ability to bear losses, and risk
tolerance as part of the suitability assessment. The European Union's
guidelines for the supervision of institutions for occupational
retirement provisions (IORPs) require member states to ensure that
IORPs consider ESG factors related to investment assets in their
investment decisions, as part of their prudential standards. Where ESG
factors are considered, an assessment must be made of new or emerging
risks, including risks related to climate change, use of resources and
the environment, social risks and risks related to the depreciation of
assets due to regulatory changes.\293\ One estimate finds that 89
percent of European pension funds take ESG risks into account as of
2019.\294\
---------------------------------------------------------------------------
\292\ Communication from the Commission to the European
Parliament, the Council, the European Economic and Social Committee
and the Committee of the Regions: EU Taxonomy, Corporate
Sustainability Reporting, Sustainability Preferences and Fiduciary
Duties: Directing finance towards the European Green Deal Brussels,
21.4.2021 COM (2021) 188 final.
\293\ ``It is essential that IORPs improve their risk management
while taking into account the aim of having an equitable spread of
risks and benefits between generations in occupational retirement
provision, so that potential vulnerabilities in relation to the
sustainability of pension schemes can be properly understood and
discussed with the relevant competent authorities. IORPs should, as
part of their risk management system, produce a risk assessment for
their activities relating to pensions. That risk assessment should
also be made available to the competent authorities and should,
where relevant, include, inter alia, risks related to climate
change, use of resources, the environment, social risks, and risks
related to the depreciation of assets due to regulatory change
(`stranded assets'). . . . Environmental, social and governance
factors, as referred to in the United Nations-supported Principles
for Responsible Investment, are important for the investment policy
and risk management systems of IORPs. Member States should require
IORPs to explicitly disclose where such factors are considered in
investment decisions and how they form part of their risk management
system. The relevance and materiality of environmental, social and
governance factors to a scheme's investments and how such factors
are taken into account should be part of the information provided by
an IORP under this Directive.''
\294\ ``ESG Becoming the New Normal for European Pensions''
(August 31, 2020), https://www.ai-cio.com/news/esg-becoming-new-normal-european-pensions/.
---------------------------------------------------------------------------
Although this final rule clarifies that risk and return factors may
include the economic effects of climate change and other ESG factors on
the investment, the final rule does not require ERISA fiduciaries to
solicit preferences regarding ESG factors nor are fiduciaries required
to consider ESG factors when making all investment decisions. While
aligning the U.S. to the European approach would have such benefits as
harmonizing taxonomy for asset and investment managers across
jurisdictions, the Department was concerned that incorporating such an
approach would increase costs without a commensurate benefit, and could
not be fully harmonized with ERISA's fiduciary provisions.
Finally, in the NPRM, the Department proposed a requirement to
inform plan participants of the collateral benefits that influenced the
selection of the investment or investment course of action, when such
investment or investment course of action constitutes a designated
investment alternative under a participant-directed individual account
plan, so participants could understand whether their preferences
regarding the collateral purpose aligned with the fiduciary's for a
given investment option. Upon further consideration, including the
comments received on the NPRM, the Department has decided to remove the
disclosure requirement from this final rule for all the reasons set
forth in section III.B.2 of this preamble.
I. Conclusion
In summary, a significant benefit of this final rule is to clarify
the application of ERISA's fiduciary duties of prudence and loyalty to
selecting investments and investment courses of action, exercising
shareholder rights, such as proxy voting, and the use of written proxy
voting policies and guidelines. These benefits, while difficult to
quantify, are anticipated to outweigh the costs.
The amendments to paragraphs (b) and (c) are designed to ensure
that plans do not improvidently avoid considering relevant ESG factors
when selecting investments or exercising shareholder
[[Page 73880]]
rights, as they might otherwise be inclined to do under the current
regulation. The Department expects that acting on relevant ESG factors
in these contexts, and in a manner consistent with the final rule, will
redound to employee benefit plans, participants, and beneficiaries
covered by ERISA. Further, by ensuring that plan fiduciaries will not
give up investment returns or take on additional investment risk to
promote unrelated goals, these amendments are expected to lead to
increased investment returns over the long run.
The final rule will also make certain that proxy voting activity by
plans will be governed by the economic interests of the plan and its
participants. The amendments require plan fiduciaries to make a
reasoned judgment deciding whether to exercise shareholder rights and
how to exercise such rights, while promoting the economic interest of
the plan. This will promote management accountability to shareholders,
including the affected shareholder plans.
The total cost of the final rule is approximately $135.4 million in
the first year with no additional costs in subsequent years. Over 10
years, the costs associated with the amendments will total
approximately $126.6 million, annualized to $18.0 million per year,
applying a seven percent discount rate.\295\ In addition, the final
rule is expected to result in cost savings. The total cost savings of
the final rule is approximately $18.2 million in the first year with an
annual cost savings of $6.6 million in subsequent years, relative to
the current regulation. The estimates for cost and cost savings of the
final rule are summarized in Table 3. Besides cost savings, the rule
will have many other benefits that have not been quantified and are not
shown in Table 3.
---------------------------------------------------------------------------
\295\ The costs would be $131.5 million over 10-year period,
annualized to $15.4 million per year, if a three percent discount
rate were applied.
Table 3--Quantified Costs and Cost Savings Associated With the Final
Rule
------------------------------------------------------------------------
Requirement Year 1 Year 2
------------------------------------------------------------------------
Aggregate Costs
------------------------------------------------------------------------
Review of Plan Investment Practices..... $91,510,494 $0
Review of Proxy Voting Practices........ 39,019,523 0
Update Proxy Voting Policies............ 4,877,440 0
-------------------------------
Total............................... 135,407,458 0
-------------------------------
Cost Savings
------------------------------------------------------------------------
Removal of the Special Collateral 506,029 0
Benefit Documentation Requirement under
the Tie-breaker Rule in the Current
Rule...................................
Removal of the Special Recordkeeping 6,072,526 6,072,526
Requirement for Proxy Voting in the
Current Rule...........................
Removal of the Proxy Voting ``Safe 11,643,651 0
Harbors'' in the Current Rule..........
-------------------------------
Total............................... 18,222,207 6,072,526
------------------------------------------------------------------------
V. Paperwork Reduction Act
The current regulations contain two collections of information with
OMB Control Number 1210-0162 and OMB Control Number 1210-0165. In the
notice of proposed rulemaking, the Department had announced its intent
to discontinue OMB Control Number 1210-0165 and revise OMB Control
Number 1210-0162 to only include the proposed disclosure requirement
contained in the proposed amendment. Paragraph (c)(3) of the NPRM
included a requirement that if a plan fiduciary uses the tiebreaker to
select a designated investment alternative for a participant-directed
individual account plan based on collateral benefits other than
investment returns, ``the plan fiduciary must ensure that the
collateral-benefit characteristic of the fund, product, or model
portfolio is prominently displayed in disclosure materials provided to
participants and beneficiaries.'' This would have been a new disclosure
requirement under ERISA. At this time, the Department has decided not
to adopt the proposed disclosure requirement. As discussed in more
detail earlier in the preamble, based on comments received, the
Department has decided that a disclosure emphasizing matters collateral
to the economics of an investment may not be in the best interests of
plan participants. Plan fiduciaries will still have the ability to use
collateral benefits to break a tie; they will not be required to make a
special disclosure. The Department is aware that the SEC is conducting
rulemaking on investment company names, addressing, among other things,
``certain broad categories of investment company names that are likely
to mislead investors about an investment company's investments and
risks.'' \296\ The SEC also is conducting rulemaking on disclosures by
mutual funds, other SEC-regulated investment companies, and SEC-
regulated investment advisers designed to provide consistent standards
for ESG disclosures, allowing investors to make more informed
decisions, including as they compare various ESG investments.\297\ The
Department will monitor these rulemaking projects and may revisit the
need for collateral benefit reporting or disclosure depending on the
findings of that agency. The Department emphasizes that the decision
against adopting a collateral benefit disclosure requirement in the
final rule has no impact on a fiduciary's duty to prudently document
the tiebreaking decisions in accordance with section 404 of ERISA.
---------------------------------------------------------------------------
\296\ 87 FR 36594 (June 17, 2022).
\297\ 87 FR 36654 (June 17, 2022).
---------------------------------------------------------------------------
Therefore, upon publication of the final rule, the Department will
request that OMB discontinue both information collection requests
(ICRs) 1210-0162 and 1210-0165, eliminating all paperwork burden
associated with the ICRs.
VI. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) \298\ imposes certain
requirements with respect to Federal rules that are
[[Page 73881]]
subject to the notice and comment requirements of section 553(b) of the
Administrative Procedure Act \299\ and that are likely to have a
significant economic impact on a substantial number of small entities.
Unless the head of an agency determines that a final rule is not likely
to have a significant economic impact on a substantial number of small
entities, section 604 of the RFA requires the agency to present a final
regulatory flexibility analysis of the final rule.
---------------------------------------------------------------------------
\298\ 5 U.S.C. 601 et seq.
\299\ 5 U.S.C. 553(b).
---------------------------------------------------------------------------
For purposes of analysis under the RFA, the Department considers a
small entity to be an employee benefit plan with fewer than 100
participants.\300\ The basis of this definition is found in section
104(a)(2) of ERISA, which permits the Secretary of Labor to prescribe
simplified annual reports for pension plans that cover fewer than 100
participants. Under section 104(a)(3), the Secretary may also provide
for exemptions or simplified annual reporting and disclosure for
welfare benefit plans. Pursuant to the authority of section 104(a)(3),
the Department has previously issued--at 29 CFR 2520.104-20, 2520.104-
21, 2520.104-41, 2520.104-46, and 2520.104b-10--certain simplified
reporting provisions and limited exemptions from reporting and
disclosure requirements for small plans. Such plans include unfunded or
insured welfare plans covering fewer than 100 participants and
satisfying certain other requirements. While some large employers may
have small plans, in general small employers maintain small plans.
Thus, EBSA believes that assessing the impact of these amendments on
small plans is an appropriate substitute for evaluating the effect on
small entities. The definition of small entity considered appropriate
for this purpose differs, however, from a definition of small business
that is based on size standards promulgated by the Small Business
Administration (SBA) \301\ pursuant to the Small Business Act.\302\
---------------------------------------------------------------------------
\300\ The Department consulted with the Small Business
Administration's Office of Advocacy before making this
determination, as required by 5 U.S.C. 603(c) and 13 CFR 121.903(c).
Memorandum received from the U.S. Small Business Administration,
Office of Advocacy on July 10, 2020.
\301\ 13 CFR 121.201.
\302\ 15 U.S.C. 631 et seq.
---------------------------------------------------------------------------
The Department has determined that this final rule could have a
significant impact on a substantial number of small entities.
Therefore, the Department has prepared a Final Regulatory Flexibility
Analysis that is presented below.
A. Need for and Objectives of the Rule
In late 2020, the Department published two final rules (the current
regulation) pertaining to the selection of plan investments and the
exercise of shareholder rights to address concerns that some investment
products may be marketed to ERISA fiduciaries on the basis of purported
benefits and goals unrelated to financial performance. Responses to the
current regulation, however, suggest that it created further
uncertainty and may have the undesirable effect of discouraging
fiduciaries' consideration of financially relevant ESG factors in
investment decisions, even when contrary to the interest of
participants and beneficiaries.
The Department is concerned that uncertainty may deter plan
fiduciaries, for small and large plans alike, from participating in
investments or investment courses of action that enhance investment
value and performance or improve investment portfolio resilience. The
Department is particularly concerned that the current regulation
created a perception that fiduciaries are at risk if they consider any
ESG factors in the financial evaluation of plan investments and that
they may need to have special justifications for even ordinary
exercises of shareholder rights.
The amendments in this document are intended to address
uncertainties stemming from the current regulation and related preamble
discussions and to increase fiduciaries' clarity about their
obligations. The Department expects that the final rule will improve
the current regulation and further promote retirement income security
and retirement savings, while safeguarding the interests of plan
participants and beneficiaries.
B. Comments
The Department received more than 895 written comments and 21,469
petitions (e.g., form letters) submitted during the open comment
period. Comments received did not focus on the impacts to just small
entities but focused on the impacts regardless of size. Comments are
discussed by topic, and readers are directed to those respective
sections for a summary of the significant comments and responses to
those comments.
The Office of Advocacy of the Small Business Administration did not
file a comment on the proposed rule.
C. Affected Small Entities
To estimate the costs associated with reviewing the final rule, the
Department considers two sub-groups of plans: plans that consider ESG
factors in their investment process and plans that hold corporate stock
with voting rights. Due to the nature of the finalized amendments,
these subsets are not mutually exclusive and some plans may be included
in both subsets. The Department does not have the data necessary to
estimate how many plans are included in both subsets, so the affected
entities and related costs are calculated separately in this analysis.
1. Small Plans Affected by the Proposed Modifications of Paragraphs (b)
and (c) of Sec. 2550.404a-1
Plans, as well as plan participants and beneficiaries, whose
fiduciaries consider or will begin considering ESG factors when
selecting investments will be affected by the modifications of
paragraphs (b) and (c). As discussed in the regulatory impact analysis,
the Department estimates that approximately 20 percent of plans
consider or will begin considering ESG factors when selecting
investments. This estimate is based on administrative data and surveys
on investment behavior, which did not address how the investment
behavior of small plans might differ from plans overall. The Department
acknowledges that this likely overestimates the number of small plans
affected. For instance, one survey indicates that only 0.03 percent of
total participant-directed DC plan assets are invested in ESG funds. In
fact, it finds that among 401(k) and profit-sharing plans with fewer
than 50 participants, none of the plans offered an ESG investment
option.\303\
---------------------------------------------------------------------------
\303\ 64th Annual Survey of Profit Sharing and 401(k) Plans,
Plan Sponsor Council of America (2021).
---------------------------------------------------------------------------
For the purpose of this analysis, the Department assumes that the
proportions of plans who consider or will begin considering ESG factors
when selecting investments is uniform across plan size. Accordingly,
the Department estimates that 20 percent of small plans will be
affected by the modifications of paragraphs (b) and (c). According to
the 2020 Form 5500, there were approximately 652,935 plans with fewer
than 100 participants,\304\ resulting in an estimate of approximately
130,600 small plans that will be affected by the
[[Page 73882]]
modifications of paragraphs (b) and (c).\305\
---------------------------------------------------------------------------
\304\ DOL calculations reflecting plans with fewer than 100
participants. (Source Private Pension Plan Bulletin: Abstract of
2020 Form 5500 Annual Reports, Employee Benefits Security
Administration (2022; forthcoming), Table B1.)
\305\ Id. This estimate is calculated as: 20% x 652,935 pension
plans = 130,587, rounded to 130,600.
---------------------------------------------------------------------------
2. Subset of Plans Affected by Modifications of Paragraph (d) and (e)
of Sec. 2550.404a-1
Paragraphs (d) and (e) of the amended rule will affect small ERISA-
covered pension, health, and other welfare plans, and plan participants
and beneficiaries, that hold shares of corporate stock, directly or
through ERISA-covered intermediaries, such as common trusts, master
trusts, pooled separate accounts, and 103-12 investment entities. While
the majority of participants and assets are in large plans, most plans
are small plans.
There is limited data available about small plans' stock holdings.
The primary source of information on assets held by pension plans is
the Form 5500. Using the various asset schedules filed, only 3,900
small plans can be identified as holding stock, either employer
securities or common stock.\306\ The Department assumes that small
plans are significantly less likely to hold common stock than larger
plans.\307\
---------------------------------------------------------------------------
\306\ Based on DOL calculations based on 2020 Form 5500 data,
only the 3,900 small plans that filed schedule H would report a
separate line item for stock holdings. The small plans filing the
Form 5500-SF (595,565) or file schedule I (52,737) do not report
stock as a separate line item, therefore these plans cannot be
identified as to whether they hold common stock.
\307\ Many small plans have exposure to stocks only through
mutual funds, and consequently will not be significantly affected by
the finalized amendments to paragraphs (d) and (e).
---------------------------------------------------------------------------
For purposes of illustrating the number of small plans that could
be affected, the Department assumes that five percent of small plans
will be affected by the amendments to paragraphs (d) and (e). In 2020,
there were approximately 652,500 small pension plans,\308\ resulting in
an estimate of approximately 32,600 small plans that will be affected
by the amended provisions.\309\ The Department requested comment on
this assumption in the NPRM but did not receive any comments.
---------------------------------------------------------------------------
\308\ DOL calculations of plans with fewer than 100 participants
find that in 2020, there were 652,935 plans with less than 100
participants, rounded to 652,900. (Source Private Pension Plan
Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee
Benefits Security Administration (2022; forthcoming), Table B1.)
\309\ This estimate is calculated as: 652,935 small plans x 5% =
32,647, rounded to 32,600.
---------------------------------------------------------------------------
While paragraph (d) of this amended rule will directly affect
ERISA-covered plans that possess the relevant shareholder rights, many
plans hire asset managers to carry out fiduciary asset management
functions, including proxy voting. The Department recognizes that
service providers, including small service providers who act as asset
managers, could also be impacted indirectly by this rule. The
Department expects that service providers will pass incremental
compliance costs onto plans.
D. Impact of the Rule
As described in the preamble and the regulatory impact analysis,
the amendments will impose costs on small and large plans
1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
Plans, plan fiduciaries, and their service providers will need to
read the amended rule and evaluate how it will impact their practices.
To estimate the costs associated with reviewing the amended rule, the
Department considers two sub-groups of plans: plans that consider ESG
factors in their investment process and plans that hold corporate stock
with voting rights.
The Department estimates that approximately 130,600 small plans
consider ESG factors in their investment practice and will be affected
by the finalized amendments in paragraphs (b) and (c). For each plan, a
legal professional will need to review paragraphs (b) and (c) of the
final rule, evaluate how these provisions might affect their investment
practices and assess whether the plan will be needed to make changes to
investment practices. The Department estimates that this review will
take a legal professional approximately four hours to complete,
resulting in a per-plan cost burden of approximately $612.84.\310\
---------------------------------------------------------------------------
\310\ The Department estimates that it will take a lawyer at
each plan four hours to review the rule. A labor rate of $153.21 is
used for a lawyer. The cost burden is estimated as follows: 4 hours
x $153.21 = $612.86. Labor rates are based on DOL estimates for
2022. For more information in how the labor costs are estimated, see
Labor Cost Inputs Used in the Employee Benefits Security
Administration, Office of Policy and Research's Regulatory Impact
Analyses and Paperwork Reduction Act Burden Calculation, Employee
Benefits Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
---------------------------------------------------------------------------
The Department estimates that approximately 32,600 small plans hold
corporate stock with voting rights and will be affected by the
finalized amendments pertaining to proxy voting in paragraph (d). For
each plan, a legal professional will need to review paragraph (d) of
the final rule and evaluate how it affects their proxy voting
practices. The Department estimates that this review process will
require a legal professional, on average, approximately four hours to
complete, resulting in a per-plan cost of approximately $612.84.\311\
---------------------------------------------------------------------------
\311\ The Department estimates that it will take a lawyer at
each plan four hours to review the rule. A labor rate of $153.21 is
used for a lawyer. The cost burden is estimated as follows: 4 hours
x $153.21 = $612.86.
---------------------------------------------------------------------------
The Department believes that most plans, in both subsets discussed
above, will rely on a service provider to perform such a review and
that each service provider will likely oversee multiple plans. The
Department does not have data that would allow it to estimate the
number of service providers acting in such a capacity for these plans.
While the Department believes that this cost is likely an overestimate,
given the lack of data, the Department believes it represents the best,
most conservative estimate.
2. Cost To Update Written Proxy Voting Policies
Paragraph (d)(3)(i) of the final rule provides that, for purposes
of deciding whether to vote a proxy, plan fiduciaries may adopt proxy
voting policies if the authority to vote a proxy is exercised pursuant
to specific parameters prudently designed to serve the plan's interests
in providing benefits to participants and their beneficiaries and
defraying reasonable expenses of administering the plan. The Department
estimates that these provisions will impose additional cost to review
such policies initially. The Department believes that the final rule
largely comports with industry practice for ERISA fiduciaries;
therefore, the Department estimates that on average, it will take a
legal professional 30 minutes to update policies and procedures for
each of the estimated 32,600 plans affected by these provisions. This
results in a cost per plan of $76.61 in the first year.\312\
---------------------------------------------------------------------------
\312\ The Department estimates that it will take a plan
fiduciary at each plan 30 minutes to update policies and procedures.
A labor rate of $153.21 is used for a plan fiduciary: (0.5 hours x
$153.21 = $76.61).
---------------------------------------------------------------------------
Paragraph (d)(3)(ii), also requires plan fiduciaries to
periodically review any such proxy voting policies. The Department
believes that the final rule largely comports with industry practice
for ERISA fiduciaries, since plans are already required to periodically
review proxy voting policies to meet their obligations under ERISA.
Therefore, the Department does not expect that plans will incur
additional cost associated with the periodic review.
[[Page 73883]]
3. Summary of Costs
As illustrated in Table 4 below, the Department estimates, if a
small plan both considers ESG factors in their investment process and
hold corporate stock with voting rights, the incremental cost
associated with the finalized amendments will be $1,302.29 per affected
plan in year 1. There are no costs expected in subsequent years. Some
plans may only incur costs associated with considering ESG factors in
their investment process or holding corporate stock with voting rights.
Table 4--Costs for Plans To Comply With the Requirements
----------------------------------------------------------------------------------------------------------------
Requirement Labor rate Hours Year 1 cost Year 2 cost
----------------------------------------------------------------------------------------------------------------
Plans considering ESG factors when selecting investments
----------------------------------------------------------------------------------------------------------------
Review of Plan Investment Practices: Lawyer..... $153.21 4 $612.84 $0.00
---------------------------------------------------------------
Total....................................... .............. 4 612.84 0.00
----------------------------------------------------------------------------------------------------------------
Plans holding corporate stock, directly or through ERISA-covered intermediaries
----------------------------------------------------------------------------------------------------------------
Review of Proxy Voting Practices: Lawyer........ 153.21 4 612.84 0.00
Update Proxy Voting Policies: Lawyer............ 153.21 0.5 76.61 0.00
---------------------------------------------------------------
Total....................................... .............. 4.5 689.49 0.00
----------------------------------------------------------------------------------------------------------------
Plans that both consider ESG factors when selecting investments and hold corporate stock, directly or through
ERISA-covered intermediaries
----------------------------------------------------------------------------------------------------------------
Total....................................... .............. 8.5 1,302.29 0
----------------------------------------------------------------------------------------------------------------
The Department believes that this is likely an overestimate of the
costs faced by small plans, as small plans are likely to rely on
service providers that provide services to multiple plans. The
Department expects that these costs will be passed on to plans, but by
offering services to multiple plans, service providers create economies
of scale.
E. Regulatory Alternatives
The final rule seeks to provide clarity and certainty regarding the
scope of fiduciary duties surrounding ESG factors in investment
practice and proxy voting policies. These duties apply to all affected
entities, both large and small; therefore, the Department's ability to
craft specific alternatives for small plans is limited. Throughout the
rulemaking process, the Department sought to minimize the burden placed
on the affected entities overall; however, the Department did not
identify any special consideration that could be made for small plans
that would not lessen the protection of participants and beneficiaries
in small plans. As discussed in the preamble, the Department has
decided to provide a general applicability date of 60 days after
publication in the Federal Register with two exceptions. In response to
comments received on the NPRM, the Department has decided to delay
applicability of paragraphs (d)(2)(iii) and (d)(4)(ii) of the final
rule's proxy voting provisions until 1 year after the date of
publication. The delayed applicability of paragraph (d)(4)(ii) of the
final rule will give fiduciaries of plans invested in pooled investment
vehicles additional time for reviewing any proxy voting policies of the
investment vehicle's investment manager and addressing any concerns.
The delayed applicability of paragraph (d)(2)(iii) will give plan
fiduciaries additional time to review proxy voting guidelines of proxy
advisory firms and make any necessary changes in their arrangements
with such firms. Outside of these two exceptions, the Department
believes the requirements in the final rule are consistent with
established Department views. As such, the Department does not believe
it is appropriate to extend the applicability date for small plans.
The Department examined as an alternative leaving the current
regulation in place without change and rescinding its enforcement
statement issued on March 10, 2021. However, as explained in more
detail earlier in this notice, following informal outreach activities
with a wide variety of stakeholders, including asset managers, labor
organizations and other plan sponsors, consumer groups, service
providers, and investment advisers, the Department believes that
uncertainty with respect to the current regulation may deter
fiduciaries of small and large plans alike from taking steps that other
marketplace investors might take in enhancing investment value and
performance, or improving investment portfolio resilience against the
potential financial risks associated with ESG factors. This could
hamper fiduciaries as they attempt to discharge their responsibilities
prudently and solely in the interests of plan participants and
beneficiaries. The Department therefore did not elect this alternative.
The Department also considered rescinding the Financial Factors in
Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting
and Shareholder Rights final rules. This alternative would remove the
entire current regulation from the Code of Federal Regulations,
including provisions that reflect the original 1979 Investment Duties
regulation. The original Investment Duties regulation has been relied
on by fiduciaries for many years in making decisions about plan
investments and investment courses of action, and complete removal of
the provisions could lead to potential disruptions in plan investment
activity, regardless of plan size. The Department rejected this
alternative.
Another alternative considered was revising the current regulation
by, in effect, reverting it to the original 1979 Investment Duties
regulation. As explained in more detail earlier in this notice, this
alternative would reduce the potential of disrupting plan investment
activity that would be caused by complete rescission, but would leave
plan fiduciaries without any guidance published in the Code of Federal
Regulations on the consideration of ESG issues. Similar to the first
alternative described above, this could inhibit fiduciaries from taking
steps that other marketplace investors might take in enhancing
investment value and performance, or from improving investment
portfolio resilience against the potential financial risks and impacts
[[Page 73884]]
associated with various ESG factors. The Department therefore rejected
this alternative.
In the NPRM, the Department proposed a requirement to inform plan
participants of the collateral benefits that influenced the selection
of the investment or investment course of action, when such investment
or investment course of action constitutes a designated investment
alternative under a participant-directed individual account plan. The
Department received one comment in favor of the collateral benefit
disclosure for QDIAs, stating that participants and beneficiaries
should have information about collateral benefits considered by their
plan. Another commenter expressed that the requirement should go
further, requiring the disclosure of specific collateral benefits
considered. However, other commenters expressed concern that the
disclosure requirement may chill the use of ESG factors in investments.
Another commenter expressed concern that the disclosure requirement is
unclear and could relegate ESG characteristics to collateral benefit
characteristics. Upon further consideration, including the comments
received on the NPRM, the Department has decided to remove the
disclosure requirement from this final rule. Commenters expressed
concern that the collateral benefit disclosure could distract plan
participants from the important-related information required by the
Department's other regulations.
F. Duplicate, Overlapping, or Relevant Federal Rules
For the requirements relating to investment practices, the
Department is issuing this final rule under sections 404(a)(1)(A) and
404(a)(1)(B) of Title I under ERISA. The Department is the only agency
with jurisdiction to interpret these provisions as they apply to plan
fiduciaries' consideration in selecting plan investment funds.
Therefore, there are no duplicate, overlapping, or relevant Federal
rules.
For the requirements relating to proxy voting policies, the
Department is monitoring other Federal agencies whose statutory and
regulatory requirements overlap with ERISA. In particular, the
Department is monitoring SEC rules and guidance to avoid creating
duplicate or overlapping requirements with respect to proxy voting.
VII. Unfunded Mandates Reform Act
Title II of the Unfunded Mandates Reform Act of 1995 \313\ requires
each Federal agency to prepare a written statement assessing the
effects of any Federal mandate in a proposed or final agency rule that
may result in an expenditure of $100 million or more (adjusted annually
for inflation with the base year 1995) in any one year by state, local,
and tribal governments, in the aggregate, or by the private sector. For
purposes of the Unfunded Mandates Reform Act, this final rule does not
include any Federal mandate that the Department expects would result in
such expenditures by state, local, or tribal governments, or the
private sector.
---------------------------------------------------------------------------
\313\ 2 U.S.C. 1501 et seq. (1995).
---------------------------------------------------------------------------
VIII. Federalism Statement
Executive Order 13132 outlines fundamental principles of federalism
and requires the adherence to specific criteria by Federal agencies in
the process of their formulation and implementation of policies that
have ``substantial direct effects'' on the states, the relationship
between the National Government and the states, or on the distribution
of power and responsibilities among the various levels of
government.\314\ Federal agencies promulgating regulations that have
federalism implications must consult with state and local officials,
and describe the extent of their consultation and the nature of the
concerns of state and local officials in the preamble to the proposed
amendment.
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\314\ Federalism, 64 FR 43255 (August 10, 1999).
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In the Department's view, these finalized amendments will not have
federalism implications because they will not have direct effects on
the states, the relationship between the National Government and the
states, or on the distribution of power and responsibilities among
various levels of government. Section 514 of ERISA provides, with
certain exceptions specifically enumerated, that the provisions of
Titles I and IV of ERISA supersede any and all laws of the states as
they relate to any employee benefit plan covered under ERISA. The
requirements implemented in the finalized amendments do not alter the
fundamental reporting and disclosure requirements of the statute with
respect to employee benefit plans, and as such have no implications for
the states or the relationship or distribution of power between the
national government and the states.
Statutory Authority
This regulation is finalized pursuant to the authority in section
505 of ERISA (Pub. L. 93-406, 88 Stat. 894; 29 U.S.C. 1135) and section
102 of Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17,
1978), effective December 31, 1978 (44 FR 1065, January 3, 1979), 3
CFR, 1978 Comp., p. 332, and under Secretary of Labor's Order No. 1-
2011, 77 FR 1088 (Jan. 9, 2012).
List of Subjects in 29 CFR Part 2550
Employee benefit plans, Employee Retirement Income Security Act,
Exemptions, Fiduciaries, Investments, Pensions, Prohibited
transactions, Reporting and recordkeeping requirements, Securities.
For the reasons set forth in the preamble, the Department amends
part 2550 of subchapter F of chapter XXV of title 29 of the Code of
Federal Regulations as follows:
Subchapter F--Fiduciary Responsibility Under the Employee Retirement
Income Security Act of 1974
PART 2550--RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY
0
1. The authority citation for part 2550 continues to read as follows:
Authority: 29 U.S.C. 1135 and Secretary of Labor's Order No. 1-
2011, 77 FR 1088 (January 9, 2012). Sec. 102, Reorganization Plan
No. 4 of 1978, 5 U.S.C. App. at 727 (2012). Sec. 2550.401c-1 also
issued under 29 U.S.C. 1101. Sec. 2550.404a-1 also issued under sec.
657, Pub. L. 107-16, 115 Stat 38. Sec. 2550.404a-2 also issued under
sec. 657 of Pub. L. 107-16, 115 Stat. 38. Sections 2550.404c-1 and
2550.404c-5 also issued under 29 U.S.C. 1104. Sec. 2550.408b-1 also
issued under 29 U.S.C. 1108(b)(1). Sec. 2550.408b-19 also issued
under sec. 611, Pub. L. 109-280, 120 Stat. 780, 972. Sec. 2550.412-1
also issued under 29 U.S.C. 1112.
0
2. Revise Sec. 2550.404a-1 to read as follows:
Sec. 2550.404a-1 Investment duties.
(a) In general. Sections 404(a)(1)(A) and 404(a)(1)(B) of the
Employee Retirement Income Security Act of 1974, as amended (ERISA or
the Act) provide, in part, that a fiduciary shall discharge that
person's duties with respect to the plan solely in the interests of the
participants and beneficiaries; for the exclusive purpose of providing
benefits to participants and their beneficiaries and defraying
reasonable expenses of administering the plan; and with the care,
skill, prudence, and diligence under the circumstances then prevailing
that a prudent person acting in a like capacity and familiar with such
matters would use in the conduct of an enterprise of a like character
and with like aims.
(b) Investment prudence duties. (1) With regard to the
consideration of an investment or investment course of
[[Page 73885]]
action taken by a fiduciary of an employee benefit plan pursuant to the
fiduciary's investment duties, the requirements of section 404(a)(1)(B)
of the Act set forth in paragraph (a) of this section are satisfied if
the fiduciary:
(i) Has given appropriate consideration to those facts and
circumstances that, given the scope of such fiduciary's investment
duties, the fiduciary knows or should know are relevant to the
particular investment or investment course of action involved,
including the role the investment or investment course of action plays
in that portion of the plan's investment portfolio or menu with respect
to which the fiduciary has investment duties; and
(ii) Has acted accordingly.
(2) For purposes of paragraph (b)(1) of this section, ``appropriate
consideration'' shall include, but is not necessarily limited to:
(i) A determination by the fiduciary that the particular investment
or investment course of action is reasonably designed, as part of the
portfolio (or, where applicable, that portion of the plan portfolio
with respect to which the fiduciary has investment duties) or menu, to
further the purposes of the plan, taking into consideration the risk of
loss and the opportunity for gain (or other return) associated with the
investment or investment course of action compared to the opportunity
for gain (or other return) associated with reasonably available
alternatives with similar risks; and
(ii) In the case of employee benefit plans other than participant-
directed individual account plans, consideration of the following
factors as they relate to such portion of the portfolio:
(A) The composition of the portfolio with regard to
diversification;
(B) The liquidity and current return of the portfolio relative to
the anticipated cash flow requirements of the plan; and
(C) The projected return of the portfolio relative to the funding
objectives of the plan.
(3) An investment manager appointed, pursuant to the provisions of
section 402(c)(3) of the Act, to manage all or part of the assets of a
plan, may, for purposes of compliance with the provisions of paragraphs
(b)(1) and (2) of this section, rely on, and act upon the basis of,
information pertaining to the plan provided by or at the direction of
the appointing fiduciary, if:
(i) Such information is provided for the stated purpose of
assisting the manager in the performance of the manager's investment
duties; and
(ii) The manager does not know and has no reason to know that the
information is incorrect.
(4) A fiduciary's determination with respect to an investment or
investment course of action must be based on factors that the fiduciary
reasonably determines are relevant to a risk and return analysis, using
appropriate investment horizons consistent with the plan's investment
objectives and taking into account the funding policy of the plan
established pursuant to section 402(b)(1) of ERISA. Risk and return
factors may include the economic effects of climate change and other
environmental, social, or governance factors on the particular
investment or investment course of action. Whether any particular
consideration is a risk-return factor depends on the individual facts
and circumstances. The weight given to any factor by a fiduciary should
appropriately reflect a reasonable assessment of its impact on risk-
return.
(c) Investment loyalty duties. (1) A fiduciary may not subordinate
the interests of the participants and beneficiaries in their retirement
income or financial benefits under the plan to other objectives, and
may not sacrifice investment return or take on additional investment
risk to promote benefits or goals unrelated to interests of the
participants and beneficiaries in their retirement income or financial
benefits under the plan.
(2) If a fiduciary prudently concludes that competing investments,
or competing investment courses of action, equally serve the financial
interests of the plan over the appropriate time horizon, the fiduciary
is not prohibited from selecting the investment, or investment course
of action, based on collateral benefits other than investment returns.
A fiduciary may not, however, accept expected reduced returns or
greater risks to secure such additional benefits.
(3) The plan fiduciary of a participant-directed individual account
plan does not violate the duty of loyalty under paragraph (c)(1) of
this section solely because the fiduciary takes into account
participants' preferences in a manner consistent with the requirements
of paragraph (b) of this section.
(d) Proxy voting and exercise of shareholder rights. (1) The
fiduciary duty to manage plan assets that are shares of stock includes
the management of shareholder rights appurtenant to those shares, such
as the right to vote proxies.
(2)(i) When deciding whether to exercise shareholder rights and
when exercising such rights, including the voting of proxies,
fiduciaries must carry out their duties prudently and solely in the
interests of the participants and beneficiaries and for the exclusive
purpose of providing benefits to participants and beneficiaries and
defraying the reasonable expenses of administering the plan.
(ii) When deciding whether to exercise shareholder rights and when
exercising shareholder rights, plan fiduciaries must:
(A) Act solely in accordance with the economic interest of the plan
and its participants and beneficiaries, in a manner consistent with
paragraph (b)(4) of this section;
(B) Consider any costs involved;
(C) Not subordinate the interests of the participants and
beneficiaries in their retirement income or financial benefits under
the plan to any other objective;
(D) Evaluate relevant facts that form the basis for any particular
proxy vote or other exercise of shareholder rights; and
(E) Exercise prudence and diligence in the selection and monitoring
of persons, if any, selected to exercise shareholder rights or
otherwise advise on or assist with exercises of shareholder rights,
such as providing research and analysis, recommendations regarding
proxy votes, administrative services with voting proxies, and
recordkeeping and reporting services.
(iii) A fiduciary may not adopt a practice of following the
recommendations of a proxy advisory firm or other service provider
without a determination that such firm or service provider's proxy
voting guidelines are consistent with the fiduciary's obligations
described in paragraphs (d)(2)(ii)(A) through (E) of this section.
(3)(i) In deciding whether to vote a proxy pursuant to paragraphs
(d)(2)(i) and (ii) of this section, fiduciaries may adopt proxy voting
policies providing that the authority to vote a proxy shall be
exercised pursuant to specific parameters prudently designed to serve
the plan's interests in providing benefits to participants and their
beneficiaries and defraying reasonable expenses of administering the
plan.
(ii) Plan fiduciaries shall periodically review proxy voting
policies adopted pursuant to paragraph (d)(3)(i) of this section.
(iii) No proxy voting policies adopted pursuant to paragraph
(d)(3)(i) of this section shall preclude submitting a proxy vote when
the fiduciary prudently determines that the matter being voted upon is
expected to have a significant effect on the value of the investment or
the investment performance of the plan's portfolio (or investment
performance of assets under management in the case of an investment
manager) after taking into
[[Page 73886]]
account the costs involved, or refraining from voting when the
fiduciary prudently determines that the matter being voted upon is not
expected to have such an effect after taking into account the costs
involved.
(4)(i)(A) The responsibility for exercising shareholder rights lies
exclusively with the plan trustee except to the extent that either:
(1) The trustee is subject to the directions of a named fiduciary
pursuant to ERISA section 403(a)(1); or
(2) The power to manage, acquire, or dispose of the relevant assets
has been delegated by a named fiduciary to one or more investment
managers pursuant to ERISA section 403(a)(2).
(B) Where the authority to manage plan assets has been delegated to
an investment manager pursuant to ERISA section 403(a)(2), the
investment manager has exclusive authority to vote proxies or exercise
other shareholder rights appurtenant to such plan assets in accordance
with this section, except to the extent the plan, trust document, or
investment management agreement expressly provides that the responsible
named fiduciary has reserved to itself (or to another named fiduciary
so authorized by the plan document) the right to direct a plan trustee
regarding the exercise or management of some or all of such shareholder
rights.
(ii) An investment manager of a pooled investment vehicle that
holds assets of more than one employee benefit plan may be subject to
an investment policy statement that conflicts with the policy of
another plan. Compliance with ERISA section 404(a)(1)(D) requires the
investment manager to reconcile, insofar as possible, the conflicting
policies (assuming compliance with each policy would be consistent with
ERISA section 404(a)(1)(D)). In the case of proxy voting, to the extent
permitted by applicable law, the investment manager must vote (or
abstain from voting) the relevant proxies to reflect such policies in
proportion to each plan's economic interest in the pooled investment
vehicle. Such an investment manager may, however, develop an investment
policy statement consistent with Title I of ERISA and this section, and
require participating plans to accept the investment manager's
investment policy statement, including any proxy voting policy, before
they are allowed to invest. In such cases, a fiduciary must assess
whether the investment manager's investment policy statement and proxy
voting policy are consistent with Title I of ERISA and this section
before deciding to retain the investment manager.
(5) This section does not apply to voting, tender, and similar
rights with respect to shares of stock that are passed through pursuant
to the terms of an individual account plan to participants and
beneficiaries with accounts holding such shares.
(e) Definitions. For purposes of this section:
(1) The term investment duties means any duties imposed upon, or
assumed or undertaken by, a person in connection with the investment of
plan assets which make or will make such person a fiduciary of an
employee benefit plan or which are performed by such person as a
fiduciary of an employee benefit plan as defined in section 3(21)(A)(i)
or (ii) of the Act.
(2) The term investment course of action means 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.
(3) The term plan means an employee benefit plan to which Title I
of the Act applies.
(4) The term designated investment alternative means any investment
alternative designated by the plan into which participants and
beneficiaries may direct the investment of assets held in, or
contributed to, their individual accounts. The term ``designated
investment alternative'' shall not include ``brokerage windows,''
``self directed brokerage accounts,'' or similar plan arrangements that
enable participants and beneficiaries to select investments beyond
those designated by the plan.
(f) Severability. If any provision of this section is held to be
invalid or unenforceable by its terms, or as applied to any person or
circumstance, or stayed pending further agency action, the provision
shall be construed so as to continue to give the maximum effect to the
provision permitted by law, unless such holding shall be one of
invalidity or unenforceability, in which event the provision shall be
severable from this section and shall not affect the remainder thereof.
(g) Applicability date. (1) Except for paragraphs (d)(2)(iii) and
(d)(4)(ii) of this section, this section shall apply in its entirety to
all investments made and investment courses of action taken after
January 30, 2023.
(2) Paragraphs (d)(2)(iii) and (d)(4)(ii) of this section apply on
December 1, 2023.
Signed at Washington, DC, this 21st day of November, 2022.
Lisa M. Gomez,
Assistant Secretary, Employee Benefits Security Administration, U.S.
Department of Labor.
[FR Doc. 2022-25783 Filed 11-30-22; 8:45 am]
BILLING CODE 4510-29-P