Department of Labor Finalizes Amendments to Investment Duties Regulation | Goodwin

On December 1, 2022, the Department of Labor (DOL) announced final amendments to the investment tax regulation under Section 404(a) of ERISA.[1] This amendment will take effect on January 30, 2023.[2]

The final amendment reverses most of the changes the previous administration made to the same rule in early 2021. In addition to the new enforcement program already in place, changes made in 2021 sought to prevent ERISA trustees from considering environmental, social, governance and more. Factors in investing plan assets or offering investment options to plan participants (ESG factors).[3]

The final amendments largely reflect the principles-based (i.e. prudent and best interest) approach to investments required under ERISA itself. The final amendments explicitly refer to ESG factors, but remain neutral on whether fiduciaries need to consider them and to the extent they are considered, the weight given to them. is taking The final amendment states:

Risk and return factors may include the economic impact of climate change and other environmental, social or governance factors for a particular investment or investment course of action. Whether a particular consideration is a risk-reward factor will depend on individual facts and circumstances. The weightings given to factors by trustees should appropriately reflect a reasonable assessment of their risk-return impact.[4]

Therefore, under the Final Amendments, fiduciaries will have room to determine whether and to what extent ESG factors are relevant in a particular case. A fiduciary is not scrutinized simply because she considers ESG factors (or does not consider ESG factors). While this should be a welcome relief for investment fiduciaries in general, but especially for those who take her ESG factors into consideration, they seek ESG-related investment options, even those in plan assets. Whether it’s offerings to participants, yes.On this latter point, the amendment also states that trustees of participant-initiated individual account plans “do not breach a duty of loyalty…just because the trustee takes into account the preferences of the participants.” [prudent] Protect your manners. . . ”[5]

The DOJ approach (i.e., referencing ESG but not requiring consideration) reflects an attempt to minimize the risk of regulation becoming political football, and successive administrations have It repeatedly changes regulations to favor or not favor a company, strategy, or industry. The final amendment is likely to take a middle path to reduce the risk of regulatory volatility and the costs associated with iteratively adapting strategies, portfolios and investment options to new requirements.

Yet, by explicitly referencing ESG factors, the DOL highlights them as potential considerations. You may be under pressure. This pressure may be greater in relation to long-term investments where some of her ESG factors are likely to influence risk-adjusted returns.

Unlike current regulations, the final amendments would also apply a principles-based approach to plan sponsors’ selection of ESG-sensitive funds or other ESG-related investment options as Qualified Default Investment Alternatives (QDIAs). increase. The Final Amendment does not impose any special disclosure or documentation requirements in connection with such selection.[6]

The final amendment amends the “tie-breaker” clause of the Rules.[7] This provision essentially allows a fiduciary to consider collateral benefits in order to break the “ties” between otherwise equally prudent investment choices. Current regulations severely limit the usefulness of their provisions by imposing conditions that are difficult to meet. This includes the somewhat cyclical condition that the secured benefits are tied to retirement or other benefit interest. A final amendment would remove these conditions and allow consideration of a wide range of social or other ancillary benefits, provided that the fiduciary does not pursue profit at the expense of potential risk-adjusted returns. to Also, the Final Amendment does not impose any special documentation or disclosure requirements when making an election under the “tie-breaker” clause. The final amendment states:

If the trustee prudently concludes that competing investments or competing investment courses of action will equally serve the economic interests of the plan over an appropriate period of time, the trustee may choose to make an investment or course of investment on the basis of collateral interests. Not forbidden to choose. Other than investment income. However, the Trustee cannot accept a reduction in expected returns or greater risk in order to secure such additional profits.[8]

This change should benefit managers and fund sponsors who, for example, consider ESG factors that may not be directly related to risk-adjusted returns, regardless of whether the fund is subject to ERISA (e.g. creation of jobs and affordable housing).[9] Fund sponsors who benefit from this tiebreaker rule change should consider updating their disclosures in this regard.

The final amendments may also affect investments in government plan assets that are not subject to ERISA. Many government plans are subject to regulations such as ERISA under local law or internal policy, and in many cases even a fiduciary or private fund manager is required to comply with her ERISA or Requests through a side letter to follow rules similar to ERISA. In response to the 2020 amendments, many private fund sponsors have begun to explicitly cut out the amendments from their side letters, instead agreeing to follow only the principles-based approach of ERISA’s prudence rules. [10]

The final amendment does not refer to ESG-related investments permitted through brokerage windows. It is unclear if this omission makes sense. Historically, plan sponsors were not considered responsible for investments offered through windows. However, in recent semi-regulatory guidance on cryptocurrency investments, the DOL proposed otherwise, obliging plan sponsors to protect plan participants from exposure to cryptocurrency investments even within the window. indicates that there is[11]

The final amendment also reverts regulatory guidance on proxy voting to a principles-based approach. The Investment Manager is obligated to vote unless it determines that voting would not be in the Plan’s interests. The final amendment will remove certain requirements of current regulations regarding monitoring and documentation.[12] However, the duty to monitor remains implicit in the general duty of prudence. Additionally, trustee appointments should continue to require that administrators maintain adequate documentation to allow for effective oversight.

[1] The Final Rule does not apply to most individual retirement accounts because they are not subject to ERISA.
[2] Certain proxy voting provisions will not take effect until December 1, 2023.
[3] See our 2020 rule change alert for more information. The 2020 amendments were published in the Federal Register on November 13, 2020. Registration 72846. In early 2021, DOL issued a non-enforcement policy on the 2020 Amendments, after which DOL proposed new rules to replace the 2020 Amendments. look 86 Fed Register 57272 (October 14, 2021).
[4] Prudence and Loyalty in Choosing Plan Investments and Enforcing Shareholder Rights, 87 Fed. Registration 73822, 73833 (December 1, 2022) (to be codified in 29 CFR pt. 2550).
[5] Ditto. at 73842.
[6] See ID. At 73843 (“…[T]The Final Rules do not contain a special set of rules for participant-initiated individual account plans, including plans that include QDIA…”).
[7] See ID. 73827 (“… [The] The final rule amends the current regulation’s “tie-breaker” test … by which criteria … allows fiduciaries to ensure that competing investments or competing investment courses of action equally serve the financial interests of the plan over an appropriate period of time. I ask you to conclude with caution. In such cases, the trustees are not prohibited from choosing investments or investment course of action on the basis of ancillary interests other than investment returns. ”)
[8] Ditto. at 73885.
[9] Nonetheless, managers of ERISA-regulated funds that take into account ESG factors must comply with the “tie breaker” rule when those factors are not reasonably related to risk-adjusted returns.
[10] Certain state legislatures and agencies have established or are pursuing laws, policies or other actions that promote or restrict the use of ESG factors in investments in state plan assets. Such a move could complicate the efforts of private and other fund sponsors to sell his ESG options to state plans.
[11] Department of Labor Compliance Assistance Release No. 2022-01 (March 10, 2022): . [crypto] Investing through an intermediary window should expect to be questioned as to how the duty of prudence and loyalty can be matched in light of the risks described above.
[12] look 87 Fed Register at 73827: “The final rule also removes the current rule’s special regulatory documentation requirements and supersedes ERISA’s generally applicable statutory mandate to carefully document its planning activities.”

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