A so-called “do-good” investing rule that restricts environmental, social, and corporate governance funds was released by the U.S. Labor Department after clearing its final White House review.
“This means investment decisions must be based solely on whether they enhance retirement savings regardless of the fiduciaries’ personal preferences,” Deputy Secretary of Labor Patrick Pizzella told reporters on a conference call Friday announcing the rule. DOL posted the final rule on its website.
The measure is one of three major proposals released this summer by DOL’s Employee Benefits Security Administration that affect fiduciary responsibilities and benefits plans focused on ESG funds. Previously, when competing investments served a plan’s economic interests equally well, plan fiduciaries could use ESG considerations as the deciding factor for an investment choice.
In contrast, the Financial Factors in Selecting Plan Investments rule [RIN: 1210-AB95] would codify the DOL’s current position that plan fiduciaries select investments based solely on financial considerations. It would require fiduciaries who invest in ESG options to provide analysis and documentation in the “rare circumstances” when they’re choosing among economically indistinguishable investments, according to a DOL fact sheet.
The final rule applies to retirement plans sponsored by private employers governed by the Employee Retirement Income Security Act of 1974. It makes clear that retirement plan fiduciaries must base their investment decisions on the financial interests of plan participants and their retirement benefits, or “pecuniary factors,” said Jeanne Klinefelter Wilson, acting assistant secretary of labor for EBSA.
Not Fully Prohibited
Fiduciaries may never sacrifice investment return, take on additional risk, or increase costs to promote goals unrelated to the financial interest of their plan participants, Klinefelter Wilson said.
“This does not mean that fiduciaries are prohibited from considering such issues as environmental impact and workplace practices when they are relevant to the financial analysis,” she said. “Because these issues are pecuniary in that instance and therefore appropriate considerations under the rule.”
The financial factors rule was first published June 30, and like the others, had a short 30-day window for the public to critique the rule and suggest changes. The proposal received thousands of public comments, and DOL officials said the final rule was changed significantly in response.
For example, the text of the final rule makes no reference to ESG, but the preamble to the rule contains a discussion of these funds and how the rule would apply to these investments, a DOL official said on the call with reporters.
The definition of “pecuniary factor” was modified to mean any factor that a fiduciary prudently determines is expected to have a material effect on risk and return based on appropriate investment guidelines, the official said.
The rule restores the original 1979 provisions, previously described as a “safe harbor,” for the duty of prudence, the official said. It also clarifies that the fiduciary only needs to compare an investment or investment course of action with reasonably available alternatives with similar risk.
The final rule retains the tiebreaker provision, but removes the proposal’s “economically indistinguishable” language, according to the official. Instead, the tiebreaker provision applies if the fiduciary is unable to distinguish on the basis of pecuniary factors. It also retains the documentation requirement when the tiebreaker rule is used.
With respect to individual account plans, the final rule was modified to require that the duty of prudence and loyalty apply to the selection of designated investment alternatives, the official said. The final rule expressly states that the tiebreaker provision may be used to select designated investment alternatives.
Changes to Final Rule
The final rule specifically permits the selection of a fund that seeks to promote one or more non-pecuniary goals if the selection satisfies the duties of prudence and loyalty, the official said. It deletes the requirement that an ESG fund may only be selected if the fiduciary uses objective criteria.
The final rule also removes the documentation requirement for the selection of designated investment alternatives, unless that alternative is being selected under the tiebreaker provision, the official said. It includes a definition of designated investment alternative that doesn’t include brokerage windows, self-directed brokerage accounts, or similar plan arrangements that enable participants to select investments beyond those designated by the plan.
While the proposed rule contained a blanket prohibition on any fund that used ESG factors or similarly oriented assessments from being a qualified default investment alternative even if those factors were used for pecuniary purposes, the final rule is different and only excludes a fund from being a QDIA if its investment objectives, goals, or principal investment strategy include, consider, or indicate the use of one or more non-pecuniary factors.
EBSA submitted the financial factors rule for review on Oct. 14 to the White House Office of Management and Budget, which took 17 days to complete.
OMB’s Office of Information and Regulatory Affairs reviews the legal justification and cost-benefit analysis of all significant federal regulations, as well as vets them through other executive branch agencies for potential conflicts.
Review times vary considerably among regulations, and can range from a few days to many months. Since the start of the Trump administration, the review time for all regulations has averaged 71 days. Labor Department rules have averaged 50 days. A rushed review by OIRA could make any regulation more vulnerable to a legal challenge.