On October 30, 2020, the U.S. Department of Labor (the “DOL”) issued a final rule on factors for selecting plan investments, which restricts “do-good” or “ESG” investing.  In response to public comments, the final rule rolls back some of the restrictions and burdens from its proposed rule issued in June (summarized here), but it reaffirms the DOL’s longstanding position that ERISA requires plan fiduciaries to treat the financial interests of plan participants and beneficiaries as paramount when making investment decisions.  The final rule states that “ESG” funds may be offered in a 401(k)- or 403(b)-type plan where participants direct investments, but the selection is subject to conditions that could pose a challenge.

Consistent with the proposed rule, the final rule generally requires ERISA plan fiduciaries to base investment decisions on financial factors alone and prohibits fiduciaries from selecting investments based on non-pecuniary considerations.  Given the lack of a precise or generally accepted definition of “ESG,” the final rule instead refers to “pecuniary” and “non-pecuniary” factors in delineating the relevant fiduciary investment duties to be followed by plan fiduciaries.

The final rule is structured as an amendment to the DOL’s “investment duties” regulation set forth at 29 C.F.R. § 2550.404a-1, and provides as follows:

  • Investment decisions must be based only on pecuniary factors (i.e., factors that a fiduciary prudently determines are expected to have a material effect on risk/return in light of the plan’s investment objectives and funding policy), except in the event of a “tie-breaker” (as discussed below).
    • Consistent with the text of the proposed rule, the preamble once again acknowledges that an “ESG”-type factor could be considered a “pecuniary” factor under certain circumstances. For example, a fiduciary may conclude that board/management diversity or a company’s environmental record would have a material financial effect on the investment.
    • However, the preamble also cautions against concluding too hastily that “ESG”-type factors are actually “pecuniary.”
    • Of note to multiemployer plans, the preamble specifically states that increasing participant contributions or otherwise benefiting union labor generally is not a “pecuniary” factor that may be considered outside of the “tie-breaker” context.
  • A plan fiduciary may not subordinate the financial interests of plan participants and beneficiaries to other objectives, and may not sacrifice investment return or take on additional risk to promote non-pecuniary goals.
  • When making an investment decision, a plan fiduciary is required to consider reasonably available alternatives with similar risks in order to satisfy its duty of prudence.
    • The preamble states that this rule does not require scouring the market or considering every possible alternative.
  • A plan fiduciary may consider non-pecuniary factors as a “tie-breaker” between two or more investment alternatives if the fiduciary is unable to distinguish them on pecuniary factors alone, provided that the fiduciary documents (i) why considering only pecuniary factors was not sufficient to make the decision, (ii) how the selected investment compares to the considered alternative(s) in light of the plan’s diversification, liquidity, cash flow requirements and funding objectives, and (iii) how the applicable non-pecuniary factor(s) is consistent with the financial interests of the plan participants and beneficiaries.
    • The proposed rule permitted consideration of non-pecuniary factors to break ties only in the case of “economically indistinguishable” investments. The DOL has relaxed the standard in response to public comments questioning the feasibility of the proposed approach.
    • Not surprisingly, the preamble encourages fiduciaries to make “tie-breaker” decisions based on pecuniary factors alone.
  • The general requirement to evaluate investments based solely on pecuniary factors applies to a 401(k)- or 403(b)-type plan fiduciary’s selection and retention of available plan investment alternatives (other than brokerage window or self-directed brokerage account investment options). However, the final rule does not categorically prohibit including an investment option that supports non-pecuniary goals (for example, in response to participant demand) if the following conditions are satisfied:
    • The plan otherwise provides a “broad range of investment alternatives”;
    • The decision to include the investment option is based on “pecuniary” factors only (outside of the “tie-breaker” context); and
    • A fund or model portfolio with objectives, goals or principal investment strategies that take non-pecuniary factors into account may not be used as, or as a component of, a qualified default investment alternative (QDIA), even if it may otherwise be permissible as a non-QDIA investment alternative. The DOL suggests in the preamble that plan fiduciaries should review any potential QDIA’s prospectus or similar disclosure document to ensure that it does not include, consider or indicate the use of non-pecuniary factors (including, for example as a “screening strategy,” where certain types of controversial activities or investments are categorically excluded).
  • The DOL has helpfully clarified that the final rule applies only to “designated” investment alternatives (e., alternatives that are selected and monitored by plan fiduciaries). The final rule does not apply to self-directed brokerage windows and similar arrangements that enable participants to select investments beyond those specifically designated by the plan.

Although the final rule is set to become effective 60 days after publication in the Federal Register, 401(k) and 403(b)-type plans will have until April 30, 2022 to make any changes that are necessary to comply with the requirements related to the selection or retention of QDIAs.

Key Takeaway:  Although the DOL has cleared a path for ERISA fiduciaries to consider “ESG” factors when making investment decisions and to offer “ESG” funds in a 401(k)- or 403(b)-type plan, the path remains relatively narrow as the final rule still requires that selection of the investment option be based solely on pecuniary factors (outside of the “tie-breaker” context).  Accordingly, decisions with respect to “ESG” require careful deliberation, balancing of risks, and documentation.

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Photo of Ira G. Bogner Ira G. Bogner

Ira G. Bogner is Managing Partner of the Firm. He is the immediate former chair of the Firm’s Tax Department. He is a member of the Employee Benefits & Executive Compensation Group and the Firm’s Executive Committee. Ira represents a varied list of…

Ira G. Bogner is Managing Partner of the Firm. He is the immediate former chair of the Firm’s Tax Department. He is a member of the Employee Benefits & Executive Compensation Group and the Firm’s Executive Committee. Ira represents a varied list of clients, including financial service companies, entertainment industry clients, and tax-exempt organizations, and also actively represents individual executives in executive compensation matters.

Ira counsels clients with respect to the tax, securities law disclosure, corporate governance, stock exchange and other requirements relevant to executive compensation arrangements. Ira also provides advice regarding equity arrangements, employment agreements, change in control agreements and all other types of executive compensation arrangements, including guidance regarding “409A,” “162m,” “457A,” and “280G.”

Ira frequently is called on to structure and analyze alternative investments for pension trusts and other exempt organizations. He also works with the Firm’s corporate and real estate lawyers in structuring and maintaining investment funds that include participation by pension plans. Through his work in the investment fund area Ira has obtained substantial experience in applying the rules provided under the “plan asset” regulations, including the operation of venture capital operating companies and real estate operating companies. He has assisted in the formation of private equity, real estate, infrastructure and hedge funds, including “fund of funds.” Ira also has advised clients on both avoiding ERISA “plan asset” status and operating an investment fund in accordance with ERISA.

Areas of Concentration

Ira has provided guidance to clients on a wide variety of matters in the areas of employee benefits and executive compensation, including:

  • investment of plan assets
  • implementation of employee benefit plans

  • employee benefit issues in mergers and acquisitions

  • awarding of equity-based compensation

  • negotiation and drafting of employment agreements and severance arrangements

  • structuring, analyzing and maintaining investment funds that are suitable for plan investors

Thought Leadership

Ira has published a number of articles in publications such as The New York Law Journal, The New Jersey Law Journal, The Daily Deal, The Journal of Pension Planning and Compliance, Mergers and Acquisitions (The Monthly Tax Journal), The Journal of Taxation and Regulation of Financial Institutions, The Metropolitan Corporate Counsel, European Private Equity & Venture Capital Associations, The LPA Anatomised and Private Equity International and has been named to the Board of Advisors of the Journal of Taxation and Regulation of Financial Institutions. He also has lectured on topics such as the classification of workers, drafting employment agreements, equity alternatives for senior executives, investing IRA assets, the plan asset regulations, shareholder approval of equity plans, Code Section 409A, and key provisions for ERISA investors investing in a private equity fund.

Recognition

Ira has been recognized and ranked by various directories. US Legal 500 has carried the following comments: “Ira Bogner is ‘available, responsive and knowledgeable;” “Ira Bogner ‘provides a level of comfort with respect to business issues that is rare in the world of ERISA;” “Ira Bogner is the ‘go-to guy for fund sponsors needing help with ERISA.’”

Photo of Russell Hirschhorn Russell Hirschhorn

Russell L. Hirschhorn, co-head of the ERISA Litigation Group, represents plan fiduciaries, trustees, sponsors and service providers on the full range of ERISA and state law benefit and fiduciary issues. From single plaintiff litigation and arbitration to complex class action litigation, he provides…

Russell L. Hirschhorn, co-head of the ERISA Litigation Group, represents plan fiduciaries, trustees, sponsors and service providers on the full range of ERISA and state law benefit and fiduciary issues. From single plaintiff litigation and arbitration to complex class action litigation, he provides practical guidance, develops unique litigation defense strategies and, when appropriate, mediates successful resolutions.

Russell represents clients across a wide array of publicly-held, multi-national companies and privately owned companies across a multitude of industries including, banking, finance and investments, pharmaceuticals, retail products and construction, to name just a few. In addition, he also counsels benefit plan clients on a host of compliance and federal and state government agency enforcement matters, including complex and lengthy investigations and audits by the U.S. Departments of Justice and Labor.

Russell is management co-chair of the American Bar Association Employee Benefits Committee as well as management co-chair of the Trial Institutes Committee of the American Bar Association’s Labor and Employment Law. He also writes on cutting-edge ERISA litigation issues, serving as a contributing author and a past chapter editor to Employee Benefits Law (BNA Third Edition).

Deeply dedicated to pro bono work, Russell was a principal drafter of several amicus briefs for the Innocence Project, a legal non-profit committed to exonerating wrongly convicted people. Russell has been recognized on several occasions for his commitment to pro bono work including by President George W. Bush in receiving the U.S. President’s Volunteer Service Award.

Photo of Seth Safra Seth Safra

Seth J. Safra is chair of Proskauer’s Employee Benefits & Executive Compensation Group. Described by clients as “extremely knowledgeable, practical, and strategic,” Seth advises clients on compensation and benefit programs.

Seth’s experience covers a broad range of retirement plan designs, from traditional defined…

Seth J. Safra is chair of Proskauer’s Employee Benefits & Executive Compensation Group. Described by clients as “extremely knowledgeable, practical, and strategic,” Seth advises clients on compensation and benefit programs.

Seth’s experience covers a broad range of retirement plan designs, from traditional defined benefit to cash balance and floor-offset arrangements, ESOPs and 401(k) plans—often coordinating qualified and non-qualified arrangements. He also advises tax-exempt and governmental employers on 403(b) and 457 arrangements, as well as innovative new plan designs; and he advises on ERISA compliance for investments.

On the health and welfare side, Seth helps employers provide benefits that are cost-effective and competitive. He advises on plan design, including consumer-driven health plans with HSAs, retiree medical, fringe benefits, and severance programs, ERISA preemption, and tax and other compliance issues, such as nondiscrimination and cafeteria plan rules.

Seth also advises for-profit and non-profit employers, compensation committees, and boards on executive employment, deferred compensation, change in control, and equity and other incentive arrangements. In addition, he advises on compensation and benefits in corporate transactions.

Seth represents clients before the Department of Labor, IRS and other government agencies.

Seth has been recognized by Chambers USA, The Legal 500, Best Lawyers, Law360, Human Resource Executive, Lawdragon and Super Lawyers.

Photo of Steven Weinstein Steven Weinstein

Steven D. Weinstein is a partner in the Employee Benefits & Executive Compensation Group and co-head of the Strategic Corporate Planning Group. He has been practicing in the employee benefits field since 1984, representing clients sponsoring single employer and Taft-Hartley pension and welfare…

Steven D. Weinstein is a partner in the Employee Benefits & Executive Compensation Group and co-head of the Strategic Corporate Planning Group. He has been practicing in the employee benefits field since 1984, representing clients sponsoring single employer and Taft-Hartley pension and welfare plans.

Steven advises clients in all aspects of pension plan tax qualification and plan administration, including drafting of plan documents and employee communications; providing advice relating to corporate acquisitions and mergers; and negotiating investment management agreements, trust agreements, recordkeeping and custodial contracts, and other plan-related contracts.

In the tax-qualified plan area, Steven assists clients concerning the rules relating to discrimination testing, participation, vesting, cash or deferred arrangements, plan limitations and plan distributions. He also counsels clients regarding voluntary correction programs offered by the Internal Revenue Service and Department of Labor.

In addition, he counsels a wide array of clients on issues relating to fiduciary responsibility in connection with the administration and operation of employee benefit programs, particularly with respect to advice relating to the investment of plan assets. The latter advice includes the rules governing investment diversification, determination of plan assets, foreign indicia of ownership, prohibited transactions, and exclusive benefit and prudence. He also advises employers in connection with the implementation of all phases of reduction-in-force programs, including the drafting of severance plans and related documents, as well as employee communications required to effect these programs.

Steven has wide-ranging experience with health and welfare plans, particularly regarding the new rules issued under the Affordable Care Act (ACA). As a member of Proskauer’s interdisciplinary Health Care Reform Task Force, he assists clients and other Firm lawyers in preparing for the numerous changes resulting from ACA.

His experience is extensive in advising Fortune 500 companies with respect to the structure of their benefit plans and how such plans may be affected by corporate transactions. He also regularly counsels plan fiduciary committees as to best procedural practices to reduce potential exposure to fiduciary breach claims. His clients are most frequently in the manufacturing, financial services and entertainment sectors.

Steven has significant experience in assisting clients with the implementation and ongoing operation of non-qualified retirement plans and other types of executive compensation, including issues relating to ERISA coverage, and Section 409A and Section 457A compliance. He also advises clients in connection with executive employment agreements and change-in-control or severance arrangements.

Photo of Adam Scoll Adam Scoll

Adam Scoll is a partner in the Firm’s Tax Department and Private Funds Group.

He specializes in the area of Title I of ERISA and the investment of ERISA “plan assets,” advising both pension trusts and their investment managers and advisers with regard…

Adam Scoll is a partner in the Firm’s Tax Department and Private Funds Group.

He specializes in the area of Title I of ERISA and the investment of ERISA “plan assets,” advising both pension trusts and their investment managers and advisers with regard to compliance with ERISA’s complex fiduciary duty and prohibited transaction rules.

Adam regularly advises private investment fund sponsors regarding the structuring of their funds in order to accept investments from ERISA-covered pension trusts, including compliance with the ERISA “plan asset” regulations and the operation of venture capital operating companies (VCOCs) and real estate operating companies (REOCs).

Adam also represents both employers and senior executives in the negotiation and drafting of employment and separation agreements, deferred compensation plans, and equity and “phantom equity” arrangements, including compliance with the nonqualified deferred compensation rules under Sections 409A and 457A of the Internal Revenue Code.