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Final Rule on Financial Factors in Investing Sidesteps ESG Focus

Regulatory Compliance

The final rule on ESG investing by ERISA plans steps away from the proposed rule’s focus on ESG.

Indeed, the Labor Department notes that “unlike the proposal, the final rule’s operative text contains no specific references to ESG or ESG-themed funds.” 

Rather, acknowledging the fluid definition of environmental, social, and governance factors, the Labor Department’s position is that “the lack of a precise or generally accepted definition of ‘ESG,’ either collectively or separately as ‘E, S, and G,’ made ESG terminology not appropriate as a regulatory standard.” Therefore, the final rule—which will be effective 60 days after publication in the Federal Register—refers to “pecuniary factors and non-pecuniary factors” in defining the relevant fiduciary investment duties.

Core Additions 

The Final Rule on Financial Factors in Selecting Plan Investments and comments (the DOL noted that there were more than 1,100 written comments and more than 7,600 form letter responses to the proposal) runs some 148 pages (the final rule is less than 8 of those) runs some 148 pages—but a fact sheet issued by the Labor Department outlines the following “core additions” to the current investment duties regulation at 29 CFR 2550.404a-1.

Loyalty Duty. The final rule adopts the proposal’s addition of a general restatement of the loyalty duty under ERISA section 404(a)(1)(A). The DOL explains that, in reaction to comments, the final rule continues to treat the original 1979 regulation’s provisions on the fiduciary duty of prudence as a safe harbor, and separately sets out a new provision regarding a fiduciary’s duty of loyalty under ERISA section 404(a)(1)(A) as minimum  requirements for meeting the statutory standard of loyalty.

Pecuniary Factors. The rule adds a specific provision to confirm that ERISA fiduciaries must evaluate investments and investment courses of action based solely on pecuniary factors—i.e., factors that the responsible fiduciary prudently determines are expected to have a material effect on risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy. The DOL notes that this provision also provides that the duty of loyalty prohibits fiduciaries from subordinating the interests of participants to unrelated objectives and bars them from sacrificing investment return or taking on additional investment risk to promote non-pecuniary goals.

Reasonable Alternatives. The rule adopts—with modifications—the provision in the proposal that explicitly requires fiduciaries to consider reasonably available alternatives to meet their prudence duties under ERISA. The modifications were made “to avoid suggesting that fiduciaries must scour the marketplace or look at an infinite number of possible alternatives as part of their evaluation.”

Investment Analysis and Documentation. The rule includes new regulatory text setting forth required investment analysis and documentation requirements for those “limited circumstances in which plan fiduciaries may use non-pecuniary factors to choose between or among investments that the fiduciary cannot distinguish based on pecuniary factors alone.” Those requirements are “intended to prevent fiduciaries making investment decisions based on non-pecuniary benefits without appropriately careful analysis and evaluation,” according to the DOL.

Investment Alternatives. The rule states that the prudence and loyalty standards set forth in ERISA apply to a fiduciary’s selection of a designated investment alternative to be offered to plan participants and beneficiaries in an individual account plan (such as a 401(k) or defined contribution plan). However, the DOL states that this rule does not  “categorically prohibit the fiduciaries of such plans from considering or including, as designated investment alternatives, investment funds, products, or model portfolios that support non-pecuniary goals if the plans allow participants and beneficiaries to choose from a broad range of investment alternatives, as defined in 29 C.F.R. § 2550.404c-1(b)(3).” The DOL goes on to point out that the rule makes clear that the fiduciaries must first satisfy the prudence and loyalty provisions in ERISA and the final rule, “including the overarching requirement to evaluate investments solely based on pecuniary factors when selecting any such investment fund, product, or model portfolio.”


In response to what to many had been one of the more controversial aspects of the proposed rule—and which the American Retirement Association had commented on—the DOL acknowledged that “in response to public comments,” the final rule modifies the provision in the proposal on qualified default investment alternatives (QDIAs), and prohibits plans from adding or retaining any investment fund, product, or model portfolio as a QDIA, or as a component of such a default investment alternative, if its objectives or goals or its principal investment strategies include, consider, or indicate the use of one or more non-pecuniary factors.

With respect to the use of the “all things being equal test” or the “tie-breaker” rule, the final rule doesn’t refer to “ties” as involving instances in which investments are “economically indistinguishable.” Rather, in response to public comments questioning the workability of such an approach, the DOL says that the final rule provides that “if, after completing an appropriate evaluation, a fiduciary cannot distinguish between alternative investments on the basis of pecuniary factors and the fiduciary chooses one of the investments on the basis of a non-pecuniary factor,” the fiduciary must document:

  • why pecuniary factors alone did not provide a sufficient basis to select the investment or investment course of action; 
  • how the selected investment compares to the alternative investments with regard to certain factors listed in the rule; and 
  • how the chosen non-pecuniary factor or factors are consistent with the interests of participants and beneficiaries in their retirement income or financial benefits under the plan. 

In addition, the preamble of the final rule encourages fiduciaries to break ties using their best judgment on the basis of pecuniary factors alone.

Effective Dates

This final rule will be effective 60 days after the date of publication in the Federal Register  so that the final rule applies prospectively in its entirety to investments made and investment courses of action taken after such date (the current 404a-1 regulation applies until then).

It also includes a provision that gives plans until April 30, 2022 to make any changes that are necessary to comply with the requirements related to the selection of qualified default investment alternatives. 

The DOL notes that “nothing in the regulation forecloses the Department from taking enforcement action based on prior conduct that violated ERISA’s provisions, including the statutory duties of prudence and loyalty, based on the statutory and regulatory standards in effect at the time of the violation.”

The final rule is available here; a fact sheet explaining the rule is here