Department of Labor Issues Final Rule for Financial Factors in Selecting Investments

Lee V. Bethel, CLU®, REBC®, RHU®, CAP®, AIF®, CASL® | April 21, 2021

Retirement plan sponsors, trustees, plan administrators, and members of plans’ investment committees are held to a fiduciary standard under the Employee Retirement Income Security Act of 1974 (ERISA.) This standard requires them to act prudently and in the sole interest of their plan’s participants and beneficiaries, including in actions related to the selection of investments and portfolio diversification.[i] This obligation was clarified recently when the Department of Labor (DOL) issued a final rule on October 30, 2020 amending the “prudence rule” or “investment duties” regulation plan fiduciaries must follow under Title I of ERISA.

Emphasis on Pecuniary Factors and Documentation

The new rule, which took effect January 12, 2021, requires fiduciaries to select plan investments solely on considerations impacting the economic value of the potential investments. Plan sponsors and other fiduciaries must consider only pecuniary factors. The rule defines a “pecuniary factor” as a factor “that a fiduciary prudently determines is expected to have a material effect on the return and/or risk of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy established pursuant to section 402(b)(1) of ERISA.”[ii]

When considering an investment based on any pecuniary factor, the rule clarifies that the DOL expects plan fiduciaries to consider potential investments by appropriately weighting the factor’s potential impact on risk and return, and not give undue weight to more minor considerations.[iii]

In the event a plan fiduciary is unable to distinguish between two investments based solely on pecuniary factors, fiduciaries may use non-pecuniary factors in making decisions as long as the fiduciary documents why pecuniary factors alone were not enough, how the selected investment compares to other reasonably-available alternative investment options, and how non-pecuniary factors used are still consistent with the best interests of plan participants or beneficiaries.[iv]

Rule and DOL Guidance Provide Investment-Specific Guidance

The final rule does not specifically prohibit, nor does it specifically permit, the use of proprietary products, fee-sharing arrangements, or fee aggregation arrangements. Instead, the DOL made clear they expect fiduciaries to consider whether, and to what extent, the use of such products or arrangements could materially impact risk and return, compared to reasonably-available alternative options.

While the proposed regulation recognized that there may be pecuniary factors related to environmental, social, and governance (ESG) investing, it warned plan fiduciaries that such factors could only be pecuniary when presenting economic risks or opportunities.[v] After the DOL received thousands of comments on its proposal, the final rule does not mention ESG factors.[vi]

Several commenters on the proposed rule questioned the rule’s impact on designated investment alternatives. Under the final rule, fiduciaries must first satisfy their basic loyalty and prudence standards under ERISA. Having satisfied those requirements, fiduciaries may consider investment alternative fund options that promote, seek, or support non-pecuniary goals, but the fund selected may not be used as (or as part of) a Qualified Default Investment Alternative (QDIA). The rule clarifies that QDIAs may not be selected based on non-pecuniary factors.[vii]

To learn more about the new rule and to review your plan’s investments, contact your plan’s financial professional today.

Important Disclosures:

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. Please keep in mind, the return on values based investments may be lower than if you make decisions based solely on investment considerations.

[i]https://www.dol.gov/general/topic/retirement/fiduciaryresp

[ii]https://www.federalregister.gov/documents/2020/11/13/2020-24515/financial-factors-in-selecting-plan-investments

[iii]https://www.morganlewis.com/pubs/2020/11/dol-finalizes-financial-factors-erisa-regulation

[iv]https://www.thompsonhine.com/publications/dol-final-rule-for-financial-factors-in-selecting-plan-investments

[v]https://www.dol.gov/newsroom/releases/ebsa/ebsa20200623

[vi]https://www.dol.gov/agencies/ebsa/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95

[vii]https://www.bradley.com/insights/publications/2020/11/the-pecuniary-rule-a-roadmap-for-navigating-the-dols-final-rule-on-financial-factors-in-selecting