January 3, 2023

Department of Labor Finalizes Amendments to Investment Duties Regulation

On December 1, 2022, the Department of Labor (DOL) released final amendments to its regulation on investment duties under Section 404(a) of ERISA.[1] The amendments will go into effect on January 30, 2023.[2]

The final amendments reverse most of the prior administration’s changes made to the same regulation in early 2021. Along with a novel enforcement program that had already been implemented, the changes made in 2021 sought to inhibit ERISA fiduciaries from considering environmental, social, governance and similar factors (ESG factors) when investing plan assets or providing investment options for plan participants.[3]

The final amendments largely mirror the principles-based (i.e., prudential and best interest) approach to investing required under ERISA itself. The final amendments expressly reference ESG factors, but take a neutral stance on whether investment fiduciaries should consider them and, to the extent they are considered, the weight to be afforded to them. The final amendments state:

Risk and return factors may include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action. Whether any particular consideration is a risk-return factor depends on the individual facts and circumstances. The weight given to any factor by a fiduciary should appropriately reflect a reasonable assessment of its impact on risk-return.[4]

Thus, under the final amendments, investment fiduciaries have leeway to determine whether and to what extent ESG factors are relevant in any given case. Fiduciaries will not be subject to heightened scrutiny merely for considering ESG factors (or not considering ESG factors). This should be a welcome relief to investment fiduciaries generally, but especially to those taking ESG factors into account, whether in investing plan assets or providing ESG-related investment alternatives to participants who press for them. In this latter regard, the amendments helpfully also provide that a fiduciary of a participant-directed individual account plan “does not violate the duty of loyalty . . . solely because the fiduciary takes into account participants’ preferences in a [prudent] manner . . . .”[5]

The Department’s approach (i.e., referencing ESG, but not requiring consideration) reflects an attempt to minimize the risk of the regulation becoming a political football, with successive administrations repeatedly changing the regulation to favor or disfavor certain investments, strategies, or industries. By steering a middle course, the final amendment may reduce the risk of regulatory volatility and the attendant costs of repeatedly conforming strategies, portfolios, and investment options to new requirements.

Still, by explicitly referencing ESG factors, the DOL has highlighted them as potential considerations. This may pressure fiduciaries to at least consider whether ESG factors are relevant in any given case. This pressure may be greater in connection with longer-term investments, where some ESG factors may be more likely to affect risk-adjusted returns.

Unlike the current regulation, the final amendments also apply their principles-based approach to a plan sponsor’s selection of an ESG-sensitive fund or other ESG-related investment option as a qualified default investment alternative (QDIA). The final amendments impose no special disclosure or documentation requirements in connection with such selection.[6]

The final amendments revise the regulation’s “tie breaker” provision.[7] That provision essentially permits an investment fiduciary to consider collateral benefits to break a “tie” among otherwise equally prudent investment alternatives. The current regulation severely limits the usefulness of that provision by imposing conditions that are difficult to meet, including a somewhat circular condition that any collateral benefit nonetheless be tied to retirement or other benefit interests. The final amendments remove those conditions, allowing the consideration of a wide range of social or other collateral benefits, provided that the investment fiduciary does not sacrifice risk-adjusted potential returns to pursue those benefits. The final amendments also do not impose any special documentation or disclosure requirements when making a selection under the “tie breaker” provision. The final amendments state:

If a fiduciary prudently concludes that competing investments, or competing investment courses of action, equally serve the financial interests of the plan over the appropriate time horizon, the fiduciary is not prohibited from selecting the investment, or investment course of action, based on collateral benefits other than investment returns. A fiduciary may not, however, accept expected reduced returns or greater risks to secure such additional benefits.[8]

This change should benefit, for example, managers and fund sponsors, whether or not the funds are subject to ERISA, who consider ESG factors that may not have a direct link to risk-adjusted returns (e.g., creating jobs or affordable housing).[9] Fund sponsors benefitting from this change to the tie-breaker rule should consider updating their disclosures in this regard.

The final amendments may also affect the investment of governmental plan assets, even though those plans are not subject to ERISA. Many governmental plans are subject to ERISA-like rules under local laws or internal policies, and many also require their investment fiduciaries and even private fund managers to follow ERISA or ERISA-like rules in managing the plans’ assets through side letters. In response to the 2020 amendments, many private fund sponsors began expressly carving out the amendments from their side letters, agreeing instead only to follow the principles-based approach of ERISA’s prudence rule. [10]

The final amendments do not speak to ESG-related investments permitted through a brokerage window. Whether this omission is meaningful is unclear. Historically, plan sponsors have not been viewed as responsible for investments made available through a window. Yet, in its recent sub-regulatory guidance on crypto investing, the DOL suggested otherwise, indicating that plan sponsors have a duty to protect plan participants from exposure to crypto investments even inside of a window.[11]

The final amendments also return regulatory guidance on proxy voting to a largely principles-based approach. Investment managers have a duty to vote proxies except where they determine that doing so is not in the plan’s interest. The final amendments remove the current regulation’s specific requirements with respect to monitoring and documentation.[12] The duty to monitor remains implicit in the general duty of prudence, however. Further, appointing fiduciaries should continue to require managers to maintain sufficient documentation, so as to permit effective monitoring.


[1] The final regulation does not apply to most individual retirement accounts, as they are not subject to ERISA.
[2] Certain proxy voting provisions do not take effect until December 1, 2023.
[3] For details, see our alert on the 2020 amendments to the regulation. The 2020 amendments were published in the Federal Register on November 13, 2020, 85 Fed. Reg. 72846. In early 2021, the DOL issued a non-enforcement policy with respect to the 2020 amendments, and the DOL subsequently proposed new regulations to replace the 2020 amendments. See 86 Fed. Reg. 57272 (Oct. 14, 2021).
[4] Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, 87 Fed. Reg. 73822, 73833 (Dec. 1, 2022) (to be codified at 29 C.F.R. pt. 2550).
[5] Id. at 73842.
[6] See id. at 73843 (“…[T]he final regulation does not contain the set of special rules for participant-directed individual account plans, including plans with QDIAs…”).
[7] See id. at 73827 (“... [The] final rule amends the current regulation’s ‘tiebreaker’ test…with a standard that… requires the fiduciary to conclude prudently that competing investments, or competing investment courses of action, equally serve the financial interests of the plan over the appropriate time horizon. In such cases, the fiduciary is not prohibited from selecting the investment, or investment course of action, based on collateral benefits other than investment returns.”).
[8] Id. at 73885.
[9] Managers of ERISA-regulated funds that take ESG factors into account nonetheless must comply with the “tie breaker” rule where those factors do not reasonably relate to risk-adjusted returns.
[10] Legislatures and administrations in certain states have established or are pursuing laws, policies, or other measures that would either promote or restrict the use of ESG factors in investing assets of their state plans. Such measures could complicate private and other fund sponsors’ efforts to market ESG options to state plans.
[11] Department of Labor Compliance Assistance Release No. 2022-01 (Mar. 10, 2022): “The plan fiduciaries responsible for . . . allowing [crypto] investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty in light of the risks described above.”.
[12] See 87 Fed. Reg. at 73827: “The final rule also removes the current regulation’s special regulatory documentation requirements in favor of ERISA’s generally applicable statutory duty to prudently document plan affairs.”