Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, 73822-73886 [2022-25783]

Download as PDF 73822 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations DEPARTMENT OF LABOR Employee Benefits Security Administration 29 CFR Part 2550 RIN 1210–AC03 Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights Employee Benefits Security Administration, Department of Labor. ACTION: Final rule. AGENCY: The Department of Labor (Department) is adopting amendments to the Investment Duties regulation under Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA). The amendments clarify the application of ERISA’s fiduciary duties of prudence and loyalty to selecting investments and investment courses of action, including selecting qualified default investment alternatives, exercising shareholder rights, such as proxy voting, and the use of written proxy voting policies and guidelines. The amendments reverse and modify certain amendments to the Investment Duties regulation adopted in 2020. DATES: Effective date: This rule is effective on January 30, 2023. Applicability dates: See § 2550.404a– 1(g) of the final rule for compliance dates for § 2550.404a–1(d)(2)(iii) and (d)(4)(ii) of the final rule. FOR FURTHER INFORMATION CONTACT: Fred Wong, Acting Chief of the Division of Regulations, Office of Regulations and Interpretations, Employee Benefits Security Administration, (202) 693– 8500. This is not a toll-free number. Customer Service Information: Individuals interested in obtaining information from the Department of Labor concerning ERISA and employee benefit plans may call the Employee Benefits Security Administration (EBSA) Toll-Free Hotline, at 1–866– 444–EBSA (3272) or visit the Department of Labor’s website (www.dol.gov/ebsa). SUPPLEMENTARY INFORMATION: SUMMARY: khammond on DSKJM1Z7X2PROD with RULES2 Table of Contents I. Background A. General B. The Department’s Prior Non-Regulatory Guidance 1. ETI/ESG Investing 2. Exercising Shareholder Rights C. Executive Order Review of Current Regulation II. Purpose of Regulatory Action and Proposed Rule VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 A. Purpose B. Major Provisions of Proposed Rule III. The Final Rule A. Executive Summary of Major Changes and Clarifications B. Detailed Discussion of Public Comments and Final Regulation 1. Section 2550.404a–1(a) and (b)—General and Investment Prudence Duties 2. Section 2550.404a–1(c) Investment Loyalty Duties 3. Investment Alternatives in Participant Directed Individual Account Plans Including Qualified Default Investment Alternatives 4. Section 2550.404a–1(d)—Proxy Voting and Exercise of Shareholder Rights 5. Section 2550.404a–1(e)—Definitions 6. Section 2550.404a–1(f)—Severability 7. Section 2550.404a–1(g)—Applicability Date 8. Miscellaneous IV. Regulatory Impact Analysis A. Executive Orders 12866 and 13563 B. Introduction and Need for Regulation C. Affected Entities 1. Subset of Plans Affected by Proposed Modifications of Paragraphs (b) and (c) of § 2550.404a–1 2. Subset of Plans Affected by the Modifications to Paragraph (d) of § 2550.404a–1 D. Benefits 1. Benefits of Paragraphs (b) and (c) 2. Cost Savings Relating to Paragraphs (c), Relative to the Current Regulation 3. Benefits of Paragraph (d) 4. Cost Savings Relating to Paragraphs (d) and (e), Relative to the Current Regulation E. Costs 1. Cost of Reviewing the Final Rule and Reviewing Plan Practices 2. Possible Changeover Costs 3. Cost Associated With Changes in Investment or Investment Course of Action 4. Cost Associated With Changes to the ‘‘Tiebreaker’’ Rule 5. Cost To Update Plan’s Written Proxy Voting Policies 6. Summary F. Transfers G. Uncertainty H. Alternatives I. Conclusion V. Paperwork Reduction Act VI. Regulatory Flexibility Act A. Need for and Objectives of the Rule B. Comments C. Affected Small Entities 1. Small Plans Affected by the Proposed Modifications of Paragraphs (b) and (c) of § 2550.404a–1 2. Subset of Plans Affected by Modifications of Paragraph (d) and (e) of § 2550.404a–1 D. Impact of the Rule 1. Cost of Reviewing the Final Rule and Reviewing Plan Practices 2. Cost To Update Written Proxy Voting Policies 3. Summary of Costs E. Regulatory Alternatives F. Duplicate, Overlapping, or Relevant Federal Rules PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 VII. Unfunded Mandates Reform Act VIII. Federalism Statement I. Background A. General Title I of the Employee Retirement Income Security Act of 1974 (ERISA) establishes minimum standards that govern the operation of private-sector employee benefit plans, including fiduciary responsibility rules. Section 404 of ERISA, in part, requires that plan fiduciaries act prudently and diversify plan investments so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so.1 Sections 403(c) and 404(a) also require fiduciaries to act solely in the interest of the plan’s participants and beneficiaries, and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan.2 To maximize employee pension and welfare benefits, section 404 of ERISA dictates that the focus of ERISA plan fiduciaries on the plan’s financial returns and risk to beneficiaries must be paramount.3 And for years, the Department’s non-regulatory guidance has recognized that, under the appropriate circumstances, ERISA does not preclude fiduciaries from making investment decisions that reflect environmental, social, or governance (‘‘ESG’’) considerations, and choosing economically targeted investments (‘‘ETIs’’) selected in part for benefits in addition to the impact those considerations could have on investment return.4 The Department’s non-regulatory guidance has also recognized that the fiduciary act of managing employee benefit plan assets includes the management of voting rights as well as other shareholder rights connected to shares of stock, and that management of those rights, as well as shareholder engagement activities, is subject to ERISA’s prudence and loyalty requirements.5 Subsection B of this background section provides a complete overview of the Department’s prior nonregulatory guidance. The Department’s Investment Duties regulation under Title I of ERISA is codified at 29 CFR 2550.404a– 1(hereinafter ‘‘current regulation’’ or ‘‘Investment Duties regulation,’’ unless otherwise stated). On June 30 and 1 29 U.S.C. 1104. U.S.C. 1103(c) and 1104(a). 3 See Interpretive Bulletin 2015–01, 80 FR 65135 (Oct. 26, 2015). 4 See, e.g., id. 5 See, e.g., Interpretive Bulletin 2016–01, 81 FR 95879 (Dec. 29, 2016). 2 29 E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations September 4, 2020, the Department published in the Federal Register proposed rules to remove prior nonregulatory guidance from the CFR and to amend the Department’s Investment Duties regulation. The objective was to address perceived confusion about the implications of that non-regulatory guidance with respect to ESG considerations, ETIs, shareholder rights, and proxy voting.6 The preambles to the 2020 proposals expressed concern that some ERISA plan fiduciaries might be making improper investment decisions, and that plan shareholder rights were being exercised in a manner that subordinated the interests of plans and their participants and beneficiaries to unrelated objectives.7 Given the persistent confusion in this area due in part to varied statements the Department had made on the subject over the years in non-regulatory guidance, the Department believed that providing further clarity on these issues in the form of a notice and comment regulation would be more helpful and permanent than another iteration of non-regulatory guidance. Less than six months later, on November 13, 2020, the Department published a final rule titled ‘‘Financial Factors in Selecting Plan Investments,’’ which adopted amendments to the Investment Duties regulation that generally require plan fiduciaries to select investments and investment courses of action based solely on consideration of ‘‘pecuniary factors.’’ 8 Among these amendments was a prohibition against adding or retaining any investment fund, product, or model portfolio as a qualified default investment alternative (QDIA) as described in 29 CFR 2550.404c–5 if the fund, product, or model portfolio includes even one non-pecuniary objective in its investment objectives or principal investment strategies. On December 16, 2020, the Department published a final rule titled ‘‘Fiduciary Duties Regarding Proxy Voting and Shareholder Rights,’’ which also adopted amendments to the Investment Duties regulation to establish regulatory standards for the obligations of plan fiduciaries under ERISA when voting proxies and exercising other shareholder rights in connection with plan investments in shares of stock.9 On January 20, 2021, the President signed Executive Order 13990 (E.O. 13990), titled ‘‘Protecting Public Health 6 See 85 FR 39113 (June 30, 2020); 85 FR 55219 (Sept. 4, 2020). 7 See 85 FR 39116; 85 FR 55221. 8 85 FR 72846 (Nov. 13, 2020). 9 85 FR 81658 (Dec. 16, 2020). VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 and the Environment and Restoring Science to Tackle the Climate Crisis.’’ 10 Section 1 of E.O. 13990 acknowledges the Nation’s ‘‘abiding commitment to empower our workers and communities; promote and protect our public health and the environment.’’ Section 1 also sets forth the policy of the Administration to listen to the science; improve public health and protect our environment; bolster resilience to the impacts of climate change; and prioritize both environmental justice and the creation of the well-paying union jobs necessary to deliver on these goals. Section 2 directed agencies to review all existing regulations promulgated, issued, or adopted between January 20, 2017, and January 20, 2021, that are or may be inconsistent with, or present obstacles to, the policies set forth in section 1 of E.O. 13990. Section 2 further provided that for any such actions identified by the agencies, the heads of agencies shall, as appropriate and consistent with applicable law, consider suspending, revising, or rescinding the agency actions.11 On March 10, 2021, the Department announced that it had begun a reexamination of the current regulation, consistent with E.O. 13990, the Administrative Procedure Act, and ERISA’s grant of regulatory authority in section 505.12 The Department also announced that, pending its review of the current regulation, the Department will not enforce the current regulation or otherwise pursue enforcement actions against any plan fiduciary based on a failure to comply with the current regulation with respect to an investment, including a QDIA, investment course of action or an exercise of shareholder rights. In announcing the enforcement policy, the Department also stated its intention to conduct significantly more stakeholder outreach to determine how to craft rules that better recognize the role that ESG integration can play in the evaluation and management of plan investments in 10 86 FR 7037 (Jan. 25, 2021). E.O. 13990 was signed eight days after the effective date of ‘‘Financial Factors in Selecting Plan Investments,’’ and five days after the effective date of ‘‘Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.’’ 11 A Fact Sheet issued simultaneously with E.O. 13990, specifically confirmed that the Department was directed to review the final rule on ‘‘Financial Factors in Selecting Plan Investments’’ Available at www.whitehouse.gov/briefing-room/statementsreleases/2021/01/20/fact-sheet-list-of-agencyactions-for-review/. 12 29 U.S.C. 1135. PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 73823 ways that further fundamental fiduciary obligations.13 On May 20, 2021, the President signed Executive Order 14030 (E.O. 14030), titled ‘‘Executive Order on Climate-Related Financial Risk.’’ 14 The policies set forth in section 1 of E.O. 14030 include advancing acts to mitigate climate-related financial risk and actions to help safeguard the financial security of America’s families, businesses, and workers from climaterelated financial risk that may threaten the life savings and pensions of U.S. workers and families. Section 4 of E.O. 14030 directed the Department to consider publishing, by September 2021, for notice and comment a proposed rule to suspend, revise, or rescind ‘‘Financial Factors in Selecting Plan Investments,’’ 15 and ‘‘Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.’’ 16 B. The Department’s Prior NonRegulatory Guidance The Department has a longstanding position that ERISA fiduciaries may not sacrifice investment returns or assume greater investment risks as a means of promoting collateral social policy goals. These proscriptions flow directly from ERISA’s stringent standards of prudence and loyalty under section 404(a) of the statute.17 The Department has a similarly longstanding position that the fiduciary act of managing plan assets that involve shares of corporate stock includes making decisions about voting proxies and exercising shareholder rights. Over the years the Department repeatedly has issued non-regulatory 13 See U.S. Department of Labor Statement Regarding Enforcement of its Final Rules on ESG Investments and Proxy Voting by Employee Benefit Plans (Mar. 10, 2021) Available at www.dol.gov/ sites/dolgov/files/ebsa/laws-and-regulations/laws/ erisa/statement-on-enforcement-of-final-rules-onesg-investments-and-proxy-voting.pdf. Following publication of the final rules the Department heard from a wide variety of stakeholders, including asset managers, labor organizations and other plan sponsors, consumer groups, service providers and investment advisers that questioned whether the 2020 Rules properly reflect the scope of fiduciaries’ duties under ERISA to act prudently and solely in the interest of plan participants and beneficiaries. The stakeholders also questioned whether the Department rushed the rulemakings unnecessarily and failed to adequately consider and address the substantial evidence submitted by public commenters on the use of environmental, social and governance considerations in improving investment value and long-term investment returns for retirement investors. 14 86 FR 27967 (May 25, 2021). E.O. 14030 was signed 128 days after the effective date of ‘‘Financial Factors in Selecting Plan Investments,’’ and 125 days after the effective date of ‘‘Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.’’ 15 85 FR 72846 (Nov. 13, 2020). 16 85 FR 81658 (Dec. 16, 2020). 17 29 U.S.C. 1104(a). E:\FR\FM\01DER2.SGM 01DER2 73824 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations guidance to assist plan fiduciaries in understanding their obligations under ERISA to apply these principles to ETIs and ESG. khammond on DSKJM1Z7X2PROD with RULES2 1. ETI/ESG Investing Interpretive Bulletin 94–1 (IB 94–1), published in 1994, addressed economically targeted investments (ETIs) selected, in part, for collateral benefits apart from the investment return to the plan investor.18 The Department’s objective in issuing IB 94– 1 was to state that ETIs 19 are not inherently incompatible with ERISA’s fiduciary obligations. The preamble to IB 94–1 explained that the requirements of sections 403 and 404 of ERISA do not prevent plan fiduciaries from investing plan assets in ETIs if the investment has an expected rate of return at least commensurate to rates of return of available alternative investments, and if the ETI is otherwise an appropriate 18 59 FR 32606 (June 23, 1994) (appeared in Code of Federal Regulations as 29 CFR 2509.94–1). Prior to issuing IB 94–1, the Department had issued a number of letters concerning a fiduciary’s ability to consider the collateral effects of an investment and granted a variety of prohibited transaction exemptions to both individual plans and pooled investment vehicles involving investments that produce collateral benefits. See Advisory Opinions 80–33A, 85–36A and 88–16A; Information Letters to Mr. George Cox, dated Jan. 16, 1981; to Mr. Theodore Groom, dated Jan. 16, 1981; to The Trustees of the Twin City Carpenters and Joiners Pension Plan, dated May 19, 1981; to Mr. William Chadwick, dated July 21, 1982; to Mr. Daniel O’Sullivan, dated Aug. 2, 1982; to Mr. Ralph Katz, dated Mar. 15, 1982; to Mr. William Ecklund, dated Dec. 18, 1985, and Jan. 16, 1986; to Mr. Reed Larson, dated July 14, 1986; to Mr. James Ray, dated July 8, 1988; to the Honorable Jack Kemp, dated Nov. 23, 1990; and to Mr. Stuart Cohen, dated May 14, 1993. The Department also issued a number of prohibited transaction exemptions that touched on these issues. See PTE 76–1, part B, concerning construction loans by multiemployer plans; PTE 84–25, issued to the Pacific Coast Roofers Pension Plan; PTE 85–58, issued to the Northwestern Ohio Building Trades and Employer Construction Industry Investment Plan; PTE 87–20, issued to the Racine Construction Industry Pension Fund; PTE 87–70, issued to the Dayton Area Building and Construction Industry Investment Plan; PTE 88–96, issued to the Real Estate for American Labor A Balcor Group Trust; PTE 89–37, issued to the Union Bank; and PTE 93–16, issued to the Toledo Roofers Local No. 134 Pension Plan and Trust, et al. In addition, one of the first directors of the Department’s benefits office authored an article on this topic in 1980. See Ian D. Lanoff, The Social Investment of Private Pension Plan Assets: May It Be Done Lawfully Under ERISA?, 31 Labor L.J. 387, 391–92 (1980) (stating that ‘‘[t]he Labor Department has concluded that economic considerations are the only ones which can be taken into account in determining which investments are consistent with ERISA standards,’’ and warning that fiduciaries who exclude investment options for non-economic reasons would be ‘‘acting at their peril’’). 19 IB 94–1 used the terms ETI and economically targeted investments to broadly refer to any investment or investment course of action that is selected, in part, for its expected collateral benefits, apart from the investment return to the employee benefit plan investor. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 investment for the plan in terms of such factors as diversification and the investment policy of the plan. Some commentators have referred to this as the ‘‘all things being equal’’ test or the ‘‘tiebreaker’’ standard. The Department stated in the preamble to IB 94–1 that when competing investments serve the plan’s economic interests equally well, plan fiduciaries can use such collateral considerations as the deciding factor for an investment decision. This was the Department’s unchanged position for approximately three decades. In 2008, the Department replaced IB 94–1 with Interpretive Bulletin 2008–01 (IB 2008–01),20 and then, in 2015, the Department replaced IB 2008–01 with Interpretive Bulletin 2015–01 (IB 2015– 01).21 Although the Interpretive Bulletins differed from each other in tone and content to some extent, each endorsed the ‘‘all things being equal’’ test, while also stressing that the paramount focus of plan fiduciaries must be the plan’s financial returns and providing promised benefits to participants and beneficiaries. Each Interpretive Bulletin also cautioned that fiduciaries violate ERISA if they accept reduced expected returns or greater risks to secure social, environmental, or other policy goals. Additionally, the preamble to IB 2015–01 explained that if a fiduciary prudently determines that an investment is appropriate based solely on economic considerations, including those that may derive from ESG factors, the fiduciary may make the investment without regard to any collateral benefits the investment may also promote. In Field Assistance Bulletin 2018–01 (FAB 2018–01), the Department indicated that IB 2015–01 had recognized that there could be instances when ESG issues present material business risk or opportunities to companies that company officers and directors need to manage as part of the company’s business plan, and that qualified investment professionals would treat the issues as material economic considerations under generally accepted investment theories. As appropriate economic considerations, such ESG issues should be considered by a prudent fiduciary along with other relevant economic factors to evaluate the risk and return profiles of alternative investments. In other words, in these instances, the factors are not ‘‘tiebreakers,’’ but ‘‘risk-return’’ factors affecting the economic merits of the investment. FAB 2018–01 cautioned, however, that ‘‘[t]o the extent ESG factors, in fact, involve business risks or opportunities that are properly treated as economic considerations themselves in evaluating alternative investments, the weight given to those factors should also be appropriate to the relative level of risk and return involved compared to other relevant economic factors.’’ 22 The Department further emphasized in FAB 2018–01 that fiduciaries ‘‘must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision,’’ as ‘‘[i]t does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors.’’ Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits, and ‘‘[a] fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives.’’ 23 FAB 2018–01 also explained that in the case of an investment platform that allows participants and beneficiaries an opportunity to choose from a broad range of investment alternatives, a prudently selected, well managed, and properly diversified ESG-themed investment alternative could be added to the available investment options on a 401(k) plan platform without requiring the plan to remove or forgo adding other non-ESG-themed investment options to the platform.24 According to the FAB, however, the selection of an investment fund as a QDIA is not analogous to a fiduciary’s decision to offer participants an additional investment alternative as part of a prudently constructed lineup of investment alternatives from which participants may choose. FAB 2018–01 expressed concern that the decision to favor the fiduciary’s own policy preferences in selecting an ESG-themed investment option as a QDIA for a 401(k)-type plan without regard to possibly different or competing views of plan participants and beneficiaries would raise questions about the fiduciary’s compliance with ERISA’s duty of loyalty.25 In addition, FAB 22 FAB 2018–01 (Apr. 23, 2018). 23 Id. 20 73 21 80 PO 00000 FR 61734 (Oct. 17, 2008). FR 65135 (Oct. 26, 2015). Frm 00004 Fmt 4701 Sfmt 4700 24 Id. 25 FAB E:\FR\FM\01DER2.SGM 2018–01. 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations 2018–01 stated that, even if consideration of such factors could be shown to be appropriate in the selection of a QDIA for a particular plan population, the plan’s fiduciaries would have to ensure compliance with the previous guidance in IB 2015–01. For example, the selection of an ESGthemed target date fund as a QDIA would not be prudent if the fund would provide a lower expected rate of return than available non-ESG alternative target date funds with commensurate degrees of risk, or if the fund would be riskier than non-ESG alternative available target date funds with commensurate rates of return. khammond on DSKJM1Z7X2PROD with RULES2 2. Exercising Shareholder Rights The Department’s past non-regulatory guidance has also consistently recognized that the fiduciary act of managing employee benefit plan assets includes the management of voting rights as well as other shareholder rights connected to shares of stock, and that management of those rights, as well as shareholder engagement activities, is subject to ERISA’s prudence and loyalty requirements. The Department first issued nonregulatory guidance on proxy voting and the exercise of shareholder rights in the 1980s. For example, in 1988, the Department issued an opinion letter to Avon Products, Inc. (the Avon Letter), in which the Department took the position that the fiduciary act of managing plan assets that are shares of corporate stock includes the voting of proxies appurtenant to those shares, and that the named fiduciary of a plan has a duty to monitor decisions made and actions taken by investment managers with regard to proxy voting.26 In 1994, the Department issued its first interpretive bulletin on proxy voting, Interpretive Bulletin 94–2 (IB 94–2).27 IB 94–2 recognized that fiduciaries may engage in shareholder activities intended to monitor or influence corporate management if the responsible fiduciary concludes that, after taking into account the costs involved, there is a reasonable expectation that such shareholder activities (by the plan alone or together with other shareholders) will enhance the value of the plan’s investment in the corporation. The Department also reiterated its view that ERISA does not permit fiduciaries, in voting proxies or exercising other shareholder rights, to subordinate the 26 Letter to Helmuth Fandl, Chairman of the Retirement Board, Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988). 27 59 FR 38860 (July 29, 1994). VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 economic interests of participants and beneficiaries to unrelated objectives. In October 2008, the Department replaced IB 94–2 with Interpretive Bulletin 2008–02 (IB 2008–02).28 The Department’s intent was to update the guidance in IB 94–2 and to reflect interpretive positions issued by the Department after 1994 on shareholder engagement and socially-directed proxy voting initiatives. IB 2008–02 stated that fiduciaries’ responsibility for managing proxies includes both deciding to vote and deciding not to vote.29 IB 2008–02 further stated that the fiduciary duties described at ERISA sections 404(a)(1)(A) and (B) require that, in voting proxies, the responsible fiduciary shall consider only those factors that relate to the economic value of the plan’s investment and shall not subordinate the interests of the participants and beneficiaries in their retirement income to unrelated objectives. In addition, IB 2008–02 stated that votes shall only be cast in accordance with a plan’s economic interests. IB 2008–02 explained that if the responsible fiduciary reasonably determines that the cost of voting (including the cost of research, if necessary, to determine how to vote) is likely to exceed the expected economic benefits of voting, the fiduciary has an obligation to refrain from voting.30 The Department also reiterated in IB 2008– 02 that any use of plan assets by a plan fiduciary to further political or social causes ‘‘that have no connection to enhancing the economic value of the plan’s investment’’ through proxy voting or shareholder activism is a violation of ERISA’s exclusive purpose and prudence requirements.31 In 2016, the Department issued Interpretive Bulletin 2016–01 (IB 2016– 01), which reinstated the language of IB 94–2 with certain modifications.32 IB 2016–01 reiterated and confirmed that ‘‘in voting proxies, the responsible fiduciary [must] consider those factors that may affect the value of the plan’s investment and not subordinate the interests of the participants and beneficiaries in their retirement income to unrelated objectives.’’ 33 In its guidance, the Department has also stated that it rejects a construction of ERISA that would render the statute’s 28 73 29 73 FR 61731 (Oct. 17, 2008). FR 61732. 30 Id. 31 73 FR 61734. FR 95879 (Dec. 29, 2016). In addition, the Department issued a Field Assistance Bulletin to provide guidance on IB 2016–01 on April 23, 2018. See FAB 2018–01, at www.dol.gov/sites/dolgov/ files/ebsa/employers-and-advisers/guidance/fieldassistance-bulletins/2018-01.pdf. 33 81 FR 95882. 32 81 PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 73825 tight limits on the use of plan assets illusory and that would permit plan fiduciaries to expend trust assets to promote a myriad of personal public policy preferences at the expense of participants’ economic interests, including through shareholder engagement activities, voting proxies, or other investment policies.34 C. Executive Order Review of Current Regulation In early 2021, consistent with E.O. 13990 and E.O. 14030, the Department engaged in informal outreach to hear views from interested stakeholders on how to craft regulations that better recognize the important role that climate change and other ESG factors can play in the evaluation and management of plan investments, while continuing to uphold fundamental fiduciary obligations. The Department heard from a wide variety of stakeholders, including asset managers, labor organizations and other plan sponsors, consumer groups, service providers, and investment advisers. Many of the stakeholders expressed skepticism as to whether the current regulation properly reflects the scope of fiduciaries’ duties under ERISA to act prudently and solely in the interest of plan participants and beneficiaries. That outreach effort by the Department suggested that, rather than provide clarity, some aspects of the current regulation instead may have created further uncertainty about whether a fiduciary under ERISA may consider ESG and other factors in making investment and proxy voting decisions that the fiduciary reasonably believes will benefit the plan and its participants and beneficiaries. Many stakeholders questioned whether the Department rushed the current regulation unnecessarily and failed to adequately consider and address substantial evidence submitted by public commenters suggesting that the use of climate change and other ESG factors can improve investment value and long-term investment returns for retirement investors. The Department also heard from stakeholders that the current regulation, and investor confusion about it, including whether climate change and other ESG factors may be treated as ‘‘pecuniary’’ factors under the regulation, already had begun to have a chilling effect on appropriate integration of climate change and other ESG factors in investment decisions. This continued through the current nonenforcement period, including in circumstances where the current 34 See E:\FR\FM\01DER2.SGM 81 FR 95881. 01DER2 73826 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 regulation may in fact allow consideration of ESG factors. After conducting a review of the current regulation, the Department concluded there is a reasonable basis for the concerns raised by the stakeholders. A number of public comment letters had criticized the 2020 proposed regulatory text for appearing to single out ESG investing for heightened scrutiny, which they asserted was inappropriate in light of research and investment practices suggesting that climate change and other ESG factors are material economic considerations.35 In response, the Department did not include explicit references to ESG in the current regulation and furthermore acknowledged in the preamble discussion to the Financial Factors in Selecting Plan Investments final rulemaking that there are instances where one or more ESG factors may be properly taken into account by a fiduciary.36 The preamble to the Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final rulemaking also acknowledged academic studies and investment experience surrounding the materiality of ESG considerations in investment decisionmaking.37 However, other statements in the preamble appeared to express skepticism about fiduciaries’ reliance on ESG considerations. For instance, the preamble to the Financial Factors in Selecting Plan Investments final rulemaking asserted that ESG investing raises heightened concerns under ERISA, and cautioned fiduciaries against ‘‘too hastily’’ concluding that ESG-themed funds may be selected based on pecuniary factors.38 Similarly, 35 See, e.g., Comment # 567 at www.dol.gov/sites/ dolgov/files/EBSA/laws-and-regulations/rules-andregulations/public-comments/1210-AB95/00567.pdf and Comment # 709 at www.dol.gov/sites/dolgov/ files/EBSA/laws-and-regulations/rules-andregulations/public-comments/1210-AB95/ 00709.pdf. 36 See 85 FR 72859 (Nov. 13, 2020) (‘‘[T]he Department believes that it would be consistent with ERISA and the final rule for a fiduciary to treat a given factor or consideration as pecuniary if it presents economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories’’). 37 85 FR 81662 (Dec. 16, 2020) (‘‘This [Fiduciary Duties Regarding Proxy Voting and Shareholder Rights] rulemaking project, similar to the recently published final rule on ERISA fiduciaries’ consideration of financial factors in investment decisions, recognizes, rather than ignores, the economic literature and fiduciary investment experience that show a particular ‘E,’ ‘S,’ or ‘G’ consideration may present issues of material business risk or opportunities to a specific company that its officers and directors need to manage as part of the company’s business plan and that qualified investment professionals would treat as economic considerations under generally accepted investment theories.’’). 38 85 FR 72848, 72859 (Nov. 13, 2020). VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 the preamble to the Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final rulemaking expressed the view that it is likely that many environmental and social shareholder proposals have little bearing on share value or other relation to plan financial interests.39 Many stakeholders indicated that the current regulation has been interpreted as putting a thumb on the scale against the consideration of ESG factors, even when those factors are financially material. The Department’s review under the Executive orders caused it concern that, as stakeholders warned, uncertainty with respect to the current regulation may be deterring fiduciaries from taking steps that other marketplace investors would take in enhancing investment value and performance, or improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors. The Department was concerned that the current regulation created a perception that fiduciaries are at risk if they include any ESG factors in the financial evaluation of plan investments, and that they would need to have special justifications for even ordinary exercises of shareholder rights. Based on these concerns, the Department, on October 14, 2021, published a notice of proposed rulemaking (NPRM) proposing amendments to the current regulation.40 The intent of the NPRM was to address uncertainties regarding aspects of the current regulation and its preamble discussion relating to the consideration of ESG issues, including climate-related financial risk, by fiduciaries in making investment and voting decisions, and to provide further clarity that will help safeguard the interests of participants and beneficiaries in the plan benefits. II. Purpose of Regulatory Action and Proposed Rule A. Purpose Like the NPRM, the purpose of the final rule is to clarify the application of ERISA’s fiduciary duties of prudence and loyalty to selecting investments and investment courses of action, including selecting QDIAs, exercising shareholder rights, such as proxy voting, and the use of written proxy voting policies and guidelines. The need for clarification comes from the chilling effect and other potential negative consequences caused by the current regulation with respect to the consideration of climate change and other ESG factors in connection with 39 85 40 86 PO 00000 FR 81681 (Dec. 16, 2020). FR 57272 (Oct. 14, 2021). Frm 00006 Fmt 4701 Sfmt 4700 these activities. Overall, the public comments support the clarifications provided by this final rule, although some commenters challenged the stated need. The Department disagrees with commenters who asserted that any clarifications to the current regulation are unnecessary. The Department’s conclusion, supported by many public commenters, is that the current regulation creates uncertainty and is having the undesirable effect of discouraging ERISA fiduciaries’ consideration of climate change and other ESG factors in investment decisions, even in cases where it is in the financial interest of plans to take such considerations into account. This uncertainty may further deter fiduciaries from taking steps that other marketplace investors take in enhancing investment value and performance or improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors. Major comments are addressed in detail below in conjunction with specific provisions of the final rule. B. Major Provisions of Proposed Rule Consistent with the purpose of the overall rulemaking initiative, the NPRM proposed several key changes and clarifications to the current regulation, as follows: • The NPRM proposed to delete the ‘‘pecuniary/non-pecuniary’’ terminology from the current regulation based on concerns that the terminology causes confusion and has a chilling effect on financially beneficial choices. • The NPRM proposed the addition of regulatory text that would have made it clear that, when considering projected returns, a fiduciary’s duty of prudence may often require an evaluation of the economic effects of climate change and other ESG factors on the particular investment or investment course of action. • The NPRM proposed to add to the operative text of the rule three sets of examples of climate change and other ESG factors that, depending on the facts and circumstances, may be material to the risk-return analysis. • The NPRM proposed to remove the special rules for QDIAs that apply under the current regulation. The NPRM would instead apply the same standards to QDIAs as apply to other investments. • The NPRM proposed to modify the current rule’s ‘‘tiebreaker’’ test, which permits fiduciaries to consider collateral benefits as tiebreakers in some circumstances. The current regulation imposes a requirement that the competing investments underlying a E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations tiebreaker situation be indistinguishable based on pecuniary factors alone before fiduciaries can turn to collateral factors to break a tie and imposes a special documentation requirement on the use of such factors. The NPRM proposed replacing those provisions with a standard that would have instead required 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. The NPRM also proposed to remove the current regulation’s special documentation requirements in favor of ERISA’s generally applicable statutory duty to prudently document plan affairs. • To the extent individual account plans use the tiebreaker test in the selection of a designated investment alternative, the NPRM proposed that plans must prominently disclose to the plans’ participants the collateral considerations that were used as tiebreakers. • The NPRM proposed to eliminate the statement in paragraph (e)(2)(ii) of the current regulation that ‘‘the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right,’’ which the Department was concerned could be misread as suggesting that plan fiduciaries should be indifferent to the exercise of their rights as shareholders, even if the cost is minimal. • The NPRM proposed to eliminate paragraph (e)(2)(iii) of the current regulation, which sets out specific monitoring obligations with respect to use of investment managers or proxy voting firms, and to address such monitoring obligations in another provision of the regulation that more generally covers selection and monitoring obligations. The Department was concerned that the specific monitoring provision could be read as requiring some special obligations above and beyond the statutory obligations of prudence and loyalty that generally apply to monitoring the work of service providers. • The NPRM proposed to remove the two ‘‘safe harbor’’ examples for proxy voting policies permissible under paragraphs (e)(3)(i)(A) and (B) of the current regulation. One of these safe harbors permitted a policy to limit voting resources to particular proposals VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 that the fiduciary had prudently determined were substantially related to the issuer’s business activities or were expected to have a material effect on the value of the investment. The other safe harbor permitted a policy of refraining from voting on proposals when the plan’s holding in a single issuer relative to the plan’s total investment assets was below a quantitative threshold. The Department was concerned that the safe harbors did not adequately safeguard the interests of plans and their participants and beneficiaries. • The NPRM proposed to eliminate from the current regulation a specific requirement on maintaining records on proxy voting activities and other exercises of shareholder rights, which appeared to treat proxy voting and other exercises of shareholder rights differently from other fiduciary activities and risked creating a misperception that proxy voting and other exercises of shareholder rights are disfavored or carry greater fiduciary obligations than other fiduciary activities. The Department invited interested persons to submit comments on the NPRM. In response to this invitation, the Department received more than 895 written comments and 21,469 petitions (e.g., form letters) submitted during the open comment period. These comments and petitions (hereinafter collectively referred to as ‘‘comments’’ unless otherwise specified) came from a variety of parties, including plan sponsors and other plan fiduciaries, individual plan participants and beneficiaries, financial services companies, academics, elected government officials, trade and industry associations, and others, both in support of and in opposition to the NPRM. These comments are available for public review on the Department’s Employee Benefits Security Administration website. III. The Final Rule A. Executive Summary of Major Changes and Clarifications The final rule generally tracks the NPRM but makes certain clarifications and changes in response to public comments. Before describing these changes, the Department emphasizes that the final rule does not change two longstanding principles. First, the final rule retains the core principle that the duties of prudence and loyalty require ERISA plan fiduciaries to focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 73827 unrelated to the provision of benefits under the plan. Second, the fiduciary duty to manage plan assets that are shares of stock includes the management of shareholder rights appurtenant to those shares, such as the right to vote proxies. As described in further detail below in subsection B of this section III, the final rule adopts the following changes to the current regulation: • Like the NPRM, the final rule amends the current regulation to delete the ‘‘pecuniary/non-pecuniary’’ terminology based on concerns that the terminology causes confusion and a chilling effect to financially beneficial choices. • Like the NPRM, the final rule amends the current regulation to make it clear that a fiduciary’s determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis and that such 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. • Like the NPRM, the final rule amends the current regulation to remove the stricter rules for QDIAs, such that, under the final rule, the same standards apply to QDIAs as to investments generally. • Like the NPRM, the final rule amends the current regulation’s ‘‘tiebreaker’’ test, which permits fiduciaries to consider collateral benefits as tiebreakers in some circumstances. The current regulation imposes a requirement that competing investments be indistinguishable based on pecuniary factors alone before fiduciaries can turn to collateral factors to break a tie and imposes a special documentation requirement on the use of such factors. The final rule replaces those provisions with a standard that instead 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. 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. • The final rule adds a new provision clarifying that fiduciaries do not violate E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 73828 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations their duty of loyalty solely because they take participants’ preferences into account when constructing a menu of prudent investment options for participant-directed individual account plans. If accommodating participants’ preferences will lead to greater participation and higher deferral rates, as suggested by commenters, then it could lead to greater retirement security. Thus, in this way, giving consideration to whether an investment option aligns with participants’ preferences can be relevant to furthering the purposes of the plan. • Like the NPRM, the final rule amends the current regulation to eliminate the statement in paragraph (e)(2)(ii) of the current regulation that ‘‘the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right.’’ The final rule eliminates this provision because it may be misread as suggesting that plan fiduciaries should be indifferent to the exercise of their rights as shareholders, even if the cost is minimal. • Like the NPRM, the final rule amends the current regulation to remove the two ‘‘safe harbor’’ examples for proxy voting policies permissible under paragraphs (e)(3)(i)(A) and (B) of the current regulation. One of these safe harbors permitted a policy to limit voting resources to types of proposals that the fiduciary has prudently determined are substantially related to the issuer’s business activities or are expected to have a material effect on the value of the investment. The other safe harbor permitted a policy of refraining from voting on proposals or types of proposals when the plan’s holding in a single issuer relative to the plan’s total investment assets is below a quantitative threshold. Taken together, the Department believes the safe harbors encouraged abstention as the normal course and the Department does not support that position because it fails to recognize the importance that prudent management of shareholder rights can have in enhancing the value of plan assets or protecting plan assets from risk. Because of this failure, the Department believes these safe harbors do not adequately safeguard the interests of plans and their participants and beneficiaries. • Like the NPRM, the final rule eliminates paragraph (e)(2)(iii) of the current regulation, which sets out specific monitoring obligations with respect to use of investment managers or proxy voting firms. The final rule instead addresses such monitoring obligations in another provision of the VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 regulation that more generally covers selection and monitoring obligations. These amendments address concerns that the specific monitoring provision could be read as requiring special obligations above and beyond the statutory obligations of prudence and loyalty that generally apply to monitoring the work of service providers. • Like the NPRM, the final rule amends the current regulation to eliminate from paragraph (e)(2)(ii)(E) of the current regulation a specific requirement on maintaining records on proxy voting activities and other exercises of shareholder rights. The provision is removed from the current regulation because it is widely perceived as treating proxy voting and other exercises of shareholder rights differently from other fiduciary activities and, in that respect, risks creating a misperception that proxy voting and other exercises of shareholder rights are disfavored or carry greater fiduciary obligations than other fiduciary activities. B. Detailed Discussion of Public Comments and Final Regulation 1. Section 2550.404a–1(a) and (b)— General and Investment Prudence Duties (a) Paragraph (a) Paragraph (a) of the final rule is unchanged from the NPRM and derives from the exclusive purpose requirements of ERISA section 404(a)(1)(A), and the prudence duty of ERISA section 404(a)(1)(B). The provision is also the same as paragraph (a) of the current regulation. The Department did not accept comments to expand the scope of the regulation to provide additional guidance on the duty of diversification under section 404(a)(1)(C) and the duty of impartiality under section 404(a)(1)(A) as interpreted in cases such as Varity v. Howe,41 as these other duties generally are beyond the scope of this rulemaking initiative. (b) Paragraph (b) Paragraph (b) of the final rule addresses the investment prudence duties of a fiduciary under ERISA. Like the NPRM, paragraph (b) of the final rule contains four subordinate paragraphs. As discussed below, the final rule includes several changes from the proposal based on public comment, mostly in paragraphs (b)(2) and (4) of the final rule. 41 516 PO 00000 U.S. 489 (1996). Frm 00008 Fmt 4701 Sfmt 4700 (c) Paragraph (b)(1) The NPRM did not propose any amendments to paragraph (b)(1) of the current regulation. Like the current regulation (and the 1979 Investment Duties regulation before it), paragraph (b)(1) of the NPRM provided that the requirements of section 404(a)(1)(B) of the Act set forth in paragraph (a) are satisfied with respect to a particular investment or investment course of action if the fiduciary meets two conditions. First, the fiduciary must give ‘‘appropriate consideration to those facts and circumstances that, given the scope of such fiduciary’s investment duties, the fiduciary knows or should know are relevant to the particular investment . . . including the role the investment or investment course of action plays in that portion of the plan’s investment portfolio with respect to which the fiduciary has investment duties.’’ And second, the fiduciary must have ‘‘acted accordingly.’’ Except for the addition of the words ‘‘or menu’’ after the word ‘‘portfolio’’ for clarification, as explained below, paragraph (b)(1) of the final rule is unchanged from the NPRM. (d) Paragraph (b)(2) Paragraph (b)(2) of the NPRM addressed the ‘‘appropriate consideration’’ language referenced in paragraph (b)(1) of the proposal. Paragraph (b)(2) of the NPRM contained two prongs. First, paragraph (b)(2)(i) of the NPRM provided that for purposes of paragraph (b)(1), ‘‘appropriate consideration’’ shall include, but is not necessarily limited to, a determination by the fiduciary that the particular investment or investment course of action is reasonably designed, as part of the portfolio (or, where applicable, that portion of the plan portfolio with respect to which the fiduciary has investment duties), to further the purposes of the plan. For this purpose, the plan fiduciary must take into consideration the risk of loss and the opportunity for gain (or other return) associated with the investment or investment course of action compared to the opportunity for gain (or other return) associated with reasonably available alternatives with similar risks. Second, paragraph (b)(2)(ii) of the NPRM provided that for purposes of paragraph (b)(1), ‘‘appropriate consideration’’ shall also include, but is not necessarily limited to, consideration of the composition of the portfolio with regard to diversification (paragraph (b)(2)(ii)(A)), the liquidity and current return of the portfolio relative to the anticipated cash flow requirements of the plan (paragraph (b)(2)(ii)(B)), and E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations the projected return of the portfolio relative to the funding objectives of the plan, which may often require the evaluation of the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action (paragraph (b)(2)(ii)(C)). khammond on DSKJM1Z7X2PROD with RULES2 (1) Reasonably Available Alternatives Several commenters provided views on the condition in paragraph (b)(2)(i) that a fiduciary must compare an investment or investment course of action under evaluation with reasonably available alternatives. This condition was not part of the original investment duties regulation adopted in 1979 and was added to the current regulation in 2020. The Department carried forward this condition in the 2021 NPRM and solicited comments on whether it was necessary to restate this principle of general applicability as part of this regulation. Some commenters agreed that prudent fiduciaries should and generally do compare similar, available investments when making investment decisions. Some commenters said that because the provision is a simple restatement of a fundamental prudence tenet, its inclusion in the final rule is unnecessary. Some commenters were concerned that the term ‘‘reasonably available’’ is ambiguous and could make fiduciaries vulnerable to litigation challenging the reasonableness of a fiduciary’s determination of the number of investments used in making the required comparison. Commenters were also concerned that the requirement imposes burdens on fiduciaries that do not necessarily have the resources to conduct research on all reasonably available alternatives. Some commenters noted that the Department did not adopt a comparative requirement in the 1979 rule and furthermore expressed concerns that the rule could be interpreted to require all fiduciaries, regardless of factors such as plan assets, to purchase and implement extensive and expensive systems to conduct the comparative analysis. One commenter suggested adding operative text that would explicitly allow for market-based comparisons using benchmarks or other market data as alternatives to the ‘‘reasonably available investment alternatives’’ language. One commenter cautioned that removing the provision would imply that the Department no longer believes that the marketplace is a true forum and benchmark of the investment selection process. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 The Department continues to believe the requirement to compare reasonably available alternatives is commonly understood by plan fiduciaries, is uncontroversial in nature, and reflects the ordinary practice of fiduciaries in selecting investments. The Department is unpersuaded by some commenters’ concerns regarding perceived ambiguity in the meaning of ‘‘reasonably available.’’ The scope of a fiduciary’s obligation to compare an investment or investment course of action is limited to those facts and circumstances that a prudent person having similar duties and familiar with such matters would consider reasonably available. Further, the term allows for the possibility that the characteristics and purposes served by a given investment or investment course of action may be sufficiently rare that a fiduciary could prudently determine that there are no other reasonably available alternatives for comparative purposes. Accordingly, the final rule continues to require in paragraph (b)(2)(i) that ‘‘appropriate consideration’’ shall include taking into consideration the risk of loss and the opportunity for gain (or other return) associated with the investment or investment course of action compared to the opportunity for gain (or other return) associated with reasonably available alternatives with similar risks. The language reflects the Department’s longstanding view, articulated in Interpretive Bulletin 94–1 (and reiterated in subsequent Interpretive Bulletins) and earlier interpretive letters, that facts and circumstances relevant to an investment or investment course of action would include consideration of the expected return on alternative investments with similar risks available to the plan.42 (2) Portfolio Versus Menu The final rule adopts minor amendments to the text in paragraph (b)(2) of the current regulation in response to commenters’ requests to clarify whether and how it applies in the context of participant-directed individual account plans. Commenters observed that language in paragraph (b)(2), which was originally developed in 1979, contains certain considerations and factors that, in their view, are germane to the selection of investments 42 59 FR 32606 at 32607 (June 23, 1994); I.B. 2008–1, 73 FR 61734 (Oct. 17, 2008); I.B. 2015–1, 80 FR 65135 (Oct. 26, 2015); see, e.g., Information Letter to Mr. Michael A. Feinberg, dated August 4, 1985; Information Letter to Mr. James Ray, dated July 8, 1988 (‘‘It is the position of the Department that, to act prudently, a fiduciary must consider, among other factors, the availability, riskiness, and potential return of alternative investments.’’). PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 73829 for defined benefit plans but not to the selection of investments for defined contribution plans that have a set of designated investment alternatives available for participant to choose from, often referred to as a ‘‘menu.’’ For instance, they noted that paragraphs (b)(2)(i) and (ii) require focusing on a ‘‘portfolio,’’ which they believe is confusing because a participant-directed defined contribution plan’s menu may include both funds that participants have chosen as investments as well as funds that have not been chosen. The commenters further noted that, in conventional investment parlance, the term ‘‘portfolio’’ refers to a collection of assets actually owned by an investor, whereas a menu of investment options for a participant-directed individual account plan consists of a range of designated investment alternatives that are available to participants. In addition, they questioned how to determine ‘‘anticipated cash flow requirements of the plan’’ in evaluating investment options for the menu of a participantdirected defined contribution plan. A commenter stated that, in its view, many of the appropriate consideration factors in paragraph (b)(2)(ii) of the NPRM seem largely irrelevant to participant-directed plans. These commenters suggested that clarification on the application of paragraph (b)(2)(ii) to the selection of investment options would be helpful for plan sponsors. The Department appreciates the difficulties raised by commenters. Paragraph (b)(2)(ii) sets out a nonexclusive list of factors that functions as a minimum set of considerations for a fiduciary seeking to rely upon paragraph (b)(1). Failure to meet those minimum considerations would leave a fiduciary at risk of failing the standard even if, in the context of choosing investment options for a participant-directed plan, the responsible fiduciary has considered the relevant facts and circumstances surrounding its decision, including making a sound determination as described in paragraph (b)(2)(i). Accordingly, the Department is making changes to paragraph (b)(2) of the final rule. The changes clarify that the determination factors in paragraph (b)(2)(i) apply to menu construction and the factors in paragraph (b)(2)(ii) do not. Specifically, the Department is adding to paragraph (b)(2)(i) of the final rule references to an investment ‘‘menu,’’ and is adding an introductory clause to paragraph (b)(2)(ii) of the final rule limiting its application to employee benefit plans other than participantdirected individual account plans. These changes do not affect the requirements of paragraph (b)(1)(i) of E:\FR\FM\01DER2.SGM 01DER2 73830 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 the final rule, that a fiduciary must give appropriate consideration to those facts and circumstances a fiduciary knows or should know are relevant to the investment. These changes also should not be interpreted as suggesting that a fiduciary of an individual account plan is subject to a lower standard in giving appropriate consideration to the facts and circumstances surrounding a particular decision relating to an investment or investment course of action. Notwithstanding the changes to paragraph (b)(2)(ii), the Department believes that in selecting investment options for a plan menu, a fiduciary’s considerations of surrounding facts and circumstances should be soundly reasoned and supported and reflect the requirements of section 404(a)(1)(B) of ERISA. The Department agrees with one commenter that, in the context of constructing a menu of investment options, the relevant analysis involves two questions: First, how does a given fund fit within the menu of funds to enable plan participants to construct an overall portfolio suitable to their circumstances? Second, how does a given fund compare to a reasonable number of alternative funds to fill the given fund’s role in the overall menu? Except for the questions described above with respect to application in the context of plan investment menus, the Department did not receive substantive comments on paragraphs (b)(2)(ii)(A) and (B) of the proposal. Those provisions are otherwise unchanged in the final rule. (3) ‘‘May Often Require’’ The Department received several comments on the language in paragraph (b)(2)(ii)(C) of the proposal which specified that consideration of the projected return of the portfolio relative to the funding objectives of the plan ‘‘may often require an evaluation of the economic effects of climate change and other environmental, social or governance factors on the particular investment or investment course of action.’’ This new language—the ‘‘may often require’’ clause—was proposed by the Department to counteract any negative perception against the consideration of climate change and other ESG factors in investment decisions caused by the current regulation. The intent behind this new clause was to clarify that plan fiduciaries may, and often should depending on the investment under consideration, consider the economic effects of climate change and other ESG factors on the investment at issue. In no way did the Department consider this proposed clause to be an expression of VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 a novel concept. Indeed, the sentiment had been expressed in earlier nonregulatory guidance, although using different terminology.43 The Department received comments supporting and opposing this new clause. On the one hand, some commenters indicated that it helped address the chilling effect on evaluating ESG issues and served as a useful reminder to fiduciaries that ESG factors often do have an impact on investments. In the main, these commenters support the regulatory text as an express acknowledgement that climate change and other ESG factors are relevant to risk and return, and as an indication that fiduciaries should not be exposed to additional perceived or actual fiduciary liability risk under ERISA if they include such factors in their evaluation of plan investments. On the other hand, a great many commenters, including some who concurred with the need to address the chilling effect under the current regulation, expressed a variety of concerns with this provision. Some commenters were concerned that by differentiating ESG considerations from other factors in express regulatory text, the regulation goes beyond removing the chilling effect and improperly places a thumb on the scale in favor of ESG investing. Some further cautioned that fiduciaries may treat the provisions as an effective mandate that they must consider ESG factors under all circumstances. The commenters argued that, absent guidance on when such an evaluation would not be required, plan fiduciaries would feel obligated to consider climate change and other ESG factors for every investment. Several commenters criticized the Department for, in their view, essentially favoring ESG investment strategies and overriding a fiduciary’s considered judgment with respect to which investment factors or strategies to consider. Multiple commenters indicated that studies and research on investment performance involving ESG strategies show mixed results, and that a regulatory bias in favor of ESG investing is not justified. In line with this comment, some commenters questioned whether the Department presented sufficient evidence to support a position on the frequency (‘‘may often require’’) with which fiduciaries may be required to consider ESG factors, or argued that the market has already priced ESG factors into the price of any given investment. 43 See Field Assistance Bulletin 2018–01 and Interpretive Bulletin 2015–01. PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 Some commenters who criticized the new language in paragraph (b)(2)(ii)(C) stated that if the regulation takes the position that evaluating the economic effects of climate change and other ESG factors ‘‘may often’’ be required, then ambiguity surrounding the definition of the term ESG factors must be reduced to provide regulatory certainty. Commenters noted, however, that it would be difficult to precisely define ESG factors. Commenters also expressed concern that the language may be interpreted as effectively directing fiduciaries to take on the costs and complexity of evaluating the effects of climate change and other ESG factors, even if not otherwise prudent. In this regard, a commenter argued that there are common situations when a prudent analysis of the projected return relative to the portfolio’s funding objective is unlikely to require an evaluation of the economic effects of ESG factors, such as when the objective of the applicable portion of the portfolio is to track the performance of an index. Several commenters offered alternative language to reduce the likelihood of misinterpreting the provision. Other commenters opined that the ‘‘may often require’’ language is largely unnecessary to address the chilling effect on consideration of ESG factors under the current regulation because of the broad language in paragraph (b)(4) of the proposal relating to the consideration of ‘‘any material factor.’’ Based on the comments received, the Department has decided to modify paragraph (b)(2)(ii)(C) of the proposal by deleting the ‘‘which may often require’’ language altogether and consolidating the reference to ‘‘climate change and other environmental, social, or governance ESG factors’’ with language in paragraph (b)(4), as further modified below. The proposed language in paragraph (b)(2)(ii)(C) of the NPRM was not intended to create an effective or de facto regulatory mandate. Nor was the language intended to create an overarching regulatory bias in favor of ESG strategies. The Department is not persuaded that alternative language suggested by commenters to replace the ‘‘may often require’’ would be as effective in removing regulatory bias as the course chosen in the final rule. The modified version of the proposed language is intended to make it clear that climate change and other ESG factors may be relevant in a risk-return analysis of an investment and do not need to be treated differently than other relevant investment factors, without causing a perception that the E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations Department favors such factors in any or all cases. As modified (and relocated to paragraph (b)(4) of the final regulation), the new text sets forth three clear principles. First, a fiduciary’s determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis, using appropriate investment horizons consistent with the plan’s investment objectives and taking into account the funding policy of the plan established pursuant to section 402(b)(1) of ERISA. Second, 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. Third, the weight given to any factor by a fiduciary should appropriately reflect an assessment of its impact on risk and return. In the Department’s view, this principles-based approach is sufficient to address the chilling effect under the current regulation without establishing an effective mandate or explicitly favoring climate change and other ESG factors. This principles-based approach is designed to eliminate the substantial chilling effect caused by the current regulation, including its reference to ‘‘pecuniary factors.’’ As previously discussed, numerous commenters indicated that the current regulation puts a thumb on the scale against ESG factors, and chills fiduciaries from considering any ESG factors even when they are relevant to a risk-return analysis. The undesired effect of the current regulation is to chill and discourage fiduciaries from considering relevant investment factors that prudent investors otherwise would consider. At the same time, the final rule makes unambiguous that it is not establishing a mandate that ESG factors are relevant under every circumstance, nor is it creating an incentive for a fiduciary to put a thumb on the scale in favor of ESG factors. By declining to carry forward the ‘‘may often require’’ clause in paragraph (b)(2)(ii)(C) of the proposal, the final rule achieves appropriate regulatory neutrality and ensures that plan fiduciaries do not misinterpret the final rule as a mandate to consider the economic effects of climate change and other ESG factors under all circumstances. Instead, the final rule makes clear that a fiduciary may exercise discretion in determining, in light of the surrounding facts and VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 circumstances, the relevance of any factor to a risk-return analysis of an investment. A fiduciary therefore remains free under the final rule to determine that an ESG-focused investment is not in fact prudent. Finally, nothing about the principlesbased approach should be construed as overturning long established ERISA doctrine or displacing relevant common law prudent investor standards. (e) Paragraph (b)(3) Paragraph (b)(3) of the final rule is unchanged from the proposal and states that an investment manager appointed pursuant to the provisions of section 402(c)(3) of the Act to manage all or part of the assets of a plan may, for purposes of compliance with the provisions of paragraphs (b)(1) and (2) of the proposal, rely on, and act upon the basis of, information pertaining to the plan provided by or at the direction of the appointing fiduciary, if such information is provided for the stated purpose of assisting the manager in the performance of the manager’s investment duties, and the manager does not know and has no reason to know that the information is incorrect. The Department did not receive substantive comment on the provision, which carries forward, without change, regulatory language dating back to the 1979 Investment duties regulation. (f) Paragraph (b)(4) (1) Introductory Text The introductory text of paragraph (b)(4) of the proposal provided that ‘‘a prudent fiduciary may consider any factor in the evaluation of an investment or investment course of action that, depending on the facts and circumstances, is material to the risk return analysis[.]’’ This introductory text was then followed by three paragraphs of specific ESG examples. Commenters were generally supportive of this provision minus the three paragraphs describing specific ESG examples. In context, many viewed paragraph (b)(4) of the NPRM as confirming the discretionary authority of fiduciaries to consider whatever factor or factors, in the reasoned judgment of the fiduciaries, are relevant to risk and return of the investment or investment course of action, including climate change and other ESG factors. Some commenters expressed the view that this introductory text (without the three paragraphs of examples), in conjunction with the removal of the socalled ‘‘pecuniary-only’’ terminology from the current regulation, would make significant headway in counteracting PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 73831 the negative perception of the consideration of climate change and other ESG factors caused by the current regulation. Paragraph (b)(4) of the final rule, therefore, retains the introductory text’s focus on factors that are relevant to a risk and return analysis. Paragraph (b)(4) also retains its central recognition that relevant risk and return factors may, depending on the facts and circumstances, include the economic effects of climate change and other ESG factors. But, paragraph (b)(4) of the final rule otherwise contains substantial modifications discussed below. (2) Three Paragraphs of ESG Examples Comments on the list of examples in paragraph (b)(4) of the NPRM focused on both content and placement and were varied. Some commenters supported both the content (only ESG examples) and placement of the examples. In general, these commenters are of the view that the list of examples, even though limited to only ESG factors, is an appropriate corrective for what they view as the severe anti-ESG bias of the current regulation. In their view, adding the three paragraphs of ESG examples directly to the regulatory text will help to reassure fiduciaries that they will not be subject to litigation solely because of the use of such factors. Many commenters, however, had concerns with the list of examples in paragraph (b)(4) of the NPRM and recommended their removal from the operative regulatory text. One frequently cited concern was that the list of examples in the proposal was too onesided in favor of ESG factors. According to these commenters, the perceived regulatory bias would predictably trigger revisions by a future Administration with opposing views, effectively reducing the reliability and durability of the rule. This concern was raised by commenters who both supported and opposed the content of the examples. Another frequently cited concern was that the list might have unintended consequences. For example, plan fiduciaries might erroneously conclude that the factors listed in the operative text are more prudent than non-listed factors. A different but possible unintended consequence mentioned several times was that some plan fiduciaries might perceive the list as a safe harbor, such that fiduciaries may believe they will be deemed to have made a prudent investment decision if they consider only the listed examples (and no others). Others suggested that, by singling out these particular examples to the exclusion of other examples, the regulation could be read E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 73832 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations as implying that these factors were especially important when selecting an investment. Consequently, according to these commenters, at least some fiduciaries would feel obligated to document in writing their justification for not considering these example factors. Similarly, some commenters suggested that, in their view, listing in the operative text only a few of the potentially material factors that a prudent fiduciary might consider might unintentionally create a perception that the Department expects fiduciaries will take these specific factors into consideration, even where it might not be possible, practical, or prudent. Another repeated concern of commenters was that the list of factors is unnecessary. According to these commenters, the general reference to material risk-return factors in paragraph (b)(4) of the NPRM would be sufficient to make clear that fiduciaries may consider any factor material to a riskreturn analysis, including ESG factors. To these commenters, the concept of materiality provides for the determination of relevant factors on a case-by-case basis. In their view, such a principles-based approach better serves plans and provides greater flexibility for ERISA fiduciaries to consider the unique factors relevant to particular investment decisions. Another frequently cited concern was that the examples would become stale over time. Several commenters opined that a list of specific examples of material factors that may be of particular importance now may be of less importance in the future. Thus, at a minimum, the regulation could require updates over time as risk management and investment strategies evolve. Some commenters indicated that the list of ESG factors could be improved with additional examples. For instance, many commenters suggested that the list should be balanced by expanding the list to include non-ESG factors that may be material risk-return factors (e.g., good products, compelling corporate strategy, tight cost controls). Some further suggested it would be helpful for the Department to add examples of when it is not prudent to consider ESG factors. A commenter noted that by including only ESG factors as examples, the Department risks creating a perception that fiduciaries may take only ESG factors into account. Another commenter criticized that some of the examples as proposed are broad and ambiguous, inherently subjective, and give too much flexibility to plan fiduciaries who may be inclined to use plan assets to further particular ESG goals. Some commenters further VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 characterized the proposed examples as singling out special interests and progressive ESG priorities that have little to no impact on financial returns. Multiple commenters suggested additions of factors that seemed to fall within the broad categories of examples but were not specifically listed. Commenters also suggested the addition of factors that did not appear to fall within any of those categories. After consideration of the comments received, the Department is persuaded that paragraph (b)(4) of the final rule should not include a list of examples. The list of examples was never intended to be exclusive; nor was it intended to define ‘‘ESG’’ or introduce any new conditions under the prudence safe harbor. The list of examples was merely intended to reaffirm that fiduciaries may consider ESG factors that are relevant to a risk-return analysis of the investment. The examples were intended to make clear that ESG factors may be more than mere tiebreakers, but rather financially material to the investment decision. The Department believes, however, that this point is made sufficiently clear by the general language in paragraph (b)(4) of the final rule. The primary justification for removing the examples from the operative text of the final rule is that the Department is wary of creating an apparent regulatory bias in favor of particular investments or investment strategies. Removal of the list from paragraph (b)(4) should not be viewed as limiting a fiduciary’s ability to take into account any risk and return factor that the fiduciary reasonably determines is relevant to a risk/return analysis. The Department continues to be of the view that, depending on the surrounding facts and circumstances, these may include the factors listed in paragraph (b)(4) of the proposal. Thus, depending on the surrounding circumstances, a fiduciary may reasonably conclude that climate-related factors, such as a corporation’s exposure to the real and potential economic effects of climate change including exposure to the physical and transitional risks of climate change and the positive or negative effect of Government regulations and policies to mitigate climate change, can be relevant to a risk/return analysis of an investment or investment course of action. A fiduciary also may make a similar determination with respect to governance factors, such as those involving board composition, executive compensation, and transparency and accountability in corporate decisionmaking; a corporation’s avoidance of criminal liability; compliance with labor, PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 employment, environmental, tax, and other applicable laws and regulations; the corporation’s progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion, and retention; investment in training to develop a skilled workforce; equal employment opportunity; and labor relations and workforce practices generally. The foregoing examples are merely illustrative, and not intended to limit a fiduciary’s discretion to identify factors that are relevant with respect to its risk/ return analysis of any particular investment or investment course of action. A fiduciary may reasonably determine that a factor that seems to fall within a general category described above (e.g., climate-related factors), but is not specifically identified above, nonetheless is relevant to the analysis (e.g., drought). For example, depending on the facts and circumstances, relevant factors may include impact on communities in which companies operate, due diligence and practices regarding supply chain management, including environmental impact, human rights violations records, and lack of transparency or failure to meet other compliance standards. As another example, labor-relations factors, such as reduced turnover and increased productivity associated with collective bargaining, also may be relevant to a risk and return analysis. Of course, a fiduciary’s determination of relevant factors is not limited to the general categories described above. Prudent investors commonly take into account a wide range of financial circumstances and considerations, depending on the particular circumstances, such as a corporation’s operating and financial history, capital structure, long-term business plans, debt load, capital expenditures, price-toearnings ratios, operating margins, projections of future earnings, sales, inventories, accounts receivable, quality of goods and products, customer base, supply chains, barriers to entry, and a myriad of other financial factors, depending on the particular investment. This rule, as amended, does not supplant such considerations, but rather makes clear that there is no inconsistency between the appropriate consideration of ESG factors and ERISA section 404(a)(1)(B)’s standard of prudence, which requires that fiduciaries act with the ‘‘care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.’’ E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations (3) Consolidation of Multiple Provisions Into Paragraph (b)(4) of the Final Rule In concert with removing the list of examples from paragraph (b)(4) of the NPRM, elements of paragraphs (b)(2)(ii)(C) and (c)(2) of the NPRM are now merged into paragraph (b)(4) of the final rule. These edits address commenters’ concerns that aspects of paragraph (b)(2)(ii)(C) of the NPRM could constitute an effective or de facto mandate to always consider the effects of climate change and other ESG factors on every investment or investment course of action, that the examples in paragraph (b)(4) of the NPRM interject inappropriate regulatory bias in favor of ESG factors, and that the final rule not retreat from the principle in paragraph (c)(2) of the NPRM that fiduciaries must base investment decisions only on factors that are relevant to a risk and return analysis. The essence of paragraph (c)(2) of the NPRM was not changed when merged into paragraph (b)(4) of the final rule. As mentioned below, the merger avoids the existence of redundant concepts in multiple paragraphs and reflects that the substance of paragraph (c)(2) of the NPRM is more closely connected to ERISA’s duty of prudence than the duty of loyalty. Accordingly, paragraph (b)(4) of the final rule provides that a fiduciary’s determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis, using appropriate investment horizons consistent with the plan’s investment objectives and taking into account the funding policy of the plan established pursuant to section 402(b)(1) of ERISA. It further indicates that 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, and whether any particular consideration is a risk-return factor depends on the individual facts and circumstances. Finally, it provides that the weight given to any factor by a fiduciary should appropriately reflect a reasonable assessment of its impact on risk-return. As revised, paragraph (b)(4) of the final rule subsumes core elements of paragraphs (c)(1) and (f)(3) of the current regulation. Specifically, the emphasis on risk and return factors in these two paragraphs carries forward into paragraph (b)(4) of the final rule. The current regulation’s reliance on ‘‘pecuniary only’’ and related terminology, however, is otherwise VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 73833 rescinded. The framework in paragraph (b)(4) of the final rule continues to adhere to the principle, underpinning paragraphs (c)(1) and (f)(3) of the current regulation, that when selecting an investment or investment course of action plan fiduciaries must focus on relevant risk and return factors, but the Department no longer supports the current regulation’s framework and terminology for advancing this principle. The Department, instead, agrees with the commenters who found the current regulation’s framework and terminology confusing and susceptible to inferences of bias against the treatment of climate change and other ESG factors as potentially relevant risk and return factors. The Department intends with these edits to dispel the perception caused by the current regulation that climate change and other ESG factors are somehow presumptively suspect or unlikely to be relevant to the risk and return of an investment or investment course of action. Paragraph (b)(4) of the final recognizes that, as with other factors, climate change and other ESG factors sometimes may be relevant to a risk and return analysis and sometimes not—and when relevant, they may be weighted and factored into investment decisions alongside other relevant factors, as deemed appropriate by the plan fiduciary. style of fund (e.g., growth versus value), style of fund management (passive versus active), an investment’s regulatory regime, participants’ understanding of the investment, participants’ preferences, and other investment-related operational considerations. These commenters expressed concern that such factors may not always perfectly align with securities law or accounting concepts of materiality or directly affect the risk and return of an investment in clear or obvious ways. In response to some of these concerns, paragraph (b)(4) of the final rule uses the word ‘‘relevant’’ instead of ‘‘material.’’ 44 The Department stresses, however, that under paragraph (b)(4) of the final rule, the fiduciary’s investment determination must ultimately rest on factors relevant to a risk and return analysis. The Department does not undertake in this document to address specific risk and return factors, but it notes that it has previously concluded that plan contributions do not constitute a ‘‘return’’ on investment. (4) Conforming Terminology— ‘‘Relevance’’ Versus ‘‘Material’’ In addition, paragraph (b)(4) of the final rule contains a change in terminology to establish consistency with the terminology in paragraph (b)(1) of the final rule. Several commenters noted that paragraph (b)(1) of the NPRM refers to ‘‘relevant’’ factors but that paragraph (b)(4) of the NPRM refers to ‘‘material’’ factors. Noting a body of decisional and regulatory law underpinning ‘‘materiality’’ under Federal securities laws and accounting conventions, many of these commenters considered the NPRM’s use of these different terms a source of confusion. In conjunction with proposed paragraph (b)(4)’s focus on risk and return factors, many commenters were concerned that paragraph (b)(4)’s use of ‘‘material’’ might be construed as circumscribing the role or authority of plan fiduciaries under ERISA’s prudence standard as reflected in the use of ‘‘relevance’’ in paragraph (b)(1) of the NPRM. In discussing these concerns, commenters mentioned many factors that, in their view, are relevant factors routinely considered by plan fiduciaries when selecting investments, such as brand name or reputation of the fund or fund manager, lifetime income options, Paragraph (c)(2) of the NPRM modified the requirement in paragraph (c)(1) of the current regulation that a fiduciary’s evaluation of an investment or investment course of action must be based ‘‘only on pecuniary factors,’’ which is defined at paragraph (f)(3) of the current regulation as a factor that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy. The Department used the phrase ‘‘pecuniary factors’’ for the first time in the 2020 regulations, and although the Department defined it in those regulations, the phrase is not found in ERISA and has no longstanding meaning in employee benefits law. The NPRM proposed to remove the ‘‘pecuniary only’’ formulation of the requirement and to integrate the concept of ‘‘risk/return’’ factors directly into paragraph (c)(2) of the NPRM. This approach was intended to address stakeholder concerns about ambiguity in the meaning and application of the PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 2. Section 2550.404a–1(c) Investment Loyalty Duties (a) Removal of Pecuniary-Only Requirement—Paragraph (c)(2) of the Proposal 44 A similar change was made in paragraph (d)(2)(ii)(D) of the final regulation to appropriately align terminology in similar contexts across different paragraphs of the final regulation. E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 73834 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations ‘‘pecuniary only’’ terminology of the current regulation. A significant number of commenters supported the NPRM’s proposed removal of the pecuniary-only test and related terminology. Many commenters on this issue were of the view that, rather than providing clarity, the current regulation’s pecuniary-only terminology created confusion by layering an additional standard or test onto the existing fiduciary framework. That framework already unambiguously required fiduciaries to base plan investment decisions on financially relevant factors. In line with that concern, many commenters asserted that this pecuniary-only terminology chills plan fiduciaries from considering climate change and other ESG factors even where they have a material effect on the bottom line of an investment, merely because such factors also may have the effect of supporting nonfinancial objectives. In such ‘‘dual purpose’’ circumstances, the position of these commenters was that just because an investment factor or strategy may simultaneously have economic and noneconomic dimensions, the noneconomic dimensions do not lessen the factor or strategy’s economic significance. These commenters stated that the NPRM’s proposed elimination of the pecuniary-only and related terminology would make clear to fiduciaries that they are free to consider the full range of potential material riskreturn factors without undue fear of regulatory second-guessing or litigation. According to these commenters, the elimination would encourage fiduciaries to take the same steps that other marketplace investors take in enhancing investment value and performance or improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors. Some commenters opposed the NPRM’s proposed changes; they emphasized the importance of basing investment decisions on only pecuniary considerations and urged the Department to retain the pecuniary factors and related terminology. These commenters generally were of the view that ERISA requires that plan fiduciaries focus solely on the economics of an investment and state that climate change and other ESG factors rarely can be harmonized with this requirement. Given that belief, these commenters were concerned that participants’ retirement security will suffer as plan fiduciaries and money managers pursue agendas unrelated to the exclusive purpose of providing financial benefits to retirement plan participants and VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 beneficiaries. In line with this concern, one commenter asserted that the insertion of non-pecuniary investment criteria in the management of pension and other such funds imposes a substantial penalty over time in terms of realized returns. One commenter questioned the consistency of permitting the consideration of nonpecuniary goals with the Supreme Court’s opinion in Fifth Third Bancorp v. Dudenhoeffer, which stressed the fiduciary’s obligation to focus on retirement plan participants’ financial interests.45 The Department is not persuaded to retain the current regulation’s use of and reliance on the novel pecuniary-only formulation and its related terminology. The pecuniary-only requirement and related terminology unfortunately caused a great deal of confusion, and it accounts for a substantial amount of the chilling effect this rulemaking project set out to redress. These facts are manifest in the many comment letters on the NPRM. Many view the ‘‘pecuniary-only’’ terminology as ambiguous or decidedly prohibitive on the question of whether climate change and other ESG factors may be considered when those factors are relevant to the risk-and-return analysis. Indeed, as indicated by commenters, the current rule actually has a chilling effect that discourages fiduciaries from prudently considering climate change and other ESG factors that may be relevant to the risk-return analysis. Some commenters, in particular, asked questions about considering factors that have both economic and noneconomic components, suggesting apprehension that this would fall outside the current regulation’s pecuniary-only requirement. In light of the foregoing, the Department no longer supports the use of this terminology. Rather, the Department thinks, and many commenters agree, that paragraph (c)(2) of the NPRM, subject to certain modifications discussed elsewhere in this preamble, is a more understandable formulation of ERISA’s requirement that a fiduciary’s evaluation of an investment or investment course of action must focus on factors that the fiduciary reasonably determines are relevant to a risk and return analysis. Removing the ‘‘based only on pecuniary factors’’ language (and related terminology throughout) from the current regulation will help re-establish the Department’s position reflected in non-regulatory guidance as early as 2015 that climate change and other ESG 45 Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014). PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 factors that may be relevant in a riskreturn analysis of an investment do not need to be treated differently than other relevant investment factors, even though they may possess the ‘‘dual purpose’’ dimensions mentioned by some commenters. Put differently, removing this novel terminology is removing the current regulation’s thumb from the scale so as not to discourage fiduciaries from considering climate change and other ESG factors where relevant to the risk-return analysis. Finally, the Department finds no merit to the argument that the final rule, either in general or in not carrying forward the pecuniary/non-pecuniary terminology, permits or requires behavior contrary to the holding in Dudenhoeffer. On the contrary, the central premise behind the final rule’s rescission of the pecuniary/nonpecuniary distinction is that the current regulation is being perceived by plan fiduciaries and others as undermining the fundamental principle Dudenhoeffer expressed: fiduciaries must protect the financial benefits of plan participants and beneficiaries. In this way, the pecuniary-only requirement would effectively prohibit or encumber plan fiduciaries from managing against or taking advantage of climate change and other ESG risk factors in selecting investments, even when it is financially prudent to do so. Thus, the final rule’s amendments to the current regulation, which are aimed solely at counteracting that perception, are entirely consistent with the principle articulated in Dudenhoeffer. Notwithstanding the foregoing, paragraph (c)(2) of the proposal has been incorporated into paragraph (b)(4) of the final rule for clarity and to avoid potentially redundant and confusing requirements. This consolidation reflects that the essence of the requirement of paragraph (c)(2) of the proposal that fiduciaries make investment decisions based on factors relevant to a risk and return analysis is inherently prudential in nature, rather than a loyalty obligation, and therefore overlaps with the requirements of paragraph (b)(4) of the proposed rule. Although including such a requirement in the regulation’s loyalty provisions may help establish regulatory guideposts for fiduciaries,46 that same function is fulfilled by incorporating it into the final regulation’s prudence provisions at paragraph (b)(4) of the final rule. 46 See E:\FR\FM\01DER2.SGM 85 FR 72854. 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations (b) Paragraph (c)(1) Paragraph (c)(1) of the proposal restated the Department’s longstanding expression of ERISA’s duty of loyalty in the context of investment decisions, as also expressed in Interpretive Bulletins and associated preamble discussions. It provided that a fiduciary may not subordinate the interests of participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives and may not sacrifice investment return or take on additional investment risk to promote goals unrelated to the plan and its participants and beneficiaries. Similar language is contained in paragraph (c)(2) of the current regulation. The Department did not receive substantive comments on paragraph (c)(1) of the proposal, and it is being adopted in the final rule without change. As in the proposal and current regulation, the final rule’s paragraph (c)(1) is a legal requirement and not a safe harbor. khammond on DSKJM1Z7X2PROD with RULES2 (c) Paragraph (c)(2)—Tie Breaker Test and Tie Breaker Standard Paragraph (c)(3) of the proposal directly rescinded the ‘‘tiebreaker’’ standard in paragraph (c)(2) of the current regulation and replaced it with a standard intended to align more closely with the Department’s original non-regulatory guidance from nearly three decades ago, IB 94–1, which first advanced the ‘‘tiebreaker’’ concept. In explaining the standard in the preamble to IB 94–1, the Department stated that ‘‘a plan fiduciary may consider collateral benefits in choosing between investments that have comparable risks and rates of return.’’ 47 In contrast, the current regulation narrowly focused on whether competing investments are ‘‘indistinguishable’’ based on pecuniary factors alone. Under such circumstances, the current regulation permits a plan fiduciary to use a nonpecuniary factor as a deciding factor in making its investment decision, but only if the fiduciary also complies with a specific documentation requirement. A number of commenters supported both the rescission of the current tiebreaker standard and the proposal’s replacement standard—i.e., that competing investments ‘‘equally serve’’ the financial interests of the plan. In their view, the proposed formulation represented a significant improvement over the current regulation, which they argued set out an unrealistically difficult and prohibitively stringent standard. Some further suggested that the standard in the current regulation is 47 59 FR 32607 (June 23, 1994). VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 so stringent that it effectively eliminated the Department’s historical tiebreaker test. For instance, according to one commenter, the current regulation’s tiebreaker standard improperly limits its application, because it would only apply when a fiduciary is unable to distinguish two or more investments based on pecuniary factors alone—an occurrence that is rare and unreasonably difficult to identify, according to this commenter. In actual practice, the commenter states, a prudent fiduciary process often produces a variety of investments that are consistent with, and in the fiduciary’s judgement, equally promote, the financial interests of participants and beneficiaries. According to a different commenter, the current regulation’s ‘‘economically indistinguishable’’ standard is in practice impossible for fiduciaries to surmount, given that differences exist even among very similar investments. As put by yet another commenter, the requirement that investments be ‘‘economically indistinguishable’’ before a fiduciary can consider collateral factors (such as ESG factors when not relevant to risk and return) effectively subverts the fiduciary’s best judgment in favor of a standard that is virtually impossible to meet. Overall, these commenters viewed the proposal’s standard as tracking the Department’s prior guidance more closely, and more accurately reflecting the realities of fiduciary decisionmaking. They supported adoption of the NPRM’s standard without change. Other commenters supported the proposal’s rescission of the current tiebreaker standard, but raised concerns with the proposal’s ‘‘equally serve’’ formulation. Commenters indicated that the proposal was not clear as to how to determine when investments meet the ‘‘equally serve’’ standard and requested further guidance. Questions presented included whether the equally-serve analysis is based on how similar investments are, or based on the potential financial effects of the investments on the plan’s portfolio. One commenter suggested that the Department should recognize that investments may vary from each other but still serve the same plan purpose. Another commenter asked how small deviations in the financial effects of two investments would affect the equally serve analysis. These commenters did not believe the tiebreaker standard should require investments to be identical, and suggested clarifying language, such as a standard based on investments that serve the financial PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 73835 interests of the plan comparably well, or equally well. Other commenters indicated that the ‘‘equally serve’’ standard appeared to imply an investment process under which a fiduciary selection process involves evaluating a group of potential investments, paring the group down to a few competing investments, and then moving on to the tiebreaker test and the selection of a single investment. Commenters opined that such a mechanical process of elimination should not be necessary if a fiduciary has already prudently determined that each investment is consistent with the plan’s objectives and is reasonably designed to further the purposes of the plan. Some commenters asserted that the tiebreaker test should focus on whether investments are the result of a prudent fiduciary process rather than on an analysis of their equivalence, and suggested formulations based on ‘‘equally prudent’’ investments, or investments identified through a prudent process. Some commenters supported the tiebreaker standard in the current regulation and objected to the rescission of the current standard. These commenters viewed the proposal’s standard as far too lenient, and the current regulation’s indistinguishability based on pecuniary factors only standard as appropriate in light of ERISA’s high standard of fiduciary responsibilities. They asserted that the current regulation’s provisions are a valuable curb against behavior that could otherwise lead to subordinating the interests of participants and beneficiaries in their retirement income. These commenters expressed concern that the proposal, with changes to the tiebreaker standard and related documentation provisions, would invite abuse and open the door to using pension plan assets for policy agendas, or encourage fiduciaries to advance personal policies and agendas at the expense of interests of trust beneficiaries in a secure retirement. A number of commenters did not support inclusion of any tiebreaker provision in the regulation. Some commenters believe the tiebreaker test cannot be reconciled with ERISA’s duty of loyalty, which requires that fiduciaries discharge their duties for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. Commenters also cautioned that the tiebreaker provision weakens the focus on the best financial outcome for plan participants and beneficiaries by encouraging consideration of collateral factors. In E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 73836 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations their view, fiduciaries desiring to seek third-party benefits may, deliberately or inadvertently, be encouraged to declare ties to free themselves from the duty of loyalty. Several of these commenters did not believe a tiebreaker is necessary regardless of formulation because, in their view, ties generally do not exist, particularly in liquid financial markets. Furthermore, they argued that the purpose of an investment manager is to exploit differences among investments and to select a winner (or buy both for increased diversification in the case of ties). In their view, fiduciaries are accustomed to deliberating on such matters, including close calls, and if they are doing their job and creating an appropriate record, there should be no need for tiebreaker guidance in the rule. Some commenters also believed that a tiebreaker test may potentially cause harm or detriment to plans. For instance, some suggested that a tiebreaker test may reduce accountability and promote complacency by allowing investment decisionmakers to adopt a ‘‘close enough’’ attitude and point to some reason other than financial merit to justify their decisions. In contrast, others suggested that the tiebreaker test promotes a misconception that there is a single ‘‘best’’ investment for a plan. Still others cautioned that the mere existence of a tiebreaker test could unintentionally signal that ESG factors cannot, on their own, be considered material to a risk-return analysis. Some also suggested that there is a chance the tiebreaker test may be overused unnecessarily in cases where the fiduciary has little doubt about the financial merits of the investment in question but where the fiduciary perceives the tiebreaker route as providing a level of protection from future allegations of disloyalty. Such overuse may lead to substantial burdens on recordkeepers in connection with the proposal’s related collateral benefit disclosure requirement. The Department is not persuaded that the tiebreaker provision should be removed from the final rule. The Department does not agree with commenters who asserted that the tiebreaker test is unnecessary or inconsistent with ERISA. Although there has been some mostly semantic variation in what constituted ties under the Department’s prior non-regulatory guidance, some version of the tiebreaker test has appeared in the CFR since 1994. Consequently, since at least that time, the Department has recognized that fiduciaries may use collateral benefits to break ties between various investments. The tiebreaker test thus aligns the final VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 rule with the settled expectations of fiduciaries and others involved in the investment of assets of employee benefits plans under ERISA, especially in the multiemployer plan context. Although some fiduciaries, by the nature of their arrangements with plans, may apply investment strategies that never require them to choose between alternatives that equally serve the plan’s needs, other fiduciaries, such as those making investments outside liquid financial markets, may find the tiebreaker test useful for circumstances in which there are equally strong cases for competing investments under a riskreturn analysis. In addition, although some commenters question the need for a tiebreaker test and whether ties exist, other commenters acknowledge the utility of the tiebreaker standard. For instance, some commenters argued that in the event of a tie between two investment options, the fiduciary should increase diversification by investing in both investment options. They acknowledge, however, that in not all circumstances is this appropriate, and thus, the tie will need to be broken. Under the commenter’s approach, for example, the tiebreaker test provides plan fiduciaries with a solution in cases when investing in two (or more) alternatives that equally serve the financial interests of the plan, rather than one, entails additional costs (such as transactional or monitoring costs) that offset the benefits of investing in two (or more) investments rather than one. More generally, those questioning the need for a tiebreaker test are reminded that ERISA does not specifically address a fiduciary’s investment choice in circumstances where multiple investment alternatives equally serve the financial interests of the plan and thus the economic interests of the plan’s participants and beneficiaries are protected by choosing either alternative. The Department is choosing to leave that decision in the hands of fiduciaries, who are charged with choosing among investment alternatives that equally serve the financial interests of the plan. Fiduciaries without a need to break a tie while selecting investments need not use the provision. This may be the case, for example, with respect to participantdirected individual account plans where adding additional investment options is not necessarily a zero-sum game, such that the fiduciary may choose only one option. Moreover, when there is a need to break a tie, there is nothing in the regulation that requires fiduciaries to look to climate change or other ESG factors to break the tie. PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 With respect to concerns that the tiebreaker provision might be subject to abuse or not be part of a prudent fiduciary process, we note that fiduciaries utilizing the tiebreaker provision remain subject to ERISA’s prudence requirements. In addition, they also remain subject to the explicit prohibition against accepting expected reduced returns or greater risks to secure such additional benefits. The Department is of the view that these provisions, coupled with the safeguards added by ERISA’s statutory prohibited transaction provisions, discussed below, sufficiently protect participants’ and beneficiaries’ retirement benefits in this context. As to commenters who suggested that the existence of a tiebreaker provision implies that ESG factors are noneconomic, the potential economic relevance of ESG factors is reflected in paragraph (b)(4) of the final rule, as discussed above. When such factors are relevant to a risk and return analysis, the tiebreaker test is not at issue. Put differently, as with other types of investment factors, climate change and other ESG factors sometimes may be relevant to a risk and return analysis and sometimes not—and when relevant, they may be factored into investment decisions alongside other relevant factors, as deemed appropriate by the plan fiduciary under paragraph (b)(4) of the final rule. However, when such factors are not relevant to a risk and return analysis, such factors may nevertheless be the decisive factor under the tiebreaker test, provided that the other conditions of the tiebreaker test are satisfied. The Department believes that rescission of the current regulation’s tiebreaker standard and replacement with a standard more closely aligned with prior nonregulatory guidance is appropriate. The current regulation’s tiebreaker standard, ‘‘unable to distinguish on the basis of pecuniary factors alone,’’ in practice, has meant indistinguishable in all respects, or identical. This standard is causing a great a deal of confusion, given that no two investments are the same in each and every respect. The imposition of a standard that effectively requires investments to be precisely identical therefore is both impractical and unworkable. Investments can and do differ in a wide range of attributes, but when considered in their totality, may serve the financial interests of the plan equally well. This problem was noted by the Department in 2020 when making the current regulation’s tiebreaker standard, but as shown by the comments discussed above, the current E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations regulation has not effectively resolved this problem.48 The Department believes the final rule’s ‘‘equally serve’’ standard comports with the realities of fiduciary decisionmaking and firmly protects participant retirement benefits, since it strictly forbids the subordination of plans’ and participants’ financial interests to any other objective. In response to comments requesting further guidance on the determination of whether investments equally serve the financial purposes of the plan, the Department has not made changes to the proposed standard. In the Department’s view, as explained in the preamble to the proposal, investments may differ on a wide range of attributes, but when considered in their totality, serve the financial interests of the plan equally well.49 Given the wide range of attributes associated with different investments, the uncertainties inherent in investing, and the practical limitations on the availability and processing of relevant data, the Department does not agree with those commenters who suggested that fiduciaries can never conclude that competing alternatives serve the financial purposes of the plan equally well. Under the final rule, investments do not need to be identical in order to equally serve the financial interests of a plan. Whether, in any particular circumstances, the tiebreaker standard is met is an inherently factual question. Like the NPRM, the final rule’s tiebreaker provision does not define or explicitly limit the concept of ‘‘collateral benefits.’’ On this topic, the preamble to the NPRM specifically provided that the proposal did not place parameters on the collateral benefits that may be considered by a fiduciary to break the tie. The preamble to the NPRM explained that this position is consistent with prior nonregulatory guidance, but the preamble nevertheless solicited comments on whether more specificity should be provided in the provision. For instance, the preamble asked if the final rule should require that any collateral benefit relied upon as a tiebreaker be based upon an assessment of the shared interests or views of the participants, above and beyond their financial interests as plan participants, such as the investment’s likely impact on participants’ jobs or plan contribution rates. This scenario was just an example. Some commenters opposed such limitations, both as a general idea and specifically the scenario mentioned in 48 85 49 86 FR 72846, 62. FR 57278. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 the preamble of the NPRM, i.e., placing additional constraints in the form of requiring an assessment of the shared interests or views of the participants. Commenters stated that the Department’s longstanding position prior to the 2020 amendments, going back at least to 1994, never defined or limited the concept of ‘‘collateral benefits’’ and that there is no history justifying a change now. Focusing on the specific scenario in the preamble to the NPRM, one commenter stated that it is not clear how a fiduciary would use information on participant views, collect such information, or even what issues should be included in such an assessment. A different commenter also focusing on this scenario stated the concern that making decisions based on a survey or estimation of participants’ views unrelated to plan returns is in tension with ERISA’s command that fiduciaries operate ‘‘for the exclusive purpose’’ of providing benefits and defraying reasonable expenses. One commenter argued that a regulatory definition is not necessary because the tiebreaker test already ensures that the investment must be prudent and serve the best interests of the participants and beneficiaries regardless of whether a collateral benefit is used. Requiring further assessment would increase costs and complexity, according to this commenter. Other commenters had different views on this question. One commenter stated that, in its view, the tiebreaker provision is unlawful, but that if some version of it is retained in the final rule, the retained version should require that any collateral benefit relied upon as a tiebreaker be based upon an assessment of the shared interests or views of the participants, along with the consent of each participant to pursue collateral benefits with funds in their account and a delineation of the causes they support. One commenter raised the concern that, because the NPRM did not place any parameters on the collateral benefits that fiduciaries may consider, fiduciaries could be left guessing which factors would be appropriate for consideration, with the possibility that the Department’s views could shift over the years. The final rule takes the same approach as the NPRM. Some form of the tiebreaker test permitting fiduciaries to consider collateral benefits has existed for more than four decades, and the Department is not aware of plan fiduciaries struggling with the concept of permissible collateral benefits. In the Department’s experience, collateral benefits have routinely involved criteria or considerations other than factors that PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 73837 are relevant to a risk and return analysis of the investment, such as stimulating union jobs and investing in the geographic region where participants live and work, as just a few examples. In response to requests from several commenters, the Department confirms that an investment that stimulates or maintains employment that, in turn, results in continued or increased contributions to a multiemployer plan is an example of ‘‘collateral benefits other than investment returns’’ under paragraph (c)(2) of the final rule. In response to the concern that, without a definition, plan fiduciaries will be forced to guess as to what constitutes a legitimate ‘‘collateral benefit’’ versus an impermissible collateral benefit, the Department reminds that plan fiduciaries are not required to consider collateral benefits in choosing between investments that have comparable risks and rates of return. Moreover, the statement that the final rule does not contain explicit parameters on the collateral benefits that may be considered by a fiduciary to break a tie directly responds to and addresses commenters’ concerns about exceeding such parameters. Finally, while the final rule itself adds no explicit parameters on collateral benefits, ERISA’s prohibited transaction provisions in section 406 remain and generally forbid collateral benefits to the extent any such benefit involves a transaction that violates those provisions.50 (d) Paragraph (c)(2) Tiebreaker Test— Documentation Paragraph (c)(3) of the NPRM also rescinded the current regulation’s novel documentation requirement applicable to any instance of use of the tiebreaker test; instead, the proposal included a requirement that if a plan fiduciary uses the tiebreaker to select a designated investment alternative for a participantdirected individual account plan based on collateral benefits other than investment returns, ‘‘the plan fiduciary must ensure that the collateral-benefit characteristic of the fund, product, or model portfolio is prominently displayed in disclosure materials provided to participants and beneficiaries.’’ A number of commenters objected to the removal of the current regulation’s 50 See, e.g., AO 85–36A (Oct. 23, 1985) (certain investment arrangements may involve a use of plan assets for the benefit of a party in interest in violation of ERISA section 406(a)(1)(D)); Information Letter to Katz (Mar. 15, 1982) (purchase by a plan of an insurance policy pursuant to an arrangement under which it is expected that the insurance company will make a loan to a party in interest is a prohibited transaction). E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 73838 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations documentation provision, under which a fiduciary using the tiebreaker test is required to document, among other things, its analysis in those cases where the fiduciary has concluded that pecuniary factors alone were insufficient to be the deciding factor.51 The requirement was intended to ‘‘provide a safeguard against the risk that plan fiduciaries will improperly find economic equivalence and make decisions based on non-pecuniary factors without a proper analysis and evaluation.’’ 52 Some of these commenters are of the view that the tiebreaker test may be inconsistent with ERISA, as discussed above, and that a stringent documentation requirement is perhaps the best way for plan fiduciaries to contemporaneously document their decisionmaking with respect to tiebreakers and mitigate the effects of their reliance on factors that do not materially affect risk-return or directly promote retirement income. Other commenters supported removal of the current regulation’s documentation requirement, arguing that the disclosure was formulaic, singled out one investment category, could chill fiduciaries from properly considering ESG factors, and was largely unnecessary given ERISA’s general obligations. For instance, one commenter indicated that the documentation requirement has a chilling effect and is seen as suggesting that ESG investing entails extraordinary risks. Other commenters also viewed the documentation requirement as creating a stigma around considering ESG factors in investment decisions. Commenters also believed that the regulation’s documentation provision is unnecessary because fiduciaries commonly document and maintain records about their investment decisions as part of their general prudence obligation. Others believed that removal of the documentation provision brings the tiebreaker standard more in line with prior non-regulatory guidance and may provide additional cost savings, which would ultimately benefit plan participants and beneficiaries. A commenter noted that some fiduciaries, even before the 2020 amendments, may have viewed tiebreaker situations as perhaps requiring enhanced documentation. This commenter requested that the Department provide further clarification regarding prudent recordkeeping if the final rule removes the current regulation’s documentation requirement. 51 29 52 85 CFR 2550.404a–1(c)(2) (2021). FR 72862. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 The Department is not persuaded that the current regulation’s brand new documentation requirement should be retained in the tiebreaker provision. Commenters confirmed the Department’s initial concern that the documentation provision in the current regulation is very likely to chill and discourage plan fiduciaries from using the tiebreaker test generally, including in cases involving the appropriate consideration of ESG factors (when such factors are not otherwise relevant to a risk and return analysis). The tiebreaker test, by its terms, applies only where competing investments equally serve the financial interests of the plan. It disallows the investment selection from sacrificing the plan’s economic interests or from exposing plans to additional risk. In light of these guardrails, the Department sees no reason for a regulatory provision imposing further burdens on its use. Since the tiebreaker test only applies in cases where the competing investments equally serve the financial interests of the plan, the Department is of the view that use of the tiebreaker test should not be discouraged with additional burdens, because neither of the competing investments sacrifices the economic interests of the plan, but one of them promotes collateral benefits the other does not. In addition, the elaborateness of the current regulation’s tiebreakerspecific documentation provision likely will be viewed by fiduciaries as suggesting that the Department sees tiebreakers as occurring infrequently, and the Department did not have in 2020 and does not now have sufficient information to make a judgement as to the frequency of ties. The documentation requirement also may be viewed by fiduciaries as a self-reported ‘‘red flag’’ that uniquely directs potential litigants’ attention to tiebreaker decisions as inherently problematic, even though there is no necessary or presumed inconsistency between their use and the requirements of ERISA. The Department is wary that the potential for litigation may cause fiduciaries to consciously or unconsciously skew their investment analyses to avoid open acknowledgment of a ‘‘tie’’ and the requirement of specifically prescribed documentation, while still favoring investments that provide collateral benefits. The Department believes this potentially creates incentives that discourage, rather than promote, proper fiduciary activity and transparency, and further reduces the likelihood that the benefits associated with the additional PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 documentation obligation would outweigh the associated costs. The Department also agrees with commenters that the current regulation’s prescribed documentation provisions are unnecessary given the general obligations of prudence under ERISA. The Department finds it noteworthy that no commenter provided contrary evidence demonstrating that ERISA’s general obligations of prudence are deficient in protecting the interests of plan participants and beneficiaries in this context. The Department emphasizes that removal of the documentation provision from the regulation does not suggest that ERISA fiduciaries are excused from complying with ERISA’s prudence obligations, or subject to a lower standard of care, with regard to documentation or otherwise. Fiduciary documentation of their investment activities already is a common practice. As explained in the preamble to the NPRM, the Department’s concern with the current regulation’s document provision rests on its formulaic and rigid nature. The Department believes ERISA section 404’s prudence obligation sufficiently protects participants’ and beneficiaries’ financial interests in their plans in this regard. That obligation, which fiduciaries had prior to the 2020 amendments and will continue to have, provides that the nature and degree of the fiduciary’s duty to document an investment decision depends upon the facts and circumstances particular to that decision, regardless of whether the decision is under the tiebreaker test or the type of collateral benefit at issue.53 Thus, the Department believes the current regulation’s specific documentation provision is not necessary and can lead to conduct contrary to the plan’s interests. This includes the risk that fiduciaries will over-document or under-document their investment decisions.54 Overdocumentation would result in increased transaction costs for no particular benefit to plan participants. 53 The preamble to Interpretive Bulletin 2015–01, in relevant part, stated that, ‘‘the Department does not construe consideration of ETIs or ESG criteria as presumptively requiring additional documentation or evaluation beyond that required by fiduciary standards applicable to plan investments generally. As a general matter, the Department believes that fiduciaries responsible for investing plan assets should maintain records sufficient to demonstrate compliance with ERISA’s fiduciary provisions. As with any other investments, the appropriate level of documentation would depend on the facts and circumstances.’’ 54 86 FR 57272 at 57279. E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 (e) Paragraph (c)(2) Tiebreaker Test— Collateral Benefit Disclosure The NPRM contained a disclosure requirement within the tiebreaker test limited to participant-directed individual account plans. Specifically, paragraph (c)(3) of the NPRM, in relevant part, provided that if a plan fiduciary selects an investment, or investment course of action, based on collateral benefits other than investment returns, ‘‘the plan fiduciary must ensure that the collateral-benefit characteristic of the fund, product, or model portfolio is prominently displayed in disclosure materials provided to participants and beneficiaries.’’ This would have been a new disclosure requirement under ERISA. The preamble to the NPRM explained the policy intent behind this proposed requirement. In relevant part, the NPRM explained that the ‘‘essential purpose of this proposed disclosure requirement is to ensure that plan participants are given sufficient information to be aware of the collateral factor or factors that tipped the scale in favor of adding the investment option to the plan menu, as opposed to its economically equivalent peers that were not.’’ 55 The Department thought the disclosure of this information would have been of potential benefit to plan participants and beneficiaries because of the possibility that ‘‘a particular plan participant or a population of plan participants does not share the same preference for a given collateral purpose as the plan fiduciary that selected the designated investment alternative for placement on the menu among the plan’s other options.’’ The preamble to the NPRM also provided an example of an application of this proposed requirement. The example, in relevant part, provided that ‘‘if the tiebreaking characteristic of a particular designated investment alternative were that it better aligns with the corporate ethos of the plan sponsor or that it improves the esprit de corps of the workforce, . . . then such feature or features prompting the selection of the investment must be prominently disclosed by the plan fiduciary. . . .’’ The NPRM believed this information ‘‘will be useful to participants and beneficiaries in deciding how to invest their plan accounts.’’ 56 The preamble to the NPRM also clarified that, in terms of compliance, the Department’s intent was to provide flexibility in how plan fiduciaries would fulfill this requirement given the 55 86 FR 57272, 80. 56 Id. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 unknown spectrum of collateral benefits that might influence a plan fiduciary’s selection. The preamble to the NPRM explained that one likely way to comply ‘‘is that the plan fiduciary could simply use the required disclosure under 29 CFR 2550.404a–5.’’ 57 That regulation, adopted in 2012, already entitles participants in participant-directed individual account plans to receive sufficient information regarding designated investment alternatives to make informed decisions about the management of their individual accounts. The information required by the 2012 rule includes information regarding the alternative’s objectives or goals and the alternative’s principal strategies (including a general description of the types of assets held by the investment) and principal risks. The NPRM, therefore, assumed these existing disclosures, perhaps with minor modifications or clarifications, would have been sufficient to satisfy the disclosure element of the tiebreaker provision in paragraph (c)(3) of the proposal. As is evident from the foregoing discussion, the NPRM assumed appreciable benefits to plan participants and beneficiaries and relatively small compliance costs resulting from this proposed disclosure requirement.58 The NPRM solicited comments on the overall utility of this disclosure provision, including ideas on how best to operationalize the provision considering its intended purpose balanced against costs of implementation and compliance. (1) Support for Disclosure Requirement The public record reflects limited support for the proposed disclosure requirement. One commenter stated that plan participants and beneficiaries should have information about collateral benefits because such information may impact participant behavior, such as whether to participate, savings rates, and asset allocations. One commenter registered its support for better disclosure to plan participants and of investment policies more generally, inclusive of sustainable investment policies and collateral benefit factors. One commenter believed the proposed requirement would protect participants and beneficiaries by 57 Id. 58 86 FR 57272 at 57300 (‘‘The Department estimates that it will take a legal professional twenty minutes on average per year to update existing disclosures for each of the 46,551 small individual account plans with participant direction that are anticipated to utilize this provision. This results in a per-plan cost of $46.14 annually relative to the pre-2020 final rule baseline.’’). PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 73839 ensuring that plan sponsors fully considered collateral benefits alongside financial performance. One commenter supported the proposed disclosure requirement as ‘‘reasonable,’’ but recommended that the Department provide plan fiduciaries with a model notice to assist compliance with this disclosure requirement. Finally, one commenter conditionally supported the proposed disclosure requirement because the commenter believed it would give plan participants needed transparency in the tiebreaking context. However, this commenter recommended that the proposed requirement, if retained, be improved with additional content requirements, including a requirement that the fiduciary disclose what specific alternative investments were considered in breaking the tie and more analysis behind the fiduciary’s decisionmaking process. (2) Concerns With Disclosure Requirement The public record also reflects substantial concerns with the proposed disclosure requirement. In summary, these concerns are as follows. Some commenters found the content requirements of proposed disclosure requirement to be inherently ambiguous. Some found the proposed disclosure requirement to be unnecessary and the required content of the disclosure to be of no economic significance. Other commenters were concerned that the proposed disclosure requirement may undermine the purposes of other disclosure regulations promulgated by the Department aimed at helping plan participants and beneficiaries make informed investment decisions. Certain commenters expressed concerns that the proposed disclosure requirement would single out certain factors and strategies over other factors and strategies, contrary to the principle of neutrality they believe is embedded in ERISA. Other commenters were concerned that the proposed disclosure requirement could have a chilling effect on the proper use of climate change and other ESG factors. Several commenters were concerned that the proposed disclosure provision would result in unnecessary litigation. Each of these concerns is explained in detail below. (a) Ambiguity Some commenters found the content requirements of the proposed disclosure requirement to be inherently ambiguous. According to them, the NPRM was unclear on what ‘‘collateralbenefit characteristics’’ a fiduciary would be required to disclose. They E:\FR\FM\01DER2.SGM 01DER2 73840 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 contrasted regulatory language requiring the disclosure of the collateral benefit characteristics ‘‘of the fund’’ with preamble language focused on the ‘‘features prompting the selection’’ by the fiduciary and other language referencing ‘‘improved employee morale’’ as the factor that ‘‘tipped the scale.’’ Commenters requested clarification of whether the proposed disclosure requirement was focused on an objective characteristic of the fund or the subjective reason the fiduciary selected the fund. According to the commenters, these are not necessarily the same things. Commenters said the subjective collateral benefit perceived by the plan fiduciary may be wholly different from the characteristic of the fund that would be expected to provide the collateral benefit. For example, assume that the plan sponsor is an organization whose primary mission is to tackle climate change. The plan fiduciary may decide to use the tiebreaker test to select a fund that uses ESG criteria with an environmental focus to improve the morale of its employees. In this example, the commenters stated that the regulatory text and preamble were unclear on what must be disclosed under the proposal— would it be the environmental focus of the fund’s strategy or improved employee morale? Most commenters on this issue requested confirmation that the former is what the Department intended, and they asserted flaws with the NPRM’s cost-benefit analysis if the latter. (b) Unnecessary Some commenters were of the view that the proposed disclosure requirement is unnecessary, and the required content of the disclosure is of no economic significance. The commenters stated that the Department and the Securities and Exchange Commission already have regulations in place to ensure that participants and investors have ready access to necessary investment-related information, such as principal strategies and risks, performance information, benchmarks, and fees. Commenters alleged that the content requirements of the proposed disclosure, by contrast, contained no information about the economics of the investment in question, but instead focused on information that was collateral to the economics of the investment and therefore would have no economic relevance to participant investors. Whether a participant shares the fiduciary’s preference for the collateral benefit or purpose that ‘‘tipped the scale’’ is of no relevance to whether the investment option is VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 economically prudent and makes economic sense to a participant. The only thing that should matter to participants, in the view of these commenters, is whether the selected investment was prudently chosen. In their view, disclosures focused on the policy or social preferences of the selecting fiduciaries will not advance intelligent investment behavior and therefore are unnecessary. (c) Interference With Existing Disclosure Regulations Some commenters were concerned the proposed disclosure requirement would undermine the purposes of other disclosure regulations promulgated by the Department aimed at helping plan participants and beneficiaries make informed investment decisions. These commenters pointed to existing disclosures under 29 CFR 2550.404a–5, 2550.404c–1, and 2550.404c–5 as being sufficient to enable plan participants and beneficiaries to make informed investment decisions.59 These disclosures, according to the commenters, focus on what the Department has determined, through multiple notice-and-comment rulemaking projects, is the relevant investment-related information that plan participants and beneficiaries need, as investors. The proposed collateral benefit disclosure requirement, by contrast, focused on non-investment information, i.e., the collateral purpose that tipped the scale—information that, by definition, is not material to risk and return. These commenters argued that not only is the proposed collateral benefit disclosure of no economic relevance, but the disclosure risks distracting participants and beneficiaries from basic and important information required under the existing regulations mentioned above. Put differently, one commenter stated that it opposes the proposed disclosure requirement because it would 59 The disclosure requirements to which these commenters refer include: 29 CFR 2550.404a–5 (requiring disclosure of certain plan administrative and investment-related information, including fee and expense information, to participants and beneficiaries in participant-directed individual account plans (e.g., 401(k) plans)); 29 CFR 2550.404c–1 (requiring that participants and beneficiaries in participant-directed individual account plans are furnished specified information about the plan’s investment alternatives and incidents of ownership appurtenant to such investment alternatives); and 29 CFR 2550.404c–5 (requiring that participants and beneficiaries whose plan assets may be invested, by default, into a plan’s QDIA by a plan fiduciary are furnished specified investment-related information about the QDIA, the circumstances in which plan assets will be invested in a QDIA, and their ability to direct their assets to plan investment alternatives other than a QDIA). PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 disproportionately emphasize one part of the fiduciary decisionmaking process over other more relevant factors in a way that could mislead participants and impact participant choices in ways that are unintended by the Department. (d) Lack of Neutrality & Chilling Effect Commenters expressed concerns that the proposed disclosure requirement singles out certain factors over other factors, contrary to the principle of neutrality, while other commenters are concerned that the proposed disclosure requirement might have a chilling effect on the proper use of climate change and other ESG factors. Certain commenters expressed opposition to the idea of singling out any class of investment factor, including collateral benefit factors, as needing additional or stricter requirements. These commenters asserted that ERISA is, and should be, factor neutral, including with respect to collateral purposes or factors. By imposing special disclosure requirements on collateral benefits, the proposed disclosure is contrary to this principle, according to these commenters. In line with this concern, other commenters were concerned that the proposed disclosure provision could inadvertently have a chilling effect on the proper use of climate change and other ESG factors. These commenters posited that investment strategies often simultaneously integrate multiple ESG factors into the analysis, some of which are relevant to a risk and return assessment while others are not. In these circumstances, commenters asserted that fiduciaries may avoid the investment based on ambiguity over whether it is subject to the disclosure requirement, or over disclose even when the options were selected solely for financial reasons. (e) Litigation Multiple commenters raised concerns that the proposed disclosure requirement would effectively act as an invitation to litigation. The very purpose of the disclosure, according to the commenters, is to draw the reader’s attention to the non-financial motives of the plan fiduciary. Considering this purpose, commenters said the disclosures themselves unintendedly would serve as a signal of potential wrongdoing and as a roadmap to litigation. To altogether avoid the litigation risk, some plan sponsors and fiduciaries simply would not use the tiebreaker test even in cases when they otherwise might have been willing to use it to promote collateral purposes, E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations such as addressing climate change, according to commenters. khammond on DSKJM1Z7X2PROD with RULES2 (f) Per Se Disloyalty Other commenters raised concerns with the idea that a disclosure violation would constitute a per se breach of ERISA’s duty of loyalty, which the commenters saw as the necessary consequence of embedding a disclosure requirement within the portion of a regulation defining ERISA’s duty of loyalty. They argued that a disclosure failure does not (and should not), by itself, prove disloyalty. But as structured, that seems to be the result under the NPRM regardless of how prudent and loyal the fiduciary is when selecting the investment, the commenters asserted. These commenters observed the unconventionality of the idea that ERISA commands that if fiduciaries fail in whole or in part to disclose their motivations to participants and beneficiaries, those fiduciaries are per se disloyal as a result of the failure, regardless of how loyal the fiduciaries were, in fact, when selecting the investment. These commenters assert that it is a non sequitur to say that a failure to disclose the scale-tipping attributes of an investment is dispositive evidence of disloyalty, especially when the investment is prudent and serves the financial interests of the plan equally as well as a reasonable number of alternatives. To this point, the commenters note that some version of the tiebreaker test has existed for approximately forty years without a related disclosure requirement, embedded in loyalty or otherwise—and nothing in the marketplace has changed in a way that supports the new disclosure requirement. The commenters question whether the many plan fiduciaries that used the tiebreaker test in the past would now be considered disloyal because they likely never disclosed to participants the collateral benefits that broke the tie. (g) Other Technical Concerns In addition to the foregoing concerns, commenters raised the following technical issues with the proposed disclosure requirement. First, commenters stated that although the NPRM is clear that a collateral benefit disclosure is required only if the fiduciary uses the tiebreaker provision to select a fund, nowhere does the NPRM offer concrete guidance on when or how often the plan fiduciary must furnish this information to participants. For example, commenters requested guidance and clarification on whether a disclosure would be required only when VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 the fund is added to the lineup, only when a participant joins the plan, annually, any time the plan or its service providers furnish any disclosure materials pertaining to the fund, or at some other interval determined solely in the judgment of the plan fiduciary based on facts and circumstances. Second, the NPRM specifies that the collateral benefit disclosure must be ‘‘prominently’’ displayed in disclosure materials provided to participants. But neither the regulation nor the preamble defines the meaning of prominence for this purpose. Several commenters therefore requested guidance on how to satisfy this standard. One concern is that this standard is being construed as requiring that collateral benefit information receive more attention or prominence than other information that likely will accompany the collateral benefit information, such as investment performance, fees, strategies, risk, etc. The commenters are of the view that collateral benefit information should not be more prominent than relevant investment-related information. These commenters assert that investment success generally turns on an intelligent evaluation of performance, fees, strategies, and risk, and that mandating the elevation of collateral information over such information potentially undermines the chances of an investor’s success. According to the commenters, this is particularly important, in part, because the concept of ‘‘prominence’’ is inherently subjective, and in part, because violations of the proposed disclosure rule are per se acts of disloyalty. (3) Decision Based on the foregoing concerns, and reasons similar to those underlying the decision to remove the documentation requirements from the current regulation, the final rule does not adopt the proposed collateral benefit disclosure requirement at this time. The Department is aware that the Securities and Exchange Commission (SEC) is conducting rulemaking on investment company names, addressing, among other things, ‘‘certain broad categories of investment company names that are likely to mislead investors about an investment company’s investments and risks.’’ 60 The SEC also is conducting rulemaking on disclosures by mutual funds, other SEC-regulated investment companies, and SEC-regulated investment advisers designed to provide consistent standards for ESG disclosures, allowing investors to make more informed decisions, including as 60 87 PO 00000 FR 36594 (June 17, 2022). Frm 00021 Fmt 4701 Sfmt 4700 73841 they compare various ESG investments.61 The Department will monitor those rulemaking projects and may revisit the need for collateral benefit reporting or disclosure depending on the findings of that agency. The Department emphasizes that the decision against adopting a collateral benefit disclosure requirement in the final rule has no impact on a fiduciary’s duty to prudently document the tiebreaking decisions in accordance with section 404 of ERISA. (f) Paragraph (c)(3)—Participant Preferences Several commenters requested clarification on whether a plan fiduciary may consider participants’ policy, social, or value preferences (i.e., nonfinancial preferences) in connection with constructing menus for defined contribution plans that permit participants to direct their own investments. Some commenters stated that, in their view, the NPRM is ambiguous on this question. Many other commenters expressed concern that the NPRM appears not to permit plan fiduciaries to consider participants’ preferences or to consider them only under the tiebreaker test. Several of these commenters stressed their view of the importance of accommodating participants’ preferences in a voluntary retirement system heavily dependent on elective deferrals. These commenters, including institutional asset managers and asset custodians, assert that both increased participation and increased deferral rates follow from accommodating such preferences. They argue that participants may not use their voluntary participant-directed savings plans to save for retirement, or will leave those plans earlier, if they cannot get access to investment choices they find attractive. Consistent with this argument, many individual commenters claim they would roll their savings out of ERISA-protected plans if the plans cannot satisfactorily accommodate their preferences. Several commenters alleged that plan fiduciaries should not have to rely solely on the tiebreaker test to consider participants’ preferences. These commenters are of the view that the NPRM’s tiebreaker test may be ill-suited to some methods of constructing menus for defined contribution plans because adding additional options is not necessarily a zero-sum game under these methods. To these commenters, therefore, if plan fiduciaries are unable to use the tiebreaker test because it does 61 87 E:\FR\FM\01DER2.SGM FR 36654 (June 17, 2022). 01DER2 73842 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 not comport with how they construct defined contribution menus, they effectively have no ability under their reading of the NPRM to consider participants’ preferences. A few commenters believe that participants’ preferences deserve equal treatment with risk and return factors; they believe fiduciaries should be allowed to consider and weigh participants’ preferences alongside risk and return factors in a prudence analysis, giving participant’s preferences such weight as the fiduciary deems appropriate, even if such preferences are not directly tied to risk or return. By contrast, a few commenters asserted that ERISA requires plan fiduciaries to focus on only pecuniary factors when selecting and retaining investments. They view participants’ preferences as essentially irrelevant to menu construction. In response to these comments, paragraph (c)(3) of the final rule provides clarification on this issue. Specifically, paragraph (c)(3) of the final rule provides that the plan fiduciary of a participant-directed individual account plan does not violate the duty of loyalty set forth in paragraph (c)(1) of the final rule solely because the fiduciary takes into account participants’ preferences consistent with requirements of paragraph (b) of this section. If accommodating participants’ preferences will lead to greater participation and higher deferral rates, then it could lead to greater retirement security, as suggested by the commenters. Thus, in this way, giving consideration to whether an investment option aligns with participants’ preferences can be relevant to furthering the purposes of the plan within the meaning of paragraph (b)(1) of the final rule. At the same time, however, plan fiduciaries may not add imprudent investment options to menus just because participants request or would prefer them.62 The clarification in paragraph (c)(3) of the final rule does not speak to the duty of prudence. Rather, paragraph (c)(3) provides only that a fiduciary does not violate the duty of loyalty as set forth in paragraph (c)(1) of the final rule solely because the fiduciary considers participants’ preferences in a manner 62 See Hughes v. Northwestern Univ., 142 S. Ct. 737 (2022) (‘‘In Tibble, this Court explained that, even in a defined-contribution plan where participants choose their investments, plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.’’ (citing Tibble v. Edison Int’l, 575 U.S. 523 (2015)). VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 that is consistent with paragraph (b) of the final rule. The reference to paragraph (b) in paragraph (c)(3) clarifies that the duty of prudence is independent and, as such, prudence determinations must be made consistent with paragraph (b) of the final rule. As paragraph (b)(4) of the final rule makes clear, the selection of investment options must be grounded in the fiduciary’s prudent risk and return analysis. The clarification in paragraph (c)(3) of the final rule is not novel or a change in Departmental position. The preamble to the current regulation being amended by this final rule articulated this position when explaining the meaning and mechanics of paragraph (d)(2) of that rule (entitled ‘‘Investment Alternatives for Participant-Directed Individual Account Plans’’). In relevant part, that preamble stated: ‘‘Nothing in the final rule precludes a fiduciary from looking into certain types of investment alternatives in light of participant demand for those types of investments. But in deciding whether to include such investment options on a 401(k)-style menu, the fiduciary must weigh only pecuniary . . . factors.’’ 63 The relevant portion of paragraph (d)(2) of that rule, however, was incorporated into paragraphs (b) and (c)(1) of the final rule (minus the pecuniary factor terminology). The final rule restates the position as regulatory text in paragraph (c)(3), rather than as a preamble statement, to provide enhanced clarity, accessibility, and prominence, as requested by commenters. The final rule declines to mandate that fiduciaries factor participants’ preferences into their evaluation, selection, and retention of designated investment alternatives, and declines to mandate a uniform methodology for determining such preferences, as requested by a few commenters. Some commenters had concerns that a mandate to consider and act on participants’ preferences would raise complex questions, such as how plan fiduciaries should properly solicit, weigh, implement, and monitor participants’ preferences, and how plan fiduciaries should reconcile conflicting preferences of their participants (e.g., some participants may oppose so-called ‘‘sin stocks’’ and other participants in the same plan may favor them). No commenter had persuasive answers or recommendations on these questions, and the NPRM did not propose such a mandate or suggest how to resolve such competing preferences. In addition, as some commenters noted, ERISA’s 63 85 PO 00000 FR 72846 at 72863. Frm 00022 Fmt 4701 Sfmt 4700 fiduciary obligations could compel plan fiduciaries to disregard participants’ preferences to the extent they are imprudent. Accordingly, the final rule declines to mandate that fiduciaries factor participants’ preferences into their evaluation, selection, and retention of designated investment alternatives, and declines to mandate a uniform methodology for determining such preferences; the final rule, instead, leaves these questions to be decided by plan fiduciaries considering the facts and circumstances of their plan and participant population. 3. Investment Alternatives in Participant-Directed Individual Account Plans Including Qualified Default Investment Alternatives Paragraph (d) of the current regulation contains additional rules that specifically govern fiduciaries’ selection and retention of investment alternatives for participant-directed individual account plans, including qualified default investment alternatives (QDIAs). The NPRM proposes to directly rescind this paragraph. The NPRM’s justification for the rescission has two dimensions. First, proposed amendments to other provisions in the section effectively merged the substance of what was paragraph (d) into these other provisions. Second, the Department no longer supports the current regulation’s provisions specific to QDIAs. As structured, paragraph (d)(2)(ii) of the current regulation disallows a fund to serve as a QDIA if it, or any of its component funds in a fund-of-fund structure, has investment objectives, goals, or principal investment strategies that include, consider, or indicate the use of one or more non-pecuniary factors in its investment objectives, even if the fund is objectively economically prudent from a risk-return perspective or even best in class. Commenters overwhelmingly supported the NPRM. A few commenters raised technical concerns regarding compliance problems and costs with paragraph (d) of the current regulation. But more globally, and fundamentally, most commenters on this issue were of the view that the provisions in paragraph (d) of the current regulation are unnecessary. This view is based, in part, on the strongly held belief, shared among a broad spectrum of commenters from various backgrounds and industries, that the legal standards under ERISA’s prudence and loyalty rules should be the same for all plans, including plans with QDIAs, with respect to the selection and retention of investment alternatives. E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations How these standards apply to a given set of facts may, of course, differ, according to the commenters, but the base standards of prudence and loyalty should be no different for these plans, absent a statutory underpinning for a difference. Yet the current regulation, according to these commenters, unnecessarily singles out individual account plans for what the commenters view as different, special, and stricter treatment (e.g., some higher level of fiduciary oversight). This special treatment is especially extreme with respect to QDIAs, according to the commenters, with some commenters equating the provisions in paragraph (d)(2)(ii) of the current regulation to an effective ban on selecting investments that consider or integrate climate change and other ESG factors, regardless of the economic merits and prudence of the investment. Many commenters disagreed that QDIAs need heightened protections beyond those specifically contained in the Department’s Qualified Default Investment Alternative regulation.64 Overall, these commenters agree that the provisions of paragraph (d) of the current regulation create a perception that fiduciaries of individual account plans, including plans with QDIAs, are subject to different and heightened—but unclear—standards of prudence and loyalty as compared to fiduciaries of other plans. And the primary consequence of this perception, according to the commenters, was a concern that funds may be excluded from selection as QDIAs solely because they expressly considered climate change or other ESG factors, even though the funds are prudent based on a consideration of their financial attributes alone. Some commenters opposed the NPRM’s proposed changes to paragraph (d) of the current regulation. In the main, these commenters oppose all aspects of the NPRM, not just the NPRM’s proposed deletion of paragraph (d) of the current regulation, but their expressed concerns with the proposed elimination of paragraph (d) are mainly limited to QDIAs. One of these commenters, for instance, stated that, because the proposal would allow a QDIA that states, as one of its investment objectives, a goal other than financial return, this part of the proposal, in the view of this commenter, is a per se violation of ERISA’s exclusive purpose rule as interpreted by the Supreme Court in Dudenhoeffer.65 A different commenter, noting that 64 29 CFR 2550.404c–5. Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014). 65 Fifth VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 individual account plans shift the risk of investment loss to participants, asserted that this shift in risk justifies enhanced—not reduced—protections for participants that are defaulted into QDIAs. This risk is compounded, according to this commenter, by the fact that defaulted employees are an increasingly larger percentage of the universe, and they tend not to opt out of the default investment. In line with the concerns of this commenter, two other commenters asserted that, to the extent ESG investing is acceptable at all, it should never be allowed in the case of QDIAs. Even if active investors are given the prerogative to align their investments with their beliefs, inattentive defaulted investors should never, according to these commenters, be forced to accept the social investment preferences of their plan fiduciaries or burdened with the obligation of having to actively recognize that the default option is misaligned with the investors’ desires for higher returns (or contrary social values) and opt out. The Department was not persuaded by these objections and the final regulation retains this aspect of the NPRM, meaning that the final regulation does not contain the set of special rules for participant-directed individual account plans, including plans with QDIAs, codified in paragraph (d) of the current regulation. The first part of paragraph (d) of the current regulation (paragraphs (d)(1) and (d)(2)(i)) was eliminated because the essential principles of this part were merged into paragraphs (b) and (c) of the final rule. As to the second part of paragraph (d) of the current regulation, i.e., the part containing special provisions for QDIAs (paragraph (d)(2)(ii) of the current), the Department generally is of the view that QDIAs warrant special treatment because plan participants have not affirmatively directed the investment of their assets into the QDIA but are nevertheless dependent on the investments for long-run financial security. Although the Department continues to believe as a general matter that special protections may be needed in some contexts for plans containing these investments, the Department no longer supports the specific restrictions in paragraph (d)(2)(ii) of the current regulation. As structured, paragraph (d)(2)(ii) of the current regulation disallows a fund to serve as a QDIA if it, or any of its component funds in a fund-of-fund structure, has investment objectives, goals, or principal investment strategies that include, consider, or indicate the use of nonpecuniary factors in its investment objectives, even if the fund is PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 73843 objectively economically prudent from a risk-return perspective or even best in class. The Department agrees with the many commenters asserting that, rather than protecting the interests of plan participants, paragraph (d)(2)(ii) of the current regulation will only serve to harm participants. It would, as the commenters notice, effectively preclude fiduciaries from considering QDIAs that include ESG strategies, even where they were otherwise prudent or economically superior to competing options. The Department sees no reason to deprive participants of such options. Consequently, the final rule directly rescinds paragraph (d)(2)(ii) of the current regulation. The rescission of this provision, however, does not leave participants and beneficiaries in plans with QDIAs without protections. QDIAs would continue to be subject to the same legal standards under the final rule as all other investments, including the prohibition against subordinating the interests of participants and beneficiaries in their retirement income to other objectives. QDIAs also would continue to be subject to the separate protections of the QDIA regulation.66 The Department finds no merit to the argument that the final rule, either in general or in not carrying forward paragraph (d) of the current regulation in specific, sanctions behavior contrary to the holding in Dudenhoeffer. On the contrary, as already stated, the central premise behind the final rule’s amendments to the current regulation is that the current regulation is being perceived by plan fiduciaries and others as an impediment to protecting the financial benefits of plan participants and beneficiaries by prohibiting or encumbering plan fiduciaries from managing against or taking advantage of climate change and other ESG risk factors in selecting investments. Thus, in this way, the final rule’s rescission of the special provision for QDIAs is entirely consistent with the principle articulated in Dudenhoeffer. 4. Section 2550.404a–1(d)—Proxy Voting and Exercise of Shareholder Rights Paragraph (d) of the final rule addresses the application of the duties of prudence and loyalty under ERISA section 404(a) to the exercise of shareholder rights, including proxy voting. As discussed below, the final rule includes several minor changes from the proposal based on public comment. 66 29 E:\FR\FM\01DER2.SGM CFR 2550.404c–5. 01DER2 73844 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations (a) Paragraph (d)(1) Paragraph (d)(1) of the final rule is unchanged from the proposal and provides that the fiduciary duty to manage plan assets that are shares of stock includes the management of shareholder rights appurtenant to those shares, such as the right to vote proxies. A commenter requested that the Department limit paragraph (d) to only proxy voting. The commenter noted that while the provisions cover both proxy voting and the exercise of shareholder rights, most of the substantive provisions relate only to proxy voting. The commenter further opined that other shareholder rights do not necessarily share the same objectives as those of proxy voting in connection with stock ownership. Moreover, according to the commenter, decisions on corporate actions like stock splits, tender offers, exchange offers on bond issues, and mergers and acquisitions are generally not governed by proxy voting policies or undertaken with advice from proxy advisors. For these reasons, the commenter expressed the view that exercise of shareholder rights should not be coupled with proxy voting in the regulation. The Department is not persuaded to make the suggested change. The exercise of shareholder rights has been part of the Department’s prior guidance since at least the first Interpretive Bulletin in 1994. The Department believes that the exercise of shareholder rights to monitor or influence management, which may occur in lieu of, or in connection with, formal proxy proposals is no less important to fiduciary management of the investment asset as proxy voting and accordingly should be covered by the final rule. khammond on DSKJM1Z7X2PROD with RULES2 (b) Paragraph (d)(2) (1) Paragraph (d)(2)(i) Paragraph (d)(2)(i) of the proposal provided that when deciding whether to exercise shareholder rights and when exercising such rights, including the voting of proxies, fiduciaries must carry out their duties prudently and solely in the interests of the participants and beneficiaries and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying the reasonable expenses of administering the plan. Paragraph (d)(2)(i) was proposed without modification from paragraph (e)(2)(i) of the current regulation and is adopted without change. (2) Paragraph (d)(2)(ii) Paragraph (d)(2)(ii) of the proposal set forth specific standards for fiduciaries to VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 meet when deciding whether to exercise shareholder rights and when exercising shareholder rights. It provided that a fiduciary must act solely in accordance with the economic interest of the plan and its participants and beneficiaries (paragraph (d)(2)(ii)(A)) and consider any costs involved (paragraph (d)(2)(ii)(B)). Paragraph (d)(2)(ii) further required that a fiduciary must not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to any other objective, or promote benefits or goals unrelated to the financial interests of the plan’s participants and beneficiaries (paragraph (d)(2)(ii)(C)). The proposal additionally provided that a fiduciary must evaluate material facts that form the basis for any particular proxy vote or other exercise of shareholder rights (paragraph (d)(2)(ii)(D)). Finally, paragraph (d)(2)(ii)(E) of the proposal provided that a fiduciary must exercise prudence and diligence in the selection and monitoring of persons, if any, selected to exercise shareholder rights or otherwise advise on or assist with exercises of shareholder rights, such as providing research and analysis, recommendations regarding proxy votes, administrative services with voting proxies, and recordkeeping and reporting services. Paragraph (d)(2)(ii) of the proposal was based on paragraph (e)(2)(ii) of the current regulation but proposed three significant changes. First, paragraph (d)(2)(ii) of the proposal directly rescinded the statement in paragraph (e)(2)(ii) of the current regulation that ‘‘the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right.’’ Second, proposed paragraph (d)(2)(ii) did not carry forward the current regulation’s specific requirement at paragraph (e)(2)(ii)(E) that, when deciding whether to exercise shareholder rights and when exercising shareholder rights, plan fiduciaries must maintain records on proxy voting activities and other exercises of shareholder rights. Third, paragraph (d)(2)(ii)(E) of the proposal broadened the corresponding provision in the current regulation (paragraph (e)(2)(ii)(F)) in connection with a proposed streamlining of fiduciary selection and monitoring obligations under the current regulation. Specifically, paragraphs (e)(2)(ii)(F) and (e)(2)(iii) of the current regulation both address fiduciary monitoring obligations, with paragraph (e)(2)(ii)(F) covering selection and monitoring of PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 persons selected to advise or otherwise assist with the exercise of shareholder rights, and paragraph (e)(2)(iii) sets out specific monitoring obligations where the authority to vote proxies or exercise shareholder rights has been delegated to an investment manager or a proxy voting firm. The NPRM proposed streamlining this approach by eliminating paragraph (e)(2)(iii) and covering selection and monitoring obligations in a single more general provision (paragraph (d)(2)(ii)(E) of the proposal). Although based on paragraph (e)(2)(ii)(F) of the current regulation, paragraph (d)(2)(ii)(E) of the proposal was broader, and covered obligations related to monitoring service providers such as investment managers and proxy advisory firms that are addressed in paragraph (e)(2)(iii) of the current regulation. (a) Rescission of ‘‘Does Not Require Voting Every Proxy’’ Language From Paragraph (e)(2)(ii) of the Current Regulation The Department proposed to rescind the statement in paragraph (e)(2)(ii) of the current regulation that ‘‘the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right’’ out of a concern that the statement could be misread as suggesting that plan fiduciaries should be indifferent to the exercise of their rights as shareholders, particularly in circumstances where the cost is minimal as is typical of voting proxies. Such indifference could leave plan investments unprotected, as the exercise of shareholder rights is important to ensuring management accountability to the shareholders that own the company. Furthermore, abstaining from a vote is not a neutral act that has no bearing on the outcome of a particular matter put to shareholders for vote; rather, depending on the relevant voting standard under state law and the company’s governing documents, abstention could determine whether a particular matter or proposal is approved. Commenters expressed a range of views with respect to the rescission of the ‘‘does not require voting every proxy’’ language. Multiple commenters supported the rescission, and agreed with the Department’s concerns that the language promotes indifference in managing proxy voting rights. A commenter furthermore cautioned that the language misleadingly signaled to fiduciaries that proxy voting is costly and unimportant. Some commenters expressed the view that the exercise of E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations shareholder rights is key to management accountability and paying attention to governance is as important as financial performance. Other commenters similarly supported rescission based on the view that exercise of shareholder rights, including through proxy voting, is an important tool for managing risk. Some commenters also indicated that the ‘‘does not require voting every proxy’’ language is not necessary in the current regulation because fiduciaries have never believed that ERISA required them to vote all proxies. In particular, commenters pointed to prior nonregulatory guidance which clearly indicated, in the context of foreign stock, that ERISA does not require fiduciaries to vote all proxies.67 Some commenters did not indicate support or opposition to rescission of the ‘‘not required to vote every proxy’’ language, but they cautioned that removal of the language could be misread as indicating that the Department believes that ERISA requires fiduciaries to vote every proxy. These commenters requested confirmation of the Department’s view. Other commenters opposed the rescission and viewed the NPRM as creating a presumption that all proxies should be voted. A commenter stated that many small plans abstain from proxy votes because performing the required due diligence would be inordinately expensive. Several commenters criticized that a presumption that all proxies should be voted will lead fiduciaries to further rely on proxy advisory firms, which they view as potentially harmful to plans because, according to these commenters, proxy advisory firms have conflicts of interest and base their votes on noneconomic ESG policy-driven goals. Some commenters also opposed the rescission because they believe language in the regulation was necessary because some fund managers believed they were obliged to vote proxies on all matters, which resulted either in the fund managers employing significant assets to explore the issues implicated in the matters, or in their relying on proxy advisory services to decide for them how to vote. After considering the comments, the Department has decided to rescind the ‘‘not required to vote every proxy’’ language as proposed. The Department’s longstanding view of ERISA is that proxies should be voted as part of the process of managing the plan’s investment in company stock unless a responsible plan fiduciary determines 67 IB 94–2, 59 FR 38864; IB 2016–01, 81 FR 95882. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 voting proxies may not be in the plan’s best interest (e.g., in cases when voting proxies may involve exceptional costs or unusual requirements, such as in the case of voting proxies on shares of certain foreign corporations).68 This position recognizes the importance that prudent management of shareholder rights can have in enhancing the value of plan assets or protecting plan assets from risk. However, as explained in the preamble to the NPRM, the removal of the language is not meant to indicate that fiduciaries must always vote proxies or engage in shareholder activism.69 Prudent fiduciaries should take steps to ensure that the cost and effort associated with voting a proxy is commensurate with the significance of an issue to the plan’s financial interests. The solution to proxy-voting costs is not abstention, but is, instead, for the fiduciary to be prudent in incurring expenses to make proxy decisions and, wherever possible, to rely on efficient structures (e.g., proxy voting guidelines, proxy advisors/managers that act on behalf of large aggregates of investors, etc.). With regard to commenters’ concerns about fiduciaries’ reliance on proxy advisory firms, the Department notes that, as discussed below, the final rule retains requirements relating to the prudent selection and monitoring of services providers to advise or assist with the exercise of shareholder rights. In order to satisfy that provision, fiduciaries would be expected to assess the qualifications of the provider, the quality of services offered, and the reasonableness of fees charged in light of the services provided. A fiduciary’s process also should be designed to 68 81 FR 95879, 81 (‘‘The essential point of IB 94– 2, however, was to articulate a general principle that a fiduciary’s obligation to manage plan assets prudently extends to proxy voting. As such, IB 94– 2 properly read was meant to express the view that proxies should be voted as part of the process of managing the plan’s investment in company stock unless a responsible plan fiduciary determined that the time and costs associated with voting proxies with respect to certain types of proposals or issuers may not be in the plan’s best interest.’’). See also IB 94–2, 59 FR 38861, 63 (July 29, 1994) (‘‘The fiduciary obligations of prudence and loyalty to plan participants and beneficiaries require the responsible fiduciary to vote proxies on Issues that may affect the value of the plan’s investment. Although the same principles apply for proxies appurtenant to shares of foreign corporations, the Department recognizes that in voting such proxies, plans may, in some cases, incur additional costs. Thus, a fiduciary should consider whether the plan’s vote, either by itself or together with the votes of other shareholders, is expected to have an effect on the value of the plan’s investment that will outweigh the cost of voting. Moreover, a fiduciary, in deciding whether to purchase shares of a foreign corporation, should consider whether the difficulty and expense in voting the shares is reflected in their market price.’’). 69 86 FR 57281. PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 73845 avoid self-dealing, conflicts of interest or other improper influence.70 Fiduciaries additionally should take steps to ensure they are fully informed of potential conflicts of proxy advisory firms and the steps such firms have taken to address them.71 To the extent relevant, fiduciaries should review the proxy voting policies and proxy voting guidelines and the implementing activities of the person being selected. If a fiduciary determines that the recommendations and other activities of such person are not being carried out in a manner consistent with those policies and/or guidelines, then the fiduciary should take appropriate action in response. The Department further notes that in 2020, the U.S. Securities and Exchange Commission adopted final rules that were intended to help ensure that investors who use proxy voting advice receive more transparent, accurate, and complete information on which to make their voting decisions.72 Information required to be provided pursuant to those final rules also may be useful to responsible plan fiduciaries relying on recommendations from proxy advisory firms. (b) Removal of Specific Recordkeeping Requirement From Paragraph (e)(2)(ii)(E) of the Current Regulation The Department proposed to eliminate the requirement in paragraph (e)(2)(ii)(E) of the current regulation that, when deciding whether to exercise shareholder rights and when exercising shareholder rights, plan fiduciaries must maintain records on proxy voting activities and other exercises of shareholder rights. The Department was concerned that the provision appeared to treat proxy voting and other exercises of shareholder rights differently from other fiduciary activities and might create a misperception that proxy voting and other exercises of shareholder rights are disfavored or carry greater fiduciary obligations, and therefore greater potential liability, than other fiduciary activities. Such a misperception could be harmful to plans, as it could potentially chill plan fiduciaries from exercising their right or result in 70 See 85 FR 81669; see also Department of Labor Information Letter to Diana Orantes Ceresi (Feb. 19, 1998). 71 See ‘‘Selecting and Monitoring Pension Consultants—Tips for Plan Fiduciaries’’ https:// www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/ our-activities/resource-center/fact-sheets/selectingand-monitoring-pension-consultants.pdf. 72 See Exemptions from the Proxy Rules for Proxy Voting Advice, Release No. 34–89372 (July 22, 2020), 85 FR 55082 (Sept. 3, 2020). In July 2022, the SEC amended these final rules. See 87 FR 43168 (July 19, 2022). E:\FR\FM\01DER2.SGM 01DER2 73846 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 excessive expenditures as fiduciaries over-document their efforts. Some commenters supported removal of the recordkeeping provision, echoing the Department’s concerns stated in the preamble to the NPRM. Several commenters believed there was no need to single out proxy voting for special recordkeeping requirements. Some commenters criticized the recordkeeping requirement as creating a misperception that exercising shareholder rights carry a greater fiduciary obligation than other fiduciary activities and a heightened burden when exercised, which might cause fiduciaries to shy away from exercising shareholder rights or incur unnecessary compliance expenses when doing so. A commenter criticized the specific recordkeeping requirement as creating a new barrier and extra expense, without justification. Several commenters were of the view that the general framework of ERISA is sufficient to govern the recordkeeping requirements for proxy voting. Other commenters opposed removal of the documentation requirement and suggested that it be retained in the regulation. A commenter indicated that removing the documentation provision deprives participants and beneficiaries of information they may use to evaluate whether fiduciaries are acting in their best interest for their exclusive benefit. Another commenter similarly suggested that eliminating the requirement impedes the ability of participants to monitor plan fiduciaries. Another commenter further opined that enhanced documentation would help to ensure that ERISA plan proxies are being voted only in a manner that is in the articulable financial interest of plan beneficiaries. The Department is not persuaded by commenters to retain the specific recordkeeping provision. The Department does not disagree with the need for proper documentation of fiduciary activity. To the contrary, in previous guidance on proxy voting, the Department indicated that section 404(a)(1)(B) requires proper documentation both of the activities of the investment manager and of the named fiduciary of the plan in monitoring the activities of the investment manager.73 Specifically, 73 See Letter to Helmuth Fandl, Chairman of the Retirement Board, Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988) (‘‘[I]t is the opinion of the Department that section 404(a)(1)(B) requires proper documentation of the activities of the investment manager and of the named fiduciary of the plan in monitoring the activities of the investment manager. Specifically, with respect to proxy voting, this would require the investment manager or other VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 with respect to proxy voting, this would require the investment manager or other responsible fiduciary to keep accurate records as to the voting of proxies. It is the Department’s view that in order for the named fiduciary to carry out the fiduciary’s responsibilities under ERISA section 404(a), the fiduciary must be able to review periodically not only the voting procedure pursuant to which the investment manager votes the proxies appurtenant to plan-owned stock, but also the actions taken in individual situations so that a determination can be made whether the investment manager is fulfilling their fiduciary obligations in a manner which justifies the continuation of the management appointment. In context, however, the Department takes note of, and to a large extent agrees with, the commenters’ concern that the current regulation could be viewed by some as treating proxy voting and other exercises of shareholder rights differently from other fiduciary activities and may create a misperception that proxy voting and other exercises of shareholder rights are disfavored or carry greater fiduciary obligations, and therefore greater potential liability, than other fiduciary activities. Because this misperception could be harmful to plans, as it could potentially chill plan fiduciaries from exercising their rights or result in excessive expenditures as fiduciaries over-document their efforts, the Department has concluded it is appropriate to rescind this provision in the current regulation. (c) Removal of Specific Monitoring Requirement From Paragraph (e)(2)(iii) of the Current Regulation As discussed above, the Department proposed to eliminate paragraph (e)(2)(iii) of the current regulation, which set out specific monitoring obligations where the authority to vote proxies or exercise shareholder rights has been delegated to an investment manager or proxy voting firm and responsible fiduciary to keep accurate records as to the voting of proxies.’’); see also Interpretive Bulletin IB 94–2 (July 29, 1994) 59 FR 38860, 63 (‘‘It is the view of the Department that compliance with the duty to monitor necessitates proper documentation of the activities that are subject to monitoring. Thus, the investment manager or other responsible fiduciary would be required to maintain accurate records as to proxy voting. Moreover, if the named fiduciary is to be able to carry out its responsibilities under ERISA § 404(a) in determining whether the investment manager is fulfilling its fiduciary obligations in investing plans assets in a manner that justifies the continuation of the management appointment, the proxy voting records must enable the named fiduciary to review not only the investment manager’s voting procedure with respect to plan-owned stock, but also to review the actions taken in individual proxy voting situations.’’). PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 proposed to broaden another provision of the regulation that more generally covers selection and monitoring obligations (paragraph (d)(2)(ii)(E) of the proposal). The Department was concerned that the more specific provision relating to providers of certain proxy-related services could be read as creating special monitoring obligations above and beyond the statutory obligations of prudence and loyalty that generally apply to monitoring service providers. In this regard, the Department noted that it had previously indicated in Interpretive Bulletin 2016– 01 that the general prudence and loyalty duties under ERISA section 404(a)(1) require a fiduciary to monitor decisions made and actions taken by an investment manager with regard to proxy voting decisions. In addition, the Department had previously indicated that in adopting paragraph (e)(2)(iii) of the current regulation it did not intend to create a higher standard for a fiduciary’s monitoring of an investment manager’s proxy voting activities than would ordinarily apply under ERISA with respect to the monitoring of any other fiduciary or fiduciary activity.74 Some commenters agreed with the Department’s proposed elimination of paragraph (e)(2)(iii) of the current regulation. One commenter opined that the specific monitoring requirement in that provision largely duplicated the general obligation in current paragraph (e)(2)(ii)(F), which the commenter viewed as redundant and suggestive that monitoring proxy-related services demand more rigor than required to monitor other service providers. Other commenters similarly observed that the current regulation’s specific monitoring requirement may have created an impression that there are special obligations above and beyond the statutory obligations of prudence and loyalty that generally apply to monitoring service providers with respect to proxy voting. Some commenters noted that ERISA’s general prudence and loyalty duties already impose a monitoring requirement on fiduciaries, and further expressed the view that monitoring service providers with respect to proxy voting is no different from other fiduciary obligations and should be subject to the 74 85 FR 81670 (‘‘The Department did not intend to create a higher standard for a fiduciary’s monitoring of an investment manager’s proxy voting activities than would ordinarily apply under ERISA with respect to the monitoring of any other fiduciary or fiduciary activity. Thus, the Department has revised the provision in the final rule to eliminate the requirement for documentation of the rationale for proxy voting decisions, and instead replaced it with a more general monitoring obligation.’’). E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations same standards. A commenter asserted that there is no basis for heightened monitoring responsibilities when a fiduciary uses the services of a proxy advisory firm, and specifically disagreed with assertions contained in the preamble to the 2020 rule that proxy advisors are prone to factual and/or analytic errors. Other commenters opposed the elimination of the specific monitoring requirement. A commenter viewed it as reasonable and justified to single out delegated voting authority as particularly deserving of due diligence and prudent monitoring. This commenter believed it appropriate for the regulation to remind fiduciaries of their obligations. Another commenter suggested that the specific monitoring requirement was necessary to protect plan participants. According to the commenter, proxy advisory firms are insufficiently staffed and otherwise illsuited to conduct the sort of research required under fiduciary law, and demonstrate a history of advising on self-interested and politically motivated grounds instead of on purely financial interests. In this commenter’s view, when fund managers rely on the recommendations of these firms, they may commit a violation of their duty of care. Another commenter cautioned that removal of the specific monitoring requirement may create confusion because it would remove the detailed standards fiduciaries must follow when monitoring the proxy voting of investment managers and proxy advisory firms. The Department is not persuaded by the public comments to retain the specific monitoring provision in paragraph (e)(2)(iii) of the current regulation. Despite the Department’s explicit indication, described above, that paragraph (e)(2)(iii) of the current regulation was not intended to create a higher standard in monitoring proxy voting activities of parties delegated such responsibilities, commenters continue to express concerns that paragraph (e)(2)(iii) of the current regulation suggests such heightened obligations. The Department believes it appropriate to resolve lingering doubts by eliminating paragraph (e)(2)(iii) of the current regulation, and broadening paragraph (d)(2)(ii)(E) of the final rule, which sets forth general selection and monitoring obligations, to additionally cover selection and monitoring of any person selected to exercise shareholder rights. The Department believes paragraph (d)(2)(ii)(E) is sufficient to remind fiduciaries of their responsibilities in selecting and monitoring persons selected to exercise VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 shareholder rights, and is sufficient to protect the interests of plan participants and beneficiaries. With respect to concerns that removal of paragraph (e)(2)(iii) of the current regulation would eliminate detailed standards that fiduciaries must follow in monitoring the proxy voting of investment managers and proxy advisory firms, the Department notes that paragraph (e)(2)(iii) of the current regulation merely references monitoring activities relating to shareholder rights for consistency with the regulation. In the Department’s view, a fiduciary’s obligations with respect to monitoring a service provider would include measures to ascertain the service provider’s compliance with ERISA and the terms of the plan. (d) Provisions of Paragraph (d)(2)(ii) of the Final Rule Paragraph (d)(2)(ii) of the final rule, like the NPRM and the current regulation, sets forth specific standards for fiduciaries to meet when deciding whether to exercise shareholder rights and when exercising shareholder rights. The requirements in paragraphs (d)(2)(ii)(A) through (E) of the final rule are intended to confirm and restate what the prudence and loyalty obligations of ERISA section 404(a)(1)(A) and (B) would require in this context. Paragraph (d)(2)(ii)(A) of the final rule is the same as proposed except for a change in cross-reference to paragraph (b)(4). It provides that a fiduciary must act solely in accordance with the economic interest of the plan and its participants and beneficiaries, in a manner consistent with paragraph (b)(4) of the final rule. A commenter requested confirmation of statements in prior nonregulatory guidance that in deciding whether to vote a proxy the fiduciary should determine whether ‘‘the plan’s vote, either by itself or together with the votes of other shareholders, is expected to have an effect on the value of the plan’s investment that warrants the additional cost of voting.’’ 75 In the commenter’s view, without such confirmation, the ‘‘solely in the interest’’ requirement of paragraph (d)(2)(ii)(A) may limit plan voting where a plan holds a relatively small investment that, on its own, might not affect the outcome of a vote. In response, the Department confirms that in making decisions regarding the exercise of a plan’s shareholder rights, a fiduciary’s analysis may include consideration of the effects of the plan’s exercise, either by itself or together with 75 Interpretive Bulletin 2016–01, 81 FR 95882 at 95883. PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 73847 the exercise of rights of other shareholders. Paragraph (d)(2)(ii)(B) of the final rule is adopted as proposed. It requires that when deciding whether to exercise shareholder rights and when exercising shareholder rights, a fiduciary must consider any costs involved. The Department received no comments on this provision. Paragraph (d)(2)(ii)(C) of the proposal provided that a fiduciary must not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to any other objective, or promote benefits or goals unrelated to those financial interests of the plan’s participants and beneficiaries. A commenter suggested deleting the clause ‘‘or promote benefits or goals unrelated to those of financial interests of the plan’s participants and beneficiaries’’ from paragraph (d)(2)(ii)(C). The commenter reasoned that where a particular exercise of a shareholder right would not directly affect shareholder value, the language could be read to prohibit such exercise. Another commenter with the same request explained that the deletion would clarify that fiduciaries are not required to undertake a burdensome economic analysis before voting proxies. This commenter opined that in some cases, it may be even less expensive to cast the vote than speculate whether the vote in question ‘‘promotes’’ benefits or goals unrelated to those financial interests of the plan’s participants and beneficiaries. Both commenters opined that voting under these circumstances would be allowed under a tiebreaker standard. Other commenters raised concerns regarding increased potential for litigation more generally and requested that the Department factor that potential into all decisions under the final regulation; in this context, that concern might present as a dispute over whether and the extent to which any particular vote was an affirmative ‘‘promotion’’ of an impermissible goal as opposed to a vote on a matter the outcome of which might confer an ancillary benefit on a stakeholder other than the plan. The Department was persuaded by the commenters’ suggestion to remove the clause from paragraph (d)(2)(ii)(C). On review, the Department has concluded that the clause at issue serves no independent function, in terms of adding protections to plan participants, that is not already served by paragraph (d)(2)(ii)(A) (requirement to act ‘‘solely in accordance with the economic interests of the plan’’) and the first clause of paragraph (d)(2)(ii)(C) E:\FR\FM\01DER2.SGM 01DER2 73848 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations (requirement ‘‘not to subordinate the interests of participant and beneficiaries in their retirement income or financial benefits under the plan to any other objectives’’) of the final rule. In addition to being unnecessary, as pointed out by the commenters, the clause is easily misconstrued as suggesting or implying an affirmative duty on plan fiduciaries, above and beyond those duties contained in the other two paragraphs already mentioned, that requires the fiduciaries to do something further to investigate and ensure that their votes or other exercises do not promote objectives or goals unrelated the financial interests of the plan, or perform an analysis of each vote’s benefit. The Department sees no reason to impose such additional duties, with their attendant costs and potential for litigation, when the other two provisions mentioned are fully adequate to protect the interests of plan participants. The purpose of the clause was to ensure that a fiduciary does not exercise proxy voting and other shareholder rights with the goal of advancing nonpecuniary goals unrelated to the financial interests of the plan’s participants and beneficiaries so long as it does not result in increased costs to the plan or a decrease in value of the investment.76 This clause thus dovetailed with a longstanding position of the Department that ERISA prohibits plan fiduciaries from expending trust assets to promote myriad public policy preferences.77 The final rule’s removal of the clause at issue does not constitute a rejection of this principle. However, with respect to the concern that the fiduciary must determine that an exercise of shareholder rights would directly affect shareholder value, the Department’s historical view has been that ERISA’s fiduciary obligations of prudence and loyalty require the responsible fiduciary to vote proxies on issues that may affect the value of the plan’s investment.78 With respect to the commenters referring to the tiebreaker test, although that test is not applicable in this context, the Department further notes that when a plan fiduciary 76 85 FR 816658, 67 (Dec. 16, 2020). FR 95879, 81 (Dec. 29, 2016) (preamble to IB 2016–01) (‘‘The Department has rejected a construction of ERISA that would render ERISA’s tight limits on the use of plan assets illusory and that would permit plan fiduciaries to expend trust assets to promote myriad public policy preferences. Rather, plan fiduciaries may not increase expenses, sacrifice investment returns, or reduce the security of plan benefits in order to promote collateral goals.’’); Advisory Opinion Nos. 2008–05A (June 27, 2008) and 2007–07A (Dec. 21, 2007). 78 See Interpretive Bulletin 94–2, 59 FR 38860; Interpretive Bulletin 2016–01, 81 FR 95879. khammond on DSKJM1Z7X2PROD with RULES2 77 81 VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 exercises voting authority, a violation of paragraph (d)(2)(ii)(C) of the final rule would not occur merely because stakeholders other than the plan would potentially benefit along with the investing plan. Paragraph (d)(2)(ii)(D) of the final rule requires that when deciding whether to exercise shareholder rights and when exercising shareholder rights, a fiduciary must evaluate relevant facts that form the basis for any particular proxy vote or other exercise of shareholder rights. The provision is the same as proposed, except that the Department has substituted the term ‘‘relevant’’ for ‘‘material’’ for purposes of consistency throughout the regulation, as discussed above. Paragraph (d)(2)(ii)(E) of the final rule is being adopted as proposed, and requires that a fiduciary must exercise prudence and diligence in the selection and monitoring of persons, if any, chosen to exercise shareholder rights or otherwise to advise on or assist with exercises of shareholder rights, such as providing research and analysis, recommendations regarding proxy votes, administrative services with voting proxies, and recordkeeping and reporting services. As discussed above, this provision covered obligations that were set forth in paragraphs (e)(2)(ii)(F) and (e)(2)(iii) of the current regulation. The provision is essentially a restatement of the general fiduciary obligations that apply to the selection and monitoring of plan service providers, articulated in the context of fiduciary and other service providers that exercise shareholder rights, or advise or assist with exercises of shareholder rights. A commenter requested that the Department delete the list of services— ‘‘research and analysis, recommendations regarding proxy votes, administrative services with voting proxies, and recordkeeping and reporting services’’—from the provision. The commenter was concerned that codifying an itemized list of duties that, according to the commenter, fiduciaries routinely delegate to investment managers and proxy voting firms may cause confusion or uncertainty over regulatory expectations regarding any delegation of these fiduciary responsibilities to a third party. The Department has not accepted this comment, and notes that this paragraph is focused on fiduciary duties of prudence and loyalty under ERISA section 404(a)(1)(A) and (B) in the selection and monitoring of particular service providers, and is not attempting to limit in any way the types of services that a plan or plan fiduciary may utilize PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 in connection with exercising shareholder rights. Another commenter requested that the Department clarify that fiduciaries are not required to monitor every proxy vote or second-guess other fiduciaries’ specific proxy voting decisions, unless the fiduciary knows or should know the designated fiduciary is violating ERISA with their proxy voting procedures. Whether a fiduciary has complied with its obligations under paragraph (d)(2)(ii)(E) depends on the surrounding circumstances. The Department does not believe that a fiduciary would generally be required to monitor each vote or second-guess other fiduciaries’ decisions. To the extent applicable, a fiduciary would be expected to review the proxy voting policies and/or proxy voting guidelines and the implementing activities of the person being selected to exercise votes. If a fiduciary determines that the activities of such person are not being carried out in a manner consistent with those policies and/or guidelines, then the fiduciary will be expected to take appropriate action in response.79 (3) Paragraph (d)(2)(iii) Paragraph (d)(2)(iii) of the proposal stated that a fiduciary may not adopt a practice of following the recommendations of a proxy advisory firm or other service provider without a determination that such firm or service provider’s proxy voting guidelines are consistent with the fiduciary’s obligations described in provisions of the regulation. This provision was based on paragraph (e)(2)(iv) of the current regulation, which was intended to address specific concerns involving fiduciaries’ use of proxy advisory firms and similar service providers, including use of automatic voting mechanisms relying on proxy advisory firms. Some commenters viewed paragraph (d)(2)(iii) as largely unnecessary because, in their view, a fiduciary’s review of a service provider’s proxy voting guidelines would already be required as part of the fiduciary’s compliance with ERISA’s prudence and loyalty requirements in the selection of a service provider. Some commenters moreover cautioned that paragraph (d)(2)(iii) could be construed as suggesting that monitoring proxy-related services demands more rigor than required to monitor other service providers. A commenter noted that the provision requires a specific determination when a fiduciary ‘‘adopts a practice of following the recommendations of a proxy advisory firm or other service provider,’’ and thus 79 See E:\FR\FM\01DER2.SGM 85 FR 81669. 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 would establish an additional vague and heightened burden that is unnecessary and a potential deterrent to informed, responsible shareholder engagement. Other commenters viewed the provisions as necessary. One commenter opined that it is crucial that ERISA fiduciaries have a full understanding of the proxy advisory firm’s guidelines and recommendations before relying on their advice. In this commenter’s view, robo-voting presents clear risks to participants given proxy advisory firms’ one-size-fits-all policies. Another commenter expressed the view that evaluation of climate risks is extremely difficult, and criticizes proxy advisors as not being particularly well-suited to perform climate analysis. Furthermore, as described above, a number of other commenters expressed concerns about proxy advisory firms’ conflicts and quality of services. In proposing paragraph (d)(2)(iii), the Department did not propose to make any changes to requirements contained in the corresponding provision of the current regulation, paragraph (e)(2)(iii). The Department is not persuaded that any of the requirements should be eliminated or otherwise modified. We note that paragraph (d)(2)(iii) deals with a fiduciary’s process for making proxy voting decisions (i.e., the reliance on recommendations or advice from a service provider) and does not touch on the fiduciary’s obligations with regard to the selection and monitoring of the service providers used. The provision relates to oversight obligations of fiduciaries that essentially automatically rely on a service provider in carrying out the fiduciary’s own obligations.80 We do not believe that potential misunderstandings as to fiduciary monitoring obligations with respect to providers of proxy-related services, which is addressed in paragraph (d)(2)(ii)(E) of the final rule, is sufficient to justify modification or elimination of paragraph (d)(2)(iii). As a result, paragraph (d)(2)(iii) is being adopted without change. (c) Paragraph (d)(3) In recognition of the appropriateness of ERISA fiduciaries’ adoption of proxy voting policies to help them more cost effectively comply with their obligations under ERISA and the regulation, paragraph (d)(3) of the proposal carried forward from the current regulation general provisions relating to the adoption of proxy voting policies. The proposal did not, however, carry forward from the current regulation two ‘‘safe harbor’’ policies that could be 80 85 FR 81671. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 used for satisfying the fiduciary responsibilities under ERISA with respect to decisions whether to vote. The first permitted a policy of limiting voting resources to particular types of proposals that the fiduciary has prudently determined are substantially related to the issuer’s business activities or are expected to have a material effect on the value of the investment. The second permitted a policy of not voting on proposals or particular types of proposals when the plan’s holding in a single issuer relative to the plan’s total investment assets is below a quantitative threshold that the fiduciary prudently determines, considering its percentage ownership of the issuer and other relevant factors, is sufficiently small that the matter being voted upon is not expected to have a material effect on the investment performance of the plan’s portfolio. The Department proposed rescinding these safe harbors because it lacked confidence that they were necessary or helpful in safeguarding the interests of plan participants and beneficiaries. The Department also was concerned that, in conjunction with other provisions in the current regulation, the safe harbors could be construed as regulatory permission for plans to broadly abstain from proxy voting without properly considering their interests as shareholders. (1) Rescission of Safe Harbors From Paragraphs (e)(3)(i)(A) and (B) of the Current Regulation The Department received a range of comments on the proposed rescission of the safe harbor policies. Some commenters agree with the Department’s general concern that, by their nature safe harbors can invite adoption, which makes it important that the safe harbors be in participants’ best interest. In this regard, some commenters generally asserted that the safe harbors may encourage fiduciaries to limit their proxy voting in ways that harm participants and beneficiaries. Also, without identifying a particular safe harbor, some commenters asserted that the proxy voting rule adopted in 2020 provided no justification as to how the safe harbors were consistent with ERISA’s duties of loyalty and prudence. Another commenter opined that because a decision by an ERISA plan to not vote effectively cedes voting power to other shareholders, it should only be permitted on a case-by-case basis rather than pursuant to a general safe harbor to refrain from voting. One commenter opined that neither safe harbor was particularly helpful, and there is little evidence that a material number of PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 73849 fiduciaries are currently relying on them. Another commenter cautioned that the safe harbor provisions could be interpreted as best-practice and encourage shareholders to follow those examples, instead of their established practices in line with stated investment policies and obligations under ERISA. Commenters also raised specific concerns on the safe harbors. With respect to the first safe harbor, a commenter expressed the view that a policy to vote only particular types of proposals, depending on the scope of the policy, may be too limited to capture all relevant proposals. Another commenter criticized the first safe harbor as being based on an unsupported premise that certain types of proxy votes are not substantially related to the issuer’s business activities or are expected to have a material effect on the value of the investment. The commenter noted that many of the topics that corporate law permits shareholders to have a say on—e.g., election of directors or ratification of auditors—play an important risk mitigation role, and asserted that these types of issues are often prophylactic and do not readily lend themselves to an analysis of whether they will lead to a material effect on the value of a plan investment. The commenter cautioned that the first safe harbor encouraged fiduciaries to pass on these and other proxy matters, and thus created a genuine risk to plan participants’ longterm interests. With respect to the second safe harbor, a commenter expressed concern that a policy to refrain from voting unless the plan holds a concentrated position in a company suggests that diversified investors, such as plan fiduciaries, should not have a voice in corporate decisions. Another commenter asserted that the second safe harbor was never fully explained or substantiated, and viewed it as being premised on the notion that not voting at most, or perhaps all, meetings a plan would be entitled to vote at would be in the best interest of participants. Other commenters neither supported nor opposed elimination of the safe harbors, but emphasized that proxy voting policies in general are useful to fiduciaries in making proxy voting decisions. One commenter requested confirmation from the Department that removal of the safe harbors from the regulation would not preclude, and should not be interpreted as discouraging, the adoption of such policies in appropriate circumstances. The commenter indicated that for many types of investment strategies, limiting voting resources, for example, to those E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 73850 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations matters that are expected to have a material effect on the value of the investment is the prudent course of action. According to the commenter, in other cases adopting a policy to refrain from voting on proposals, or particular types of proposals, based on a prudently determined quantitative threshold could be in the best interest of plan participants and beneficiaries. Other commenters opposed rescission of the safe harbors. A commenter stated that the safe harbors appropriately recognized instances in which proxy voting would not be expected to have economic effect. The commenter cautioned that without the safe harbors, fiduciaries find the path of least resistance in hiring proxy advisory firm to vote all proxies, which would result in promoting ESG policies and raising a variety of concerns regarding proxy advisory firms, as discussed above. After considering the public comments, the Department is not persuaded to retain the safe harbors. Taken together, they encourage abstention as the normal course. Regulatory safe harbors tend to be widely adopted and the Department no longer believes it should be promoting abstention with these safe harbors. The Department has never taken the position that ERISA requires fiduciaries to cast a proxy vote on every ballot item. Thus, it follows that abstention or not voting on a matter or matters may be appropriate and not a violation of ERISA, from the Department’s perspective. Voting rights, however, are a type of plan asset and, in the Department’s view, an important tool to protect the plan’s investment. The Department’s longstanding view of ERISA is that proxies should be voted as part of the process of managing the plan’s investment in company stock unless a responsible plan fiduciary determines voting proxies may not be in the plan’s best interest (e.g., in cases when voting proxies may involve out of the ordinary costs or unusual requirements, such as in the case of voting proxies on shares of certain foreign corporations).81 This position recognizes the importance that prudent management of shareholder rights can have in enhancing the value of plan assets or protecting plan assets from risk. Finally, as to commenters’ concerns about reliance on proxy advisory firms and quality of their services, the final rule also retains requirements relating to the prudent selection and monitoring of service 81 81 FR 95879, 81. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 providers to advise or assist with the exercise of shareholder rights. (2) Provisions of Paragraph (d)(3) of the Final Rule Paragraph (d)(3)(i) of the proposal provided that in deciding whether to vote a proxy pursuant to paragraphs (d)(2)(i) and (ii) of the proposal, fiduciaries may adopt proxy voting policies providing that the authority to vote a proxy shall be exercised pursuant to specific parameters prudently designed to serve the plan’s interest in providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan. Proposed paragraph (d)(3)(i) was based on paragraph (e)(3)(i) of the current regulation, but as discussed above did not retain the current regulation’s two safe harbor proxy voting policies. Several commenters expressed general support for the Department’s recognition of the usefulness of proxy voting policies to fiduciaries. However, the Department did not receive substantive comment on this provision of the proposal, and it is being adopted without substantive modification.82 Paragraphs (d)(3)(ii) of the proposal required plan fiduciaries to periodically review proxy voting policies adopted pursuant to the regulation. The Department received no comments on this provision of the proposal, and it is being adopted without modification. Paragraph (d)(3)(iii) of the proposal related to the effect of proxy voting policies adopted pursuant to the regulation, and provided that no proxy voting policies adopted pursuant to paragraph (d)(3)(i) shall preclude submitting a proxy vote when the fiduciary prudently determines that the matter being voted upon is expected to have a material effect on the value of the investment or the investment 82 Paragraph (d)(3)(iii) of the final rule uses the term ‘‘significant effect on the value of the investment’’ rather than ‘‘material’’ effect. No substantive change is intended by the revision as the Department believes that ‘‘significant’’ is generally the same as the adjective ‘‘material’’ in this context. The Department recognized this similarity in the preamble to the current regulation, but erroneously concluded then that the term ‘‘material’’ would be more familiar and helpful to ERISA plan fiduciaries. 85 FR 81658, 72 (December 16, 2020). However, as discussed above at section B1.(f) (4) of this preamble, commenters on the NPRM did not agree that the word ‘‘material’’ is a helpful term in this regulatory section because of its varied uses and meanings under accounting conventions, Federal securities laws, and other regulatory regimes. Compare note 44 (in other contexts, the final regulation substitutes ‘‘material’’ with ‘‘relevant,’’ but that adjective does not work well here where the focus is on the size of the impact of one thing on another thing as opposed to the closeness of connection between two things). PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 performance of the plan’s portfolio (or investment performance of assets under management in the case of an investment manager) after taking into account the costs involved, or refraining from voting when the fiduciary prudently determines that the matter being voted upon is not expected to have such a material effect after taking into account the costs involved. This provision recognized that, depending on the circumstances, a fiduciary may conclude that the best interests of the plan and its participant and beneficiaries would not be served by following the plan’s proxy voting policies in a particular case. In such cases, paragraph (d)(3)(iii) of the proposal ensured that a fiduciary have the needed flexibility to deviate from those policies and take a different approach. The Department received no substantive comments on this provision of the proposal, and it is being adopted without modification. One commenter requested clarification that fiduciaries are not required by this provision to conduct an analysis of each proxy vote to determine whether a fiduciary needs to deviate from the proxy voting policies. The commenter misapprehends the nature of the provision. The provision does not speak, directly or indirectly, to voting frequency or establish obligations with respect to the question of whether or how often plan fiduciaries should be voting proxies. The provision seeks to ensure that plan fiduciaries may safely deviate from the generally governing written instruments as may be needed from time-to-time in circumstances when doing so is in the best economic interest of plan participants. In this way, the provision shields a fiduciary from liability to the extent that a fiduciary deviates from written policies based on the fiduciary’s conclusion that a different approach in a particular case is in the economic interests of the plan considering the facts and circumstances. (d) Paragraph (d)(4) Paragraphs (d)(4)(i) and (ii) of the proposal, like paragraphs (e)(4)(i) and (ii) of the current regulation, reflect longstanding positions expressed in the Department’s prior Interpretive Bulletins. (1) Paragraph (d)(4)(i) Paragraph (d)(4)(i)(A) of the proposal stated that the responsibility for exercising shareholder rights lies exclusively with the plan trustee except to the extent that either the trustee is subject to the directions of a named fiduciary pursuant to ERISA section 403(a)(1), or the power to manage, E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 acquire, or dispose of the relevant assets has been delegated by a named fiduciary to one or more investment managers pursuant to ERISA section 403(a)(2). Paragraph (d)(4)(i)(B) of the proposal stated that where the authority to manage plan assets has been delegated to an investment manager pursuant to ERISA section 403(a)(2), the investment manager has exclusive authority to vote proxies or exercise other shareholder rights appurtenant to such plan assets in accordance with this section, except to the extent the plan, trust document, or investment management agreement expressly provides that the responsible named fiduciary has reserved to itself (or to another named fiduciary so authorized by the plan document) the right to direct a plan trustee regarding the exercise or management of some or all of such shareholder rights. A commenter indicated that an increasing number of ERISA plan fiduciaries may choose to retain the ability to instruct the plan’s trustee or investment manager to implement a proxy voting policy chosen by the plan fiduciary. The commenter requested that the Department add to paragraph (d)(4)(i)(B) language stating that a named fiduciary may direct an investment manager regarding the exercise or management of shareholder rights. The Department declines to adopt this commenter’s request. In the Avon Letter, discussed above, the Department cautioned that ERISA contains no provision that would relieve an investment manager of fiduciary liability for any decision it made at the direction of another person. The commenter did not indicate whether it was requesting a reconsideration of this aspect of the Avon Letter, or guidance on different issues or arrangements than considered in the Avon Letter. In any event, an evaluation of issues related to the direction of a fiduciary investment manager by another person implicates provisions of ERISA, including sections 402, 403, and 405, that are beyond the scope of this rulemaking. (2) Paragraph (d)(4)(ii) Paragraph (d)(4)(ii) of the proposal described obligations of an investment manager of a pooled investment vehicle that holds assets of more than one employee benefit plan. The provision provides that an investment manager of such a pooled investment vehicle may be subject to an investment policy statement that conflicts with the policy of another plan. Furthermore, it provided that compliance with ERISA section 404(a)(1)(D) requires the investment manager to reconcile, insofar as possible, the conflicting policies VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 (assuming compliance with each policy would be consistent with ERISA section 404(a)(1)(D)).83 The provision further stated that, in the case of proxy voting, to the extent permitted by applicable law, the investment manager must vote (or abstain from voting) the relevant proxies to reflect such policies in proportion to each plan’s economic interest in the pooled investment vehicle. The provision further provided that such an investment manager may, however, develop an investment policy statement consistent with Title I of ERISA and the regulation, and require participating plans to accept the investment manager’s investment policy statement, including any proxy voting policy, before they are allowed to invest. In such cases, a fiduciary must assess whether the investment manager’s investment policy statement and proxy voting policy are consistent with Title I of ERISA and the regulation before deciding to retain the investment manager. The Department received a number of comments indicating generally that investment managers of pooled funds would face operational challenges in reconciling conflicting proxy voting policies of investing plans and voting in a proportional manner, as described in the beginning of proposed paragraph (d)(4)(ii). Commenters indicated that because of these challenges, most investment managers of pooled investments require investing plans to accept the investment manager’s policy, which is also contemplated in the latter portions of proposed paragraph (d)(4)(ii). Some commenters suggested that paragraph (d)(4)(ii) could be improved by placing more emphasis on the current common practices that do not require proportional voting (i.e., where investment managers require plans’ acceptance of the managers’ proxy voting policies prior to investment), and less emphasis on arrangements that require proportional voting, which these commenters believe is rare. Some commenters requested that the Department broaden proposed paragraph (d)(4)(ii). One commenter requested modification to address the possibility that the responsible named fiduciary may choose to retain the authority to vote proxies or to direct an 83 Section 404(a)(1)(D) of ERISA provides that a fiduciary must discharge its duties with respect to the plan in accordance with the documents and instruments governing the plan insofar as such documents are consistent with the provisions of title I and title IV of ERISA. Under section 404(a)(1)(D), a fiduciary to whom an investment policy applies would be required to comply with such policy unless, for example, it would be imprudent to do so in a given instance. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 73851 investment manager regarding the voting of proxies appurtenant to those plan assets that are invested in a pooled investment vehicle. Other commenters requested that the Department extend the provision to separately-managed accounts that are managed by investment managers. This suggestion appears to be based on the common practice of investment managers in single-plan separate account arrangements requiring that plans accept the managers’ proxy voting policy prior to investing. Some commenters requested that the final rule address circumstances where investment managers have not obtained consent from participating plans accepting the manager’s investment policy and proxy voting policy prior to initial investment. Commenters requested that the Department allow an investment manager to rely on a ‘‘negative consent’’ procedure, such as by sending a written notice stating that plans will be deemed to have accepted the investment manager’s investment policy and proxy voting policy if they continue investing with the investment manager after receiving the notice. Another commenter suggested that the Department eliminate proposed paragraph (d)(4)(ii) in its entirety and revise proposed paragraph (d)(4)(i)(B) to explicitly cover investment managers for pooled investment vehicles that hold plan assets. According to the commenter, proposed paragraph (d)(4)(ii) could result in conflicting or misinterpreted regulatory expectations. Similar to commenters discussed above, this commenter explained that paragraph (d)(4)(ii) does not reflect current industry standard practice followed by investment managers for collective investment funds and other pooled investment vehicles that hold ERISA plan assets. In particular, it stated that it was not aware of any collective investment fund or other pooled investment vehicles that did not have their own investment objectives, guidelines, and/or policies that must be accepted as a condition for investment. The commenter further suggested that if a national bank trustee of a collective investment fund, in managing the fund’s portfolio, attempts ‘‘to reconcile, insofar as possible, the conflicting [investment] policies [of plans],’’ this may inevitably favor some plans over others. The commenter raised the question as to whether this may be inconsistent with Office of the Comptroller of the Currency expectations regarding that bank’s treatment of participants in a pooled investment fund. The Department is not persuaded to remove paragraph (d)(4)(ii) from the E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 73852 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations final rule or make the language changes requested by commenters. Paragraph (d)(4)(ii) of the proposal is identical to paragraph (e)(4)(ii) of the current regulation, and also is similar to guidance relating to pooled investment vehicles that has been consistently part of the Department’s prior Interpretive Bulletins since 1994. A number of the issues raised with respect to paragraph (d)(4)(ii) of the proposal, particularly relating to difficulties with proportional voting and industry common practices to avoid being subject to proportional voting, were also raised by commenters with respect to paragraph (e)(4)(ii) of the current regulation but not accepted by the Department. As with the current regulation, the Department declines to reorder the provisions within paragraph (d)(4)(ii) of the final rule solely to put more emphasis on the exception to the proportional voting provision. The Department does not interpret the public comments as saying that paragraph (d)(4)(ii) of the NPRM is unworkable, but rather that the popularity of the exception justifies a reorganization of the constituent parts of the paragraph to elevate the prominence of the exception to match common industry practice. The organizational structure of paragraph (d)(4)(ii) of the final rule intentionally begins with the general requirement and is followed by the exception to that requirement—a structure which has been in place for approximately four decades. The Department believes this structure to be sound and logical notwithstanding the current popularity of the exception. In addition, with respect to the commenters’ more fundamental suggestions including eliminating paragraph (d)(4)(ii) in its entirety, the NPRM narrowly solicited comments on whether the provision in question should be revised to conform more closely to the Department’s prior guidance.84 These more fundamental suggestions are well beyond the scope of the solicitation in the NPRM because, if adopted, they would cause paragraph (d)(4)(ii) of the final to diverge substantially from the prior guidance. Also, as discussed above, issues relating to a named fiduciary’s direction of an investment manager with respect to voting decisions implicate provisions of ERISA beyond the scope of this rulemaking. Although the Department declines to extend paragraph (d)(4)(ii) of the final rule to include managers of separately managed accounts, we note that there is nothing in ERISA that precludes an investment manager from requiring a plan fiduciary to accept the 84 86 FR 57283. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 investment manager’s proxy voting policies before agreeing to become a plan investment manager. With regard to requests for approval of ‘‘negative consent’’ procedure for adoption of proxy policies by plans with current investments in a pooled investment vehicle, the Department believes the later applicability date of paragraph (d)(4)(ii) should alleviate commenters’ concerns. (e) Paragraph (d)(5) Paragraph (d)(5) of the NPRM provided that the regulation does not apply to voting, tender, and similar rights with respect to shares of stock that, pursuant to the terms of an individual account plan, are passed through to participants and beneficiaries with accounts holding such shares. The Department did not receive comments on this provision, which is being adopted as proposed. Despite this exclusion, participants and beneficiaries are not without ERISA’s protections. The Department stresses that plan trustees and other fiduciaries must comply with ERISA’s general statutory duties of prudence and loyalty provisions with respect to the pass through of votes to plan participants and beneficiaries. In doing so, however, plan fiduciaries may continue to rely on the Department’s prior guidance with respect to such participant-directed voting, including 29 CFR 2550.404c–1 (implementing ERISA section 404(c)(1) to participant-directed pass-through voting) and interpretive letters.85 5. Section 2550.404a–1(e)—Definitions Paragraph (e) of the final rule provides definitions and is unchanged from the proposal and current regulation. Under paragraph (e)(1) of the final rule, ‘‘investment duties’’ means any duties imposed upon, or assumed or undertaken by, a person in connection with the investment of plan assets which make or will make such person a fiduciary of an employee benefit plan or which are performed by such person as a fiduciary of an employee benefit plan as defined in section 3(21)(A)(i) or (ii) of ERISA. Paragraph (e)(2) defines the term ‘‘investment course of action’’ as any series or program of investments or actions related to a fiduciary’s performance of the fiduciary’s investment duties and includes the selection of an investment fund as a plan investment, or in the case of an individual account plan, a designated 85 See, e.g., Letter from Deputy Assistant Secretary Lebowitz to Thobin Elrod (Feb. 23, 1989); Letter from Assistant Secretary Berg to Ian Lanoff (Sept. 28, 1995). PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 investment alternative under the plan. Paragraph (e)(3) defines ‘‘plan’’ to mean an employee benefit plan to which Title I of ERISA applies. Finally, under paragraph (e)(4) of the final rule, the term ‘‘designated investment alternative’’ means any investment alternative designated by the plan into which participants and beneficiaries may direct the investment of assets held in, or contributed to, their individual accounts. The provision further provides that the term ‘‘designated investment alternative’’ shall not include ‘‘brokerage windows,’’ ‘‘selfdirected brokerage accounts,’’ or similar plan arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan. 6. Section 2550.404a–1(f)—Severability Paragraph (f) of the final rule, like paragraph (f) of the proposal and paragraph (h) of the current regulation, provides that should a court of competent jurisdiction hold any provision of the rule invalid, such action will not affect any other provision. Including a severability clause describes the Department’s intent that any legal infirmity found with part of the final rule should not affect any other part of the rule. 7. Section 2550.404a–1(g)— Applicability Date The proposed rule did not include an applicability date provision. Some commenters requested that the Department provide a prospective applicability date for all recent changes to the regulation (including both changes made in 2020 as well as amendments to the current regulation made today by the final rule) that is no earlier than the date that would be one year after the Department’s publication of this final rule in the Federal Register. The commenters indicated that plan sponsors, investment managers, proxy advisory firms, and other fiduciaries need adequate time to, as necessary, review and modify their policies, procedures, and practices to conform to the final rule’s requirements. Some commenters also specifically suggested a need for transition relief or a delayed applicability date with respect to the proxy voting provisions. One commenter requested that the Department retain and extend the delayed applicability date of certain requirements of the regulation as set forth in paragraph (g)(3) of the current regulation. In general, that provision delayed until January 31, 2022, the applicability of the requirements of paragraphs (e)(2)(ii)(D) (evaluation of E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations material facts that form the basis of a vote), (e)(2)(ii)(E) (maintenance of proxy voting records), (e)(2)(iv) (prohibition against adopting practice of following proxy advisory firm recommendations without determination that firm’s voting guidelines consistent with requirements of regulation), and (e)(4)(ii) (responsibilities of investment managers to pooled investment vehicles holding plan assets) of the current regulation.86 The commenter noted that investment managers to pooled investment vehicles may have delayed their implementation efforts due to the announcement in March 2021 of the Department’s enforcement policy. Others pointed to difficulties faced by investment managers in assuring that investing plans had adequately adopted manager’s proxy voting policies as required under paragraph (d)(4)(ii). After consideration of the comments, the Department has decided to provide a general applicability date of 60 days after publication in the Federal Register, but to delay applicability of certain provisions of the final rule’s proxy voting provisions until 1 year after the date of publication. The Department is persuaded that a delayed applicability of paragraph (d)(4)(ii) of the final rule is appropriate as it gives fiduciaries of plans invested in pooled investment vehicles additional time for reviewing any proxy voting policies of the investment vehicle’s investment manager; and also provides investment managers additional time to determine whether investing plans have adequately adopted their proxy voting policies, as well as assessing and reconciling, insofar as possible, any conflicting policies. The Department also believes it appropriate to delay application of paragraph (d)(2)(iii) to give additional time to plan fiduciaries to review proxy voting guidelines of proxy advisory firms and make any necessary changes in their arrangements with such firms. The Department is providing for a delay of one year as requested by commenters. The Department’s March 10, 2021, enforcement statement continues to apply with respect to paragraphs (d)(2)(iii) and (d)(4)(ii) until the delayed applicability date. Thus, paragraph (g)(1) provides that except for paragraphs (d)(2)(iii) and (d)(4)(ii), the final rule will apply in its entirety to all investments made and investment courses of action taken after January 30, 2023. Paragraph (g)(2) provides that paragraphs (d)(2)(iii) and (d)(4)(ii) of the final rule will apply on December 1, 2023. 86 Fiduciaries that are investment advisers registered with the SEC were not able to take advantage of the delayed applicability of paragraphs (e)(2)(ii)(D) and (E). See 85 FR 81676. 87 See 29 U.S.C. 1135 (providing that ‘‘the Secretary may prescribe such regulations as he finds necessary or appropriate to carry out the provisions of this subchapter’’). VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 8. Miscellaneous (a) Constitutional Concerns A few commenters argue that the proposed rule violates the U.S. Constitution. These commenters contend that the proposal is unconstitutional because permitting fiduciaries to base their investment decisions on any non-pecuniary factors cannot be consistent with ERISA and thus rewrites the statute, which is the sole responsibility of Congress. As a result, they argue that the Department violates the separation of powers imposed by the Constitution. The Department does not agree that the final rule rewrites ERISA or violates the Constitution. Congress has given the Secretary of Labor authority to promulgate regulations that interpret and fill up the details in the fiduciary duties under ERISA section 404, including the duties of prudence and loyalty.87 The Department here interprets those duties to protect plan participants’ financial benefits and strictly prohibits any other goal from subordinating their interests in those benefits. Nothing in the final rule permits a fiduciary, outside of a tiebreaker situation, to base investment decisions on factors irrelevant to a risk and return analysis. The Secretary has maintained these fundamental interpretive principles in its guidance, referenced earlier in this preamble, since 1980 and its first comprehensive guidance in 1994. Moreover, the principles stated in the proposed and final rule, including the tiebreaker, were fundamental aspects of that guidance. (b) Administrative Procedure Act In addition, some commenters asserted that the proposed rule was arbitrary and capricious and thus violated the Administrative Procedure Act (APA). The Department is of the view that the final rule comports with the APA. Several commenters claimed that the NPRM did not engage in reasoned decision-making, did not look at all aspects of the problem, and did not properly consider the costs to participants and beneficiaries. These commenters, for instance, characterized the NPRM as arbitrarily and capriciously focused on clarifying that ERISA permits ESG considerations in PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 73853 plan investments at the expense of protecting participants from ESG investing ‘‘run amok’’ or violations of ERISA’s duty of loyalty. One commenter contended that the NPRM was more a political action taken because of the popularity of ESG investing rather than a reflection of the current administration’s concern about a problem to be addressed. Another commenter espoused that the Department’s real agenda was to encourage ESG investing. Yet another asserted that the only reason this rule was being promulgated was because of an Executive order.88 And another commenter contended that it could not give input on the Department’s view of how its rule promotes retiree welfare, because, the commenter states, the agency gives no reasoning on this point. The Department disagrees with these contentions. The final rule repeatedly emphasizes that the Department’s purpose is to remedy the chilling effect of certain aspects of the 2020 rule and preamble on the consideration of ESG factors. As stated above, the final rule allows such factors to influence investment decisions only when relevant to a risk and return analysis or when used as a tiebreaker. By tying the final rule to the statutory language and to the fact that ESG factors may, in some circumstances, affect both returns and risk, the Department has engaged in the essence of reasoned decisionmaking. Moreover, the fact that ESG investing has increased in popularity is another reason why fiduciaries need a clarifying rule and why the Department is promulgating one. This would be the case even if the President had never issued Executive Orders 13990 and 14030. The final rule also emphatically addresses potential loyalty breaches by forbidding subordination of participants’ financial benefits under the plan to ESG or any other goal and, likewise, by prohibiting fiduciaries from sacrificing investment return or taking on additional investment risk to promote benefits or goals unrelated to interests of participants and beneficiaries in their retirement or financial benefits under the plan. A few commenters stated that the NPRM effectively placed a ‘‘heavy thumb’’ on the scale in favor of ESG factors and ignored other options, such as a policy statement or interpretive guidance. At least one commenter also claimed that the NPRM was trying to address a problem that does not exist. The Department has explained its reasons for amending the current regulation, including the chilling effect 88 E.O. E:\FR\FM\01DER2.SGM 14030, 86 FR 27967 (May 25, 2021). 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 73854 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations caused by, for example, its explicit documentation requirements for investments and the exercising of shareholder rights, and its restrictions on QDIAs, as discussed earlier in this preamble. The Department determined and received confirmation in public comments that features such as these, combined with the overall chilling tone of the current regulation (including its preamble) as it relates to financially beneficial ESG considerations, rendered interpretive guidance under the current regulation insufficient. Rather than placing a thumb on the scale, the final rule removes the current regulation’s thumb against ESG strategies. It does this by simply clarifying that ESG factors may be relevant to a risk and return analysis to the same extent as any other relevant factor. Many commenters expressed concerns that the NPRM language, as one put it, ‘‘imposes a de facto mandate’’ on retirement plan fiduciaries to consider ESG factors and declares that such a presumption would be arbitrary and capricious. The commenters referenced paragraph (b)(2)(ii)(C) of the NPRM stating that the consideration of the projected return of the portfolio relative to the plan’s funding objectives ‘‘may often require’’ an evaluation of the economic effects of climate change and other ESG factors. As explained earlier in this preamble, in response to these comments, the Department recognizes that the language as drafted created a misimpression of its intent and has modified the provision to eliminate the ‘‘may often require’’ language altogether. At least three commenters took issue with the NPRM’s use of the term ‘‘ESG’’. They contended that the NPRM failed to define ‘‘ESG’’ factors and that the term ‘‘ESG’’ was too imprecise to serve as a basis for a regulatory standard. Commenters, citing to the November 2020 preamble statement that the term ‘‘was not a clear or helpful lexicon for a regulatory standard,’’ claimed the Department changed its position without acknowledging it. One commenter contended that a more precise definition was especially important given the perceived ‘‘de facto mandate’’ in the NPRM. Use of the term ESG in the NPRM was not intended to create a regulatory mandate or standard for compliance, and as stated above, the ‘‘may often require’’ provision has been removed in the final rule. Rather, it was the Department’s intent to clarify that ESG factors are no different than other non-ESG relevant risk-return factors. Consequently, the final rule does not define ESG because the precision of terminology is less important than the VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 Department’s fundamental premise that fiduciaries may consider ESG factors— irrespective of the definition of the term ‘‘ESG’’—when they are relevant to a risk-return analysis to the same extent as any other relevant factor. One commenter expressed an opinion about the Department’s position on negative screening which the commenter defines as excluding certain types of investments from a portfolio based on non-economic or nonpecuniary reasons. The commenter states that the NPRM, if adopted, would change a Departmental position against negative screening, without considering a serious reliance interest on the prior position. The commenter is correct that when promulgating a change in policy, the Department must consider serious reliance interests in a prior policy. The Department never has posited, however, that ERISA imposes a blanket bar against all forms of exclusionary investments. The two Department of Labor (DOL) letters the commenter cites comport. They state that the exclusionary investment first required ‘‘an economic analysis of economic consequences’’ of the exclusion,89 or put another way, a ‘‘consideration of the economic and financial merit.’’ 90 Both the NPRM and the final rule are fully consistent and in fact reinforce the position in these letters. Further, as stated in the preamble of the NPRM, the Department long has acknowledged, since the publication of those letters, the potential risk and return attributes of ESG criteria in fiduciary investment decisionmaking and portfolio construction. Thus, there is no change of position in this regard and no reliance interest on any former position to address. Another commenter stated that the Department has not acknowledged or considered the cost of the risk of ‘‘channeling’’ plan assets into ESG investments given the concerns of misrepresentation highlighted by staff of Division of Examinations of the SEC in its April 2021 Risk Alert on ESG investing. The commenter concluded that the Department’s NPRM, if adopted, would be arbitrary and capricious, in part, because of its failure to acknowledge the profound effect of the risk of misrepresentation. This final rule is not intended to channel assets into any particular type of investment. Rather, the intent of the final rule is simply to remove barriers to the 89 Letter to the Honorable Howard M. Metzenbaum from Assistant Secretary Dennis Kass (May 27, 1986). 90 Letter to Daniel O’Sullivan from Jeffrey Clayton (Aug. 2, 1982). PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 fiduciary’s consideration of all financially relevant factors, which may include ESG, as part of a prudent and loyal process of investment decisionmaking. The Department anticipates that fiduciaries will give careful consideration in a meaningful comparison and selection process of ESG investments just as they do with any other type of investment. The Department also disagrees with the comment that it prejudged the outcome of this rule. Offering a proposed solution to a problem is the foundation of notice and comment rulemaking. Under the APA, policymakers are required to solicit comments on the problem and its proposed solution and to adequately review those comments in the development of the final rule. The changes made to the NPRM in this final rule demonstrate that the Department has not prejudged the rule’s outcome. Substantive changes in response to public comments include the elimination of the language that the evaluation of investments ‘‘may often require’’ consideration of ESG factors, the elimination of the list of ESG examples from the regulatory text, and removal of the collateral benefit disclosure requirement. Some commenters added that the Department failed to identify which investors the 2020 rule confused and did not produce data showing that consideration of ESG factors will sustain or increase plan returns—returns one commenter called ‘‘phantom benefits.’’ As amply explained in both the NPRM preamble and here, and as reflected by the Department’s longstanding Investment Duties regulation, ensuring that determinations are based on relevant risk and return factors, which may include the economic effects of climate change and other ESG factors, will serve the retirement participants and beneficiaries’ financial interests. The Department believes, and many commenters confirmed, the current regulation causes an unwanted chilling effect on the use of climate change and other ESG factors, and therefore is a barrier to that consideration. The Department is not required to produce a record of extensive and detailed data showing the extent to which ESG considerations will grow retirement accounts. The final rule does not require fiduciaries to consider ESG factors to a different extent than any other factors that the fiduciary reasonably determines are relevant to a risk and return analysis. Nor does the APA require the Department to specifically identify investors who were confused by or chilled by the current regulation. As E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations previously stated, many commenters— whose identity is public—indicated this concern. Multiple commenters also questioned the quantitative support for the Department’s position. For instance, some commenters contended that the Department’s claims about climate change were unsubstantiated. The Department believes it has made reasonable efforts to quantify all aspects of the final rule, and their potential effects, for which data is available. The Department also notes that efforts have been made to qualitatively address those areas where the Department is unable to adequately derive quantitative assessments. Further, the preamble to this final rule (as well as the proposed rule) adequately cites to research supporting the Department’s views. Responses to these and related additional comments are discussed later in the Regulatory Impact Analysis (RIA) section of this preamble. Finally, one commenter asserts Chevron deference does not apply to the NPRM because, if adopted, it would be a ‘‘major question’’ in the sense that it would constitute a ‘‘decision of vast political and economic significance’’ and ‘‘in the realm of climate.’’ The final rule does not represent one of the rare ‘‘extraordinary cases’’ for which the major questions doctrine compels a ‘‘different approach’’ to analyzing agency authority.91 Indeed, far from representing a ‘‘transformative expansion in [the agency’s] regulatory authority,’’ 92 the Department has for decades issued guidance addressing how fiduciaries, compliant with ERISA’s prudence and loyalty duties, may or may not incorporate various factors into investment and shareholder rights decisions. And even if the major questions doctrine did apply, Congress has provided clear authorization to issue the final rule, including by authorizing the Secretary to ‘‘prescribe such regulations as he finds necessary or appropriate to carry out the provisions of’’ the subchapter encompassing fiduciary responsibilities.93 Finally, as stated in the NPRM, this final rule does not undermine serious reliance interests on the part of fiduciaries selecting investments and investment courses of action or exercising shareholder rights.94 This final rule does not upend longstanding 91 West Virginia v. EPA, 142 S. Ct. 2587, 2608 (2022) (quoting FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 159 (2000)). 92 Id. (quoting Utility Air Regul. Grp. v. EPA, 573 U.S. 302, 324 (2014)). 93 29 U.S.C. 1135. 94 85 FR 57272, 57283 (Oct. 14, 2021). VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 standards governing the selection of investments and investment courses of action or the exercise of shareholder rights. Instead, it addresses new policies included in a recently promulgated regulation. Further, the Department stayed its enforcement of the current regulation shortly after its effective date and before all portions were applicable. Consequently, the Department concludes any serious reliance interest in the changes introduced by the current regulation in 2020 is unlikely and does not outweigh the Department’s good reasons for change. IV. Regulatory Impact Analysis This section of the preamble analyzes the regulatory impact of the final rule in 29 CFR 2550.404a–1. As explained earlier in this preamble, the final rule clarifies the legal standard imposed by sections 404(a)(1)(A) and 404(a)(1)(B) of ERISA with respect to the selection of a plan investment or, in the case of an ERISA section 404(c) plan or other individual account plan, a designated investment alternative under the plan, and with respect to the exercise of shareholder rights, including proxy voting. The primary benefit of the final rule is to clarify legal standards and prevent confusion among stakeholders. The Department has heard from stakeholders that the current regulation, and investor confusion related to the regulation, has had a chilling effect on appropriate use of climate change and other ESG factors in investment decisions, even in circumstances allowed by the current regulation. Based on stakeholder feedback, the Department has determined that aspects of the current regulation could deter plan fiduciaries from: (a) taking into account climate change and other ESG factors when they are relevant to a risk and return analysis, and (b) engaging in proxy voting and other exercises of shareholder rights when doing so is in the plan’s best interest. If these concerns with the current regulation were left unaddressed, the regulation would have (a) a negative impact on plans’ financial performance as they avoid using climate change and other ESG considerations in investment analysis even when directly relevant to the financial merits of the investment, and (b) a negative impact on plans’ financial performance as they shy away from proxy votes and shareholder engagement activities that are economically relevant. The final rule’s clarification of the relevant legal standards is intended to address these negative impacts. The final rule provides cost savings by eliminating the current regulation’s PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 73855 special documentation provisions pertaining to the tiebreaker and eliminating its proxy voting safe harbors. In the impact analysis for the current regulation, the Department had estimated that these provisions would impose a regulatory burden. Other benefits include clarifying the tiebreaker standard and clarifying the standards governing QDIAs. All benefits of the amendments are discussed below in section IV.D. As discussed in section IV.E, the final rule will impose costs; however, the costs are expected to be relatively small. Overall, the Department anticipates that the final rule’s benefits justify its costs. The Department has examined the effects of this final rule as required by Executive Order 12866,95 Executive Order 13563,96 the Congressional Review Act,97 the Paperwork Reduction Act of 1995,98 the Regulatory Flexibility Act,99 section 202 of the Unfunded Mandates Reform Act of 1995,100 and Executive Order 13132.101 A. Executive Orders 12866 and 13563 Executive Orders 12866 and 13563 direct agencies to assess all costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health, and safety effects; distributive impacts; and equity). Executive Order 13563 emphasizes the importance of quantifying costs and benefits, reducing costs, harmonizing rules, and promoting flexibility. Under Executive Order 12866, ‘‘significant’’ regulatory actions are subject to review by the Office of Management and Budget (OMB). Section 3(f) of the Executive order defines a ‘‘significant regulatory action’’ as an action that is likely to result in a rule (1) having an annual effect on the economy of $100 million or more, or adversely and materially affecting a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or state, local, or tribal governments or communities (also referred to as ‘‘economically significant’’); (2) creating a serious inconsistency or otherwise interfering with an action taken or planned by 95 Regulatory Planning and Review, 58 FR 51735 (Oct. 4, 1993). 96 Improving Regulation and Regulatory Review, 76 FR 3821 (Jan. 21, 2011). 97 5 U.S.C. 804(2) (1996). 98 44 U.S.C. 3506(c)(2)(A) (1995). 99 5 U.S.C. 601 et seq. (1980). 100 2 U.S.C. 1501 et seq. (1995). 101 Federalism, 64 FR 43255 (Aug. 10, 1999). E:\FR\FM\01DER2.SGM 01DER2 73856 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 another agency; (3) materially altering the budgetary impacts of entitlement grants, user fees, or loan programs or the rights and obligations of recipients thereof; or (4) raising novel legal or policy issues arising out of legal mandates, the President’s priorities, or the principles set forth in the Executive order. OMB has determined that this final rule is economically significant within the meaning of section 3(f)(1) of Executive Order 12866. Given the large scale of investments held by covered plans, approximately $12.0 trillion, changes in investment decisions and/or plan performance may result in changes in returns in excess of $100 million in a given year.102 Therefore, below the Department provides an assessment of the potential costs, benefits, and transfers associated with the final rule. B. Introduction and Need for Regulation In late 2020, the Department published two final rules dealing with the selection of plan investments and the exercise of shareholder rights, including proxy voting. The Department intended to provide clarity and certainty to plan fiduciaries regarding their legal duties under ERISA section 404 in connection with making plan investments and for exercising shareholder rights. The Department was also concerned that some investment products may be marketed to ERISA fiduciaries based on purported benefits and goals unrelated to financial performance. Before issuing the 2020 regulation, the Department had periodically issued guidance pertaining to the application of ERISA’s fiduciary rules to plan investment decisions that are based, in whole or part, on factors unrelated to financial performance. This nonregulatory guidance consisted of varied statements that led to confusion. Accordingly, the 2020 regulation was intended to provide clarity and certainty regarding the scope of fiduciary duties surrounding such issues. Responses to the 2020 rules, however, suggest that they may have inadvertently caused more confusion than clarity. Many stakeholders told the Department that the terms and tone of the final rules and preambles increased concerns and uncertainty about the extent to which plan fiduciaries may consider climate change and other ESG 102 EBSA projected ERISA covered pension, welfare, and total assets based on the 2020 Form 5500 filings with the U.S. Department of Labor (DOL), reported SIMPLE assets from the Investment Company Institute (ICI) Report: The U.S. Retirement Market, Second Quarter 2022, and the Federal Reserve Board’s Financial Accounts of the United States Z1 September 9, 2022. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 factors in their investment decisions, and that the 2020 rules had chilling effects that would tend to deter consideration of ESG factors and that were contrary to the interests of participants and beneficiaries. Consequently, on March 10, 2021, the Department announced that it would stay enforcement of the 2020 rules pending a complete review of the matter. Subsequently, on May 20, 2021, the President issued Executive Order 14030, entitled ‘‘Executive Order on Climate-Related Financial Risk.’’ Section 4 of the Executive order directs the Department to consider suspending, revising, or rescinding any rules from the prior administration that would have barred plan fiduciaries (and their investment-firm service providers) from considering climate change and other ESG factors in their investment decisions related to workers’ pensions.103 In light of the foregoing confusion among stakeholders, the Department concluded that additional notice and comment rulemaking was necessary to safeguard the interests of participants and beneficiaries in their retirement and welfare plan benefits. The baseline for purposes of the analysis is a future in which the current regulations are implemented. The baseline does not take into account the fact that the Department stayed enforcement of the current regulations pursuant to the March 10, 2021, enforcement policy, which was after their effective date in January 2021 but before their full applicability date.104 C. Affected Entities The clarifications in the final rule will affect subsets of ERISA-covered plans and their participants and beneficiaries. The subset of plans affected by the proposed modifications of paragraphs (b) and (c) of § 2550.404a–1 include those plans whose fiduciaries consider or will begin considering climate change and other ESG factors when selecting investments and the participants in 103 See White House Fact Sheet titled FACT SHEET: President Biden Directs Agencies to Analyze and Mitigate the Risk Climate Change Poses to Homeowners and Consumers, Businesses and Workers, and the Financial System and Federal Government Itself (May 20, 2021) (stating, ‘‘The Executive Order directs the Labor Secretary to consider suspending, revising, or rescinding any rules from the prior administration that would have barred investment firms from considering environmental, social and governance factors, including climate-related risks, in their investment decisions related to workers’ pensions.’’). 104 U.S. Department of Labor Statement Regarding Enforcement of its Final Rules on ESG Investments and Proxy Voting by Employee Benefit Plans (Mar. 10, 2021), available at www.dol.gov/sites/dolgov/ files/ebsa/laws-and-regulations/laws/erisa/ statement-on-enforcement-of-final-rules-on-esginvestments-and-proxy-voting.pdf. PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 those plans. Based on the sources below, the Department estimates that about 20 percent of plans will be affected by this final rule. Another subset of affected plans includes ERISA-covered plans (pension, health, and other welfare) that hold shares of corporate stock. This subset of plans will be affected by the proposed modifications to paragraph (d) (relating to proxy voting) of § 2550.404a–1. Some plans will be in both subsets, some in only one subset, and some in neither. There is substantial uncertainty about the number and size of affected plans. 1. Subset of Plans Affected by Proposed Modifications of Paragraphs (b) and (c) of § 2550.404a–1 The Department estimates that 20 percent of plans, both defined contribution (DC) and defined benefit (DB), will be affected by the proposed modifications of paragraphs (b) and (c) of § 2550.404a–1 because their fiduciaries consider or will begin considering climate change or other ESG factors when selecting investments. The administrative data and surveys relied upon for this estimate are discussed below. According to a survey by the NEPC, LLC (2018), approximately 12 percent of private pension plans (both DB and DC) have adopted ESG investing.105 A survey conducted by the Callan Institute (2021), which included a greater share of DB plans, found that about 20 percent of private sector pension plans consider ESG factors in investment decisions.106 In a comment letter on the NPRM, Morningstar estimates that approximately 36 percent of large plans (with at least 100 participants) use ESG information to consider their investments. Their analysis is based on whether a fund’s prospectus references considering ESG information when selecting securities. It includes both DB and DC plans. To focus on ESG investing by participant-directed defined contribution plans, the Department draws from several sources. According to the Plan Sponsor Council of America (PSCA, 2021), about 5 percent of 401(k) and/or profit-sharing ERISA plans offered at least one ESG-themed 105 Brad Smith and Kelly Regan, NEPC ESG Survey: A Profile of Corporate & Healthcare Plan Decisionmakers’ Perspectives, NEPC (Jul. 11, 2018), https://cdn2.hubspot.net/hubfs/2529352/files/ 2018%2007%20NEPC%20ESG%20Survey%20 Results%20.pdf. 106 2021 ESG Survey, Callan Institute (2021), https://www.callan.com/e508ca6d-4014-4c99-b0aa9fb15170bb18. E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations investment option in 2020.107 The PSCA survey was cited by several commenters on the NPRM. NEPC (2022) surveyed DC plans, the vast majority of which were in the private sector, and found that 6 percent of DC plans in 2020 had at least one fund labeled as ‘‘socially responsible’’ or ‘‘ESG.’’ 108 Vanguard’s administrative data for 2021 indicated that approximately 13 percent of DC plans offered one or more ‘‘socially responsible’’ funds.109 Moreover, about 30 percent of participants were offered at least one ‘‘socially responsible’’ fund, and of those participants, 6 percent were using these funds. In a comment letter received on the 2020 NPRM Financial Factors in Selecting Plan Investments, Fidelity Investments reported that approximately 14.5 percent of corporate DC plans with fewer than 50 participants offered an ESG option, and that the figure is higher for large plans with at least 1,000 participants. While survey and administrative data is the best information available, it is not perfect. For instance, a plan fiduciary responding to a survey likely bases their answer on whether the plan offers an investment with a name indicating it is a ‘‘sustainable’’ fund or with advertising emphasizing that it pursues ESG. If the plan offers a fund that does not have these characteristics, even if the asset manager factors in ESG information, the plan fiduciary may not be aware of this and would respond to a survey by saying the plan does not consider any ESG factors. To the degree this situation occurs, it would lead to survey data that underestimate the consideration of ESG factors. It is also likely that ESG investing will increase in the future. Many of the sources above show increases in ESG investing in recent years, and a trend towards ESG investing has also been observed in the wider universe of all investors. A study from Morningstar (2021) shows that between 2018 and 2020, assets under management in sustainable funds increased over three hundred percent.110 Additionally, U.S. SIF (2020) estimates that U.S.-domiciled assets under management using khammond on DSKJM1Z7X2PROD with RULES2 107 64th Annual Survey of Profit Sharing and 401(k) Plans, Plan Sponsor Council of America (2021). 108 NEPC 2021 Defined Contribution Plan Trends and Fee Survey Results, NEPC (February 2022). 109 How America Saves 2022, Vanguard (June 2022), https://institutional.vanguard.com/content/ dam/inst/vanguard-has/insights-pdfs/22_TL_HAS_ FullReport_2022.pdf. 110 Morningstar, ‘‘Sustainable Funds U.S. Landscape Report: More Funds, More Flows, and Impressive Returns in 2020’’ (February 10, 2021), https://www.morningstar.com/lp/sustainable-fundslandscape-report. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 sustainable investing strategies reached $17.1 trillion at the start of 2020, an increase of 42 percent since 2018.111 The Deloitte Center for Financial Services (2020) estimates that assets under management with mandates related to ESG factors could comprise half of all professionally managed investments in the U.S. by 2025. This study also finds investment managers are likely to launch up to 200 new ESG funds by 2023, more than double the activity in the previous three years.112 The Department received several comments and resources exploring the perception of ESG investing from investors. A survey of individual investors by the Morgan Stanley Institute for Sustainable Investing (2019) finds that 85 percent of investors overall, and 95 percent of millennial investors, are interested in sustainable investing. About 88 percent of all surveyed investors are ‘‘very’’ or ‘‘somewhat’’ interested in pursuing sustainable investing in 401(k) plans.113 A survey of consumers between ages 45 and 75 by Schroders (2021) found that 90 percent said that ‘‘they invested in ESG options when they were aware of their availability in their DC plan.’’ Of those who said their plans did not offer ESG investment options or did not know, 69 percent said they would increase their overall contribution rate if they were offered an ESG option.114 A survey conducted by CNBC (2021) finds that ‘‘about one-third of millennials often or exclusively use investments that take ESG factors into account, compared to 19 percent of Gen Z, 16 percent of Gen X, and 2 percent of Baby Boomers.’’ 115 A study by Natixis finds that ‘‘7 in 10 individual investors believe it is important to make a 111 US SIF, ‘‘US SIF Trends Report Executive Summary: Report on US Sustainable and Impact Investing Trends 2020,’’ https://www.ussif.org/files/ US%20SIF%20Trends%20Report%20 2020%20Executive%20Summary.pdf. 112 Sean Collins and Kristen Sullivan, ‘‘Advancing Environmental, Social, and Governance Investing: A Holistic approach for Investment Management Firms’’ (February 2020), https://www2.deloitte.com/us/en/insights/industry/ financial-services/esg-investing-performance.html. 113 Morgan Stanley Institute for Sustainable Investing, ‘‘Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction, and Choice’’ (2019), https://www.morganstanley.com/pub/ content/dam/msdotcom/infographics/sustainableinvesting/Sustainable_Signals_Individual_Investor_ White_Paper_Final.pdf. 114 Schroders, ‘‘Schroders US Retirement Survey Results—2021,’’ https://www.schroders.com/en/us/ defined-contribution/dc/retirement-survey-2021. 115 Alicia Adamczyk, ‘‘Millennials Spurred Growth in Sustainable Investing for Years. Now All Generations are Interested in ESG Options,’’ CNBC (May 2021), https://www.cnbc.com/2021/05/21/ millennials-spurred-growth-in-esg-investing-nowall-ages-are-on-board.html. PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 73857 positive social impact through their investments.’’ 116 These studies suggest that investor demand for ESG is strong and is poised to increase, given the preferences of younger investors. Taking into account likely future growth, the Department’s best estimate of the share of plans that will be affected by the final rule is 20 percent. This is an increase from the 11 percent estimate in the NPRM; the Department increased the estimate based on updated data, comment letters, and to account for future growth. This is an overall estimate, and it is unclear how the share affected may vary between DB and DC plans. An estimate of 20 percent of plans means that approximately 149,300 plans will be affected.117 The Department estimates that more than 28.5 million participants belong to plans that will be affected.118 The proportion of plan assets actually invested in ESG options, however, may be much less than 20 percent; the PSCA survey indicates that the average participant-directed DC plan has approximately 0.03 percent of its assets invested in ESG funds in 2020.119 2. Subset of Plans Affected by the Modifications to Paragraph (d) of § 2550.404a–1 The final rule, at paragraph (d), will codify longstanding principles of prudence and loyalty applicable to the exercise of shareholder rights, including proxy voting, the use of written proxy voting policies and guidelines, and the selection and monitoring of proxy advisory firms. In particular, paragraph (d) of the final rule will adopt the Department’s longstanding position, which was first issued in guidance in the 1980s, that the fiduciary act of managing plan assets includes the management of voting rights (as well as other shareholder rights) appurtenant to shares of stock. Paragraph (d) of the final rule also eliminates the two safe harbors from paragraphs (d)(3)(i)(A) and (B) of § 2550.404a–1. Under paragraph (d) of the final rule, when deciding whether to exercise shareholder rights and how to exercise 116 Natixis, ‘‘ESG Investing Survey: Investors Want the Best of Both Worlds,’’ (2019), https:// www.im.natixis.com/us/research/esg-investingreport-2019. 117 This estimate is calculated as: 20% × 746,610 pension plans = 149,322 pension plans, rounded to 149,300. (Source Private Pension Plan Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee Benefits Security Administration (2022; forthcoming), Table B1.) 118 Id. This estimate is calculated as: 20% × 142.3 = 28.5 million total participants. 119 64th Annual Survey of Profit Sharing and 401(k) Plans, Plan Sponsor Council of America (2021). E:\FR\FM\01DER2.SGM 01DER2 73858 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations such rights, including the voting of proxies, fiduciaries must carry out their duties prudently and solely in the interests of the participants and beneficiaries and for the exclusive purpose of providing benefit to participants and beneficiaries and defraying the reasonable expenses of administering the plan. An assessment of affected parties follows, but the Department believes that the estimate of affected plans is likely an overestimate. Paragraph (d) of the final rule will affect ERISA-covered pension, health, and other welfare plans that hold shares of corporate stock. It will affect plans with respect to stocks that they hold directly, as well as with respect to stocks they hold through ERISA-covered intermediaries, such as common trusts, master trusts, pooled separate accounts, and 103–12 investment entities. Paragraph (d) will not affect plans with respect to stock held through registered investment companies, such as mutual funds, because it will not apply to such funds’ internal management of such underlying investments. Paragraph (d) of the final rule also will not apply to voting, tender, and similar rights with respect to securities that are passed through pursuant to the terms of an individual account plan to participants and beneficiaries with accounts holding such securities. ERISA-covered plans annually report data on their asset holdings. However, only plans that file the Form 5500 schedule H report their stock holdings as a separate line item (see Table 1). Most plans filing schedule H have 100 or more participants (large plans).120 All plans with employer stock report their holdings on either schedule H or schedule I. However, schedule I lacks the specificity to determine if small plans hold employer stock or other employer securities. Approximately 25,900 defined contribution plans and 4,600 defined benefit plans, with approximately 83.6 million participants, filed the schedule H in 2020 and report holding common stocks or are an Employee Stock Ownership Plan (ESOP). Additionally, 518 health and other welfare plans file the schedule H and report holding common stocks either directly or indirectly. In total, pension plans and welfare plans filing schedule H hold approximately $2.4 trillion in common stock value. Common stocks constitute about 28 percent of total assets of those pension plans that are not ESOPs and hold common stock. Out of the 24,100 pension plans that hold common stock and are not ESOPs, about 19,300 plans hold common stock through an ERISAcovered intermediary and approximately 3,300 plans hold common stock directly. A smaller number of plans hold stock both directly and indirectly.121 In total, information is available on approximately 30,500 pension plans, welfare plans, and ESOPs that hold either common stock or employer stock. TABLE 1—NUMBER OF PENSION AND WELFARE PLANS REPORTING HOLDING COMMON STOCKS OR ESOP BY TYPE OF PLAN, 2020 a Common stock (no employer securities) Defined contribution Total pension plans Welfare plans Total all plans Direct Holdings Only ............................................................ Indirect Holdings Only .......................................................... Both Direct and Indirect ....................................................... 1,059 2,649 849 2,228 16,691 645 3,288 19,340 1,494 517 ........................ 1 3,805 19,340 1,495 Total .............................................................................. 4,558 19,564 24,122 518 24,640 ESOP (No Common Stock) ................................................. Common Stock and ESOP .................................................. ........................ ........................ 5,809 574 5,809 574 ........................ ........................ 5,809 574 Total All Plans Holding Stocks ..................................... 4,558 25,947 30,505 518 31,023 a DOL khammond on DSKJM1Z7X2PROD with RULES2 Defined benefit calculations from the 2020 Form 5500 Pension Research Files. There are approximately 652,900 small pension plans that hold assets that could be invested in stock.122 Given that fewer than 1 percent of small plans file a Schedule H, there is minimal data available about small plans’ stock holdings. While most participants and assets are in large plans, most plans are small plans. The Department lacks sufficient data to estimate the number of small plans that hold stock, but the Department expects that many small plans are only exposed to stock through mutual funds and consequently will not be significantly affected by paragraph (d) of the final rule. For purposes of estimating the number of small plans that will be affected, the Department assumes that five percent of small plans, or approximately 32,600 small pension plans, hold stock.123 In the NPRM, the Department solicited comments on the impact of small plans holding stock only through mutual funds and on the assumption that five percent of small plans hold stock. No comments were received in response to either inquiry. The combined effect of these assumptions is an estimate of 63,700 plans, large and small, that will be affected by the final rule pertaining to proxy voting.124 While paragraph (d) of this final rule will directly affect ERISA-covered plans that possess the relevant shareholder rights, the activities covered under paragraph (d) will be carried out by responsible fiduciaries on plans’ behalf. 120 487 plans with less than 100 participants filed the Form 5500 schedule H and reported holding common stock. 121 DOL estimates from the 2020 Form 5500 Pension Research Files. 122 The Form 5500 does not require these plans to categorize the assets as common stock, so the Department does not know if they hold stock. (Source Private Pension Plan Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee Benefits Security Administration (2022; forthcoming), Table B1.) 123 This estimate is calculated as 652,935 pension plans × 5% = 32,647 plans, rounded to 32,600. To assess the reasonableness of the five percent estimate, the Department looked at the number of pension plans filing the 2020 Form 5500, just above the threshold (100 participants) for needing to file the schedule H. Common stock or employer stock in an ESOP was held by eight percent of pension plans with 100 participants up to 109 participants. Common stock or employer stock in an ESOP was held by twelve percent of pension plans with 110 participants up to 119 participants. While both percentages are above five percent, the percentage falls as the plan size decreases, suggesting that five percent is a reasonable estimate of the percent of small plans holding common stock or employer stock in an ESOP. 124 This estimate is calculated as 30,505 large pension plans holding common stock or employer stock + 518 large health or welfare plans holding common stock or employer stock + 32,647 small pension plans holding stock = 63,670 plans rounded to 63,700. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 Many plans hire asset managers to carry out fiduciary asset management functions, including proxy voting. The Department estimates that large ERISA plans use approximately 17,600 different service providers, some of whom provide services related to the exercise of plans’ shareholder rights.125 Such service providers include trustees, trust companies, banks, investment advisers, investment managers, and proxy advisory firms.126 Asset managers hired as fiduciaries to carry out proxy voting functions will be subject to the final rule to the same extent as a plan trustee or named fiduciary. The final rule could indirectly affect proxy advisory firms to the extent that plan fiduciaries opt for customized recommendations about which proxy proposals to vote or how they should cast their vote. Plans’ preferences for proxy advice services moreover could shift to prioritize services offering more rigorous and impartial recommendations. These effects may be more muted, however; recent rule amendments by the Securities and Exchange Commission (SEC) may enhance the transparency, accuracy, and completeness of the information provided to clients of proxy advisory firms in connection with proxy voting decisions.127 125 DOL estimates are derived from the historical Form 5500 Schedule C data. This value reflects the number of entities that have ever been reported with the service codes associated with trustees (individual, bank, trust company, or similar financial institution), plan investment advisory, or investment management. 126 A commenter on the proposal for the 2020 rule shared results from a proprietary survey of the largest pension funds and defined contribution plans. The survey finds that approximately 92 percent of the respondents indicated that they have formally delegated proxy voting responsibilities to another named fiduciary and approximately 42 percent of respondents engage a proxy advisory firm (directly or indirectly) to help with voting some or all proxies. 127 In September 2019, the SEC issued an interpretation and guidance addressing the application of the proxy rules to proxy voting advice businesses. (See 84 FR 47416). In July of 2020, the SEC adopted amendments to 17 CFR 240.14a–1(l), 240.14a–2(b), and 240.14a–9 concerning proxy voting advice (the ‘‘2020 Rule Amendments’’). (See 85 FR 55082) On June 1, 2021, SEC Chair Gary Gensler directed SEC staff to consider whether to recommend further regulatory action regarding proxy voting advice. SEC staff were asked to consider whether to recommend that the SEC revisit its 2020 codification of the definition of solicitation as encompassing proxy voting advice, the 2019 Interpretation and Guidance regarding that definition, and the conditions on exemptions from the information and filing requirements in the 2020 Rule Amendments, among other matters. In July, 2022, the SEC adopted final amendments that, among other things, rescinded certain conditions that were adopted in the 2020 Rule Amendments to the availability of certain exemptions from the information and filing requirements of the Federal proxy rules for proxy advisory firms. (See 87 FR 43168) VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 D. Benefits The final rule will clarify the legal standard imposed by sections 404(a)(1)(A) and 404(a)(1)(B) of ERISA with respect to the selection of a plan investment or investment course of action, and the exercise of shareholder rights, including proxy voting. As indicated above, the final rule will benefit plans by making clear that plan fiduciaries are permitted to consider risk and return ESG factors and to exercise shareholder rights that may enhance the value of plan investments. The Department is concerned that the current regulation dissuades plan fiduciaries from such considerations and activities even when they are financially relevant to the plan. Prior to the NPRM, stakeholders told the Department that the current regulation had already had a chilling effect on appropriate use of ESG factors in investment decisions. Acting on relevant ESG factors in a manner consistent with the final rule will redound to the benefit of employee benefit plans, participants, and beneficiaries covered by ERISA. The public provided many comments about the proposal and cited many studies and reports which have helped the Department to assess what the effects of the rule will be. The literature examined by the Department generally shows that the consideration of ESG factors can be beneficial to investing in many circumstances. The Department anticipates that the benefits of this final rule will be significant. 1. Benefits of Paragraphs (b) and (c) Paragraph (b) of the final rule addresses ERISA section 404(a)(1)(B)’s duty of prudence and clarifies how that duty applies to a fiduciary’s consideration of an investment or investment course of action. Paragraphs (b)(1) through (3) of the final rule carry forward much of the same regulatory language that has been in place since 1979. The preservation of settled law should minimize new costs attributable to the final rule. Paragraph (b)(4) addresses uncertainty under the current regulation as to whether a fiduciary may consider ESG factors in making investment decisions under ERISA. This paragraph clarifies that when selecting an investment or investment course of action plan fiduciaries must base their determination on factors that the fiduciary reasonably determines are relevant to a risk and return analysis. Paragraph (b)(4) further clarifies that risk and return factors may, depending on particular facts and circumstances, PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 73859 include the economic effects of climate change and other ESG factors. The intent of this paragraph is to establish that ESG factors that may be relevant in a risk-return analysis of an investment do not need to be treated differently than other relevant investment factors, and to remove prejudice to the contrary contained in the current regulation. When relevant to a risk and return analysis of an investment, ESG factors may be weighted and factored into investment decisions alongside other relevant factors, as prudently determined by the fiduciary. For the sake of clarity and to eliminate any doubt caused by the current regulation, the preamble further explains paragraph (b)(4) by providing examples of factors that may be relevant to a fiduciary’s risk and return analysis depending on the particular facts and circumstances. For example, such factors may include: (i) climate changerelated factors, such as a corporation’s exposure to the real and potential economic effects of climate change, including exposure to the physical and transitional risks of climate change and the positive or negative effects of government regulations and policies related to climate change; (ii) governance factors, such as those involving board composition, executive compensation, transparency and accountability in corporate decisionmaking, as well as a corporation’s avoidance of criminal liability and compliance with labor, employment, environmental, tax, and other applicable laws and regulations; and (iii) workforce practices, including the corporation’s progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion, and retention; its investment in training to develop its workforce’s skill; equal employment opportunity; and labor relations. To its list of examples in section III.B.1.(f)(2) of this preamble the Department added other examples to emphasize that the examples are merely illustrative, and not intended to limit a fiduciary’s discretion to identify factors that are relevant to its risk/return analysis of any particular investment or investment course of action. This expansion of examples is intended to avoid regulatory bias and not favor particular investments or investment strategies. As paragraph (b)(4) explicitly states, whether any particular factor is relevant to a risk and return analysis depends upon the individual facts and circumstances. Paragraph (c)(1) of the final rule addresses the application of the duty of loyalty under ERISA as applied to a fiduciary’s consideration of an E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 73860 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations investment or investment course of action. The primary benefit of this provision to plan participants and beneficiaries is that it clarifies in no uncertain terms that a plan fiduciary may not subordinate the interests of participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives, and may not sacrifice investment return or take on additional investment risk to promote benefits or goals unrelated to the interests of participants and beneficiaries in their retirement income or financial benefits under the plan. By ensuring that plan fiduciaries may not sacrifice investment returns or take on additional investment risk to promote unrelated goals, paragraph (c)(1) protects the investment returns that accrue to participants and sponsors of ERISA-covered plans. Over the years, the Department has stated this bedrock principle of loyalty many times in nonregulatory guidance, and this final rule, like the current regulation, incorporates the principle directly into title 29 of the Code of Federal Regulations. This incorporation will result in a higher degree of permanency and certainty for plan fiduciaries, relative to periodic restatements in non-regulatory guidance, and as such is considered a benefit. Much of the anticipated economic benefits under this final rule is derived from paragraph (b)(4) of the final rule and the examples earlier in section III.B.1.(f)(2) of this preamble and the clarity they provide to plan fiduciaries. In the Department’s view, and consistent with the comments of the concerned stakeholders mentioned above, the examples in the preamble should overcome unwarranted concerns about investing in ESG-themed funds that are economically advantageous to plans. Removing this uncertainty is considered a primary benefit of this final rule. Two comments on the proposal argued against the Department’s assertion that the current regulation has had a chilling effect. One argued that the Department did not articulate what confusion it had created, while the other said the Department had failed to demonstrate that it had a negative impact. However, many comments on the NPRM agreed with the Department’s assessment of the impact of the 2020 rule, noting the 2020 rule created confusion on whether ERISA fiduciaries should incorporate ESG factors into their decision-making and that this confusion created a chilling effect. One comment states that the 2020 rule had introduced ‘‘significant uncertainty’’ VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 and ‘‘potential legal liability’’ for fiduciaries making investment decisions. Some of the commenters assert that the documentation requirement in the 2020 rule could chill investments in ESG assets. According to Lipton (2020), under the 2020 rule it would be harder for 401(k) plans to offer ESG investment options and fewer plan participants would have access to these options.128 According to the United Nations Principles for Responsible Investment, the uncertainty in how considerations of ESG factors fall within the legal standard of ERISA has precluded plan fiduciaries from considering ESG factors within their investment analysis.129 Avoiding the chilling effects described by these comments and reports will be a benefit to participants and beneficiaries. As described in the preamble, paragraph (c)(2) of the final rule will replace the tiebreaker provision in the current regulation with a formulation that is intended to be broader. Paragraph (c)(2) provides that if a fiduciary prudently concludes that competing investments or 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. Paragraph (c)(2) of the final rule will not carry forward the documentation requirements contained in paragraphs (c)(2)(i) through (iii) of the current regulation. Commenters said these requirements are burdensome and have the effect of singling out ESG investments for special scrutiny. Stakeholders point to these special, heightened documentation provisions as casting an unnecessarily negative shadow on investments or investment courses of action that are prudent. Paragraph (c)(2) of the final rule permits fiduciaries to take into account an investment’s potential collateral benefits, including potential increases in plan contributions, to break a tie. The Department received several comments citing research that increased access to ESG investment could increase contributions to retirement plans. Avoiding unnecessarily burdensome 128 Martin Lipton, ‘‘DOL Proposes New Rules Regulating ESG Investments,’’ Harvard Law School Forum on Corporate Governance (2020), https:// corpgov.law.harvard.edu/2020/07/07/dol-proposesnew-rules-regulating-esg-investments/. 129 Rory Sullivan, Will Martindale, Elodie Feller, and Anna Bordon, ‘‘Fiduciary Duty in the 21st Century,’’ United Nations Principles for Responsible Investment, https://www.unpri.org/ download?ac=1378. PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 documentation and clarifying the extent to which fiduciaries may factor in collateral benefits to break ties are benefits of the final rule. Several commenters supported the proposed changes to the tiebreaker. One commenter noted that under the current rule, fiduciaries may only consider the collateral benefit between two investments if the fiduciaries are unable to distinguish between two investments based on pecuniary factors. However, it may be unclear under what circumstances, if any, two investment courses of action would meet the current rule’s standard. The proposed rule recognizes that competing investments can equally serve the financial interests of the plan. However, several commenters expressed that the proposed provisions were still too narrow, while other commenters argued that the tiebreaker should be eliminated altogether. One commenter argued that the test was obsolete and additional tests or documentation would increase costs for plan participants and beneficiaries without a corresponding benefit. Paragraph (c)(3) of the final rule confirms that plan fiduciaries do not violate the paragraph (c)(1) duty of loyalty solely because they take participant preferences into consideration. Plan fiduciaries must ensure that consideration of participant preferences is consistent with the requirements in paragraph (b). This clarification may lead to investment options that are more aligned with employee preferences and that, accordingly, result in increased contributions to the plan and greater retirement savings. Commenters on the NPRM supported the idea that reflecting participant preferences in investment options has a positive effect on participation and retirement savings, including comments from institutional asset managers and asset custodians. This is supported by a survey conducted by Schroders (2021) of consumers between ages 45 and 75, finding that 69 percent of participants, who said their plans did not offer ESG investment options or did not know, would increase their overall contribution rate if an ESG option was offered.130 Commenters also suggested that not considering participant preferences may be detrimental to retirement savings. A few of the commenters argued that participants may not utilize ERISA plans that do not offer investments reflective of their 130 Schroders, ‘‘Schroders US Retirement Survey Results—2021,’’ https://www.schroders.com/en/us/ defined-contribution/dc/retirement-survey-2021. E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations values, resulting in some individuals foregoing saving for retirement or choosing to save outside of a qualified plan. The current regulation prohibits fiduciaries from adding or retaining any investment fund, product, or model portfolio as a qualified default investment alternative (QDIA) as described in 29 CFR 2550.404c–5 if the fund, product, or model portfolio reflects non-pecuniary objectives in its investment objectives or principal investment strategies. The final rule amends the current regulation to remove the stricter rules for QDIAs, such that, under the final rule, the same standards apply to QDIAs as to investments generally. The Department expects to see an increase in the number of QDIAs that are ESG funds. This will affect many participants since a large and growing share of plans use automatic enrollment. For example, Vanguard administrative data shows that 70 percent of participants in 2021 were in plans with automatic enrollment.131 It is difficult to obtain data on how many of these participants’ accounts were invested in a QDIA. The clarifications provided by paragraphs (b) and (c) of this final rule relate to the appropriate use of ESG factors by plan fiduciaries in selecting investments or investment courses of action. Outside the ERISA context, investors may choose to invest in funds that promote collateral objectives, and even choose to sacrifice return or increase risk to achieve those objectives. Such conduct, however, would be impermissible for ERISA plan fiduciaries, who cannot sacrifice return or increase risk for the purpose of promoting collateral goals unrelated to the economic interests of plan participants in their benefits. In the proposal, the Department requested comment on the financial materiality of ESG factors in various investment contexts. In the analysis below, the Department has considered and taken into account the comments received and the resources referenced by commenters as well as other resources that came to its attention. The studies and reports often examine investing circumstances that are outside of ERISA and may not apply to an ERISA context. Several comments on the NPRM criticized the Department’s survey of the literature. For example, one commenter asserted that there was an oversampling of studies showing better returns from ESG investing, compared to literature showing lower returns. The comparison between the 131 How America Saves 2022, Vanguard, 2022. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 various studies cited is difficult, however, as studies differ between whether they consider corporate or investment performance, which benchmarks are considered, the time horizon studied, and how ESG is incorporated into the company or investment strategy. The Department has reviewed the literature received from commenters and summarized the findings. (a) Challenges of Determining the Relationship Between Performance and ESG Factors The primary types of ESG portfolio management are integration, negative screening, and positive screening. Integration incorporates ESG factors into the investment analysis and decisions. Screening filters investments based on ESG-related preferences. Negative screening excludes investments based on the investment’s sector, issuer, activity, or other ESG criteria; positive screening includes investments based on similar characteristics. Positive screening is often referred to as ‘‘best-inclass’’ investing.132 The Royal Bank of Canada (RBC, 2019) outlines the challenges of comparing studies on ESG. This report divides the research literature on socially responsible investment (SRI) into four categories: index comparison, mutual fund comparison, hypothetical portfolios, and company performance. In their review, they find that research comparing equity SRI and non-SRI indices generally find that equity SRI indices do not underperform traditional indices, with much of the literature finding that SRI indices outperformed traditional indices. However, mutual fund comparison studies prove difficult to compare because of the variety of funds and investment strategies considered as SRI, resulting in mixed and inconclusive results from this type of study. Similarly, hypothetical portfolio studies may use different techniques to incorporate ESG, making it difficult to compare results.133 Other research has pointed to the lack of a standardized definition for ESG as a cause of mixed conclusions on the benefits of ESG. For instance, Lioui and Tarelli (2022) analyze ESG data from three vendors, comparing the properties 132 United Nations Principles for Responsible Investment, ‘‘An Introduction to Responsible Investment: Screening’’ (May 2020), https:// www.unpri.org/an-introduction-to-responsibleinvestment/an-introduction-to-responsibleinvestment-screening/5834.article. 133 RBC Global Asset Management, ‘‘Does socially responsible investing hurt investment returns?’’ (2019), https://www.rbcgam.com/documents/en/ articles/does-socially-responsible-investing-hurtinvestment-returns.pdf. PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 73861 of their ESG factors. They find that the different factor construction methodologies can contribute to the mixed evidence on the ESG performance in the literature and that disagreement across data vendors has substantial implications for the performances of ESG factors.134 Similarly, Cornell, and Damodaran (2020) review ESG literature and note that while there is evidence that ‘‘being good’’ benefits a company’s operating performance, the literature’s findings are sensitive to how ESG is defined and profitability is measured.135 Likewise, the comments on the proposal are mixed in their assessment on the relationship between ESG performance and corporate or investment performance. Several comments note that ESG factors are financially material for financial returns. For example, a comment notes that firms with strong ratings on material sustainability issues have better performance than firms with inferior ratings. One commenter states that ESGfocused companies in the MSCI ACWI Index saw higher returns, stronger earnings, and higher dividends. Another commenter notes that the iShares ESG Aware MSCI USA ETF outperformed the S&P 500 index by five percentage points from the beginning of 2020 to the second quarter of 2021. Still another commenter notes that ignoring the entire category of information and analysis that comprises ESG factors could be deemed an abrogation of a fiduciary’s responsibility to consider all relevant information when assessing the risk and return of an investment opportunity. Conversely, several commenters assert that ESG factors are not relevant for financial returns and may be detrimental to returns and retirement savings. For instance, one commenter remarks that the time horizon associated with ESG risks often surpasses the time horizon of retirement investors. Other commenters note that ESG return premiums are due to larger weights placed on technology stocks, which have experienced increased value but also present increased risk. A commenter asserts that the claim in the NPRM that the proposal would lead to increased investment returns is unsubstantiated. 134 Abraham Lioui and Andrea Tarelli, ‘‘Chasing the ESG Factor,’’ Journal of Banking and Finance, forthcoming (March 2022), https://papers.ssrn.com/ sol3/papers.cfm?abstract_id=3878314. 135 Bradford Cornell and Aswath Damodaran, ‘‘Valuing ESG: Doing Good or Sounding Good?’’ The Journal of Impact and ESG Investing, Fall 2020, 1(1). https://jesg.pm-research.com/content/1/1/76. E:\FR\FM\01DER2.SGM 01DER2 73862 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations (b) Meta-Studies khammond on DSKJM1Z7X2PROD with RULES2 The body of research evaluating ESG investing shows ESG investing can have financial benefits, although the literature overall has varied findings. In a meta-analysis of over 1,000 studies published between 2015 and 2020, Whelan et al. (2021) report that of the studies concerning corporate performance—focusing on measurements such as return on equity, return on assets, and stock price for an individual firm—58 percent find a positive relationship between corporate financial performance and ESG, while 13 percent find a neutral relationship, 21 percent find a mixed relationship, and 8 percent find a negative relationship. For the studies concerning investment performance—focusing on risk-adjusted return measurements for a portfolio of stocks—33 percent find a positive relationship between investment performance and ESG, 26 percent find a neutral impact, 28 percent find mixed results, and 14 percent find negative results.136 They found similar results when focusing only on studies about climate change and financial performance. Clark, Feiner, and Vieha (2014) conduct a meta-study analyzing more than 200 studies, 45 of which looked at operational performance, and showed that 88 percent of these studies found that ESG practices lead to better operational performance. Additionally, 41 of the operational performance studies review the relationship between sustainability and financial market performance, of which 80 percent show that stock price performance of companies is positively influenced by good sustainability practices.137 Friede et al. (2015) find in their meta-study that only 10.0 percent of studies found a negative ESG performance relationship, while 47.9 percent of vote-count 136 Tenise Whelan, Ulrich Atz, Tracy Van Holt, and Casey Clark, ‘‘ESG and Financial Performance: Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published Between 2015 and 2020,’’ Journal of Sustainable Finance & Investment (2021). https:// www.stern.nyu.edu/sites/default/files/assets/ documents/NYU-RAM_ESG-Paper_2021%20Rev_ 0.pdf. 137 Gordon Clark, Andreas Feiner, and Michael Viehs, ‘‘From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance,’’ University of Oxford and Arabesque Partner (2014), https://papers.ssrn.com/ sol3/papers.cfm?abstract_id=2508281. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 studies 138 and 62.6 percent of metastudies 139 show positive findings.140 (c) Association Between ESG Investing and Performance Ito, Managi, and Matsuda (2013) find that socially responsible funds outperformed conventional funds in the European Union and United States.141 The Morgan Stanley Institute for Sustainable Investing (2019) compared the performance of sustainable funds to traditional funds between 2004 and 2018 and found that sustainable funds provided returns in line with comparable traditional funds such that the returns, net of fees, were not statistically significantly different.142 Morningstar (2022) finds that of trailing three- and five-year periods, 44 percent of sustainable funds, as defined by Morningstar, ranked in the top quartile of their respective categories.143 Curtis, Fisch, and Robertson (2021) measures ESG orientation of mutual fund portfolios from four rating providers to analyze returns of ESG funds between 2018 and 2019. They find that ESG funds did not perform worse in terms of either raw or risk-adjusted returns.144 138 A ‘‘vote count study’’ in this context is a review study which counts the number of primary studies with significant positive, negative, and nonsignificant results and ‘‘votes’’ the category with the highest share as winner. 139 A ‘‘meta-study’’ in this context is a review study which directly imports effect sizes and sample sizes of primary studies to compute a summary effect across all primary studies. 140 In this study, the authors analyze 60 review studies on ESG performance, encompassing the finding of 2,250 unique underlying studies. (See Gunnar Friede, Michael Lewis, Alexander Bassen, and Timo Busch. ‘‘ESG & Corporate Financial Performance: Mapping the global landscape.’’ DWS, University of Hamburg (December 2015). https:// download.dws.com/download?elibassetguid=2c2023f453ef4284be4430003b0fbeee.) 141 Yutaka Ito, Shunsuke Managi, and Akimi Matsuda, ‘‘Performances of Socially Responsible Investment and Environmentally Friendly Funds,’’ 64 Journal of the Operational Research Society 11 (2013). 142 Morgan Stanley Institute for Sustainable Investing, ‘‘Sustainable Reality: Analyzing Risk and Returns of sustainable Funds,’’ https:// www.morganstanley.com/pub/content/dam/ msdotcom/ideas/sustainable-investing-offersfinancial-performance-lowered-risk/Sustainable_ Reality_Analyzing_Risk_and_Returns_of_ Sustainable_Funds.pdf. 143 Morningstar Manager Research, ‘‘Sustainable U.S. Landscape Report. 2021: Another Year of Broken Records’’ (January 2022), https://assets. contentstack.io/v3/assets/blt4eb669caa7dc65b2/ blta4326c09c190e82b/62100fefcf85c1619ad897b2/ U.S._Sustainable_Funds_Landscape_2022.pdf. 144 In this study, the authors identify ESG funds based on their fund names. (See Quinn Curtis, Jill Fisch, and Adriana Robertson, ‘‘Do ESG Funds Deliver on Their Promises?’’ Michigan Law Review, Vol. 120(3) (2021), https://repository.law.umich. edu/cgi/viewcontent.cgi?params=/context/mlr/ article/7846/&path_info=#:∼:text=We%20 find%20that%20ESG%20funds,increasing%20 costs%20or%20reducing%20returns.) PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 In contrast, other studies have found that ESG investing has resulted in lower returns than conventional investing. For example, Winegarden (2019) shows that over ten years, a portfolio of ESG funds has a net return that is 43.9 percent lower than if it had been invested in an S&P 500 index fund.145 One commenter criticizes the Winegarden report, saying that the study does not isolate how incorporation of ESG data affects performance. Trinks and Scholten (2017) examine socially responsible investment funds and find that a market portfolio based on negative screening significantly underperforms an unscreened market portfolio.146 Ferruz, Mun˜oz, and Vicente (2012) find that a portfolio of mutual funds that implements negative screening 147 underperforms a portfolio of conventionally matched pairs.148 Ciciretti, Dalo`, and Dam (2019) analyze a global sample of operating companies and find that companies that score poorly on ESG indicators have higher expected returns.149 Furthermore, there are many studies with inconclusive results. Goldreyer and Diltz (1999) find that employing positive social screens does not affect the investment performance of mutual funds, based on analysis of 49 socially responsible mutual funds.150 Similarly, Renneboog, Ter Horst, and Zhang (2008) find that the risk-adjusted returns of socially responsible mutual funds are not statistically different from conventional funds when analyzing a sample of global socially responsible mutual funds.151 Research by Bello 145 Wayne Winegarden, ‘‘Environmental, Social, and Governance (ESG) Investing: An Evaluation of the Evidence,’’ Pacific Research Institute (2019), https://www.pacificresearch.org/wp-content/ uploads/2019/05/ESG_Funds_F_web.pdf. 146 Pieter Jan Trinks and Bert Scholtens, ‘‘The Opportunity Cost of Negative Screening in Socially Responsible Investing’’ Journal of Business Ethics 140, 193–208 (2017). 147 The authors describe a negative screening strategy as one that ‘‘removes stocks’’ that do not align with the socially responsible ideology from a portfolio. Comparatively, a positive screening strategy ‘‘selects stocks’’ that align with the socially responsible ideology for a portfolio. 148 Luis Ferruz, Fernando Mun ˜ oz, and Ruth Vicente, ‘‘Effect of Positive Screens on Financial Performance: Evidence from Ethical Mutual Fund Industry’’ (2012), https://www.efmaefm.org/ 0efmameetings/efma%20annual%20meetings/ 2012-Barcelona/papers/EFMA2012_0183_ fullpaper.pdf. 149 Rocco Ciciretti, Ambrogio Dalo ` , and Lammertjan Dam, ‘‘The Contributions of Betas versus Characteristics to the ESG Premium,’’ (2019). 150 Elizabeth Goldreyer and David Diltz, ‘‘The Performance of Socially Responsible Mutual Funds: Incorporating Sociopolitical Information in Portfolio Selection,’’ 25 Managerial Finance 1 (1999). 151 Luc Renneboog, Jenke Ter Horst, and Chendi Zhang, ‘‘The Price of Ethics and Stakeholder E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 (2005), which examines 126 mutual funds, finds that the long-run investment performance is not statistically different between conventional and socially responsible funds.152 Likewise, Ferruz, Mun˜oz, and Vicente (2012) finds that a portfolio of mutual funds that implement positive screening performs equally well as a comparable conventional mutual funds, matched based on fund age, size, risk factors.153 Humphrey and Tan (2014), which examines socially responsible investment funds, finds no evidence of negative screening affecting the risks or returns of portfolios.154 Marsat and Williams (2020) uses the Markowitz Portfolio optimization model, the direct application of modern portfolio theory, to create the ‘‘best complete portfolio’’ by allocating to the optimal risky portfolio and the risk-free asset. It does so assuming that investors are risk averse and that, given equal returns, an investor would prefer the one with less risk. Backtesting various constructed portfolios over the past 10 years, the study did not observe a correlation between high ESG scores and financial returns. The study observes a wide range of performance depending on the provider of ESG data.155 A few of the studies referenced in the comments discussed the performance of ESG funds during the COVID–19 pandemic. Whieldon and Clark (2021) look at the performance of 26 ESG exchange traded funds (ETFs) and mutual funds with more than $250 million in assets between March of 2020 and 2021 and found that 19 of the 26 funds outperformed the S&P 500.156 The Morgan Stanley Institute for Sustainable Investing (2020) finds that, three out of four sustainable equity funds beat their Morningstar category average. The authors posit that the performance of sustainable funds in 2020 demonstrates Governance: The Performance of Socially Responsible Mutual Funds’’, 14 Journal of Corporate Finance 3 (2008). 152 Zakri Bello, ‘‘Socially Responsible Investing and Portfolio Diversification,’’ 28 Journal of Financial Research 1 (2005). 153 Ferruz, Mun ˜ oz, and Vicente, ‘‘Effect of Positive Screens on Financial Performance,’’ 2012. 154 Jacquelyn Humphrey and David Tan, ‘‘Does It Really Hurt to be Responsible?’’, 122 Journal of Business Ethics 3 (2014). 155 Organisation for Economic Co-operation and Development (OECD). ‘‘ESG Investing: Practices, Progress and Challenges’’ (2020). https:// www.oecd.org/finance/ESG-Investing-PracticesProgress-Challenges.pdf. 156 Esther Whieldon and Robert Clark, ‘‘ESG Funds Beat Out S&P 500 in 1st Year of COVID–19; How 1 Fund Shot to the Top,’’ S&P Global Market Intelligence (2021), https://www.spglobal.com/ marketintelligence/en/news-insights/latest-newsheadlines/esg-funds-beat-out-s-p-500-in-1st-year-ofcovid-19-how-1-fund-shot-to-the-top-63224550. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 that investing strategies that manage material ESG risks can produce good returns in an uncertain economic environment. The study finds that between January and June of 2020, domestic sustainable equity funds outperformed their traditional peers by a median of 3.9 percentage points.157 (d) Fees Some commenters expressed concern that higher fees associated with ESG investments will result in lower returns and retirement savings. The Department recognizes that ESG investing requires information collection and research that will incur costs. For instance, a 2020 study estimates that, globally, investment managers would spend $745 million in 2020 on ESG information.158 The findings in the literature discussing fees on ESG funds were mixed. Morningstar (2020) finds that sustainable funds have higher assetweighted average expense ratios (0.61 percent) than their traditional peers (0.41 percent).159 According to Wursthorn (2021), at the end of 2020, the average fee for ESG funds was 0.20 percent, compared to 0.14 percent for standard ETFs that invest in U.S. largecap stocks.160 Winegarden (2019) analyzes 30 ESG funds that have either existed for more than 10 years or have outperformed the S&P 500 over a shortterm timeframe and finds that the average expense ratio was 0.69 percent for the 30 ESG funds, compared to an expense ratio of 0.09 percent for a S&P 500 index fund.161 Conversely, a study conducted by Curtis, Fisch, and Robertson (2021) found that when controlling for whether a fund is an actively managed fund or an index fund, as well as net assets by fund manager, fund, and class, there is not a statistically significant difference 157 Morgan Stanley Institute for Sustainable Investing, ‘‘Sustainable Reality: 2020 Update,’’ Morgan Stanley (2020), https:// www.morganstanley.com/content/dam/msdotcom/ en/assets/pdfs/3190436-20-09-15_SustainableReality-2020-update_Final-Revised.pdf. 158 Sean Collins and Kristen Sullivan, ‘‘Advancing ESG Investing: a Holistic Approach for Investment Management Firms,’’ Harvard Law School Forum on Corporate Governance (March 2020), https://corpgov.law.harvard.edu/2020/03/11/ advancing-esg-investing-a-holistic-approach-forinvestment-management-firms/. 159 Morningstar, ‘‘2020 U.S. Fund Fee Study: Fees Keep Falling’’ (August 2021), https:// www.morningstar.com/content/dam/marketing/ shared/pdfs/Research/annual-us-fund-fee-studyupdated.pdf. 160 Michael Wursthorn, ‘‘Tidal Wave of ESG Funds Brings Profit to Wall Street,’’ Wall Street Journal (March 2021), https://www.wsj.com/ articles/tidal-wave-of-esg-funds-brings-profit-towall-street-11615887004. 161 Winegarden, ‘‘Environmental, Social, and Governance (ESG) Investing,’’ 2019. PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 73863 between the fees of ESG funds and the fees that would be expected given fund characteristics.162 There has been some reduction in sustainable funds fees. Morningstar (2020) finds that the average fee charged by sustainable funds fell 27 percent between 2011 and 2021 and that this decline in average fees has been driven by the rise of low-fee sustainable index mutual funds and ETFs.163 The studies of ESG investment performance discussed in this document generally take fees into account. (e) Sectoral Bias Some of the literature addresses the role of sectoral biases within ESG investing. A study by Morningstar (2021) finds that between November 2020 and March 2021, a rally in energy prices may have hampered sustainable equity fund returns.164 Hale (2020) notes that the performance of sustainable funds during the first quarter of 2020 was helped by having less exposure to energy stocks and a larger exposure to technology stocks than the comparable market indices. The study estimates that U.S. ‘sustainable index funds’ energy-sector under-weightings contributed an average of 0.43 percent to their outperformance of the S&P 500 during this period. Information technology was the quarter’s best-performing sector, and sustainable funds generally had a higher proportion of assets invested in the sector than broad market indices. The study estimates information technology contributed an average of 0.21 percent to the funds’ outperformance of the S&P 500. Nevertheless, the author posits that ‘‘the biggest reason for their outperformance is that sustainable funds appear to have benefited from selecting stocks with better ESG credentials.’’ 165 Bruno, Esakia, and Goltz (2021) addresses sectorial bias in general, finding that over representation of the technology sector increases ESG performance. The study finds that when 162 Curtis, Fisch, and Robertson, ‘‘Do ESG Funds Deliver on Their Promises?’’ 2021. 163 Morningstar, ‘‘2020 U.S. Fund Fee Study: Fees Keep Falling,’’ Morningstar (2020), https://assets. contentstack.io/v3/assets/blt4eb669caa7dc65b2/ blt0b2eed63bfb1eb8b/619f8bf6224a1b121d540f7e/ annual-us-fund-fee-study-updated.pdf. 164 Morningstar Manager Research, ‘‘Sustainable U.S. Landscape Report. 2021: Another Year of Broken Records’’ (Jan. 2022), https://assets.content stack.io/v3/assets/blt4eb669caa7dc65b2/ blta4326c09c190e82b/62100fefcf85c1619ad897b2/ U.S._Sustainable_Funds_Landscape_2022.pdf. 165 Jon Hale, ‘‘Sustainable Funds Weather the First Quarter Better than Conventional Funds,’’ Morningstar (April 2020), https://www.morning star.com/articles/976361/sustainable-fundsweather-the-first-guarter-better-thanconventionalfunds. E:\FR\FM\01DER2.SGM 01DER2 73864 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations the sectoral weights of portfolios are rebalanced to more closely resemble the overall sectoral composition of the market, ESG strategies ‘‘consistently deliver zero alpha.’’ 166 However, Lefkovitz (2021) refutes the claims that ESG performance is entirely due to sectorial bias, observing that companies with a sustainable competitive advantage have often experienced lower volatility. The author posits that while sectoral bias contributes to the performance of ESG strategies, security selection also contributes to the outperformance.167 Conversely, Brav, and Heaton (2021) compare the returns of high-carbon assets and low-carbon assets. The study found that, for firms included in the S&P 500, the average return for the energy sector in 2021 was 64.8 percent, compared to an average return of 28.7 percent for all companies not in the energy sector. Similarly, for firms included in the Russell 3000, the average return for the energy sector was 74.4 percent, compared to an average return of 25.5 percent for all companies not in the energy sector. The authors state that the transition to a low-carbon economy may fail and investors should not avoid high-carbon assets.168 (f) Investment Screening khammond on DSKJM1Z7X2PROD with RULES2 As discussed above, one of the ESG investment strategies used is investment screening. One commenter noted that many of the studies cited by the Department in the proposal finding ESG underperformance focus on the implications of negative screening or a socially responsible investing lens. The commenter notes that most of the studies cited by the Department showing ESG as beneficial to returns focus on ESG as a means to maximize risk-adjusted returns. The commenter further notes that most plan sponsors, except for those relying on the tiebreaker test, would rely on a modern, financially material ESG lens to select investments. Similarly, one commenter called integrated ESG analysis a tool in the modern investment toolkit to be used alongside traditional fundamental 166 Giovanni Bruno, Mikheil Esakia, and Felix Goltz, ‘‘ ‘Honey, I Shrunk the ESG Alpha’: RiskAdjusting ESG Portfolio Returns’’ (April 2021), https://cdn.ihsmarkit.com/www/pdf/0521/Honey-IShrunk-the-ESG-Alpha.pdf. 167 Dan Lefkovitz, ‘‘Morningstar’s ESG Indexes have Outperformed and Protected on the Downside’’ (February 2021), https:// www.morningstar.com/insights/2021/02/08/ morningstars-esg-indexes-have-outperformed-andprotected-on-the-downside. 168 Alon Brav and J.B. Heaton, ‘‘Brown Assets for the Prudent Investor,’’ Harvard Business Law Review (2021), https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3895887. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 analysis, valuation assessment, or quantitative analysis. For instance, one asset manager with more than $50 billion assets under management commented that they seek to generate superior, risk-adjusted investment returns by investing in assets they believe are better positioned to seize opportunities and mitigate risks associated with the transition to a more sustainable economy. Another commenter noted that the ‘‘digitalization of the economy and pioneering research has helped generate awareness of critical issues that were previously not considered significant for investors, including, but not limited to, climate change, data privacy and social justice issues.’’ The commenter notes that the drawdowns and the risks associated with these ESG issues are factors that financial markets and ERISA fiduciaries must consider when making business, investment and voting decisions. Several studies have specifically addressed the ESG investment strategy of screening. For instance, the U.S. Commodity Futures Tradition Commission (2020) refutes the historical view that ESG investing is a valuesdriven activity inconsistent with fiduciary duty. The study notes that this view ‘‘ignore[s] the evolution of a wide range of financial ESG factors and strategies, as well as the proposition that impact investing may yield additional returns.’’ 169 Verheyden, Eccles, and Feiner (2016) analyze stock portfolios that were selected using ESG screening.170 The study finds that screening tends to increase a stock portfolio’s annual performance by 0.16 percent. Similarly, Kempf, and Osthoff (2007) examine stocks in the S&P 500 and the Domini 400 Social Index (renamed as the MSCI KLD 400 Social Index in 2010) and find that it is financially beneficial for investors to positively screen their portfolios.171 A study from Morningstar (2021), looking at the performance of 69 ESG-screened Morningstar indices, finds that 75 percent ‘‘outperformed 169 U.S. Commodity Futures Trading Commission, ‘‘Managing Climate Risk in the U.S. Financial System’’ (2020), https://www.cftc.gov/sites/default/ files/2020-09/9-9-20%20Report%20of%20the %20Subcommittee%20on%20ClimateRelated%20Market%20Risk%20%20Managing%20Climate%20Risk%20in%20the %20U.S.%20Financial%20System %20for%20posting.pdf. 170 Tim Verheyden, Robert G. Eccles, and Andreas Feiner, ‘‘ESG for All? The Impact of ESG Screening on Return, Risk, and Diversification,’’ 28 Journal of Applied Corporate Finance 2 (2016). 171 Alexander Kempf and Peer Osthoff, The Effect of Socially Responsible Investing on Portfolio Performance, 13 European Financial Management 5 (2007). PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 their broad market equivalents in 2020’’, 88 percent outperformed between 2015 and 2020, and 91 percent ‘‘lost less than their broad market equivalents during down markets over the past five years, including the bear market in the first quarter of 2020.’’ 172 Trinks and Scholtens (2017) explores the effect of negative screening stocks related to abortion, adult entertainment, alcohol, animal testing, contraceptives, controversial weapons, fur, gambling, genetic engineering, meat, nuclear power, pork, embryonic stem cells, and tobacco has on investment returns. Looking at a sample of 1,763 stocks between 1991 and 2013, the authors note that negative screens decrease the investment universe and limit the ability to diversify. The study finds that there is an opportunity cost in negative screening of ‘‘refraining from investing in controversial firms.’’ The study finds that screened portfolios underperformed the unscreened portfolio and notes that there ‘‘can be a trade-off between values and beliefs and financial returns.’’ 173 AQR Capital Management warns that the performance of a constrained portfolio will always ex-ante be less than or equal to an unconstrained portfolio.174 Similarly, Cornell and Damodaran (2020) present a theoretical framework demonstrating that adding an ESG constraint to investing increases expected returns is counter intuitive, as a constrained optimum can, at best, match an unconstrained one, and most of the time, the constraint will create a cost.175 Sharfman (2021) argues that ‘‘screening techniques based on nonfinancial factors lead to an increased probability that the big winners in the stock market will be excluded from or underweighted in an investment portfolio.’’ Based on this premise, the author concludes that screening will result in lower expected risk-adjusted returns, relative to a benchmark index.176 172 Dan Lefkovitz, ‘‘Morningstar’s ESG Indexes have Outperformed and Protected on the Downside’’ (February 2021), https:// www.morningstar.com/insights/2021/02/08/ morningstars-esg-indexes-have-outperformed-andprotected-on-the-downside. 173 Trinks and Scholtens, ‘‘The Opportunity Cost of Negative Screening in Socially Responsible Investing,’’ 2017. 174 Cliff Asness, ‘‘Virtue Is Its Own Reward: Or, One Man’s Ceiling Is Another Man’s Floor,’’ AQR Capital (May 2017), https://www.aqr.com/Insights/ Perspectives/Virtue-is-its-Own-Reward-Or-OneMans-Ceiling-is-Another-Mans-Floor. 175 Cornell and Damodaran, ‘‘Valuing ESG,’’ 2020. 176 Bernard Sharfman, ‘‘ESG Investing Under ERISA.’’ Yale Journal on Regulation Bulletin, Vol. 38 (March 2021). https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3809129. E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations (g) ESG Factors and Risk In addition to performance, the ESG literature also addresses the relationship between ESG factors and risk. Common ESG factors are also common risk factors, for both companies and investors. As such, ESG integration inherently serves as a risk management function. For instance, the E in ESG may include risks from climate change, deforestation, or water scarcity. The S may consider risk associated with data protection and privacy, employee engagement, or labor standards within a supply chain. The G may address issues with bribery and corruption, board and executive compensation, and whistleblower protections.177 Each of these factors has direct connections to the profitability and resilience of an investment, but as pointed out by Kumar et al. (2016), may also be relevant with respect to the reputation, political, and regulatory risk faced by the investment.178 As a reference to the magnitude of risks associated with ESG factors, a study by Schroders (2019) estimates that the negative externalities of listed companies equate to almost half of their combined earnings. The authors posit that these economic costs will become tangible in the future, affecting financial cost and income.179 This was confirmed by several commenters. Some commenters on the NPRM state that ESG funds have lower downside risk or lower systematic volatility. One commenter noted that ESG consideration is a form of risk mitigation that can confer an investment edge and that neglecting ESG-related risk can impact a company’s competitive advantage and diminish long-term economic gains. Another commenter noted that ESG factors should be treated no differently than other risk and return factors, as appropriate for a given industry and investment timeframe. Several studies have found that the consideration of ESG factors in investment processes can mitigate risk. For instance, a meta study by Clark et al. (2014) observes that most of the studies (90 percent) addressing the relationship between sustainability standards and the cost of capital show khammond on DSKJM1Z7X2PROD with RULES2 177 CFA Institute, ‘‘The Rise of ESG Investing: What is Sustainable Investing?’’ https://interactive. cfainstitute.org/ESG-guide/what-is-sustainableinvesting-238UB-188048.html. 178 Ashwin Kumar, Camille Smith, Leila Badis, Nan Wang, Paz Amroxy, and Rodrigo Tavres, ‘‘ESG Factors and Risk-Adjusted Performance: A New Quantitative Model,’’ Journal of Sustainable Finance & Investment (2016) Vol. 6, No. 4, 292–300. 179 Schroders, ‘‘SustainEx’’ (April 2019), https:// www.schroders.com/en/sysglobalassets/digital/ insights/2019/pdfs/sustainability/sustainex/ sustainex-short.pdf. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 that incorporating sustainability standards is associated with a lower cost of equity or cost of debt.180 This finding suggests that incorporating sustainable standards is associated with lower risk. The consensus of the relationship between ESG factors and risk has also been confirmed by more recent studies. Campagna, Spellman, and Mishra (2020) find that higher ESG performance is associated with lower volatility.181 The Morgan Stanley Institute for Sustainable Investing (2019) shows that when comparing downside deviation,182 sustainable funds were less risky. On average the distribution of downside deviation for sustainable funds was 20.0 percent less than what traditional fund investors experienced in the same period.183 Surveys of the investment industry and investors indicate that the application of ESG factors in riskmanagement is a common practice. In an investigation performed by the Government Accountability Office (GAO) (2020), 12 of 14 interviewed institutional investors seek information on ESG to better understand risks that could affect company financial performance over time, and five of seven public pension funds seek ESG information to enhance their understanding of risks that could affect a companies’ value over time.184 180 This meta study analyzes more than 200 studies, of which 29 discuss the cost of capital. (See Clark, Feiner, and Viehs, ‘‘From the Stockholder to the Stakeholder,’’ 2014. 181 This study looks at the relationship between ESG ratings and returns for 534 securities, with a market cap exceeding $250 million, between 2013 and 2019. (See Anthony Campagna, G. Kevin Spellman, and Subodh Mishra, ‘‘ESG Matters,’’ Harvard Law School Forum on Corporate Governance (2020), https:// corpgov.law.harvard.edu/2020/01/14/esg-matters/.) 182 Downside deviation is a risk measurement that focuses on returns below a minimum threshold. (See Mark Jahn, ‘‘Downside Deviation,’’ Investopedia (2022), https:// www.investopedia.com/terms/d/downsidedeviation.asp#:∼:text=Downside%20deviation%20 is%20a%20measure,measure%20of%20risk%2D adjusted%20return.) 183 This study compares the performance of sustainable funds to traditional funds between 2004 and 2018 using Morningstar data on ETF and openended mutual funds. Funds considered to be ESGfocused are defined as those that prioritize investments based on multiple screens for numerous ESG factors and a variety of strategies. (See Morgan Stanley Institute for Sustainable Investing, ‘‘Sustainable Reality: Analyzing Risk and Returns of sustainable Funds’’ (2019), https://www. morganstanley.com/pub/content/dam/msdotcom/ ideas/sustainable-investing-offers-financialperformance-lowered-risk/Sustainable_Reality_ Analyzing_Risk_and_Returns_of_Sustainable_ Funds.pdf.) 184 GAO, ‘‘Report to the Honorable Mark Warner U.S. Senate: Disclosure of Environmental, Social, and Governance Factors and Options to Enhance Them’’ (July 2020), https://www.gao.gov/assets/gao20-530.pdf. PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 73865 Similarly, survey data reported by Natixis (2018) observes that 46 percent of institutional investors implementing ESG say that the analysis of ESG-related factors is ‘‘as important to their investment process as traditional fundamental analysis’’ and that 56 percent of institutional investors believe incorporating ESG mitigates governance and social risks.185 According to a survey conducted by FTSE Russell (2021), 64 percent of asset owners implementing or evaluating sustainability in portfolios cite risk as a motivator.186 The Department agrees that considering relevant ESG factors plays an important role in mitigating risks in the portfolios of ERISA plan participants and beneficiaries. (h) Market Pricing of ESG Risks In the proposal, the Department also welcomed comments on the extent to which climate-related financial risk is not already incorporated into market pricing. The Department received two comments that argued that climate risks are not yet fully reflected in asset prices. Conversely, another commenter criticized that the proposal’s regulatory impact analysis did not provide a rational basis for the contention that climate change and other ESG factors are not already priced into the market. This commenter argued that if climate change and ESG factors are already priced into the market, then further consideration would not result in investment gains. Commenters also referenced literature exploring market pricing. For instance, Brest, Gilson, and Wolfson (2018) argue that if ESG ratings and investments in ESG affect productivity, then they should already be reflected in stock prices.187 However, Condon (2021) identifies several sources of mispricing pertaining to climate risks, including limited asset-level data, reliance on outdated risk assessments, misaligned incentives, and regulatory distortions within the market. Although the efficient market hypothesis posits that arbitrageurs would exploit mispriced assets until the assets are no longer 185 Natixis Investment Managers, ‘‘Looking for the Best of Both Worlds’’ (2019), https://www.im. natixis.com/us/resources/esg-investing-survey-2019. 186 FTSE Russell, ‘‘Sustainable Investment Is Now Standard According to Global Asset Owner Survey’’ (October 2021), https://www.ftserussell.com/press/ sustainable-investment-now-standard-accordingglobal-asset-owner-survey. 187 Paul Brest, Ronald Gilson, and Mark Wolfson, ‘‘How Investors Can (and Can’t) Create Social Value,’’ Columbia Law School Scholarship Archive (2018), https://scholarship.law.columbia.edu/cgi/ viewcontent.cgi?article=3099&context=faculty_ scholarship. E:\FR\FM\01DER2.SGM 01DER2 73866 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations mispriced, the author acknowledges that the role of arbitrage in the real world is limited by imperfect information, heterogeneous expectations about the future, and uncertainty about when climate-related risks will occur.188 Brav and Heaton (2021) notes that research in this area is difficult, as the theories rely on expected returns, while researchers only have access to realized returns. The authors note, ‘‘When researchers study average, realized returns, it is always uncertain whether the realized price reflected one of the possible price realizations that investors anticipated at the probability they assigned it, or whether that price reflected a change in the underlying probability distribution.’’ 189 (i) Literature on Environmental Factors khammond on DSKJM1Z7X2PROD with RULES2 Reflective of the significant economic impacts of climate change to date across various sectors of the economy, the Department believes it can be as appropriate to treat climate change as a relevant factor in assessing the risks and returns of investments as any other relevant factor a prudent fiduciary would consider. In the proposal, the Department requested comments on whether fiduciaries should consider climate change as presumptively material in their assessment of investment risks and returns, if adopted. The Department received numerous comments specifically addressing the materiality of climate change and environmental risks. Some of the commenters note that while climate change risks are often considered strategic and regulatory, they are also operational risks. One commenter notes that the physical and transition impacts from climate change are already materially affecting public companies and financial institutions. Another commenter notes that weak control of environmental activities, such as pollution, over-consumption of raw materials, or lack of recycling, can lead to volatile or lower financial margins or returns to investors. A few commenters note that climate-related financial risks are especially relevant to retirement investors, who invest over decades and 188 Madison Condon, ‘‘Market Myopia’s Climate Bubble,’’ 1 Utah Law Review 63 (2022), Boston University School of Law Research Paper (February 2021), https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3782675. 189 Alon Brav and J.B. Heaton, ‘‘Brown Assets for the Prudent Investor,’’ Harvard Business Law Review (2021). https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3895887. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 are often universal owners with exposure to many at-risk sectors. There is a breadth of literature that provides evidence for the materiality of climate change as a driver of riskadjusted returns. These risks are often referred to in two broad categories: physical risk and transition risk. Physical risk captures the financial impacts associated with a rise in extreme weather events and a changing climate, both chronic and acute. The literature maintains that these risks can be especially material for long duration assets and grow in severity the more that climate mitigation and adaptation are neglected. We are already seeing significant economic costs as a result of warming, and a certain amount of additional warming is guaranteed based on the greenhouse gas pollution already in the atmosphere.190 This implies that the physical risks of climate change to our economy and to investments will persist. A 2019 report from BlackRock notes that the physical risk of extreme weather poses growing risks that are underpriced in certain sectors and asset classes.191 Additionally, S&P Trucost found that almost 60 percent of the companies in the S&P500 index hold assets that were at high risk to the physical effects of climate change.192 The Treasury Financial Stability Oversight Council (2021) provides a sense of the magnitude of the effect, noting that in 2020, there were 22 weather and climate disasters with damages exceeding a billion dollars, resulting in a combined $95 billion in damages.193 The report asserted that 190 Renee Cho, ‘‘How Climate Change Impacts the Economy’’ (June 20, 2019), https:// news.climate.columbia.edu/2019/06/20/climatechange-economy-impacts/. Celso Brunetti, Benjamin Dennis, Dylan Gates, Diana Hancock, David Ignell, Elizabeth K. Kiser, Gurubala Kotta, Anna Kovner, Richard J. Rosen, and Nicholas K. Tabor, ‘‘Climate Change and Financial Stability,’’ FEDS Notes. Washington: Board of Governors of the Federal Reserve System, March 19, 2021, https:// doi.org/10.17016/2380-7172.2893. 191 BlackRock Investment Institute, ‘‘Getting Physical: Assessing Climate Risks’’ (2019), https:// www.blackrock.com/us/individual/insights/ blackrock-investment-institute/physicalclimaterisks. 192 S&P Trucost Limited, Understanding Climate Risk at the Asset Level: The Interplay of Transition and Physical Risks (2019), https:// www.spglobal.com/_division_assets/images/ specialeditorial/understanding-climate-risk-at-theassetlevel/sp-trucost-interplay-of-transitionandphysical-risk-report-05a.pdf. 193 U.S. Treasury Financial Stability Oversight Council, ‘‘Report on Climate-Related Financial Risk: 2021’’ (2021), https://home.treasury.gov/system/ files/261/FSOC-Climate-Report.pdf. PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 weather and climate disasters may result in credit and market risks, associated with loss of income, defaults, changes in the value of assets, liquidity risks, operational risks, and legal risks.194 In contrast, transition risk reflects the risks that carbon-dependent businesses lose profitability and market share as government policies and new technology drive the transition to a carbon-neutral economy. Existing government policies and increasingly ambitious national and international greenhouse reduction goals will continue to create significant transition risk for investments. Studies assess the value of global financial assets at risk from climate change to be in the range of $2.5 trillion to $4.2 trillion, including transition risks and other impacts from climate change. The U.S. Commodity Futures Trading Commission (CFTC, 2020) warns that much of the risk associated with climate change is not priced into the market, which increases the risk for a systemic shock. The report notes that a ‘‘sudden revision of market participants’ perceptions about climate risk could trigger a disorderly repricing of assets, which could have cascading effects on portfolios and balance sheets and, therefore, systemic implications for financial stability.’’ 195 A Federal Reserve Board report from 2020, which states ‘‘[c]limate change, which increases the likelihood of dislocations and disruptions in the economy, is likely to increase financial shocks and financial system vulnerabilities that could further amplify these shocks.’’ 196 The report continues: ‘‘Opacity of exposures and heterogeneous beliefs of market participants about exposures to climate risks can lead to mispricing of assets and the risk of downward price shocks.’’ 197 194 Id. 195 Climate-Related Market Risk Subcommittee, ‘‘Managing Climate Risk in the U.S. Financial System,’’ U.S. Commodity Futures Trading Commission, Market Risk Advisory Committee (2020), https://www.cftc.gov/sites/default/files/ 2020-09/9-9-20%20Report%20of %20the%20Subcommittee%20on%20ClimateRelated%20Market%20Risk%20%20Managing%20Climate%20Risk%20in%20the %20U.S.%20Financial%20System %20for%20posting.pdf. 196 Board of Governors of the Federal Reserve System, ‘‘Financial Stability Report’’ (November 2020), https://www.federalreserve.gov/publications/ files/financial-stability-report-20201109.pdf. 197 Id. E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 Several studies quantify the direct economic effects of climate change. For instance, the CFTC estimates that by the end of the century, climate change will decrease the U.S. annual GDP by 1.2 percent for every 1 degree Celsius increase and that by 2090, total impacts from extreme heat conditions could result in more than 2 billion lost labor hours, corresponding to $160 billion (2015) in lost wages.198 CFTC (2020) notes that transition risks may lead to both stranded capital—where capital assets are at-risk from devaluation—or stranded value—where the market-value of a project or firm is at-risk from devaluation or otherwise negatively discounted.199 Mecure et al. (2018) estimates that the stranded fossil fuel assets may result in a discounted global wealth loss between $1 trillion and $4 trillion.200 Similarly, a Mercer and the Center for International Environmental Law 2016 report estimates that the coal subsector may lose as much as 84 percent of its annual return potential over the next 35 years. The study also estimates that the annual returns for the oil and utilities subsectors could fall by as much as 63 percent, and 39 percent, respectively. In comparison, the study estimates that annual returns for renewables could increase by as much 54 percent over the same period.201 The risks associated with climate change are also expected to have direct implication for retirement investors. For example, Mercer and the Center for International Environmental Law (2016) 198 U.S. Commodity Futures Trading Commission, ‘‘Managing Climate Risk in the U.S. Financial System’’ (2020), https://www.cftc.gov/sites/default/ files/2020-09/9-9-20%20Report%20of%20the% 20Subcommittee%20on%20ClimateRelated%20Market%20Risk%20%20Managing%20Climate% 20Risk%20in%20the%20U.S.%20Financial% 20System%20for%20posting.pdf. 199 U.S. Commodity Futures Trading Commission. ‘‘Managing Climate Risk in the U.S. Financial System,’’ (2020). https://www.cftc.gov/sites/default/ files/2020-09/9-9-20%20Report%20of%20the% 20Subcommittee%20on%20ClimateRelated%20Market%20Risk%20%20Managing%20Climate% 20Risk%20in%20the% 20U.S.%20Financial%20System% 20for%20posting.pdf. 200 J.F. Mercure, H. Pollitt, J.E. Vin ˜ uales, N.R. Edwards, P.B. Holden. U. Chewpreecha, P. Salas, I. Sognnaes, A. Lam, and F. Knobloch, ‘‘Macroeconmic Impact of Stranded Fossil Fuel Assets,’’ Nature Climate Change 8, 588–593 (2018). 201 Mercer and the Center for International Environmental Law, ‘‘Trillion-Dollar Transformation: A Guide to Climate Change Investment Risk Management for US Public Defined Benefit Trustees’’ (2016), https://static1. squarespace.com/static/569da6479cadb6436 a8fecc8/t/584dcf37893fc01633e3572a/ 1481494366264/gl-2016-responsible-investments-aguide-to-climate-change-investment-riskmanagement-for-us-public-defined-benefit-plantrustees-mercer.pdf. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 finds that the total value of assets in an average U.S. public pension portfolio could be 6 percent lower by 2050 than under a business-as-usual scenario due largely to transition risks associated with climate change.202 However, it is worth noting that climate change also represents an investment opportunity, with research suggesting that investment in climate change mitigation will produce increasingly attractive yields.203 Addressing transition risks can present opportunities to identify investments that are strategically positioned to succeed in the transition. Gradual shifts in investor preferences toward sustainability and the growing recognition that climate risk is investment risk may lead to a reallocation of capital. For instance, Matthews, Eaton, and Benoit (2021) estimates that to meet global energy demand and climate aspirations, annual investments in clean energy would need to grow from $1.1 trillion in 2021 to $3.4 trillion until 2030.204 (j) Literature on Social Factors The literature also has findings on the materiality of weighing social factors in investment processes. The aforementioned meta-analysis by Friede et al. (2015) finds that 55.1 percent of the studies reviewed found a positive correlation between corporate financial performance and social-focused investing.205 Two topics focused on in the literature were (1) diversity and inclusion and (2) worker voice. (1) Diversity and Inclusion Many studies show the material financial benefits of diverse and inclusive workplaces. The Department received several comments noting that diversity is material to financial performance. For instance, one commenter notes that high staff turnover, high strike rates, absenteeism, or death have all been linked to lower 202 Id. 203 Jason Channell, Elizabeth Curmi, Phuc Nguyen, Elaine Prior, Alastair Syme, Heath Jansen, Ebrahim Rahbari, Edward Morse, Seth Kleinman, and Tim Kruger, ‘‘Energy Darwinism II: Why a Low Carbon Future Doesn’t Have to Cost the Earth,’’ Citi (August 2015). https://www.citivelocity.com/citigps/ energy-darwinism-ii/. 204 Christopher Matthews, Collin Eaton, and Faucon Benoit, ‘‘Behind the Energy Crisis: Fossil Fuel Investment Drops, and Renewables Aren’t Ready,’’ Wall Street Journal (October 2021), https:// www.proquest.com/docview/2582603911? accountid=41086. 205 Gunnar Friede, Michael Lewis, and Alexander Bassen, Timo Busch, ‘‘ESG & Corporate Financial Performance: Mapping the Global Landscape,’’ Deutsche Asset & Wealth Management, University of Hamburg (December 2015). https:// download.dws.com/download?elibassetguid=2c2023f453ef4284be4430003b0fbeee. PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 73867 productivity and poor-quality control. There are three main vectors across which a company’s diversity and inclusion practices that can have a financially material impact on their business: employee recruitment and retention, performance and productivity, and litigation. (a) Employee Recruitment and Retention There is evidence that corporate social responsibility affects employee recruitment, productivity, satisfaction, and retention.206 While not all turnover is undesirable, turnover is costly. These costs are both direct and indirect. Direct costs include staff time to off-board the former employee, covering the reduced capacity with a contingent employee or with existing staff, and the cost of recruitment. The indirect costs include on-the-job training, employee socialization, and productivity gaps between the new and former employees.207 These costs are commonly estimated as equating to 6 to 9 months of the salary for the position (or 50 to 75 percent of the salary) on top of the salary itself, depending on how exhaustively one catalogues the different types of costs.208 • In a survey of 2,745 respondents, the job site Glassdoor found that 76 percent of employees and job seekers overall look at workforce diversity when evaluating an offer.209 • The Level Playing Institute (2007) estimates firms incur a cost of $64 206 Hong-yan Wang and Zhi-Xia Chen, ‘‘Corporate Social Responsibility and Job Applicant Attraction: a Moderated-Mediation Model,’’ PLOS ONE 17(3): e0260125. https://doi.org/10.1371/ journal.pone.0260125. DiversityInc., ‘‘Millennial and Gen Z Jobseekers: An Emphasis on Social Responsibility,’’ https:// www.diversityincbestpractices.com/millennial-andgen-z-jobseekers-an-emphasis-on-socialresponsibility/. 207 David Allen, ‘‘Retaining Talent,’’ Society for Human Resources Management Foundation (2008), https://www.shrm.org/hr-today/trends-andforecasting/special-reports-and-expert-views/ documents/retaining-talent.pdf. 208 Shane McFeely and Wigert, Ben, ‘‘This Fixable Problem Costs U.S. Businesses $1 Trillion,’’ Gallup (March 2019), https://www.gallup.com/workplace/ 247391/fixable-problem-costs-businessestrillion.aspx#:∼:text=The%20cost%20of% 20replacing%20an,to%20%242.6% 20million%20per%20year. John Hall, ‘‘The Cost of Turnover Can Kill Your Business and Make Things Less Fun,’’ Forbes (May 2019), https:// www.forbes.com/sites/johnhall/2019/05/09/thecost-of-turnover-can-kill-your-business-and-makethings-less-fun/?sh=323adfac7943. Aharon Tziner and Assa Birati, ‘‘Assessing Employee Turnover Costs: A Revised Approach,’’ Human Resources Management Review (1996). 118–119. 209 Glassdoor, ‘‘Diversity & Inclusion Workplace Survey’’ (September 2020), https://b2bassets.glassdoor.com/glassdoor-diversity-inclusionworkplace-survey.pdf?_gl=1*14tssal*_ ga*MTY5NTI5NTgwMi4xNjYwNjUzMDY3*_ga_ RC95PMVB3H*MTY2MDY 1MzA2Ni4xLjEuMTY2MDY1MzA3NS41MQ. E:\FR\FM\01DER2.SGM 01DER2 73868 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations billion per year from losing and replacing over 2 million American professionals and managers who leave their jobs each year due to unfairness and discrimination.210 • Robinson and Dechant (1997) estimate that replacing a departing employee costs between $5,000 and $10,000 for an hourly worker, and between $75,000 and $211,000 for an executive making $100,000 per year.211 (b) Performance and Productivity • Chen, Leung, and Evans (2018) find that increased representation of women on corporate boards is associated with an increase in the number of patents and citations, when controlling for the amount of research and development spending.212 • Lorenzo et al. (2017) review of 171 German, Swiss, and Austrian companies finds that management diversity has a positive and statistically significant relationship to higher revenue from new products and services.213 • Phillips, Lijenquist, and Neale (2008) find that socially different group members do more than simply introduce new viewpoints or approaches. In the study, diverse groups outperformed more homogeneous groups not because of an influx of new ideas, but because diversity triggered more careful information processing that is absent in homogeneous groups.214 • A study from Deloitte (2013) finds employee perception of an organization’s commitment to diversity and inclusion is associated with higher levels of innovation, responsiveness to customer needs, and team collaboration.215 khammond on DSKJM1Z7X2PROD with RULES2 210 Level Playing Field Institute, ‘‘The Cost of Employee Turnover Due Solely to Unfairness in the Workplace’’ (2007). 211 Gail Robinson and Kathleen Dechant, ‘‘Building a Business Case for Diversity,’’ Academy of Management Executive 11 (3) (1997): 21–31. 212 Jie Chen, Woon Sau Leung, and Kevin P. Evans, ‘‘Female Board Representation, Corporate Innovation and Firm Performance,’’ Journal of Empirical Finance 48 (September 2018): 236–254. 213 Rocio Lorenzo, Nicole Voigt, Karin Schetelig, Annika Zawadzki, Isabelle Welpe, and Prisca Brosi, ‘‘The Mix that Matters: Innovation through Diversity,’’ BCG (2017), https://www.bcg.com/ publications/2017/people-organization-leadershiptalent-innovation-through-diversity-mix-thatmatters. 214 Katherine W. Phllips, Katie A. Lijenquist, and Margaret A. Neale ‘‘Is the Pain Worth the Gain? The Advantages and Liabilities of Agreeing with Socially Distinct Newcomers,’’ Personality and Social Psychology Bulletin (December 2008), https://journals.sagepub.com/doi/abs/10.1177/ 0146167208328062. 215 Deloitte, ‘‘Waiter, Is that Inclusion in My Soup? A New Recipe to Improve Business Performance,’’ Deloitte (2013), https:// www2.deloitte.com/content/dam/Deloitte/au/ Documents/human-capital/deloitte-au-hc-diversityinclusion-soup-051. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 • A 2013 report released by the Center for Talent Innovation (CTI) finds that employees at publicly traded companies that exhibit both inherent and acquired diversity 216 reported substantial benefits. CTI conducted a survey and found that employees at diverse companies were 70 percent more likely to report that they had captured a new market, and 75 percent more likely to report that their ideas had become productized. Employees were also as much as 158 percent more likely to report that they believed they understood their target end-users if one or more members on the team represent the user’s demographic.217 • Companies in the top quartile for ethnic and racial diversity in management were 36 percent more likely to have financial returns above the median for their industry in their country, and those in the top quartile for gender diversity were 25 percent more likely to have returns above the median for their industry in their country.218 • Companies in the top quartile of gender diversity or ethnic diversity on executive teams were more likely to outperform peer companies in the bottom quartile of diversity on executive teams, in terms of profitability.219 (c) Litigation • The U.S. Equal Employment Opportunity Commission (EEOC) received 67,448 charges of workplace discrimination in Fiscal Year (FY) 2020. The agency secured $439.2 million for victims of discrimination in the private sector and state and local government workplaces through voluntary resolutions and litigation.220 (d) Studies Covering Multiple Topics • A meta-analysis on 7,939 business units in 36 companies further confirms 216 The report defined inherent diversity to include gender, race, age, religious background, socioeconomic background, sexual orientation, disability, and nationality. The report defines acquired diversity to include cultural fluency, generational savviness, gender smarts, social media skills, cross-functional knowledge, global mindset, military experience, and language skills. 217 Sylvia Ann Hewlett, Melinda Marshall, Laura Sherbin, and Tara Gonsalves, ‘‘Innovation, Diversity, and Market Growth,’’ Center for Talent Innovation (2013), https://coqual.org/wp-content/ uploads/2020/09/31_ innovationdiversityandmarketgrowth_keyfindings1.pdf. 218 Vivian Hunt, Sara Prince, Sundiatu DixonFyle, and Kevin Dolan. ‘‘Diversity Wins: How Inclusion Matters,’’ McKinsey & Company (2020). https://www.mckinsey.com/∼/media/mckinsey/ featured%20insights/diversity%20and %20inclusion/diversity%20wins%20how% 20inclusion%20matters/diversity-wins-howinclusion-matters-vf.pdf. 219 Ibid. 220 ‘‘EEOC Releases Fiscal Year 2020 Enforcement and Litigation Data,’’ (2021). PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 that higher employee satisfaction levels are associated with higher profitability, higher customer satisfaction, and lower employee turnover.221 • One study found that ‘‘companies reporting highest levels of racial diversity brought in nearly 15 times more sales revenue on average than those with lowest levels of racial diversity.’’ It also found that ‘‘[c]ompanies with highest rates reported an average of 35,000 customers compared to 22,700 average customers among those companies with lowest rates of racial diversity.’’ 222 • A study of Federal agencies finds that diversity management is strongly linked to both work group performance and job satisfaction, and people of color see benefits from diversity management above and beyond those experienced by white employees.223 • A 6-month research study ‘‘found evidence that a growing number of companies known for their hard-nosed approach to business—such as Gap Inc., PayPal, and Cigna—have found new sources of growth and profit by driving equitable outcomes for employees, customers, and communities of color.’’ 224 However, some studies surveyed by the Department did not find a statistically significant link between board diversity and corporate financial performance. For instance: • A 2016 meta-analysis finds that the correlation between gender diversity and corporate financial performance is either nonexistent or very small.225 • A 2021 review found that most of the literature used to support diversity mandates on corporate boards does not identify causal effects and that the conclusions of studies that do isolate a causal effect are mixed.226 221 James K. Harter, Frank L. Schmidt, and Theodore L. Hayes, ‘‘Business-Unit-Level Relationship Between Employee Satisfaction, Employee Engagement, and Business Outcomes: A Meta-Analysis,’’ Journal of Applied Psychology 87(2) (2002) 268–279. 222 Cedric Herring, ‘‘Does Diversity Pay? Race, Gender, and the Business Case for Diversity,’’ American Sociological Review (2009). 223 David Pitts, ‘‘Diversity Management, Job Satisfaction, and Performance: Evidence from U.S. Federal Agencies,’’ Public Administration Review (2009). 224 Angela Glover Blackwell, Mark Kramer, Lalitha Vaidyanathan, Lakshmi Iyer, and Josh Kirschenbaum, ‘‘The Competitive Advantage of Racial Equity,’’ FSG and PolicyLink (2018). 225 Alive Eagly, ‘‘When Passionate Advocates Meet Research on Diversity, Does the Honest Broker Stand a Chance,’’ Journal of Social Issues, Vol. 72, No. 1 (2016). https://web.p.ebscohost.com/ehost/ pdfviewer/pdfviewer?vid=1&sid=8ad704e4-79e44998-827b-07473bb39c31%40redis. 226 Jonathan Klick, ‘‘Review of the Literature on Diversity on Corporate Boards,’’ American Enterprise Institute (2021), https://www.aei.org/ E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations • A 2010 study did not find a statistically significant relationship between the gender or ethnic diversity of boards and financial performance.227 • A 2015 meta-analysis from 20 studies on 3,097 companies analyzed the relationship between female representation on corporate boards and firm performance. The analysis found the mean-weighted correlation between female representation and firm performance was small and nonsignificant. However, the authors note that a higher representation of females on corporate boards was also not associated with a detrimental effect on firm financial performance.228 One study cautions that ‘‘the empirical connection between a single dimension of board structure and firm performance may be too nuanced to statistically tease out. Research that empirically links board structure to board or firm actions is a much better method to test if a relationship between board composition and performance exists than an analysis that attempts to go from board structure directly to firm performance and skips over board and firm actions.’’ 229 Another study cautioned that when diversity is enforced by regulation, there was no effect on performance.230 khammond on DSKJM1Z7X2PROD with RULES2 (2) Worker Voice The research literature also finds material financial benefits from employee engagement and representation in corporate governance as employees’ voices are amplified through unions or through direct representation on corporate boards. research-products/report/review-of-the-literatureon-diversity-on-corporate-boards/. 227 David A. Carter, Frank D’Souza, Betty J. Simkins, and W. Gary Simpson, ‘‘The Gender and Ethnic Diversity of US Boards and Board Committees and Firm Financial Performance,’’ Corporate Governance: An International Review 18, no. 5 (2010): 396–414, https://wedconline.wildapricot.org/Resources/WEDCDocuments/Women%20On%20Board/ Gender%20Diversity%20and%20Boards.pdf. 228 Jan Luca Pletzer, Romina Nikolova, Karina Karolina Kedzior, and Sven Constantin Voelpel, ‘‘Does Gender Matter? Female Representation on Corporate Boards and Firm Financial Performance—A Meta-Analysis’’ (June 2015), https://journals.plos.org/plosone/article/ file?id=10.1371/journal.pone.0130005 &type=printable. 229 David A. Carter, Frank D’Souza, Betty J. Simkins, and W. Gary Simpson, ‘‘The Gender and Ethnic Diversity of US Boards and Board Committees and Firm Financial Performance,’’ Corporate Governance: An International Review 18, no. 5 (2010): 396–414. https://wedconline.wildapricot.org/Resources/WEDC-Documents /Women%20On%20Board/Gender %20Diversity%20and%20Boards.pdf. 230 Deloitte and Nyenrode Research Program, ‘‘Good Governance Driving Corporate Performance? A Meta-Analysis of Academic Research & Invitation to Engage in the Dialogue’’ (December 2016). VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 Similar to the literature on diversity and inclusion, the literature focuses on the benefits of employee retention and productivity. Much of the literature on employee voice builds on the tradeoff between exit and voice laid out by Hirschman (1970), in which management becomes aware of failures either by actors, such as employees, leaving the organization (‘‘quitting’’) or by actors expressing dissatisfaction to management (‘‘voicing’’).231 A review of theoretical and empirical research by Palladino (2021) finds that when employees have access to voice mechanisms, such as union representation, firms are likely to experience fewer employee ‘‘exits.’’ 232 For example, Freeman (1980) shows empirically that the presence of unions reduces turnover.233 The literature surveyed by Palladino (2021) also suggests that unionization and worker voice improves employee productivity.234 Freeman and Lazear (1995) model the economic value of workers’ councils, finding that workers’ councils may reduce economic inefficiencies by decreasing information asymmetries and aligning employer and worker incentives during difficult times. Their modeling also finds that workers’ councils with co-determination rights were associated with increased perceptions of job security amongst workers, aligning long-run interests of the worker and employer, and ultimately increasing productivity.235 Ja¨ger et al. (2021) performed an empirical analysis of the impact of a policy reform in Germany affecting the degree of worker representation on corporate boards.236 They found that 231 Albert Hirschman, Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States, Harvard University Press, Cambridge, Massachusetts (1970). 232 Lenore Palladino, ‘‘Economic Democracy at Work: Why (and How) Workers Should be Represented on US Corporate Boards,’’ Journal of Law and Political Economy, Vol. 1, No. 3 (2021). 233 Richard B. Freeman, ‘‘The Exit-Voice Tradeoff in the Labor Market: Unionism, Job Tenure, Quits, and Separations,’’ The Quarterly Journal of Economics, Vol. 94, No. 4 (1980), https:// www.jstor.org/stable/pdf/1885662.pdf? refreqid=excelsior%3A04abe 825526fefa1f141b7b509419d18&ab_ segments=&origin=&acceptTC=1. 234 Lenore Palladino, ‘‘Economic Democracy at Work: Why (and How) Workers Should be Represented on US Corporate Boards,’’ Journal of Law and Political Economy, Vol. 1, No. 3 (2021). 235 Richard Freeman and Edward Lazear, ‘‘An Economic Analysis of Works Councils,’’ Works Councils: Consultation, Representation, and Cooperation in Industrial Relations, University of Chicago Press (1995), https://www.nber.org/system/ files/chapters/c11555/c11555.pdf. 236 Simon Ja ¨ ger, Benjamin Schoefer, Jo¨rg Heining, ‘‘Labor in the Boardroom,’’ Quarterly Journal of Economics, Vol. 136, Issue 2, 2021. https://doi.org/ 10.1093/qje/qjaa038. PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 73869 worker representation does not lower wages or reduce capital formation. (k) ESG Data, Ratings, and Disclosures The research community and commenters also weighed in on the data, ratings, and disclosures used to inform ESG investments. Surveys conducted by Natixis Investment Managers in 2018 found that among investment managers implementing ESG, 70 percent of institutions rely on sustainability ratings to evaluate ESG performance, which is higher than the percent of institutions relying on company reports (37 percent), rankings and awards (37 percent), regulatory filings (24 percent), news reports (24 percent), and non-governmental organizations (23 percent).237 Research indicates that one of the challenges faced by investment managers and rating agencies is that many of the company disclosures on ESG-related issues are voluntary. Condon (2022) finds that, as of 2018, complying companies, on average, provided less than four of the eleven disclosure metrics recommended by the Task Force on Climate-related Financial Disclosures. The study also finds that voluntary disclosures are more likely to focus on transition risks than physical risks.238 To mitigate missing information in voluntary disclosures, ESG rating agencies and investment professionals have begun to utilize alternative data and artificial intelligence. These techniques allow the industry to uncover material data that were not disclosed by the company.239 For instance, Morgan Stanley Capital International (MSCI) estimates that only 35 percent of the data inputs for the MSCI ESG Ratings model are from voluntary disclosures.240 Additionally, a 2020 survey of CFA Institute members finds that 71 percent of the participants polled agreed that alternative data reinforce sustainability analysis and 43 237 Natixis Investment Managers, ‘‘Looking for the Best of Both Worlds’’ (2019), https:// www.im.natixis.com/us/resources/esg-investingsurvey-2019. 238 Madison Condon, ‘‘Market Myopia’s Climate Bubble,’’ 1 Utah Law Review 63 (2022), Boston University School of Law Research Paper (February 2021), https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3782675. 239 Sean Collins and Kristen Sullivan, ‘‘Advancing ESG Investing: a Holistic Approach for Investment Management Firms,’’ Harvard Law School Forum on Corporate Governance (March 2020), https://corpgov.law.harvard.edu/2020/03/11/ advancing-esg-investing-a-holistic-approach-forinvestment-management-firms/. 240 Samuel Block, ‘‘Using Alternative Data to Spot ESG Risks,’’ MSCI (June 2019), https:// www.msci.com/www/blog-posts/using-alternativedata-to-spot/01516155636. E:\FR\FM\01DER2.SGM 01DER2 73870 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations percent expect applying artificial intelligence to sustainability analysis will further improve the analysis.241 Another challenge faced by investment managers and rating agencies is a lack of standardization in ESG terminology, which makes it difficult to do relative comparisons or to create well-defined categories.242 In a 2020 report to Congress, the GAO reviewed annual reports, 10–K filings, proxy statements, and voluntary sustainability reports for 32 companies and interviewed 14 large and midsized institutional investors. The report found that the ‘‘differences in methods and measures companies use to disclose quantitative information make it difficult to compare across companies.’’ 243 Similarly, the CFA Institute notes that differing terminology, such as the same measure being called different names or different measures sharing the same name, makes it difficult to do relative comparisons.244 While ESG rating agencies have improved their methods and transparency in recent years, rating providers vary significantly in scoring methodology, data, analyses, metric weighting, materiality, and how missing information is accounted for.245 Several studies analyze how ratings differ between agencies. For instance, Feifei and Polychronopoulos (2020) construct four separate portfolios, two in the United States and two in Europe, using ESG ratings data from two providers. The study simulates portfolio performance between July 2010 and June 2018. The authors found that the two constructed portfolios ‘‘have a performance dispersion of 70 basis points (bps) a year in Europe (9.4 percent versus 8.7 percent) and 130 bps a year in the United States (14.2 percent versus 12.9 percent).’’ 246 Similarly, a khammond on DSKJM1Z7X2PROD with RULES2 241 CFA Institute. ‘‘Future of Sustainability in Investment Management: From Ideas to Reality.’’ https://www.cfainstitute.org/-/media/documents/ survey/future-of-sustainability.ashx. 242 CFA Institute, ‘‘Global ESG Disclosure Standards for Investment Products’’ (2021), https:// www.cfainstitute.org/-/media/documents/ESGstandards/Global-ESG-Disclosure-Standards-forInvestment-Products.pdf. 243 GAO, ‘‘Report to the Honorable Mark Warner U.S. Senate: Disclosure of Environmental, Social, and Governance Factors and Options to Enhance Them’’ (July 2020), https://www.gao.gov/assets/gao20-530.pdf. 244 CFA Institute, ‘‘Global ESG Disclosure Standards for Investment Products’’ (2021). 245 OECD, ‘‘ESG Investing: Practices, Progress and Challenges’’ (2020), https://www.oecd.org/finance/ ESG-Investing-Practices-Progress-Challenges.pdf. 246 Feifei Li and Ari Polychronopoulos, ‘‘What a Different an ESG Ratings Provider Makes!’’ Research Affiliates (January 2020), https:// www.researchaffiliates.com/content/dam/ra/ documents/770-what-a-difference-an-esg-ratingsprovider-makes.pdf. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 2020 study from the OECD constructed portfolios using ESG scores from different rating providers and found that risk-adjusted returns varied significantly between different rating providers.247 Berg, Ko¨lbel, and Rigobon (2022) compared 709 ESG indicators from different rating systems, to estimate how measurement, scope, and weight divergence account for the differences between ESG ratings. They find that measurement divergence accounts for 56 percent of the difference, while scope and weight divergence account for 38 percent and 6 percent, respectively.248 They caution that inconsistency with ESG ratings sends mixed signals to companies as to which actions are expected and will be valued by the market. They believe that the divergence of ratings poses a challenge for empirical research, as using one rater versus another may alter a study’s results and conclusions. Curtis, Fisch, and Robertson (2021) find that there is substantial heterogeneity in ESG ratings of companies but more consistency in ESG ratings of portfolios, and that in general ESG portfolios provide a degree of ESG characteristics.249 They argue this is what really matters from an investor’s point of view. They make the analogy that the concerns with an ESG mutual fund are similar to those of a growth mutual fund—neither has a standardized definition, but they offer investors certain characteristics to a degree even if those characteristics vary widely across funds and even if different ratings providers rate them differently. A 2021 study from MSCI finds that ESG ratings within the same category can have low pairwise correlations, which the study attributes to the use of different ESG metrics and weights.250 The study creates a composite ESG rating based on subindustry specific weights of E, S, and G and finds composite ratings tend to outperform any of the individual E, S, or G ratings. The bottom quintile of E, S, G, and composite ratings tend to have more stock drawdowns than their top quintile, especially when it comes to large drawdowns. From 2007 to 2019, 247 OECD, ‘‘ESG Investing: Practices, Progress and Challenges’’ (2020), https://www.oecd.org/finance/ ESG-Investing-Practices-Progress-Challenges.pdf. 248 Florian Berg, Julian Ko ¨ lbel, and Roberto Rigobon, ‘‘Aggregate Confusion: The Divergence of ESG Ratings,’’ 2022, https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3438533. 249 Curtis, Fisch, and Robertson, ‘‘Do ESG Funds Deliver on Their Promises?’’ 2021. 250 MSCI’s ESG ratings are based on subindustry level ratings, selected from 37 ESG metrics. For each subindustry, metrics are weighted based on subindustry specific weights. PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 the bottom quintiles of E, S, G, and composite scores all performed worse than their top quintile. In this longer run analysis, E, S, and G scores had about equal effects, with the composite score improving on all these ratings. However, the top E, S, and G scores underperformed the bottom quintile during some time periods of their analysis. The top quintile of the composite ESG score outperformed for the entire time period.251 Many commenters, academic researchers, and industry observers have raised serious questions about the reliability of ESG ratings. Fiduciaries use ratings as tools to synthesize large amounts of information. Reliability concerns make it more challenging for fiduciaries to conduct an analysis, but making decisions based on imperfect information is not limited to ESG investing. The Department anticipates that fiduciaries will give the same careful consideration to the usefulness and shortcomings of data sources pertaining to ESG as they do to any relevant data source. (l) Summary of the Literature Reviewed Paragraphs (b) and (c) of the final rule will reduce the uncertainty that fiduciaries might have about considering ESG factors, thereby permitting them to take into account the beneficial impact that ESG can have on investing. The studies examined by the Department show that ESG can have a beneficial impact on investing in many circumstances. However, that impact is not universal and does not mean that ESG investing will result in improved performance or reduced risk in every circumstance. The current lack of standardized ratings also makes it difficult to directly measure the full impact of ESG strategies. 2. Cost Savings Relating to Paragraphs (c), Relative to the Current Regulation The current regulation expressly requires a fiduciary making an investment decision on collateral benefits when using the tiebreaker to document why pecuniary factors were not sufficient to select the investment, how the selected investment compares to alternative investments with regard to the factors listed in paragraphs (b)(2)(ii)(A) through (C) of the current regulation, and how the chosen nonpecuniary factors are consistent with the interests of the plan. This provision implemented a more rigid, heightened documentation requirement, which 251 MSCI ESG Research, ‘‘Deconstructing ESG Ratings Performance’’ (2021), https:// www.msci.com/our-solutions/esg-investing/ deconstructing-esg-performance. E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 imposed an annual cost burden of $122,115 according to the impact analysis of the current rule. This view was also supported by commenters, who stated that the current regulation created an extra burden of documentation. The final rule eliminates this special documentation requirement. The removal of this provision does not excuse ERISA fiduciaries from the documentation required to satisfy their general prudence obligations. Removing the special documentation leads to a cost savings. Like in the current regulation, the Department estimates that one percent of plans will invoke the tiebreaker in an investment decision each year, and the special documentation would have required two hours of labor from both a plan fiduciary and clerical worker. Assuming an hourly labor cost of $129.74 for a plan fiduciary and $61.01 for a clerical worker,252 the Department estimates that this elimination, updated for revised affected entity estimates, will save approximately $506,000 annually.253 252 The Department estimates labor costs by occupation. Estimates for total compensation are based on mean hourly wages by occupation from the 2021 Occupational Employment Statistics and estimates of wages and salaries as a percentage of total compensation by occupation from the December 2021 National Compensation Survey’s Employee Cost for Employee Compensation. Estimates for overhead costs for services are imputed from the 2020 Service Annual Survey. To estimate overhead cost on an occupational basis, the Office of Research and Analysis (ORA) allocates total industry overhead cost to unique occupations using a matrix of detailed occupational employment for each North American Industry Classification System (NAICS) industry. All values are in 2022 dollars. For more information in how the labor costs are estimated see: Labor Cost Inputs Used in the Employee Benefits Security Administration, Office of Policy and Research’s Regulatory Impact Analyses and Paperwork Reduction Act Burden Calculation, Employee Benefits Security Administration (June 2019), www.dol.gov/sites/ dolgov/files/EBSA/laws-and-regulations/rules-andregulations/technical-appendices/labor-cost-inputsused-in-ebsa-opr-ria-and-pra-burden-calculationsjune-2019.pdf. 253 In the 2020 final rule published on November 13, it was estimated that that plan fiduciaries and clerical staff would each expend, on average, two hours of labor to maintain the needed documentation, resulting in an annual burden estimate of 1,290 hours annually, with an equivalent cost of $122,115 for plans with ESG investments. For the purposes of this analysis, the Department assumes that DB plans will change investments annually, while DC plans review their investments every three years, on average. Updated to reflect updated estimates for affected plans and labor costs, the Department estimates the updated costs as: (124,302 DB plans that use ESG × 1% of plans that have ties × 2 hours × $129.74 per hour for a plan fiduciary) + (124,302 DB plans that use ESG × 1% of plans that have ties × 2 hours × $61.01 per hour for a clerical worker) + (25,020 DC plans that use ESG × 1% of plans that have ties × 1⁄3 of plans reviewing investments annually × 2 hours × $129.74 per hour for a plan fiduciary) + (25,020 DC plans that use ESG × 1% of plans that have ties × VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 3. Benefits of Paragraph (d) Paragraph (d) of the final rule contains provisions addressing the application of the prudence and loyalty duties to the exercise of shareholder rights, including proxy voting, the use of written proxy voting guidelines, and the selection and monitoring of proxy advisory firms. The final rule’s paragraph (d) will benefit plans by providing improved guidance regarding these activities. As discussed above, non-regulatory guidance that the Department has previously issued over the years may have led to the misapprehension that fiduciaries are required to participate in all proxy votes presented to them or, conversely, that they may not participate in proxy votes unless they first perform a formal costbenefit analysis and quantify net benefits. Although the current regulation sought to address the first misunderstanding (i.e., that fiduciaries are required to participate in all proxy votes) with express language, the Department is concerned that the language used may have effectively reinstated the second misunderstanding—that they may not participate in proxy votes unless they first perform a formal cost-benefit analysis and quantify net benefits—by suggesting that fiduciaries need special justification to participate in proxy votes. Several commenters stated that this misinterpretation leads some fiduciaries to abstain from many proxy votes out of an abundance of caution. These abstentions leave the interests of plans, participants, and beneficiaries unrepresented in proxy votes. An increase in proxy votes by plans will improve corporate accountability. The Department believes that the principles-based approach retained in paragraph (d) of the final rule will address these misunderstandings and clarify that neither extreme is required. Instead, plan fiduciaries, after an evaluation of relevant facts that form the basis for any particular proxy vote or other exercise of shareholder rights, must make a reasoned judgment both in deciding whether to exercise shareholder rights and how to exercise such rights. In making this judgment, plan fiduciaries must act in accordance with the economic interest of the plan, must consider any costs involved, and must never subordinate the interests of 1⁄3 of plans reviewing investments annually × 2 hours × $61.01 per hour for a clerical worker) = $506,029. This requirement has been eliminated in the finalized rule. 85 FR 72846. (Source Private Pension Plan Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee Benefits Security Administration (2022; forthcoming), Table D3.) PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 73871 participants in their retirement benefits to unrelated goals. The clarifications offered in this final rule will lead to increased proxy voting activity compared to the baseline. The reason is that the final rule will address the misunderstanding that fiduciaries need special justification to participate in proxy votes. With this additional guidance, fiduciaries will have sufficient clarity to participate in proxy votes unless a responsible plan fiduciary determines it is not in the plan’s best interest. The Department believes this is beneficial because it ensures that shareholders’ interests, as a company’s owners, are protected. By extension, this means the interests of plan participants and beneficiaries as shareholders are also protected. Preserving flexibility, paragraph (d) of the final rule carries forward core elements of the provision from the current regulation that allows a plan to have written proxy voting policies that govern decisions on when to vote on different categories or types of proposals, subject to the aforementioned principles. With the ability for plans to adopt policies to govern the decision whether to vote on a matter or class of matters, plan fiduciaries will be in a better position to conserve plan assets by establishing specific parameters designed to serve the plan’s interests. The Department received several comments on the NPRM expressing support for proxy voting as an essential fiduciary function. One commenter argued that proxy voting can help reduce investment risk and pointed to the success of shareholder resolutions in reducing hazardous chemicals and pesticides, which could cause reputational and financial damage to firms if improperly managed. Several commenters argued that proxy votes can provide critical oversight of management, which can reduce downside risk. One investment management firm commented that they approach proxy voting with ‘‘the consistent goal of promoting strong corporate governance, acting in the best interest of [. . .] shareholders and clients.’’ Another commenter argued that the Department should go further and require voting in favor of proxy votes that align holdings with ESG metrics when in the interest of plan participants and beneficiaries, citing the financial effects that waste reduction efforts can have on lowering business costs. The Department considered this suggestion, but believes that the Department’s longstanding view of ERISA with regards to proxy voting sets out a more balanced approach. The Department believes that proxies should E:\FR\FM\01DER2.SGM 01DER2 73872 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations be voted as part of the process of managing the plan’s investment in company stock unless a responsible plan fiduciary determines a proxy vote may not be in the plan’s best interest; for example, if the costs associated with voting outweigh the expected benefits. Commenters provided literature on the cost, benefits, and effects of shareholder engagement and proxy voting. khammond on DSKJM1Z7X2PROD with RULES2 (a) Changes in Levels of Proxy Voting The Department expects that the final rule will promote, rather than deter, responsible proxy voting compared to the 2020 rule; however, it is less certain that it will result in any increase in proxy voting as compared to the preregulatory guidance, which took a similar approach. In the NPRM, the Department invited comments on whether the proposed rule would increase proxy voting as compared to the pre-regulatory guidance but did not receive any comments on the question. Some commenters discussed how the proposed rule would affect proxy voting activity. For instance, one commenter noted that the proposed rule would help support appropriate levels of proxy voting, though they did not specify how, while recognizing that a professional advisor across many accounts can play a practical role in alleviating the costs and burdens of voting at the plan level. Conversely, another commenter noted that even large funds could be ‘‘rationally apathetic’’ because the costs of analyzing a given proxy vote and overcoming conflicts of interest will likely outweigh the marginal benefits of a ‘‘correct’’ proxy vote. This commenter expressed that unless there are explicit standards in place making clear that proxy voting is a fiduciary obligation, there is a significant risk of sub-optimal proxy votes. The Department’s longstanding view of ERISA is that proxies should be voted as part of the process of managing the plan’s investment in company stock unless a responsible plan fiduciary determines a proxy vote may not be in the plan’s best interest. We believe that this standard highlights the importance of proxy voting, while also allowing a fiduciary to make prudent decisions regarding the costs and benefits of any particular proxy vote. (b) Trends in Proxy Voting Commenters provided literature on the state of proxy voting. Orowitz, Kumar, and Hagel (2022) observe that by June of the 2022 proxy season there were already 924 shareholder proposal VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 submissions.254 Even though the 2022 proxy season was not complete at the time of the study, this figure represented a 10 percent increase from 2021, when 837 shareholder proposals were submitted. There was a similar 11 percent increase between 2020 and 2021, when the number of proposals increased from 754 to 837. Based on projections for the rest of the year, the authors state that it is possible that 621 of these shareholder resolutions may eventually come to a vote. This would represent a 42 percent increase from 2021.255 Cook and Solberg (2021) examined the number of shareholder resolutions brought to a vote regarding environmental and social issues. The authors observed 171 votes on shareholder-sponsored resolutions pertaining to environmental and social issues between July 1, 2020 and June 30, 2021, down from 220 votes in 2017. The study attributes the decline in environmental and social shareholder resolution votes to SEC regulations, which discouraged climate shareholder resolutions. Of the 171 resolutions, however, a record 36 resolutions passed with majority support. Despite the decline in shareholder resolutions received, average support rose to 34 percent, which is five percentage points higher than the previous record set in 2019.256 Koningsburg, Thorne, and Cahill (2021) analyzes trends across annual general meetings in 2021. The authors find that U.S. shareholders submitted 115 proposals related to the environment, with 74 percent of those being related to climate. This is a significant increase from 2020, when shareholders submitted 89 environmental resolutions, with 54 percent of those related to climate. There were 9 shareholder resolutions filed on diversity disclosure, three of which requested public disclosure of EEO–1 data and six of which requested enhanced reporting on diversity, equity, and inclusion data. Further, there were eight shareholder proposals on racial equity audits. For governance, in 2021, there was 95 percent support for reelection of directors in the Russell 3000; however, the proportion of directors receiving less than 80 percent support 254 Hannah Orowitz, Rajeev Kumar, and Lee Ann Hagel, ‘‘An Early Look at the 2022 Proxy Season,’’ The Harvard Law School Forum on Corporate Governance (7 June 2022), https://corpgov.law. harvard.edu/2022/06/07/an-early-look-at-the-2022proxy-season/. 255 Id. 256 Jackie Cook and Lauren Solberg, ‘‘The 2021 Proxy Season in Charts,’’ Morningstar (August 2021), https://www.morningstar.com/articles/ 1052234/the-2021-proxy-voting-season-in-7-charts. PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 has increased in recent years. The authors attribute the decline in support to lack of progress by the board on climate change and diversity.257 Another important facet of proxy voting is the investor’s approach to proposals by management. Shareholder resolutions are often the most discussed aspect of proxy voting, but only make up a small share of total proxy votes. According to ICI (2019), 98 percent of proxy proposals at the 3,000 largest publicly traded firms were submitted by management, with the majority of those proposals being related to compensation, personnel, and other key business decisions. ICI also finds investors are significantly more likely to support management resolutions than they are shareholder resolutions. They found that 94 percent of the votes were cast in favor of proposals by management, whereas only 34 percent of votes were cast in favor of shareholder resolutions. This relationship also held with respect to the recommendations of proxy advisors. Proxy advisors recommended voting in favor of 93 percent of management proposals, but only 65 percent of shareholder proposals.258 (c) The Role of Proxy Advisory Firms Several commenters weighed in on the role of proxy advisory firms. Multiple commenters expressed concerns over the role of the proxy advisory service industry, which they observed as being highly concentrated. Several commenters argued that proxy advisory firms do not have the knowledge or sufficient staff necessary to adequately conduct the type of analysis necessary for making recommendations to fiduciaries. One commenter went on to further express concern that proxy advisory firms have no obligation to explain their recommendations or provide the underlying research to back them up. In addition to concerns over the role of proxy advisory firms, several commenters expressed concerns regarding the potential for conflicts of interests at these firms. If a proxy advisory firm makes proxy voting recommendations that promote ESG it may increase their lines of business providing ESG ratings and advising companies on how to increase their ESG ratings. 257 Dan Konigsburg, Sharon Thorne, and Stephen Cahill, ‘‘Investor Behavior in the 2021 Proxy Season,’’ Harvard Law School Forum on Corporate Governance (2021), https:// corpgov.law.harvard.edu/2021/11/10/investorbehavior-in-the-2021-proxy-season/. 258 ‘‘ICI Research Perspective’’, ICI (2019), https:// www.ici.org/system/files/attachments/per25-05.pdf. E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations Commenters primarily focused on four sections of the final rule which they asserted would lead to increased reliance on proxy advisory firms. First, commenters pointed to the rescission of language from paragraph (e)(2)(ii) of the current regulation stating that ‘‘the fiduciary duty to manage shareholder rights appurtenant to shares of stock does not require the voting of every proxy or the exercise of every shareholder right.’’ They believe that removing this language will encourage higher levels of proxy voting by fiduciaries and that fiduciaries will rely on proxy advisory services to deal with the workload from increased proxy voting. Second, commenters stated that removing the specific monitoring provisions from paragraph (e)(2)(ii) of the existing regulation would reduce the effort associated with using proxy advisory firms while simultaneously reducing accountability and monitoring of those firms. Third, commenters stated that the removal of specific recordkeeping requirements from paragraph (e)(2)(ii)(E) of the current regulation would similarly make it easier to rely on proxy advisory firms, while also impeding the ability of participants to ensure that ERISA plan proxies are being voted in a manner consistent with the financial interest of the plan. Finally, the commenters point to the removal of two safe harbors from paragraphs (e)(3)(i)(A) and (B) of the current regulation, which specified policies of limiting voting based on voting type and holding size. Other commenters stated that the safe harbors applied to instances in which proxy voting would not be expected to have an economic effect. They further expanded that without the safe harbors, fiduciaries would participate in all proxy votes, which would require increased reliance on proxy advisory firms. The Department understands these concerns, and notes that fiduciaries still have a duty under the final rule’s general monitoring provision, at paragraph (d)(2)(ii)(E) to prudently select and monitor the provider of proxy advisory services. However, the Department did not find it necessary to retain an additional provision to differentiate the monitoring of a proxy advisory firm from the monitoring of any other service providers that a fiduciary may utilize. Additionally, section 404 (a)(1)(B) of ERISA already requires proper documentation both of the activities of the investment manager and of the named fiduciary of the plan in monitoring the activities of the investment manager. This would require the investment manager or other VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 responsible fiduciary to keep accurate records as to the voting of proxies, and periodically review the voting procedures and individual votes. The Department did not find it necessary to retain additional recordkeeping requirements beyond these that were already required of fiduciaries. With regards to the safe harbors, the Department notes that fiduciaries may still develop written guidelines to determine their decisions to participate in proxy votes. The Department reiterates its longstanding view of ERISA that proxies should be voted unless a responsible plan fiduciary determines a proxy vote is not in the plan’s best interest. Several commenters referenced studies discussing the role of proxy advisory firms. A central theme in this literature was the argument that shareholder resolutions are heavily influenced by the proxy advisory service industry. Malenko and Shen (2016) studied the effects of the proxy advisory industry on say-on-pay proposals from 2010 to 2011. The authors observed that negative recommendations by proxy advisory firms reduced support for proposals by 25 percentage points.259 A Timothy Doyle (2018) report also observed that certain large institutional investors vote in line with proxy advisory firm recommendations 80–95 percent of the time for positive recommendations, and 50–85 percent for negative recommendations.260 At its most extreme, this influence can manifest into ‘‘robovoting’’ whereby investors follow a proxy advisory firm’s voting guidance without any independent review. Another report by Timothy Doyle (2018) finds that 175 asset managers representing more than $5 trillion in assets under management and who voted on more than 100 shareholder resolutions voted in line with proxy advisory firm recommendations more than 95 percent of the time. Of these 175 asset managers, 82 voted with proxy advisory services more than 99 percent of the time.261 In a similar vein, Paul Rose (2019) found 259 Nadya Malenko and Yao Shen, ‘‘The Role of Proxy Advisory Firms: Evidence from a RegressionDiscontinuity Design,’’ The Review of Financial Studies, Volume 29, Issue 12, December 2016, Pages 3394–3427, https://doi.org/10.1093/rfs/hhw070. 260 Timothy Doyle, ‘‘The Conflicted Role of Proxy Advisors,’’ American Council for Capital Formation (May 2018), https://accf.org/wp-content/uploads/ 2018/05/ACCF-The-Conflicted-Role-of-ProxyAdvisor-FINAL.pdf. 261 Timothy Doyle, ‘‘The Realities of RoboVoting,’’ American Council on Capital Formation (November 2018), https://accfcorpgov.org/wpcontent/uploads/ACCF-RoboVoting-Report_11_8_ FINAL.pdf. PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 73873 98 investors, representing $3.2 trillion in assets under management, voted in alignment with ISS more than 99.5 percent of the time.262 In addition to concerns over the influence of proxy advisory firms, some literature also took issue with the quality of their recommendations. Larcker, McCall, and Ormazabal (2015) find that companies faced with the prospect of a negative proxy advisory service recommendation on say-on-pay proposals will often change their compensation programs ‘‘in a manner consistent with the features known to be favored by proxy advisory firms.’’ The stock market reaction to these preemptive changes is statistically negative.263 Some literature was more skeptical on the level of influence by the proxy advisory service industry. Nili and Kastiel (2020) find that the success rates of the two largest proxy advisory firms, Glass Lewis and ISS, varies significantly from year to year.264 From 2005 to 2017, the percentage of proxy fights won by the dissidents when supported by Glass Lewis has been as low as 33 percent in 2012 and as high as 100 percent in 2010. When supported by ISS, the percentage of proxy fights won by the dissidents has been as low as 43 percent in 2006 and as high as 89 percent in 2014. Similar variation was found in the percentage of proxy fights won by management when supported by these proxy advisory firms. The authors found that these mixed findings were consistent with the overall corporate governance literature on proxy advisory services. In a review of relevant literature, Larcker, Tayan, and Copland (2015), observe that ‘‘the empirical evidence shows that an against recommendation is associated with a reduction in the favorable vote count by 10 percent to 30 percent.’’ 265 Choi, Fisch, and Kahan (2010) estimate that the negative recommendations of proxy advisory firms only shifted investor votes by 6 to 10 percent after controlling 262 Paul Rose, ‘‘Robovoting and Proxy Vote Disclosure’’ (November 2019). https://ssrn.com/ abstract=3486322. 263 David F. Larcker, Allan McCall, and Gaizka Ormazabal, ‘‘The Economic Consequences of Proxy Advisor Say-on-Pay Voting Policies,’’ Journal of Law and Economics, vol. 58, no. 1, Feb. 2015, pp. 173–204, https://doi.org/10.2139/ssrn.2101453. 264 Yaron Nili and Kobi Kastiel, ‘‘Competing for Votes,’’ Wisconsin Law School Legal Studies Research Paper Series Paper, No. 1605 (2020), https://ssrn.com/abstract=3681541. 265 David F. Larcker, Brian Tayan, and James R. Copland, ‘‘The Big Thumb on the Scale: An Overview of the Proxy Access Advisory Industry,’’ Harvard Law School Forum on Corporate Governance (June 14, 2018), https://corpgov.law. harvard.edu/2018/06/14/the-big-thumb-on-thescale-an-overview-of-the-proxy-advisory-industry/. E:\FR\FM\01DER2.SGM 01DER2 73874 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations for observable factors.266 McCahery, Sauthner, and Starks (2015) find that ‘‘55 percent of institutional investors agree that proxy advisory firms help them make more informed voting decisions,’’ but concluded that institutional investors rely on the advice of proxy advisory firms as a complement to their decision-making, rather than a substitute.267 As stated in the preamble, the Department believes that the solution to proxy-voting costs is for the fiduciary to be prudent in incurring expenses to make proxy decisions and, wherever possible, to rely on efficient structures, which may include the use of proxy advisory services. However, paragraph (d)(2)(iii) of the final rule states that a fiduciary may not adopt a practice of following the recommendations of a proxy advisory firm or other service provider without a determination that such firm or service provider’s proxy voting guidelines are consistent with the fiduciary’s obligations described in paragraphs (d)(2)(ii)(A) through (E) of this section. The Department recognizes some commenters’ continued concerns about the role of proxy advisory firms, but this provision (in conjunction with the general monitoring provision in paragraph (d)(2)(ii)(E), discussed above) will protect plan participants and beneficiaries by ensuring adequate oversight of proxy advisory firms. khammond on DSKJM1Z7X2PROD with RULES2 (d) Costs of Proxy Voting and Shareholder Engagement and Its Effect on Company Behavior The effects of proxy voting and shareholder engagement on company activity is the subject of a diverse body of literature. Much of the research on proxy voting and shareholder engagement focuses on the effects of proxy voting and shareholder engagement on a company’s ESG performance, which could then affect a company’s financial performance. The association between ESG and financial performance was discussed in detail in previous sections. Another body of research looks at the effectiveness of shareholder resolutions as a tool to incite change. For instance, Ko¨lbel, Heeb, Paetzold, and Busch (2020) review five studies on shareholder resolutions and found that 18 to 60 percent of shareholder 266 Stephen Choi, Jill Fisch, and Marcel Kahan, ‘‘The Power of Proxy Advisors: Myth or Reality?’’ 59 Emory Law Journal 869, 882 (2010), https:// scholarlycommons.law.emory.edu/elj/vol59/iss4/2/. 267 Joseph A. McCahery, Zacharias Sautner, and Laura T. Starks, ‘‘Behind the Scenes: The Corporate Governance Preferences of Institutional Investors,’’ 71 Journal of Finance, 2905, 2928 (2016). https:// www.jstor.org/stable/44155408#metadata_info_tab_ contents. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 resolutions are successful in changing company behavior.268 The 18 percent finding by Dimson, Karakas, and Li (2015) comes from the oldest sample period (1999–2009) of the five papers, with more recent studies suggesting higher success rates.269 One of the studies reviewed went on to further demonstrate an increase in ESG ratings as a result of these shareholder resolutions.270 Literature on the direct financial effects of proxy voting on stock returns is more limited. A literature summary by Clark, Feiner, and Viehs (2014) finds that most papers on proxy voting find inconclusive or statistically insignificant results on the relationship to stock returns. The authors find that the reviewed literature ‘‘only provides limited evidence that proxy voting is an effective tool to promote proper ESG standards, or that it is helpful in creating superior financial performance at investee firms.’’ 271 Cun˜at, Gine, and Guadalupe (2012) find that companies with successful shareholder governance proposals yielded abnormal returns—1.3 percent higher than firms with failed proposals on the day of the vote. Over the week of the vote, these abnormal returns accumulate to 2.4 percent. This gain in shareholder value is more pronounced regarding anti-takeover provisions, like eliminating classified boards and poison pills. This effect is also stronger at firms with more concentrated ownership, more anti-takeover provisions in place, more research and development (R&D) expenditures, and more shareholder proposals in the past. The effect is also larger for proposals made by institutional shareholders rather than individuals. The authors further find that actually implementing these accepted proposals increases the shareholder value effect to 2.8 percent.272 In summary, the literature provided leads the Department to believe that proxy voting and shareholder 268 Julian F. Ko ¨ lbel, Florian Heeb, Falko Paetzold, and Timo Busch, ‘‘Can Sustainable Investing Save the World? Reviewing the Mechanisms of Investor Impact,’’ Organization & Environment, vol. 33, no. 4, 2020, pp. 554–574, https://doi.org/10.1177/ 1086026620919202. 269 E. Dimson, O. Karakas, and X Li, ‘‘Active Ownership,’’ Review of Financial Studies, volume 28, issue 12, p. 3225–3268, 2015. 270 Ko ¨ lbel, Heeb, Paetzold, and Busch, ‘‘Can Sustainable Investing Save the World?’’ 2020. 271 Clark, Feiner, and Viehs, ‘‘From the Stockholder to the Stakeholder,’’ 2014. 272 Cun ˜ at Vicente, Mireia Gine, and Maria Guadalupe, ‘‘The Vote Is Cast: The Effect of Corporate Governance on Shareholder Value,’’ The Journal of Finance, vol. 67, no. 5, 2012, pp. 1943– 1977, https://doi.org/10.1111/j.15406261.2012.01776.x. PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 engagement is increasing in its frequency and scope. The effects of this activity are not uniformly agreed upon in the literature, however there is evidence of proxy voting and shareholder engagement leading to increased shareholder value and financial returns at firms. There is also evidence of proxy voting and shareholder engagement being able to increase a company’s ESG performance, which may have financial performance benefits that were discussed previously. Proxy voting and shareholder engagement has a tangible time cost, which can be reduced through the use of efficient structures, including proxy voting guidelines, and proxy advisers/ managers that act on behalf of large aggregates of investors. Evidence regarding the influence of these proxy advisory firms is mixed, and varies from year to year, company to company, and topic to topic. Accordingly, the Department stresses fiduciaries’ obligation to monitor the performance of proxy advisory firms to ensure that they are performing their work in a way that is consistent with the plan’s best interest. 4. Cost Savings Relating to Paragraphs (d) and (e), Relative to the Current Regulation In the cost savings estimates below, the Department assumes an hourly labor cost of $129.74 for a plan fiduciary and $61.01 for a clerical worker.273 Paragraph (d) of the final rule eliminates the recordkeeping requirement in paragraph (e)(2)(ii)(E) of the current regulation which provides that, when deciding whether to exercise shareholder rights and when exercising shareholder rights, plan fiduciaries must maintain records on proxy voting activities and other exercises of shareholder rights. The change is 273 The Department estimates labor costs by occupation. Estimates for total compensation are based on mean hourly wages by occupation from the 2021 Occupational Employment Statistics and estimates of wages and salaries as a percentage of total compensation by occupation from the December 2021 National Compensation Survey’s Employee Cost for Employee Compensation. Estimates for overhead costs for services are imputed from the 2020 Service Annual Survey. To estimate overhead cost on an occupational basis, ORA allocates total industry overhead cost to unique occupations using a matrix of detailed occupational employment for each NAICS industry. All values are in 2022 dollars. For more information in how the labor costs are estimated see: Labor Cost Inputs Used in the Employee Benefits Security Administration, Office of Policy and Research’s Regulatory Impact Analyses and Paperwork Reduction Act Burden Calculation, Employee Benefits Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-andregulations/rules-and-regulations/technicalappendices/labor-cost-inputs-used-in-ebsa-opr-riaand-pra-burden-calculations-june-2019.pdf. E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations expected to produce a cost savings of $6.1 million per year relative to the current regulation.274 This cost savings was confirmed by one commenter. The final rule amends the provision of the current regulation that addresses proxy voting policies, paragraph (e)(3)(i) of the current regulation, by removing the two ‘‘safe harbor’’ examples for proxy voting policies that would be permissible under the provisions of the current regulation. As discussed earlier in the preamble to this regulation, the Department believes that the two ‘‘safe harbor’’ examples would likely become widely adopted by plan fiduciaries if maintained. When adopting the current regulation, the Department estimated that it would take a legal professional two hours to evaluate and implement changes to proxy voting policies within the scope of the safe harbors. In the final rule, without the safe harbors, the Department estimates that it will take a legal professional 30 minutes to update policies and procedures. This final rule thus reduces the burden related to evaluating, updating, and implementing proxy voting policies and procedures and voting by $11.6 million in the first year relative to the current regulation.275 The total costs savings associated with the amendments to paragraph (d) are estimated to be approximately $17.7 million. E. Costs The Department expects the amendments made by the final rule will change plan fiduciary investment behavior; however, the overall effect of amendments on investment behavior is largely uncertain. In the analysis below, the Department has carefully considered the costs associated with the amendments and quantified the costs khammond on DSKJM1Z7X2PROD with RULES2 274 In the 2020 final rule published on December 16, it was estimated that a plan fiduciary and a clerical staff would expend, on average, 30 minutes each to fulfill the recordkeeping requirement. The burden in the 2020 rule was estimated as $6.05 million. Updated to reflect updated estimates for affected plans and labor costs, the Department estimates the updated costs as: (63,670 plans * 0.5 hours * $129.74 per hour for a plan fiduciary) + (63,670 plans * 0.5 hours * $61.01 per hour for a clerical worker) = $6,072,526, or $6.1 million. 275 In the 2020 final rule published on December 16, it was estimated that a legal professional would expend, on average, two hours to update policies and procedures. The burden in the 2020 rule was estimated as $17.2 million. Updated to reflect updated estimates for affected plans and labor costs, the Department estimates the updated costs for the original requirement as: 63,670 plans * 2 hours * $129.74 per hour for a plan fiduciary = $16,521,092. As discussed in the Cost section of this analysis, the Department estimates that it will take a legal professional just thirty minutes to update policies and procedures for each of the estimated 63,670 plans affected by the rule, resulting in a cost of $4,877,440. This results in a cost savings of $11,643,651, or $11.6 million. 85 FR 81658. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 expected to result from the final rule, with the acknowledgment that a precise quantification of all costs stemming from changes in behavior is not possible. Nevertheless, the Department expects the incremental costs of the final rule to be relatively small and the overall benefits to outweigh the costs. As shown in the analysis below, the known incremental costs of the proposal are expected to be minimal on a perplan basis. The analysis below is based on labor cost estimates of $153.21 for a legal professional.276 1. Cost of Reviewing the Final Rule and Reviewing Plan Practices Plans, plan fiduciaries, and their service providers will need to read the final rule and evaluate how it will impact their practices. To estimate the costs associated with reviewing the amended rule, the Department considers two sub-groups of plans: plans that consider ESG factors in their investment process and plans that hold corporate stock with voting rights. The Department estimates that approximately 149,300 plans will consider ESG factors in their investment practice and will be affected by the finalized amendments in paragraphs (b) and (c).277 For each plan, a legal professional will need to review paragraphs (b) and (c) of the final rule, evaluate how these provisions might affect their investment practices and assess whether the plan will need to make changes to investment practices. The Department estimates that this review will take a legal professional approximately four hours to complete, resulting in an aggregate cost burden of approximately $91.5 million 278 or a per276 The Department estimates labor costs by occupation. Estimates for total compensation are based on mean hourly wages by occupation from the 2021 Occupational Employment Statistics and estimates of wages and salaries as a percentage of total compensation by occupation from the December 2021 National Compensation Survey’s Employee Cost for Employee Compensation. Estimates for overhead costs for services are imputed from the 2020 Service Annual Survey. To estimate overhead cost on an occupational basis, ORA allocates total industry overhead cost to unique occupations using a matrix of detailed occupational employment for each NAICS industry. All values are in 2022 dollars. For more information in how the labor costs are estimated see: Labor Cost Inputs Used in the Employee Benefits Security Administration, Office of Policy and Research’s Regulatory Impact Analyses and Paperwork Reduction Act Burden Calculation, Employee Benefits Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-andregulations/rules-and-regulations/technicalappendices/labor-cost-inputs-used-in-ebsa-opr-riaand-pra-burden-calculations-june-2019.pdf. 277 For more information on this estimate, refer to the discussion of affected entities in section IV.C. 278 The burden is estimated as follows: 149,322 plans × 4 hours = 597,288 hours. A labor rate of PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 73875 plan cost burden of approximately $613.279 The Department estimates that 63,670 plans hold corporate stock with voting rights and will be affected by the finalized amendments pertaining to proxy voting in paragraph (d). For each plan, a legal professional will need to review paragraph (d) of the amended rule and evaluate how it affects their proxy voting practices. The Department estimates that this review process will require a legal professional, on average, approximately four hours to complete, resulting in an aggregate cost burden of approximately $39.0 million 280 or a perplan cost of approximately $613.281 The Department believes that most plans, in both subsets discussed above, will rely on a service provider to perform such a review and that each service provider will likely oversee multiple plans. The Department does not have data that would allow it to estimate the number of service providers acting in such a capacity for these plans. While the Department believes that this cost is likely an overestimate, given the lack of data, the Department believes it is reasonable. 2. Possible Changeover Costs The Department expects that some plans may change investments or investment processes in light of the clarifications in the final rule. For example, plans may decide to replace existing investments with ESG investments. This may involve some short-term costs. In the Department’s view, this will be net beneficial because compliant acquisitions of ESG assets will be done with the aim of reducing the plan’s ESG-related financial risk or improving the plan’s investment performance. Thus, even if there are short-term costs associated with changed investment practices, the benefits to the plan of reduced ESGrelated financial risk are expected to exceed these costs over time. The Department lacks data to estimate the likely size of this impact. The Department solicited comments on this assumption in the NPRM but did not receive any comments. $153.21 is used for a legal professional. The cost is estimated as follows: 149,322 plans × 4 hours × $153.21 = $91,510,494. 279 The per-plan burden is estimated as follows: $91,510,494/149,322 plans = $612.84, rounded to $613. 280 The burden is estimated as follows: 63,670 plans × 4 hours = 254,680 hours. A labor rate of $153.21 is used for a lawyer. The cost burden is estimated as follows: 63,670 plans × 4 hours × $153.21 = $39,019,523. 281 The per-plan burden is estimated as follows: $39,019,523/63,670 plans = $612.84, rounded to $613. E:\FR\FM\01DER2.SGM 01DER2 73876 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 3. Cost Associated With Changes in Investment or Investment Course of Action Paragraphs (b) and (c)(1) of the final rule address a fiduciary’s duty of prudence and loyalty under ERISA with respect to consideration of an investment or investment course of action. Paragraph (c)(1) of the final rule provides that a fiduciary may not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives, and may not sacrifice investment return or take on additional investment risk to promote benefits or goals unrelated to said interests of the participants and beneficiaries. Paragraph (b)(4) of the final rule, in relevant part, provides that a fiduciary’s determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis, using appropriate investment horizons consistent with the plan’s investment objectives and taking into account the funding policy of the plan established pursuant to section 402(b)(1) of ERISA. These provisions will require a fiduciary to perform an evaluation, including a prudent analysis of risk and return factors. These provisions provide direction on what to include in that evaluation. In the NPRM, the Department did not attribute a cost to these requirements, with the understanding that many plan fiduciaries already undertake such evaluations as part of their investment selection decision-making process, including documentation of their decisions, process, and reasoning. One commenter refuted this assumption, noting that the industry lacks consistent definitions on ESG topics and stating that evaluating ESG topics would be a manual process for plan sponsors, requiring time and resources. Conversely, another commenter noted that data collection costs imposed by the rule would likely be de minimis, as the investment community is collecting ESG data independent of the rulemaking process. The commenters have not persuaded the Department to change its views on this topic. Plan fiduciaries generally already undertake deliberative VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 evaluations as part of their investment selection decision-making process and this final rule does not add burden to those deliberations; but rather, the final rule clarifies that the scope of those deliberations may include climate change and other ESG factors within the confines of paragraphs (b)(4) and (c)(1) of the final rule. The Department does not intend to increase fiduciaries’ burden of care attendant to such consideration; therefore, no incremental costs are estimated for these requirements. 4. Cost Associated With Changes to the ‘‘Tiebreaker’’ Rule The final rule, at paragraph (c)(2), implements a version of the tiebreaker concept that is comparable to and commensurate with the formulation previously expressed in Interpretive Bulletin 2015–1 (and first explained in Interpretive Bulletin 94–1). The final rule’s tiebreaker provision is relevant and operable only once a prudent fiduciary determines that competing alternative investments equally serve the financial interests of the plan. In these circumstances, the plan fiduciary may focus on the collateral benefits of an investment or investment course of action to decide the outcome. This version of the tiebreaker is more flexible than the regulation this rule replaces, which requires that the risk and reward of competing investments be indistinguishable before the tiebreaker can be utilized. While the provision implies a requirement for analysis and documentation, the Department expects that the analytics and documentation requirements of the tiebreaker provision are subsumed in the analytics and documentation requirements of the risk and return analysis required by paragraphs (c)(1) and (b)(4) of the final rule. The analysis of risk and return factors under paragraphs (c)(1) and (b)(4) of the final rule in the first instance will necessarily reveal any collateral benefits of an investment or investment course of action, which may then be used to break a tie pursuant to paragraph (c)(2) of the final rule. In this sense, paragraph (c)(2) of the final rule thus imposes no distinct process, and therefore no significant additional costs, apart from a plan’s ordinary investment selection process. Based on this PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 assumption, the Department attributes no costs to paragraph (c)(2) of the final rule. 5. Cost To Update Plan’s Written Proxy Voting Policies Paragraph (d)(3)(i) of the final rule provides that plan fiduciaries may adopt proxy voting policies on when to vote a proxy ballot. Such a policy must be prudently designed to serve the plan’s interests in providing benefits to participants and their beneficiaries and to defray reasonable expenses of administering the plan. In addition, plan fiduciaries must periodically review any such proxy voting policies under paragraph (d)(3)(ii). The Department estimates that 63,670 plans hold corporate stock with voting rights and will be affected by the finalized amendments pertaining to proxy voting in paragraph (d).282 For each plan, the Department estimates that, on average, it will take a legal professional thirty minutes to update policies and procedures, resulting in an aggregate incremental cost of $4.9 million,283 or a per-plan incremental cost of $77,284 in the first year relative to the current rule. The amended paragraph (d)(3)(ii) will require plans to periodically review proxy voting policies. However, the Department believes that the final rule largely comports with current practice for ERISA fiduciaries, such that plan fiduciaries already periodically review proxy voting policies to meet their obligations under ERISA. The Department does not expect that plans will incur additional cost associated with the periodic review. 6. Summary The Department estimates that the total incremental costs associated with the final rule will be $135.4 million in the first year with no additional costs in subsequent years. The aggregate and per-plan costs are summarized in Table 2. 282 For more information on this estimate, refer to the discussion of affected entities in section IV.C. 283 The burden is estimated as follows: 63,670 plans × 0.5 hour = 31,835 hours. A labor rate of $153.21 is used for a legal professional: (63,670 plans × 0.5 hour × $153.21 = $4,877,440). 284 The per-plan burden is estimated as follows: $4,877,440/63,670 plans = $76.61, rounded to $77. E:\FR\FM\01DER2.SGM 01DER2 73877 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations TABLE 2—COSTS FOR PLANS TO COMPLY WITH THE REQUIREMENTS Aggregate cost Per-plan cost Requirement Year 1 I Year 2 Year 1 I Year 2 Plans considering ESG factors when selecting investments Review of Plan Investment Practices .............................................................. $91,510,494 $0.00 $612.84 $0.00 Total .......................................................................................................... 91,510,494 0.00 612.84 0.00 Plans holding corporate stock, directly or through ERISA-covered intermediaries Review of Proxy Voting Practices ................................................................... Update Proxy Voting Policies .......................................................................... 39,019,523 4,877,440 0.00 0.00 612.84 76.61 0.00 0.00 Total .......................................................................................................... 43,896,963 0.00 689.45 0.00 Plans that both consider ESG factors when selecting investments and hold corporate stock, directly or through ERISA-covered intermediaries Total .......................................................................................................... khammond on DSKJM1Z7X2PROD with RULES2 This cost estimate differs from the cost estimate in the NPRM in several ways. First, paragraph (c)(3) of the NPRM included a disclosure requirement when collateral benefits were used in a tiebreaker. The removal of this requirement in the final rule decreased the cost estimate. Additionally, in the NPRM, the Department estimated that 11 percent of retirement plans would be affected by paragraph (c) of the proposal. In the final rule, in consideration of comments received on the NPRM, this estimate was increased to 20 percent of retirement plans. This change increased the cost estimate. Finally, this cost estimate reflects more recent data on the number of retirement plans and updated estimates of labor costs. The incorporation of updated data also increased the cost estimate. F. Transfers The final rule will result in transfers. For instance, the final rule may facilitate changes in plan fiduciary behavior, resulting in transactions in which a party experiences increased returns while other parties experience decreased returns of equal magnitude, resulting in a transfer, due to either the selection of investments or the investment course of action. In particular, transfers could arise as a result of substantially greater confidence on the part of fiduciaries that they may consider ESG factors going forward. As discussed previously, the public record reflects that the current regulation has already had a chilling effect on appropriate use of relevant ESG factors in investment decisions. Although the current regulation acknowledges that ESG factors can in some instances be taken VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 135,407,458 into account by a fiduciary, it also includes multiple statements that have been interpreted as discouraging their consideration. This conflicting guidance has disincentivized fiduciaries from considering relevant ESG factors in order to minimize potential legal liability under ERISA. Such a disincentive has a distortionary effect on the investment of ERISA plan assets well into the future by changing fiduciaries’ investment decisions and preventing them from considering ESG factors that they would otherwise find economically advantageous. The Department expects the clear guidance in this final rule to eliminate this existing market distortion. While the effect the amendments will have on assets is discussed as a benefit in section IV.D, this will also impact the flow of revenue to investment entities. For example, if, because of the amendments, plan assets are moved from Fund A to Fund B, Fund A’s asset managers would experience a decrease in revenue while Fund B’s asset managers would experience an increase in revenue. As a result, there would be a transfer from non-ESG product providers to ESG product providers. Similarly, there could be a transfer from companies with lower ESG ratings to companies with higher ESG ratings. Although the Department is unable to quantify the transfers that might result, the Department expects the magnitude of transfers will likely exceed $100 million annually, given that roughly $12.0 trillion is currently invested in ERISA plan assets,285 and the lower 285 EBSA projected ERISA covered pension, welfare, and total assets based on the 2020 Form 5500 filings with the U.S. Department of Labor (DOL), reported SIMPLE assets from the Investment Company Institute (ICI) Report: The U.S. Retirement PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 0 1,302.29 0.00 bound estimate of plan assets invested using ESG factors in 2020 is 0.03 percent.286 Similarly, transfers also could arise as a result of the proposed changes to the proxy voting provisions in paragraph (e) of the current regulation (relocated to paragraph (d) of the amended rule). For instance, the current regulation may discourage plans from voting proxies as a result of the no-vote statement in paragraph (e)(2)(ii) and the two safe harbors in paragraphs (e)(3)(i)(A) and (B) of the current regulation. The final rule’s rescission of these provisions, however, will increase plan proxy votes and effectively transfer some voting power from other shareholders back to ERISA plans. A common proxy vote where such an outcome may occur would be a vote to select a member of the Board of Directors, resulting in a shift in power from a losing candidate to a winning candidate. A transfer might also occur related to a proxy vote for one company to acquire another company. G. Uncertainty The Department’s economic assessment of the final rule’s effects is subject to uncertainty. Special areas of uncertainty are discussed below: A significant source of uncertainty comes from the lack of a widelyaccepted standard or definition of what ESG is. This uncertainty was echoed by commenters. The Department received several comments concerned with the lack of a standard definition of ESG. Market, Second Quarter 2022, and the Federal Reserve Board’s Financial Accounts of the United States Z1 September 9, 2022. 286 64th Annual Survey of Profit Sharing and 401(k) Plans, Plan Sponsor Council of America (2021). E:\FR\FM\01DER2.SGM 01DER2 73878 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 One commenter noted that there is no way to uniformly assess or weight the separate E, S, and G factors. Another commenter noted that because ESG frameworks in the U.S. have been designed by the private sector and are voluntary in nature, there is no industry-wide standard for how to disclose information or comply under these frameworks. In the affected-entities discussion of the regulatory impact analysis, the Department estimates that 20 percent of plans, both defined benefit (DB) and defined contribution (DC), consider or will begin considering ESG factors when selecting investments and, thus, will be affected by the final rule’s amendments to paragraphs (b) and (c) of the current regulation. As discussed in the regulatory impact analysis, the Department referenced several sources and surveys for DB and DC plans to arrive at this estimate. However, the range of estimates from these resources confirms the degree of uncertainty of how many plan fiduciaries currently consider ESG factors when selecting investments. This is particularly true for DB plans. While there is some survey evidence on how many DB plans factor in ESG considerations, the surveys were based on small samples and yielded varying results. It is also difficult to estimate the degree to which the use of ESG factors by ERISA fiduciaries will expand in the future. The clarification provided by this final rule may encourage more plan fiduciaries to use ESG factors. Trends in other countries suggest that pressure for such expansion may continue to increase.287 Based on current trends, the Department believes that the use of ESG factors by ERISA plan fiduciaries will likely increase in the future, although it is uncertain when or by how much. For purposes of this analysis, the Department has prepared low-, mid-, and high-cost scenarios for costs associated with paragraphs (b) and (c), varying by the estimated number of affected plans. As discussed in the cost discussion, the Department’s estimate of 20 percent of ERISA plans being affected by these provisions translated into approximately 149,300 affected plans and a cost of $91.5 million. If instead, the Department were to rely on 287 See generally Government Accountability Office Report No. 18–398, Retirement Plan Investing: Clearer Information on Consideration of Environmental, Social, and Governance Factors Would Be Helpful (May 2018), https://www.gao.gov/ products/gao-18-398; Principles for Responsible Investment, Fiduciary Duty in the 21st Century, United Nations Environment Programme Finance Initiative (2019), https://www.unepfi.org/ wordpress/wp-content/uploads/2019/10/Fiduciaryduty-21st-century-final-report.pdf. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 the 5 percent estimate of 401(k) and/or profit-sharing plans offering at least one ESG themed investment option from the Plan Sponsor Council of America 288 and the 12 percent estimate of private pension plans that have adopted ESG investing from NEPC,289 this would result in an estimate of approximately 46,100 affected plans and a cost of $28.2 million.290 Further if the Department were to rely on the 36 percent estimate of large plans using ESG information to consider their investments provided by commenters to all plans, this would result in an estimate of approximately 268,800 affected plans and a cost of $164.7 million.291 Regarding paragraph (d) of the final rule, it is uncertain whether the amendments would create a demand for new or different services associated with proxy voting and if so, what alternate services or relationships with service providers might result and how overall plan expenses could be impacted. Similarly, it is unclear whether and to what extent paragraph (d) of the amended rule will cause plans to modify their securities holdings, for example, in favor of greater mutual fund holdings (to avoid management responsibilities with respect to holdings of individual companies). The Department has heard from stakeholders that the current regulation, and investor confusion about it, has already had a chilling effect on appropriate use of ESG factors in investment decisions. Additionally, the Department received a significant number of comments on the impacts the current regulation has had on the appropriate use of ESG factors in investment decisions. A larger discussion of the comments received is included in the discussion of the benefits above. 288 64th Annual Survey of Profit Sharing and 401(k) Plans, Plan Sponsor Council of America (2021). 289 Smith and Regan, NEPC ESG Survey, 2018. 290 The estimate of plans is calculated as: (5% × 621,509 401(k) type plans) + (12% × 125,101 defined benefit and nonparticipant-directed defined contribution plans) = 46,087 plans, rounded to 46,100 plans. The cost estimate is calculated as: 46,087 plans × 4 hours = 184,348 hours. A labor rate of $153.21 is used for a lawyer. The cost burden is estimated as follows: 46,087 plans × 4 hours × $153.21 = $28,243,957. (Source Private Pension Plan Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee Benefits Security Administration (2022; forthcoming), Table D3.) 291 The estimate of plans is calculated as: (36% × 746,610 pension plans) = 268,779 plans, rounded to 268,800 plans. The cost estimate is calculated as: 268,779 plans × 4 hours = 1,075,116 hours. A labor rate of $153.21 is used for a lawyer. The cost burden is estimated as follows: 268,779 plans × 4 hours × $153.21 = $164,718,522. PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 H. Alternatives In developing this final rule on the application of ERISA’s fiduciary duties of prudence and loyalty to selecting investments and investment courses of action, the Department considered several regulatory approaches to the overarching rule and its various elements. Beyond the major alternatives discussed below, the Department considered many other specific alternatives. For example, the Department considered eliminating the tiebreaker test in response to commenters’ requests to do so. The Department decided against this alternative because the tiebreaker test has been relied on by fiduciaries for many years in making decisions about plan investments and investment courses of action, is consistent with the fiduciary obligations set forth in Section 404 of ERISA, and complete removal of the provision could lead to disruptions in plan investment activity. In addition, the Department, in response to commenters’ requests, considered amending the current regulation to explicitly provide participants’ preferences with a status equal to risk and return factors under the final regulation, such that participants’ preferences could be considered and factored into decisions alongside risk and return factors, and weighted as determined appropriate by the plan’s fiduciary. The Department decided against this alternative for many reasons, but mainly because plan fiduciaries must focus on financial benefits and fiduciaries may not add imprudent investment options to menus based on participant preferences or requests because that would violate ERISA’s duty of prudence. Many other relatively more granular alternatives that were considered and not accepted are discussed throughout section III of this preamble in connection with views of the commenters. In order to ensure a comprehensive review, the Department examined as an alternative leaving the current regulation in place without change. However, as explained in more detail earlier in this document, following informal outreach activities with a wide variety of stakeholders, including asset managers, labor organizations and other plan sponsors, consumer groups, service providers and investment advisers, and after considering the significant volume of public comment on the NPRM, the Department believes that uncertainty with respect to the current regulation has and likely will continue to deter fiduciaries from taking steps that other E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations marketplace investors might take to enhance investment value and performance, or improve investment portfolio resilience against the financial risks and impacts associated with climate change. This could hamper fiduciaries as they attempt to discharge their responsibilities prudently and solely in the interests of plan participants and beneficiaries. The Department therefore did not elect this alternative. The Department also considered rescinding the Financial Factors in Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final rules. This alternative would remove the entire current regulation from the Code of Federal Regulations, including provisions that reflect the original 1979 Investment Duties regulation. The original Investment Duties regulation has been relied on by fiduciaries for many years in making decisions about plan investments and investment courses of action, and complete removal of the provisions could lead to disruptions in plan investment activity. Accordingly, the Department rejected this alternative. As discussed in section IV.D.4, the Department quantified some costs of the current rule related to proxy voting totaled $17.7 million in the first year and $6.1 million in subsequent years for the current rule. Rescission of the current rule would save this quantified amount, but these savings would be offset by the aforementioned disruptions. As another alternative, the Department considered revising the current regulation by, in effect, reverting it to the original 1979 Investment Duties regulation. This would reduce the potential of disrupting plan investment activity that would be caused by complete rescission, as described above. However, because the Department’s prior non-regulatory guidance on ESG investing and proxy voting was removed from the Code of Federal Regulations by the Financial Factors in Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final rules, this alternative will leave plan fiduciaries without any guidance on the consideration of ESG issues when relevant to plan financial interests. Similar to the first alternative described above, this could inhibit fiduciaries from taking steps that other marketplace investors might take in enhancing investment value and performance, or from improving investment portfolio resilience against the potential financial risks and impacts associated with climate change. The Department VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 73879 therefore rejected this alternative. As discussed in section IV.D.2, the Department quantified some of the costs for the current rule related to the tiebreaker, which totaled approximately $506,000 annually. The Department also considered revising the current regulation by adopting changes similar to the fiduciary responsibilities as proposed by the European Commission.292 The European Commission (EC) is amending existing rules on fiduciary duties in delegated acts for asset management, insurance, reinsurance and investment sectors to encompass sustainability risks such as the impact of climate change and environmental degradation on the value of investments. Specifically, the EC has added the requirement that fiduciaries must proactively solicit client’s sustainability preferences, in addition to existing requirements that a fiduciary obtain information about the client’s investment knowledge and experience, ability to bear losses, and risk tolerance as part of the suitability assessment. The European Union’s guidelines for the supervision of institutions for occupational retirement provisions (IORPs) require member states to ensure that IORPs consider ESG factors related to investment assets in their investment decisions, as part of their prudential standards. Where ESG factors are considered, an assessment must be made of new or emerging risks, including risks related to climate change, use of resources and the environment, social risks and risks related to the depreciation of assets due to regulatory changes.293 One estimate finds that 89 percent of European pension funds take ESG risks into account as of 2019.294 Although this final rule clarifies that risk and return factors may include the economic effects of climate change and other ESG factors on the investment, the final rule does not require ERISA fiduciaries to solicit preferences regarding ESG factors nor are fiduciaries required to consider ESG factors when making all investment decisions. While aligning the U.S. to the European approach would have such benefits as harmonizing taxonomy for asset and investment managers across jurisdictions, the Department was concerned that incorporating such an approach would increase costs without a commensurate benefit, and could not be fully harmonized with ERISA’s fiduciary provisions. Finally, in the NPRM, the Department proposed a requirement to inform plan participants of the collateral benefits that influenced the selection of the investment or investment course of action, when such investment or investment course of action constitutes a designated investment alternative under a participant-directed individual account plan, so participants could understand whether their preferences regarding the collateral purpose aligned with the fiduciary’s for a given investment option. Upon further consideration, including the comments received on the NPRM, the Department has decided to remove the disclosure requirement from this final rule for all the reasons set forth in section III.B.2 of this preamble. 292 Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions: EU Taxonomy, Corporate Sustainability Reporting, Sustainability Preferences and Fiduciary Duties: Directing finance towards the European Green Deal Brussels, 21.4.2021 COM (2021) 188 final. 293 ‘‘It is essential that IORPs improve their risk management while taking into account the aim of having an equitable spread of risks and benefits between generations in occupational retirement provision, so that potential vulnerabilities in relation to the sustainability of pension schemes can be properly understood and discussed with the relevant competent authorities. IORPs should, as part of their risk management system, produce a risk assessment for their activities relating to pensions. That risk assessment should also be made available to the competent authorities and should, where relevant, include, inter alia, risks related to climate change, use of resources, the environment, social risks, and risks related to the depreciation of assets due to regulatory change (‘stranded assets’). . . . Environmental, social and governance factors, as referred to in the United Nationssupported Principles for Responsible Investment, are important for the investment policy and risk management systems of IORPs. Member States should require IORPs to explicitly disclose where such factors are considered in investment decisions and how they form part of their risk management I. Conclusion PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 In summary, a significant benefit of this final rule is to clarify the application of ERISA’s fiduciary duties of prudence and loyalty to selecting investments and investment courses of action, exercising shareholder rights, such as proxy voting, and the use of written proxy voting policies and guidelines. These benefits, while difficult to quantify, are anticipated to outweigh the costs. The amendments to paragraphs (b) and (c) are designed to ensure that plans do not improvidently avoid considering relevant ESG factors when selecting investments or exercising shareholder system. The relevance and materiality of environmental, social and governance factors to a scheme’s investments and how such factors are taken into account should be part of the information provided by an IORP under this Directive.’’ 294 ‘‘ESG Becoming the New Normal for European Pensions’’ (August 31, 2020), https://www.aicio.com/news/esg-becoming-new-normal-europeanpensions/. E:\FR\FM\01DER2.SGM 01DER2 73880 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations rights, as they might otherwise be inclined to do under the current regulation. The Department expects that acting on relevant ESG factors in these contexts, and in a manner consistent with the final rule, will redound to employee benefit plans, participants, and beneficiaries covered by ERISA. Further, by ensuring that plan fiduciaries will not give up investment returns or take on additional investment risk to promote unrelated goals, these amendments are expected to lead to increased investment returns over the long run. The final rule will also make certain that proxy voting activity by plans will be governed by the economic interests of the plan and its participants. The amendments require plan fiduciaries to make a reasoned judgment deciding whether to exercise shareholder rights and how to exercise such rights, while promoting the economic interest of the plan. This will promote management accountability to shareholders, including the affected shareholder plans. The total cost of the final rule is approximately $135.4 million in the first year with no additional costs in subsequent years. Over 10 years, the costs associated with the amendments will total approximately $126.6 million, annualized to $18.0 million per year, applying a seven percent discount rate.295 In addition, the final rule is expected to result in cost savings. The total cost savings of the final rule is approximately $18.2 million in the first year with an annual cost savings of $6.6 million in subsequent years, relative to the current regulation. The estimates for cost and cost savings of the final rule are summarized in Table 3. Besides cost savings, the rule will have many other benefits that have not been quantified and are not shown in Table 3. TABLE 3—QUANTIFIED COSTS AND COST SAVINGS ASSOCIATED WITH THE FINAL RULE Requirement Year 1 Year 2 Aggregate Costs Review of Plan Investment Practices ...................................................................................................................... Review of Proxy Voting Practices ........................................................................................................................... Update Proxy Voting Policies .................................................................................................................................. $91,510,494 39,019,523 4,877,440 $0 0 0 Total .................................................................................................................................................................. 135,407,458 0 Removal of the Special Collateral Benefit Documentation Requirement under the Tie-breaker Rule in the Current Rule ............................................................................................................................................................... Removal of the Special Recordkeeping Requirement for Proxy Voting in the Current Rule ................................. Removal of the Proxy Voting ‘‘Safe Harbors’’ in the Current Rule ......................................................................... 506,029 6,072,526 11,643,651 0 6,072,526 0 Total .................................................................................................................................................................. 18,222,207 6,072,526 Cost Savings khammond on DSKJM1Z7X2PROD with RULES2 V. Paperwork Reduction Act The current regulations contain two collections of information with OMB Control Number 1210–0162 and OMB Control Number 1210–0165. In the notice of proposed rulemaking, the Department had announced its intent to discontinue OMB Control Number 1210–0165 and revise OMB Control Number 1210–0162 to only include the proposed disclosure requirement contained in the proposed amendment. Paragraph (c)(3) of the NPRM included a requirement that if a plan fiduciary uses the tiebreaker to select a designated investment alternative for a participantdirected individual account plan based on collateral benefits other than investment returns, ‘‘the plan fiduciary must ensure that the collateral-benefit characteristic of the fund, product, or model portfolio is prominently displayed in disclosure materials provided to participants and beneficiaries.’’ This would have been a new disclosure requirement under 295 The costs would be $131.5 million over 10year period, annualized to $15.4 million per year, if a three percent discount rate were applied. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 ERISA. At this time, the Department has decided not to adopt the proposed disclosure requirement. As discussed in more detail earlier in the preamble, based on comments received, the Department has decided that a disclosure emphasizing matters collateral to the economics of an investment may not be in the best interests of plan participants. Plan fiduciaries will still have the ability to use collateral benefits to break a tie; they will not be required to make a special disclosure. The Department is aware that the SEC is conducting rulemaking on investment company names, addressing, among other things, ‘‘certain broad categories of investment company names that are likely to mislead investors about an investment company’s investments and risks.’’ 296 The SEC also is conducting rulemaking on disclosures by mutual funds, other SEC-regulated investment companies, and SEC-regulated investment advisers designed to provide consistent standards for ESG disclosures, allowing 296 87 297 87 PO 00000 FR 36594 (June 17, 2022). FR 36654 (June 17, 2022). Frm 00060 Fmt 4701 Sfmt 4700 investors to make more informed decisions, including as they compare various ESG investments.297 The Department will monitor these rulemaking projects and may revisit the need for collateral benefit reporting or disclosure depending on the findings of that agency. The Department emphasizes that the decision against adopting a collateral benefit disclosure requirement in the final rule has no impact on a fiduciary’s duty to prudently document the tiebreaking decisions in accordance with section 404 of ERISA. Therefore, upon publication of the final rule, the Department will request that OMB discontinue both information collection requests (ICRs) 1210–0162 and 1210–0165, eliminating all paperwork burden associated with the ICRs. VI. Regulatory Flexibility Act The Regulatory Flexibility Act (RFA) 298 imposes certain requirements with respect to Federal rules that are 298 5 E:\FR\FM\01DER2.SGM U.S.C. 601 et seq. 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 subject to the notice and comment requirements of section 553(b) of the Administrative Procedure Act 299 and that are likely to have a significant economic impact on a substantial number of small entities. Unless the head of an agency determines that a final rule is not likely to have a significant economic impact on a substantial number of small entities, section 604 of the RFA requires the agency to present a final regulatory flexibility analysis of the final rule. For purposes of analysis under the RFA, the Department considers a small entity to be an employee benefit plan with fewer than 100 participants.300 The basis of this definition is found in section 104(a)(2) of ERISA, which permits the Secretary of Labor to prescribe simplified annual reports for pension plans that cover fewer than 100 participants. Under section 104(a)(3), the Secretary may also provide for exemptions or simplified annual reporting and disclosure for welfare benefit plans. Pursuant to the authority of section 104(a)(3), the Department has previously issued—at 29 CFR 2520.104– 20, 2520.104–21, 2520.104–41, 2520.104–46, and 2520.104b–10— certain simplified reporting provisions and limited exemptions from reporting and disclosure requirements for small plans. Such plans include unfunded or insured welfare plans covering fewer than 100 participants and satisfying certain other requirements. While some large employers may have small plans, in general small employers maintain small plans. Thus, EBSA believes that assessing the impact of these amendments on small plans is an appropriate substitute for evaluating the effect on small entities. The definition of small entity considered appropriate for this purpose differs, however, from a definition of small business that is based on size standards promulgated by the Small Business Administration (SBA) 301 pursuant to the Small Business Act.302 The Department has determined that this final rule could have a significant impact on a substantial number of small entities. Therefore, the Department has prepared a Final Regulatory Flexibility Analysis that is presented below. 299 5 U.S.C. 553(b). Department consulted with the Small Business Administration’s Office of Advocacy before making this determination, as required by 5 U.S.C. 603(c) and 13 CFR 121.903(c). Memorandum received from the U.S. Small Business Administration, Office of Advocacy on July 10, 2020. 301 13 CFR 121.201. 302 15 U.S.C. 631 et seq. 300 The VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 A. Need for and Objectives of the Rule In late 2020, the Department published two final rules (the current regulation) pertaining to the selection of plan investments and the exercise of shareholder rights to address concerns that some investment products may be marketed to ERISA fiduciaries on the basis of purported benefits and goals unrelated to financial performance. Responses to the current regulation, however, suggest that it created further uncertainty and may have the undesirable effect of discouraging fiduciaries’ consideration of financially relevant ESG factors in investment decisions, even when contrary to the interest of participants and beneficiaries. The Department is concerned that uncertainty may deter plan fiduciaries, for small and large plans alike, from participating in investments or investment courses of action that enhance investment value and performance or improve investment portfolio resilience. The Department is particularly concerned that the current regulation created a perception that fiduciaries are at risk if they consider any ESG factors in the financial evaluation of plan investments and that they may need to have special justifications for even ordinary exercises of shareholder rights. The amendments in this document are intended to address uncertainties stemming from the current regulation and related preamble discussions and to increase fiduciaries’ clarity about their obligations. The Department expects that the final rule will improve the current regulation and further promote retirement income security and retirement savings, while safeguarding the interests of plan participants and beneficiaries. B. Comments The Department received more than 895 written comments and 21,469 petitions (e.g., form letters) submitted during the open comment period. Comments received did not focus on the impacts to just small entities but focused on the impacts regardless of size. Comments are discussed by topic, and readers are directed to those respective sections for a summary of the significant comments and responses to those comments. The Office of Advocacy of the Small Business Administration did not file a comment on the proposed rule. C. Affected Small Entities To estimate the costs associated with reviewing the final rule, the Department PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 73881 considers two sub-groups of plans: plans that consider ESG factors in their investment process and plans that hold corporate stock with voting rights. Due to the nature of the finalized amendments, these subsets are not mutually exclusive and some plans may be included in both subsets. The Department does not have the data necessary to estimate how many plans are included in both subsets, so the affected entities and related costs are calculated separately in this analysis. 1. Small Plans Affected by the Proposed Modifications of Paragraphs (b) and (c) of § 2550.404a–1 Plans, as well as plan participants and beneficiaries, whose fiduciaries consider or will begin considering ESG factors when selecting investments will be affected by the modifications of paragraphs (b) and (c). As discussed in the regulatory impact analysis, the Department estimates that approximately 20 percent of plans consider or will begin considering ESG factors when selecting investments. This estimate is based on administrative data and surveys on investment behavior, which did not address how the investment behavior of small plans might differ from plans overall. The Department acknowledges that this likely overestimates the number of small plans affected. For instance, one survey indicates that only 0.03 percent of total participant-directed DC plan assets are invested in ESG funds. In fact, it finds that among 401(k) and profit-sharing plans with fewer than 50 participants, none of the plans offered an ESG investment option.303 For the purpose of this analysis, the Department assumes that the proportions of plans who consider or will begin considering ESG factors when selecting investments is uniform across plan size. Accordingly, the Department estimates that 20 percent of small plans will be affected by the modifications of paragraphs (b) and (c). According to the 2020 Form 5500, there were approximately 652,935 plans with fewer than 100 participants,304 resulting in an estimate of approximately 130,600 small plans that will be affected by the 303 64th Annual Survey of Profit Sharing and 401(k) Plans, Plan Sponsor Council of America (2021). 304 DOL calculations reflecting plans with fewer than 100 participants. (Source Private Pension Plan Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee Benefits Security Administration (2022; forthcoming), Table B1.) E:\FR\FM\01DER2.SGM 01DER2 73882 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations modifications of paragraphs (b) and (c).305 khammond on DSKJM1Z7X2PROD with RULES2 2. Subset of Plans Affected by Modifications of Paragraph (d) and (e) of § 2550.404a–1 Paragraphs (d) and (e) of the amended rule will affect small ERISA-covered pension, health, and other welfare plans, and plan participants and beneficiaries, that hold shares of corporate stock, directly or through ERISA-covered intermediaries, such as common trusts, master trusts, pooled separate accounts, and 103–12 investment entities. While the majority of participants and assets are in large plans, most plans are small plans. There is limited data available about small plans’ stock holdings. The primary source of information on assets held by pension plans is the Form 5500. Using the various asset schedules filed, only 3,900 small plans can be identified as holding stock, either employer securities or common stock.306 The Department assumes that small plans are significantly less likely to hold common stock than larger plans.307 For purposes of illustrating the number of small plans that could be affected, the Department assumes that five percent of small plans will be affected by the amendments to paragraphs (d) and (e). In 2020, there were approximately 652,500 small pension plans,308 resulting in an estimate of approximately 32,600 small plans that will be affected by the amended provisions.309 The Department requested comment on this assumption in the NPRM but did not receive any comments. While paragraph (d) of this amended rule will directly affect ERISA-covered plans that possess the relevant shareholder rights, many plans hire asset managers to carry out fiduciary 305 Id. This estimate is calculated as: 20% × 652,935 pension plans = 130,587, rounded to 130,600. 306 Based on DOL calculations based on 2020 Form 5500 data, only the 3,900 small plans that filed schedule H would report a separate line item for stock holdings. The small plans filing the Form 5500–SF (595,565) or file schedule I (52,737) do not report stock as a separate line item, therefore these plans cannot be identified as to whether they hold common stock. 307 Many small plans have exposure to stocks only through mutual funds, and consequently will not be significantly affected by the finalized amendments to paragraphs (d) and (e). 308 DOL calculations of plans with fewer than 100 participants find that in 2020, there were 652,935 plans with less than 100 participants, rounded to 652,900. (Source Private Pension Plan Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee Benefits Security Administration (2022; forthcoming), Table B1.) 309 This estimate is calculated as: 652,935 small plans × 5% = 32,647, rounded to 32,600. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 asset management functions, including proxy voting. The Department recognizes that service providers, including small service providers who act as asset managers, could also be impacted indirectly by this rule. The Department expects that service providers will pass incremental compliance costs onto plans. D. Impact of the Rule As described in the preamble and the regulatory impact analysis, the amendments will impose costs on small and large plans 1. Cost of Reviewing the Final Rule and Reviewing Plan Practices Plans, plan fiduciaries, and their service providers will need to read the amended rule and evaluate how it will impact their practices. To estimate the costs associated with reviewing the amended rule, the Department considers two sub-groups of plans: plans that consider ESG factors in their investment process and plans that hold corporate stock with voting rights. The Department estimates that approximately 130,600 small plans consider ESG factors in their investment practice and will be affected by the finalized amendments in paragraphs (b) and (c). For each plan, a legal professional will need to review paragraphs (b) and (c) of the final rule, evaluate how these provisions might affect their investment practices and assess whether the plan will be needed to make changes to investment practices. The Department estimates that this review will take a legal professional approximately four hours to complete, resulting in a per-plan cost burden of approximately $612.84.310 The Department estimates that approximately 32,600 small plans hold corporate stock with voting rights and will be affected by the finalized amendments pertaining to proxy voting in paragraph (d). For each plan, a legal professional will need to review paragraph (d) of the final rule and evaluate how it affects their proxy voting practices. The Department 310 The Department estimates that it will take a lawyer at each plan four hours to review the rule. A labor rate of $153.21 is used for a lawyer. The cost burden is estimated as follows: 4 hours × $153.21 = $612.86. Labor rates are based on DOL estimates for 2022. For more information in how the labor costs are estimated, see Labor Cost Inputs Used in the Employee Benefits Security Administration, Office of Policy and Research’s Regulatory Impact Analyses and Paperwork Reduction Act Burden Calculation, Employee Benefits Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-andregulations/rules-and-regulations/technicalappendices/labor-cost-inputs-used-in-ebsa-opr-riaand-pra-burden-calculations-june-2019.pdf. PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 estimates that this review process will require a legal professional, on average, approximately four hours to complete, resulting in a per-plan cost of approximately $612.84.311 The Department believes that most plans, in both subsets discussed above, will rely on a service provider to perform such a review and that each service provider will likely oversee multiple plans. The Department does not have data that would allow it to estimate the number of service providers acting in such a capacity for these plans. While the Department believes that this cost is likely an overestimate, given the lack of data, the Department believes it represents the best, most conservative estimate. 2. Cost To Update Written Proxy Voting Policies Paragraph (d)(3)(i) of the final rule provides that, for purposes of deciding whether to vote a proxy, plan fiduciaries may adopt proxy voting policies if the authority to vote a proxy is exercised pursuant to specific parameters prudently designed to serve the plan’s interests in providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan. The Department estimates that these provisions will impose additional cost to review such policies initially. The Department believes that the final rule largely comports with industry practice for ERISA fiduciaries; therefore, the Department estimates that on average, it will take a legal professional 30 minutes to update policies and procedures for each of the estimated 32,600 plans affected by these provisions. This results in a cost per plan of $76.61 in the first year.312 Paragraph (d)(3)(ii), also requires plan fiduciaries to periodically review any such proxy voting policies. The Department believes that the final rule largely comports with industry practice for ERISA fiduciaries, since plans are already required to periodically review proxy voting policies to meet their obligations under ERISA. Therefore, the Department does not expect that plans will incur additional cost associated with the periodic review. 311 The Department estimates that it will take a lawyer at each plan four hours to review the rule. A labor rate of $153.21 is used for a lawyer. The cost burden is estimated as follows: 4 hours × $153.21 = $612.86. 312 The Department estimates that it will take a plan fiduciary at each plan 30 minutes to update policies and procedures. A labor rate of $153.21 is used for a plan fiduciary: (0.5 hours × $153.21 = $76.61). E:\FR\FM\01DER2.SGM 01DER2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations 3. Summary of Costs investment process and hold corporate stock with voting rights, the incremental cost associated with the finalized amendments will be $1,302.29 per affected plan in year 1. There are no As illustrated in Table 4 below, the Department estimates, if a small plan both considers ESG factors in their 73883 costs expected in subsequent years. Some plans may only incur costs associated with considering ESG factors in their investment process or holding corporate stock with voting rights. TABLE 4—COSTS FOR PLANS TO COMPLY WITH THE REQUIREMENTS Requirement Labor rate Hours Year 1 cost Year 2 cost Plans considering ESG factors when selecting investments Review of Plan Investment Practices: Lawyer ................................................ $153.21 4 $612.84 $0.00 Total .......................................................................................................... ........................ 4 612.84 0.00 Plans holding corporate stock, directly or through ERISA-covered intermediaries Review of Proxy Voting Practices: Lawyer ...................................................... Update Proxy Voting Policies: Lawyer ............................................................ 153.21 153.21 4 0.5 612.84 76.61 0.00 0.00 Total .......................................................................................................... ........................ 4.5 689.49 0.00 Plans that both consider ESG factors when selecting investments and hold corporate stock, directly or through ERISA-covered intermediaries Total .......................................................................................................... khammond on DSKJM1Z7X2PROD with RULES2 The Department believes that this is likely an overestimate of the costs faced by small plans, as small plans are likely to rely on service providers that provide services to multiple plans. The Department expects that these costs will be passed on to plans, but by offering services to multiple plans, service providers create economies of scale. E. Regulatory Alternatives The final rule seeks to provide clarity and certainty regarding the scope of fiduciary duties surrounding ESG factors in investment practice and proxy voting policies. These duties apply to all affected entities, both large and small; therefore, the Department’s ability to craft specific alternatives for small plans is limited. Throughout the rulemaking process, the Department sought to minimize the burden placed on the affected entities overall; however, the Department did not identify any special consideration that could be made for small plans that would not lessen the protection of participants and beneficiaries in small plans. As discussed in the preamble, the Department has decided to provide a general applicability date of 60 days after publication in the Federal Register with two exceptions. In response to comments received on the NPRM, the Department has decided to delay applicability of paragraphs (d)(2)(iii) and (d)(4)(ii) of the final rule’s proxy voting provisions until 1 year after the date of publication. The delayed applicability of paragraph (d)(4)(ii) of the final rule will give fiduciaries of plans invested in pooled investment VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 ........................ vehicles additional time for reviewing any proxy voting policies of the investment vehicle’s investment manager and addressing any concerns. The delayed applicability of paragraph (d)(2)(iii) will give plan fiduciaries additional time to review proxy voting guidelines of proxy advisory firms and make any necessary changes in their arrangements with such firms. Outside of these two exceptions, the Department believes the requirements in the final rule are consistent with established Department views. As such, the Department does not believe it is appropriate to extend the applicability date for small plans. The Department examined as an alternative leaving the current regulation in place without change and rescinding its enforcement statement issued on March 10, 2021. However, as explained in more detail earlier in this notice, following informal outreach activities with a wide variety of stakeholders, including asset managers, labor organizations and other plan sponsors, consumer groups, service providers, and investment advisers, the Department believes that uncertainty with respect to the current regulation may deter fiduciaries of small and large plans alike from taking steps that other marketplace investors might take in enhancing investment value and performance, or improving investment portfolio resilience against the potential financial risks associated with ESG factors. This could hamper fiduciaries as they attempt to discharge their responsibilities prudently and solely in PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 8.5 1,302.29 0 the interests of plan participants and beneficiaries. The Department therefore did not elect this alternative. The Department also considered rescinding the Financial Factors in Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final rules. This alternative would remove the entire current regulation from the Code of Federal Regulations, including provisions that reflect the original 1979 Investment Duties regulation. The original Investment Duties regulation has been relied on by fiduciaries for many years in making decisions about plan investments and investment courses of action, and complete removal of the provisions could lead to potential disruptions in plan investment activity, regardless of plan size. The Department rejected this alternative. Another alternative considered was revising the current regulation by, in effect, reverting it to the original 1979 Investment Duties regulation. As explained in more detail earlier in this notice, this alternative would reduce the potential of disrupting plan investment activity that would be caused by complete rescission, but would leave plan fiduciaries without any guidance published in the Code of Federal Regulations on the consideration of ESG issues. Similar to the first alternative described above, this could inhibit fiduciaries from taking steps that other marketplace investors might take in enhancing investment value and performance, or from improving investment portfolio resilience against the potential financial risks and impacts E:\FR\FM\01DER2.SGM 01DER2 73884 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 associated with various ESG factors. The Department therefore rejected this alternative. In the NPRM, the Department proposed a requirement to inform plan participants of the collateral benefits that influenced the selection of the investment or investment course of action, when such investment or investment course of action constitutes a designated investment alternative under a participant-directed individual account plan. The Department received one comment in favor of the collateral benefit disclosure for QDIAs, stating that participants and beneficiaries should have information about collateral benefits considered by their plan. Another commenter expressed that the requirement should go further, requiring the disclosure of specific collateral benefits considered. However, other commenters expressed concern that the disclosure requirement may chill the use of ESG factors in investments. Another commenter expressed concern that the disclosure requirement is unclear and could relegate ESG characteristics to collateral benefit characteristics. Upon further consideration, including the comments received on the NPRM, the Department has decided to remove the disclosure requirement from this final rule. Commenters expressed concern that the collateral benefit disclosure could distract plan participants from the important-related information required by the Department’s other regulations. F. Duplicate, Overlapping, or Relevant Federal Rules For the requirements relating to investment practices, the Department is issuing this final rule under sections 404(a)(1)(A) and 404(a)(1)(B) of Title I under ERISA. The Department is the only agency with jurisdiction to interpret these provisions as they apply to plan fiduciaries’ consideration in selecting plan investment funds. Therefore, there are no duplicate, overlapping, or relevant Federal rules. For the requirements relating to proxy voting policies, the Department is monitoring other Federal agencies whose statutory and regulatory requirements overlap with ERISA. In particular, the Department is monitoring SEC rules and guidance to avoid creating duplicate or overlapping requirements with respect to proxy voting. VII. Unfunded Mandates Reform Act Title II of the Unfunded Mandates Reform Act of 1995 313 requires each 313 2 U.S.C. 1501 et seq. (1995). VerDate Sep<11>2014 16:57 Nov 30, 2022 Federal agency to prepare a written statement assessing the effects of any Federal mandate in a proposed or final agency rule that may result in an expenditure of $100 million or more (adjusted annually for inflation with the base year 1995) in any one year by state, local, and tribal governments, in the aggregate, or by the private sector. For purposes of the Unfunded Mandates Reform Act, this final rule does not include any Federal mandate that the Department expects would result in such expenditures by state, local, or tribal governments, or the private sector. VIII. Federalism Statement Executive Order 13132 outlines fundamental principles of federalism and requires the adherence to specific criteria by Federal agencies in the process of their formulation and implementation of policies that have ‘‘substantial direct effects’’ on the states, the relationship between the National Government and the states, or on the distribution of power and responsibilities among the various levels of government.314 Federal agencies promulgating regulations that have federalism implications must consult with state and local officials, and describe the extent of their consultation and the nature of the concerns of state and local officials in the preamble to the proposed amendment. In the Department’s view, these finalized amendments will not have federalism implications because they will not have direct effects on the states, the relationship between the National Government and the states, or on the distribution of power and responsibilities among various levels of government. Section 514 of ERISA provides, with certain exceptions specifically enumerated, that the provisions of Titles I and IV of ERISA supersede any and all laws of the states as they relate to any employee benefit plan covered under ERISA. The requirements implemented in the finalized amendments do not alter the fundamental reporting and disclosure requirements of the statute with respect to employee benefit plans, and as such have no implications for the states or the relationship or distribution of power between the national government and the states. Statutory Authority This regulation is finalized pursuant to the authority in section 505 of ERISA (Pub. L. 93–406, 88 Stat. 894; 29 U.S.C. 1135) and section 102 of Reorganization 314 Federalism, Jkt 259001 PO 00000 Frm 00064 64 FR 43255 (August 10, 1999). Fmt 4701 Sfmt 4700 Plan No. 4 of 1978 (43 FR 47713, October 17, 1978), effective December 31, 1978 (44 FR 1065, January 3, 1979), 3 CFR, 1978 Comp., p. 332, and under Secretary of Labor’s Order No. 1–2011, 77 FR 1088 (Jan. 9, 2012). List of Subjects in 29 CFR Part 2550 Employee benefit plans, Employee Retirement Income Security Act, Exemptions, Fiduciaries, Investments, Pensions, Prohibited transactions, Reporting and recordkeeping requirements, Securities. For the reasons set forth in the preamble, the Department amends part 2550 of subchapter F of chapter XXV of title 29 of the Code of Federal Regulations as follows: Subchapter F—Fiduciary Responsibility Under the Employee Retirement Income Security Act of 1974 PART 2550—RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY 1. The authority citation for part 2550 continues to read as follows: ■ Authority: 29 U.S.C. 1135 and Secretary of Labor’s Order No. 1–2011, 77 FR 1088 (January 9, 2012). Sec. 102, Reorganization Plan No. 4 of 1978, 5 U.S.C. App. at 727 (2012). Sec. 2550.401c–1 also issued under 29 U.S.C. 1101. Sec. 2550.404a–1 also issued under sec. 657, Pub. L. 107–16, 115 Stat 38. Sec. 2550.404a–2 also issued under sec. 657 of Pub. L. 107–16, 115 Stat. 38. Sections 2550.404c–1 and 2550.404c–5 also issued under 29 U.S.C. 1104. Sec. 2550.408b–1 also issued under 29 U.S.C. 1108(b)(1). Sec. 2550.408b–19 also issued under sec. 611, Pub. L. 109–280, 120 Stat. 780, 972. Sec. 2550.412–1 also issued under 29 U.S.C. 1112. 2. Revise § 2550.404a–1 to read as follows: ■ § 2550.404a–1 Investment duties. (a) In general. Sections 404(a)(1)(A) and 404(a)(1)(B) of the Employee Retirement Income Security Act of 1974, as amended (ERISA or the Act) provide, in part, that a fiduciary shall discharge that person’s duties with respect to the plan solely in the interests of the participants and beneficiaries; for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan; and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. (b) Investment prudence duties. (1) With regard to the consideration of an investment or investment course of E:\FR\FM\01DER2.SGM 01DER2 khammond on DSKJM1Z7X2PROD with RULES2 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations action taken by a fiduciary of an employee benefit plan pursuant to the fiduciary’s investment duties, the requirements of section 404(a)(1)(B) of the Act set forth in paragraph (a) of this section are satisfied if the fiduciary: (i) Has given appropriate consideration to those facts and circumstances that, given the scope of such fiduciary’s investment duties, the fiduciary knows or should know are relevant to the particular investment or investment course of action involved, including the role the investment or investment course of action plays in that portion of the plan’s investment portfolio or menu with respect to which the fiduciary has investment duties; and (ii) Has acted accordingly. (2) For purposes of paragraph (b)(1) of this section, ‘‘appropriate consideration’’ shall include, but is not necessarily limited to: (i) A determination by the fiduciary that the particular investment or investment course of action is reasonably designed, as part of the portfolio (or, where applicable, that portion of the plan portfolio with respect to which the fiduciary has investment duties) or menu, to further the purposes of the plan, taking into consideration the risk of loss and the opportunity for gain (or other return) associated with the investment or investment course of action compared to the opportunity for gain (or other return) associated with reasonably available alternatives with similar risks; and (ii) In the case of employee benefit plans other than participant-directed individual account plans, consideration of the following factors as they relate to such portion of the portfolio: (A) The composition of the portfolio with regard to diversification; (B) The liquidity and current return of the portfolio relative to the anticipated cash flow requirements of the plan; and (C) The projected return of the portfolio relative to the funding objectives of the plan. (3) An investment manager appointed, pursuant to the provisions of section 402(c)(3) of the Act, to manage all or part of the assets of a plan, may, for purposes of compliance with the provisions of paragraphs (b)(1) and (2) of this section, rely on, and act upon the basis of, information pertaining to the plan provided by or at the direction of the appointing fiduciary, if: (i) Such information is provided for the stated purpose of assisting the manager in the performance of the manager’s investment duties; and (ii) The manager does not know and has no reason to know that the information is incorrect. VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 (4) A fiduciary’s determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis, using appropriate investment horizons consistent with the plan’s investment objectives and taking into account the funding policy of the plan established pursuant to section 402(b)(1) of ERISA. 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 riskreturn 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. (c) Investment loyalty duties. (1) A fiduciary may not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives, and may not sacrifice investment return or take on additional investment risk to promote benefits or goals unrelated to interests of the participants and beneficiaries in their retirement income or financial benefits under the plan. (2) 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. (3) The plan fiduciary of a participantdirected individual account plan does not violate the duty of loyalty under paragraph (c)(1) of this section solely because the fiduciary takes into account participants’ preferences in a manner consistent with the requirements of paragraph (b) of this section. (d) Proxy voting and exercise of shareholder rights. (1) The fiduciary duty to manage plan assets that are shares of stock includes the management of shareholder rights appurtenant to those shares, such as the right to vote proxies. (2)(i) When deciding whether to exercise shareholder rights and when exercising such rights, including the voting of proxies, fiduciaries must carry out their duties prudently and solely in the interests of the participants and beneficiaries and for the exclusive PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 73885 purpose of providing benefits to participants and beneficiaries and defraying the reasonable expenses of administering the plan. (ii) When deciding whether to exercise shareholder rights and when exercising shareholder rights, plan fiduciaries must: (A) Act solely in accordance with the economic interest of the plan and its participants and beneficiaries, in a manner consistent with paragraph (b)(4) of this section; (B) Consider any costs involved; (C) Not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to any other objective; (D) Evaluate relevant facts that form the basis for any particular proxy vote or other exercise of shareholder rights; and (E) Exercise prudence and diligence in the selection and monitoring of persons, if any, selected to exercise shareholder rights or otherwise advise on or assist with exercises of shareholder rights, such as providing research and analysis, recommendations regarding proxy votes, administrative services with voting proxies, and recordkeeping and reporting services. (iii) A fiduciary may not adopt a practice of following the recommendations of a proxy advisory firm or other service provider without a determination that such firm or service provider’s proxy voting guidelines are consistent with the fiduciary’s obligations described in paragraphs (d)(2)(ii)(A) through (E) of this section. (3)(i) In deciding whether to vote a proxy pursuant to paragraphs (d)(2)(i) and (ii) of this section, fiduciaries may adopt proxy voting policies providing that the authority to vote a proxy shall be exercised pursuant to specific parameters prudently designed to serve the plan’s interests in providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan. (ii) Plan fiduciaries shall periodically review proxy voting policies adopted pursuant to paragraph (d)(3)(i) of this section. (iii) No proxy voting policies adopted pursuant to paragraph (d)(3)(i) of this section shall preclude submitting a proxy vote when the fiduciary prudently determines that the matter being voted upon is expected to have a significant effect on the value of the investment or the investment performance of the plan’s portfolio (or investment performance of assets under management in the case of an investment manager) after taking into E:\FR\FM\01DER2.SGM 01DER2 73886 Federal Register / Vol. 87, No. 230 / Thursday, December 1, 2022 / Rules and Regulations khammond on DSKJM1Z7X2PROD with RULES2 account the costs involved, or refraining from voting when the fiduciary prudently determines that the matter being voted upon is not expected to have such an effect after taking into account the costs involved. (4)(i)(A) The responsibility for exercising shareholder rights lies exclusively with the plan trustee except to the extent that either: (1) The trustee is subject to the directions of a named fiduciary pursuant to ERISA section 403(a)(1); or (2) The power to manage, acquire, or dispose of the relevant assets has been delegated by a named fiduciary to one or more investment managers pursuant to ERISA section 403(a)(2). (B) Where the authority to manage plan assets has been delegated to an investment manager pursuant to ERISA section 403(a)(2), the investment manager has exclusive authority to vote proxies or exercise other shareholder rights appurtenant to such plan assets in accordance with this section, except to the extent the plan, trust document, or investment management agreement expressly provides that the responsible named fiduciary has reserved to itself (or to another named fiduciary so authorized by the plan document) the right to direct a plan trustee regarding the exercise or management of some or all of such shareholder rights. (ii) An investment manager of a pooled investment vehicle that holds assets of more than one employee benefit plan may be subject to an investment policy statement that conflicts with the policy of another plan. Compliance with ERISA section 404(a)(1)(D) requires the investment manager to reconcile, insofar as possible, the conflicting policies (assuming compliance with each policy would be consistent with ERISA section 404(a)(1)(D)). In the case of proxy voting, to the extent permitted by VerDate Sep<11>2014 16:57 Nov 30, 2022 Jkt 259001 applicable law, the investment manager must vote (or abstain from voting) the relevant proxies to reflect such policies in proportion to each plan’s economic interest in the pooled investment vehicle. Such an investment manager may, however, develop an investment policy statement consistent with Title I of ERISA and this section, and require participating plans to accept the investment manager’s investment policy statement, including any proxy voting policy, before they are allowed to invest. In such cases, a fiduciary must assess whether the investment manager’s investment policy statement and proxy voting policy are consistent with Title I of ERISA and this section before deciding to retain the investment manager. (5) This section does not apply to voting, tender, and similar rights with respect to shares of stock that are passed through pursuant to the terms of an individual account plan to participants and beneficiaries with accounts holding such shares. (e) Definitions. For purposes of this section: (1) The term investment duties means any duties imposed upon, or assumed or undertaken by, a person in connection with the investment of plan assets which make or will make such person a fiduciary of an employee benefit plan or which are performed by such person as a fiduciary of an employee benefit plan as defined in section 3(21)(A)(i) or (ii) of the Act. (2) The term investment course of action means any series or program of investments or actions related to a fiduciary’s performance of the fiduciary’s investment duties, and includes the selection of an investment fund as a plan investment, or in the case of an individual account plan, a designated investment alternative under the plan. PO 00000 Frm 00066 Fmt 4701 Sfmt 9990 (3) The term plan means an employee benefit plan to which Title I of the Act applies. (4) The term designated investment alternative means any investment alternative designated by the plan into which participants and beneficiaries may direct the investment of assets held in, or contributed to, their individual accounts. The term ‘‘designated investment alternative’’ shall not include ‘‘brokerage windows,’’ ‘‘self directed brokerage accounts,’’ or similar plan arrangements that enable participants and beneficiaries to select investments beyond those designated by the plan. (f) Severability. If any provision of this section is held to be invalid or unenforceable by its terms, or as applied to any person or circumstance, or stayed pending further agency action, the provision shall be construed so as to continue to give the maximum effect to the provision permitted by law, unless such holding shall be one of invalidity or unenforceability, in which event the provision shall be severable from this section and shall not affect the remainder thereof. (g) Applicability date. (1) Except for paragraphs (d)(2)(iii) and (d)(4)(ii) of this section, this section shall apply in its entirety to all investments made and investment courses of action taken after January 30, 2023. (2) Paragraphs (d)(2)(iii) and (d)(4)(ii) of this section apply on December 1, 2023. Signed at Washington, DC, this 21st day of November, 2022. Lisa M. Gomez, Assistant Secretary, Employee Benefits Security Administration, U.S. Department of Labor. [FR Doc. 2022–25783 Filed 11–30–22; 8:45 am] BILLING CODE 4510–29–P E:\FR\FM\01DER2.SGM 01DER2

Agencies

[Federal Register Volume 87, Number 230 (Thursday, December 1, 2022)]
[Rules and Regulations]
[Pages 73822-73886]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-25783]



[[Page 73821]]

Vol. 87

Thursday,

No. 230

December 1, 2022

Part II





Department of Labor





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Employee Benefits Security Administration





29 CFR Part 2550





Prudence and Loyalty in Selecting Plan Investments and Exercising 
Shareholder Rights; Final Rule

Federal Register / Vol. 87 , No. 230 / Thursday, December 1, 2022 / 
Rules and Regulations

[[Page 73822]]


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DEPARTMENT OF LABOR

Employee Benefits Security Administration

29 CFR Part 2550

RIN 1210-AC03


Prudence and Loyalty in Selecting Plan Investments and Exercising 
Shareholder Rights

AGENCY: Employee Benefits Security Administration, Department of Labor.

ACTION: Final rule.

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SUMMARY: The Department of Labor (Department) is adopting amendments to 
the Investment Duties regulation under Title I of the Employee 
Retirement Income Security Act of 1974, as amended (ERISA). The 
amendments clarify the application of ERISA's fiduciary duties of 
prudence and loyalty to selecting investments and investment courses of 
action, including selecting qualified default investment alternatives, 
exercising shareholder rights, such as proxy voting, and the use of 
written proxy voting policies and guidelines. The amendments reverse 
and modify certain amendments to the Investment Duties regulation 
adopted in 2020.

DATES: 
    Effective date: This rule is effective on January 30, 2023.
    Applicability dates: See Sec.  2550.404a-1(g) of the final rule for 
compliance dates for Sec.  2550.404a-1(d)(2)(iii) and (d)(4)(ii) of the 
final rule.

FOR FURTHER INFORMATION CONTACT: Fred Wong, Acting Chief of the 
Division of Regulations, Office of Regulations and Interpretations, 
Employee Benefits Security Administration, (202) 693-8500. This is not 
a toll-free number.
    Customer Service Information: Individuals interested in obtaining 
information from the Department of Labor concerning ERISA and employee 
benefit plans may call the Employee Benefits Security Administration 
(EBSA) Toll-Free Hotline, at 1-866-444-EBSA (3272) or visit the 
Department of Labor's website (www.dol.gov/ebsa).

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Background
    A. General
    B. The Department's Prior Non-Regulatory Guidance
    1. ETI/ESG Investing
    2. Exercising Shareholder Rights
    C. Executive Order Review of Current Regulation
II. Purpose of Regulatory Action and Proposed Rule
    A. Purpose
    B. Major Provisions of Proposed Rule
III. The Final Rule
    A. Executive Summary of Major Changes and Clarifications
    B. Detailed Discussion of Public Comments and Final Regulation
    1. Section 2550.404a-1(a) and (b)--General and Investment 
Prudence Duties
    2. Section 2550.404a-1(c) Investment Loyalty Duties
    3. Investment Alternatives in Participant Directed Individual 
Account Plans Including Qualified Default Investment Alternatives
    4. Section 2550.404a-1(d)--Proxy Voting and Exercise of 
Shareholder Rights
    5. Section 2550.404a-1(e)--Definitions
    6. Section 2550.404a-1(f)--Severability
    7. Section 2550.404a-1(g)--Applicability Date
    8. Miscellaneous
IV. Regulatory Impact Analysis
    A. Executive Orders 12866 and 13563
    B. Introduction and Need for Regulation
    C. Affected Entities
    1. Subset of Plans Affected by Proposed Modifications of 
Paragraphs (b) and (c) of Sec.  2550.404a-1
    2. Subset of Plans Affected by the Modifications to Paragraph 
(d) of Sec.  2550.404a-1
    D. Benefits
    1. Benefits of Paragraphs (b) and (c)
    2. Cost Savings Relating to Paragraphs (c), Relative to the 
Current Regulation
    3. Benefits of Paragraph (d)
    4. Cost Savings Relating to Paragraphs (d) and (e), Relative to 
the Current Regulation
    E. Costs
    1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
    2. Possible Changeover Costs
    3. Cost Associated With Changes in Investment or Investment 
Course of Action
    4. Cost Associated With Changes to the ``Tiebreaker'' Rule
    5. Cost To Update Plan's Written Proxy Voting Policies
    6. Summary
    F. Transfers
    G. Uncertainty
    H. Alternatives
    I. Conclusion
V. Paperwork Reduction Act
VI. Regulatory Flexibility Act
    A. Need for and Objectives of the Rule
    B. Comments
    C. Affected Small Entities
    1. Small Plans Affected by the Proposed Modifications of 
Paragraphs (b) and (c) of Sec.  2550.404a-1
    2. Subset of Plans Affected by Modifications of Paragraph (d) 
and (e) of Sec.  2550.404a-1
    D. Impact of the Rule
    1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
    2. Cost To Update Written Proxy Voting Policies
    3. Summary of Costs
    E. Regulatory Alternatives
    F. Duplicate, Overlapping, or Relevant Federal Rules
VII. Unfunded Mandates Reform Act
VIII. Federalism Statement

I. Background

A. General

    Title I of the Employee Retirement Income Security Act of 1974 
(ERISA) establishes minimum standards that govern the operation of 
private-sector employee benefit plans, including fiduciary 
responsibility rules. Section 404 of ERISA, in part, requires that plan 
fiduciaries act prudently and diversify plan investments so as to 
minimize the risk of large losses, unless under the circumstances it is 
clearly prudent not to do so.\1\ Sections 403(c) and 404(a) also 
require fiduciaries to act solely in the interest of the plan's 
participants and beneficiaries, and for the exclusive purpose of 
providing benefits to participants and beneficiaries and defraying 
reasonable expenses of administering the plan.\2\
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    \1\ 29 U.S.C. 1104.
    \2\ 29 U.S.C. 1103(c) and 1104(a).
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    To maximize employee pension and welfare benefits, section 404 of 
ERISA dictates that the focus of ERISA plan fiduciaries on the plan's 
financial returns and risk to beneficiaries must be paramount.\3\ And 
for years, the Department's non-regulatory guidance has recognized 
that, under the appropriate circumstances, ERISA does not preclude 
fiduciaries from making investment decisions that reflect 
environmental, social, or governance (``ESG'') considerations, and 
choosing economically targeted investments (``ETIs'') selected in part 
for benefits in addition to the impact those considerations could have 
on investment return.\4\ The Department's non-regulatory guidance has 
also recognized that the fiduciary act of managing employee benefit 
plan assets includes the management of voting rights as well as other 
shareholder rights connected to shares of stock, and that management of 
those rights, as well as shareholder engagement activities, is subject 
to ERISA's prudence and loyalty requirements.\5\ Subsection B of this 
background section provides a complete overview of the Department's 
prior non-regulatory guidance.
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    \3\ See Interpretive Bulletin 2015-01, 80 FR 65135 (Oct. 26, 
2015).
    \4\ See, e.g., id.
    \5\ See, e.g., Interpretive Bulletin 2016-01, 81 FR 95879 (Dec. 
29, 2016).
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    The Department's Investment Duties regulation under Title I of 
ERISA is codified at 29 CFR 2550.404a-1(hereinafter ``current 
regulation'' or ``Investment Duties regulation,'' unless otherwise 
stated). On June 30 and

[[Page 73823]]

September 4, 2020, the Department published in the Federal Register 
proposed rules to remove prior non-regulatory guidance from the CFR and 
to amend the Department's Investment Duties regulation. The objective 
was to address perceived confusion about the implications of that non-
regulatory guidance with respect to ESG considerations, ETIs, 
shareholder rights, and proxy voting.\6\ The preambles to the 2020 
proposals expressed concern that some ERISA plan fiduciaries might be 
making improper investment decisions, and that plan shareholder rights 
were being exercised in a manner that subordinated the interests of 
plans and their participants and beneficiaries to unrelated 
objectives.\7\ Given the persistent confusion in this area due in part 
to varied statements the Department had made on the subject over the 
years in non-regulatory guidance, the Department believed that 
providing further clarity on these issues in the form of a notice and 
comment regulation would be more helpful and permanent than another 
iteration of non-regulatory guidance.
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    \6\ See 85 FR 39113 (June 30, 2020); 85 FR 55219 (Sept. 4, 
2020).
    \7\ See 85 FR 39116; 85 FR 55221.
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    Less than six months later, on November 13, 2020, the Department 
published a final rule titled ``Financial Factors in Selecting Plan 
Investments,'' which adopted amendments to the Investment Duties 
regulation that generally require plan fiduciaries to select 
investments and investment courses of action based solely on 
consideration of ``pecuniary factors.'' \8\ Among these amendments was 
a prohibition against adding or retaining any investment fund, product, 
or model portfolio as a qualified default investment alternative (QDIA) 
as described in 29 CFR 2550.404c-5 if the fund, product, or model 
portfolio includes even one non-pecuniary objective in its investment 
objectives or principal investment strategies. On December 16, 2020, 
the Department published a final rule titled ``Fiduciary Duties 
Regarding Proxy Voting and Shareholder Rights,'' which also adopted 
amendments to the Investment Duties regulation to establish regulatory 
standards for the obligations of plan fiduciaries under ERISA when 
voting proxies and exercising other shareholder rights in connection 
with plan investments in shares of stock.\9\
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    \8\ 85 FR 72846 (Nov. 13, 2020).
    \9\ 85 FR 81658 (Dec. 16, 2020).
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    On January 20, 2021, the President signed Executive Order 13990 
(E.O. 13990), titled ``Protecting Public Health and the Environment and 
Restoring Science to Tackle the Climate Crisis.'' \10\ Section 1 of 
E.O. 13990 acknowledges the Nation's ``abiding commitment to empower 
our workers and communities; promote and protect our public health and 
the environment.'' Section 1 also sets forth the policy of the 
Administration to listen to the science; improve public health and 
protect our environment; bolster resilience to the impacts of climate 
change; and prioritize both environmental justice and the creation of 
the well-paying union jobs necessary to deliver on these goals. Section 
2 directed agencies to review all existing regulations promulgated, 
issued, or adopted between January 20, 2017, and January 20, 2021, that 
are or may be inconsistent with, or present obstacles to, the policies 
set forth in section 1 of E.O. 13990. Section 2 further provided that 
for any such actions identified by the agencies, the heads of agencies 
shall, as appropriate and consistent with applicable law, consider 
suspending, revising, or rescinding the agency actions.\11\
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    \10\ 86 FR 7037 (Jan. 25, 2021). E.O. 13990 was signed eight 
days after the effective date of ``Financial Factors in Selecting 
Plan Investments,'' and five days after the effective date of 
``Fiduciary Duties Regarding Proxy Voting and Shareholder Rights.''
    \11\ A Fact Sheet issued simultaneously with E.O. 13990, 
specifically confirmed that the Department was directed to review 
the final rule on ``Financial Factors in Selecting Plan 
Investments'' Available at www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/fact-sheet-list-of-agency-actions-for-review/.
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    On March 10, 2021, the Department announced that it had begun a 
reexamination of the current regulation, consistent with E.O. 13990, 
the Administrative Procedure Act, and ERISA's grant of regulatory 
authority in section 505.\12\ The Department also announced that, 
pending its review of the current regulation, the Department will not 
enforce the current regulation or otherwise pursue enforcement actions 
against any plan fiduciary based on a failure to comply with the 
current regulation with respect to an investment, including a QDIA, 
investment course of action or an exercise of shareholder rights. In 
announcing the enforcement policy, the Department also stated its 
intention to conduct significantly more stakeholder outreach to 
determine how to craft rules that better recognize the role that ESG 
integration can play in the evaluation and management of plan 
investments in ways that further fundamental fiduciary obligations.\13\
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    \12\ 29 U.S.C. 1135.
    \13\ See U.S. Department of Labor Statement Regarding 
Enforcement of its Final Rules on ESG Investments and Proxy Voting 
by Employee Benefit Plans (Mar. 10, 2021) Available at www.dol.gov/sites/dolgov/files/ebsa/laws-and-regulations/laws/erisa/statement-on-enforcement-of-final-rules-on-esg-investments-and-proxy-voting.pdf. Following publication of the final rules the Department 
heard from a wide variety of stakeholders, including asset managers, 
labor organizations and other plan sponsors, consumer groups, 
service providers and investment advisers that questioned whether 
the 2020 Rules properly reflect the scope of fiduciaries' duties 
under ERISA to act prudently and solely in the interest of plan 
participants and beneficiaries. The stakeholders also questioned 
whether the Department rushed the rulemakings unnecessarily and 
failed to adequately consider and address the substantial evidence 
submitted by public commenters on the use of environmental, social 
and governance considerations in improving investment value and 
long-term investment returns for retirement investors.
---------------------------------------------------------------------------

    On May 20, 2021, the President signed Executive Order 14030 (E.O. 
14030), titled ``Executive Order on Climate-Related Financial Risk.'' 
\14\ The policies set forth in section 1 of E.O. 14030 include 
advancing acts to mitigate climate-related financial risk and actions 
to help safeguard the financial security of America's families, 
businesses, and workers from climate-related financial risk that may 
threaten the life savings and pensions of U.S. workers and families. 
Section 4 of E.O. 14030 directed the Department to consider publishing, 
by September 2021, for notice and comment a proposed rule to suspend, 
revise, or rescind ``Financial Factors in Selecting Plan Investments,'' 
\15\ and ``Fiduciary Duties Regarding Proxy Voting and Shareholder 
Rights.'' \16\
---------------------------------------------------------------------------

    \14\ 86 FR 27967 (May 25, 2021). E.O. 14030 was signed 128 days 
after the effective date of ``Financial Factors in Selecting Plan 
Investments,'' and 125 days after the effective date of ``Fiduciary 
Duties Regarding Proxy Voting and Shareholder Rights.''
    \15\ 85 FR 72846 (Nov. 13, 2020).
    \16\ 85 FR 81658 (Dec. 16, 2020).
---------------------------------------------------------------------------

B. The Department's Prior Non-Regulatory Guidance

    The Department has a longstanding position that ERISA fiduciaries 
may not sacrifice investment returns or assume greater investment risks 
as a means of promoting collateral social policy goals. These 
proscriptions flow directly from ERISA's stringent standards of 
prudence and loyalty under section 404(a) of the statute.\17\ The 
Department has a similarly longstanding position that the fiduciary act 
of managing plan assets that involve shares of corporate stock includes 
making decisions about voting proxies and exercising shareholder 
rights. Over the years the Department repeatedly has issued non-
regulatory

[[Page 73824]]

guidance to assist plan fiduciaries in understanding their obligations 
under ERISA to apply these principles to ETIs and ESG.
---------------------------------------------------------------------------

    \17\ 29 U.S.C. 1104(a).
---------------------------------------------------------------------------

1. ETI/ESG Investing
    Interpretive Bulletin 94-1 (IB 94-1), published in 1994, addressed 
economically targeted investments (ETIs) selected, in part, for 
collateral benefits apart from the investment return to the plan 
investor.\18\ The Department's objective in issuing IB 94-1 was to 
state that ETIs \19\ are not inherently incompatible with ERISA's 
fiduciary obligations. The preamble to IB 94-1 explained that the 
requirements of sections 403 and 404 of ERISA do not prevent plan 
fiduciaries from investing plan assets in ETIs if the investment has an 
expected rate of return at least commensurate to rates of return of 
available alternative investments, and if the ETI is otherwise an 
appropriate investment for the plan in terms of such factors as 
diversification and the investment policy of the plan. Some 
commentators have referred to this as the ``all things being equal'' 
test or the ``tiebreaker'' standard. The Department stated in the 
preamble to IB 94-1 that when competing investments serve the plan's 
economic interests equally well, plan fiduciaries can use such 
collateral considerations as the deciding factor for an investment 
decision. This was the Department's unchanged position for 
approximately three decades.
---------------------------------------------------------------------------

    \18\ 59 FR 32606 (June 23, 1994) (appeared in Code of Federal 
Regulations as 29 CFR 2509.94-1). Prior to issuing IB 94-1, the 
Department had issued a number of letters concerning a fiduciary's 
ability to consider the collateral effects of an investment and 
granted a variety of prohibited transaction exemptions to both 
individual plans and pooled investment vehicles involving 
investments that produce collateral benefits. See Advisory Opinions 
80-33A, 85-36A and 88-16A; Information Letters to Mr. George Cox, 
dated Jan. 16, 1981; to Mr. Theodore Groom, dated Jan. 16, 1981; to 
The Trustees of the Twin City Carpenters and Joiners Pension Plan, 
dated May 19, 1981; to Mr. William Chadwick, dated July 21, 1982; to 
Mr. Daniel O'Sullivan, dated Aug. 2, 1982; to Mr. Ralph Katz, dated 
Mar. 15, 1982; to Mr. William Ecklund, dated Dec. 18, 1985, and Jan. 
16, 1986; to Mr. Reed Larson, dated July 14, 1986; to Mr. James Ray, 
dated July 8, 1988; to the Honorable Jack Kemp, dated Nov. 23, 1990; 
and to Mr. Stuart Cohen, dated May 14, 1993. The Department also 
issued a number of prohibited transaction exemptions that touched on 
these issues. See PTE 76-1, part B, concerning construction loans by 
multiemployer plans; PTE 84-25, issued to the Pacific Coast Roofers 
Pension Plan; PTE 85-58, issued to the Northwestern Ohio Building 
Trades and Employer Construction Industry Investment Plan; PTE 87-
20, issued to the Racine Construction Industry Pension Fund; PTE 87-
70, issued to the Dayton Area Building and Construction Industry 
Investment Plan; PTE 88-96, issued to the Real Estate for American 
Labor A Balcor Group Trust; PTE 89-37, issued to the Union Bank; and 
PTE 93-16, issued to the Toledo Roofers Local No. 134 Pension Plan 
and Trust, et al. In addition, one of the first directors of the 
Department's benefits office authored an article on this topic in 
1980. See Ian D. Lanoff, The Social Investment of Private Pension 
Plan Assets: May It Be Done Lawfully Under ERISA?, 31 Labor L.J. 
387, 391-92 (1980) (stating that ``[t]he Labor Department has 
concluded that economic considerations are the only ones which can 
be taken into account in determining which investments are 
consistent with ERISA standards,'' and warning that fiduciaries who 
exclude investment options for non-economic reasons would be 
``acting at their peril'').
    \19\ IB 94-1 used the terms ETI and economically targeted 
investments to broadly refer to any investment or investment course 
of action that is selected, in part, for its expected collateral 
benefits, apart from the investment return to the employee benefit 
plan investor.
---------------------------------------------------------------------------

    In 2008, the Department replaced IB 94-1 with Interpretive Bulletin 
2008-01 (IB 2008-01),\20\ and then, in 2015, the Department replaced IB 
2008-01 with Interpretive Bulletin 2015-01 (IB 2015-01).\21\ Although 
the Interpretive Bulletins differed from each other in tone and content 
to some extent, each endorsed the ``all things being equal'' test, 
while also stressing that the paramount focus of plan fiduciaries must 
be the plan's financial returns and providing promised benefits to 
participants and beneficiaries. Each Interpretive Bulletin also 
cautioned that fiduciaries violate ERISA if they accept reduced 
expected returns or greater risks to secure social, environmental, or 
other policy goals.
---------------------------------------------------------------------------

    \20\ 73 FR 61734 (Oct. 17, 2008).
    \21\ 80 FR 65135 (Oct. 26, 2015).
---------------------------------------------------------------------------

    Additionally, the preamble to IB 2015-01 explained that if a 
fiduciary prudently determines that an investment is appropriate based 
solely on economic considerations, including those that may derive from 
ESG factors, the fiduciary may make the investment without regard to 
any collateral benefits the investment may also promote. In Field 
Assistance Bulletin 2018-01 (FAB 2018-01), the Department indicated 
that IB 2015-01 had recognized that there could be instances when ESG 
issues present material business risk or opportunities to companies 
that company officers and directors need to manage as part of the 
company's business plan, and that qualified investment professionals 
would treat the issues as material economic considerations under 
generally accepted investment theories. As appropriate economic 
considerations, such ESG issues should be considered by a prudent 
fiduciary along with other relevant economic factors to evaluate the 
risk and return profiles of alternative investments. In other words, in 
these instances, the factors are not ``tiebreakers,'' but ``risk-
return'' factors affecting the economic merits of the investment.
    FAB 2018-01 cautioned, however, that ``[t]o the extent ESG factors, 
in fact, involve business risks or opportunities that are properly 
treated as economic considerations themselves in evaluating alternative 
investments, the weight given to those factors should also be 
appropriate to the relative level of risk and return involved compared 
to other relevant economic factors.'' \22\ The Department further 
emphasized in FAB 2018-01 that fiduciaries ``must not too readily treat 
ESG factors as economically relevant to the particular investment 
choices at issue when making a decision,'' as ``[i]t does not 
ineluctably follow from the fact that an investment promotes ESG 
factors, or that it arguably promotes positive general market trends or 
industry growth, that the investment is a prudent choice for retirement 
or other investors.'' Rather, ERISA fiduciaries must always put first 
the economic interests of the plan in providing retirement benefits, 
and ``[a] fiduciary's evaluation of the economics of an investment 
should be focused on financial factors that have a material effect on 
the return and risk of an investment based on appropriate investment 
horizons consistent with the plan's articulated funding and investment 
objectives.'' \23\
---------------------------------------------------------------------------

    \22\ FAB 2018-01 (Apr. 23, 2018).
    \23\ Id.
---------------------------------------------------------------------------

    FAB 2018-01 also explained that in the case of an investment 
platform that allows participants and beneficiaries an opportunity to 
choose from a broad range of investment alternatives, a prudently 
selected, well managed, and properly diversified ESG-themed investment 
alternative could be added to the available investment options on a 
401(k) plan platform without requiring the plan to remove or forgo 
adding other non-ESG-themed investment options to the platform.\24\ 
According to the FAB, however, the selection of an investment fund as a 
QDIA is not analogous to a fiduciary's decision to offer participants 
an additional investment alternative as part of a prudently constructed 
lineup of investment alternatives from which participants may choose. 
FAB 2018-01 expressed concern that the decision to favor the 
fiduciary's own policy preferences in selecting an ESG-themed 
investment option as a QDIA for a 401(k)-type plan without regard to 
possibly different or competing views of plan participants and 
beneficiaries would raise questions about the fiduciary's compliance 
with ERISA's duty of loyalty.\25\ In addition, FAB

[[Page 73825]]

2018-01 stated that, even if consideration of such factors could be 
shown to be appropriate in the selection of a QDIA for a particular 
plan population, the plan's fiduciaries would have to ensure compliance 
with the previous guidance in IB 2015-01. For example, the selection of 
an ESG-themed target date fund as a QDIA would not be prudent if the 
fund would provide a lower expected rate of return than available non-
ESG alternative target date funds with commensurate degrees of risk, or 
if the fund would be riskier than non-ESG alternative available target 
date funds with commensurate rates of return.
---------------------------------------------------------------------------

    \24\ Id.
    \25\ FAB 2018-01.
---------------------------------------------------------------------------

2. Exercising Shareholder Rights
    The Department's past non-regulatory guidance has also consistently 
recognized that the fiduciary act of managing employee benefit plan 
assets includes the management of voting rights as well as other 
shareholder rights connected to shares of stock, and that management of 
those rights, as well as shareholder engagement activities, is subject 
to ERISA's prudence and loyalty requirements.
    The Department first issued non-regulatory guidance on proxy voting 
and the exercise of shareholder rights in the 1980s. For example, in 
1988, the Department issued an opinion letter to Avon Products, Inc. 
(the Avon Letter), in which the Department took the position that the 
fiduciary act of managing plan assets that are shares of corporate 
stock includes the voting of proxies appurtenant to those shares, and 
that the named fiduciary of a plan has a duty to monitor decisions made 
and actions taken by investment managers with regard to proxy 
voting.\26\ In 1994, the Department issued its first interpretive 
bulletin on proxy voting, Interpretive Bulletin 94-2 (IB 94-2).\27\ IB 
94-2 recognized that fiduciaries may engage in shareholder activities 
intended to monitor or influence corporate management if the 
responsible fiduciary concludes that, after taking into account the 
costs involved, there is a reasonable expectation that such shareholder 
activities (by the plan alone or together with other shareholders) will 
enhance the value of the plan's investment in the corporation. The 
Department also reiterated its view that ERISA does not permit 
fiduciaries, in voting proxies or exercising other shareholder rights, 
to subordinate the economic interests of participants and beneficiaries 
to unrelated objectives.
---------------------------------------------------------------------------

    \26\ Letter to Helmuth Fandl, Chairman of the Retirement Board, 
Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988).
    \27\ 59 FR 38860 (July 29, 1994).
---------------------------------------------------------------------------

    In October 2008, the Department replaced IB 94-2 with Interpretive 
Bulletin 2008-02 (IB 2008-02).\28\ The Department's intent was to 
update the guidance in IB 94-2 and to reflect interpretive positions 
issued by the Department after 1994 on shareholder engagement and 
socially-directed proxy voting initiatives. IB 2008-02 stated that 
fiduciaries' responsibility for managing proxies includes both deciding 
to vote and deciding not to vote.\29\ IB 2008-02 further stated that 
the fiduciary duties described at ERISA sections 404(a)(1)(A) and (B) 
require that, in voting proxies, the responsible fiduciary shall 
consider only those factors that relate to the economic value of the 
plan's investment and shall not subordinate the interests of the 
participants and beneficiaries in their retirement income to unrelated 
objectives. In addition, IB 2008-02 stated that votes shall only be 
cast in accordance with a plan's economic interests. IB 2008-02 
explained that if the responsible fiduciary reasonably determines that 
the cost of voting (including the cost of research, if necessary, to 
determine how to vote) is likely to exceed the expected economic 
benefits of voting, the fiduciary has an obligation to refrain from 
voting.\30\ The Department also reiterated in IB 2008-02 that any use 
of plan assets by a plan fiduciary to further political or social 
causes ``that have no connection to enhancing the economic value of the 
plan's investment'' through proxy voting or shareholder activism is a 
violation of ERISA's exclusive purpose and prudence requirements.\31\
---------------------------------------------------------------------------

    \28\ 73 FR 61731 (Oct. 17, 2008).
    \29\ 73 FR 61732.
    \30\ Id.
    \31\ 73 FR 61734.
---------------------------------------------------------------------------

    In 2016, the Department issued Interpretive Bulletin 2016-01 (IB 
2016-01), which reinstated the language of IB 94-2 with certain 
modifications.\32\ IB 2016-01 reiterated and confirmed that ``in voting 
proxies, the responsible fiduciary [must] consider those factors that 
may affect the value of the plan's investment and not subordinate the 
interests of the participants and beneficiaries in their retirement 
income to unrelated objectives.'' \33\ In its guidance, the Department 
has also stated that it rejects a construction of ERISA that would 
render the statute's tight limits on the use of plan assets illusory 
and that would permit plan fiduciaries to expend trust assets to 
promote a myriad of personal public policy preferences at the expense 
of participants' economic interests, including through shareholder 
engagement activities, voting proxies, or other investment 
policies.\34\
---------------------------------------------------------------------------

    \32\ 81 FR 95879 (Dec. 29, 2016). In addition, the Department 
issued a Field Assistance Bulletin to provide guidance on IB 2016-01 
on April 23, 2018. See FAB 2018-01, at www.dol.gov/sites/dolgov/files/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2018-01.pdf.
    \33\ 81 FR 95882.
    \34\ See 81 FR 95881.
---------------------------------------------------------------------------

C. Executive Order Review of Current Regulation

    In early 2021, consistent with E.O. 13990 and E.O. 14030, the 
Department engaged in informal outreach to hear views from interested 
stakeholders on how to craft regulations that better recognize the 
important role that climate change and other ESG factors can play in 
the evaluation and management of plan investments, while continuing to 
uphold fundamental fiduciary obligations. The Department heard from a 
wide variety of stakeholders, including asset managers, labor 
organizations and other plan sponsors, consumer groups, service 
providers, and investment advisers. Many of the stakeholders expressed 
skepticism as to whether the current regulation properly reflects the 
scope of fiduciaries' duties under ERISA to act prudently and solely in 
the interest of plan participants and beneficiaries.
    That outreach effort by the Department suggested that, rather than 
provide clarity, some aspects of the current regulation instead may 
have created further uncertainty about whether a fiduciary under ERISA 
may consider ESG and other factors in making investment and proxy 
voting decisions that the fiduciary reasonably believes will benefit 
the plan and its participants and beneficiaries. Many stakeholders 
questioned whether the Department rushed the current regulation 
unnecessarily and failed to adequately consider and address substantial 
evidence submitted by public commenters suggesting that the use of 
climate change and other ESG factors can improve investment value and 
long-term investment returns for retirement investors. The Department 
also heard from stakeholders that the current regulation, and investor 
confusion about it, including whether climate change and other ESG 
factors may be treated as ``pecuniary'' factors under the regulation, 
already had begun to have a chilling effect on appropriate integration 
of climate change and other ESG factors in investment decisions. This 
continued through the current non-enforcement period, including in 
circumstances where the current

[[Page 73826]]

regulation may in fact allow consideration of ESG factors.
    After conducting a review of the current regulation, the Department 
concluded there is a reasonable basis for the concerns raised by the 
stakeholders. A number of public comment letters had criticized the 
2020 proposed regulatory text for appearing to single out ESG investing 
for heightened scrutiny, which they asserted was inappropriate in light 
of research and investment practices suggesting that climate change and 
other ESG factors are material economic considerations.\35\ In 
response, the Department did not include explicit references to ESG in 
the current regulation and furthermore acknowledged in the preamble 
discussion to the Financial Factors in Selecting Plan Investments final 
rulemaking that there are instances where one or more ESG factors may 
be properly taken into account by a fiduciary.\36\ The preamble to the 
Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final 
rulemaking also acknowledged academic studies and investment experience 
surrounding the materiality of ESG considerations in investment 
decisionmaking.\37\ However, other statements in the preamble appeared 
to express skepticism about fiduciaries' reliance on ESG 
considerations. For instance, the preamble to the Financial Factors in 
Selecting Plan Investments final rulemaking asserted that ESG investing 
raises heightened concerns under ERISA, and cautioned fiduciaries 
against ``too hastily'' concluding that ESG-themed funds may be 
selected based on pecuniary factors.\38\ Similarly, the preamble to the 
Fiduciary Duties Regarding Proxy Voting and Shareholder Rights final 
rulemaking expressed the view that it is likely that many environmental 
and social shareholder proposals have little bearing on share value or 
other relation to plan financial interests.\39\ Many stakeholders 
indicated that the current regulation has been interpreted as putting a 
thumb on the scale against the consideration of ESG factors, even when 
those factors are financially material.
---------------------------------------------------------------------------

    \35\ See, e.g., Comment # 567 at www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00567.pdf and Comment # 709 at www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/public-comments/1210-AB95/00709.pdf.
    \36\ See 85 FR 72859 (Nov. 13, 2020) (``[T]he Department 
believes that it would be consistent with ERISA and the final rule 
for a fiduciary to treat a given factor or consideration as 
pecuniary if it presents economic risks or opportunities that 
qualified investment professionals would treat as material economic 
considerations under generally accepted investment theories'').
    \37\ 85 FR 81662 (Dec. 16, 2020) (``This [Fiduciary Duties 
Regarding Proxy Voting and Shareholder Rights] rulemaking project, 
similar to the recently published final rule on ERISA fiduciaries' 
consideration of financial factors in investment decisions, 
recognizes, rather than ignores, the economic literature and 
fiduciary investment experience that show a particular `E,' `S,' or 
`G' consideration may present issues of material business risk or 
opportunities to a specific company that its officers and directors 
need to manage as part of the company's business plan and that 
qualified investment professionals would treat as economic 
considerations under generally accepted investment theories.'').
    \38\ 85 FR 72848, 72859 (Nov. 13, 2020).
    \39\ 85 FR 81681 (Dec. 16, 2020).
---------------------------------------------------------------------------

    The Department's review under the Executive orders caused it 
concern that, as stakeholders warned, uncertainty with respect to the 
current regulation may be deterring fiduciaries from taking steps that 
other marketplace investors would take in enhancing investment value 
and performance, or improving investment portfolio resilience against 
the potential financial risks and impacts associated with climate 
change and other ESG factors. The Department was concerned that the 
current regulation created a perception that fiduciaries are at risk if 
they include any ESG factors in the financial evaluation of plan 
investments, and that they would need to have special justifications 
for even ordinary exercises of shareholder rights.
    Based on these concerns, the Department, on October 14, 2021, 
published a notice of proposed rulemaking (NPRM) proposing amendments 
to the current regulation.\40\ The intent of the NPRM was to address 
uncertainties regarding aspects of the current regulation and its 
preamble discussion relating to the consideration of ESG issues, 
including climate-related financial risk, by fiduciaries in making 
investment and voting decisions, and to provide further clarity that 
will help safeguard the interests of participants and beneficiaries in 
the plan benefits.
---------------------------------------------------------------------------

    \40\ 86 FR 57272 (Oct. 14, 2021).
---------------------------------------------------------------------------

II. Purpose of Regulatory Action and Proposed Rule

A. Purpose

    Like the NPRM, the purpose of the final rule is to clarify the 
application of ERISA's fiduciary duties of prudence and loyalty to 
selecting investments and investment courses of action, including 
selecting QDIAs, exercising shareholder rights, such as proxy voting, 
and the use of written proxy voting policies and guidelines. The need 
for clarification comes from the chilling effect and other potential 
negative consequences caused by the current regulation with respect to 
the consideration of climate change and other ESG factors in connection 
with these activities. Overall, the public comments support the 
clarifications provided by this final rule, although some commenters 
challenged the stated need. The Department disagrees with commenters 
who asserted that any clarifications to the current regulation are 
unnecessary. The Department's conclusion, supported by many public 
commenters, is that the current regulation creates uncertainty and is 
having the undesirable effect of discouraging ERISA fiduciaries' 
consideration of climate change and other ESG factors in investment 
decisions, even in cases where it is in the financial interest of plans 
to take such considerations into account. This uncertainty may further 
deter fiduciaries from taking steps that other marketplace investors 
take in enhancing investment value and performance or improving 
investment portfolio resilience against the potential financial risks 
and impacts associated with climate change and other ESG factors. Major 
comments are addressed in detail below in conjunction with specific 
provisions of the final rule.

B. Major Provisions of Proposed Rule

    Consistent with the purpose of the overall rulemaking initiative, 
the NPRM proposed several key changes and clarifications to the current 
regulation, as follows:
     The NPRM proposed to delete the ``pecuniary/non-
pecuniary'' terminology from the current regulation based on concerns 
that the terminology causes confusion and has a chilling effect on 
financially beneficial choices.
     The NPRM proposed the addition of regulatory text that 
would have made it clear that, when considering projected returns, a 
fiduciary's duty of prudence may often require an evaluation of the 
economic effects of climate change and other ESG factors on the 
particular investment or investment course of action.
     The NPRM proposed to add to the operative text of the rule 
three sets of examples of climate change and other ESG factors that, 
depending on the facts and circumstances, may be material to the risk-
return analysis.
     The NPRM proposed to remove the special rules for QDIAs 
that apply under the current regulation. The NPRM would instead apply 
the same standards to QDIAs as apply to other investments.
     The NPRM proposed to modify the current rule's 
``tiebreaker'' test, which permits fiduciaries to consider collateral 
benefits as tiebreakers in some circumstances. The current regulation 
imposes a requirement that the competing investments underlying a

[[Page 73827]]

tiebreaker situation be indistinguishable based on pecuniary factors 
alone before fiduciaries can turn to collateral factors to break a tie 
and imposes a special documentation requirement on the use of such 
factors. The NPRM proposed replacing those provisions with a standard 
that would have instead required 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. The NPRM also 
proposed to remove the current regulation's special documentation 
requirements in favor of ERISA's generally applicable statutory duty to 
prudently document plan affairs.
     To the extent individual account plans use the tiebreaker 
test in the selection of a designated investment alternative, the NPRM 
proposed that plans must prominently disclose to the plans' 
participants the collateral considerations that were used as 
tiebreakers.
     The NPRM proposed to eliminate the statement in paragraph 
(e)(2)(ii) of the current regulation that ``the fiduciary duty to 
manage shareholder rights appurtenant to shares of stock does not 
require the voting of every proxy or the exercise of every shareholder 
right,'' which the Department was concerned could be misread as 
suggesting that plan fiduciaries should be indifferent to the exercise 
of their rights as shareholders, even if the cost is minimal.
     The NPRM proposed to eliminate paragraph (e)(2)(iii) of 
the current regulation, which sets out specific monitoring obligations 
with respect to use of investment managers or proxy voting firms, and 
to address such monitoring obligations in another provision of the 
regulation that more generally covers selection and monitoring 
obligations. The Department was concerned that the specific monitoring 
provision could be read as requiring some special obligations above and 
beyond the statutory obligations of prudence and loyalty that generally 
apply to monitoring the work of service providers.
     The NPRM proposed to remove the two ``safe harbor'' 
examples for proxy voting policies permissible under paragraphs 
(e)(3)(i)(A) and (B) of the current regulation. One of these safe 
harbors permitted a policy to limit voting resources to particular 
proposals that the fiduciary had prudently determined were 
substantially related to the issuer's business activities or were 
expected to have a material effect on the value of the investment. The 
other safe harbor permitted a policy of refraining from voting on 
proposals when the plan's holding in a single issuer relative to the 
plan's total investment assets was below a quantitative threshold. The 
Department was concerned that the safe harbors did not adequately 
safeguard the interests of plans and their participants and 
beneficiaries.
     The NPRM proposed to eliminate from the current regulation 
a specific requirement on maintaining records on proxy voting 
activities and other exercises of shareholder rights, which appeared to 
treat proxy voting and other exercises of shareholder rights 
differently from other fiduciary activities and risked creating a 
misperception that proxy voting and other exercises of shareholder 
rights are disfavored or carry greater fiduciary obligations than other 
fiduciary activities.
    The Department invited interested persons to submit comments on the 
NPRM. In response to this invitation, the Department received more than 
895 written comments and 21,469 petitions (e.g., form letters) 
submitted during the open comment period. These comments and petitions 
(hereinafter collectively referred to as ``comments'' unless otherwise 
specified) came from a variety of parties, including plan sponsors and 
other plan fiduciaries, individual plan participants and beneficiaries, 
financial services companies, academics, elected government officials, 
trade and industry associations, and others, both in support of and in 
opposition to the NPRM. These comments are available for public review 
on the Department's Employee Benefits Security Administration website.

III. The Final Rule

A. Executive Summary of Major Changes and Clarifications

    The final rule generally tracks the NPRM but makes certain 
clarifications and changes in response to public comments. Before 
describing these changes, the Department emphasizes that the final rule 
does not change two longstanding principles. First, the final rule 
retains the core principle that the duties of prudence and loyalty 
require ERISA plan fiduciaries to focus on relevant risk-return factors 
and not subordinate the interests of participants and beneficiaries 
(such as by sacrificing investment returns or taking on additional 
investment risk) to objectives unrelated to the provision of benefits 
under the plan. Second, the fiduciary duty to manage plan assets that 
are shares of stock includes the management of shareholder rights 
appurtenant to those shares, such as the right to vote proxies. As 
described in further detail below in subsection B of this section III, 
the final rule adopts the following changes to the current regulation:
     Like the NPRM, the final rule amends the current 
regulation to delete the ``pecuniary/non-pecuniary'' terminology based 
on concerns that the terminology causes confusion and a chilling effect 
to financially beneficial choices.
     Like the NPRM, the final rule amends the current 
regulation to make it clear that a fiduciary's determination with 
respect to an investment or investment course of action must be based 
on factors that the fiduciary reasonably determines are relevant to a 
risk and return analysis and that such 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.
     Like the NPRM, the final rule amends the current 
regulation to remove the stricter rules for QDIAs, such that, under the 
final rule, the same standards apply to QDIAs as to investments 
generally.
     Like the NPRM, the final rule amends the current 
regulation's ``tiebreaker'' test, which permits fiduciaries to consider 
collateral benefits as tiebreakers in some circumstances. The current 
regulation imposes a requirement that competing investments be 
indistinguishable based on pecuniary factors alone before fiduciaries 
can turn to collateral factors to break a tie and imposes a special 
documentation requirement on the use of such factors. The final rule 
replaces those provisions with a standard that instead 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. 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.
     The final rule adds a new provision clarifying that 
fiduciaries do not violate

[[Page 73828]]

their duty of loyalty solely because they take participants' 
preferences into account when constructing a menu of prudent investment 
options for participant-directed individual account plans. If 
accommodating participants' preferences will lead to greater 
participation and higher deferral rates, as suggested by commenters, 
then it could lead to greater retirement security. Thus, in this way, 
giving consideration to whether an investment option aligns with 
participants' preferences can be relevant to furthering the purposes of 
the plan.
     Like the NPRM, the final rule amends the current 
regulation to eliminate the statement in paragraph (e)(2)(ii) of the 
current regulation that ``the fiduciary duty to manage shareholder 
rights appurtenant to shares of stock does not require the voting of 
every proxy or the exercise of every shareholder right.'' The final 
rule eliminates this provision because it may be misread as suggesting 
that plan fiduciaries should be indifferent to the exercise of their 
rights as shareholders, even if the cost is minimal.
     Like the NPRM, the final rule amends the current 
regulation to remove the two ``safe harbor'' examples for proxy voting 
policies permissible under paragraphs (e)(3)(i)(A) and (B) of the 
current regulation. One of these safe harbors permitted a policy to 
limit voting resources to types of proposals that the fiduciary has 
prudently determined are substantially related to the issuer's business 
activities or are expected to have a material effect on the value of 
the investment. The other safe harbor permitted a policy of refraining 
from voting on proposals or types of proposals when the plan's holding 
in a single issuer relative to the plan's total investment assets is 
below a quantitative threshold. Taken together, the Department believes 
the safe harbors encouraged abstention as the normal course and the 
Department does not support that position because it fails to recognize 
the importance that prudent management of shareholder rights can have 
in enhancing the value of plan assets or protecting plan assets from 
risk. Because of this failure, the Department believes these safe 
harbors do not adequately safeguard the interests of plans and their 
participants and beneficiaries.
     Like the NPRM, the final rule eliminates paragraph 
(e)(2)(iii) of the current regulation, which sets out specific 
monitoring obligations with respect to use of investment managers or 
proxy voting firms. The final rule instead addresses such monitoring 
obligations in another provision of the regulation that more generally 
covers selection and monitoring obligations. These amendments address 
concerns that the specific monitoring provision could be read as 
requiring special obligations above and beyond the statutory 
obligations of prudence and loyalty that generally apply to monitoring 
the work of service providers.
     Like the NPRM, the final rule amends the current 
regulation to eliminate from paragraph (e)(2)(ii)(E) of the current 
regulation a specific requirement on maintaining records on proxy 
voting activities and other exercises of shareholder rights. The 
provision is removed from the current regulation because it is widely 
perceived as treating proxy voting and other exercises of shareholder 
rights differently from other fiduciary activities and, in that 
respect, risks creating a misperception that proxy voting and other 
exercises of shareholder rights are disfavored or carry greater 
fiduciary obligations than other fiduciary activities.

B. Detailed Discussion of Public Comments and Final Regulation

1. Section 2550.404a-1(a) and (b)--General and Investment Prudence 
Duties
(a) Paragraph (a)
    Paragraph (a) of the final rule is unchanged from the NPRM and 
derives from the exclusive purpose requirements of ERISA section 
404(a)(1)(A), and the prudence duty of ERISA section 404(a)(1)(B). The 
provision is also the same as paragraph (a) of the current regulation. 
The Department did not accept comments to expand the scope of the 
regulation to provide additional guidance on the duty of 
diversification under section 404(a)(1)(C) and the duty of impartiality 
under section 404(a)(1)(A) as interpreted in cases such as Varity v. 
Howe,\41\ as these other duties generally are beyond the scope of this 
rulemaking initiative.
---------------------------------------------------------------------------

    \41\ 516 U.S. 489 (1996).
---------------------------------------------------------------------------

(b) Paragraph (b)
    Paragraph (b) of the final rule addresses the investment prudence 
duties of a fiduciary under ERISA. Like the NPRM, paragraph (b) of the 
final rule contains four subordinate paragraphs. As discussed below, 
the final rule includes several changes from the proposal based on 
public comment, mostly in paragraphs (b)(2) and (4) of the final rule.
(c) Paragraph (b)(1)
    The NPRM did not propose any amendments to paragraph (b)(1) of the 
current regulation. Like the current regulation (and the 1979 
Investment Duties regulation before it), paragraph (b)(1) of the NPRM 
provided that the requirements of section 404(a)(1)(B) of the Act set 
forth in paragraph (a) are satisfied with respect to a particular 
investment or investment course of action if the fiduciary meets two 
conditions. First, the fiduciary must give ``appropriate consideration 
to those facts and circumstances that, given the scope of such 
fiduciary's investment duties, the fiduciary knows or should know are 
relevant to the particular investment . . . including the role the 
investment or investment course of action plays in that portion of the 
plan's investment portfolio with respect to which the fiduciary has 
investment duties.'' And second, the fiduciary must have ``acted 
accordingly.'' Except for the addition of the words ``or menu'' after 
the word ``portfolio'' for clarification, as explained below, paragraph 
(b)(1) of the final rule is unchanged from the NPRM.
(d) Paragraph (b)(2)
    Paragraph (b)(2) of the NPRM addressed the ``appropriate 
consideration'' language referenced in paragraph (b)(1) of the 
proposal. Paragraph (b)(2) of the NPRM contained two prongs.
    First, paragraph (b)(2)(i) of the NPRM provided that for purposes 
of paragraph (b)(1), ``appropriate consideration'' shall include, but 
is not necessarily limited to, a determination by the fiduciary that 
the particular investment or investment course of action is reasonably 
designed, as part of the portfolio (or, where applicable, that portion 
of the plan portfolio with respect to which the fiduciary has 
investment duties), to further the purposes of the plan. For this 
purpose, the plan fiduciary must take into consideration the risk of 
loss and the opportunity for gain (or other return) associated with the 
investment or investment course of action compared to the opportunity 
for gain (or other return) associated with reasonably available 
alternatives with similar risks.
    Second, paragraph (b)(2)(ii) of the NPRM provided that for purposes 
of paragraph (b)(1), ``appropriate consideration'' shall also include, 
but is not necessarily limited to, consideration of the composition of 
the portfolio with regard to diversification (paragraph (b)(2)(ii)(A)), 
the liquidity and current return of the portfolio relative to the 
anticipated cash flow requirements of the plan (paragraph 
(b)(2)(ii)(B)), and

[[Page 73829]]

the projected return of the portfolio relative to the funding 
objectives of the plan, which may often require the evaluation of the 
economic effects of climate change and other environmental, social, or 
governance factors on the particular investment or investment course of 
action (paragraph (b)(2)(ii)(C)).
(1) Reasonably Available Alternatives
    Several commenters provided views on the condition in paragraph 
(b)(2)(i) that a fiduciary must compare an investment or investment 
course of action under evaluation with reasonably available 
alternatives. This condition was not part of the original investment 
duties regulation adopted in 1979 and was added to the current 
regulation in 2020. The Department carried forward this condition in 
the 2021 NPRM and solicited comments on whether it was necessary to 
restate this principle of general applicability as part of this 
regulation.
    Some commenters agreed that prudent fiduciaries should and 
generally do compare similar, available investments when making 
investment decisions. Some commenters said that because the provision 
is a simple restatement of a fundamental prudence tenet, its inclusion 
in the final rule is unnecessary. Some commenters were concerned that 
the term ``reasonably available'' is ambiguous and could make 
fiduciaries vulnerable to litigation challenging the reasonableness of 
a fiduciary's determination of the number of investments used in making 
the required comparison. Commenters were also concerned that the 
requirement imposes burdens on fiduciaries that do not necessarily have 
the resources to conduct research on all reasonably available 
alternatives. Some commenters noted that the Department did not adopt a 
comparative requirement in the 1979 rule and furthermore expressed 
concerns that the rule could be interpreted to require all fiduciaries, 
regardless of factors such as plan assets, to purchase and implement 
extensive and expensive systems to conduct the comparative analysis. 
One commenter suggested adding operative text that would explicitly 
allow for market-based comparisons using benchmarks or other market 
data as alternatives to the ``reasonably available investment 
alternatives'' language. One commenter cautioned that removing the 
provision would imply that the Department no longer believes that the 
marketplace is a true forum and benchmark of the investment selection 
process.
    The Department continues to believe the requirement to compare 
reasonably available alternatives is commonly understood by plan 
fiduciaries, is uncontroversial in nature, and reflects the ordinary 
practice of fiduciaries in selecting investments. The Department is 
unpersuaded by some commenters' concerns regarding perceived ambiguity 
in the meaning of ``reasonably available.'' The scope of a fiduciary's 
obligation to compare an investment or investment course of action is 
limited to those facts and circumstances that a prudent person having 
similar duties and familiar with such matters would consider reasonably 
available. Further, the term allows for the possibility that the 
characteristics and purposes served by a given investment or investment 
course of action may be sufficiently rare that a fiduciary could 
prudently determine that there are no other reasonably available 
alternatives for comparative purposes. Accordingly, the final rule 
continues to require in paragraph (b)(2)(i) that ``appropriate 
consideration'' shall include taking into consideration the risk of 
loss and the opportunity for gain (or other return) associated with the 
investment or investment course of action compared to the opportunity 
for gain (or other return) associated with reasonably available 
alternatives with similar risks. The language reflects the Department's 
longstanding view, articulated in Interpretive Bulletin 94-1 (and 
reiterated in subsequent Interpretive Bulletins) and earlier 
interpretive letters, that facts and circumstances relevant to an 
investment or investment course of action would include consideration 
of the expected return on alternative investments with similar risks 
available to the plan.\42\
---------------------------------------------------------------------------

    \42\ 59 FR 32606 at 32607 (June 23, 1994); I.B. 2008-1, 73 FR 
61734 (Oct. 17, 2008); I.B. 2015-1, 80 FR 65135 (Oct. 26, 2015); 
see, e.g., Information Letter to Mr. Michael A. Feinberg, dated 
August 4, 1985; Information Letter to Mr. James Ray, dated July 8, 
1988 (``It is the position of the Department that, to act prudently, 
a fiduciary must consider, among other factors, the availability, 
riskiness, and potential return of alternative investments.'').
---------------------------------------------------------------------------

(2) Portfolio Versus Menu
    The final rule adopts minor amendments to the text in paragraph 
(b)(2) of the current regulation in response to commenters' requests to 
clarify whether and how it applies in the context of participant-
directed individual account plans. Commenters observed that language in 
paragraph (b)(2), which was originally developed in 1979, contains 
certain considerations and factors that, in their view, are germane to 
the selection of investments for defined benefit plans but not to the 
selection of investments for defined contribution plans that have a set 
of designated investment alternatives available for participant to 
choose from, often referred to as a ``menu.'' For instance, they noted 
that paragraphs (b)(2)(i) and (ii) require focusing on a ``portfolio,'' 
which they believe is confusing because a participant-directed defined 
contribution plan's menu may include both funds that participants have 
chosen as investments as well as funds that have not been chosen. The 
commenters further noted that, in conventional investment parlance, the 
term ``portfolio'' refers to a collection of assets actually owned by 
an investor, whereas a menu of investment options for a participant-
directed individual account plan consists of a range of designated 
investment alternatives that are available to participants. In 
addition, they questioned how to determine ``anticipated cash flow 
requirements of the plan'' in evaluating investment options for the 
menu of a participant-directed defined contribution plan. A commenter 
stated that, in its view, many of the appropriate consideration factors 
in paragraph (b)(2)(ii) of the NPRM seem largely irrelevant to 
participant-directed plans. These commenters suggested that 
clarification on the application of paragraph (b)(2)(ii) to the 
selection of investment options would be helpful for plan sponsors.
    The Department appreciates the difficulties raised by commenters. 
Paragraph (b)(2)(ii) sets out a non-exclusive list of factors that 
functions as a minimum set of considerations for a fiduciary seeking to 
rely upon paragraph (b)(1). Failure to meet those minimum 
considerations would leave a fiduciary at risk of failing the standard 
even if, in the context of choosing investment options for a 
participant-directed plan, the responsible fiduciary has considered the 
relevant facts and circumstances surrounding its decision, including 
making a sound determination as described in paragraph (b)(2)(i). 
Accordingly, the Department is making changes to paragraph (b)(2) of 
the final rule. The changes clarify that the determination factors in 
paragraph (b)(2)(i) apply to menu construction and the factors in 
paragraph (b)(2)(ii) do not. Specifically, the Department is adding to 
paragraph (b)(2)(i) of the final rule references to an investment 
``menu,'' and is adding an introductory clause to paragraph (b)(2)(ii) 
of the final rule limiting its application to employee benefit plans 
other than participant-directed individual account plans.
    These changes do not affect the requirements of paragraph (b)(1)(i) 
of

[[Page 73830]]

the final rule, that a fiduciary must give appropriate consideration to 
those facts and circumstances a fiduciary knows or should know are 
relevant to the investment. These changes also should not be 
interpreted as suggesting that a fiduciary of an individual account 
plan is subject to a lower standard in giving appropriate consideration 
to the facts and circumstances surrounding a particular decision 
relating to an investment or investment course of action. 
Notwithstanding the changes to paragraph (b)(2)(ii), the Department 
believes that in selecting investment options for a plan menu, a 
fiduciary's considerations of surrounding facts and circumstances 
should be soundly reasoned and supported and reflect the requirements 
of section 404(a)(1)(B) of ERISA. The Department agrees with one 
commenter that, in the context of constructing a menu of investment 
options, the relevant analysis involves two questions: First, how does 
a given fund fit within the menu of funds to enable plan participants 
to construct an overall portfolio suitable to their circumstances? 
Second, how does a given fund compare to a reasonable number of 
alternative funds to fill the given fund's role in the overall menu?
    Except for the questions described above with respect to 
application in the context of plan investment menus, the Department did 
not receive substantive comments on paragraphs (b)(2)(ii)(A) and (B) of 
the proposal. Those provisions are otherwise unchanged in the final 
rule.
(3) ``May Often Require''
    The Department received several comments on the language in 
paragraph (b)(2)(ii)(C) of the proposal which specified that 
consideration of the projected return of the portfolio relative to the 
funding objectives of the plan ``may often require an evaluation of the 
economic effects of climate change and other environmental, social or 
governance factors on the particular investment or investment course of 
action.'' This new language--the ``may often require'' clause--was 
proposed by the Department to counteract any negative perception 
against the consideration of climate change and other ESG factors in 
investment decisions caused by the current regulation. The intent 
behind this new clause was to clarify that plan fiduciaries may, and 
often should depending on the investment under consideration, consider 
the economic effects of climate change and other ESG factors on the 
investment at issue. In no way did the Department consider this 
proposed clause to be an expression of a novel concept. Indeed, the 
sentiment had been expressed in earlier non-regulatory guidance, 
although using different terminology.\43\
---------------------------------------------------------------------------

    \43\ See Field Assistance Bulletin 2018-01 and Interpretive 
Bulletin 2015-01.
---------------------------------------------------------------------------

    The Department received comments supporting and opposing this new 
clause. On the one hand, some commenters indicated that it helped 
address the chilling effect on evaluating ESG issues and served as a 
useful reminder to fiduciaries that ESG factors often do have an impact 
on investments. In the main, these commenters support the regulatory 
text as an express acknowledgement that climate change and other ESG 
factors are relevant to risk and return, and as an indication that 
fiduciaries should not be exposed to additional perceived or actual 
fiduciary liability risk under ERISA if they include such factors in 
their evaluation of plan investments.
    On the other hand, a great many commenters, including some who 
concurred with the need to address the chilling effect under the 
current regulation, expressed a variety of concerns with this 
provision. Some commenters were concerned that by differentiating ESG 
considerations from other factors in express regulatory text, the 
regulation goes beyond removing the chilling effect and improperly 
places a thumb on the scale in favor of ESG investing. Some further 
cautioned that fiduciaries may treat the provisions as an effective 
mandate that they must consider ESG factors under all circumstances. 
The commenters argued that, absent guidance on when such an evaluation 
would not be required, plan fiduciaries would feel obligated to 
consider climate change and other ESG factors for every investment. 
Several commenters criticized the Department for, in their view, 
essentially favoring ESG investment strategies and overriding a 
fiduciary's considered judgment with respect to which investment 
factors or strategies to consider. Multiple commenters indicated that 
studies and research on investment performance involving ESG strategies 
show mixed results, and that a regulatory bias in favor of ESG 
investing is not justified. In line with this comment, some commenters 
questioned whether the Department presented sufficient evidence to 
support a position on the frequency (``may often require'') with which 
fiduciaries may be required to consider ESG factors, or argued that the 
market has already priced ESG factors into the price of any given 
investment.
    Some commenters who criticized the new language in paragraph 
(b)(2)(ii)(C) stated that if the regulation takes the position that 
evaluating the economic effects of climate change and other ESG factors 
``may often'' be required, then ambiguity surrounding the definition of 
the term ESG factors must be reduced to provide regulatory certainty. 
Commenters noted, however, that it would be difficult to precisely 
define ESG factors. Commenters also expressed concern that the language 
may be interpreted as effectively directing fiduciaries to take on the 
costs and complexity of evaluating the effects of climate change and 
other ESG factors, even if not otherwise prudent. In this regard, a 
commenter argued that there are common situations when a prudent 
analysis of the projected return relative to the portfolio's funding 
objective is unlikely to require an evaluation of the economic effects 
of ESG factors, such as when the objective of the applicable portion of 
the portfolio is to track the performance of an index. Several 
commenters offered alternative language to reduce the likelihood of 
misinterpreting the provision. Other commenters opined that the ``may 
often require'' language is largely unnecessary to address the chilling 
effect on consideration of ESG factors under the current regulation 
because of the broad language in paragraph (b)(4) of the proposal 
relating to the consideration of ``any material factor.''
    Based on the comments received, the Department has decided to 
modify paragraph (b)(2)(ii)(C) of the proposal by deleting the ``which 
may often require'' language altogether and consolidating the reference 
to ``climate change and other environmental, social, or governance ESG 
factors'' with language in paragraph (b)(4), as further modified below. 
The proposed language in paragraph (b)(2)(ii)(C) of the NPRM was not 
intended to create an effective or de facto regulatory mandate. Nor was 
the language intended to create an overarching regulatory bias in favor 
of ESG strategies. The Department is not persuaded that alternative 
language suggested by commenters to replace the ``may often require'' 
would be as effective in removing regulatory bias as the course chosen 
in the final rule. The modified version of the proposed language is 
intended to make it clear that climate change and other ESG factors may 
be relevant in a risk-return analysis of an investment and do not need 
to be treated differently than other relevant investment factors, 
without causing a perception that the

[[Page 73831]]

Department favors such factors in any or all cases.
    As modified (and relocated to paragraph (b)(4) of the final 
regulation), the new text sets forth three clear principles. First, a 
fiduciary's determination with respect to an investment or investment 
course of action must be based on factors that the fiduciary reasonably 
determines are relevant to a risk and return analysis, using 
appropriate investment horizons consistent with the plan's investment 
objectives and taking into account the funding policy of the plan 
established pursuant to section 402(b)(1) of ERISA. Second, 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. Third, the weight given to any factor by a fiduciary 
should appropriately reflect an assessment of its impact on risk and 
return.
    In the Department's view, this principles-based approach is 
sufficient to address the chilling effect under the current regulation 
without establishing an effective mandate or explicitly favoring 
climate change and other ESG factors. This principles-based approach is 
designed to eliminate the substantial chilling effect caused by the 
current regulation, including its reference to ``pecuniary factors.'' 
As previously discussed, numerous commenters indicated that the current 
regulation puts a thumb on the scale against ESG factors, and chills 
fiduciaries from considering any ESG factors even when they are 
relevant to a risk-return analysis. The undesired effect of the current 
regulation is to chill and discourage fiduciaries from considering 
relevant investment factors that prudent investors otherwise would 
consider. At the same time, the final rule makes unambiguous that it is 
not establishing a mandate that ESG factors are relevant under every 
circumstance, nor is it creating an incentive for a fiduciary to put a 
thumb on the scale in favor of ESG factors. By declining to carry 
forward the ``may often require'' clause in paragraph (b)(2)(ii)(C) of 
the proposal, the final rule achieves appropriate regulatory neutrality 
and ensures that plan fiduciaries do not misinterpret the final rule as 
a mandate to consider the economic effects of climate change and other 
ESG factors under all circumstances. Instead, the final rule makes 
clear that a fiduciary may exercise discretion in determining, in light 
of the surrounding facts and circumstances, the relevance of any factor 
to a risk-return analysis of an investment. A fiduciary therefore 
remains free under the final rule to determine that an ESG-focused 
investment is not in fact prudent. Finally, nothing about the 
principles-based approach should be construed as overturning long 
established ERISA doctrine or displacing relevant common law prudent 
investor standards.
(e) Paragraph (b)(3)
    Paragraph (b)(3) of the final rule is unchanged from the proposal 
and states that an investment manager appointed pursuant to the 
provisions of section 402(c)(3) of the Act to manage all or part of the 
assets of a plan may, for purposes of compliance with the provisions of 
paragraphs (b)(1) and (2) of the proposal, rely on, and act upon the 
basis of, information pertaining to the plan provided by or at the 
direction of the appointing fiduciary, if such information is provided 
for the stated purpose of assisting the manager in the performance of 
the manager's investment duties, and the manager does not know and has 
no reason to know that the information is incorrect. The Department did 
not receive substantive comment on the provision, which carries 
forward, without change, regulatory language dating back to the 1979 
Investment duties regulation.
(f) Paragraph (b)(4)
(1) Introductory Text
    The introductory text of paragraph (b)(4) of the proposal provided 
that ``a prudent fiduciary may consider any factor in the evaluation of 
an investment or investment course of action that, depending on the 
facts and circumstances, is material to the risk return analysis[.]'' 
This introductory text was then followed by three paragraphs of 
specific ESG examples. Commenters were generally supportive of this 
provision minus the three paragraphs describing specific ESG examples. 
In context, many viewed paragraph (b)(4) of the NPRM as confirming the 
discretionary authority of fiduciaries to consider whatever factor or 
factors, in the reasoned judgment of the fiduciaries, are relevant to 
risk and return of the investment or investment course of action, 
including climate change and other ESG factors. Some commenters 
expressed the view that this introductory text (without the three 
paragraphs of examples), in conjunction with the removal of the so-
called ``pecuniary-only'' terminology from the current regulation, 
would make significant headway in counteracting the negative perception 
of the consideration of climate change and other ESG factors caused by 
the current regulation. Paragraph (b)(4) of the final rule, therefore, 
retains the introductory text's focus on factors that are relevant to a 
risk and return analysis. Paragraph (b)(4) also retains its central 
recognition that relevant risk and return factors may, depending on the 
facts and circumstances, include the economic effects of climate change 
and other ESG factors. But, paragraph (b)(4) of the final rule 
otherwise contains substantial modifications discussed below.
(2) Three Paragraphs of ESG Examples
    Comments on the list of examples in paragraph (b)(4) of the NPRM 
focused on both content and placement and were varied. Some commenters 
supported both the content (only ESG examples) and placement of the 
examples. In general, these commenters are of the view that the list of 
examples, even though limited to only ESG factors, is an appropriate 
corrective for what they view as the severe anti-ESG bias of the 
current regulation. In their view, adding the three paragraphs of ESG 
examples directly to the regulatory text will help to reassure 
fiduciaries that they will not be subject to litigation solely because 
of the use of such factors.
    Many commenters, however, had concerns with the list of examples in 
paragraph (b)(4) of the NPRM and recommended their removal from the 
operative regulatory text. One frequently cited concern was that the 
list of examples in the proposal was too one-sided in favor of ESG 
factors. According to these commenters, the perceived regulatory bias 
would predictably trigger revisions by a future Administration with 
opposing views, effectively reducing the reliability and durability of 
the rule. This concern was raised by commenters who both supported and 
opposed the content of the examples.
    Another frequently cited concern was that the list might have 
unintended consequences. For example, plan fiduciaries might 
erroneously conclude that the factors listed in the operative text are 
more prudent than non-listed factors. A different but possible 
unintended consequence mentioned several times was that some plan 
fiduciaries might perceive the list as a safe harbor, such that 
fiduciaries may believe they will be deemed to have made a prudent 
investment decision if they consider only the listed examples (and no 
others). Others suggested that, by singling out these particular 
examples to the exclusion of other examples, the regulation could be 
read

[[Page 73832]]

as implying that these factors were especially important when selecting 
an investment. Consequently, according to these commenters, at least 
some fiduciaries would feel obligated to document in writing their 
justification for not considering these example factors. Similarly, 
some commenters suggested that, in their view, listing in the operative 
text only a few of the potentially material factors that a prudent 
fiduciary might consider might unintentionally create a perception that 
the Department expects fiduciaries will take these specific factors 
into consideration, even where it might not be possible, practical, or 
prudent.
    Another repeated concern of commenters was that the list of factors 
is unnecessary. According to these commenters, the general reference to 
material risk-return factors in paragraph (b)(4) of the NPRM would be 
sufficient to make clear that fiduciaries may consider any factor 
material to a risk-return analysis, including ESG factors. To these 
commenters, the concept of materiality provides for the determination 
of relevant factors on a case-by-case basis. In their view, such a 
principles-based approach better serves plans and provides greater 
flexibility for ERISA fiduciaries to consider the unique factors 
relevant to particular investment decisions.
    Another frequently cited concern was that the examples would become 
stale over time. Several commenters opined that a list of specific 
examples of material factors that may be of particular importance now 
may be of less importance in the future. Thus, at a minimum, the 
regulation could require updates over time as risk management and 
investment strategies evolve.
    Some commenters indicated that the list of ESG factors could be 
improved with additional examples. For instance, many commenters 
suggested that the list should be balanced by expanding the list to 
include non-ESG factors that may be material risk-return factors (e.g., 
good products, compelling corporate strategy, tight cost controls). 
Some further suggested it would be helpful for the Department to add 
examples of when it is not prudent to consider ESG factors. A commenter 
noted that by including only ESG factors as examples, the Department 
risks creating a perception that fiduciaries may take only ESG factors 
into account. Another commenter criticized that some of the examples as 
proposed are broad and ambiguous, inherently subjective, and give too 
much flexibility to plan fiduciaries who may be inclined to use plan 
assets to further particular ESG goals. Some commenters further 
characterized the proposed examples as singling out special interests 
and progressive ESG priorities that have little to no impact on 
financial returns. Multiple commenters suggested additions of factors 
that seemed to fall within the broad categories of examples but were 
not specifically listed. Commenters also suggested the addition of 
factors that did not appear to fall within any of those categories.
    After consideration of the comments received, the Department is 
persuaded that paragraph (b)(4) of the final rule should not include a 
list of examples. The list of examples was never intended to be 
exclusive; nor was it intended to define ``ESG'' or introduce any new 
conditions under the prudence safe harbor. The list of examples was 
merely intended to reaffirm that fiduciaries may consider ESG factors 
that are relevant to a risk-return analysis of the investment. The 
examples were intended to make clear that ESG factors may be more than 
mere tiebreakers, but rather financially material to the investment 
decision. The Department believes, however, that this point is made 
sufficiently clear by the general language in paragraph (b)(4) of the 
final rule. The primary justification for removing the examples from 
the operative text of the final rule is that the Department is wary of 
creating an apparent regulatory bias in favor of particular investments 
or investment strategies.
    Removal of the list from paragraph (b)(4) should not be viewed as 
limiting a fiduciary's ability to take into account any risk and return 
factor that the fiduciary reasonably determines is relevant to a risk/
return analysis. The Department continues to be of the view that, 
depending on the surrounding facts and circumstances, these may include 
the factors listed in paragraph (b)(4) of the proposal. Thus, depending 
on the surrounding circumstances, a fiduciary may reasonably conclude 
that climate-related factors, such as a corporation's exposure to the 
real and potential economic effects of climate change including 
exposure to the physical and transitional risks of climate change and 
the positive or negative effect of Government regulations and policies 
to mitigate climate change, can be relevant to a risk/return analysis 
of an investment or investment course of action. A fiduciary also may 
make a similar determination with respect to governance factors, such 
as those involving board composition, executive compensation, and 
transparency and accountability in corporate decisionmaking; a 
corporation's avoidance of criminal liability; compliance with labor, 
employment, environmental, tax, and other applicable laws and 
regulations; the corporation's progress on workforce diversity, 
inclusion, and other drivers of employee hiring, promotion, and 
retention; investment in training to develop a skilled workforce; equal 
employment opportunity; and labor relations and workforce practices 
generally.
    The foregoing examples are merely illustrative, and not intended to 
limit a fiduciary's discretion to identify factors that are relevant 
with respect to its risk/return analysis of any particular investment 
or investment course of action. A fiduciary may reasonably determine 
that a factor that seems to fall within a general category described 
above (e.g., climate-related factors), but is not specifically 
identified above, nonetheless is relevant to the analysis (e.g., 
drought). For example, depending on the facts and circumstances, 
relevant factors may include impact on communities in which companies 
operate, due diligence and practices regarding supply chain management, 
including environmental impact, human rights violations records, and 
lack of transparency or failure to meet other compliance standards. As 
another example, labor-relations factors, such as reduced turnover and 
increased productivity associated with collective bargaining, also may 
be relevant to a risk and return analysis.
    Of course, a fiduciary's determination of relevant factors is not 
limited to the general categories described above. Prudent investors 
commonly take into account a wide range of financial circumstances and 
considerations, depending on the particular circumstances, such as a 
corporation's operating and financial history, capital structure, long-
term business plans, debt load, capital expenditures, price-to-earnings 
ratios, operating margins, projections of future earnings, sales, 
inventories, accounts receivable, quality of goods and products, 
customer base, supply chains, barriers to entry, and a myriad of other 
financial factors, depending on the particular investment. This rule, 
as amended, does not supplant such considerations, but rather makes 
clear that there is no inconsistency between the appropriate 
consideration of ESG factors and ERISA section 404(a)(1)(B)'s standard 
of prudence, which requires that fiduciaries act with the ``care, 
skill, prudence, and diligence under the circumstances then prevailing 
that a prudent man acting in a like capacity and familiar with such 
matters would use in the conduct of an enterprise of a like character 
and with like aims.''

[[Page 73833]]

(3) Consolidation of Multiple Provisions Into Paragraph (b)(4) of the 
Final Rule
    In concert with removing the list of examples from paragraph (b)(4) 
of the NPRM, elements of paragraphs (b)(2)(ii)(C) and (c)(2) of the 
NPRM are now merged into paragraph (b)(4) of the final rule. These 
edits address commenters' concerns that aspects of paragraph 
(b)(2)(ii)(C) of the NPRM could constitute an effective or de facto 
mandate to always consider the effects of climate change and other ESG 
factors on every investment or investment course of action, that the 
examples in paragraph (b)(4) of the NPRM interject inappropriate 
regulatory bias in favor of ESG factors, and that the final rule not 
retreat from the principle in paragraph (c)(2) of the NPRM that 
fiduciaries must base investment decisions only on factors that are 
relevant to a risk and return analysis. The essence of paragraph (c)(2) 
of the NPRM was not changed when merged into paragraph (b)(4) of the 
final rule. As mentioned below, the merger avoids the existence of 
redundant concepts in multiple paragraphs and reflects that the 
substance of paragraph (c)(2) of the NPRM is more closely connected to 
ERISA's duty of prudence than the duty of loyalty.
    Accordingly, paragraph (b)(4) of the final rule provides that a 
fiduciary's determination with respect to an investment or investment 
course of action must be based on factors that the fiduciary reasonably 
determines are relevant to a risk and return analysis, using 
appropriate investment horizons consistent with the plan's investment 
objectives and taking into account the funding policy of the plan 
established pursuant to section 402(b)(1) of ERISA. It further 
indicates that 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, 
and whether any particular consideration is a risk-return factor 
depends on the individual facts and circumstances. Finally, it provides 
that the weight given to any factor by a fiduciary should appropriately 
reflect a reasonable assessment of its impact on risk-return.
    As revised, paragraph (b)(4) of the final rule subsumes core 
elements of paragraphs (c)(1) and (f)(3) of the current regulation. 
Specifically, the emphasis on risk and return factors in these two 
paragraphs carries forward into paragraph (b)(4) of the final rule. The 
current regulation's reliance on ``pecuniary only'' and related 
terminology, however, is otherwise rescinded. The framework in 
paragraph (b)(4) of the final rule continues to adhere to the 
principle, underpinning paragraphs (c)(1) and (f)(3) of the current 
regulation, that when selecting an investment or investment course of 
action plan fiduciaries must focus on relevant risk and return factors, 
but the Department no longer supports the current regulation's 
framework and terminology for advancing this principle. The Department, 
instead, agrees with the commenters who found the current regulation's 
framework and terminology confusing and susceptible to inferences of 
bias against the treatment of climate change and other ESG factors as 
potentially relevant risk and return factors. The Department intends 
with these edits to dispel the perception caused by the current 
regulation that climate change and other ESG factors are somehow 
presumptively suspect or unlikely to be relevant to the risk and return 
of an investment or investment course of action. Paragraph (b)(4) of 
the final recognizes that, as with other factors, climate change and 
other ESG factors sometimes may be relevant to a risk and return 
analysis and sometimes not--and when relevant, they may be weighted and 
factored into investment decisions alongside other relevant factors, as 
deemed appropriate by the plan fiduciary.
(4) Conforming Terminology--``Relevance'' Versus ``Material''
    In addition, paragraph (b)(4) of the final rule contains a change 
in terminology to establish consistency with the terminology in 
paragraph (b)(1) of the final rule. Several commenters noted that 
paragraph (b)(1) of the NPRM refers to ``relevant'' factors but that 
paragraph (b)(4) of the NPRM refers to ``material'' factors. Noting a 
body of decisional and regulatory law underpinning ``materiality'' 
under Federal securities laws and accounting conventions, many of these 
commenters considered the NPRM's use of these different terms a source 
of confusion. In conjunction with proposed paragraph (b)(4)'s focus on 
risk and return factors, many commenters were concerned that paragraph 
(b)(4)'s use of ``material'' might be construed as circumscribing the 
role or authority of plan fiduciaries under ERISA's prudence standard 
as reflected in the use of ``relevance'' in paragraph (b)(1) of the 
NPRM.
    In discussing these concerns, commenters mentioned many factors 
that, in their view, are relevant factors routinely considered by plan 
fiduciaries when selecting investments, such as brand name or 
reputation of the fund or fund manager, lifetime income options, style 
of fund (e.g., growth versus value), style of fund management (passive 
versus active), an investment's regulatory regime, participants' 
understanding of the investment, participants' preferences, and other 
investment-related operational considerations. These commenters 
expressed concern that such factors may not always perfectly align with 
securities law or accounting concepts of materiality or directly affect 
the risk and return of an investment in clear or obvious ways.
    In response to some of these concerns, paragraph (b)(4) of the 
final rule uses the word ``relevant'' instead of ``material.'' \44\ The 
Department stresses, however, that under paragraph (b)(4) of the final 
rule, the fiduciary's investment determination must ultimately rest on 
factors relevant to a risk and return analysis. The Department does not 
undertake in this document to address specific risk and return factors, 
but it notes that it has previously concluded that plan contributions 
do not constitute a ``return'' on investment.
---------------------------------------------------------------------------

    \44\ A similar change was made in paragraph (d)(2)(ii)(D) of the 
final regulation to appropriately align terminology in similar 
contexts across different paragraphs of the final regulation.
---------------------------------------------------------------------------

2. Section 2550.404a-1(c) Investment Loyalty Duties
(a) Removal of Pecuniary-Only Requirement--Paragraph (c)(2) of the 
Proposal
    Paragraph (c)(2) of the NPRM modified the requirement in paragraph 
(c)(1) of the current regulation that a fiduciary's evaluation of an 
investment or investment course of action must be based ``only on 
pecuniary factors,'' which is defined at paragraph (f)(3) of the 
current regulation as a factor that a fiduciary prudently determines is 
expected to have a material effect on the risk and/or return of an 
investment based on appropriate investment horizons consistent with the 
plan's investment objectives and the funding policy. The Department 
used the phrase ``pecuniary factors'' for the first time in the 2020 
regulations, and although the Department defined it in those 
regulations, the phrase is not found in ERISA and has no longstanding 
meaning in employee benefits law. The NPRM proposed to remove the 
``pecuniary only'' formulation of the requirement and to integrate the 
concept of ``risk/return'' factors directly into paragraph (c)(2) of 
the NPRM. This approach was intended to address stakeholder concerns 
about ambiguity in the meaning and application of the

[[Page 73834]]

``pecuniary only'' terminology of the current regulation.
    A significant number of commenters supported the NPRM's proposed 
removal of the pecuniary-only test and related terminology. Many 
commenters on this issue were of the view that, rather than providing 
clarity, the current regulation's pecuniary-only terminology created 
confusion by layering an additional standard or test onto the existing 
fiduciary framework. That framework already unambiguously required 
fiduciaries to base plan investment decisions on financially relevant 
factors. In line with that concern, many commenters asserted that this 
pecuniary-only terminology chills plan fiduciaries from considering 
climate change and other ESG factors even where they have a material 
effect on the bottom line of an investment, merely because such factors 
also may have the effect of supporting non-financial objectives. In 
such ``dual purpose'' circumstances, the position of these commenters 
was that just because an investment factor or strategy may 
simultaneously have economic and non-economic dimensions, the non-
economic dimensions do not lessen the factor or strategy's economic 
significance. These commenters stated that the NPRM's proposed 
elimination of the pecuniary-only and related terminology would make 
clear to fiduciaries that they are free to consider the full range of 
potential material risk-return factors without undue fear of regulatory 
second-guessing or litigation. According to these commenters, the 
elimination would encourage fiduciaries to take the same steps that 
other marketplace investors take in enhancing investment value and 
performance or improving investment portfolio resilience against the 
potential financial risks and impacts associated with climate change 
and other ESG factors.
    Some commenters opposed the NPRM's proposed changes; they 
emphasized the importance of basing investment decisions on only 
pecuniary considerations and urged the Department to retain the 
pecuniary factors and related terminology. These commenters generally 
were of the view that ERISA requires that plan fiduciaries focus solely 
on the economics of an investment and state that climate change and 
other ESG factors rarely can be harmonized with this requirement. Given 
that belief, these commenters were concerned that participants' 
retirement security will suffer as plan fiduciaries and money managers 
pursue agendas unrelated to the exclusive purpose of providing 
financial benefits to retirement plan participants and beneficiaries. 
In line with this concern, one commenter asserted that the insertion of 
non-pecuniary investment criteria in the management of pension and 
other such funds imposes a substantial penalty over time in terms of 
realized returns. One commenter questioned the consistency of 
permitting the consideration of non-pecuniary goals with the Supreme 
Court's opinion in Fifth Third Bancorp v. Dudenhoeffer, which stressed 
the fiduciary's obligation to focus on retirement plan participants' 
financial interests.\45\
---------------------------------------------------------------------------

    \45\ Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014).
---------------------------------------------------------------------------

    The Department is not persuaded to retain the current regulation's 
use of and reliance on the novel pecuniary-only formulation and its 
related terminology. The pecuniary-only requirement and related 
terminology unfortunately caused a great deal of confusion, and it 
accounts for a substantial amount of the chilling effect this 
rulemaking project set out to redress. These facts are manifest in the 
many comment letters on the NPRM. Many view the ``pecuniary-only'' 
terminology as ambiguous or decidedly prohibitive on the question of 
whether climate change and other ESG factors may be considered when 
those factors are relevant to the risk-and-return analysis. Indeed, as 
indicated by commenters, the current rule actually has a chilling 
effect that discourages fiduciaries from prudently considering climate 
change and other ESG factors that may be relevant to the risk-return 
analysis. Some commenters, in particular, asked questions about 
considering factors that have both economic and noneconomic components, 
suggesting apprehension that this would fall outside the current 
regulation's pecuniary-only requirement. In light of the foregoing, the 
Department no longer supports the use of this terminology. Rather, the 
Department thinks, and many commenters agree, that paragraph (c)(2) of 
the NPRM, subject to certain modifications discussed elsewhere in this 
preamble, is a more understandable formulation of ERISA's requirement 
that a fiduciary's evaluation of an investment or investment course of 
action must focus on factors that the fiduciary reasonably determines 
are relevant to a risk and return analysis. Removing the ``based only 
on pecuniary factors'' language (and related terminology throughout) 
from the current regulation will help re-establish the Department's 
position reflected in non-regulatory guidance as early as 2015 that 
climate change and other ESG factors that may be relevant in a risk-
return analysis of an investment do not need to be treated differently 
than other relevant investment factors, even though they may possess 
the ``dual purpose'' dimensions mentioned by some commenters. Put 
differently, removing this novel terminology is removing the current 
regulation's thumb from the scale so as not to discourage fiduciaries 
from considering climate change and other ESG factors where relevant to 
the risk-return analysis.
    Finally, the Department finds no merit to the argument that the 
final rule, either in general or in not carrying forward the pecuniary/
non-pecuniary terminology, permits or requires behavior contrary to the 
holding in Dudenhoeffer. On the contrary, the central premise behind 
the final rule's rescission of the pecuniary/non-pecuniary distinction 
is that the current regulation is being perceived by plan fiduciaries 
and others as undermining the fundamental principle Dudenhoeffer 
expressed: fiduciaries must protect the financial benefits of plan 
participants and beneficiaries. In this way, the pecuniary-only 
requirement would effectively prohibit or encumber plan fiduciaries 
from managing against or taking advantage of climate change and other 
ESG risk factors in selecting investments, even when it is financially 
prudent to do so. Thus, the final rule's amendments to the current 
regulation, which are aimed solely at counteracting that perception, 
are entirely consistent with the principle articulated in Dudenhoeffer.
    Notwithstanding the foregoing, paragraph (c)(2) of the proposal has 
been incorporated into paragraph (b)(4) of the final rule for clarity 
and to avoid potentially redundant and confusing requirements. This 
consolidation reflects that the essence of the requirement of paragraph 
(c)(2) of the proposal that fiduciaries make investment decisions based 
on factors relevant to a risk and return analysis is inherently 
prudential in nature, rather than a loyalty obligation, and therefore 
overlaps with the requirements of paragraph (b)(4) of the proposed 
rule. Although including such a requirement in the regulation's loyalty 
provisions may help establish regulatory guideposts for 
fiduciaries,\46\ that same function is fulfilled by incorporating it 
into the final regulation's prudence provisions at paragraph (b)(4) of 
the final rule.
---------------------------------------------------------------------------

    \46\ See 85 FR 72854.

---------------------------------------------------------------------------

[[Page 73835]]

(b) Paragraph (c)(1)
    Paragraph (c)(1) of the proposal restated the Department's 
longstanding expression of ERISA's duty of loyalty in the context of 
investment decisions, as also expressed in Interpretive Bulletins and 
associated preamble discussions. It provided that a fiduciary may not 
subordinate the interests of participants and beneficiaries in their 
retirement income or financial benefits under the plan to other 
objectives and may not sacrifice investment return or take on 
additional investment risk to promote goals unrelated to the plan and 
its participants and beneficiaries. Similar language is contained in 
paragraph (c)(2) of the current regulation. The Department did not 
receive substantive comments on paragraph (c)(1) of the proposal, and 
it is being adopted in the final rule without change. As in the 
proposal and current regulation, the final rule's paragraph (c)(1) is a 
legal requirement and not a safe harbor.
(c) Paragraph (c)(2)--Tie Breaker Test and Tie Breaker Standard
    Paragraph (c)(3) of the proposal directly rescinded the 
``tiebreaker'' standard in paragraph (c)(2) of the current regulation 
and replaced it with a standard intended to align more closely with the 
Department's original non-regulatory guidance from nearly three decades 
ago, IB 94-1, which first advanced the ``tiebreaker'' concept. In 
explaining the standard in the preamble to IB 94-1, the Department 
stated that ``a plan fiduciary may consider collateral benefits in 
choosing between investments that have comparable risks and rates of 
return.'' \47\ In contrast, the current regulation narrowly focused on 
whether competing investments are ``indistinguishable'' based on 
pecuniary factors alone. Under such circumstances, the current 
regulation permits a plan fiduciary to use a non-pecuniary factor as a 
deciding factor in making its investment decision, but only if the 
fiduciary also complies with a specific documentation requirement.
---------------------------------------------------------------------------

    \47\ 59 FR 32607 (June 23, 1994).
---------------------------------------------------------------------------

    A number of commenters supported both the rescission of the current 
tiebreaker standard and the proposal's replacement standard--i.e., that 
competing investments ``equally serve'' the financial interests of the 
plan. In their view, the proposed formulation represented a significant 
improvement over the current regulation, which they argued set out an 
unrealistically difficult and prohibitively stringent standard. Some 
further suggested that the standard in the current regulation is so 
stringent that it effectively eliminated the Department's historical 
tiebreaker test. For instance, according to one commenter, the current 
regulation's tiebreaker standard improperly limits its application, 
because it would only apply when a fiduciary is unable to distinguish 
two or more investments based on pecuniary factors alone--an occurrence 
that is rare and unreasonably difficult to identify, according to this 
commenter. In actual practice, the commenter states, a prudent 
fiduciary process often produces a variety of investments that are 
consistent with, and in the fiduciary's judgement, equally promote, the 
financial interests of participants and beneficiaries. According to a 
different commenter, the current regulation's ``economically 
indistinguishable'' standard is in practice impossible for fiduciaries 
to surmount, given that differences exist even among very similar 
investments. As put by yet another commenter, the requirement that 
investments be ``economically indistinguishable'' before a fiduciary 
can consider collateral factors (such as ESG factors when not relevant 
to risk and return) effectively subverts the fiduciary's best judgment 
in favor of a standard that is virtually impossible to meet. Overall, 
these commenters viewed the proposal's standard as tracking the 
Department's prior guidance more closely, and more accurately 
reflecting the realities of fiduciary decisionmaking. They supported 
adoption of the NPRM's standard without change.
    Other commenters supported the proposal's rescission of the current 
tiebreaker standard, but raised concerns with the proposal's ``equally 
serve'' formulation. Commenters indicated that the proposal was not 
clear as to how to determine when investments meet the ``equally 
serve'' standard and requested further guidance. Questions presented 
included whether the equally-serve analysis is based on how similar 
investments are, or based on the potential financial effects of the 
investments on the plan's portfolio. One commenter suggested that the 
Department should recognize that investments may vary from each other 
but still serve the same plan purpose. Another commenter asked how 
small deviations in the financial effects of two investments would 
affect the equally serve analysis. These commenters did not believe the 
tiebreaker standard should require investments to be identical, and 
suggested clarifying language, such as a standard based on investments 
that serve the financial interests of the plan comparably well, or 
equally well.
    Other commenters indicated that the ``equally serve'' standard 
appeared to imply an investment process under which a fiduciary 
selection process involves evaluating a group of potential investments, 
paring the group down to a few competing investments, and then moving 
on to the tiebreaker test and the selection of a single investment. 
Commenters opined that such a mechanical process of elimination should 
not be necessary if a fiduciary has already prudently determined that 
each investment is consistent with the plan's objectives and is 
reasonably designed to further the purposes of the plan. Some 
commenters asserted that the tiebreaker test should focus on whether 
investments are the result of a prudent fiduciary process rather than 
on an analysis of their equivalence, and suggested formulations based 
on ``equally prudent'' investments, or investments identified through a 
prudent process.
    Some commenters supported the tiebreaker standard in the current 
regulation and objected to the rescission of the current standard. 
These commenters viewed the proposal's standard as far too lenient, and 
the current regulation's indistinguishability based on pecuniary 
factors only standard as appropriate in light of ERISA's high standard 
of fiduciary responsibilities. They asserted that the current 
regulation's provisions are a valuable curb against behavior that could 
otherwise lead to subordinating the interests of participants and 
beneficiaries in their retirement income. These commenters expressed 
concern that the proposal, with changes to the tiebreaker standard and 
related documentation provisions, would invite abuse and open the door 
to using pension plan assets for policy agendas, or encourage 
fiduciaries to advance personal policies and agendas at the expense of 
interests of trust beneficiaries in a secure retirement.
    A number of commenters did not support inclusion of any tiebreaker 
provision in the regulation. Some commenters believe the tiebreaker 
test cannot be reconciled with ERISA's duty of loyalty, which requires 
that fiduciaries discharge their duties for the exclusive purpose of 
providing benefits to participants and beneficiaries and defraying 
reasonable expenses of administering the plan. Commenters also 
cautioned that the tiebreaker provision weakens the focus on the best 
financial outcome for plan participants and beneficiaries by 
encouraging consideration of collateral factors. In

[[Page 73836]]

their view, fiduciaries desiring to seek third-party benefits may, 
deliberately or inadvertently, be encouraged to declare ties to free 
themselves from the duty of loyalty. Several of these commenters did 
not believe a tiebreaker is necessary regardless of formulation 
because, in their view, ties generally do not exist, particularly in 
liquid financial markets. Furthermore, they argued that the purpose of 
an investment manager is to exploit differences among investments and 
to select a winner (or buy both for increased diversification in the 
case of ties). In their view, fiduciaries are accustomed to 
deliberating on such matters, including close calls, and if they are 
doing their job and creating an appropriate record, there should be no 
need for tiebreaker guidance in the rule.
    Some commenters also believed that a tiebreaker test may 
potentially cause harm or detriment to plans. For instance, some 
suggested that a tiebreaker test may reduce accountability and promote 
complacency by allowing investment decisionmakers to adopt a ``close 
enough'' attitude and point to some reason other than financial merit 
to justify their decisions. In contrast, others suggested that the 
tiebreaker test promotes a misconception that there is a single 
``best'' investment for a plan. Still others cautioned that the mere 
existence of a tiebreaker test could unintentionally signal that ESG 
factors cannot, on their own, be considered material to a risk-return 
analysis. Some also suggested that there is a chance the tiebreaker 
test may be overused unnecessarily in cases where the fiduciary has 
little doubt about the financial merits of the investment in question 
but where the fiduciary perceives the tiebreaker route as providing a 
level of protection from future allegations of disloyalty. Such overuse 
may lead to substantial burdens on recordkeepers in connection with the 
proposal's related collateral benefit disclosure requirement.
    The Department is not persuaded that the tiebreaker provision 
should be removed from the final rule. The Department does not agree 
with commenters who asserted that the tiebreaker test is unnecessary or 
inconsistent with ERISA. Although there has been some mostly semantic 
variation in what constituted ties under the Department's prior non-
regulatory guidance, some version of the tiebreaker test has appeared 
in the CFR since 1994. Consequently, since at least that time, the 
Department has recognized that fiduciaries may use collateral benefits 
to break ties between various investments. The tiebreaker test thus 
aligns the final rule with the settled expectations of fiduciaries and 
others involved in the investment of assets of employee benefits plans 
under ERISA, especially in the multiemployer plan context. Although 
some fiduciaries, by the nature of their arrangements with plans, may 
apply investment strategies that never require them to choose between 
alternatives that equally serve the plan's needs, other fiduciaries, 
such as those making investments outside liquid financial markets, may 
find the tiebreaker test useful for circumstances in which there are 
equally strong cases for competing investments under a risk-return 
analysis. In addition, although some commenters question the need for a 
tiebreaker test and whether ties exist, other commenters acknowledge 
the utility of the tiebreaker standard. For instance, some commenters 
argued that in the event of a tie between two investment options, the 
fiduciary should increase diversification by investing in both 
investment options. They acknowledge, however, that in not all 
circumstances is this appropriate, and thus, the tie will need to be 
broken. Under the commenter's approach, for example, the tiebreaker 
test provides plan fiduciaries with a solution in cases when investing 
in two (or more) alternatives that equally serve the financial 
interests of the plan, rather than one, entails additional costs (such 
as transactional or monitoring costs) that offset the benefits of 
investing in two (or more) investments rather than one.
    More generally, those questioning the need for a tiebreaker test 
are reminded that ERISA does not specifically address a fiduciary's 
investment choice in circumstances where multiple investment 
alternatives equally serve the financial interests of the plan and thus 
the economic interests of the plan's participants and beneficiaries are 
protected by choosing either alternative. The Department is choosing to 
leave that decision in the hands of fiduciaries, who are charged with 
choosing among investment alternatives that equally serve the financial 
interests of the plan. Fiduciaries without a need to break a tie while 
selecting investments need not use the provision. This may be the case, 
for example, with respect to participant-directed individual account 
plans where adding additional investment options is not necessarily a 
zero-sum game, such that the fiduciary may choose only one option. 
Moreover, when there is a need to break a tie, there is nothing in the 
regulation that requires fiduciaries to look to climate change or other 
ESG factors to break the tie.
    With respect to concerns that the tiebreaker provision might be 
subject to abuse or not be part of a prudent fiduciary process, we note 
that fiduciaries utilizing the tiebreaker provision remain subject to 
ERISA's prudence requirements. In addition, they also remain subject to 
the explicit prohibition against accepting expected reduced returns or 
greater risks to secure such additional benefits. The Department is of 
the view that these provisions, coupled with the safeguards added by 
ERISA's statutory prohibited transaction provisions, discussed below, 
sufficiently protect participants' and beneficiaries' retirement 
benefits in this context.
    As to commenters who suggested that the existence of a tiebreaker 
provision implies that ESG factors are non-economic, the potential 
economic relevance of ESG factors is reflected in paragraph (b)(4) of 
the final rule, as discussed above. When such factors are relevant to a 
risk and return analysis, the tiebreaker test is not at issue. Put 
differently, as with other types of investment factors, climate change 
and other ESG factors sometimes may be relevant to a risk and return 
analysis and sometimes not--and when relevant, they may be factored 
into investment decisions alongside other relevant factors, as deemed 
appropriate by the plan fiduciary under paragraph (b)(4) of the final 
rule. However, when such factors are not relevant to a risk and return 
analysis, such factors may nevertheless be the decisive factor under 
the tiebreaker test, provided that the other conditions of the 
tiebreaker test are satisfied. The Department believes that rescission 
of the current regulation's tiebreaker standard and replacement with a 
standard more closely aligned with prior non-regulatory guidance is 
appropriate. The current regulation's tiebreaker standard, ``unable to 
distinguish on the basis of pecuniary factors alone,'' in practice, has 
meant indistinguishable in all respects, or identical. This standard is 
causing a great a deal of confusion, given that no two investments are 
the same in each and every respect. The imposition of a standard that 
effectively requires investments to be precisely identical therefore is 
both impractical and unworkable. Investments can and do differ in a 
wide range of attributes, but when considered in their totality, may 
serve the financial interests of the plan equally well. This problem 
was noted by the Department in 2020 when making the current 
regulation's tiebreaker standard, but as shown by the comments 
discussed above, the current

[[Page 73837]]

regulation has not effectively resolved this problem.\48\ The 
Department believes the final rule's ``equally serve'' standard 
comports with the realities of fiduciary decisionmaking and firmly 
protects participant retirement benefits, since it strictly forbids the 
subordination of plans' and participants' financial interests to any 
other objective.
---------------------------------------------------------------------------

    \48\ 85 FR 72846, 62.
---------------------------------------------------------------------------

    In response to comments requesting further guidance on the 
determination of whether investments equally serve the financial 
purposes of the plan, the Department has not made changes to the 
proposed standard. In the Department's view, as explained in the 
preamble to the proposal, investments may differ on a wide range of 
attributes, but when considered in their totality, serve the financial 
interests of the plan equally well.\49\ Given the wide range of 
attributes associated with different investments, the uncertainties 
inherent in investing, and the practical limitations on the 
availability and processing of relevant data, the Department does not 
agree with those commenters who suggested that fiduciaries can never 
conclude that competing alternatives serve the financial purposes of 
the plan equally well. Under the final rule, investments do not need to 
be identical in order to equally serve the financial interests of a 
plan. Whether, in any particular circumstances, the tiebreaker standard 
is met is an inherently factual question.
---------------------------------------------------------------------------

    \49\ 86 FR 57278.
---------------------------------------------------------------------------

    Like the NPRM, the final rule's tiebreaker provision does not 
define or explicitly limit the concept of ``collateral benefits.'' On 
this topic, the preamble to the NPRM specifically provided that the 
proposal did not place parameters on the collateral benefits that may 
be considered by a fiduciary to break the tie. The preamble to the NPRM 
explained that this position is consistent with prior nonregulatory 
guidance, but the preamble nevertheless solicited comments on whether 
more specificity should be provided in the provision. For instance, the 
preamble asked if the final rule should require that any collateral 
benefit relied upon as a tiebreaker be based upon an assessment of the 
shared interests or views of the participants, above and beyond their 
financial interests as plan participants, such as the investment's 
likely impact on participants' jobs or plan contribution rates. This 
scenario was just an example.
    Some commenters opposed such limitations, both as a general idea 
and specifically the scenario mentioned in the preamble of the NPRM, 
i.e., placing additional constraints in the form of requiring an 
assessment of the shared interests or views of the participants. 
Commenters stated that the Department's longstanding position prior to 
the 2020 amendments, going back at least to 1994, never defined or 
limited the concept of ``collateral benefits'' and that there is no 
history justifying a change now. Focusing on the specific scenario in 
the preamble to the NPRM, one commenter stated that it is not clear how 
a fiduciary would use information on participant views, collect such 
information, or even what issues should be included in such an 
assessment. A different commenter also focusing on this scenario stated 
the concern that making decisions based on a survey or estimation of 
participants' views unrelated to plan returns is in tension with 
ERISA's command that fiduciaries operate ``for the exclusive purpose'' 
of providing benefits and defraying reasonable expenses. One commenter 
argued that a regulatory definition is not necessary because the 
tiebreaker test already ensures that the investment must be prudent and 
serve the best interests of the participants and beneficiaries 
regardless of whether a collateral benefit is used. Requiring further 
assessment would increase costs and complexity, according to this 
commenter.
    Other commenters had different views on this question. One 
commenter stated that, in its view, the tiebreaker provision is 
unlawful, but that if some version of it is retained in the final rule, 
the retained version should require that any collateral benefit relied 
upon as a tiebreaker be based upon an assessment of the shared 
interests or views of the participants, along with the consent of each 
participant to pursue collateral benefits with funds in their account 
and a delineation of the causes they support. One commenter raised the 
concern that, because the NPRM did not place any parameters on the 
collateral benefits that fiduciaries may consider, fiduciaries could be 
left guessing which factors would be appropriate for consideration, 
with the possibility that the Department's views could shift over the 
years.
    The final rule takes the same approach as the NPRM. Some form of 
the tiebreaker test permitting fiduciaries to consider collateral 
benefits has existed for more than four decades, and the Department is 
not aware of plan fiduciaries struggling with the concept of 
permissible collateral benefits. In the Department's experience, 
collateral benefits have routinely involved criteria or considerations 
other than factors that are relevant to a risk and return analysis of 
the investment, such as stimulating union jobs and investing in the 
geographic region where participants live and work, as just a few 
examples. In response to requests from several commenters, the 
Department confirms that an investment that stimulates or maintains 
employment that, in turn, results in continued or increased 
contributions to a multiemployer plan is an example of ``collateral 
benefits other than investment returns'' under paragraph (c)(2) of the 
final rule. In response to the concern that, without a definition, plan 
fiduciaries will be forced to guess as to what constitutes a legitimate 
``collateral benefit'' versus an impermissible collateral benefit, the 
Department reminds that plan fiduciaries are not required to consider 
collateral benefits in choosing between investments that have 
comparable risks and rates of return. Moreover, the statement that the 
final rule does not contain explicit parameters on the collateral 
benefits that may be considered by a fiduciary to break a tie directly 
responds to and addresses commenters' concerns about exceeding such 
parameters. Finally, while the final rule itself adds no explicit 
parameters on collateral benefits, ERISA's prohibited transaction 
provisions in section 406 remain and generally forbid collateral 
benefits to the extent any such benefit involves a transaction that 
violates those provisions.\50\
---------------------------------------------------------------------------

    \50\ See, e.g., AO 85-36A (Oct. 23, 1985) (certain investment 
arrangements may involve a use of plan assets for the benefit of a 
party in interest in violation of ERISA section 406(a)(1)(D)); 
Information Letter to Katz (Mar. 15, 1982) (purchase by a plan of an 
insurance policy pursuant to an arrangement under which it is 
expected that the insurance company will make a loan to a party in 
interest is a prohibited transaction).
---------------------------------------------------------------------------

(d) Paragraph (c)(2) Tiebreaker Test--Documentation
    Paragraph (c)(3) of the NPRM also rescinded the current 
regulation's novel documentation requirement applicable to any instance 
of use of the tiebreaker test; instead, the proposal included a 
requirement that if a plan fiduciary uses the tiebreaker to select a 
designated investment alternative for a participant-directed individual 
account plan based on collateral benefits other than investment 
returns, ``the plan fiduciary must ensure that the collateral-benefit 
characteristic of the fund, product, or model portfolio is prominently 
displayed in disclosure materials provided to participants and 
beneficiaries.''
    A number of commenters objected to the removal of the current 
regulation's

[[Page 73838]]

documentation provision, under which a fiduciary using the tiebreaker 
test is required to document, among other things, its analysis in those 
cases where the fiduciary has concluded that pecuniary factors alone 
were insufficient to be the deciding factor.\51\ The requirement was 
intended to ``provide a safeguard against the risk that plan 
fiduciaries will improperly find economic equivalence and make 
decisions based on non-pecuniary factors without a proper analysis and 
evaluation.'' \52\ Some of these commenters are of the view that the 
tiebreaker test may be inconsistent with ERISA, as discussed above, and 
that a stringent documentation requirement is perhaps the best way for 
plan fiduciaries to contemporaneously document their decisionmaking 
with respect to tiebreakers and mitigate the effects of their reliance 
on factors that do not materially affect risk-return or directly 
promote retirement income.
---------------------------------------------------------------------------

    \51\ 29 CFR 2550.404a-1(c)(2) (2021).
    \52\ 85 FR 72862.
---------------------------------------------------------------------------

    Other commenters supported removal of the current regulation's 
documentation requirement, arguing that the disclosure was formulaic, 
singled out one investment category, could chill fiduciaries from 
properly considering ESG factors, and was largely unnecessary given 
ERISA's general obligations. For instance, one commenter indicated that 
the documentation requirement has a chilling effect and is seen as 
suggesting that ESG investing entails extraordinary risks. Other 
commenters also viewed the documentation requirement as creating a 
stigma around considering ESG factors in investment decisions. 
Commenters also believed that the regulation's documentation provision 
is unnecessary because fiduciaries commonly document and maintain 
records about their investment decisions as part of their general 
prudence obligation. Others believed that removal of the documentation 
provision brings the tiebreaker standard more in line with prior non-
regulatory guidance and may provide additional cost savings, which 
would ultimately benefit plan participants and beneficiaries. A 
commenter noted that some fiduciaries, even before the 2020 amendments, 
may have viewed tiebreaker situations as perhaps requiring enhanced 
documentation. This commenter requested that the Department provide 
further clarification regarding prudent recordkeeping if the final rule 
removes the current regulation's documentation requirement.
    The Department is not persuaded that the current regulation's brand 
new documentation requirement should be retained in the tiebreaker 
provision. Commenters confirmed the Department's initial concern that 
the documentation provision in the current regulation is very likely to 
chill and discourage plan fiduciaries from using the tiebreaker test 
generally, including in cases involving the appropriate consideration 
of ESG factors (when such factors are not otherwise relevant to a risk 
and return analysis). The tiebreaker test, by its terms, applies only 
where competing investments equally serve the financial interests of 
the plan. It disallows the investment selection from sacrificing the 
plan's economic interests or from exposing plans to additional risk. In 
light of these guardrails, the Department sees no reason for a 
regulatory provision imposing further burdens on its use. Since the 
tiebreaker test only applies in cases where the competing investments 
equally serve the financial interests of the plan, the Department is of 
the view that use of the tiebreaker test should not be discouraged with 
additional burdens, because neither of the competing investments 
sacrifices the economic interests of the plan, but one of them promotes 
collateral benefits the other does not. In addition, the elaborateness 
of the current regulation's tiebreaker-specific documentation provision 
likely will be viewed by fiduciaries as suggesting that the Department 
sees tiebreakers as occurring infrequently, and the Department did not 
have in 2020 and does not now have sufficient information to make a 
judgement as to the frequency of ties. The documentation requirement 
also may be viewed by fiduciaries as a self-reported ``red flag'' that 
uniquely directs potential litigants' attention to tie-breaker 
decisions as inherently problematic, even though there is no necessary 
or presumed inconsistency between their use and the requirements of 
ERISA. The Department is wary that the potential for litigation may 
cause fiduciaries to consciously or unconsciously skew their investment 
analyses to avoid open acknowledgment of a ``tie'' and the requirement 
of specifically prescribed documentation, while still favoring 
investments that provide collateral benefits. The Department believes 
this potentially creates incentives that discourage, rather than 
promote, proper fiduciary activity and transparency, and further 
reduces the likelihood that the benefits associated with the additional 
documentation obligation would outweigh the associated costs.
    The Department also agrees with commenters that the current 
regulation's prescribed documentation provisions are unnecessary given 
the general obligations of prudence under ERISA. The Department finds 
it noteworthy that no commenter provided contrary evidence 
demonstrating that ERISA's general obligations of prudence are 
deficient in protecting the interests of plan participants and 
beneficiaries in this context. The Department emphasizes that removal 
of the documentation provision from the regulation does not suggest 
that ERISA fiduciaries are excused from complying with ERISA's prudence 
obligations, or subject to a lower standard of care, with regard to 
documentation or otherwise. Fiduciary documentation of their investment 
activities already is a common practice. As explained in the preamble 
to the NPRM, the Department's concern with the current regulation's 
document provision rests on its formulaic and rigid nature. The 
Department believes ERISA section 404's prudence obligation 
sufficiently protects participants' and beneficiaries' financial 
interests in their plans in this regard. That obligation, which 
fiduciaries had prior to the 2020 amendments and will continue to have, 
provides that the nature and degree of the fiduciary's duty to document 
an investment decision depends upon the facts and circumstances 
particular to that decision, regardless of whether the decision is 
under the tiebreaker test or the type of collateral benefit at 
issue.\53\ Thus, the Department believes the current regulation's 
specific documentation provision is not necessary and can lead to 
conduct contrary to the plan's interests. This includes the risk that 
fiduciaries will over-document or under-document their investment 
decisions.\54\ Over-documentation would result in increased transaction 
costs for no particular benefit to plan participants.
---------------------------------------------------------------------------

    \53\ The preamble to Interpretive Bulletin 2015-01, in relevant 
part, stated that, ``the Department does not construe consideration 
of ETIs or ESG criteria as presumptively requiring additional 
documentation or evaluation beyond that required by fiduciary 
standards applicable to plan investments generally. As a general 
matter, the Department believes that fiduciaries responsible for 
investing plan assets should maintain records sufficient to 
demonstrate compliance with ERISA's fiduciary provisions. As with 
any other investments, the appropriate level of documentation would 
depend on the facts and circumstances.''
    \54\ 86 FR 57272 at 57279.

---------------------------------------------------------------------------

[[Page 73839]]

(e) Paragraph (c)(2) Tiebreaker Test--Collateral Benefit Disclosure
    The NPRM contained a disclosure requirement within the tiebreaker 
test limited to participant-directed individual account plans. 
Specifically, paragraph (c)(3) of the NPRM, in relevant part, provided 
that if a plan fiduciary selects an investment, or investment course of 
action, based on collateral benefits other than investment returns, 
``the plan fiduciary must ensure that the collateral-benefit 
characteristic of the fund, product, or model portfolio is prominently 
displayed in disclosure materials provided to participants and 
beneficiaries.'' This would have been a new disclosure requirement 
under ERISA.
    The preamble to the NPRM explained the policy intent behind this 
proposed requirement. In relevant part, the NPRM explained that the 
``essential purpose of this proposed disclosure requirement is to 
ensure that plan participants are given sufficient information to be 
aware of the collateral factor or factors that tipped the scale in 
favor of adding the investment option to the plan menu, as opposed to 
its economically equivalent peers that were not.'' \55\ The Department 
thought the disclosure of this information would have been of potential 
benefit to plan participants and beneficiaries because of the 
possibility that ``a particular plan participant or a population of 
plan participants does not share the same preference for a given 
collateral purpose as the plan fiduciary that selected the designated 
investment alternative for placement on the menu among the plan's other 
options.''
---------------------------------------------------------------------------

    \55\ 86 FR 57272, 80.
---------------------------------------------------------------------------

    The preamble to the NPRM also provided an example of an application 
of this proposed requirement. The example, in relevant part, provided 
that ``if the tiebreaking characteristic of a particular designated 
investment alternative were that it better aligns with the corporate 
ethos of the plan sponsor or that it improves the esprit de corps of 
the workforce, . . . then such feature or features prompting the 
selection of the investment must be prominently disclosed by the plan 
fiduciary. . . .'' The NPRM believed this information ``will be useful 
to participants and beneficiaries in deciding how to invest their plan 
accounts.'' \56\
---------------------------------------------------------------------------

    \56\ Id.
---------------------------------------------------------------------------

    The preamble to the NPRM also clarified that, in terms of 
compliance, the Department's intent was to provide flexibility in how 
plan fiduciaries would fulfill this requirement given the unknown 
spectrum of collateral benefits that might influence a plan fiduciary's 
selection. The preamble to the NPRM explained that one likely way to 
comply ``is that the plan fiduciary could simply use the required 
disclosure under 29 CFR 2550.404a-5.'' \57\ That regulation, adopted in 
2012, already entitles participants in participant-directed individual 
account plans to receive sufficient information regarding designated 
investment alternatives to make informed decisions about the management 
of their individual accounts. The information required by the 2012 rule 
includes information regarding the alternative's objectives or goals 
and the alternative's principal strategies (including a general 
description of the types of assets held by the investment) and 
principal risks. The NPRM, therefore, assumed these existing 
disclosures, perhaps with minor modifications or clarifications, would 
have been sufficient to satisfy the disclosure element of the 
tiebreaker provision in paragraph (c)(3) of the proposal.
---------------------------------------------------------------------------

    \57\ Id.
---------------------------------------------------------------------------

    As is evident from the foregoing discussion, the NPRM assumed 
appreciable benefits to plan participants and beneficiaries and 
relatively small compliance costs resulting from this proposed 
disclosure requirement.\58\ The NPRM solicited comments on the overall 
utility of this disclosure provision, including ideas on how best to 
operationalize the provision considering its intended purpose balanced 
against costs of implementation and compliance.
---------------------------------------------------------------------------

    \58\ 86 FR 57272 at 57300 (``The Department estimates that it 
will take a legal professional twenty minutes on average per year to 
update existing disclosures for each of the 46,551 small individual 
account plans with participant direction that are anticipated to 
utilize this provision. This results in a per-plan cost of $46.14 
annually relative to the pre-2020 final rule baseline.'').
---------------------------------------------------------------------------

(1) Support for Disclosure Requirement
    The public record reflects limited support for the proposed 
disclosure requirement. One commenter stated that plan participants and 
beneficiaries should have information about collateral benefits because 
such information may impact participant behavior, such as whether to 
participate, savings rates, and asset allocations. One commenter 
registered its support for better disclosure to plan participants and 
of investment policies more generally, inclusive of sustainable 
investment policies and collateral benefit factors. One commenter 
believed the proposed requirement would protect participants and 
beneficiaries by ensuring that plan sponsors fully considered 
collateral benefits alongside financial performance. One commenter 
supported the proposed disclosure requirement as ``reasonable,'' but 
recommended that the Department provide plan fiduciaries with a model 
notice to assist compliance with this disclosure requirement. Finally, 
one commenter conditionally supported the proposed disclosure 
requirement because the commenter believed it would give plan 
participants needed transparency in the tiebreaking context. However, 
this commenter recommended that the proposed requirement, if retained, 
be improved with additional content requirements, including a 
requirement that the fiduciary disclose what specific alternative 
investments were considered in breaking the tie and more analysis 
behind the fiduciary's decisionmaking process.
(2) Concerns With Disclosure Requirement
    The public record also reflects substantial concerns with the 
proposed disclosure requirement. In summary, these concerns are as 
follows. Some commenters found the content requirements of proposed 
disclosure requirement to be inherently ambiguous. Some found the 
proposed disclosure requirement to be unnecessary and the required 
content of the disclosure to be of no economic significance. Other 
commenters were concerned that the proposed disclosure requirement may 
undermine the purposes of other disclosure regulations promulgated by 
the Department aimed at helping plan participants and beneficiaries 
make informed investment decisions. Certain commenters expressed 
concerns that the proposed disclosure requirement would single out 
certain factors and strategies over other factors and strategies, 
contrary to the principle of neutrality they believe is embedded in 
ERISA. Other commenters were concerned that the proposed disclosure 
requirement could have a chilling effect on the proper use of climate 
change and other ESG factors. Several commenters were concerned that 
the proposed disclosure provision would result in unnecessary 
litigation. Each of these concerns is explained in detail below.
(a) Ambiguity
    Some commenters found the content requirements of the proposed 
disclosure requirement to be inherently ambiguous. According to them, 
the NPRM was unclear on what ``collateral-benefit characteristics'' a 
fiduciary would be required to disclose. They

[[Page 73840]]

contrasted regulatory language requiring the disclosure of the 
collateral benefit characteristics ``of the fund'' with preamble 
language focused on the ``features prompting the selection'' by the 
fiduciary and other language referencing ``improved employee morale'' 
as the factor that ``tipped the scale.'' Commenters requested 
clarification of whether the proposed disclosure requirement was 
focused on an objective characteristic of the fund or the subjective 
reason the fiduciary selected the fund. According to the commenters, 
these are not necessarily the same things. Commenters said the 
subjective collateral benefit perceived by the plan fiduciary may be 
wholly different from the characteristic of the fund that would be 
expected to provide the collateral benefit. For example, assume that 
the plan sponsor is an organization whose primary mission is to tackle 
climate change. The plan fiduciary may decide to use the tiebreaker 
test to select a fund that uses ESG criteria with an environmental 
focus to improve the morale of its employees. In this example, the 
commenters stated that the regulatory text and preamble were unclear on 
what must be disclosed under the proposal--would it be the 
environmental focus of the fund's strategy or improved employee morale? 
Most commenters on this issue requested confirmation that the former is 
what the Department intended, and they asserted flaws with the NPRM's 
cost-benefit analysis if the latter.
(b) Unnecessary
    Some commenters were of the view that the proposed disclosure 
requirement is unnecessary, and the required content of the disclosure 
is of no economic significance. The commenters stated that the 
Department and the Securities and Exchange Commission already have 
regulations in place to ensure that participants and investors have 
ready access to necessary investment-related information, such as 
principal strategies and risks, performance information, benchmarks, 
and fees. Commenters alleged that the content requirements of the 
proposed disclosure, by contrast, contained no information about the 
economics of the investment in question, but instead focused on 
information that was collateral to the economics of the investment and 
therefore would have no economic relevance to participant investors. 
Whether a participant shares the fiduciary's preference for the 
collateral benefit or purpose that ``tipped the scale'' is of no 
relevance to whether the investment option is economically prudent and 
makes economic sense to a participant. The only thing that should 
matter to participants, in the view of these commenters, is whether the 
selected investment was prudently chosen. In their view, disclosures 
focused on the policy or social preferences of the selecting 
fiduciaries will not advance intelligent investment behavior and 
therefore are unnecessary.
(c) Interference With Existing Disclosure Regulations
    Some commenters were concerned the proposed disclosure requirement 
would undermine the purposes of other disclosure regulations 
promulgated by the Department aimed at helping plan participants and 
beneficiaries make informed investment decisions. These commenters 
pointed to existing disclosures under 29 CFR 2550.404a-5, 2550.404c-1, 
and 2550.404c-5 as being sufficient to enable plan participants and 
beneficiaries to make informed investment decisions.\59\ These 
disclosures, according to the commenters, focus on what the Department 
has determined, through multiple notice-and-comment rulemaking 
projects, is the relevant investment-related information that plan 
participants and beneficiaries need, as investors. The proposed 
collateral benefit disclosure requirement, by contrast, focused on non-
investment information, i.e., the collateral purpose that tipped the 
scale--information that, by definition, is not material to risk and 
return. These commenters argued that not only is the proposed 
collateral benefit disclosure of no economic relevance, but the 
disclosure risks distracting participants and beneficiaries from basic 
and important information required under the existing regulations 
mentioned above. Put differently, one commenter stated that it opposes 
the proposed disclosure requirement because it would disproportionately 
emphasize one part of the fiduciary decisionmaking process over other 
more relevant factors in a way that could mislead participants and 
impact participant choices in ways that are unintended by the 
Department.
---------------------------------------------------------------------------

    \59\ The disclosure requirements to which these commenters refer 
include: 29 CFR 2550.404a-5 (requiring disclosure of certain plan 
administrative and investment-related information, including fee and 
expense information, to participants and beneficiaries in 
participant-directed individual account plans (e.g., 401(k) plans)); 
29 CFR 2550.404c-1 (requiring that participants and beneficiaries in 
participant-directed individual account plans are furnished 
specified information about the plan's investment alternatives and 
incidents of ownership appurtenant to such investment alternatives); 
and 29 CFR 2550.404c-5 (requiring that participants and 
beneficiaries whose plan assets may be invested, by default, into a 
plan's QDIA by a plan fiduciary are furnished specified investment-
related information about the QDIA, the circumstances in which plan 
assets will be invested in a QDIA, and their ability to direct their 
assets to plan investment alternatives other than a QDIA).
---------------------------------------------------------------------------

(d) Lack of Neutrality & Chilling Effect
    Commenters expressed concerns that the proposed disclosure 
requirement singles out certain factors over other factors, contrary to 
the principle of neutrality, while other commenters are concerned that 
the proposed disclosure requirement might have a chilling effect on the 
proper use of climate change and other ESG factors. Certain commenters 
expressed opposition to the idea of singling out any class of 
investment factor, including collateral benefit factors, as needing 
additional or stricter requirements. These commenters asserted that 
ERISA is, and should be, factor neutral, including with respect to 
collateral purposes or factors. By imposing special disclosure 
requirements on collateral benefits, the proposed disclosure is 
contrary to this principle, according to these commenters.
    In line with this concern, other commenters were concerned that the 
proposed disclosure provision could inadvertently have a chilling 
effect on the proper use of climate change and other ESG factors. These 
commenters posited that investment strategies often simultaneously 
integrate multiple ESG factors into the analysis, some of which are 
relevant to a risk and return assessment while others are not. In these 
circumstances, commenters asserted that fiduciaries may avoid the 
investment based on ambiguity over whether it is subject to the 
disclosure requirement, or over disclose even when the options were 
selected solely for financial reasons.
(e) Litigation
    Multiple commenters raised concerns that the proposed disclosure 
requirement would effectively act as an invitation to litigation. The 
very purpose of the disclosure, according to the commenters, is to draw 
the reader's attention to the non-financial motives of the plan 
fiduciary. Considering this purpose, commenters said the disclosures 
themselves unintendedly would serve as a signal of potential wrongdoing 
and as a roadmap to litigation. To altogether avoid the litigation 
risk, some plan sponsors and fiduciaries simply would not use the 
tiebreaker test even in cases when they otherwise might have been 
willing to use it to promote collateral purposes,

[[Page 73841]]

such as addressing climate change, according to commenters.
(f) Per Se Disloyalty
    Other commenters raised concerns with the idea that a disclosure 
violation would constitute a per se breach of ERISA's duty of loyalty, 
which the commenters saw as the necessary consequence of embedding a 
disclosure requirement within the portion of a regulation defining 
ERISA's duty of loyalty. They argued that a disclosure failure does not 
(and should not), by itself, prove disloyalty. But as structured, that 
seems to be the result under the NPRM regardless of how prudent and 
loyal the fiduciary is when selecting the investment, the commenters 
asserted. These commenters observed the unconventionality of the idea 
that ERISA commands that if fiduciaries fail in whole or in part to 
disclose their motivations to participants and beneficiaries, those 
fiduciaries are per se disloyal as a result of the failure, regardless 
of how loyal the fiduciaries were, in fact, when selecting the 
investment. These commenters assert that it is a non sequitur to say 
that a failure to disclose the scale-tipping attributes of an 
investment is dispositive evidence of disloyalty, especially when the 
investment is prudent and serves the financial interests of the plan 
equally as well as a reasonable number of alternatives. To this point, 
the commenters note that some version of the tiebreaker test has 
existed for approximately forty years without a related disclosure 
requirement, embedded in loyalty or otherwise--and nothing in the 
marketplace has changed in a way that supports the new disclosure 
requirement. The commenters question whether the many plan fiduciaries 
that used the tiebreaker test in the past would now be considered 
disloyal because they likely never disclosed to participants the 
collateral benefits that broke the tie.
(g) Other Technical Concerns
    In addition to the foregoing concerns, commenters raised the 
following technical issues with the proposed disclosure requirement. 
First, commenters stated that although the NPRM is clear that a 
collateral benefit disclosure is required only if the fiduciary uses 
the tiebreaker provision to select a fund, nowhere does the NPRM offer 
concrete guidance on when or how often the plan fiduciary must furnish 
this information to participants. For example, commenters requested 
guidance and clarification on whether a disclosure would be required 
only when the fund is added to the lineup, only when a participant 
joins the plan, annually, any time the plan or its service providers 
furnish any disclosure materials pertaining to the fund, or at some 
other interval determined solely in the judgment of the plan fiduciary 
based on facts and circumstances.
    Second, the NPRM specifies that the collateral benefit disclosure 
must be ``prominently'' displayed in disclosure materials provided to 
participants. But neither the regulation nor the preamble defines the 
meaning of prominence for this purpose. Several commenters therefore 
requested guidance on how to satisfy this standard. One concern is that 
this standard is being construed as requiring that collateral benefit 
information receive more attention or prominence than other information 
that likely will accompany the collateral benefit information, such as 
investment performance, fees, strategies, risk, etc. The commenters are 
of the view that collateral benefit information should not be more 
prominent than relevant investment-related information. These 
commenters assert that investment success generally turns on an 
intelligent evaluation of performance, fees, strategies, and risk, and 
that mandating the elevation of collateral information over such 
information potentially undermines the chances of an investor's 
success. According to the commenters, this is particularly important, 
in part, because the concept of ``prominence'' is inherently 
subjective, and in part, because violations of the proposed disclosure 
rule are per se acts of disloyalty.
(3) Decision
    Based on the foregoing concerns, and reasons similar to those 
underlying the decision to remove the documentation requirements from 
the current regulation, the final rule does not adopt the proposed 
collateral benefit disclosure requirement at this time. The Department 
is aware that the Securities and Exchange Commission (SEC) is 
conducting rulemaking on investment company names, addressing, among 
other things, ``certain broad categories of investment company names 
that are likely to mislead investors about an investment company's 
investments and risks.'' \60\ The SEC also is conducting rulemaking on 
disclosures by mutual funds, other SEC-regulated investment companies, 
and SEC-regulated investment advisers designed to provide consistent 
standards for ESG disclosures, allowing investors to make more informed 
decisions, including as they compare various ESG investments.\61\ The 
Department will monitor those rulemaking projects and may revisit the 
need for collateral benefit reporting or disclosure depending on the 
findings of that agency. The Department emphasizes that the decision 
against adopting a collateral benefit disclosure requirement in the 
final rule has no impact on a fiduciary's duty to prudently document 
the tiebreaking decisions in accordance with section 404 of ERISA.
---------------------------------------------------------------------------

    \60\ 87 FR 36594 (June 17, 2022).
    \61\ 87 FR 36654 (June 17, 2022).
---------------------------------------------------------------------------

(f) Paragraph (c)(3)--Participant Preferences
    Several commenters requested clarification on whether a plan 
fiduciary may consider participants' policy, social, or value 
preferences (i.e., non-financial preferences) in connection with 
constructing menus for defined contribution plans that permit 
participants to direct their own investments. Some commenters stated 
that, in their view, the NPRM is ambiguous on this question. Many other 
commenters expressed concern that the NPRM appears not to permit plan 
fiduciaries to consider participants' preferences or to consider them 
only under the tiebreaker test.
    Several of these commenters stressed their view of the importance 
of accommodating participants' preferences in a voluntary retirement 
system heavily dependent on elective deferrals. These commenters, 
including institutional asset managers and asset custodians, assert 
that both increased participation and increased deferral rates follow 
from accommodating such preferences. They argue that participants may 
not use their voluntary participant-directed savings plans to save for 
retirement, or will leave those plans earlier, if they cannot get 
access to investment choices they find attractive. Consistent with this 
argument, many individual commenters claim they would roll their 
savings out of ERISA-protected plans if the plans cannot satisfactorily 
accommodate their preferences.
    Several commenters alleged that plan fiduciaries should not have to 
rely solely on the tiebreaker test to consider participants' 
preferences. These commenters are of the view that the NPRM's 
tiebreaker test may be ill-suited to some methods of constructing menus 
for defined contribution plans because adding additional options is not 
necessarily a zero-sum game under these methods. To these commenters, 
therefore, if plan fiduciaries are unable to use the tiebreaker test 
because it does

[[Page 73842]]

not comport with how they construct defined contribution menus, they 
effectively have no ability under their reading of the NPRM to consider 
participants' preferences.
    A few commenters believe that participants' preferences deserve 
equal treatment with risk and return factors; they believe fiduciaries 
should be allowed to consider and weigh participants' preferences 
alongside risk and return factors in a prudence analysis, giving 
participant's preferences such weight as the fiduciary deems 
appropriate, even if such preferences are not directly tied to risk or 
return. By contrast, a few commenters asserted that ERISA requires plan 
fiduciaries to focus on only pecuniary factors when selecting and 
retaining investments. They view participants' preferences as 
essentially irrelevant to menu construction.
    In response to these comments, paragraph (c)(3) of the final rule 
provides clarification on this issue. Specifically, paragraph (c)(3) of 
the final rule provides that the plan fiduciary of a participant-
directed individual account plan does not violate the duty of loyalty 
set forth in paragraph (c)(1) of the final rule solely because the 
fiduciary takes into account participants' preferences consistent with 
requirements of paragraph (b) of this section.
    If accommodating participants' preferences will lead to greater 
participation and higher deferral rates, then it could lead to greater 
retirement security, as suggested by the commenters. Thus, in this way, 
giving consideration to whether an investment option aligns with 
participants' preferences can be relevant to furthering the purposes of 
the plan within the meaning of paragraph (b)(1) of the final rule. At 
the same time, however, plan fiduciaries may not add imprudent 
investment options to menus just because participants request or would 
prefer them.\62\
---------------------------------------------------------------------------

    \62\ See Hughes v. Northwestern Univ., 142 S. Ct. 737 (2022) 
(``In Tibble, this Court explained that, even in a defined-
contribution plan where participants choose their investments, plan 
fiduciaries are required to conduct their own independent evaluation 
to determine which investments may be prudently included in the 
plan's menu of options.'' (citing Tibble v. Edison Int'l, 575 U.S. 
523 (2015)).
---------------------------------------------------------------------------

    The clarification in paragraph (c)(3) of the final rule does not 
speak to the duty of prudence. Rather, paragraph (c)(3) provides only 
that a fiduciary does not violate the duty of loyalty as set forth in 
paragraph (c)(1) of the final rule solely because the fiduciary 
considers participants' preferences in a manner that is consistent with 
paragraph (b) of the final rule. The reference to paragraph (b) in 
paragraph (c)(3) clarifies that the duty of prudence is independent 
and, as such, prudence determinations must be made consistent with 
paragraph (b) of the final rule. As paragraph (b)(4) of the final rule 
makes clear, the selection of investment options must be grounded in 
the fiduciary's prudent risk and return analysis.
    The clarification in paragraph (c)(3) of the final rule is not 
novel or a change in Departmental position. The preamble to the current 
regulation being amended by this final rule articulated this position 
when explaining the meaning and mechanics of paragraph (d)(2) of that 
rule (entitled ``Investment Alternatives for Participant-Directed 
Individual Account Plans''). In relevant part, that preamble stated: 
``Nothing in the final rule precludes a fiduciary from looking into 
certain types of investment alternatives in light of participant demand 
for those types of investments. But in deciding whether to include such 
investment options on a 401(k)-style menu, the fiduciary must weigh 
only pecuniary . . . factors.'' \63\ The relevant portion of paragraph 
(d)(2) of that rule, however, was incorporated into paragraphs (b) and 
(c)(1) of the final rule (minus the pecuniary factor terminology). The 
final rule restates the position as regulatory text in paragraph 
(c)(3), rather than as a preamble statement, to provide enhanced 
clarity, accessibility, and prominence, as requested by commenters.
---------------------------------------------------------------------------

    \63\ 85 FR 72846 at 72863.
---------------------------------------------------------------------------

    The final rule declines to mandate that fiduciaries factor 
participants' preferences into their evaluation, selection, and 
retention of designated investment alternatives, and declines to 
mandate a uniform methodology for determining such preferences, as 
requested by a few commenters. Some commenters had concerns that a 
mandate to consider and act on participants' preferences would raise 
complex questions, such as how plan fiduciaries should properly 
solicit, weigh, implement, and monitor participants' preferences, and 
how plan fiduciaries should reconcile conflicting preferences of their 
participants (e.g., some participants may oppose so-called ``sin 
stocks'' and other participants in the same plan may favor them). No 
commenter had persuasive answers or recommendations on these questions, 
and the NPRM did not propose such a mandate or suggest how to resolve 
such competing preferences. In addition, as some commenters noted, 
ERISA's fiduciary obligations could compel plan fiduciaries to 
disregard participants' preferences to the extent they are imprudent. 
Accordingly, the final rule declines to mandate that fiduciaries factor 
participants' preferences into their evaluation, selection, and 
retention of designated investment alternatives, and declines to 
mandate a uniform methodology for determining such preferences; the 
final rule, instead, leaves these questions to be decided by plan 
fiduciaries considering the facts and circumstances of their plan and 
participant population.
3. Investment Alternatives in Participant-Directed Individual Account 
Plans Including Qualified Default Investment Alternatives
    Paragraph (d) of the current regulation contains additional rules 
that specifically govern fiduciaries' selection and retention of 
investment alternatives for participant-directed individual account 
plans, including qualified default investment alternatives (QDIAs). The 
NPRM proposes to directly rescind this paragraph. The NPRM's 
justification for the rescission has two dimensions. First, proposed 
amendments to other provisions in the section effectively merged the 
substance of what was paragraph (d) into these other provisions. 
Second, the Department no longer supports the current regulation's 
provisions specific to QDIAs. As structured, paragraph (d)(2)(ii) of 
the current regulation disallows a fund to serve as a QDIA if it, or 
any of its component funds in a fund-of-fund structure, has investment 
objectives, goals, or principal investment strategies that include, 
consider, or indicate the use of one or more non-pecuniary factors in 
its investment objectives, even if the fund is objectively economically 
prudent from a risk-return perspective or even best in class.
    Commenters overwhelmingly supported the NPRM. A few commenters 
raised technical concerns regarding compliance problems and costs with 
paragraph (d) of the current regulation. But more globally, and 
fundamentally, most commenters on this issue were of the view that the 
provisions in paragraph (d) of the current regulation are unnecessary. 
This view is based, in part, on the strongly held belief, shared among 
a broad spectrum of commenters from various backgrounds and industries, 
that the legal standards under ERISA's prudence and loyalty rules 
should be the same for all plans, including plans with QDIAs, with 
respect to the selection and retention of investment alternatives.

[[Page 73843]]

How these standards apply to a given set of facts may, of course, 
differ, according to the commenters, but the base standards of prudence 
and loyalty should be no different for these plans, absent a statutory 
underpinning for a difference. Yet the current regulation, according to 
these commenters, unnecessarily singles out individual account plans 
for what the commenters view as different, special, and stricter 
treatment (e.g., some higher level of fiduciary oversight). This 
special treatment is especially extreme with respect to QDIAs, 
according to the commenters, with some commenters equating the 
provisions in paragraph (d)(2)(ii) of the current regulation to an 
effective ban on selecting investments that consider or integrate 
climate change and other ESG factors, regardless of the economic merits 
and prudence of the investment. Many commenters disagreed that QDIAs 
need heightened protections beyond those specifically contained in the 
Department's Qualified Default Investment Alternative regulation.\64\ 
Overall, these commenters agree that the provisions of paragraph (d) of 
the current regulation create a perception that fiduciaries of 
individual account plans, including plans with QDIAs, are subject to 
different and heightened--but unclear--standards of prudence and 
loyalty as compared to fiduciaries of other plans. And the primary 
consequence of this perception, according to the commenters, was a 
concern that funds may be excluded from selection as QDIAs solely 
because they expressly considered climate change or other ESG factors, 
even though the funds are prudent based on a consideration of their 
financial attributes alone.
---------------------------------------------------------------------------

    \64\ 29 CFR 2550.404c-5.
---------------------------------------------------------------------------

    Some commenters opposed the NPRM's proposed changes to paragraph 
(d) of the current regulation. In the main, these commenters oppose all 
aspects of the NPRM, not just the NPRM's proposed deletion of paragraph 
(d) of the current regulation, but their expressed concerns with the 
proposed elimination of paragraph (d) are mainly limited to QDIAs. One 
of these commenters, for instance, stated that, because the proposal 
would allow a QDIA that states, as one of its investment objectives, a 
goal other than financial return, this part of the proposal, in the 
view of this commenter, is a per se violation of ERISA's exclusive 
purpose rule as interpreted by the Supreme Court in Dudenhoeffer.\65\ A 
different commenter, noting that individual account plans shift the 
risk of investment loss to participants, asserted that this shift in 
risk justifies enhanced--not reduced--protections for participants that 
are defaulted into QDIAs. This risk is compounded, according to this 
commenter, by the fact that defaulted employees are an increasingly 
larger percentage of the universe, and they tend not to opt out of the 
default investment. In line with the concerns of this commenter, two 
other commenters asserted that, to the extent ESG investing is 
acceptable at all, it should never be allowed in the case of QDIAs. 
Even if active investors are given the prerogative to align their 
investments with their beliefs, inattentive defaulted investors should 
never, according to these commenters, be forced to accept the social 
investment preferences of their plan fiduciaries or burdened with the 
obligation of having to actively recognize that the default option is 
misaligned with the investors' desires for higher returns (or contrary 
social values) and opt out.
---------------------------------------------------------------------------

    \65\ Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409 (2014).
---------------------------------------------------------------------------

    The Department was not persuaded by these objections and the final 
regulation retains this aspect of the NPRM, meaning that the final 
regulation does not contain the set of special rules for participant-
directed individual account plans, including plans with QDIAs, codified 
in paragraph (d) of the current regulation. The first part of paragraph 
(d) of the current regulation (paragraphs (d)(1) and (d)(2)(i)) was 
eliminated because the essential principles of this part were merged 
into paragraphs (b) and (c) of the final rule.
    As to the second part of paragraph (d) of the current regulation, 
i.e., the part containing special provisions for QDIAs (paragraph 
(d)(2)(ii) of the current), the Department generally is of the view 
that QDIAs warrant special treatment because plan participants have not 
affirmatively directed the investment of their assets into the QDIA but 
are nevertheless dependent on the investments for long-run financial 
security. Although the Department continues to believe as a general 
matter that special protections may be needed in some contexts for 
plans containing these investments, the Department no longer supports 
the specific restrictions in paragraph (d)(2)(ii) of the current 
regulation. As structured, paragraph (d)(2)(ii) of the current 
regulation disallows a fund to serve as a QDIA if it, or any of its 
component funds in a fund-of-fund structure, has investment objectives, 
goals, or principal investment strategies that include, consider, or 
indicate the use of non-pecuniary factors in its investment objectives, 
even if the fund is objectively economically prudent from a risk-return 
perspective or even best in class.
    The Department agrees with the many commenters asserting that, 
rather than protecting the interests of plan participants, paragraph 
(d)(2)(ii) of the current regulation will only serve to harm 
participants. It would, as the commenters notice, effectively preclude 
fiduciaries from considering QDIAs that include ESG strategies, even 
where they were otherwise prudent or economically superior to competing 
options. The Department sees no reason to deprive participants of such 
options. Consequently, the final rule directly rescinds paragraph 
(d)(2)(ii) of the current regulation. The rescission of this provision, 
however, does not leave participants and beneficiaries in plans with 
QDIAs without protections. QDIAs would continue to be subject to the 
same legal standards under the final rule as all other investments, 
including the prohibition against subordinating the interests of 
participants and beneficiaries in their retirement income to other 
objectives. QDIAs also would continue to be subject to the separate 
protections of the QDIA regulation.\66\ The Department finds no merit 
to the argument that the final rule, either in general or in not 
carrying forward paragraph (d) of the current regulation in specific, 
sanctions behavior contrary to the holding in Dudenhoeffer. On the 
contrary, as already stated, the central premise behind the final 
rule's amendments to the current regulation is that the current 
regulation is being perceived by plan fiduciaries and others as an 
impediment to protecting the financial benefits of plan participants 
and beneficiaries by prohibiting or encumbering plan fiduciaries from 
managing against or taking advantage of climate change and other ESG 
risk factors in selecting investments. Thus, in this way, the final 
rule's rescission of the special provision for QDIAs is entirely 
consistent with the principle articulated in Dudenhoeffer.
---------------------------------------------------------------------------

    \66\ 29 CFR 2550.404c-5.
---------------------------------------------------------------------------

4. Section 2550.404a-1(d)--Proxy Voting and Exercise of Shareholder 
Rights
    Paragraph (d) of the final rule addresses the application of the 
duties of prudence and loyalty under ERISA section 404(a) to the 
exercise of shareholder rights, including proxy voting. As discussed 
below, the final rule includes several minor changes from the proposal 
based on public comment.

[[Page 73844]]

(a) Paragraph (d)(1)
    Paragraph (d)(1) of the final rule is unchanged from the proposal 
and provides that the fiduciary duty to manage plan assets that are 
shares of stock includes the management of shareholder rights 
appurtenant to those shares, such as the right to vote proxies. A 
commenter requested that the Department limit paragraph (d) to only 
proxy voting. The commenter noted that while the provisions cover both 
proxy voting and the exercise of shareholder rights, most of the 
substantive provisions relate only to proxy voting. The commenter 
further opined that other shareholder rights do not necessarily share 
the same objectives as those of proxy voting in connection with stock 
ownership. Moreover, according to the commenter, decisions on corporate 
actions like stock splits, tender offers, exchange offers on bond 
issues, and mergers and acquisitions are generally not governed by 
proxy voting policies or undertaken with advice from proxy advisors. 
For these reasons, the commenter expressed the view that exercise of 
shareholder rights should not be coupled with proxy voting in the 
regulation. The Department is not persuaded to make the suggested 
change. The exercise of shareholder rights has been part of the 
Department's prior guidance since at least the first Interpretive 
Bulletin in 1994. The Department believes that the exercise of 
shareholder rights to monitor or influence management, which may occur 
in lieu of, or in connection with, formal proxy proposals is no less 
important to fiduciary management of the investment asset as proxy 
voting and accordingly should be covered by the final rule.
(b) Paragraph (d)(2)
(1) Paragraph (d)(2)(i)
    Paragraph (d)(2)(i) of the proposal provided that when deciding 
whether to exercise shareholder rights and when exercising such rights, 
including the voting of proxies, fiduciaries must carry out their 
duties prudently and solely in the interests of the participants and 
beneficiaries and for the exclusive purpose of providing benefits to 
participants and beneficiaries and defraying the reasonable expenses of 
administering the plan. Paragraph (d)(2)(i) was proposed without 
modification from paragraph (e)(2)(i) of the current regulation and is 
adopted without change.
(2) Paragraph (d)(2)(ii)
    Paragraph (d)(2)(ii) of the proposal set forth specific standards 
for fiduciaries to meet when deciding whether to exercise shareholder 
rights and when exercising shareholder rights. It provided that a 
fiduciary must act solely in accordance with the economic interest of 
the plan and its participants and beneficiaries (paragraph 
(d)(2)(ii)(A)) and consider any costs involved (paragraph 
(d)(2)(ii)(B)). Paragraph (d)(2)(ii) further required that a fiduciary 
must not subordinate the interests of the participants and 
beneficiaries in their retirement income or financial benefits under 
the plan to any other objective, or promote benefits or goals unrelated 
to the financial interests of the plan's participants and beneficiaries 
(paragraph (d)(2)(ii)(C)). The proposal additionally provided that a 
fiduciary must evaluate material facts that form the basis for any 
particular proxy vote or other exercise of shareholder rights 
(paragraph (d)(2)(ii)(D)). Finally, paragraph (d)(2)(ii)(E) of the 
proposal provided that a fiduciary must exercise prudence and diligence 
in the selection and monitoring of persons, if any, selected to 
exercise shareholder rights or otherwise advise on or assist with 
exercises of shareholder rights, such as providing research and 
analysis, recommendations regarding proxy votes, administrative 
services with voting proxies, and recordkeeping and reporting services.
    Paragraph (d)(2)(ii) of the proposal was based on paragraph 
(e)(2)(ii) of the current regulation but proposed three significant 
changes. First, paragraph (d)(2)(ii) of the proposal directly rescinded 
the statement in paragraph (e)(2)(ii) of the current regulation that 
``the fiduciary duty to manage shareholder rights appurtenant to shares 
of stock does not require the voting of every proxy or the exercise of 
every shareholder right.'' Second, proposed paragraph (d)(2)(ii) did 
not carry forward the current regulation's specific requirement at 
paragraph (e)(2)(ii)(E) that, when deciding whether to exercise 
shareholder rights and when exercising shareholder rights, plan 
fiduciaries must maintain records on proxy voting activities and other 
exercises of shareholder rights. Third, paragraph (d)(2)(ii)(E) of the 
proposal broadened the corresponding provision in the current 
regulation (paragraph (e)(2)(ii)(F)) in connection with a proposed 
streamlining of fiduciary selection and monitoring obligations under 
the current regulation. Specifically, paragraphs (e)(2)(ii)(F) and 
(e)(2)(iii) of the current regulation both address fiduciary monitoring 
obligations, with paragraph (e)(2)(ii)(F) covering selection and 
monitoring of persons selected to advise or otherwise assist with the 
exercise of shareholder rights, and paragraph (e)(2)(iii) sets out 
specific monitoring obligations where the authority to vote proxies or 
exercise shareholder rights has been delegated to an investment manager 
or a proxy voting firm. The NPRM proposed streamlining this approach by 
eliminating paragraph (e)(2)(iii) and covering selection and monitoring 
obligations in a single more general provision (paragraph (d)(2)(ii)(E) 
of the proposal). Although based on paragraph (e)(2)(ii)(F) of the 
current regulation, paragraph (d)(2)(ii)(E) of the proposal was 
broader, and covered obligations related to monitoring service 
providers such as investment managers and proxy advisory firms that are 
addressed in paragraph (e)(2)(iii) of the current regulation.
(a) Rescission of ``Does Not Require Voting Every Proxy'' Language From 
Paragraph (e)(2)(ii) of the Current Regulation
    The Department proposed to rescind the statement in paragraph 
(e)(2)(ii) of the current regulation that ``the fiduciary duty to 
manage shareholder rights appurtenant to shares of stock does not 
require the voting of every proxy or the exercise of every shareholder 
right'' out of a concern that the statement could be misread as 
suggesting that plan fiduciaries should be indifferent to the exercise 
of their rights as shareholders, particularly in circumstances where 
the cost is minimal as is typical of voting proxies. Such indifference 
could leave plan investments unprotected, as the exercise of 
shareholder rights is important to ensuring management accountability 
to the shareholders that own the company. Furthermore, abstaining from 
a vote is not a neutral act that has no bearing on the outcome of a 
particular matter put to shareholders for vote; rather, depending on 
the relevant voting standard under state law and the company's 
governing documents, abstention could determine whether a particular 
matter or proposal is approved.
    Commenters expressed a range of views with respect to the 
rescission of the ``does not require voting every proxy'' language. 
Multiple commenters supported the rescission, and agreed with the 
Department's concerns that the language promotes indifference in 
managing proxy voting rights. A commenter furthermore cautioned that 
the language misleadingly signaled to fiduciaries that proxy voting is 
costly and unimportant. Some commenters expressed the view that the 
exercise of

[[Page 73845]]

shareholder rights is key to management accountability and paying 
attention to governance is as important as financial performance. Other 
commenters similarly supported rescission based on the view that 
exercise of shareholder rights, including through proxy voting, is an 
important tool for managing risk. Some commenters also indicated that 
the ``does not require voting every proxy'' language is not necessary 
in the current regulation because fiduciaries have never believed that 
ERISA required them to vote all proxies. In particular, commenters 
pointed to prior non-regulatory guidance which clearly indicated, in 
the context of foreign stock, that ERISA does not require fiduciaries 
to vote all proxies.\67\
---------------------------------------------------------------------------

    \67\ IB 94-2, 59 FR 38864; IB 2016-01, 81 FR 95882.
---------------------------------------------------------------------------

    Some commenters did not indicate support or opposition to 
rescission of the ``not required to vote every proxy'' language, but 
they cautioned that removal of the language could be misread as 
indicating that the Department believes that ERISA requires fiduciaries 
to vote every proxy. These commenters requested confirmation of the 
Department's view.
    Other commenters opposed the rescission and viewed the NPRM as 
creating a presumption that all proxies should be voted. A commenter 
stated that many small plans abstain from proxy votes because 
performing the required due diligence would be inordinately expensive. 
Several commenters criticized that a presumption that all proxies 
should be voted will lead fiduciaries to further rely on proxy advisory 
firms, which they view as potentially harmful to plans because, 
according to these commenters, proxy advisory firms have conflicts of 
interest and base their votes on noneconomic ESG policy-driven goals. 
Some commenters also opposed the rescission because they believe 
language in the regulation was necessary because some fund managers 
believed they were obliged to vote proxies on all matters, which 
resulted either in the fund managers employing significant assets to 
explore the issues implicated in the matters, or in their relying on 
proxy advisory services to decide for them how to vote.
    After considering the comments, the Department has decided to 
rescind the ``not required to vote every proxy'' language as proposed. 
The Department's longstanding view of ERISA is that proxies should be 
voted as part of the process of managing the plan's investment in 
company stock unless a responsible plan fiduciary determines voting 
proxies may not be in the plan's best interest (e.g., in cases when 
voting proxies may involve exceptional costs or unusual requirements, 
such as in the case of voting proxies on shares of certain foreign 
corporations).\68\ This position recognizes the importance that prudent 
management of shareholder rights can have in enhancing the value of 
plan assets or protecting plan assets from risk. However, as explained 
in the preamble to the NPRM, the removal of the language is not meant 
to indicate that fiduciaries must always vote proxies or engage in 
shareholder activism.\69\ Prudent fiduciaries should take steps to 
ensure that the cost and effort associated with voting a proxy is 
commensurate with the significance of an issue to the plan's financial 
interests. The solution to proxy-voting costs is not abstention, but 
is, instead, for the fiduciary to be prudent in incurring expenses to 
make proxy decisions and, wherever possible, to rely on efficient 
structures (e.g., proxy voting guidelines, proxy advisors/managers that 
act on behalf of large aggregates of investors, etc.). With regard to 
commenters' concerns about fiduciaries' reliance on proxy advisory 
firms, the Department notes that, as discussed below, the final rule 
retains requirements relating to the prudent selection and monitoring 
of services providers to advise or assist with the exercise of 
shareholder rights. In order to satisfy that provision, fiduciaries 
would be expected to assess the qualifications of the provider, the 
quality of services offered, and the reasonableness of fees charged in 
light of the services provided. A fiduciary's process also should be 
designed to avoid self-dealing, conflicts of interest or other improper 
influence.\70\ Fiduciaries additionally should take steps to ensure 
they are fully informed of potential conflicts of proxy advisory firms 
and the steps such firms have taken to address them.\71\ To the extent 
relevant, fiduciaries should review the proxy voting policies and proxy 
voting guidelines and the implementing activities of the person being 
selected. If a fiduciary determines that the recommendations and other 
activities of such person are not being carried out in a manner 
consistent with those policies and/or guidelines, then the fiduciary 
should take appropriate action in response. The Department further 
notes that in 2020, the U.S. Securities and Exchange Commission adopted 
final rules that were intended to help ensure that investors who use 
proxy voting advice receive more transparent, accurate, and complete 
information on which to make their voting decisions.\72\ Information 
required to be provided pursuant to those final rules also may be 
useful to responsible plan fiduciaries relying on recommendations from 
proxy advisory firms.
---------------------------------------------------------------------------

    \68\ 81 FR 95879, 81 (``The essential point of IB 94-2, however, 
was to articulate a general principle that a fiduciary's obligation 
to manage plan assets prudently extends to proxy voting. As such, IB 
94-2 properly read was meant to express the view that proxies should 
be voted as part of the process of managing the plan's investment in 
company stock unless a responsible plan fiduciary determined that 
the time and costs associated with voting proxies with respect to 
certain types of proposals or issuers may not be in the plan's best 
interest.''). See also IB 94-2, 59 FR 38861, 63 (July 29, 1994) 
(``The fiduciary obligations of prudence and loyalty to plan 
participants and beneficiaries require the responsible fiduciary to 
vote proxies on Issues that may affect the value of the plan's 
investment. Although the same principles apply for proxies 
appurtenant to shares of foreign corporations, the Department 
recognizes that in voting such proxies, plans may, in some cases, 
incur additional costs. Thus, a fiduciary should consider whether 
the plan's vote, either by itself or together with the votes of 
other shareholders, is expected to have an effect on the value of 
the plan's investment that will outweigh the cost of voting. 
Moreover, a fiduciary, in deciding whether to purchase shares of a 
foreign corporation, should consider whether the difficulty and 
expense in voting the shares is reflected in their market price.'').
    \69\ 86 FR 57281.
    \70\ See 85 FR 81669; see also Department of Labor Information 
Letter to Diana Orantes Ceresi (Feb. 19, 1998).
    \71\ See ``Selecting and Monitoring Pension Consultants--Tips 
for Plan Fiduciaries'' https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/our-activities/resource-center/fact-sheets/selecting-and-monitoring-pension-consultants.pdf.
    \72\ See Exemptions from the Proxy Rules for Proxy Voting 
Advice, Release No. 34-89372 (July 22, 2020), 85 FR 55082 (Sept. 3, 
2020). In July 2022, the SEC amended these final rules. See 87 FR 
43168 (July 19, 2022).
---------------------------------------------------------------------------

(b) Removal of Specific Recordkeeping Requirement From Paragraph 
(e)(2)(ii)(E) of the Current Regulation
    The Department proposed to eliminate the requirement in paragraph 
(e)(2)(ii)(E) of the current regulation that, when deciding whether to 
exercise shareholder rights and when exercising shareholder rights, 
plan fiduciaries must maintain records on proxy voting activities and 
other exercises of shareholder rights. The Department was concerned 
that the provision appeared to treat proxy voting and other exercises 
of shareholder rights differently from other fiduciary activities and 
might create a misperception that proxy voting and other exercises of 
shareholder rights are disfavored or carry greater fiduciary 
obligations, and therefore greater potential liability, than other 
fiduciary activities. Such a misperception could be harmful to plans, 
as it could potentially chill plan fiduciaries from exercising their 
right or result in

[[Page 73846]]

excessive expenditures as fiduciaries over-document their efforts.
    Some commenters supported removal of the recordkeeping provision, 
echoing the Department's concerns stated in the preamble to the NPRM. 
Several commenters believed there was no need to single out proxy 
voting for special recordkeeping requirements. Some commenters 
criticized the recordkeeping requirement as creating a misperception 
that exercising shareholder rights carry a greater fiduciary obligation 
than other fiduciary activities and a heightened burden when exercised, 
which might cause fiduciaries to shy away from exercising shareholder 
rights or incur unnecessary compliance expenses when doing so. A 
commenter criticized the specific recordkeeping requirement as creating 
a new barrier and extra expense, without justification. Several 
commenters were of the view that the general framework of ERISA is 
sufficient to govern the recordkeeping requirements for proxy voting.
    Other commenters opposed removal of the documentation requirement 
and suggested that it be retained in the regulation. A commenter 
indicated that removing the documentation provision deprives 
participants and beneficiaries of information they may use to evaluate 
whether fiduciaries are acting in their best interest for their 
exclusive benefit. Another commenter similarly suggested that 
eliminating the requirement impedes the ability of participants to 
monitor plan fiduciaries. Another commenter further opined that 
enhanced documentation would help to ensure that ERISA plan proxies are 
being voted only in a manner that is in the articulable financial 
interest of plan beneficiaries.
    The Department is not persuaded by commenters to retain the 
specific recordkeeping provision. The Department does not disagree with 
the need for proper documentation of fiduciary activity. To the 
contrary, in previous guidance on proxy voting, the Department 
indicated that section 404(a)(1)(B) requires proper documentation both 
of the activities of the investment manager and of the named fiduciary 
of the plan in monitoring the activities of the investment manager.\73\ 
Specifically, with respect to proxy voting, this would require the 
investment manager or other responsible fiduciary to keep accurate 
records as to the voting of proxies. It is the Department's view that 
in order for the named fiduciary to carry out the fiduciary's 
responsibilities under ERISA section 404(a), the fiduciary must be able 
to review periodically not only the voting procedure pursuant to which 
the investment manager votes the proxies appurtenant to plan-owned 
stock, but also the actions taken in individual situations so that a 
determination can be made whether the investment manager is fulfilling 
their fiduciary obligations in a manner which justifies the 
continuation of the management appointment. In context, however, the 
Department takes note of, and to a large extent agrees with, the 
commenters' concern that the current regulation could be viewed by some 
as treating proxy voting and other exercises of shareholder rights 
differently from other fiduciary activities and may create a 
misperception that proxy voting and other exercises of shareholder 
rights are disfavored or carry greater fiduciary obligations, and 
therefore greater potential liability, than other fiduciary activities. 
Because this misperception could be harmful to plans, as it could 
potentially chill plan fiduciaries from exercising their rights or 
result in excessive expenditures as fiduciaries over-document their 
efforts, the Department has concluded it is appropriate to rescind this 
provision in the current regulation.
---------------------------------------------------------------------------

    \73\ See Letter to Helmuth Fandl, Chairman of the Retirement 
Board, Avon Products, Inc. 1988 WL 897696 (Feb. 23, 1988) (``[I]t is 
the opinion of the Department that section 404(a)(1)(B) requires 
proper documentation of the activities of the investment manager and 
of the named fiduciary of the plan in monitoring the activities of 
the investment manager. Specifically, with respect to proxy voting, 
this would require the investment manager or other responsible 
fiduciary to keep accurate records as to the voting of proxies.''); 
see also Interpretive Bulletin IB 94-2 (July 29, 1994) 59 FR 38860, 
63 (``It is the view of the Department that compliance with the duty 
to monitor necessitates proper documentation of the activities that 
are subject to monitoring. Thus, the investment manager or other 
responsible fiduciary would be required to maintain accurate records 
as to proxy voting. Moreover, if the named fiduciary is to be able 
to carry out its responsibilities under ERISA Sec.  404(a) in 
determining whether the investment manager is fulfilling its 
fiduciary obligations in investing plans assets in a manner that 
justifies the continuation of the management appointment, the proxy 
voting records must enable the named fiduciary to review not only 
the investment manager's voting procedure with respect to plan-owned 
stock, but also to review the actions taken in individual proxy 
voting situations.'').
---------------------------------------------------------------------------

(c) Removal of Specific Monitoring Requirement From Paragraph 
(e)(2)(iii) of the Current Regulation
    As discussed above, the Department proposed to eliminate paragraph 
(e)(2)(iii) of the current regulation, which set out specific 
monitoring obligations where the authority to vote proxies or exercise 
shareholder rights has been delegated to an investment manager or proxy 
voting firm and proposed to broaden another provision of the regulation 
that more generally covers selection and monitoring obligations 
(paragraph (d)(2)(ii)(E) of the proposal). The Department was concerned 
that the more specific provision relating to providers of certain 
proxy-related services could be read as creating special monitoring 
obligations above and beyond the statutory obligations of prudence and 
loyalty that generally apply to monitoring service providers. In this 
regard, the Department noted that it had previously indicated in 
Interpretive Bulletin 2016-01 that the general prudence and loyalty 
duties under ERISA section 404(a)(1) require a fiduciary to monitor 
decisions made and actions taken by an investment manager with regard 
to proxy voting decisions. In addition, the Department had previously 
indicated that in adopting paragraph (e)(2)(iii) of the current 
regulation it did not intend to create a higher standard for a 
fiduciary's monitoring of an investment manager's proxy voting 
activities than would ordinarily apply under ERISA with respect to the 
monitoring of any other fiduciary or fiduciary activity.\74\
---------------------------------------------------------------------------

    \74\ 85 FR 81670 (``The Department did not intend to create a 
higher standard for a fiduciary's monitoring of an investment 
manager's proxy voting activities than would ordinarily apply under 
ERISA with respect to the monitoring of any other fiduciary or 
fiduciary activity. Thus, the Department has revised the provision 
in the final rule to eliminate the requirement for documentation of 
the rationale for proxy voting decisions, and instead replaced it 
with a more general monitoring obligation.'').
---------------------------------------------------------------------------

    Some commenters agreed with the Department's proposed elimination 
of paragraph (e)(2)(iii) of the current regulation. One commenter 
opined that the specific monitoring requirement in that provision 
largely duplicated the general obligation in current paragraph 
(e)(2)(ii)(F), which the commenter viewed as redundant and suggestive 
that monitoring proxy-related services demand more rigor than required 
to monitor other service providers. Other commenters similarly observed 
that the current regulation's specific monitoring requirement may have 
created an impression that there are special obligations above and 
beyond the statutory obligations of prudence and loyalty that generally 
apply to monitoring service providers with respect to proxy voting. 
Some commenters noted that ERISA's general prudence and loyalty duties 
already impose a monitoring requirement on fiduciaries, and further 
expressed the view that monitoring service providers with respect to 
proxy voting is no different from other fiduciary obligations and 
should be subject to the

[[Page 73847]]

same standards. A commenter asserted that there is no basis for 
heightened monitoring responsibilities when a fiduciary uses the 
services of a proxy advisory firm, and specifically disagreed with 
assertions contained in the preamble to the 2020 rule that proxy 
advisors are prone to factual and/or analytic errors.
    Other commenters opposed the elimination of the specific monitoring 
requirement. A commenter viewed it as reasonable and justified to 
single out delegated voting authority as particularly deserving of due 
diligence and prudent monitoring. This commenter believed it 
appropriate for the regulation to remind fiduciaries of their 
obligations. Another commenter suggested that the specific monitoring 
requirement was necessary to protect plan participants. According to 
the commenter, proxy advisory firms are insufficiently staffed and 
otherwise ill-suited to conduct the sort of research required under 
fiduciary law, and demonstrate a history of advising on self-interested 
and politically motivated grounds instead of on purely financial 
interests. In this commenter's view, when fund managers rely on the 
recommendations of these firms, they may commit a violation of their 
duty of care. Another commenter cautioned that removal of the specific 
monitoring requirement may create confusion because it would remove the 
detailed standards fiduciaries must follow when monitoring the proxy 
voting of investment managers and proxy advisory firms.
    The Department is not persuaded by the public comments to retain 
the specific monitoring provision in paragraph (e)(2)(iii) of the 
current regulation. Despite the Department's explicit indication, 
described above, that paragraph (e)(2)(iii) of the current regulation 
was not intended to create a higher standard in monitoring proxy voting 
activities of parties delegated such responsibilities, commenters 
continue to express concerns that paragraph (e)(2)(iii) of the current 
regulation suggests such heightened obligations. The Department 
believes it appropriate to resolve lingering doubts by eliminating 
paragraph (e)(2)(iii) of the current regulation, and broadening 
paragraph (d)(2)(ii)(E) of the final rule, which sets forth general 
selection and monitoring obligations, to additionally cover selection 
and monitoring of any person selected to exercise shareholder rights. 
The Department believes paragraph (d)(2)(ii)(E) is sufficient to remind 
fiduciaries of their responsibilities in selecting and monitoring 
persons selected to exercise shareholder rights, and is sufficient to 
protect the interests of plan participants and beneficiaries. With 
respect to concerns that removal of paragraph (e)(2)(iii) of the 
current regulation would eliminate detailed standards that fiduciaries 
must follow in monitoring the proxy voting of investment managers and 
proxy advisory firms, the Department notes that paragraph (e)(2)(iii) 
of the current regulation merely references monitoring activities 
relating to shareholder rights for consistency with the regulation. In 
the Department's view, a fiduciary's obligations with respect to 
monitoring a service provider would include measures to ascertain the 
service provider's compliance with ERISA and the terms of the plan.
(d) Provisions of Paragraph (d)(2)(ii) of the Final Rule
    Paragraph (d)(2)(ii) of the final rule, like the NPRM and the 
current regulation, sets forth specific standards for fiduciaries to 
meet when deciding whether to exercise shareholder rights and when 
exercising shareholder rights. The requirements in paragraphs 
(d)(2)(ii)(A) through (E) of the final rule are intended to confirm and 
restate what the prudence and loyalty obligations of ERISA section 
404(a)(1)(A) and (B) would require in this context. Paragraph 
(d)(2)(ii)(A) of the final rule is the same as proposed except for a 
change in cross-reference to paragraph (b)(4). It provides that a 
fiduciary must act solely in accordance with the economic interest of 
the plan and its participants and beneficiaries, in a manner consistent 
with paragraph (b)(4) of the final rule. A commenter requested 
confirmation of statements in prior non-regulatory guidance that in 
deciding whether to vote a proxy the fiduciary should determine whether 
``the plan's vote, either by itself or together with the votes of other 
shareholders, is expected to have an effect on the value of the plan's 
investment that warrants the additional cost of voting.'' \75\ In the 
commenter's view, without such confirmation, the ``solely in the 
interest'' requirement of paragraph (d)(2)(ii)(A) may limit plan voting 
where a plan holds a relatively small investment that, on its own, 
might not affect the outcome of a vote. In response, the Department 
confirms that in making decisions regarding the exercise of a plan's 
shareholder rights, a fiduciary's analysis may include consideration of 
the effects of the plan's exercise, either by itself or together with 
the exercise of rights of other shareholders.
---------------------------------------------------------------------------

    \75\ Interpretive Bulletin 2016-01, 81 FR 95882 at 95883.
---------------------------------------------------------------------------

    Paragraph (d)(2)(ii)(B) of the final rule is adopted as proposed. 
It requires that when deciding whether to exercise shareholder rights 
and when exercising shareholder rights, a fiduciary must consider any 
costs involved. The Department received no comments on this provision.
    Paragraph (d)(2)(ii)(C) of the proposal provided that a fiduciary 
must not subordinate the interests of the participants and 
beneficiaries in their retirement income or financial benefits under 
the plan to any other objective, or promote benefits or goals unrelated 
to those financial interests of the plan's participants and 
beneficiaries. A commenter suggested deleting the clause ``or promote 
benefits or goals unrelated to those of financial interests of the 
plan's participants and beneficiaries'' from paragraph (d)(2)(ii)(C). 
The commenter reasoned that where a particular exercise of a 
shareholder right would not directly affect shareholder value, the 
language could be read to prohibit such exercise. Another commenter 
with the same request explained that the deletion would clarify that 
fiduciaries are not required to undertake a burdensome economic 
analysis before voting proxies. This commenter opined that in some 
cases, it may be even less expensive to cast the vote than speculate 
whether the vote in question ``promotes'' benefits or goals unrelated 
to those financial interests of the plan's participants and 
beneficiaries. Both commenters opined that voting under these 
circumstances would be allowed under a tiebreaker standard. Other 
commenters raised concerns regarding increased potential for litigation 
more generally and requested that the Department factor that potential 
into all decisions under the final regulation; in this context, that 
concern might present as a dispute over whether and the extent to which 
any particular vote was an affirmative ``promotion'' of an 
impermissible goal as opposed to a vote on a matter the outcome of 
which might confer an ancillary benefit on a stakeholder other than the 
plan.
    The Department was persuaded by the commenters' suggestion to 
remove the clause from paragraph (d)(2)(ii)(C). On review, the 
Department has concluded that the clause at issue serves no independent 
function, in terms of adding protections to plan participants, that is 
not already served by paragraph (d)(2)(ii)(A) (requirement to act 
``solely in accordance with the economic interests of the plan'') and 
the first clause of paragraph (d)(2)(ii)(C)

[[Page 73848]]

(requirement ``not to subordinate the interests of participant and 
beneficiaries in their retirement income or financial benefits under 
the plan to any other objectives'') of the final rule. In addition to 
being unnecessary, as pointed out by the commenters, the clause is 
easily misconstrued as suggesting or implying an affirmative duty on 
plan fiduciaries, above and beyond those duties contained in the other 
two paragraphs already mentioned, that requires the fiduciaries to do 
something further to investigate and ensure that their votes or other 
exercises do not promote objectives or goals unrelated the financial 
interests of the plan, or perform an analysis of each vote's benefit. 
The Department sees no reason to impose such additional duties, with 
their attendant costs and potential for litigation, when the other two 
provisions mentioned are fully adequate to protect the interests of 
plan participants.
    The purpose of the clause was to ensure that a fiduciary does not 
exercise proxy voting and other shareholder rights with the goal of 
advancing nonpecuniary goals unrelated to the financial interests of 
the plan's participants and beneficiaries so long as it does not result 
in increased costs to the plan or a decrease in value of the 
investment.\76\ This clause thus dovetailed with a longstanding 
position of the Department that ERISA prohibits plan fiduciaries from 
expending trust assets to promote myriad public policy preferences.\77\ 
The final rule's removal of the clause at issue does not constitute a 
rejection of this principle. However, with respect to the concern that 
the fiduciary must determine that an exercise of shareholder rights 
would directly affect shareholder value, the Department's historical 
view has been that ERISA's fiduciary obligations of prudence and 
loyalty require the responsible fiduciary to vote proxies on issues 
that may affect the value of the plan's investment.\78\ With respect to 
the commenters referring to the tiebreaker test, although that test is 
not applicable in this context, the Department further notes that when 
a plan fiduciary exercises voting authority, a violation of paragraph 
(d)(2)(ii)(C) of the final rule would not occur merely because 
stakeholders other than the plan would potentially benefit along with 
the investing plan.
---------------------------------------------------------------------------

    \76\ 85 FR 816658, 67 (Dec. 16, 2020).
    \77\ 81 FR 95879, 81 (Dec. 29, 2016) (preamble to IB 2016-01) 
(``The Department has rejected a construction of ERISA that would 
render ERISA's tight limits on the use of plan assets illusory and 
that would permit plan fiduciaries to expend trust assets to promote 
myriad public policy preferences. Rather, plan fiduciaries may not 
increase expenses, sacrifice investment returns, or reduce the 
security of plan benefits in order to promote collateral goals.''); 
Advisory Opinion Nos. 2008-05A (June 27, 2008) and 2007-07A (Dec. 
21, 2007).
    \78\ See Interpretive Bulletin 94-2, 59 FR 38860; Interpretive 
Bulletin 2016-01, 81 FR 95879.
---------------------------------------------------------------------------

    Paragraph (d)(2)(ii)(D) of the final rule requires that when 
deciding whether to exercise shareholder rights and when exercising 
shareholder rights, a fiduciary must evaluate relevant facts that form 
the basis for any particular proxy vote or other exercise of 
shareholder rights. The provision is the same as proposed, except that 
the Department has substituted the term ``relevant'' for ``material'' 
for purposes of consistency throughout the regulation, as discussed 
above.
    Paragraph (d)(2)(ii)(E) of the final rule is being adopted as 
proposed, and requires that a fiduciary must exercise prudence and 
diligence in the selection and monitoring of persons, if any, chosen to 
exercise shareholder rights or otherwise to advise on or assist with 
exercises of shareholder rights, such as providing research and 
analysis, recommendations regarding proxy votes, administrative 
services with voting proxies, and recordkeeping and reporting services. 
As discussed above, this provision covered obligations that were set 
forth in paragraphs (e)(2)(ii)(F) and (e)(2)(iii) of the current 
regulation. The provision is essentially a restatement of the general 
fiduciary obligations that apply to the selection and monitoring of 
plan service providers, articulated in the context of fiduciary and 
other service providers that exercise shareholder rights, or advise or 
assist with exercises of shareholder rights.
    A commenter requested that the Department delete the list of 
services--``research and analysis, recommendations regarding proxy 
votes, administrative services with voting proxies, and recordkeeping 
and reporting services''--from the provision. The commenter was 
concerned that codifying an itemized list of duties that, according to 
the commenter, fiduciaries routinely delegate to investment managers 
and proxy voting firms may cause confusion or uncertainty over 
regulatory expectations regarding any delegation of these fiduciary 
responsibilities to a third party. The Department has not accepted this 
comment, and notes that this paragraph is focused on fiduciary duties 
of prudence and loyalty under ERISA section 404(a)(1)(A) and (B) in the 
selection and monitoring of particular service providers, and is not 
attempting to limit in any way the types of services that a plan or 
plan fiduciary may utilize in connection with exercising shareholder 
rights.
    Another commenter requested that the Department clarify that 
fiduciaries are not required to monitor every proxy vote or second-
guess other fiduciaries' specific proxy voting decisions, unless the 
fiduciary knows or should know the designated fiduciary is violating 
ERISA with their proxy voting procedures. Whether a fiduciary has 
complied with its obligations under paragraph (d)(2)(ii)(E) depends on 
the surrounding circumstances. The Department does not believe that a 
fiduciary would generally be required to monitor each vote or second-
guess other fiduciaries' decisions. To the extent applicable, a 
fiduciary would be expected to review the proxy voting policies and/or 
proxy voting guidelines and the implementing activities of the person 
being selected to exercise votes. If a fiduciary determines that the 
activities of such person are not being carried out in a manner 
consistent with those policies and/or guidelines, then the fiduciary 
will be expected to take appropriate action in response.\79\
---------------------------------------------------------------------------

    \79\ See 85 FR 81669.
---------------------------------------------------------------------------

(3) Paragraph (d)(2)(iii)
    Paragraph (d)(2)(iii) of the proposal stated that a fiduciary may 
not adopt a practice of following the recommendations of a proxy 
advisory firm or other service provider without a determination that 
such firm or service provider's proxy voting guidelines are consistent 
with the fiduciary's obligations described in provisions of the 
regulation. This provision was based on paragraph (e)(2)(iv) of the 
current regulation, which was intended to address specific concerns 
involving fiduciaries' use of proxy advisory firms and similar service 
providers, including use of automatic voting mechanisms relying on 
proxy advisory firms.
    Some commenters viewed paragraph (d)(2)(iii) as largely unnecessary 
because, in their view, a fiduciary's review of a service provider's 
proxy voting guidelines would already be required as part of the 
fiduciary's compliance with ERISA's prudence and loyalty requirements 
in the selection of a service provider. Some commenters moreover 
cautioned that paragraph (d)(2)(iii) could be construed as suggesting 
that monitoring proxy-related services demands more rigor than required 
to monitor other service providers. A commenter noted that the 
provision requires a specific determination when a fiduciary ``adopts a 
practice of following the recommendations of a proxy advisory firm or 
other service provider,'' and thus

[[Page 73849]]

would establish an additional vague and heightened burden that is 
unnecessary and a potential deterrent to informed, responsible 
shareholder engagement.
    Other commenters viewed the provisions as necessary. One commenter 
opined that it is crucial that ERISA fiduciaries have a full 
understanding of the proxy advisory firm's guidelines and 
recommendations before relying on their advice. In this commenter's 
view, robo-voting presents clear risks to participants given proxy 
advisory firms' one-size-fits-all policies. Another commenter expressed 
the view that evaluation of climate risks is extremely difficult, and 
criticizes proxy advisors as not being particularly well-suited to 
perform climate analysis. Furthermore, as described above, a number of 
other commenters expressed concerns about proxy advisory firms' 
conflicts and quality of services.
    In proposing paragraph (d)(2)(iii), the Department did not propose 
to make any changes to requirements contained in the corresponding 
provision of the current regulation, paragraph (e)(2)(iii). The 
Department is not persuaded that any of the requirements should be 
eliminated or otherwise modified. We note that paragraph (d)(2)(iii) 
deals with a fiduciary's process for making proxy voting decisions 
(i.e., the reliance on recommendations or advice from a service 
provider) and does not touch on the fiduciary's obligations with regard 
to the selection and monitoring of the service providers used. The 
provision relates to oversight obligations of fiduciaries that 
essentially automatically rely on a service provider in carrying out 
the fiduciary's own obligations.\80\ We do not believe that potential 
misunderstandings as to fiduciary monitoring obligations with respect 
to providers of proxy-related services, which is addressed in paragraph 
(d)(2)(ii)(E) of the final rule, is sufficient to justify modification 
or elimination of paragraph (d)(2)(iii). As a result, paragraph 
(d)(2)(iii) is being adopted without change.
---------------------------------------------------------------------------

    \80\ 85 FR 81671.
---------------------------------------------------------------------------

(c) Paragraph (d)(3)
    In recognition of the appropriateness of ERISA fiduciaries' 
adoption of proxy voting policies to help them more cost effectively 
comply with their obligations under ERISA and the regulation, paragraph 
(d)(3) of the proposal carried forward from the current regulation 
general provisions relating to the adoption of proxy voting policies. 
The proposal did not, however, carry forward from the current 
regulation two ``safe harbor'' policies that could be used for 
satisfying the fiduciary responsibilities under ERISA with respect to 
decisions whether to vote. The first permitted a policy of limiting 
voting resources to particular types of proposals that the fiduciary 
has prudently determined are substantially related to the issuer's 
business activities or are expected to have a material effect on the 
value of the investment. The second permitted a policy of not voting on 
proposals or particular types of proposals when the plan's holding in a 
single issuer relative to the plan's total investment assets is below a 
quantitative threshold that the fiduciary prudently determines, 
considering its percentage ownership of the issuer and other relevant 
factors, is sufficiently small that the matter being voted upon is not 
expected to have a material effect on the investment performance of the 
plan's portfolio. The Department proposed rescinding these safe harbors 
because it lacked confidence that they were necessary or helpful in 
safeguarding the interests of plan participants and beneficiaries. The 
Department also was concerned that, in conjunction with other 
provisions in the current regulation, the safe harbors could be 
construed as regulatory permission for plans to broadly abstain from 
proxy voting without properly considering their interests as 
shareholders.
(1) Rescission of Safe Harbors From Paragraphs (e)(3)(i)(A) and (B) of 
the Current Regulation
    The Department received a range of comments on the proposed 
rescission of the safe harbor policies. Some commenters agree with the 
Department's general concern that, by their nature safe harbors can 
invite adoption, which makes it important that the safe harbors be in 
participants' best interest. In this regard, some commenters generally 
asserted that the safe harbors may encourage fiduciaries to limit their 
proxy voting in ways that harm participants and beneficiaries. Also, 
without identifying a particular safe harbor, some commenters asserted 
that the proxy voting rule adopted in 2020 provided no justification as 
to how the safe harbors were consistent with ERISA's duties of loyalty 
and prudence. Another commenter opined that because a decision by an 
ERISA plan to not vote effectively cedes voting power to other 
shareholders, it should only be permitted on a case-by-case basis 
rather than pursuant to a general safe harbor to refrain from voting. 
One commenter opined that neither safe harbor was particularly helpful, 
and there is little evidence that a material number of fiduciaries are 
currently relying on them. Another commenter cautioned that the safe 
harbor provisions could be interpreted as best-practice and encourage 
shareholders to follow those examples, instead of their established 
practices in line with stated investment policies and obligations under 
ERISA.
    Commenters also raised specific concerns on the safe harbors. With 
respect to the first safe harbor, a commenter expressed the view that a 
policy to vote only particular types of proposals, depending on the 
scope of the policy, may be too limited to capture all relevant 
proposals. Another commenter criticized the first safe harbor as being 
based on an unsupported premise that certain types of proxy votes are 
not substantially related to the issuer's business activities or are 
expected to have a material effect on the value of the investment. The 
commenter noted that many of the topics that corporate law permits 
shareholders to have a say on--e.g., election of directors or 
ratification of auditors--play an important risk mitigation role, and 
asserted that these types of issues are often prophylactic and do not 
readily lend themselves to an analysis of whether they will lead to a 
material effect on the value of a plan investment. The commenter 
cautioned that the first safe harbor encouraged fiduciaries to pass on 
these and other proxy matters, and thus created a genuine risk to plan 
participants' long-term interests.
    With respect to the second safe harbor, a commenter expressed 
concern that a policy to refrain from voting unless the plan holds a 
concentrated position in a company suggests that diversified investors, 
such as plan fiduciaries, should not have a voice in corporate 
decisions. Another commenter asserted that the second safe harbor was 
never fully explained or substantiated, and viewed it as being premised 
on the notion that not voting at most, or perhaps all, meetings a plan 
would be entitled to vote at would be in the best interest of 
participants.
    Other commenters neither supported nor opposed elimination of the 
safe harbors, but emphasized that proxy voting policies in general are 
useful to fiduciaries in making proxy voting decisions. One commenter 
requested confirmation from the Department that removal of the safe 
harbors from the regulation would not preclude, and should not be 
interpreted as discouraging, the adoption of such policies in 
appropriate circumstances. The commenter indicated that for many types 
of investment strategies, limiting voting resources, for example, to 
those

[[Page 73850]]

matters that are expected to have a material effect on the value of the 
investment is the prudent course of action. According to the commenter, 
in other cases adopting a policy to refrain from voting on proposals, 
or particular types of proposals, based on a prudently determined 
quantitative threshold could be in the best interest of plan 
participants and beneficiaries.
    Other commenters opposed rescission of the safe harbors. A 
commenter stated that the safe harbors appropriately recognized 
instances in which proxy voting would not be expected to have economic 
effect. The commenter cautioned that without the safe harbors, 
fiduciaries find the path of least resistance in hiring proxy advisory 
firm to vote all proxies, which would result in promoting ESG policies 
and raising a variety of concerns regarding proxy advisory firms, as 
discussed above.
    After considering the public comments, the Department is not 
persuaded to retain the safe harbors. Taken together, they encourage 
abstention as the normal course. Regulatory safe harbors tend to be 
widely adopted and the Department no longer believes it should be 
promoting abstention with these safe harbors. The Department has never 
taken the position that ERISA requires fiduciaries to cast a proxy vote 
on every ballot item. Thus, it follows that abstention or not voting on 
a matter or matters may be appropriate and not a violation of ERISA, 
from the Department's perspective. Voting rights, however, are a type 
of plan asset and, in the Department's view, an important tool to 
protect the plan's investment. The Department's longstanding view of 
ERISA is that proxies should be voted as part of the process of 
managing the plan's investment in company stock unless a responsible 
plan fiduciary determines voting proxies may not be in the plan's best 
interest (e.g., in cases when voting proxies may involve out of the 
ordinary costs or unusual requirements, such as in the case of voting 
proxies on shares of certain foreign corporations).\81\ This position 
recognizes the importance that prudent management of shareholder rights 
can have in enhancing the value of plan assets or protecting plan 
assets from risk. Finally, as to commenters' concerns about reliance on 
proxy advisory firms and quality of their services, the final rule also 
retains requirements relating to the prudent selection and monitoring 
of service providers to advise or assist with the exercise of 
shareholder rights.
---------------------------------------------------------------------------

    \81\ 81 FR 95879, 81.
---------------------------------------------------------------------------

(2) Provisions of Paragraph (d)(3) of the Final Rule
    Paragraph (d)(3)(i) of the proposal provided that in deciding 
whether to vote a proxy pursuant to paragraphs (d)(2)(i) and (ii) of 
the proposal, fiduciaries may adopt proxy voting policies providing 
that the authority to vote a proxy shall be exercised pursuant to 
specific parameters prudently designed to serve the plan's interest in 
providing benefits to participants and their beneficiaries and 
defraying reasonable expenses of administering the plan. Proposed 
paragraph (d)(3)(i) was based on paragraph (e)(3)(i) of the current 
regulation, but as discussed above did not retain the current 
regulation's two safe harbor proxy voting policies. Several commenters 
expressed general support for the Department's recognition of the 
usefulness of proxy voting policies to fiduciaries. However, the 
Department did not receive substantive comment on this provision of the 
proposal, and it is being adopted without substantive modification.\82\
---------------------------------------------------------------------------

    \82\ Paragraph (d)(3)(iii) of the final rule uses the term 
``significant effect on the value of the investment'' rather than 
``material'' effect. No substantive change is intended by the 
revision as the Department believes that ``significant'' is 
generally the same as the adjective ``material'' in this context. 
The Department recognized this similarity in the preamble to the 
current regulation, but erroneously concluded then that the term 
``material'' would be more familiar and helpful to ERISA plan 
fiduciaries. 85 FR 81658, 72 (December 16, 2020). However, as 
discussed above at section B1.(f) (4) of this preamble, commenters 
on the NPRM did not agree that the word ``material'' is a helpful 
term in this regulatory section because of its varied uses and 
meanings under accounting conventions, Federal securities laws, and 
other regulatory regimes. Compare note 44 (in other contexts, the 
final regulation substitutes ``material'' with ``relevant,'' but 
that adjective does not work well here where the focus is on the 
size of the impact of one thing on another thing as opposed to the 
closeness of connection between two things).
---------------------------------------------------------------------------

    Paragraphs (d)(3)(ii) of the proposal required plan fiduciaries to 
periodically review proxy voting policies adopted pursuant to the 
regulation. The Department received no comments on this provision of 
the proposal, and it is being adopted without modification.
    Paragraph (d)(3)(iii) of the proposal related to the effect of 
proxy voting policies adopted pursuant to the regulation, and provided 
that no proxy voting policies adopted pursuant to paragraph (d)(3)(i) 
shall preclude submitting a proxy vote when the fiduciary prudently 
determines that the matter being voted upon is expected to have a 
material effect on the value of the investment or the investment 
performance of the plan's portfolio (or investment performance of 
assets under management in the case of an investment manager) after 
taking into account the costs involved, or refraining from voting when 
the fiduciary prudently determines that the matter being voted upon is 
not expected to have such a material effect after taking into account 
the costs involved. This provision recognized that, depending on the 
circumstances, a fiduciary may conclude that the best interests of the 
plan and its participant and beneficiaries would not be served by 
following the plan's proxy voting policies in a particular case. In 
such cases, paragraph (d)(3)(iii) of the proposal ensured that a 
fiduciary have the needed flexibility to deviate from those policies 
and take a different approach. The Department received no substantive 
comments on this provision of the proposal, and it is being adopted 
without modification. One commenter requested clarification that 
fiduciaries are not required by this provision to conduct an analysis 
of each proxy vote to determine whether a fiduciary needs to deviate 
from the proxy voting policies. The commenter misapprehends the nature 
of the provision. The provision does not speak, directly or indirectly, 
to voting frequency or establish obligations with respect to the 
question of whether or how often plan fiduciaries should be voting 
proxies. The provision seeks to ensure that plan fiduciaries may safely 
deviate from the generally governing written instruments as may be 
needed from time-to-time in circumstances when doing so is in the best 
economic interest of plan participants. In this way, the provision 
shields a fiduciary from liability to the extent that a fiduciary 
deviates from written policies based on the fiduciary's conclusion that 
a different approach in a particular case is in the economic interests 
of the plan considering the facts and circumstances.
(d) Paragraph (d)(4)
    Paragraphs (d)(4)(i) and (ii) of the proposal, like paragraphs 
(e)(4)(i) and (ii) of the current regulation, reflect longstanding 
positions expressed in the Department's prior Interpretive Bulletins.
(1) Paragraph (d)(4)(i)
    Paragraph (d)(4)(i)(A) of the proposal stated that the 
responsibility for exercising shareholder rights lies exclusively with 
the plan trustee except to the extent that either the trustee is 
subject to the directions of a named fiduciary pursuant to ERISA 
section 403(a)(1), or the power to manage,

[[Page 73851]]

acquire, or dispose of the relevant assets has been delegated by a 
named fiduciary to one or more investment managers pursuant to ERISA 
section 403(a)(2). Paragraph (d)(4)(i)(B) of the proposal stated that 
where the authority to manage plan assets has been delegated to an 
investment manager pursuant to ERISA section 403(a)(2), the investment 
manager has exclusive authority to vote proxies or exercise other 
shareholder rights appurtenant to such plan assets in accordance with 
this section, except to the extent the plan, trust document, or 
investment management agreement expressly provides that the responsible 
named fiduciary has reserved to itself (or to another named fiduciary 
so authorized by the plan document) the right to direct a plan trustee 
regarding the exercise or management of some or all of such shareholder 
rights.
    A commenter indicated that an increasing number of ERISA plan 
fiduciaries may choose to retain the ability to instruct the plan's 
trustee or investment manager to implement a proxy voting policy chosen 
by the plan fiduciary. The commenter requested that the Department add 
to paragraph (d)(4)(i)(B) language stating that a named fiduciary may 
direct an investment manager regarding the exercise or management of 
shareholder rights. The Department declines to adopt this commenter's 
request. In the Avon Letter, discussed above, the Department cautioned 
that ERISA contains no provision that would relieve an investment 
manager of fiduciary liability for any decision it made at the 
direction of another person. The commenter did not indicate whether it 
was requesting a reconsideration of this aspect of the Avon Letter, or 
guidance on different issues or arrangements than considered in the 
Avon Letter. In any event, an evaluation of issues related to the 
direction of a fiduciary investment manager by another person 
implicates provisions of ERISA, including sections 402, 403, and 405, 
that are beyond the scope of this rulemaking.
(2) Paragraph (d)(4)(ii)
    Paragraph (d)(4)(ii) of the proposal described obligations of an 
investment manager of a pooled investment vehicle that holds assets of 
more than one employee benefit plan. The provision provides that an 
investment manager of such a pooled investment vehicle may be subject 
to an investment policy statement that conflicts with the policy of 
another plan. Furthermore, it provided that compliance with ERISA 
section 404(a)(1)(D) requires the investment manager to reconcile, 
insofar as possible, the conflicting policies (assuming compliance with 
each policy would be consistent with ERISA section 404(a)(1)(D)).\83\ 
The provision further stated that, in the case of proxy voting, to the 
extent permitted by applicable law, the investment manager must vote 
(or abstain from voting) the relevant proxies to reflect such policies 
in proportion to each plan's economic interest in the pooled investment 
vehicle. The provision further provided that such an investment manager 
may, however, develop an investment policy statement consistent with 
Title I of ERISA and the regulation, and require participating plans to 
accept the investment manager's investment policy statement, including 
any proxy voting policy, before they are allowed to invest. In such 
cases, a fiduciary must assess whether the investment manager's 
investment policy statement and proxy voting policy are consistent with 
Title I of ERISA and the regulation before deciding to retain the 
investment manager.
---------------------------------------------------------------------------

    \83\ Section 404(a)(1)(D) of ERISA provides that a fiduciary 
must discharge its duties with respect to the plan in accordance 
with the documents and instruments governing the plan insofar as 
such documents are consistent with the provisions of title I and 
title IV of ERISA. Under section 404(a)(1)(D), a fiduciary to whom 
an investment policy applies would be required to comply with such 
policy unless, for example, it would be imprudent to do so in a 
given instance.
---------------------------------------------------------------------------

    The Department received a number of comments indicating generally 
that investment managers of pooled funds would face operational 
challenges in reconciling conflicting proxy voting policies of 
investing plans and voting in a proportional manner, as described in 
the beginning of proposed paragraph (d)(4)(ii). Commenters indicated 
that because of these challenges, most investment managers of pooled 
investments require investing plans to accept the investment manager's 
policy, which is also contemplated in the latter portions of proposed 
paragraph (d)(4)(ii). Some commenters suggested that paragraph 
(d)(4)(ii) could be improved by placing more emphasis on the current 
common practices that do not require proportional voting (i.e., where 
investment managers require plans' acceptance of the managers' proxy 
voting policies prior to investment), and less emphasis on arrangements 
that require proportional voting, which these commenters believe is 
rare.
    Some commenters requested that the Department broaden proposed 
paragraph (d)(4)(ii). One commenter requested modification to address 
the possibility that the responsible named fiduciary may choose to 
retain the authority to vote proxies or to direct an investment manager 
regarding the voting of proxies appurtenant to those plan assets that 
are invested in a pooled investment vehicle. Other commenters requested 
that the Department extend the provision to separately-managed accounts 
that are managed by investment managers. This suggestion appears to be 
based on the common practice of investment managers in single-plan 
separate account arrangements requiring that plans accept the managers' 
proxy voting policy prior to investing.
    Some commenters requested that the final rule address circumstances 
where investment managers have not obtained consent from participating 
plans accepting the manager's investment policy and proxy voting policy 
prior to initial investment. Commenters requested that the Department 
allow an investment manager to rely on a ``negative consent'' 
procedure, such as by sending a written notice stating that plans will 
be deemed to have accepted the investment manager's investment policy 
and proxy voting policy if they continue investing with the investment 
manager after receiving the notice.
    Another commenter suggested that the Department eliminate proposed 
paragraph (d)(4)(ii) in its entirety and revise proposed paragraph 
(d)(4)(i)(B) to explicitly cover investment managers for pooled 
investment vehicles that hold plan assets. According to the commenter, 
proposed paragraph (d)(4)(ii) could result in conflicting or 
misinterpreted regulatory expectations. Similar to commenters discussed 
above, this commenter explained that paragraph (d)(4)(ii) does not 
reflect current industry standard practice followed by investment 
managers for collective investment funds and other pooled investment 
vehicles that hold ERISA plan assets. In particular, it stated that it 
was not aware of any collective investment fund or other pooled 
investment vehicles that did not have their own investment objectives, 
guidelines, and/or policies that must be accepted as a condition for 
investment. The commenter further suggested that if a national bank 
trustee of a collective investment fund, in managing the fund's 
portfolio, attempts ``to reconcile, insofar as possible, the 
conflicting [investment] policies [of plans],'' this may inevitably 
favor some plans over others. The commenter raised the question as to 
whether this may be inconsistent with Office of the Comptroller of the 
Currency expectations regarding that bank's treatment of participants 
in a pooled investment fund.
    The Department is not persuaded to remove paragraph (d)(4)(ii) from 
the

[[Page 73852]]

final rule or make the language changes requested by commenters. 
Paragraph (d)(4)(ii) of the proposal is identical to paragraph 
(e)(4)(ii) of the current regulation, and also is similar to guidance 
relating to pooled investment vehicles that has been consistently part 
of the Department's prior Interpretive Bulletins since 1994. A number 
of the issues raised with respect to paragraph (d)(4)(ii) of the 
proposal, particularly relating to difficulties with proportional 
voting and industry common practices to avoid being subject to 
proportional voting, were also raised by commenters with respect to 
paragraph (e)(4)(ii) of the current regulation but not accepted by the 
Department. As with the current regulation, the Department declines to 
reorder the provisions within paragraph (d)(4)(ii) of the final rule 
solely to put more emphasis on the exception to the proportional voting 
provision. The Department does not interpret the public comments as 
saying that paragraph (d)(4)(ii) of the NPRM is unworkable, but rather 
that the popularity of the exception justifies a reorganization of the 
constituent parts of the paragraph to elevate the prominence of the 
exception to match common industry practice. The organizational 
structure of paragraph (d)(4)(ii) of the final rule intentionally 
begins with the general requirement and is followed by the exception to 
that requirement--a structure which has been in place for approximately 
four decades. The Department believes this structure to be sound and 
logical notwithstanding the current popularity of the exception. In 
addition, with respect to the commenters' more fundamental suggestions 
including eliminating paragraph (d)(4)(ii) in its entirety, the NPRM 
narrowly solicited comments on whether the provision in question should 
be revised to conform more closely to the Department's prior 
guidance.\84\ These more fundamental suggestions are well beyond the 
scope of the solicitation in the NPRM because, if adopted, they would 
cause paragraph (d)(4)(ii) of the final to diverge substantially from 
the prior guidance. Also, as discussed above, issues relating to a 
named fiduciary's direction of an investment manager with respect to 
voting decisions implicate provisions of ERISA beyond the scope of this 
rulemaking. Although the Department declines to extend paragraph 
(d)(4)(ii) of the final rule to include managers of separately managed 
accounts, we note that there is nothing in ERISA that precludes an 
investment manager from requiring a plan fiduciary to accept the 
investment manager's proxy voting policies before agreeing to become a 
plan investment manager. With regard to requests for approval of 
``negative consent'' procedure for adoption of proxy policies by plans 
with current investments in a pooled investment vehicle, the Department 
believes the later applicability date of paragraph (d)(4)(ii) should 
alleviate commenters' concerns.
---------------------------------------------------------------------------

    \84\ 86 FR 57283.
---------------------------------------------------------------------------

(e) Paragraph (d)(5)
    Paragraph (d)(5) of the NPRM provided that the regulation does not 
apply to voting, tender, and similar rights with respect to shares of 
stock that, pursuant to the terms of an individual account plan, are 
passed through to participants and beneficiaries with accounts holding 
such shares. The Department did not receive comments on this provision, 
which is being adopted as proposed. Despite this exclusion, 
participants and beneficiaries are not without ERISA's protections. The 
Department stresses that plan trustees and other fiduciaries must 
comply with ERISA's general statutory duties of prudence and loyalty 
provisions with respect to the pass through of votes to plan 
participants and beneficiaries. In doing so, however, plan fiduciaries 
may continue to rely on the Department's prior guidance with respect to 
such participant-directed voting, including 29 CFR 2550.404c-1 
(implementing ERISA section 404(c)(1) to participant-directed pass-
through voting) and interpretive letters.\85\
---------------------------------------------------------------------------

    \85\ See, e.g., Letter from Deputy Assistant Secretary Lebowitz 
to Thobin Elrod (Feb. 23, 1989); Letter from Assistant Secretary 
Berg to Ian Lanoff (Sept. 28, 1995).
---------------------------------------------------------------------------

5. Section 2550.404a-1(e)--Definitions
    Paragraph (e) of the final rule provides definitions and is 
unchanged from the proposal and current regulation. Under paragraph 
(e)(1) of the final rule, ``investment duties'' means any duties 
imposed upon, or assumed or undertaken by, a person in connection with 
the investment of plan assets which make or will make such person a 
fiduciary of an employee benefit plan or which are performed by such 
person as a fiduciary of an employee benefit plan as defined in section 
3(21)(A)(i) or (ii) of ERISA. Paragraph (e)(2) defines the term 
``investment course of action'' as any series or program of investments 
or actions related to a fiduciary's performance of the fiduciary's 
investment duties and includes the selection of an investment fund as a 
plan investment, or in the case of an individual account plan, a 
designated investment alternative under the plan. Paragraph (e)(3) 
defines ``plan'' to mean an employee benefit plan to which Title I of 
ERISA applies. Finally, under paragraph (e)(4) of the final rule, the 
term ``designated investment alternative'' means any investment 
alternative designated by the plan into which participants and 
beneficiaries may direct the investment of assets held in, or 
contributed to, their individual accounts. The provision further 
provides that the term ``designated investment alternative'' shall not 
include ``brokerage windows,'' ``self-directed brokerage accounts,'' or 
similar plan arrangements that enable participants and beneficiaries to 
select investments beyond those designated by the plan.
6. Section 2550.404a-1(f)--Severability
    Paragraph (f) of the final rule, like paragraph (f) of the proposal 
and paragraph (h) of the current regulation, provides that should a 
court of competent jurisdiction hold any provision of the rule invalid, 
such action will not affect any other provision. Including a 
severability clause describes the Department's intent that any legal 
infirmity found with part of the final rule should not affect any other 
part of the rule.
7. Section 2550.404a-1(g)--Applicability Date
    The proposed rule did not include an applicability date provision. 
Some commenters requested that the Department provide a prospective 
applicability date for all recent changes to the regulation (including 
both changes made in 2020 as well as amendments to the current 
regulation made today by the final rule) that is no earlier than the 
date that would be one year after the Department's publication of this 
final rule in the Federal Register. The commenters indicated that plan 
sponsors, investment managers, proxy advisory firms, and other 
fiduciaries need adequate time to, as necessary, review and modify 
their policies, procedures, and practices to conform to the final 
rule's requirements.
    Some commenters also specifically suggested a need for transition 
relief or a delayed applicability date with respect to the proxy voting 
provisions. One commenter requested that the Department retain and 
extend the delayed applicability date of certain requirements of the 
regulation as set forth in paragraph (g)(3) of the current regulation. 
In general, that provision delayed until January 31, 2022, the 
applicability of the requirements of paragraphs (e)(2)(ii)(D) 
(evaluation of

[[Page 73853]]

material facts that form the basis of a vote), (e)(2)(ii)(E) 
(maintenance of proxy voting records), (e)(2)(iv) (prohibition against 
adopting practice of following proxy advisory firm recommendations 
without determination that firm's voting guidelines consistent with 
requirements of regulation), and (e)(4)(ii) (responsibilities of 
investment managers to pooled investment vehicles holding plan assets) 
of the current regulation.\86\ The commenter noted that investment 
managers to pooled investment vehicles may have delayed their 
implementation efforts due to the announcement in March 2021 of the 
Department's enforcement policy. Others pointed to difficulties faced 
by investment managers in assuring that investing plans had adequately 
adopted manager's proxy voting policies as required under paragraph 
(d)(4)(ii).
---------------------------------------------------------------------------

    \86\ Fiduciaries that are investment advisers registered with 
the SEC were not able to take advantage of the delayed applicability 
of paragraphs (e)(2)(ii)(D) and (E). See 85 FR 81676.
---------------------------------------------------------------------------

    After consideration of the comments, the Department has decided to 
provide a general applicability date of 60 days after publication in 
the Federal Register, but to delay applicability of certain provisions 
of the final rule's proxy voting provisions until 1 year after the date 
of publication. The Department is persuaded that a delayed 
applicability of paragraph (d)(4)(ii) of the final rule is appropriate 
as it gives fiduciaries of plans invested in pooled investment vehicles 
additional time for reviewing any proxy voting policies of the 
investment vehicle's investment manager; and also provides investment 
managers additional time to determine whether investing plans have 
adequately adopted their proxy voting policies, as well as assessing 
and reconciling, insofar as possible, any conflicting policies. The 
Department also believes it appropriate to delay application of 
paragraph (d)(2)(iii) to give additional time to plan fiduciaries to 
review proxy voting guidelines of proxy advisory firms and make any 
necessary changes in their arrangements with such firms. The Department 
is providing for a delay of one year as requested by commenters. The 
Department's March 10, 2021, enforcement statement continues to apply 
with respect to paragraphs (d)(2)(iii) and (d)(4)(ii) until the delayed 
applicability date.
    Thus, paragraph (g)(1) provides that except for paragraphs 
(d)(2)(iii) and (d)(4)(ii), the final rule will apply in its entirety 
to all investments made and investment courses of action taken after 
January 30, 2023. Paragraph (g)(2) provides that paragraphs (d)(2)(iii) 
and (d)(4)(ii) of the final rule will apply on December 1, 2023.
8. Miscellaneous
(a) Constitutional Concerns
    A few commenters argue that the proposed rule violates the U.S. 
Constitution. These commenters contend that the proposal is 
unconstitutional because permitting fiduciaries to base their 
investment decisions on any non-pecuniary factors cannot be consistent 
with ERISA and thus rewrites the statute, which is the sole 
responsibility of Congress. As a result, they argue that the Department 
violates the separation of powers imposed by the Constitution.
    The Department does not agree that the final rule rewrites ERISA or 
violates the Constitution. Congress has given the Secretary of Labor 
authority to promulgate regulations that interpret and fill up the 
details in the fiduciary duties under ERISA section 404, including the 
duties of prudence and loyalty.\87\ The Department here interprets 
those duties to protect plan participants' financial benefits and 
strictly prohibits any other goal from subordinating their interests in 
those benefits. Nothing in the final rule permits a fiduciary, outside 
of a tiebreaker situation, to base investment decisions on factors 
irrelevant to a risk and return analysis. The Secretary has maintained 
these fundamental interpretive principles in its guidance, referenced 
earlier in this preamble, since 1980 and its first comprehensive 
guidance in 1994. Moreover, the principles stated in the proposed and 
final rule, including the tiebreaker, were fundamental aspects of that 
guidance.
---------------------------------------------------------------------------

    \87\ See 29 U.S.C. 1135 (providing that ``the Secretary may 
prescribe such regulations as he finds necessary or appropriate to 
carry out the provisions of this subchapter'').
---------------------------------------------------------------------------

(b) Administrative Procedure Act
    In addition, some commenters asserted that the proposed rule was 
arbitrary and capricious and thus violated the Administrative Procedure 
Act (APA). The Department is of the view that the final rule comports 
with the APA.
    Several commenters claimed that the NPRM did not engage in reasoned 
decision-making, did not look at all aspects of the problem, and did 
not properly consider the costs to participants and beneficiaries. 
These commenters, for instance, characterized the NPRM as arbitrarily 
and capriciously focused on clarifying that ERISA permits ESG 
considerations in plan investments at the expense of protecting 
participants from ESG investing ``run amok'' or violations of ERISA's 
duty of loyalty. One commenter contended that the NPRM was more a 
political action taken because of the popularity of ESG investing 
rather than a reflection of the current administration's concern about 
a problem to be addressed. Another commenter espoused that the 
Department's real agenda was to encourage ESG investing. Yet another 
asserted that the only reason this rule was being promulgated was 
because of an Executive order.\88\ And another commenter contended that 
it could not give input on the Department's view of how its rule 
promotes retiree welfare, because, the commenter states, the agency 
gives no reasoning on this point.
---------------------------------------------------------------------------

    \88\ E.O. 14030, 86 FR 27967 (May 25, 2021).
---------------------------------------------------------------------------

    The Department disagrees with these contentions. The final rule 
repeatedly emphasizes that the Department's purpose is to remedy the 
chilling effect of certain aspects of the 2020 rule and preamble on the 
consideration of ESG factors. As stated above, the final rule allows 
such factors to influence investment decisions only when relevant to a 
risk and return analysis or when used as a tiebreaker. By tying the 
final rule to the statutory language and to the fact that ESG factors 
may, in some circumstances, affect both returns and risk, the 
Department has engaged in the essence of reasoned decisionmaking. 
Moreover, the fact that ESG investing has increased in popularity is 
another reason why fiduciaries need a clarifying rule and why the 
Department is promulgating one. This would be the case even if the 
President had never issued Executive Orders 13990 and 14030. The final 
rule also emphatically addresses potential loyalty breaches by 
forbidding subordination of participants' financial benefits under the 
plan to ESG or any other goal and, likewise, by prohibiting fiduciaries 
from sacrificing investment return or taking on additional investment 
risk to promote benefits or goals unrelated to interests of 
participants and beneficiaries in their retirement or financial 
benefits under the plan.
    A few commenters stated that the NPRM effectively placed a ``heavy 
thumb'' on the scale in favor of ESG factors and ignored other options, 
such as a policy statement or interpretive guidance. At least one 
commenter also claimed that the NPRM was trying to address a problem 
that does not exist. The Department has explained its reasons for 
amending the current regulation, including the chilling effect

[[Page 73854]]

caused by, for example, its explicit documentation requirements for 
investments and the exercising of shareholder rights, and its 
restrictions on QDIAs, as discussed earlier in this preamble. The 
Department determined and received confirmation in public comments that 
features such as these, combined with the overall chilling tone of the 
current regulation (including its preamble) as it relates to 
financially beneficial ESG considerations, rendered interpretive 
guidance under the current regulation insufficient. Rather than placing 
a thumb on the scale, the final rule removes the current regulation's 
thumb against ESG strategies. It does this by simply clarifying that 
ESG factors may be relevant to a risk and return analysis to the same 
extent as any other relevant factor.
    Many commenters expressed concerns that the NPRM language, as one 
put it, ``imposes a de facto mandate'' on retirement plan fiduciaries 
to consider ESG factors and declares that such a presumption would be 
arbitrary and capricious. The commenters referenced paragraph 
(b)(2)(ii)(C) of the NPRM stating that the consideration of the 
projected return of the portfolio relative to the plan's funding 
objectives ``may often require'' an evaluation of the economic effects 
of climate change and other ESG factors. As explained earlier in this 
preamble, in response to these comments, the Department recognizes that 
the language as drafted created a misimpression of its intent and has 
modified the provision to eliminate the ``may often require'' language 
altogether.
    At least three commenters took issue with the NPRM's use of the 
term ``ESG''. They contended that the NPRM failed to define ``ESG'' 
factors and that the term ``ESG'' was too imprecise to serve as a basis 
for a regulatory standard. Commenters, citing to the November 2020 
preamble statement that the term ``was not a clear or helpful lexicon 
for a regulatory standard,'' claimed the Department changed its 
position without acknowledging it. One commenter contended that a more 
precise definition was especially important given the perceived ``de 
facto mandate'' in the NPRM. Use of the term ESG in the NPRM was not 
intended to create a regulatory mandate or standard for compliance, and 
as stated above, the ``may often require'' provision has been removed 
in the final rule. Rather, it was the Department's intent to clarify 
that ESG factors are no different than other non-ESG relevant risk-
return factors. Consequently, the final rule does not define ESG 
because the precision of terminology is less important than the 
Department's fundamental premise that fiduciaries may consider ESG 
factors--irrespective of the definition of the term ``ESG''--when they 
are relevant to a risk-return analysis to the same extent as any other 
relevant factor.
    One commenter expressed an opinion about the Department's position 
on negative screening which the commenter defines as excluding certain 
types of investments from a portfolio based on non-economic or non-
pecuniary reasons. The commenter states that the NPRM, if adopted, 
would change a Departmental position against negative screening, 
without considering a serious reliance interest on the prior position. 
The commenter is correct that when promulgating a change in policy, the 
Department must consider serious reliance interests in a prior policy. 
The Department never has posited, however, that ERISA imposes a blanket 
bar against all forms of exclusionary investments. The two Department 
of Labor (DOL) letters the commenter cites comport. They state that the 
exclusionary investment first required ``an economic analysis of 
economic consequences'' of the exclusion,\89\ or put another way, a 
``consideration of the economic and financial merit.'' \90\ Both the 
NPRM and the final rule are fully consistent and in fact reinforce the 
position in these letters. Further, as stated in the preamble of the 
NPRM, the Department long has acknowledged, since the publication of 
those letters, the potential risk and return attributes of ESG criteria 
in fiduciary investment decisionmaking and portfolio construction. 
Thus, there is no change of position in this regard and no reliance 
interest on any former position to address.
---------------------------------------------------------------------------

    \89\ Letter to the Honorable Howard M. Metzenbaum from Assistant 
Secretary Dennis Kass (May 27, 1986).
    \90\ Letter to Daniel O'Sullivan from Jeffrey Clayton (Aug. 2, 
1982).
---------------------------------------------------------------------------

    Another commenter stated that the Department has not acknowledged 
or considered the cost of the risk of ``channeling'' plan assets into 
ESG investments given the concerns of misrepresentation highlighted by 
staff of Division of Examinations of the SEC in its April 2021 Risk 
Alert on ESG investing. The commenter concluded that the Department's 
NPRM, if adopted, would be arbitrary and capricious, in part, because 
of its failure to acknowledge the profound effect of the risk of 
misrepresentation. This final rule is not intended to channel assets 
into any particular type of investment. Rather, the intent of the final 
rule is simply to remove barriers to the fiduciary's consideration of 
all financially relevant factors, which may include ESG, as part of a 
prudent and loyal process of investment decisionmaking. The Department 
anticipates that fiduciaries will give careful consideration in a 
meaningful comparison and selection process of ESG investments just as 
they do with any other type of investment.
    The Department also disagrees with the comment that it prejudged 
the outcome of this rule. Offering a proposed solution to a problem is 
the foundation of notice and comment rulemaking. Under the APA, 
policymakers are required to solicit comments on the problem and its 
proposed solution and to adequately review those comments in the 
development of the final rule. The changes made to the NPRM in this 
final rule demonstrate that the Department has not prejudged the rule's 
outcome. Substantive changes in response to public comments include the 
elimination of the language that the evaluation of investments ``may 
often require'' consideration of ESG factors, the elimination of the 
list of ESG examples from the regulatory text, and removal of the 
collateral benefit disclosure requirement.
    Some commenters added that the Department failed to identify which 
investors the 2020 rule confused and did not produce data showing that 
consideration of ESG factors will sustain or increase plan returns--
returns one commenter called ``phantom benefits.'' As amply explained 
in both the NPRM preamble and here, and as reflected by the 
Department's longstanding Investment Duties regulation, ensuring that 
determinations are based on relevant risk and return factors, which may 
include the economic effects of climate change and other ESG factors, 
will serve the retirement participants and beneficiaries' financial 
interests. The Department believes, and many commenters confirmed, the 
current regulation causes an unwanted chilling effect on the use of 
climate change and other ESG factors, and therefore is a barrier to 
that consideration. The Department is not required to produce a record 
of extensive and detailed data showing the extent to which ESG 
considerations will grow retirement accounts. The final rule does not 
require fiduciaries to consider ESG factors to a different extent than 
any other factors that the fiduciary reasonably determines are relevant 
to a risk and return analysis. Nor does the APA require the Department 
to specifically identify investors who were confused by or chilled by 
the current regulation. As

[[Page 73855]]

previously stated, many commenters--whose identity is public--indicated 
this concern.
    Multiple commenters also questioned the quantitative support for 
the Department's position. For instance, some commenters contended that 
the Department's claims about climate change were unsubstantiated. The 
Department believes it has made reasonable efforts to quantify all 
aspects of the final rule, and their potential effects, for which data 
is available. The Department also notes that efforts have been made to 
qualitatively address those areas where the Department is unable to 
adequately derive quantitative assessments. Further, the preamble to 
this final rule (as well as the proposed rule) adequately cites to 
research supporting the Department's views. Responses to these and 
related additional comments are discussed later in the Regulatory 
Impact Analysis (RIA) section of this preamble.
    Finally, one commenter asserts Chevron deference does not apply to 
the NPRM because, if adopted, it would be a ``major question'' in the 
sense that it would constitute a ``decision of vast political and 
economic significance'' and ``in the realm of climate.'' The final rule 
does not represent one of the rare ``extraordinary cases'' for which 
the major questions doctrine compels a ``different approach'' to 
analyzing agency authority.\91\ Indeed, far from representing a 
``transformative expansion in [the agency's] regulatory authority,'' 
\92\ the Department has for decades issued guidance addressing how 
fiduciaries, compliant with ERISA's prudence and loyalty duties, may or 
may not incorporate various factors into investment and shareholder 
rights decisions. And even if the major questions doctrine did apply, 
Congress has provided clear authorization to issue the final rule, 
including by authorizing the Secretary to ``prescribe such regulations 
as he finds necessary or appropriate to carry out the provisions of'' 
the subchapter encompassing fiduciary responsibilities.\93\
---------------------------------------------------------------------------

    \91\ West Virginia v. EPA, 142 S. Ct. 2587, 2608 (2022) (quoting 
FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 159 (2000)).
    \92\ Id. (quoting Utility Air Regul. Grp. v. EPA, 573 U.S. 302, 
324 (2014)).
    \93\ 29 U.S.C. 1135.
---------------------------------------------------------------------------

    Finally, as stated in the NPRM, this final rule does not undermine 
serious reliance interests on the part of fiduciaries selecting 
investments and investment courses of action or exercising shareholder 
rights.\94\ This final rule does not upend longstanding standards 
governing the selection of investments and investment courses of action 
or the exercise of shareholder rights. Instead, it addresses new 
policies included in a recently promulgated regulation. Further, the 
Department stayed its enforcement of the current regulation shortly 
after its effective date and before all portions were applicable. 
Consequently, the Department concludes any serious reliance interest in 
the changes introduced by the current regulation in 2020 is unlikely 
and does not outweigh the Department's good reasons for change.
---------------------------------------------------------------------------

    \94\ 85 FR 57272, 57283 (Oct. 14, 2021).
---------------------------------------------------------------------------

IV. Regulatory Impact Analysis

    This section of the preamble analyzes the regulatory impact of the 
final rule in 29 CFR 2550.404a-1. As explained earlier in this 
preamble, the final rule clarifies the legal standard imposed by 
sections 404(a)(1)(A) and 404(a)(1)(B) of ERISA with respect to the 
selection of a plan investment or, in the case of an ERISA section 
404(c) plan or other individual account plan, a designated investment 
alternative under the plan, and with respect to the exercise of 
shareholder rights, including proxy voting.
    The primary benefit of the final rule is to clarify legal standards 
and prevent confusion among stakeholders. The Department has heard from 
stakeholders that the current regulation, and investor confusion 
related to the regulation, has had a chilling effect on appropriate use 
of climate change and other ESG factors in investment decisions, even 
in circumstances allowed by the current regulation. Based on 
stakeholder feedback, the Department has determined that aspects of the 
current regulation could deter plan fiduciaries from: (a) taking into 
account climate change and other ESG factors when they are relevant to 
a risk and return analysis, and (b) engaging in proxy voting and other 
exercises of shareholder rights when doing so is in the plan's best 
interest. If these concerns with the current regulation were left 
unaddressed, the regulation would have (a) a negative impact on plans' 
financial performance as they avoid using climate change and other ESG 
considerations in investment analysis even when directly relevant to 
the financial merits of the investment, and (b) a negative impact on 
plans' financial performance as they shy away from proxy votes and 
shareholder engagement activities that are economically relevant. The 
final rule's clarification of the relevant legal standards is intended 
to address these negative impacts.
    The final rule provides cost savings by eliminating the current 
regulation's special documentation provisions pertaining to the 
tiebreaker and eliminating its proxy voting safe harbors. In the impact 
analysis for the current regulation, the Department had estimated that 
these provisions would impose a regulatory burden. Other benefits 
include clarifying the tiebreaker standard and clarifying the standards 
governing QDIAs. All benefits of the amendments are discussed below in 
section IV.D. As discussed in section IV.E, the final rule will impose 
costs; however, the costs are expected to be relatively small. Overall, 
the Department anticipates that the final rule's benefits justify its 
costs.
    The Department has examined the effects of this final rule as 
required by Executive Order 12866,\95\ Executive Order 13563,\96\ the 
Congressional Review Act,\97\ the Paperwork Reduction Act of 1995,\98\ 
the Regulatory Flexibility Act,\99\ section 202 of the Unfunded 
Mandates Reform Act of 1995,\100\ and Executive Order 13132.\101\
---------------------------------------------------------------------------

    \95\ Regulatory Planning and Review, 58 FR 51735 (Oct. 4, 1993).
    \96\ Improving Regulation and Regulatory Review, 76 FR 3821 
(Jan. 21, 2011).
    \97\ 5 U.S.C. 804(2) (1996).
    \98\ 44 U.S.C. 3506(c)(2)(A) (1995).
    \99\ 5 U.S.C. 601 et seq. (1980).
    \100\ 2 U.S.C. 1501 et seq. (1995).
    \101\ Federalism, 64 FR 43255 (Aug. 10, 1999).
---------------------------------------------------------------------------

A. Executive Orders 12866 and 13563

    Executive Orders 12866 and 13563 direct agencies to assess all 
costs and benefits of available regulatory alternatives and, if 
regulation is necessary, to select regulatory approaches that maximize 
net benefits (including potential economic, environmental, public 
health, and safety effects; distributive impacts; and equity). 
Executive Order 13563 emphasizes the importance of quantifying costs 
and benefits, reducing costs, harmonizing rules, and promoting 
flexibility.
    Under Executive Order 12866, ``significant'' regulatory actions are 
subject to review by the Office of Management and Budget (OMB). Section 
3(f) of the Executive order defines a ``significant regulatory action'' 
as an action that is likely to result in a rule (1) having an annual 
effect on the economy of $100 million or more, or adversely and 
materially affecting a sector of the economy, productivity, 
competition, jobs, the environment, public health or safety, or state, 
local, or tribal governments or communities (also referred to as 
``economically significant''); (2) creating a serious inconsistency or 
otherwise interfering with an action taken or planned by

[[Page 73856]]

another agency; (3) materially altering the budgetary impacts of 
entitlement grants, user fees, or loan programs or the rights and 
obligations of recipients thereof; or (4) raising novel legal or policy 
issues arising out of legal mandates, the President's priorities, or 
the principles set forth in the Executive order. OMB has determined 
that this final rule is economically significant within the meaning of 
section 3(f)(1) of Executive Order 12866. Given the large scale of 
investments held by covered plans, approximately $12.0 trillion, 
changes in investment decisions and/or plan performance may result in 
changes in returns in excess of $100 million in a given year.\102\ 
Therefore, below the Department provides an assessment of the potential 
costs, benefits, and transfers associated with the final rule.
---------------------------------------------------------------------------

    \102\ EBSA projected ERISA covered pension, welfare, and total 
assets based on the 2020 Form 5500 filings with the U.S. Department 
of Labor (DOL), reported SIMPLE assets from the Investment Company 
Institute (ICI) Report: The U.S. Retirement Market, Second Quarter 
2022, and the Federal Reserve Board's Financial Accounts of the 
United States Z1 September 9, 2022.
---------------------------------------------------------------------------

B. Introduction and Need for Regulation

    In late 2020, the Department published two final rules dealing with 
the selection of plan investments and the exercise of shareholder 
rights, including proxy voting. The Department intended to provide 
clarity and certainty to plan fiduciaries regarding their legal duties 
under ERISA section 404 in connection with making plan investments and 
for exercising shareholder rights. The Department was also concerned 
that some investment products may be marketed to ERISA fiduciaries 
based on purported benefits and goals unrelated to financial 
performance.
    Before issuing the 2020 regulation, the Department had periodically 
issued guidance pertaining to the application of ERISA's fiduciary 
rules to plan investment decisions that are based, in whole or part, on 
factors unrelated to financial performance. This nonregulatory guidance 
consisted of varied statements that led to confusion. Accordingly, the 
2020 regulation was intended to provide clarity and certainty regarding 
the scope of fiduciary duties surrounding such issues.
    Responses to the 2020 rules, however, suggest that they may have 
inadvertently caused more confusion than clarity. Many stakeholders 
told the Department that the terms and tone of the final rules and 
preambles increased concerns and uncertainty about the extent to which 
plan fiduciaries may consider climate change and other ESG factors in 
their investment decisions, and that the 2020 rules had chilling 
effects that would tend to deter consideration of ESG factors and that 
were contrary to the interests of participants and beneficiaries. 
Consequently, on March 10, 2021, the Department announced that it would 
stay enforcement of the 2020 rules pending a complete review of the 
matter. Subsequently, on May 20, 2021, the President issued Executive 
Order 14030, entitled ``Executive Order on Climate-Related Financial 
Risk.'' Section 4 of the Executive order directs the Department to 
consider suspending, revising, or rescinding any rules from the prior 
administration that would have barred plan fiduciaries (and their 
investment-firm service providers) from considering climate change and 
other ESG factors in their investment decisions related to workers' 
pensions.\103\ In light of the foregoing confusion among stakeholders, 
the Department concluded that additional notice and comment rulemaking 
was necessary to safeguard the interests of participants and 
beneficiaries in their retirement and welfare plan benefits.
---------------------------------------------------------------------------

    \103\ See White House Fact Sheet titled FACT SHEET: President 
Biden Directs Agencies to Analyze and Mitigate the Risk Climate 
Change Poses to Homeowners and Consumers, Businesses and Workers, 
and the Financial System and Federal Government Itself (May 20, 
2021) (stating, ``The Executive Order directs the Labor Secretary to 
consider suspending, revising, or rescinding any rules from the 
prior administration that would have barred investment firms from 
considering environmental, social and governance factors, including 
climate-related risks, in their investment decisions related to 
workers' pensions.'').
---------------------------------------------------------------------------

    The baseline for purposes of the analysis is a future in which the 
current regulations are implemented. The baseline does not take into 
account the fact that the Department stayed enforcement of the current 
regulations pursuant to the March 10, 2021, enforcement policy, which 
was after their effective date in January 2021 but before their full 
applicability date.\104\
---------------------------------------------------------------------------

    \104\ U.S. Department of Labor Statement Regarding Enforcement 
of its Final Rules on ESG Investments and Proxy Voting by Employee 
Benefit Plans (Mar. 10, 2021), available at www.dol.gov/sites/dolgov/files/ebsa/laws-and-regulations/laws/erisa/statement-on-enforcement-of-final-rules-on-esg-investments-and-proxy-voting.pdf.
---------------------------------------------------------------------------

C. Affected Entities

    The clarifications in the final rule will affect subsets of ERISA-
covered plans and their participants and beneficiaries. The subset of 
plans affected by the proposed modifications of paragraphs (b) and (c) 
of Sec.  2550.404a-1 include those plans whose fiduciaries consider or 
will begin considering climate change and other ESG factors when 
selecting investments and the participants in those plans. Based on the 
sources below, the Department estimates that about 20 percent of plans 
will be affected by this final rule.
    Another subset of affected plans includes ERISA-covered plans 
(pension, health, and other welfare) that hold shares of corporate 
stock. This subset of plans will be affected by the proposed 
modifications to paragraph (d) (relating to proxy voting) of Sec.  
2550.404a-1. Some plans will be in both subsets, some in only one 
subset, and some in neither. There is substantial uncertainty about the 
number and size of affected plans.
1. Subset of Plans Affected by Proposed Modifications of Paragraphs (b) 
and (c) of Sec.  2550.404a-1
    The Department estimates that 20 percent of plans, both defined 
contribution (DC) and defined benefit (DB), will be affected by the 
proposed modifications of paragraphs (b) and (c) of Sec.  2550.404a-1 
because their fiduciaries consider or will begin considering climate 
change or other ESG factors when selecting investments. The 
administrative data and surveys relied upon for this estimate are 
discussed below.
    According to a survey by the NEPC, LLC (2018), approximately 12 
percent of private pension plans (both DB and DC) have adopted ESG 
investing.\105\ A survey conducted by the Callan Institute (2021), 
which included a greater share of DB plans, found that about 20 percent 
of private sector pension plans consider ESG factors in investment 
decisions.\106\ In a comment letter on the NPRM, Morningstar estimates 
that approximately 36 percent of large plans (with at least 100 
participants) use ESG information to consider their investments. Their 
analysis is based on whether a fund's prospectus references considering 
ESG information when selecting securities. It includes both DB and DC 
plans.
---------------------------------------------------------------------------

    \105\ Brad Smith and Kelly Regan, NEPC ESG Survey: A Profile of 
Corporate & Healthcare Plan Decisionmakers' Perspectives, NEPC (Jul. 
11, 2018), https://cdn2.hubspot.net/hubfs/2529352/files/2018%2007%20NEPC%20ESG%20Survey%20Results%20.pdf.
    \106\ 2021 ESG Survey, Callan Institute (2021), https://www.callan.com/e508ca6d-4014-4c99-b0aa-9fb15170bb18.
---------------------------------------------------------------------------

    To focus on ESG investing by participant-directed defined 
contribution plans, the Department draws from several sources. 
According to the Plan Sponsor Council of America (PSCA, 2021), about 5 
percent of 401(k) and/or profit-sharing ERISA plans offered at least 
one ESG-themed

[[Page 73857]]

investment option in 2020.\107\ The PSCA survey was cited by several 
commenters on the NPRM. NEPC (2022) surveyed DC plans, the vast 
majority of which were in the private sector, and found that 6 percent 
of DC plans in 2020 had at least one fund labeled as ``socially 
responsible'' or ``ESG.'' \108\ Vanguard's administrative data for 2021 
indicated that approximately 13 percent of DC plans offered one or more 
``socially responsible'' funds.\109\ Moreover, about 30 percent of 
participants were offered at least one ``socially responsible'' fund, 
and of those participants, 6 percent were using these funds. In a 
comment letter received on the 2020 NPRM Financial Factors in Selecting 
Plan Investments, Fidelity Investments reported that approximately 14.5 
percent of corporate DC plans with fewer than 50 participants offered 
an ESG option, and that the figure is higher for large plans with at 
least 1,000 participants.
---------------------------------------------------------------------------

    \107\ 64th Annual Survey of Profit Sharing and 401(k) Plans, 
Plan Sponsor Council of America (2021).
    \108\ NEPC 2021 Defined Contribution Plan Trends and Fee Survey 
Results, NEPC (February 2022).
    \109\ How America Saves 2022, Vanguard (June 2022), https://institutional.vanguard.com/content/dam/inst/vanguard-has/insights-pdfs/22_TL_HAS_FullReport_2022.pdf.
---------------------------------------------------------------------------

    While survey and administrative data is the best information 
available, it is not perfect. For instance, a plan fiduciary responding 
to a survey likely bases their answer on whether the plan offers an 
investment with a name indicating it is a ``sustainable'' fund or with 
advertising emphasizing that it pursues ESG. If the plan offers a fund 
that does not have these characteristics, even if the asset manager 
factors in ESG information, the plan fiduciary may not be aware of this 
and would respond to a survey by saying the plan does not consider any 
ESG factors. To the degree this situation occurs, it would lead to 
survey data that underestimate the consideration of ESG factors.
    It is also likely that ESG investing will increase in the future. 
Many of the sources above show increases in ESG investing in recent 
years, and a trend towards ESG investing has also been observed in the 
wider universe of all investors. A study from Morningstar (2021) shows 
that between 2018 and 2020, assets under management in sustainable 
funds increased over three hundred percent.\110\ Additionally, U.S. SIF 
(2020) estimates that U.S.-domiciled assets under management using 
sustainable investing strategies reached $17.1 trillion at the start of 
2020, an increase of 42 percent since 2018.\111\ The Deloitte Center 
for Financial Services (2020) estimates that assets under management 
with mandates related to ESG factors could comprise half of all 
professionally managed investments in the U.S. by 2025. This study also 
finds investment managers are likely to launch up to 200 new ESG funds 
by 2023, more than double the activity in the previous three 
years.\112\
---------------------------------------------------------------------------

    \110\ Morningstar, ``Sustainable Funds U.S. Landscape Report: 
More Funds, More Flows, and Impressive Returns in 2020'' (February 
10, 2021), https://www.morningstar.com/lp/sustainable-funds-landscape-report.
    \111\ US SIF, ``US SIF Trends Report Executive Summary: Report 
on US Sustainable and Impact Investing Trends 2020,'' https://www.ussif.org/files/US%20SIF%20Trends%20Report%202020%20Executive%20Summary.pdf.
    \112\ Sean Collins and Kristen Sullivan, ``Advancing 
Environmental, Social, and Governance Investing: A Holistic approach 
for Investment Management Firms'' (February 2020), https://www2.deloitte.com/us/en/insights/industry/financial-services/esg-investing-performance.html.
---------------------------------------------------------------------------

    The Department received several comments and resources exploring 
the perception of ESG investing from investors. A survey of individual 
investors by the Morgan Stanley Institute for Sustainable Investing 
(2019) finds that 85 percent of investors overall, and 95 percent of 
millennial investors, are interested in sustainable investing. About 88 
percent of all surveyed investors are ``very'' or ``somewhat'' 
interested in pursuing sustainable investing in 401(k) plans.\113\ A 
survey of consumers between ages 45 and 75 by Schroders (2021) found 
that 90 percent said that ``they invested in ESG options when they were 
aware of their availability in their DC plan.'' Of those who said their 
plans did not offer ESG investment options or did not know, 69 percent 
said they would increase their overall contribution rate if they were 
offered an ESG option.\114\ A survey conducted by CNBC (2021) finds 
that ``about one-third of millennials often or exclusively use 
investments that take ESG factors into account, compared to 19 percent 
of Gen Z, 16 percent of Gen X, and 2 percent of Baby Boomers.'' \115\ A 
study by Natixis finds that ``7 in 10 individual investors believe it 
is important to make a positive social impact through their 
investments.'' \116\
---------------------------------------------------------------------------

    \113\ Morgan Stanley Institute for Sustainable Investing, 
``Sustainable Signals: Individual Investor Interest Driven by 
Impact, Conviction, and Choice'' (2019), https://www.morganstanley.com/pub/content/dam/msdotcom/infographics/sustainable-investing/Sustainable_Signals_Individual_Investor_White_Paper_Final.pdf.
    \114\ Schroders, ``Schroders US Retirement Survey Results--
2021,'' https://www.schroders.com/en/us/defined-contribution/dc/retirement-survey-2021.
    \115\ Alicia Adamczyk, ``Millennials Spurred Growth in 
Sustainable Investing for Years. Now All Generations are Interested 
in ESG Options,'' CNBC (May 2021), https://www.cnbc.com/2021/05/21/millennials-spurred-growth-in-esg-investing-now-all-ages-are-on-board.html.
    \116\ Natixis, ``ESG Investing Survey: Investors Want the Best 
of Both Worlds,'' (2019), https://www.im.natixis.com/us/research/esg-investing-report-2019.
---------------------------------------------------------------------------

    These studies suggest that investor demand for ESG is strong and is 
poised to increase, given the preferences of younger investors. Taking 
into account likely future growth, the Department's best estimate of 
the share of plans that will be affected by the final rule is 20 
percent. This is an increase from the 11 percent estimate in the NPRM; 
the Department increased the estimate based on updated data, comment 
letters, and to account for future growth. This is an overall estimate, 
and it is unclear how the share affected may vary between DB and DC 
plans. An estimate of 20 percent of plans means that approximately 
149,300 plans will be affected.\117\ The Department estimates that more 
than 28.5 million participants belong to plans that will be 
affected.\118\ The proportion of plan assets actually invested in ESG 
options, however, may be much less than 20 percent; the PSCA survey 
indicates that the average participant-directed DC plan has 
approximately 0.03 percent of its assets invested in ESG funds in 
2020.\119\
---------------------------------------------------------------------------

    \117\ This estimate is calculated as: 20% x 746,610 pension 
plans = 149,322 pension plans, rounded to 149,300. (Source Private 
Pension Plan Bulletin: Abstract of 2020 Form 5500 Annual Reports, 
Employee Benefits Security Administration (2022; forthcoming), Table 
B1.)
    \118\ Id. This estimate is calculated as: 20% x 142.3 = 28.5 
million total participants.
    \119\ 64th Annual Survey of Profit Sharing and 401(k) Plans, 
Plan Sponsor Council of America (2021).
---------------------------------------------------------------------------

2. Subset of Plans Affected by the Modifications to Paragraph (d) of 
Sec.  2550.404a-1
    The final rule, at paragraph (d), will codify longstanding 
principles of prudence and loyalty applicable to the exercise of 
shareholder rights, including proxy voting, the use of written proxy 
voting policies and guidelines, and the selection and monitoring of 
proxy advisory firms. In particular, paragraph (d) of the final rule 
will adopt the Department's longstanding position, which was first 
issued in guidance in the 1980s, that the fiduciary act of managing 
plan assets includes the management of voting rights (as well as other 
shareholder rights) appurtenant to shares of stock. Paragraph (d) of 
the final rule also eliminates the two safe harbors from paragraphs 
(d)(3)(i)(A) and (B) of Sec.  2550.404a-1.
    Under paragraph (d) of the final rule, when deciding whether to 
exercise shareholder rights and how to exercise

[[Page 73858]]

such rights, including the voting of proxies, fiduciaries must carry 
out their duties prudently and solely in the interests of the 
participants and beneficiaries and for the exclusive purpose of 
providing benefit to participants and beneficiaries and defraying the 
reasonable expenses of administering the plan. An assessment of 
affected parties follows, but the Department believes that the estimate 
of affected plans is likely an overestimate.
    Paragraph (d) of the final rule will affect ERISA-covered pension, 
health, and other welfare plans that hold shares of corporate stock. It 
will affect plans with respect to stocks that they hold directly, as 
well as with respect to stocks they hold through ERISA-covered 
intermediaries, such as common trusts, master trusts, pooled separate 
accounts, and 103-12 investment entities. Paragraph (d) will not affect 
plans with respect to stock held through registered investment 
companies, such as mutual funds, because it will not apply to such 
funds' internal management of such underlying investments. Paragraph 
(d) of the final rule also will not apply to voting, tender, and 
similar rights with respect to securities that are passed through 
pursuant to the terms of an individual account plan to participants and 
beneficiaries with accounts holding such securities.
    ERISA-covered plans annually report data on their asset holdings. 
However, only plans that file the Form 5500 schedule H report their 
stock holdings as a separate line item (see Table 1). Most plans filing 
schedule H have 100 or more participants (large plans).\120\ All plans 
with employer stock report their holdings on either schedule H or 
schedule I. However, schedule I lacks the specificity to determine if 
small plans hold employer stock or other employer securities. 
Approximately 25,900 defined contribution plans and 4,600 defined 
benefit plans, with approximately 83.6 million participants, filed the 
schedule H in 2020 and report holding common stocks or are an Employee 
Stock Ownership Plan (ESOP). Additionally, 518 health and other welfare 
plans file the schedule H and report holding common stocks either 
directly or indirectly. In total, pension plans and welfare plans 
filing schedule H hold approximately $2.4 trillion in common stock 
value. Common stocks constitute about 28 percent of total assets of 
those pension plans that are not ESOPs and hold common stock. Out of 
the 24,100 pension plans that hold common stock and are not ESOPs, 
about 19,300 plans hold common stock through an ERISA-covered 
intermediary and approximately 3,300 plans hold common stock directly. 
A smaller number of plans hold stock both directly and indirectly.\121\ 
In total, information is available on approximately 30,500 pension 
plans, welfare plans, and ESOPs that hold either common stock or 
employer stock.
---------------------------------------------------------------------------

    \120\ 487 plans with less than 100 participants filed the Form 
5500 schedule H and reported holding common stock.
    \121\ DOL estimates from the 2020 Form 5500 Pension Research 
Files.

  Table 1--Number of Pension and Welfare Plans Reporting Holding Common Stocks or ESOP by Type of Plan, 2020 a
----------------------------------------------------------------------------------------------------------------
    Common stock (no employer         Defined         Defined      Total pension                     Total all
           securities)                benefit      contribution        plans       Welfare plans       plans
----------------------------------------------------------------------------------------------------------------
Direct Holdings Only............           1,059           2,228           3,288             517           3,805
Indirect Holdings Only..........           2,649          16,691          19,340  ..............          19,340
Both Direct and Indirect........             849             645           1,494               1           1,495
                                 -------------------------------------------------------------------------------
    Total.......................           4,558          19,564          24,122             518          24,640
----------------------------------------------------------------------------------------------------------------
ESOP (No Common Stock)..........  ..............           5,809           5,809  ..............           5,809
Common Stock and ESOP...........  ..............             574             574  ..............             574
                                 -------------------------------------------------------------------------------
    Total All Plans Holding                4,558          25,947          30,505             518          31,023
     Stocks.....................
----------------------------------------------------------------------------------------------------------------
\a\ DOL calculations from the 2020 Form 5500 Pension Research Files.

    There are approximately 652,900 small pension plans that hold 
assets that could be invested in stock.\122\ Given that fewer than 1 
percent of small plans file a Schedule H, there is minimal data 
available about small plans' stock holdings. While most participants 
and assets are in large plans, most plans are small plans. The 
Department lacks sufficient data to estimate the number of small plans 
that hold stock, but the Department expects that many small plans are 
only exposed to stock through mutual funds and consequently will not be 
significantly affected by paragraph (d) of the final rule. For purposes 
of estimating the number of small plans that will be affected, the 
Department assumes that five percent of small plans, or approximately 
32,600 small pension plans, hold stock.\123\ In the NPRM, the 
Department solicited comments on the impact of small plans holding 
stock only through mutual funds and on the assumption that five percent 
of small plans hold stock. No comments were received in response to 
either inquiry.
---------------------------------------------------------------------------

    \122\ The Form 5500 does not require these plans to categorize 
the assets as common stock, so the Department does not know if they 
hold stock. (Source Private Pension Plan Bulletin: Abstract of 2020 
Form 5500 Annual Reports, Employee Benefits Security Administration 
(2022; forthcoming), Table B1.)
    \123\ This estimate is calculated as 652,935 pension plans x 5% 
= 32,647 plans, rounded to 32,600. To assess the reasonableness of 
the five percent estimate, the Department looked at the number of 
pension plans filing the 2020 Form 5500, just above the threshold 
(100 participants) for needing to file the schedule H. Common stock 
or employer stock in an ESOP was held by eight percent of pension 
plans with 100 participants up to 109 participants. Common stock or 
employer stock in an ESOP was held by twelve percent of pension 
plans with 110 participants up to 119 participants. While both 
percentages are above five percent, the percentage falls as the plan 
size decreases, suggesting that five percent is a reasonable 
estimate of the percent of small plans holding common stock or 
employer stock in an ESOP.
---------------------------------------------------------------------------

    The combined effect of these assumptions is an estimate of 63,700 
plans, large and small, that will be affected by the final rule 
pertaining to proxy voting.\124\
---------------------------------------------------------------------------

    \124\ This estimate is calculated as 30,505 large pension plans 
holding common stock or employer stock + 518 large health or welfare 
plans holding common stock or employer stock + 32,647 small pension 
plans holding stock = 63,670 plans rounded to 63,700.
---------------------------------------------------------------------------

    While paragraph (d) of this final rule will directly affect ERISA-
covered plans that possess the relevant shareholder rights, the 
activities covered under paragraph (d) will be carried out by 
responsible fiduciaries on plans' behalf.

[[Page 73859]]

Many plans hire asset managers to carry out fiduciary asset management 
functions, including proxy voting. The Department estimates that large 
ERISA plans use approximately 17,600 different service providers, some 
of whom provide services related to the exercise of plans' shareholder 
rights.\125\ Such service providers include trustees, trust companies, 
banks, investment advisers, investment managers, and proxy advisory 
firms.\126\ Asset managers hired as fiduciaries to carry out proxy 
voting functions will be subject to the final rule to the same extent 
as a plan trustee or named fiduciary. The final rule could indirectly 
affect proxy advisory firms to the extent that plan fiduciaries opt for 
customized recommendations about which proxy proposals to vote or how 
they should cast their vote. Plans' preferences for proxy advice 
services moreover could shift to prioritize services offering more 
rigorous and impartial recommendations. These effects may be more 
muted, however; recent rule amendments by the Securities and Exchange 
Commission (SEC) may enhance the transparency, accuracy, and 
completeness of the information provided to clients of proxy advisory 
firms in connection with proxy voting decisions.\127\
---------------------------------------------------------------------------

    \125\ DOL estimates are derived from the historical Form 5500 
Schedule C data. This value reflects the number of entities that 
have ever been reported with the service codes associated with 
trustees (individual, bank, trust company, or similar financial 
institution), plan investment advisory, or investment management.
    \126\ A commenter on the proposal for the 2020 rule shared 
results from a proprietary survey of the largest pension funds and 
defined contribution plans. The survey finds that approximately 92 
percent of the respondents indicated that they have formally 
delegated proxy voting responsibilities to another named fiduciary 
and approximately 42 percent of respondents engage a proxy advisory 
firm (directly or indirectly) to help with voting some or all 
proxies.
    \127\ In September 2019, the SEC issued an interpretation and 
guidance addressing the application of the proxy rules to proxy 
voting advice businesses. (See 84 FR 47416). In July of 2020, the 
SEC adopted amendments to 17 CFR 240.14a-1(l), 240.14a-2(b), and 
240.14a-9 concerning proxy voting advice (the ``2020 Rule 
Amendments''). (See 85 FR 55082) On June 1, 2021, SEC Chair Gary 
Gensler directed SEC staff to consider whether to recommend further 
regulatory action regarding proxy voting advice. SEC staff were 
asked to consider whether to recommend that the SEC revisit its 2020 
codification of the definition of solicitation as encompassing proxy 
voting advice, the 2019 Interpretation and Guidance regarding that 
definition, and the conditions on exemptions from the information 
and filing requirements in the 2020 Rule Amendments, among other 
matters. In July, 2022, the SEC adopted final amendments that, among 
other things, rescinded certain conditions that were adopted in the 
2020 Rule Amendments to the availability of certain exemptions from 
the information and filing requirements of the Federal proxy rules 
for proxy advisory firms. (See 87 FR 43168)
---------------------------------------------------------------------------

D. Benefits

    The final rule will clarify the legal standard imposed by sections 
404(a)(1)(A) and 404(a)(1)(B) of ERISA with respect to the selection of 
a plan investment or investment course of action, and the exercise of 
shareholder rights, including proxy voting. As indicated above, the 
final rule will benefit plans by making clear that plan fiduciaries are 
permitted to consider risk and return ESG factors and to exercise 
shareholder rights that may enhance the value of plan investments. The 
Department is concerned that the current regulation dissuades plan 
fiduciaries from such considerations and activities even when they are 
financially relevant to the plan. Prior to the NPRM, stakeholders told 
the Department that the current regulation had already had a chilling 
effect on appropriate use of ESG factors in investment decisions. 
Acting on relevant ESG factors in a manner consistent with the final 
rule will redound to the benefit of employee benefit plans, 
participants, and beneficiaries covered by ERISA. The public provided 
many comments about the proposal and cited many studies and reports 
which have helped the Department to assess what the effects of the rule 
will be. The literature examined by the Department generally shows that 
the consideration of ESG factors can be beneficial to investing in many 
circumstances. The Department anticipates that the benefits of this 
final rule will be significant.
1. Benefits of Paragraphs (b) and (c)
    Paragraph (b) of the final rule addresses ERISA section 
404(a)(1)(B)'s duty of prudence and clarifies how that duty applies to 
a fiduciary's consideration of an investment or investment course of 
action. Paragraphs (b)(1) through (3) of the final rule carry forward 
much of the same regulatory language that has been in place since 1979. 
The preservation of settled law should minimize new costs attributable 
to the final rule.
    Paragraph (b)(4) addresses uncertainty under the current regulation 
as to whether a fiduciary may consider ESG factors in making investment 
decisions under ERISA. This paragraph clarifies that when selecting an 
investment or investment course of action plan fiduciaries must base 
their determination on factors that the fiduciary reasonably determines 
are relevant to a risk and return analysis. Paragraph (b)(4) further 
clarifies that risk and return factors may, depending on particular 
facts and circumstances, include the economic effects of climate change 
and other ESG factors. The intent of this paragraph is to establish 
that ESG factors that may be relevant in a risk-return analysis of an 
investment do not need to be treated differently than other relevant 
investment factors, and to remove prejudice to the contrary contained 
in the current regulation. When relevant to a risk and return analysis 
of an investment, ESG factors may be weighted and factored into 
investment decisions alongside other relevant factors, as prudently 
determined by the fiduciary.
    For the sake of clarity and to eliminate any doubt caused by the 
current regulation, the preamble further explains paragraph (b)(4) by 
providing examples of factors that may be relevant to a fiduciary's 
risk and return analysis depending on the particular facts and 
circumstances. For example, such factors may include: (i) climate 
change-related factors, such as a corporation's exposure to the real 
and potential economic effects of climate change, including exposure to 
the physical and transitional risks of climate change and the positive 
or negative effects of government regulations and policies related to 
climate change; (ii) governance factors, such as those involving board 
composition, executive compensation, transparency and accountability in 
corporate decision-making, as well as a corporation's avoidance of 
criminal liability and compliance with labor, employment, 
environmental, tax, and other applicable laws and regulations; and 
(iii) workforce practices, including the corporation's progress on 
workforce diversity, inclusion, and other drivers of employee hiring, 
promotion, and retention; its investment in training to develop its 
workforce's skill; equal employment opportunity; and labor relations.
    To its list of examples in section III.B.1.(f)(2) of this preamble 
the Department added other examples to emphasize that the examples are 
merely illustrative, and not intended to limit a fiduciary's discretion 
to identify factors that are relevant to its risk/return analysis of 
any particular investment or investment course of action. This 
expansion of examples is intended to avoid regulatory bias and not 
favor particular investments or investment strategies. As paragraph 
(b)(4) explicitly states, whether any particular factor is relevant to 
a risk and return analysis depends upon the individual facts and 
circumstances.
    Paragraph (c)(1) of the final rule addresses the application of the 
duty of loyalty under ERISA as applied to a fiduciary's consideration 
of an

[[Page 73860]]

investment or investment course of action. The primary benefit of this 
provision to plan participants and beneficiaries is that it clarifies 
in no uncertain terms that a plan fiduciary may not subordinate the 
interests of participants and beneficiaries in their retirement income 
or financial benefits under the plan to other objectives, and may not 
sacrifice investment return or take on additional investment risk to 
promote benefits or goals unrelated to the interests of participants 
and beneficiaries in their retirement income or financial benefits 
under the plan. By ensuring that plan fiduciaries may not sacrifice 
investment returns or take on additional investment risk to promote 
unrelated goals, paragraph (c)(1) protects the investment returns that 
accrue to participants and sponsors of ERISA-covered plans. Over the 
years, the Department has stated this bedrock principle of loyalty many 
times in non-regulatory guidance, and this final rule, like the current 
regulation, incorporates the principle directly into title 29 of the 
Code of Federal Regulations. This incorporation will result in a higher 
degree of permanency and certainty for plan fiduciaries, relative to 
periodic restatements in non-regulatory guidance, and as such is 
considered a benefit.
    Much of the anticipated economic benefits under this final rule is 
derived from paragraph (b)(4) of the final rule and the examples 
earlier in section III.B.1.(f)(2) of this preamble and the clarity they 
provide to plan fiduciaries. In the Department's view, and consistent 
with the comments of the concerned stakeholders mentioned above, the 
examples in the preamble should overcome unwarranted concerns about 
investing in ESG-themed funds that are economically advantageous to 
plans. Removing this uncertainty is considered a primary benefit of 
this final rule.
    Two comments on the proposal argued against the Department's 
assertion that the current regulation has had a chilling effect. One 
argued that the Department did not articulate what confusion it had 
created, while the other said the Department had failed to demonstrate 
that it had a negative impact.
    However, many comments on the NPRM agreed with the Department's 
assessment of the impact of the 2020 rule, noting the 2020 rule created 
confusion on whether ERISA fiduciaries should incorporate ESG factors 
into their decision-making and that this confusion created a chilling 
effect. One comment states that the 2020 rule had introduced 
``significant uncertainty'' and ``potential legal liability'' for 
fiduciaries making investment decisions. Some of the commenters assert 
that the documentation requirement in the 2020 rule could chill 
investments in ESG assets. According to Lipton (2020), under the 2020 
rule it would be harder for 401(k) plans to offer ESG investment 
options and fewer plan participants would have access to these 
options.\128\ According to the United Nations Principles for 
Responsible Investment, the uncertainty in how considerations of ESG 
factors fall within the legal standard of ERISA has precluded plan 
fiduciaries from considering ESG factors within their investment 
analysis.\129\ Avoiding the chilling effects described by these 
comments and reports will be a benefit to participants and 
beneficiaries.
---------------------------------------------------------------------------

    \128\ Martin Lipton, ``DOL Proposes New Rules Regulating ESG 
Investments,'' Harvard Law School Forum on Corporate Governance 
(2020), https://corpgov.law.harvard.edu/2020/07/07/dol-proposes-new-rules-regulating-esg-investments/.
    \129\ Rory Sullivan, Will Martindale, Elodie Feller, and Anna 
Bordon, ``Fiduciary Duty in the 21st Century,'' United Nations 
Principles for Responsible Investment, https://www.unpri.org/download?ac=1378.
---------------------------------------------------------------------------

    As described in the preamble, paragraph (c)(2) of the final rule 
will replace the tiebreaker provision in the current regulation with a 
formulation that is intended to be broader. Paragraph (c)(2) provides 
that if a fiduciary prudently concludes that competing investments or 
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. 
Paragraph (c)(2) of the final rule will not carry forward the 
documentation requirements contained in paragraphs (c)(2)(i) through 
(iii) of the current regulation.
    Commenters said these requirements are burdensome and have the 
effect of singling out ESG investments for special scrutiny. 
Stakeholders point to these special, heightened documentation 
provisions as casting an unnecessarily negative shadow on investments 
or investment courses of action that are prudent. Paragraph (c)(2) of 
the final rule permits fiduciaries to take into account an investment's 
potential collateral benefits, including potential increases in plan 
contributions, to break a tie. The Department received several comments 
citing research that increased access to ESG investment could increase 
contributions to retirement plans. Avoiding unnecessarily burdensome 
documentation and clarifying the extent to which fiduciaries may factor 
in collateral benefits to break ties are benefits of the final rule.
    Several commenters supported the proposed changes to the 
tiebreaker. One commenter noted that under the current rule, 
fiduciaries may only consider the collateral benefit between two 
investments if the fiduciaries are unable to distinguish between two 
investments based on pecuniary factors. However, it may be unclear 
under what circumstances, if any, two investment courses of action 
would meet the current rule's standard. The proposed rule recognizes 
that competing investments can equally serve the financial interests of 
the plan. However, several commenters expressed that the proposed 
provisions were still too narrow, while other commenters argued that 
the tiebreaker should be eliminated altogether. One commenter argued 
that the test was obsolete and additional tests or documentation would 
increase costs for plan participants and beneficiaries without a 
corresponding benefit.
    Paragraph (c)(3) of the final rule confirms that plan fiduciaries 
do not violate the paragraph (c)(1) duty of loyalty solely because they 
take participant preferences into consideration. Plan fiduciaries must 
ensure that consideration of participant preferences is consistent with 
the requirements in paragraph (b). This clarification may lead to 
investment options that are more aligned with employee preferences and 
that, accordingly, result in increased contributions to the plan and 
greater retirement savings.
    Commenters on the NPRM supported the idea that reflecting 
participant preferences in investment options has a positive effect on 
participation and retirement savings, including comments from 
institutional asset managers and asset custodians. This is supported by 
a survey conducted by Schroders (2021) of consumers between ages 45 and 
75, finding that 69 percent of participants, who said their plans did 
not offer ESG investment options or did not know, would increase their 
overall contribution rate if an ESG option was offered.\130\ Commenters 
also suggested that not considering participant preferences may be 
detrimental to retirement savings. A few of the commenters argued that 
participants may not utilize ERISA plans that do not offer investments 
reflective of their

[[Page 73861]]

values, resulting in some individuals foregoing saving for retirement 
or choosing to save outside of a qualified plan.
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    \130\ Schroders, ``Schroders US Retirement Survey Results--
2021,'' https://www.schroders.com/en/us/defined-contribution/dc/retirement-survey-2021.
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    The current regulation prohibits fiduciaries from adding or 
retaining any investment fund, product, or model portfolio as a 
qualified default investment alternative (QDIA) as described in 29 CFR 
2550.404c-5 if the fund, product, or model portfolio reflects non-
pecuniary objectives in its investment objectives or principal 
investment strategies. The final rule amends the current regulation to 
remove the stricter rules for QDIAs, such that, under the final rule, 
the same standards apply to QDIAs as to investments generally. The 
Department expects to see an increase in the number of QDIAs that are 
ESG funds. This will affect many participants since a large and growing 
share of plans use automatic enrollment. For example, Vanguard 
administrative data shows that 70 percent of participants in 2021 were 
in plans with automatic enrollment.\131\ It is difficult to obtain data 
on how many of these participants' accounts were invested in a QDIA.
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    \131\ How America Saves 2022, Vanguard, 2022.
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    The clarifications provided by paragraphs (b) and (c) of this final 
rule relate to the appropriate use of ESG factors by plan fiduciaries 
in selecting investments or investment courses of action. Outside the 
ERISA context, investors may choose to invest in funds that promote 
collateral objectives, and even choose to sacrifice return or increase 
risk to achieve those objectives. Such conduct, however, would be 
impermissible for ERISA plan fiduciaries, who cannot sacrifice return 
or increase risk for the purpose of promoting collateral goals 
unrelated to the economic interests of plan participants in their 
benefits.
    In the proposal, the Department requested comment on the financial 
materiality of ESG factors in various investment contexts. In the 
analysis below, the Department has considered and taken into account 
the comments received and the resources referenced by commenters as 
well as other resources that came to its attention. The studies and 
reports often examine investing circumstances that are outside of ERISA 
and may not apply to an ERISA context. Several comments on the NPRM 
criticized the Department's survey of the literature. For example, one 
commenter asserted that there was an oversampling of studies showing 
better returns from ESG investing, compared to literature showing lower 
returns. The comparison between the various studies cited is difficult, 
however, as studies differ between whether they consider corporate or 
investment performance, which benchmarks are considered, the time 
horizon studied, and how ESG is incorporated into the company or 
investment strategy. The Department has reviewed the literature 
received from commenters and summarized the findings.
(a) Challenges of Determining the Relationship Between Performance and 
ESG Factors
    The primary types of ESG portfolio management are integration, 
negative screening, and positive screening. Integration incorporates 
ESG factors into the investment analysis and decisions. Screening 
filters investments based on ESG-related preferences. Negative 
screening excludes investments based on the investment's sector, 
issuer, activity, or other ESG criteria; positive screening includes 
investments based on similar characteristics. Positive screening is 
often referred to as ``best-in-class'' investing.\132\
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    \132\ United Nations Principles for Responsible Investment, ``An 
Introduction to Responsible Investment: Screening'' (May 2020), 
https://www.unpri.org/an-introduction-to-responsible-investment/an-introduction-to-responsible-investment-screening/5834.article.
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    The Royal Bank of Canada (RBC, 2019) outlines the challenges of 
comparing studies on ESG. This report divides the research literature 
on socially responsible investment (SRI) into four categories: index 
comparison, mutual fund comparison, hypothetical portfolios, and 
company performance. In their review, they find that research comparing 
equity SRI and non-SRI indices generally find that equity SRI indices 
do not underperform traditional indices, with much of the literature 
finding that SRI indices outperformed traditional indices. However, 
mutual fund comparison studies prove difficult to compare because of 
the variety of funds and investment strategies considered as SRI, 
resulting in mixed and inconclusive results from this type of study. 
Similarly, hypothetical portfolio studies may use different techniques 
to incorporate ESG, making it difficult to compare results.\133\
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    \133\ RBC Global Asset Management, ``Does socially responsible 
investing hurt investment returns?'' (2019), https://www.rbcgam.com/documents/en/articles/does-socially-responsible-investing-hurt-investment-returns.pdf.
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    Other research has pointed to the lack of a standardized definition 
for ESG as a cause of mixed conclusions on the benefits of ESG. For 
instance, Lioui and Tarelli (2022) analyze ESG data from three vendors, 
comparing the properties of their ESG factors. They find that the 
different factor construction methodologies can contribute to the mixed 
evidence on the ESG performance in the literature and that disagreement 
across data vendors has substantial implications for the performances 
of ESG factors.\134\ Similarly, Cornell, and Damodaran (2020) review 
ESG literature and note that while there is evidence that ``being 
good'' benefits a company's operating performance, the literature's 
findings are sensitive to how ESG is defined and profitability is 
measured.\135\
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    \134\ Abraham Lioui and Andrea Tarelli, ``Chasing the ESG 
Factor,'' Journal of Banking and Finance, forthcoming (March 2022), 
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3878314.
    \135\ Bradford Cornell and Aswath Damodaran, ``Valuing ESG: 
Doing Good or Sounding Good?'' The Journal of Impact and ESG 
Investing, Fall 2020, 1(1). https://jesg.pm-research.com/content/1/1/76.
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    Likewise, the comments on the proposal are mixed in their 
assessment on the relationship between ESG performance and corporate or 
investment performance. Several comments note that ESG factors are 
financially material for financial returns. For example, a comment 
notes that firms with strong ratings on material sustainability issues 
have better performance than firms with inferior ratings. One commenter 
states that ESG-focused companies in the MSCI ACWI Index saw higher 
returns, stronger earnings, and higher dividends. Another commenter 
notes that the iShares ESG Aware MSCI USA ETF outperformed the S&P 500 
index by five percentage points from the beginning of 2020 to the 
second quarter of 2021. Still another commenter notes that ignoring the 
entire category of information and analysis that comprises ESG factors 
could be deemed an abrogation of a fiduciary's responsibility to 
consider all relevant information when assessing the risk and return of 
an investment opportunity.
    Conversely, several commenters assert that ESG factors are not 
relevant for financial returns and may be detrimental to returns and 
retirement savings. For instance, one commenter remarks that the time 
horizon associated with ESG risks often surpasses the time horizon of 
retirement investors. Other commenters note that ESG return premiums 
are due to larger weights placed on technology stocks, which have 
experienced increased value but also present increased risk. A 
commenter asserts that the claim in the NPRM that the proposal would 
lead to increased investment returns is unsubstantiated.

[[Page 73862]]

(b) Meta-Studies
    The body of research evaluating ESG investing shows ESG investing 
can have financial benefits, although the literature overall has varied 
findings. In a meta-analysis of over 1,000 studies published between 
2015 and 2020, Whelan et al. (2021) report that of the studies 
concerning corporate performance--focusing on measurements such as 
return on equity, return on assets, and stock price for an individual 
firm--58 percent find a positive relationship between corporate 
financial performance and ESG, while 13 percent find a neutral 
relationship, 21 percent find a mixed relationship, and 8 percent find 
a negative relationship. For the studies concerning investment 
performance--focusing on risk-adjusted return measurements for a 
portfolio of stocks--33 percent find a positive relationship between 
investment performance and ESG, 26 percent find a neutral impact, 28 
percent find mixed results, and 14 percent find negative results.\136\ 
They found similar results when focusing only on studies about climate 
change and financial performance. Clark, Feiner, and Vieha (2014) 
conduct a meta-study analyzing more than 200 studies, 45 of which 
looked at operational performance, and showed that 88 percent of these 
studies found that ESG practices lead to better operational 
performance. Additionally, 41 of the operational performance studies 
review the relationship between sustainability and financial market 
performance, of which 80 percent show that stock price performance of 
companies is positively influenced by good sustainability 
practices.\137\ Friede et al. (2015) find in their meta-study that only 
10.0 percent of studies found a negative ESG performance relationship, 
while 47.9 percent of vote-count studies \138\ and 62.6 percent of 
meta-studies \139\ show positive findings.\140\
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    \136\ Tenise Whelan, Ulrich Atz, Tracy Van Holt, and Casey 
Clark, ``ESG and Financial Performance: Uncovering the Relationship 
by Aggregating Evidence from 1,000 Plus Studies Published Between 
2015 and 2020,'' Journal of Sustainable Finance & Investment (2021). 
https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf.
    \137\ Gordon Clark, Andreas Feiner, and Michael Viehs, ``From 
the Stockholder to the Stakeholder: How Sustainability Can Drive 
Financial Outperformance,'' University of Oxford and Arabesque 
Partner (2014), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2508281.
    \138\ A ``vote count study'' in this context is a review study 
which counts the number of primary studies with significant 
positive, negative, and non-significant results and ``votes'' the 
category with the highest share as winner.
    \139\ A ``meta-study'' in this context is a review study which 
directly imports effect sizes and sample sizes of primary studies to 
compute a summary effect across all primary studies.
    \140\ In this study, the authors analyze 60 review studies on 
ESG performance, encompassing the finding of 2,250 unique underlying 
studies. (See Gunnar Friede, Michael Lewis, Alexander Bassen, and 
Timo Busch. ``ESG & Corporate Financial Performance: Mapping the 
global landscape.'' DWS, University of Hamburg (December 2015). 
https://download.dws.com/download?elib-assetguid=2c2023f453ef4284be4430003b0fbeee.)
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(c) Association Between ESG Investing and Performance
    Ito, Managi, and Matsuda (2013) find that socially responsible 
funds outperformed conventional funds in the European Union and United 
States.\141\ The Morgan Stanley Institute for Sustainable Investing 
(2019) compared the performance of sustainable funds to traditional 
funds between 2004 and 2018 and found that sustainable funds provided 
returns in line with comparable traditional funds such that the 
returns, net of fees, were not statistically significantly 
different.\142\ Morningstar (2022) finds that of trailing three- and 
five-year periods, 44 percent of sustainable funds, as defined by 
Morningstar, ranked in the top quartile of their respective 
categories.\143\ Curtis, Fisch, and Robertson (2021) measures ESG 
orientation of mutual fund portfolios from four rating providers to 
analyze returns of ESG funds between 2018 and 2019. They find that ESG 
funds did not perform worse in terms of either raw or risk-adjusted 
returns.\144\
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    \141\ Yutaka Ito, Shunsuke Managi, and Akimi Matsuda, 
``Performances of Socially Responsible Investment and 
Environmentally Friendly Funds,'' 64 Journal of the Operational 
Research Society 11 (2013).
    \142\ Morgan Stanley Institute for Sustainable Investing, 
``Sustainable Reality: Analyzing Risk and Returns of sustainable 
Funds,'' https://www.morganstanley.com/pub/content/dam/msdotcom/ideas/sustainable-investing-offers-financial-performance-lowered-risk/Sustainable_Reality_Analyzing_Risk_and_Returns_of_Sustainable_Funds.pdf.
    \143\ Morningstar Manager Research, ``Sustainable U.S. Landscape 
Report. 2021: Another Year of Broken Records'' (January 2022), 
https://assets.contentstack.io/v3/assets/blt4eb669caa7dc65b2/blta4326c09c190e82b/62100fefcf85c1619ad897b2/U.S._Sustainable_Funds_Landscape_2022.pdf.
    \144\ In this study, the authors identify ESG funds based on 
their fund names. (See Quinn Curtis, Jill Fisch, and Adriana 
Robertson, ``Do ESG Funds Deliver on Their Promises?'' Michigan Law 
Review, Vol. 120(3) (2021), https://repository.law.umich.edu/cgi/
viewcontent.cgi?params=/context/mlr/article/7846/
&path_info=#:~:text=We%20find%20that%20ESG%20funds,increasing%20costs
%20or%20reducing%20returns.)
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    In contrast, other studies have found that ESG investing has 
resulted in lower returns than conventional investing. For example, 
Winegarden (2019) shows that over ten years, a portfolio of ESG funds 
has a net return that is 43.9 percent lower than if it had been 
invested in an S&P 500 index fund.\145\ One commenter criticizes the 
Winegarden report, saying that the study does not isolate how 
incorporation of ESG data affects performance. Trinks and Scholten 
(2017) examine socially responsible investment funds and find that a 
market portfolio based on negative screening significantly 
underperforms an unscreened market portfolio.\146\ Ferruz, 
Mu[ntilde]oz, and Vicente (2012) find that a portfolio of mutual funds 
that implements negative screening \147\ underperforms a portfolio of 
conventionally matched pairs.\148\ Ciciretti, Dal[ograve], and Dam 
(2019) analyze a global sample of operating companies and find that 
companies that score poorly on ESG indicators have higher expected 
returns.\149\
---------------------------------------------------------------------------

    \145\ Wayne Winegarden, ``Environmental, Social, and Governance 
(ESG) Investing: An Evaluation of the Evidence,'' Pacific Research 
Institute (2019), https://www.pacificresearch.org/wp-content/uploads/2019/05/ESG_Funds_F_web.pdf.
    \146\ Pieter Jan Trinks and Bert Scholtens, ``The Opportunity 
Cost of Negative Screening in Socially Responsible Investing'' 
Journal of Business Ethics 140, 193-208 (2017).
    \147\ The authors describe a negative screening strategy as one 
that ``removes stocks'' that do not align with the socially 
responsible ideology from a portfolio. Comparatively, a positive 
screening strategy ``selects stocks'' that align with the socially 
responsible ideology for a portfolio.
    \148\ Luis Ferruz, Fernando Mu[ntilde]oz, and Ruth Vicente, 
``Effect of Positive Screens on Financial Performance: Evidence from 
Ethical Mutual Fund Industry'' (2012), https://www.efmaefm.org/0efmameetings/efma%20annual%20meetings/2012-Barcelona/papers/EFMA2012_0183_fullpaper.pdf.
    \149\ Rocco Ciciretti, Ambrogio Dal[ograve], and Lammertjan Dam, 
``The Contributions of Betas versus Characteristics to the ESG 
Premium,'' (2019).
---------------------------------------------------------------------------

    Furthermore, there are many studies with inconclusive results. 
Goldreyer and Diltz (1999) find that employing positive social screens 
does not affect the investment performance of mutual funds, based on 
analysis of 49 socially responsible mutual funds.\150\ Similarly, 
Renneboog, Ter Horst, and Zhang (2008) find that the risk-adjusted 
returns of socially responsible mutual funds are not statistically 
different from conventional funds when analyzing a sample of global 
socially responsible mutual funds.\151\ Research by Bello

[[Page 73863]]

(2005), which examines 126 mutual funds, finds that the long-run 
investment performance is not statistically different between 
conventional and socially responsible funds.\152\ Likewise, Ferruz, 
Mu[ntilde]oz, and Vicente (2012) finds that a portfolio of mutual funds 
that implement positive screening performs equally well as a comparable 
conventional mutual funds, matched based on fund age, size, risk 
factors.\153\ Humphrey and Tan (2014), which examines socially 
responsible investment funds, finds no evidence of negative screening 
affecting the risks or returns of portfolios.\154\
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    \150\ Elizabeth Goldreyer and David Diltz, ``The Performance of 
Socially Responsible Mutual Funds: Incorporating Sociopolitical 
Information in Portfolio Selection,'' 25 Managerial Finance 1 
(1999).
    \151\ Luc Renneboog, Jenke Ter Horst, and Chendi Zhang, ``The 
Price of Ethics and Stakeholder Governance: The Performance of 
Socially Responsible Mutual Funds'', 14 Journal of Corporate Finance 
3 (2008).
    \152\ Zakri Bello, ``Socially Responsible Investing and 
Portfolio Diversification,'' 28 Journal of Financial Research 1 
(2005).
    \153\ Ferruz, Mu[ntilde]oz, and Vicente, ``Effect of Positive 
Screens on Financial Performance,'' 2012.
    \154\ Jacquelyn Humphrey and David Tan, ``Does It Really Hurt to 
be Responsible?'', 122 Journal of Business Ethics 3 (2014).
---------------------------------------------------------------------------

    Marsat and Williams (2020) uses the Markowitz Portfolio 
optimization model, the direct application of modern portfolio theory, 
to create the ``best complete portfolio'' by allocating to the optimal 
risky portfolio and the risk-free asset. It does so assuming that 
investors are risk averse and that, given equal returns, an investor 
would prefer the one with less risk. Backtesting various constructed 
portfolios over the past 10 years, the study did not observe a 
correlation between high ESG scores and financial returns. The study 
observes a wide range of performance depending on the provider of ESG 
data.\155\
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    \155\ Organisation for Economic Co-operation and Development 
(OECD). ``ESG Investing: Practices, Progress and Challenges'' 
(2020). https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf.
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    A few of the studies referenced in the comments discussed the 
performance of ESG funds during the COVID-19 pandemic. Whieldon and 
Clark (2021) look at the performance of 26 ESG exchange traded funds 
(ETFs) and mutual funds with more than $250 million in assets between 
March of 2020 and 2021 and found that 19 of the 26 funds outperformed 
the S&P 500.\156\ The Morgan Stanley Institute for Sustainable 
Investing (2020) finds that, three out of four sustainable equity funds 
beat their Morningstar category average. The authors posit that the 
performance of sustainable funds in 2020 demonstrates that investing 
strategies that manage material ESG risks can produce good returns in 
an uncertain economic environment. The study finds that between January 
and June of 2020, domestic sustainable equity funds outperformed their 
traditional peers by a median of 3.9 percentage points.\157\
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    \156\ Esther Whieldon and Robert Clark, ``ESG Funds Beat Out S&P 
500 in 1st Year of COVID-19; How 1 Fund Shot to the Top,'' S&P 
Global Market Intelligence (2021), https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/esg-funds-beat-out-s-p-500-in-1st-year-of-covid-19-how-1-fund-shot-to-the-top-63224550.
    \157\ Morgan Stanley Institute for Sustainable Investing, 
``Sustainable Reality: 2020 Update,'' Morgan Stanley (2020), https://www.morganstanley.com/content/dam/msdotcom/en/assets/pdfs/3190436-20-09-15_Sustainable-Reality-2020-update_Final-Revised.pdf.
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(d) Fees
    Some commenters expressed concern that higher fees associated with 
ESG investments will result in lower returns and retirement savings. 
The Department recognizes that ESG investing requires information 
collection and research that will incur costs. For instance, a 2020 
study estimates that, globally, investment managers would spend $745 
million in 2020 on ESG information.\158\
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    \158\ Sean Collins and Kristen Sullivan, ``Advancing ESG 
Investing: a Holistic Approach for Investment Management Firms,'' 
Harvard Law School Forum on Corporate Governance (March 2020), 
https://corpgov.law.harvard.edu/2020/03/11/advancing-esg-investing-a-holistic-approach-for-investment-management-firms/.
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    The findings in the literature discussing fees on ESG funds were 
mixed. Morningstar (2020) finds that sustainable funds have higher 
asset-weighted average expense ratios (0.61 percent) than their 
traditional peers (0.41 percent).\159\ According to Wursthorn (2021), 
at the end of 2020, the average fee for ESG funds was 0.20 percent, 
compared to 0.14 percent for standard ETFs that invest in U.S. large-
cap stocks.\160\ Winegarden (2019) analyzes 30 ESG funds that have 
either existed for more than 10 years or have outperformed the S&P 500 
over a short-term timeframe and finds that the average expense ratio 
was 0.69 percent for the 30 ESG funds, compared to an expense ratio of 
0.09 percent for a S&P 500 index fund.\161\ Conversely, a study 
conducted by Curtis, Fisch, and Robertson (2021) found that when 
controlling for whether a fund is an actively managed fund or an index 
fund, as well as net assets by fund manager, fund, and class, there is 
not a statistically significant difference between the fees of ESG 
funds and the fees that would be expected given fund 
characteristics.\162\
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    \159\ Morningstar, ``2020 U.S. Fund Fee Study: Fees Keep 
Falling'' (August 2021), https://www.morningstar.com/content/dam/marketing/shared/pdfs/Research/annual-us-fund-fee-study-updated.pdf.
    \160\ Michael Wursthorn, ``Tidal Wave of ESG Funds Brings Profit 
to Wall Street,'' Wall Street Journal (March 2021), https://www.wsj.com/articles/tidal-wave-of-esg-funds-brings-profit-to-wall-street-11615887004.
    \161\ Winegarden, ``Environmental, Social, and Governance (ESG) 
Investing,'' 2019.
    \162\ Curtis, Fisch, and Robertson, ``Do ESG Funds Deliver on 
Their Promises?'' 2021.
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    There has been some reduction in sustainable funds fees. 
Morningstar (2020) finds that the average fee charged by sustainable 
funds fell 27 percent between 2011 and 2021 and that this decline in 
average fees has been driven by the rise of low-fee sustainable index 
mutual funds and ETFs.\163\
---------------------------------------------------------------------------

    \163\ Morningstar, ``2020 U.S. Fund Fee Study: Fees Keep 
Falling,'' Morningstar (2020), https://assets.contentstack.io/v3/assets/blt4eb669caa7dc65b2/blt0b2eed63bfb1eb8b/619f8bf6224a1b121d540f7e/annual-us-fund-fee-study-updated.pdf.
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    The studies of ESG investment performance discussed in this 
document generally take fees into account.
(e) Sectoral Bias
    Some of the literature addresses the role of sectoral biases within 
ESG investing. A study by Morningstar (2021) finds that between 
November 2020 and March 2021, a rally in energy prices may have 
hampered sustainable equity fund returns.\164\ Hale (2020) notes that 
the performance of sustainable funds during the first quarter of 2020 
was helped by having less exposure to energy stocks and a larger 
exposure to technology stocks than the comparable market indices. The 
study estimates that U.S. `sustainable index funds' energy-sector 
under-weightings contributed an average of 0.43 percent to their 
outperformance of the S&P 500 during this period. Information 
technology was the quarter's best-performing sector, and sustainable 
funds generally had a higher proportion of assets invested in the 
sector than broad market indices. The study estimates information 
technology contributed an average of 0.21 percent to the funds' 
outperformance of the S&P 500. Nevertheless, the author posits that 
``the biggest reason for their outperformance is that sustainable funds 
appear to have benefited from selecting stocks with better ESG 
credentials.'' \165\ Bruno, Esakia, and Goltz (2021) addresses 
sectorial bias in general, finding that over representation of the 
technology sector increases ESG performance. The study finds that when

[[Page 73864]]

the sectoral weights of portfolios are rebalanced to more closely 
resemble the overall sectoral composition of the market, ESG strategies 
``consistently deliver zero alpha.'' \166\ However, Lefkovitz (2021) 
refutes the claims that ESG performance is entirely due to sectorial 
bias, observing that companies with a sustainable competitive advantage 
have often experienced lower volatility. The author posits that while 
sectoral bias contributes to the performance of ESG strategies, 
security selection also contributes to the outperformance.\167\
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    \164\ Morningstar Manager Research, ``Sustainable U.S. Landscape 
Report. 2021: Another Year of Broken Records'' (Jan. 2022), https://assets.contentstack.io/v3/assets/blt4eb669caa7dc65b2/blta4326c09c190e82b/62100fefcf85c1619ad897b2/U.S._Sustainable_Funds_Landscape_2022.pdf.
    \165\ Jon Hale, ``Sustainable Funds Weather the First Quarter 
Better than Conventional Funds,'' Morningstar (April 2020), https://www.morningstar.com/articles/976361/sustainable-funds-weather-the-first-guarter-better-thanconventional-funds.
    \166\ Giovanni Bruno, Mikheil Esakia, and Felix Goltz, `` 
`Honey, I Shrunk the ESG Alpha': Risk-Adjusting ESG Portfolio 
Returns'' (April 2021), https://cdn.ihsmarkit.com/www/pdf/0521/Honey-I-Shrunk-the-ESG-Alpha.pdf.
    \167\ Dan Lefkovitz, ``Morningstar's ESG Indexes have 
Outperformed and Protected on the Downside'' (February 2021), 
https://www.morningstar.com/insights/2021/02/08/morningstars-esg-indexes-have-outperformed-and-protected-on-the-downside.
---------------------------------------------------------------------------

    Conversely, Brav, and Heaton (2021) compare the returns of high-
carbon assets and low-carbon assets. The study found that, for firms 
included in the S&P 500, the average return for the energy sector in 
2021 was 64.8 percent, compared to an average return of 28.7 percent 
for all companies not in the energy sector. Similarly, for firms 
included in the Russell 3000, the average return for the energy sector 
was 74.4 percent, compared to an average return of 25.5 percent for all 
companies not in the energy sector. The authors state that the 
transition to a low-carbon economy may fail and investors should not 
avoid high-carbon assets.\168\
---------------------------------------------------------------------------

    \168\ Alon Brav and J.B. Heaton, ``Brown Assets for the Prudent 
Investor,'' Harvard Business Law Review (2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3895887.
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(f) Investment Screening
    As discussed above, one of the ESG investment strategies used is 
investment screening. One commenter noted that many of the studies 
cited by the Department in the proposal finding ESG underperformance 
focus on the implications of negative screening or a socially 
responsible investing lens. The commenter notes that most of the 
studies cited by the Department showing ESG as beneficial to returns 
focus on ESG as a means to maximize risk-adjusted returns. The 
commenter further notes that most plan sponsors, except for those 
relying on the tiebreaker test, would rely on a modern, financially 
material ESG lens to select investments. Similarly, one commenter 
called integrated ESG analysis a tool in the modern investment toolkit 
to be used alongside traditional fundamental analysis, valuation 
assessment, or quantitative analysis. For instance, one asset manager 
with more than $50 billion assets under management commented that they 
seek to generate superior, risk-adjusted investment returns by 
investing in assets they believe are better positioned to seize 
opportunities and mitigate risks associated with the transition to a 
more sustainable economy. Another commenter noted that the 
``digitalization of the economy and pioneering research has helped 
generate awareness of critical issues that were previously not 
considered significant for investors, including, but not limited to, 
climate change, data privacy and social justice issues.'' The commenter 
notes that the drawdowns and the risks associated with these ESG issues 
are factors that financial markets and ERISA fiduciaries must consider 
when making business, investment and voting decisions.
    Several studies have specifically addressed the ESG investment 
strategy of screening. For instance, the U.S. Commodity Futures 
Tradition Commission (2020) refutes the historical view that ESG 
investing is a values-driven activity inconsistent with fiduciary duty. 
The study notes that this view ``ignore[s] the evolution of a wide 
range of financial ESG factors and strategies, as well as the 
proposition that impact investing may yield additional returns.'' \169\
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    \169\ U.S. Commodity Futures Trading Commission, ``Managing 
Climate Risk in the U.S. Financial System'' (2020), https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
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    Verheyden, Eccles, and Feiner (2016) analyze stock portfolios that 
were selected using ESG screening.\170\ The study finds that screening 
tends to increase a stock portfolio's annual performance by 0.16 
percent. Similarly, Kempf, and Osthoff (2007) examine stocks in the S&P 
500 and the Domini 400 Social Index (renamed as the MSCI KLD 400 Social 
Index in 2010) and find that it is financially beneficial for investors 
to positively screen their portfolios.\171\ A study from Morningstar 
(2021), looking at the performance of 69 ESG-screened Morningstar 
indices, finds that 75 percent ``outperformed their broad market 
equivalents in 2020'', 88 percent outperformed between 2015 and 2020, 
and 91 percent ``lost less than their broad market equivalents during 
down markets over the past five years, including the bear market in the 
first quarter of 2020.'' \172\
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    \170\ Tim Verheyden, Robert G. Eccles, and Andreas Feiner, ``ESG 
for All? The Impact of ESG Screening on Return, Risk, and 
Diversification,'' 28 Journal of Applied Corporate Finance 2 (2016).
    \171\ Alexander Kempf and Peer Osthoff, The Effect of Socially 
Responsible Investing on Portfolio Performance, 13 European 
Financial Management 5 (2007).
    \172\ Dan Lefkovitz, ``Morningstar's ESG Indexes have 
Outperformed and Protected on the Downside'' (February 2021), 
https://www.morningstar.com/insights/2021/02/08/morningstars-esg-indexes-have-outperformed-and-protected-on-the-downside.
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    Trinks and Scholtens (2017) explores the effect of negative 
screening stocks related to abortion, adult entertainment, alcohol, 
animal testing, contraceptives, controversial weapons, fur, gambling, 
genetic engineering, meat, nuclear power, pork, embryonic stem cells, 
and tobacco has on investment returns. Looking at a sample of 1,763 
stocks between 1991 and 2013, the authors note that negative screens 
decrease the investment universe and limit the ability to diversify. 
The study finds that there is an opportunity cost in negative screening 
of ``refraining from investing in controversial firms.'' The study 
finds that screened portfolios underperformed the unscreened portfolio 
and notes that there ``can be a trade-off between values and beliefs 
and financial returns.'' \173\ AQR Capital Management warns that the 
performance of a constrained portfolio will always ex-ante be less than 
or equal to an unconstrained portfolio.\174\ Similarly, Cornell and 
Damodaran (2020) present a theoretical framework demonstrating that 
adding an ESG constraint to investing increases expected returns is 
counter intuitive, as a constrained optimum can, at best, match an 
unconstrained one, and most of the time, the constraint will create a 
cost.\175\ Sharfman (2021) argues that ``screening techniques based on 
non-financial factors lead to an increased probability that the big 
winners in the stock market will be excluded from or underweighted in 
an investment portfolio.'' Based on this premise, the author concludes 
that screening will result in lower expected risk-adjusted returns, 
relative to a benchmark index.\176\
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    \173\ Trinks and Scholtens, ``The Opportunity Cost of Negative 
Screening in Socially Responsible Investing,'' 2017.
    \174\ Cliff Asness, ``Virtue Is Its Own Reward: Or, One Man's 
Ceiling Is Another Man's Floor,'' AQR Capital (May 2017), https://www.aqr.com/Insights/Perspectives/Virtue-is-its-Own-Reward-Or-One-Mans-Ceiling-is-Another-Mans-Floor.
    \175\ Cornell and Damodaran, ``Valuing ESG,'' 2020.
    \176\ Bernard Sharfman, ``ESG Investing Under ERISA.'' Yale 
Journal on Regulation Bulletin, Vol. 38 (March 2021). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3809129.

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[[Page 73865]]

(g) ESG Factors and Risk
    In addition to performance, the ESG literature also addresses the 
relationship between ESG factors and risk. Common ESG factors are also 
common risk factors, for both companies and investors. As such, ESG 
integration inherently serves as a risk management function. For 
instance, the E in ESG may include risks from climate change, 
deforestation, or water scarcity. The S may consider risk associated 
with data protection and privacy, employee engagement, or labor 
standards within a supply chain. The G may address issues with bribery 
and corruption, board and executive compensation, and whistleblower 
protections.\177\ Each of these factors has direct connections to the 
profitability and resilience of an investment, but as pointed out by 
Kumar et al. (2016), may also be relevant with respect to the 
reputation, political, and regulatory risk faced by the 
investment.\178\ As a reference to the magnitude of risks associated 
with ESG factors, a study by Schroders (2019) estimates that the 
negative externalities of listed companies equate to almost half of 
their combined earnings. The authors posit that these economic costs 
will become tangible in the future, affecting financial cost and 
income.\179\
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    \177\ CFA Institute, ``The Rise of ESG Investing: What is 
Sustainable Investing?'' https://interactive.cfainstitute.org/ESG-guide/what-is-sustainable-investing-238UB-188048.html.
    \178\ Ashwin Kumar, Camille Smith, Leila Badis, Nan Wang, Paz 
Amroxy, and Rodrigo Tavres, ``ESG Factors and Risk-Adjusted 
Performance: A New Quantitative Model,'' Journal of Sustainable 
Finance & Investment (2016) Vol. 6, No. 4, 292-300.
    \179\ Schroders, ``SustainEx'' (April 2019), https://www.schroders.com/en/sysglobalassets/digital/insights/2019/pdfs/sustainability/sustainex/sustainex-short.pdf.
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    This was confirmed by several commenters. Some commenters on the 
NPRM state that ESG funds have lower downside risk or lower systematic 
volatility. One commenter noted that ESG consideration is a form of 
risk mitigation that can confer an investment edge and that neglecting 
ESG-related risk can impact a company's competitive advantage and 
diminish long-term economic gains. Another commenter noted that ESG 
factors should be treated no differently than other risk and return 
factors, as appropriate for a given industry and investment timeframe.
    Several studies have found that the consideration of ESG factors in 
investment processes can mitigate risk. For instance, a meta study by 
Clark et al. (2014) observes that most of the studies (90 percent) 
addressing the relationship between sustainability standards and the 
cost of capital show that incorporating sustainability standards is 
associated with a lower cost of equity or cost of debt.\180\ This 
finding suggests that incorporating sustainable standards is associated 
with lower risk. The consensus of the relationship between ESG factors 
and risk has also been confirmed by more recent studies. Campagna, 
Spellman, and Mishra (2020) find that higher ESG performance is 
associated with lower volatility.\181\ The Morgan Stanley Institute for 
Sustainable Investing (2019) shows that when comparing downside 
deviation,\182\ sustainable funds were less risky. On average the 
distribution of downside deviation for sustainable funds was 20.0 
percent less than what traditional fund investors experienced in the 
same period.\183\
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    \180\ This meta study analyzes more than 200 studies, of which 
29 discuss the cost of capital. (See Clark, Feiner, and Viehs, 
``From the Stockholder to the Stakeholder,'' 2014.
    \181\ This study looks at the relationship between ESG ratings 
and returns for 534 securities, with a market cap exceeding $250 
million, between 2013 and 2019. (See Anthony Campagna, G. Kevin 
Spellman, and Subodh Mishra, ``ESG Matters,'' Harvard Law School 
Forum on Corporate Governance (2020), https://corpgov.law.harvard.edu/2020/01/14/esg-matters/.)
    \182\ Downside deviation is a risk measurement that focuses on 
returns below a minimum threshold. (See Mark Jahn, ``Downside 
Deviation,'' Investopedia (2022), https://www.investopedia.com/
terms/d/downside-
deviation.asp#:~:text=Downside%20deviation%20is%20a%20measure,measure
%20of%20risk%2Dadjusted%20return.)
    \183\ This study compares the performance of sustainable funds 
to traditional funds between 2004 and 2018 using Morningstar data on 
ETF and open-ended mutual funds. Funds considered to be ESG-focused 
are defined as those that prioritize investments based on multiple 
screens for numerous ESG factors and a variety of strategies. (See 
Morgan Stanley Institute for Sustainable Investing, ``Sustainable 
Reality: Analyzing Risk and Returns of sustainable Funds'' (2019), 
https://www.morganstanley.com/pub/content/dam/msdotcom/ideas/sustainable-investing-offers-financial-performance-lowered-risk/Sustainable_Reality_Analyzing_Risk_and_Returns_of_Sustainable_Funds.pdf.)
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    Surveys of the investment industry and investors indicate that the 
application of ESG factors in risk-management is a common practice. In 
an investigation performed by the Government Accountability Office 
(GAO) (2020), 12 of 14 interviewed institutional investors seek 
information on ESG to better understand risks that could affect company 
financial performance over time, and five of seven public pension funds 
seek ESG information to enhance their understanding of risks that could 
affect a companies' value over time.\184\ Similarly, survey data 
reported by Natixis (2018) observes that 46 percent of institutional 
investors implementing ESG say that the analysis of ESG-related factors 
is ``as important to their investment process as traditional 
fundamental analysis'' and that 56 percent of institutional investors 
believe incorporating ESG mitigates governance and social risks.\185\ 
According to a survey conducted by FTSE Russell (2021), 64 percent of 
asset owners implementing or evaluating sustainability in portfolios 
cite risk as a motivator.\186\
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    \184\ GAO, ``Report to the Honorable Mark Warner U.S. Senate: 
Disclosure of Environmental, Social, and Governance Factors and 
Options to Enhance Them'' (July 2020), https://www.gao.gov/assets/gao-20-530.pdf.
    \185\ Natixis Investment Managers, ``Looking for the Best of 
Both Worlds'' (2019), https://www.im.natixis.com/us/resources/esg-investing-survey-2019.
    \186\ FTSE Russell, ``Sustainable Investment Is Now Standard 
According to Global Asset Owner Survey'' (October 2021), https://www.ftserussell.com/press/sustainable-investment-now-standard-according-global-asset-owner-survey.
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    The Department agrees that considering relevant ESG factors plays 
an important role in mitigating risks in the portfolios of ERISA plan 
participants and beneficiaries.
(h) Market Pricing of ESG Risks
    In the proposal, the Department also welcomed comments on the 
extent to which climate-related financial risk is not already 
incorporated into market pricing. The Department received two comments 
that argued that climate risks are not yet fully reflected in asset 
prices. Conversely, another commenter criticized that the proposal's 
regulatory impact analysis did not provide a rational basis for the 
contention that climate change and other ESG factors are not already 
priced into the market. This commenter argued that if climate change 
and ESG factors are already priced into the market, then further 
consideration would not result in investment gains.
    Commenters also referenced literature exploring market pricing. For 
instance, Brest, Gilson, and Wolfson (2018) argue that if ESG ratings 
and investments in ESG affect productivity, then they should already be 
reflected in stock prices.\187\ However, Condon (2021) identifies 
several sources of mispricing pertaining to climate risks, including 
limited asset-level data, reliance on outdated risk assessments, 
misaligned incentives, and regulatory distortions within the market. 
Although the efficient market hypothesis posits that arbitrageurs would 
exploit mispriced assets until the assets are no longer

[[Page 73866]]

mispriced, the author acknowledges that the role of arbitrage in the 
real world is limited by imperfect information, heterogeneous 
expectations about the future, and uncertainty about when climate-
related risks will occur.\188\ Brav and Heaton (2021) notes that 
research in this area is difficult, as the theories rely on expected 
returns, while researchers only have access to realized returns. The 
authors note, ``When researchers study average, realized returns, it is 
always uncertain whether the realized price reflected one of the 
possible price realizations that investors anticipated at the 
probability they assigned it, or whether that price reflected a change 
in the underlying probability distribution.'' \189\
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    \187\ Paul Brest, Ronald Gilson, and Mark Wolfson, ``How 
Investors Can (and Can't) Create Social Value,'' Columbia Law School 
Scholarship Archive (2018), https://scholarship.law.columbia.edu/cgi/viewcontent.cgi?article=3099&context=faculty_scholarship.
    \188\ Madison Condon, ``Market Myopia's Climate Bubble,'' 1 Utah 
Law Review 63 (2022), Boston University School of Law Research Paper 
(February 2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3782675.
    \189\ Alon Brav and J.B. Heaton, ``Brown Assets for the Prudent 
Investor,'' Harvard Business Law Review (2021). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3895887.
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(i) Literature on Environmental Factors
    Reflective of the significant economic impacts of climate change to 
date across various sectors of the economy, the Department believes it 
can be as appropriate to treat climate change as a relevant factor in 
assessing the risks and returns of investments as any other relevant 
factor a prudent fiduciary would consider.
    In the proposal, the Department requested comments on whether 
fiduciaries should consider climate change as presumptively material in 
their assessment of investment risks and returns, if adopted. The 
Department received numerous comments specifically addressing the 
materiality of climate change and environmental risks. Some of the 
commenters note that while climate change risks are often considered 
strategic and regulatory, they are also operational risks. One 
commenter notes that the physical and transition impacts from climate 
change are already materially affecting public companies and financial 
institutions. Another commenter notes that weak control of 
environmental activities, such as pollution, over-consumption of raw 
materials, or lack of recycling, can lead to volatile or lower 
financial margins or returns to investors. A few commenters note that 
climate-related financial risks are especially relevant to retirement 
investors, who invest over decades and are often universal owners with 
exposure to many at-risk sectors.
    There is a breadth of literature that provides evidence for the 
materiality of climate change as a driver of risk-adjusted returns. 
These risks are often referred to in two broad categories: physical 
risk and transition risk. Physical risk captures the financial impacts 
associated with a rise in extreme weather events and a changing 
climate, both chronic and acute. The literature maintains that these 
risks can be especially material for long duration assets and grow in 
severity the more that climate mitigation and adaptation are neglected. 
We are already seeing significant economic costs as a result of 
warming, and a certain amount of additional warming is guaranteed based 
on the greenhouse gas pollution already in the atmosphere.\190\ This 
implies that the physical risks of climate change to our economy and to 
investments will persist. A 2019 report from BlackRock notes that the 
physical risk of extreme weather poses growing risks that are 
underpriced in certain sectors and asset classes.\191\ Additionally, 
S&P Trucost found that almost 60 percent of the companies in the S&P500 
index hold assets that were at high risk to the physical effects of 
climate change.\192\ The Treasury Financial Stability Oversight Council 
(2021) provides a sense of the magnitude of the effect, noting that in 
2020, there were 22 weather and climate disasters with damages 
exceeding a billion dollars, resulting in a combined $95 billion in 
damages.\193\ The report asserted that weather and climate disasters 
may result in credit and market risks, associated with loss of income, 
defaults, changes in the value of assets, liquidity risks, operational 
risks, and legal risks.\194\
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    \190\ Renee Cho, ``How Climate Change Impacts the Economy'' 
(June 20, 2019), https://news.climate.columbia.edu/2019/06/20/climate-change-economy-impacts/. Celso Brunetti, Benjamin Dennis, 
Dylan Gates, Diana Hancock, David Ignell, Elizabeth K. Kiser, 
Gurubala Kotta, Anna Kovner, Richard J. Rosen, and Nicholas K. 
Tabor, ``Climate Change and Financial Stability,'' FEDS Notes. 
Washington: Board of Governors of the Federal Reserve System, March 
19, 2021, https://doi.org/10.17016/2380-7172.2893.
    \191\ BlackRock Investment Institute, ``Getting Physical: 
Assessing Climate Risks'' (2019), https://www.blackrock.com/us/individual/insights/blackrock-investment-institute/physical-climaterisks.
    \192\ S&P Trucost Limited, Understanding Climate Risk at the 
Asset Level: The Interplay of Transition and Physical Risks (2019), 
https://www.spglobal.com/_division_assets/images/specialeditorial/understanding-climate-risk-at-the-assetlevel/sp-trucost-interplay-of-transition-andphysical-risk-report-05a.pdf.
    \193\ U.S. Treasury Financial Stability Oversight Council, 
``Report on Climate-Related Financial Risk: 2021'' (2021), https://home.treasury.gov/system/files/261/FSOC-Climate-Report.pdf.
    \194\ Id.
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    In contrast, transition risk reflects the risks that carbon-
dependent businesses lose profitability and market share as government 
policies and new technology drive the transition to a carbon-neutral 
economy. Existing government policies and increasingly ambitious 
national and international greenhouse reduction goals will continue to 
create significant transition risk for investments. Studies assess the 
value of global financial assets at risk from climate change to be in 
the range of $2.5 trillion to $4.2 trillion, including transition risks 
and other impacts from climate change.
    The U.S. Commodity Futures Trading Commission (CFTC, 2020) warns 
that much of the risk associated with climate change is not priced into 
the market, which increases the risk for a systemic shock. The report 
notes that a ``sudden revision of market participants' perceptions 
about climate risk could trigger a disorderly repricing of assets, 
which could have cascading effects on portfolios and balance sheets 
and, therefore, systemic implications for financial stability.'' \195\ 
A Federal Reserve Board report from 2020, which states ``[c]limate 
change, which increases the likelihood of dislocations and disruptions 
in the economy, is likely to increase financial shocks and financial 
system vulnerabilities that could further amplify these shocks.'' \196\ 
The report continues: ``Opacity of exposures and heterogeneous beliefs 
of market participants about exposures to climate risks can lead to 
mispricing of assets and the risk of downward price shocks.'' \197\
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    \195\ Climate-Related Market Risk Subcommittee, ``Managing 
Climate Risk in the U.S. Financial System,'' U.S. Commodity Futures 
Trading Commission, Market Risk Advisory Committee (2020), https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
    \196\ Board of Governors of the Federal Reserve System, 
``Financial Stability Report'' (November 2020), https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf.
    \197\ Id.

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[[Page 73867]]

    Several studies quantify the direct economic effects of climate 
change. For instance, the CFTC estimates that by the end of the 
century, climate change will decrease the U.S. annual GDP by 1.2 
percent for every 1 degree Celsius increase and that by 2090, total 
impacts from extreme heat conditions could result in more than 2 
billion lost labor hours, corresponding to $160 billion (2015) in lost 
wages.\198\ CFTC (2020) notes that transition risks may lead to both 
stranded capital--where capital assets are at-risk from devaluation--or 
stranded value--where the market-value of a project or firm is at-risk 
from devaluation or otherwise negatively discounted.\199\ Mecure et al. 
(2018) estimates that the stranded fossil fuel assets may result in a 
discounted global wealth loss between $1 trillion and $4 trillion.\200\ 
Similarly, a Mercer and the Center for International Environmental Law 
2016 report estimates that the coal subsector may lose as much as 84 
percent of its annual return potential over the next 35 years. The 
study also estimates that the annual returns for the oil and utilities 
subsectors could fall by as much as 63 percent, and 39 percent, 
respectively. In comparison, the study estimates that annual returns 
for renewables could increase by as much 54 percent over the same 
period.\201\
---------------------------------------------------------------------------

    \198\ U.S. Commodity Futures Trading Commission, ``Managing 
Climate Risk in the U.S. Financial System'' (2020), https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
    \199\ U.S. Commodity Futures Trading Commission. ``Managing 
Climate Risk in the U.S. Financial System,'' (2020). https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
    \200\ J.F. Mercure, H. Pollitt, J.E. Vi[ntilde]uales, N.R. 
Edwards, P.B. Holden. U. Chewpreecha, P. Salas, I. Sognnaes, A. Lam, 
and F. Knobloch, ``Macroeconmic Impact of Stranded Fossil Fuel 
Assets,'' Nature Climate Change 8, 588-593 (2018).
    \201\ Mercer and the Center for International Environmental Law, 
``Trillion-Dollar Transformation: A Guide to Climate Change 
Investment Risk Management for US Public Defined Benefit Trustees'' 
(2016), https://static1.squarespace.com/static/569da6479cadb6436a8fecc8/t/584dcf37893fc01633e3572a/1481494366264/gl-2016-responsible-investments-a-guide-to-climate-change-investment-risk-management-for-us-public-defined-benefit-plan-trustees-mercer.pdf.
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    The risks associated with climate change are also expected to have 
direct implication for retirement investors. For example, Mercer and 
the Center for International Environmental Law (2016) finds that the 
total value of assets in an average U.S. public pension portfolio could 
be 6 percent lower by 2050 than under a business-as-usual scenario due 
largely to transition risks associated with climate change.\202\
---------------------------------------------------------------------------

    \202\ Id.
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    However, it is worth noting that climate change also represents an 
investment opportunity, with research suggesting that investment in 
climate change mitigation will produce increasingly attractive 
yields.\203\ Addressing transition risks can present opportunities to 
identify investments that are strategically positioned to succeed in 
the transition. Gradual shifts in investor preferences toward 
sustainability and the growing recognition that climate risk is 
investment risk may lead to a reallocation of capital. For instance, 
Matthews, Eaton, and Benoit (2021) estimates that to meet global energy 
demand and climate aspirations, annual investments in clean energy 
would need to grow from $1.1 trillion in 2021 to $3.4 trillion until 
2030.\204\
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    \203\ Jason Channell, Elizabeth Curmi, Phuc Nguyen, Elaine 
Prior, Alastair Syme, Heath Jansen, Ebrahim Rahbari, Edward Morse, 
Seth Kleinman, and Tim Kruger, ``Energy Darwinism II: Why a Low 
Carbon Future Doesn't Have to Cost the Earth,'' Citi (August 2015). 
https://www.citivelocity.com/citigps/energy-darwinism-ii/.
    \204\ Christopher Matthews, Collin Eaton, and Faucon Benoit, 
``Behind the Energy Crisis: Fossil Fuel Investment Drops, and 
Renewables Aren't Ready,'' Wall Street Journal (October 2021), 
https://www.proquest.com/docview/2582603911?accountid=41086.
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(j) Literature on Social Factors
    The literature also has findings on the materiality of weighing 
social factors in investment processes. The aforementioned meta-
analysis by Friede et al. (2015) finds that 55.1 percent of the studies 
reviewed found a positive correlation between corporate financial 
performance and social-focused investing.\205\ Two topics focused on in 
the literature were (1) diversity and inclusion and (2) worker voice.
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    \205\ Gunnar Friede, Michael Lewis, and Alexander Bassen, Timo 
Busch, ``ESG & Corporate Financial Performance: Mapping the Global 
Landscape,'' Deutsche Asset & Wealth Management, University of 
Hamburg (December 2015). https://download.dws.com/download?elib-assetguid=2c2023f453ef4284be4430003b0fbeee.
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(1) Diversity and Inclusion
    Many studies show the material financial benefits of diverse and 
inclusive workplaces. The Department received several comments noting 
that diversity is material to financial performance. For instance, one 
commenter notes that high staff turnover, high strike rates, 
absenteeism, or death have all been linked to lower productivity and 
poor-quality control. There are three main vectors across which a 
company's diversity and inclusion practices that can have a financially 
material impact on their business: employee recruitment and retention, 
performance and productivity, and litigation.
(a) Employee Recruitment and Retention
    There is evidence that corporate social responsibility affects 
employee recruitment, productivity, satisfaction, and retention.\206\ 
While not all turnover is undesirable, turnover is costly. These costs 
are both direct and indirect. Direct costs include staff time to off-
board the former employee, covering the reduced capacity with a 
contingent employee or with existing staff, and the cost of 
recruitment. The indirect costs include on-the-job training, employee 
socialization, and productivity gaps between the new and former 
employees.\207\ These costs are commonly estimated as equating to 6 to 
9 months of the salary for the position (or 50 to 75 percent of the 
salary) on top of the salary itself, depending on how exhaustively one 
catalogues the different types of costs.\208\
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    \206\ Hong-yan Wang and Zhi-Xia Chen, ``Corporate Social 
Responsibility and Job Applicant Attraction: a Moderated-Mediation 
Model,'' PLOS ONE 17(3): e0260125. https://doi.org/10.1371/journal.pone.0260125. DiversityInc., ``Millennial and Gen Z 
Jobseekers: An Emphasis on Social Responsibility,'' https://www.diversityincbestpractices.com/millennial-and-gen-z-jobseekers-an-emphasis-on-social-responsibility/.
    \207\ David Allen, ``Retaining Talent,'' Society for Human 
Resources Management Foundation (2008), https://www.shrm.org/hr-today/trends-and-forecasting/special-reports-and-expert-views/documents/retaining-talent.pdf.
    \208\ Shane McFeely and Wigert, Ben, ``This Fixable Problem 
Costs U.S. Businesses $1 Trillion,'' Gallup (March 2019), https://
www.gallup.com/workplace/247391/fixable-problem-costs-businesses-
trillion.aspx#:~:text=The%20cost%20of%20replacing%20an,to%20%242.6%20
million%20per%20year. John Hall, ``The Cost of Turnover Can Kill 
Your Business and Make Things Less Fun,'' Forbes (May 2019), https://www.forbes.com/sites/johnhall/2019/05/09/the-cost-of-turnover-can-kill-your-business-and-make-things-less-fun/?sh=323adfac7943. Aharon 
Tziner and Assa Birati, ``Assessing Employee Turnover Costs: A 
Revised Approach,'' Human Resources Management Review (1996). 118-
119.
---------------------------------------------------------------------------

     In a survey of 2,745 respondents, the job site Glassdoor 
found that 76 percent of employees and job seekers overall look at 
workforce diversity when evaluating an offer.\209\
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    \209\ Glassdoor, ``Diversity & Inclusion Workplace Survey'' 
(September 2020), https://b2b-assets.glassdoor.com/glassdoor-diversity-inclusion-workplace-survey.pdf?_gl=1*14tssal*_ga*MTY5NTI5NTgwMi4xNjYwNjUzMDY3*_ga_RC95PMVB3H*MTY2MDY1MzA2Ni4xLjEuMTY2MDY1MzA3NS41MQ.
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     The Level Playing Institute (2007) estimates firms incur a 
cost of $64

[[Page 73868]]

billion per year from losing and replacing over 2 million American 
professionals and managers who leave their jobs each year due to 
unfairness and discrimination.\210\
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    \210\ Level Playing Field Institute, ``The Cost of Employee 
Turnover Due Solely to Unfairness in the Workplace'' (2007).
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     Robinson and Dechant (1997) estimate that replacing a 
departing employee costs between $5,000 and $10,000 for an hourly 
worker, and between $75,000 and $211,000 for an executive making 
$100,000 per year.\211\
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    \211\ Gail Robinson and Kathleen Dechant, ``Building a Business 
Case for Diversity,'' Academy of Management Executive 11 (3) (1997): 
21-31.
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(b) Performance and Productivity
     Chen, Leung, and Evans (2018) find that increased 
representation of women on corporate boards is associated with an 
increase in the number of patents and citations, when controlling for 
the amount of research and development spending.\212\
---------------------------------------------------------------------------

    \212\ Jie Chen, Woon Sau Leung, and Kevin P. Evans, ``Female 
Board Representation, Corporate Innovation and Firm Performance,'' 
Journal of Empirical Finance 48 (September 2018): 236-254.
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     Lorenzo et al. (2017) review of 171 German, Swiss, and 
Austrian companies finds that management diversity has a positive and 
statistically significant relationship to higher revenue from new 
products and services.\213\
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    \213\ Rocio Lorenzo, Nicole Voigt, Karin Schetelig, Annika 
Zawadzki, Isabelle Welpe, and Prisca Brosi, ``The Mix that Matters: 
Innovation through Diversity,'' BCG (2017), https://www.bcg.com/publications/2017/people-organization-leadership-talent-innovation-through-diversity-mix-that-matters.
---------------------------------------------------------------------------

     Phillips, Lijenquist, and Neale (2008) find that socially 
different group members do more than simply introduce new viewpoints or 
approaches. In the study, diverse groups outperformed more homogeneous 
groups not because of an influx of new ideas, but because diversity 
triggered more careful information processing that is absent in 
homogeneous groups.\214\
---------------------------------------------------------------------------

    \214\ Katherine W. Phllips, Katie A. Lijenquist, and Margaret A. 
Neale ``Is the Pain Worth the Gain? The Advantages and Liabilities 
of Agreeing with Socially Distinct Newcomers,'' Personality and 
Social Psychology Bulletin (December 2008), https://journals.sagepub.com/doi/abs/10.1177/0146167208328062.
---------------------------------------------------------------------------

     A study from Deloitte (2013) finds employee perception of 
an organization's commitment to diversity and inclusion is associated 
with higher levels of innovation, responsiveness to customer needs, and 
team collaboration.\215\
---------------------------------------------------------------------------

    \215\ Deloitte, ``Waiter, Is that Inclusion in My Soup? A New 
Recipe to Improve Business Performance,'' Deloitte (2013), https://www2.deloitte.com/content/dam/Deloitte/au/Documents/human-capital/deloitte-au-hc-diversity-inclusion-soup-051.
---------------------------------------------------------------------------

     A 2013 report released by the Center for Talent Innovation 
(CTI) finds that employees at publicly traded companies that exhibit 
both inherent and acquired diversity \216\ reported substantial 
benefits. CTI conducted a survey and found that employees at diverse 
companies were 70 percent more likely to report that they had captured 
a new market, and 75 percent more likely to report that their ideas had 
become productized. Employees were also as much as 158 percent more 
likely to report that they believed they understood their target end-
users if one or more members on the team represent the user's 
demographic.\217\
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    \216\ The report defined inherent diversity to include gender, 
race, age, religious background, socioeconomic background, sexual 
orientation, disability, and nationality. The report defines 
acquired diversity to include cultural fluency, generational 
savviness, gender smarts, social media skills, cross-functional 
knowledge, global mindset, military experience, and language skills.
    \217\ Sylvia Ann Hewlett, Melinda Marshall, Laura Sherbin, and 
Tara Gonsalves, ``Innovation, Diversity, and Market Growth,'' Center 
for Talent Innovation (2013), https://coqual.org/wp-content/uploads/2020/09/31_innovationdiversityandmarketgrowth_keyfindings-1.pdf.
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     Companies in the top quartile for ethnic and racial 
diversity in management were 36 percent more likely to have financial 
returns above the median for their industry in their country, and those 
in the top quartile for gender diversity were 25 percent more likely to 
have returns above the median for their industry in their country.\218\
---------------------------------------------------------------------------

    \218\ Vivian Hunt, Sara Prince, Sundiatu Dixon-Fyle, and Kevin 
Dolan. ``Diversity Wins: How Inclusion Matters,'' McKinsey & Company 
(2020). https://www.mckinsey.com/~/media/mckinsey/
featured%20insights/diversity%20and%20inclusion/
diversity%20wins%20how%20inclusion%20matters/diversity-wins-how-
inclusion-matters-vf.pdf.
---------------------------------------------------------------------------

     Companies in the top quartile of gender diversity or 
ethnic diversity on executive teams were more likely to outperform peer 
companies in the bottom quartile of diversity on executive teams, in 
terms of profitability.\219\
---------------------------------------------------------------------------

    \219\ Ibid.
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(c) Litigation
     The U.S. Equal Employment Opportunity Commission (EEOC) 
received 67,448 charges of workplace discrimination in Fiscal Year (FY) 
2020. The agency secured $439.2 million for victims of discrimination 
in the private sector and state and local government workplaces through 
voluntary resolutions and litigation.\220\
---------------------------------------------------------------------------

    \220\ ``EEOC Releases Fiscal Year 2020 Enforcement and 
Litigation Data,'' (2021).
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(d) Studies Covering Multiple Topics
     A meta-analysis on 7,939 business units in 36 companies 
further confirms that higher employee satisfaction levels are 
associated with higher profitability, higher customer satisfaction, and 
lower employee turnover.\221\
---------------------------------------------------------------------------

    \221\ James K. Harter, Frank L. Schmidt, and Theodore L. Hayes, 
``Business-Unit-Level Relationship Between Employee Satisfaction, 
Employee Engagement, and Business Outcomes: A Meta-Analysis,'' 
Journal of Applied Psychology 87(2) (2002) 268-279.
---------------------------------------------------------------------------

     One study found that ``companies reporting highest levels 
of racial diversity brought in nearly 15 times more sales revenue on 
average than those with lowest levels of racial diversity.'' It also 
found that ``[c]ompanies with highest rates reported an average of 
35,000 customers compared to 22,700 average customers among those 
companies with lowest rates of racial diversity.'' \222\
---------------------------------------------------------------------------

    \222\ Cedric Herring, ``Does Diversity Pay? Race, Gender, and 
the Business Case for Diversity,'' American Sociological Review 
(2009).
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     A study of Federal agencies finds that diversity 
management is strongly linked to both work group performance and job 
satisfaction, and people of color see benefits from diversity 
management above and beyond those experienced by white employees.\223\
---------------------------------------------------------------------------

    \223\ David Pitts, ``Diversity Management, Job Satisfaction, and 
Performance: Evidence from U.S. Federal Agencies,'' Public 
Administration Review (2009).
---------------------------------------------------------------------------

     A 6-month research study ``found evidence that a growing 
number of companies known for their hard-nosed approach to business--
such as Gap Inc., PayPal, and Cigna--have found new sources of growth 
and profit by driving equitable outcomes for employees, customers, and 
communities of color.'' \224\
---------------------------------------------------------------------------

    \224\ Angela Glover Blackwell, Mark Kramer, Lalitha 
Vaidyanathan, Lakshmi Iyer, and Josh Kirschenbaum, ``The Competitive 
Advantage of Racial Equity,'' FSG and PolicyLink (2018).
---------------------------------------------------------------------------

    However, some studies surveyed by the Department did not find a 
statistically significant link between board diversity and corporate 
financial performance. For instance:
     A 2016 meta-analysis finds that the correlation between 
gender diversity and corporate financial performance is either 
nonexistent or very small.\225\
---------------------------------------------------------------------------

    \225\ Alive Eagly, ``When Passionate Advocates Meet Research on 
Diversity, Does the Honest Broker Stand a Chance,'' Journal of 
Social Issues, Vol. 72, No. 1 (2016). https://web.p.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=1&sid=8ad704e4-79e4-4998-827b-07473bb39c31%40redis.
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     A 2021 review found that most of the literature used to 
support diversity mandates on corporate boards does not identify causal 
effects and that the conclusions of studies that do isolate a causal 
effect are mixed.\226\
---------------------------------------------------------------------------

    \226\ Jonathan Klick, ``Review of the Literature on Diversity on 
Corporate Boards,'' American Enterprise Institute (2021), https://www.aei.org/research-products/report/review-of-the-literature-on-diversity-on-corporate-boards/.

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[[Page 73869]]

     A 2010 study did not find a statistically significant 
relationship between the gender or ethnic diversity of boards and 
financial performance.\227\
---------------------------------------------------------------------------

    \227\ David A. Carter, Frank D'Souza, Betty J. Simkins, and W. 
Gary Simpson, ``The Gender and Ethnic Diversity of US Boards and 
Board Committees and Firm Financial Performance,'' Corporate 
Governance: An International Review 18, no. 5 (2010): 396-414, 
https://wedc-online.wildapricot.org/Resources/WEDC-Documents/Women%20On%20Board/Gender%20Diversity%20and%20Boards.pdf.
---------------------------------------------------------------------------

     A 2015 meta-analysis from 20 studies on 3,097 companies 
analyzed the relationship between female representation on corporate 
boards and firm performance. The analysis found the mean-weighted 
correlation between female representation and firm performance was 
small and non-significant. However, the authors note that a higher 
representation of females on corporate boards was also not associated 
with a detrimental effect on firm financial performance.\228\
---------------------------------------------------------------------------

    \228\ Jan Luca Pletzer, Romina Nikolova, Karina Karolina 
Kedzior, and Sven Constantin Voelpel, ``Does Gender Matter? Female 
Representation on Corporate Boards and Firm Financial Performance--A 
Meta-Analysis'' (June 2015), https://journals.plos.org/plosone/article/file?id=10.1371/journal.pone.0130005&type=printable.
---------------------------------------------------------------------------

    One study cautions that ``the empirical connection between a single 
dimension of board structure and firm performance may be too nuanced to 
statistically tease out. Research that empirically links board 
structure to board or firm actions is a much better method to test if a 
relationship between board composition and performance exists than an 
analysis that attempts to go from board structure directly to firm 
performance and skips over board and firm actions.'' \229\ Another 
study cautioned that when diversity is enforced by regulation, there 
was no effect on performance.\230\
---------------------------------------------------------------------------

    \229\ David A. Carter, Frank D'Souza, Betty J. Simkins, and W. 
Gary Simpson, ``The Gender and Ethnic Diversity of US Boards and 
Board Committees and Firm Financial Performance,'' Corporate 
Governance: An International Review 18, no. 5 (2010): 396-414. 
https://wedc-online.wildapricot.org/Resources/WEDC-Documents/Women%20On%20Board/Gender%20Diversity%20and%20Boards.pdf.
    \230\ Deloitte and Nyenrode Research Program, ``Good Governance 
Driving Corporate Performance? A Meta-Analysis of Academic Research 
& Invitation to Engage in the Dialogue'' (December 2016).
---------------------------------------------------------------------------

(2) Worker Voice
    The research literature also finds material financial benefits from 
employee engagement and representation in corporate governance as 
employees' voices are amplified through unions or through direct 
representation on corporate boards. Similar to the literature on 
diversity and inclusion, the literature focuses on the benefits of 
employee retention and productivity.
    Much of the literature on employee voice builds on the tradeoff 
between exit and voice laid out by Hirschman (1970), in which 
management becomes aware of failures either by actors, such as 
employees, leaving the organization (``quitting'') or by actors 
expressing dissatisfaction to management (``voicing'').\231\ A review 
of theoretical and empirical research by Palladino (2021) finds that 
when employees have access to voice mechanisms, such as union 
representation, firms are likely to experience fewer employee 
``exits.'' \232\ For example, Freeman (1980) shows empirically that the 
presence of unions reduces turnover.\233\
---------------------------------------------------------------------------

    \231\ Albert Hirschman, Exit, Voice, and Loyalty: Responses to 
Decline in Firms, Organizations, and States, Harvard University 
Press, Cambridge, Massachusetts (1970).
    \232\ Lenore Palladino, ``Economic Democracy at Work: Why (and 
How) Workers Should be Represented on US Corporate Boards,'' Journal 
of Law and Political Economy, Vol. 1, No. 3 (2021).
    \233\ Richard B. Freeman, ``The Exit-Voice Tradeoff in the Labor 
Market: Unionism, Job Tenure, Quits, and Separations,'' The 
Quarterly Journal of Economics, Vol. 94, No. 4 (1980), https://www.jstor.org/stable/pdf/1885662.pdf?refreqid=excelsior%3A04abe825526fefa1f141b7b509419d18&ab_segments=&origin=&acceptTC=1.
---------------------------------------------------------------------------

    The literature surveyed by Palladino (2021) also suggests that 
unionization and worker voice improves employee productivity.\234\ 
Freeman and Lazear (1995) model the economic value of workers' 
councils, finding that workers' councils may reduce economic 
inefficiencies by decreasing information asymmetries and aligning 
employer and worker incentives during difficult times. Their modeling 
also finds that workers' councils with co-determination rights were 
associated with increased perceptions of job security amongst workers, 
aligning long-run interests of the worker and employer, and ultimately 
increasing productivity.\235\ J[auml]ger et al. (2021) performed an 
empirical analysis of the impact of a policy reform in Germany 
affecting the degree of worker representation on corporate boards.\236\ 
They found that worker representation does not lower wages or reduce 
capital formation.
---------------------------------------------------------------------------

    \234\ Lenore Palladino, ``Economic Democracy at Work: Why (and 
How) Workers Should be Represented on US Corporate Boards,'' Journal 
of Law and Political Economy, Vol. 1, No. 3 (2021).
    \235\ Richard Freeman and Edward Lazear, ``An Economic Analysis 
of Works Councils,'' Works Councils: Consultation, Representation, 
and Cooperation in Industrial Relations, University of Chicago Press 
(1995), https://www.nber.org/system/files/chapters/c11555/c11555.pdf.
    \236\ Simon J[auml]ger, Benjamin Schoefer, J[ouml]rg Heining, 
``Labor in the Boardroom,'' Quarterly Journal of Economics, Vol. 
136, Issue 2, 2021. https://doi.org/10.1093/qje/qjaa038.
---------------------------------------------------------------------------

(k) ESG Data, Ratings, and Disclosures
    The research community and commenters also weighed in on the data, 
ratings, and disclosures used to inform ESG investments. Surveys 
conducted by Natixis Investment Managers in 2018 found that among 
investment managers implementing ESG, 70 percent of institutions rely 
on sustainability ratings to evaluate ESG performance, which is higher 
than the percent of institutions relying on company reports (37 
percent), rankings and awards (37 percent), regulatory filings (24 
percent), news reports (24 percent), and non-governmental organizations 
(23 percent).\237\
---------------------------------------------------------------------------

    \237\ Natixis Investment Managers, ``Looking for the Best of 
Both Worlds'' (2019), https://www.im.natixis.com/us/resources/esg-investing-survey-2019.
---------------------------------------------------------------------------

    Research indicates that one of the challenges faced by investment 
managers and rating agencies is that many of the company disclosures on 
ESG-related issues are voluntary. Condon (2022) finds that, as of 2018, 
complying companies, on average, provided less than four of the eleven 
disclosure metrics recommended by the Task Force on Climate-related 
Financial Disclosures. The study also finds that voluntary disclosures 
are more likely to focus on transition risks than physical risks.\238\
---------------------------------------------------------------------------

    \238\ Madison Condon, ``Market Myopia's Climate Bubble,'' 1 Utah 
Law Review 63 (2022), Boston University School of Law Research Paper 
(February 2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3782675.
---------------------------------------------------------------------------

    To mitigate missing information in voluntary disclosures, ESG 
rating agencies and investment professionals have begun to utilize 
alternative data and artificial intelligence. These techniques allow 
the industry to uncover material data that were not disclosed by the 
company.\239\ For instance, Morgan Stanley Capital International (MSCI) 
estimates that only 35 percent of the data inputs for the MSCI ESG 
Ratings model are from voluntary disclosures.\240\ Additionally, a 2020 
survey of CFA Institute members finds that 71 percent of the 
participants polled agreed that alternative data reinforce 
sustainability analysis and 43

[[Page 73870]]

percent expect applying artificial intelligence to sustainability 
analysis will further improve the analysis.\241\
---------------------------------------------------------------------------

    \239\ Sean Collins and Kristen Sullivan, ``Advancing ESG 
Investing: a Holistic Approach for Investment Management Firms,'' 
Harvard Law School Forum on Corporate Governance (March 2020), 
https://corpgov.law.harvard.edu/2020/03/11/advancing-esg-investing-a-holistic-approach-for-investment-management-firms/.
    \240\ Samuel Block, ``Using Alternative Data to Spot ESG 
Risks,'' MSCI (June 2019), https://www.msci.com/www/blog-posts/using-alternative-data-to-spot/01516155636.
    \241\ CFA Institute. ``Future of Sustainability in Investment 
Management: From Ideas to Reality.'' https://www.cfainstitute.org/-/media/documents/survey/future-of-sustainability.ashx.
---------------------------------------------------------------------------

    Another challenge faced by investment managers and rating agencies 
is a lack of standardization in ESG terminology, which makes it 
difficult to do relative comparisons or to create well-defined 
categories.\242\ In a 2020 report to Congress, the GAO reviewed annual 
reports, 10-K filings, proxy statements, and voluntary sustainability 
reports for 32 companies and interviewed 14 large and midsized 
institutional investors. The report found that the ``differences in 
methods and measures companies use to disclose quantitative information 
make it difficult to compare across companies.'' \243\ Similarly, the 
CFA Institute notes that differing terminology, such as the same 
measure being called different names or different measures sharing the 
same name, makes it difficult to do relative comparisons.\244\
---------------------------------------------------------------------------

    \242\ CFA Institute, ``Global ESG Disclosure Standards for 
Investment Products'' (2021), https://www.cfainstitute.org/-/media/documents/ESG-standards/Global-ESG-Disclosure-Standards-for-Investment-Products.pdf.
    \243\ GAO, ``Report to the Honorable Mark Warner U.S. Senate: 
Disclosure of Environmental, Social, and Governance Factors and 
Options to Enhance Them'' (July 2020), https://www.gao.gov/assets/gao-20-530.pdf.
    \244\ CFA Institute, ``Global ESG Disclosure Standards for 
Investment Products'' (2021).
---------------------------------------------------------------------------

    While ESG rating agencies have improved their methods and 
transparency in recent years, rating providers vary significantly in 
scoring methodology, data, analyses, metric weighting, materiality, and 
how missing information is accounted for.\245\ Several studies analyze 
how ratings differ between agencies. For instance, Feifei and 
Polychronopoulos (2020) construct four separate portfolios, two in the 
United States and two in Europe, using ESG ratings data from two 
providers. The study simulates portfolio performance between July 2010 
and June 2018. The authors found that the two constructed portfolios 
``have a performance dispersion of 70 basis points (bps) a year in 
Europe (9.4 percent versus 8.7 percent) and 130 bps a year in the 
United States (14.2 percent versus 12.9 percent).'' \246\ Similarly, a 
2020 study from the OECD constructed portfolios using ESG scores from 
different rating providers and found that risk-adjusted returns varied 
significantly between different rating providers.\247\
---------------------------------------------------------------------------

    \245\ OECD, ``ESG Investing: Practices, Progress and 
Challenges'' (2020), https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf.
    \246\ Feifei Li and Ari Polychronopoulos, ``What a Different an 
ESG Ratings Provider Makes!'' Research Affiliates (January 2020), 
https://www.researchaffiliates.com/content/dam/ra/documents/770-what-a-difference-an-esg-ratings-provider-makes.pdf.
    \247\ OECD, ``ESG Investing: Practices, Progress and 
Challenges'' (2020), https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf.
---------------------------------------------------------------------------

    Berg, K[ouml]lbel, and Rigobon (2022) compared 709 ESG indicators 
from different rating systems, to estimate how measurement, scope, and 
weight divergence account for the differences between ESG ratings. They 
find that measurement divergence accounts for 56 percent of the 
difference, while scope and weight divergence account for 38 percent 
and 6 percent, respectively.\248\ They caution that inconsistency with 
ESG ratings sends mixed signals to companies as to which actions are 
expected and will be valued by the market. They believe that the 
divergence of ratings poses a challenge for empirical research, as 
using one rater versus another may alter a study's results and 
conclusions.
---------------------------------------------------------------------------

    \248\ Florian Berg, Julian K[ouml]lbel, and Roberto Rigobon, 
``Aggregate Confusion: The Divergence of ESG Ratings,'' 2022, 
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533.
---------------------------------------------------------------------------

    Curtis, Fisch, and Robertson (2021) find that there is substantial 
heterogeneity in ESG ratings of companies but more consistency in ESG 
ratings of portfolios, and that in general ESG portfolios provide a 
degree of ESG characteristics.\249\ They argue this is what really 
matters from an investor's point of view. They make the analogy that 
the concerns with an ESG mutual fund are similar to those of a growth 
mutual fund--neither has a standardized definition, but they offer 
investors certain characteristics to a degree even if those 
characteristics vary widely across funds and even if different ratings 
providers rate them differently.
---------------------------------------------------------------------------

    \249\ Curtis, Fisch, and Robertson, ``Do ESG Funds Deliver on 
Their Promises?'' 2021.
---------------------------------------------------------------------------

    A 2021 study from MSCI finds that ESG ratings within the same 
category can have low pairwise correlations, which the study attributes 
to the use of different ESG metrics and weights.\250\ The study creates 
a composite ESG rating based on subindustry specific weights of E, S, 
and G and finds composite ratings tend to outperform any of the 
individual E, S, or G ratings. The bottom quintile of E, S, G, and 
composite ratings tend to have more stock drawdowns than their top 
quintile, especially when it comes to large drawdowns. From 2007 to 
2019, the bottom quintiles of E, S, G, and composite scores all 
performed worse than their top quintile. In this longer run analysis, 
E, S, and G scores had about equal effects, with the composite score 
improving on all these ratings. However, the top E, S, and G scores 
underperformed the bottom quintile during some time periods of their 
analysis. The top quintile of the composite ESG score outperformed for 
the entire time period.\251\
---------------------------------------------------------------------------

    \250\ MSCI's ESG ratings are based on subindustry level ratings, 
selected from 37 ESG metrics. For each subindustry, metrics are 
weighted based on subindustry specific weights.
    \251\ MSCI ESG Research, ``Deconstructing ESG Ratings 
Performance'' (2021), https://www.msci.com/our-solutions/esg-investing/deconstructing-esg-performance.
---------------------------------------------------------------------------

    Many commenters, academic researchers, and industry observers have 
raised serious questions about the reliability of ESG ratings. 
Fiduciaries use ratings as tools to synthesize large amounts of 
information. Reliability concerns make it more challenging for 
fiduciaries to conduct an analysis, but making decisions based on 
imperfect information is not limited to ESG investing. The Department 
anticipates that fiduciaries will give the same careful consideration 
to the usefulness and shortcomings of data sources pertaining to ESG as 
they do to any relevant data source.
(l) Summary of the Literature Reviewed
    Paragraphs (b) and (c) of the final rule will reduce the 
uncertainty that fiduciaries might have about considering ESG factors, 
thereby permitting them to take into account the beneficial impact that 
ESG can have on investing. The studies examined by the Department show 
that ESG can have a beneficial impact on investing in many 
circumstances. However, that impact is not universal and does not mean 
that ESG investing will result in improved performance or reduced risk 
in every circumstance. The current lack of standardized ratings also 
makes it difficult to directly measure the full impact of ESG 
strategies.
2. Cost Savings Relating to Paragraphs (c), Relative to the Current 
Regulation
    The current regulation expressly requires a fiduciary making an 
investment decision on collateral benefits when using the tiebreaker to 
document why pecuniary factors were not sufficient to select the 
investment, how the selected investment compares to alternative 
investments with regard to the factors listed in paragraphs 
(b)(2)(ii)(A) through (C) of the current regulation, and how the chosen 
non-pecuniary factors are consistent with the interests of the plan. 
This provision implemented a more rigid, heightened documentation 
requirement, which

[[Page 73871]]

imposed an annual cost burden of $122,115 according to the impact 
analysis of the current rule. This view was also supported by 
commenters, who stated that the current regulation created an extra 
burden of documentation. The final rule eliminates this special 
documentation requirement. The removal of this provision does not 
excuse ERISA fiduciaries from the documentation required to satisfy 
their general prudence obligations.
    Removing the special documentation leads to a cost savings. Like in 
the current regulation, the Department estimates that one percent of 
plans will invoke the tiebreaker in an investment decision each year, 
and the special documentation would have required two hours of labor 
from both a plan fiduciary and clerical worker. Assuming an hourly 
labor cost of $129.74 for a plan fiduciary and $61.01 for a clerical 
worker,\252\ the Department estimates that this elimination, updated 
for revised affected entity estimates, will save approximately $506,000 
annually.\253\
---------------------------------------------------------------------------

    \252\ The Department estimates labor costs by occupation. 
Estimates for total compensation are based on mean hourly wages by 
occupation from the 2021 Occupational Employment Statistics and 
estimates of wages and salaries as a percentage of total 
compensation by occupation from the December 2021 National 
Compensation Survey's Employee Cost for Employee Compensation. 
Estimates for overhead costs for services are imputed from the 2020 
Service Annual Survey. To estimate overhead cost on an occupational 
basis, the Office of Research and Analysis (ORA) allocates total 
industry overhead cost to unique occupations using a matrix of 
detailed occupational employment for each North American Industry 
Classification System (NAICS) industry. All values are in 2022 
dollars. For more information in how the labor costs are estimated 
see: Labor Cost Inputs Used in the Employee Benefits Security 
Administration, Office of Policy and Research's Regulatory Impact 
Analyses and Paperwork Reduction Act Burden Calculation, Employee 
Benefits Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
    \253\ In the 2020 final rule published on November 13, it was 
estimated that that plan fiduciaries and clerical staff would each 
expend, on average, two hours of labor to maintain the needed 
documentation, resulting in an annual burden estimate of 1,290 hours 
annually, with an equivalent cost of $122,115 for plans with ESG 
investments. For the purposes of this analysis, the Department 
assumes that DB plans will change investments annually, while DC 
plans review their investments every three years, on average. 
Updated to reflect updated estimates for affected plans and labor 
costs, the Department estimates the updated costs as: (124,302 DB 
plans that use ESG x 1% of plans that have ties x 2 hours x $129.74 
per hour for a plan fiduciary) + (124,302 DB plans that use ESG x 1% 
of plans that have ties x 2 hours x $61.01 per hour for a clerical 
worker) + (25,020 DC plans that use ESG x 1% of plans that have ties 
x \1/3\ of plans reviewing investments annually x 2 hours x $129.74 
per hour for a plan fiduciary) + (25,020 DC plans that use ESG x 1% 
of plans that have ties x \1/3\ of plans reviewing investments 
annually x 2 hours x $61.01 per hour for a clerical worker) = 
$506,029. This requirement has been eliminated in the finalized 
rule. 85 FR 72846. (Source Private Pension Plan Bulletin: Abstract 
of 2020 Form 5500 Annual Reports, Employee Benefits Security 
Administration (2022; forthcoming), Table D3.)
---------------------------------------------------------------------------

3. Benefits of Paragraph (d)
    Paragraph (d) of the final rule contains provisions addressing the 
application of the prudence and loyalty duties to the exercise of 
shareholder rights, including proxy voting, the use of written proxy 
voting guidelines, and the selection and monitoring of proxy advisory 
firms. The final rule's paragraph (d) will benefit plans by providing 
improved guidance regarding these activities. As discussed above, non-
regulatory guidance that the Department has previously issued over the 
years may have led to the misapprehension that fiduciaries are required 
to participate in all proxy votes presented to them or, conversely, 
that they may not participate in proxy votes unless they first perform 
a formal cost-benefit analysis and quantify net benefits. Although the 
current regulation sought to address the first misunderstanding (i.e., 
that fiduciaries are required to participate in all proxy votes) with 
express language, the Department is concerned that the language used 
may have effectively reinstated the second misunderstanding--that they 
may not participate in proxy votes unless they first perform a formal 
cost-benefit analysis and quantify net benefits--by suggesting that 
fiduciaries need special justification to participate in proxy votes. 
Several commenters stated that this misinterpretation leads some 
fiduciaries to abstain from many proxy votes out of an abundance of 
caution. These abstentions leave the interests of plans, participants, 
and beneficiaries unrepresented in proxy votes. An increase in proxy 
votes by plans will improve corporate accountability.
    The Department believes that the principles-based approach retained 
in paragraph (d) of the final rule will address these misunderstandings 
and clarify that neither extreme is required. Instead, plan 
fiduciaries, after an evaluation of relevant facts that form the basis 
for any particular proxy vote or other exercise of shareholder rights, 
must make a reasoned judgment both in deciding whether to exercise 
shareholder rights and how to exercise such rights. In making this 
judgment, plan fiduciaries must act in accordance with the economic 
interest of the plan, must consider any costs involved, and must never 
subordinate the interests of participants in their retirement benefits 
to unrelated goals.
    The clarifications offered in this final rule will lead to 
increased proxy voting activity compared to the baseline. The reason is 
that the final rule will address the misunderstanding that fiduciaries 
need special justification to participate in proxy votes. With this 
additional guidance, fiduciaries will have sufficient clarity to 
participate in proxy votes unless a responsible plan fiduciary 
determines it is not in the plan's best interest. The Department 
believes this is beneficial because it ensures that shareholders' 
interests, as a company's owners, are protected. By extension, this 
means the interests of plan participants and beneficiaries as 
shareholders are also protected.
    Preserving flexibility, paragraph (d) of the final rule carries 
forward core elements of the provision from the current regulation that 
allows a plan to have written proxy voting policies that govern 
decisions on when to vote on different categories or types of 
proposals, subject to the aforementioned principles. With the ability 
for plans to adopt policies to govern the decision whether to vote on a 
matter or class of matters, plan fiduciaries will be in a better 
position to conserve plan assets by establishing specific parameters 
designed to serve the plan's interests.
    The Department received several comments on the NPRM expressing 
support for proxy voting as an essential fiduciary function. One 
commenter argued that proxy voting can help reduce investment risk and 
pointed to the success of shareholder resolutions in reducing hazardous 
chemicals and pesticides, which could cause reputational and financial 
damage to firms if improperly managed. Several commenters argued that 
proxy votes can provide critical oversight of management, which can 
reduce downside risk. One investment management firm commented that 
they approach proxy voting with ``the consistent goal of promoting 
strong corporate governance, acting in the best interest of [. . .] 
shareholders and clients.'' Another commenter argued that the 
Department should go further and require voting in favor of proxy votes 
that align holdings with ESG metrics when in the interest of plan 
participants and beneficiaries, citing the financial effects that waste 
reduction efforts can have on lowering business costs. The Department 
considered this suggestion, but believes that the Department's 
longstanding view of ERISA with regards to proxy voting sets out a more 
balanced approach. The Department believes that proxies should

[[Page 73872]]

be voted as part of the process of managing the plan's investment in 
company stock unless a responsible plan fiduciary determines a proxy 
vote may not be in the plan's best interest; for example, if the costs 
associated with voting outweigh the expected benefits.
    Commenters provided literature on the cost, benefits, and effects 
of shareholder engagement and proxy voting.
(a) Changes in Levels of Proxy Voting
    The Department expects that the final rule will promote, rather 
than deter, responsible proxy voting compared to the 2020 rule; 
however, it is less certain that it will result in any increase in 
proxy voting as compared to the pre-regulatory guidance, which took a 
similar approach. In the NPRM, the Department invited comments on 
whether the proposed rule would increase proxy voting as compared to 
the pre-regulatory guidance but did not receive any comments on the 
question.
    Some commenters discussed how the proposed rule would affect proxy 
voting activity. For instance, one commenter noted that the proposed 
rule would help support appropriate levels of proxy voting, though they 
did not specify how, while recognizing that a professional advisor 
across many accounts can play a practical role in alleviating the costs 
and burdens of voting at the plan level. Conversely, another commenter 
noted that even large funds could be ``rationally apathetic'' because 
the costs of analyzing a given proxy vote and overcoming conflicts of 
interest will likely outweigh the marginal benefits of a ``correct'' 
proxy vote. This commenter expressed that unless there are explicit 
standards in place making clear that proxy voting is a fiduciary 
obligation, there is a significant risk of sub-optimal proxy votes. The 
Department's longstanding view of ERISA is that proxies should be voted 
as part of the process of managing the plan's investment in company 
stock unless a responsible plan fiduciary determines a proxy vote may 
not be in the plan's best interest. We believe that this standard 
highlights the importance of proxy voting, while also allowing a 
fiduciary to make prudent decisions regarding the costs and benefits of 
any particular proxy vote.
(b) Trends in Proxy Voting
    Commenters provided literature on the state of proxy voting. 
Orowitz, Kumar, and Hagel (2022) observe that by June of the 2022 proxy 
season there were already 924 shareholder proposal submissions.\254\ 
Even though the 2022 proxy season was not complete at the time of the 
study, this figure represented a 10 percent increase from 2021, when 
837 shareholder proposals were submitted. There was a similar 11 
percent increase between 2020 and 2021, when the number of proposals 
increased from 754 to 837. Based on projections for the rest of the 
year, the authors state that it is possible that 621 of these 
shareholder resolutions may eventually come to a vote. This would 
represent a 42 percent increase from 2021.\255\
---------------------------------------------------------------------------

    \254\ Hannah Orowitz, Rajeev Kumar, and Lee Ann Hagel, ``An 
Early Look at the 2022 Proxy Season,'' The Harvard Law School Forum 
on Corporate Governance (7 June 2022), https://corpgov.law.harvard.edu/2022/06/07/an-early-look-at-the-2022-proxy-season/.
    \255\ Id.
---------------------------------------------------------------------------

    Cook and Solberg (2021) examined the number of shareholder 
resolutions brought to a vote regarding environmental and social 
issues. The authors observed 171 votes on shareholder-sponsored 
resolutions pertaining to environmental and social issues between July 
1, 2020 and June 30, 2021, down from 220 votes in 2017. The study 
attributes the decline in environmental and social shareholder 
resolution votes to SEC regulations, which discouraged climate 
shareholder resolutions. Of the 171 resolutions, however, a record 36 
resolutions passed with majority support. Despite the decline in 
shareholder resolutions received, average support rose to 34 percent, 
which is five percentage points higher than the previous record set in 
2019.\256\
---------------------------------------------------------------------------

    \256\ Jackie Cook and Lauren Solberg, ``The 2021 Proxy Season in 
Charts,'' Morningstar (August 2021), https://www.morningstar.com/articles/1052234/the-2021-proxy-voting-season-in-7-charts.
---------------------------------------------------------------------------

    Koningsburg, Thorne, and Cahill (2021) analyzes trends across 
annual general meetings in 2021. The authors find that U.S. 
shareholders submitted 115 proposals related to the environment, with 
74 percent of those being related to climate. This is a significant 
increase from 2020, when shareholders submitted 89 environmental 
resolutions, with 54 percent of those related to climate. There were 9 
shareholder resolutions filed on diversity disclosure, three of which 
requested public disclosure of EEO-1 data and six of which requested 
enhanced reporting on diversity, equity, and inclusion data. Further, 
there were eight shareholder proposals on racial equity audits. For 
governance, in 2021, there was 95 percent support for re-election of 
directors in the Russell 3000; however, the proportion of directors 
receiving less than 80 percent support has increased in recent years. 
The authors attribute the decline in support to lack of progress by the 
board on climate change and diversity.\257\
---------------------------------------------------------------------------

    \257\ Dan Konigsburg, Sharon Thorne, and Stephen Cahill, 
``Investor Behavior in the 2021 Proxy Season,'' Harvard Law School 
Forum on Corporate Governance (2021), https://corpgov.law.harvard.edu/2021/11/10/investor-behavior-in-the-2021-proxy-season/.
---------------------------------------------------------------------------

    Another important facet of proxy voting is the investor's approach 
to proposals by management. Shareholder resolutions are often the most 
discussed aspect of proxy voting, but only make up a small share of 
total proxy votes. According to ICI (2019), 98 percent of proxy 
proposals at the 3,000 largest publicly traded firms were submitted by 
management, with the majority of those proposals being related to 
compensation, personnel, and other key business decisions. ICI also 
finds investors are significantly more likely to support management 
resolutions than they are shareholder resolutions. They found that 94 
percent of the votes were cast in favor of proposals by management, 
whereas only 34 percent of votes were cast in favor of shareholder 
resolutions. This relationship also held with respect to the 
recommendations of proxy advisors. Proxy advisors recommended voting in 
favor of 93 percent of management proposals, but only 65 percent of 
shareholder proposals.\258\
---------------------------------------------------------------------------

    \258\ ``ICI Research Perspective'', ICI (2019), https://www.ici.org/system/files/attachments/per25-05.pdf.
---------------------------------------------------------------------------

(c) The Role of Proxy Advisory Firms
    Several commenters weighed in on the role of proxy advisory firms. 
Multiple commenters expressed concerns over the role of the proxy 
advisory service industry, which they observed as being highly 
concentrated. Several commenters argued that proxy advisory firms do 
not have the knowledge or sufficient staff necessary to adequately 
conduct the type of analysis necessary for making recommendations to 
fiduciaries. One commenter went on to further express concern that 
proxy advisory firms have no obligation to explain their 
recommendations or provide the underlying research to back them up.
    In addition to concerns over the role of proxy advisory firms, 
several commenters expressed concerns regarding the potential for 
conflicts of interests at these firms. If a proxy advisory firm makes 
proxy voting recommendations that promote ESG it may increase their 
lines of business providing ESG ratings and advising companies on how 
to increase their ESG ratings.

[[Page 73873]]

    Commenters primarily focused on four sections of the final rule 
which they asserted would lead to increased reliance on proxy advisory 
firms. First, commenters pointed to the rescission of language from 
paragraph (e)(2)(ii) of the current regulation stating that ``the 
fiduciary duty to manage shareholder rights appurtenant to shares of 
stock does not require the voting of every proxy or the exercise of 
every shareholder right.'' They believe that removing this language 
will encourage higher levels of proxy voting by fiduciaries and that 
fiduciaries will rely on proxy advisory services to deal with the 
workload from increased proxy voting. Second, commenters stated that 
removing the specific monitoring provisions from paragraph (e)(2)(ii) 
of the existing regulation would reduce the effort associated with 
using proxy advisory firms while simultaneously reducing accountability 
and monitoring of those firms. Third, commenters stated that the 
removal of specific recordkeeping requirements from paragraph 
(e)(2)(ii)(E) of the current regulation would similarly make it easier 
to rely on proxy advisory firms, while also impeding the ability of 
participants to ensure that ERISA plan proxies are being voted in a 
manner consistent with the financial interest of the plan. Finally, the 
commenters point to the removal of two safe harbors from paragraphs 
(e)(3)(i)(A) and (B) of the current regulation, which specified 
policies of limiting voting based on voting type and holding size. 
Other commenters stated that the safe harbors applied to instances in 
which proxy voting would not be expected to have an economic effect. 
They further expanded that without the safe harbors, fiduciaries would 
participate in all proxy votes, which would require increased reliance 
on proxy advisory firms.
    The Department understands these concerns, and notes that 
fiduciaries still have a duty under the final rule's general monitoring 
provision, at paragraph (d)(2)(ii)(E) to prudently select and monitor 
the provider of proxy advisory services. However, the Department did 
not find it necessary to retain an additional provision to 
differentiate the monitoring of a proxy advisory firm from the 
monitoring of any other service providers that a fiduciary may utilize. 
Additionally, section 404 (a)(1)(B) of ERISA already requires proper 
documentation both of the activities of the investment manager and of 
the named fiduciary of the plan in monitoring the activities of the 
investment manager. This would require the investment manager or other 
responsible fiduciary to keep accurate records as to the voting of 
proxies, and periodically review the voting procedures and individual 
votes. The Department did not find it necessary to retain additional 
recordkeeping requirements beyond these that were already required of 
fiduciaries. With regards to the safe harbors, the Department notes 
that fiduciaries may still develop written guidelines to determine 
their decisions to participate in proxy votes. The Department 
reiterates its longstanding view of ERISA that proxies should be voted 
unless a responsible plan fiduciary determines a proxy vote is not in 
the plan's best interest.
    Several commenters referenced studies discussing the role of proxy 
advisory firms. A central theme in this literature was the argument 
that shareholder resolutions are heavily influenced by the proxy 
advisory service industry. Malenko and Shen (2016) studied the effects 
of the proxy advisory industry on say-on-pay proposals from 2010 to 
2011. The authors observed that negative recommendations by proxy 
advisory firms reduced support for proposals by 25 percentage 
points.\259\ A Timothy Doyle (2018) report also observed that certain 
large institutional investors vote in line with proxy advisory firm 
recommendations 80-95 percent of the time for positive recommendations, 
and 50-85 percent for negative recommendations.\260\ At its most 
extreme, this influence can manifest into ``robovoting'' whereby 
investors follow a proxy advisory firm's voting guidance without any 
independent review. Another report by Timothy Doyle (2018) finds that 
175 asset managers representing more than $5 trillion in assets under 
management and who voted on more than 100 shareholder resolutions voted 
in line with proxy advisory firm recommendations more than 95 percent 
of the time. Of these 175 asset managers, 82 voted with proxy advisory 
services more than 99 percent of the time.\261\ In a similar vein, Paul 
Rose (2019) found 98 investors, representing $3.2 trillion in assets 
under management, voted in alignment with ISS more than 99.5 percent of 
the time.\262\
---------------------------------------------------------------------------

    \259\ Nadya Malenko and Yao Shen, ``The Role of Proxy Advisory 
Firms: Evidence from a Regression-Discontinuity Design,'' The Review 
of Financial Studies, Volume 29, Issue 12, December 2016, Pages 
3394-3427, https://doi.org/10.1093/rfs/hhw070.
    \260\ Timothy Doyle, ``The Conflicted Role of Proxy Advisors,'' 
American Council for Capital Formation (May 2018), https://accf.org/wp-content/uploads/2018/05/ACCF-The-Conflicted-Role-of-Proxy-Advisor-FINAL.pdf.
    \261\ Timothy Doyle, ``The Realities of Robo-Voting,'' American 
Council on Capital Formation (November 2018), https://accfcorpgov.org/wp-content/uploads/ACCF-RoboVoting-Report_11_8_FINAL.pdf.
    \262\ Paul Rose, ``Robovoting and Proxy Vote Disclosure'' 
(November 2019). https://ssrn.com/abstract=3486322.
---------------------------------------------------------------------------

    In addition to concerns over the influence of proxy advisory firms, 
some literature also took issue with the quality of their 
recommendations. Larcker, McCall, and Ormazabal (2015) find that 
companies faced with the prospect of a negative proxy advisory service 
recommendation on say-on-pay proposals will often change their 
compensation programs ``in a manner consistent with the features known 
to be favored by proxy advisory firms.'' The stock market reaction to 
these pre-emptive changes is statistically negative.\263\
---------------------------------------------------------------------------

    \263\ David F. Larcker, Allan McCall, and Gaizka Ormazabal, 
``The Economic Consequences of Proxy Advisor Say-on-Pay Voting 
Policies,'' Journal of Law and Economics, vol. 58, no. 1, Feb. 2015, 
pp. 173-204, https://doi.org/10.2139/ssrn.2101453.
---------------------------------------------------------------------------

    Some literature was more skeptical on the level of influence by the 
proxy advisory service industry. Nili and Kastiel (2020) find that the 
success rates of the two largest proxy advisory firms, Glass Lewis and 
ISS, varies significantly from year to year.\264\ From 2005 to 2017, 
the percentage of proxy fights won by the dissidents when supported by 
Glass Lewis has been as low as 33 percent in 2012 and as high as 100 
percent in 2010. When supported by ISS, the percentage of proxy fights 
won by the dissidents has been as low as 43 percent in 2006 and as high 
as 89 percent in 2014.
---------------------------------------------------------------------------

    \264\ Yaron Nili and Kobi Kastiel, ``Competing for Votes,'' 
Wisconsin Law School Legal Studies Research Paper Series Paper, No. 
1605 (2020), https://ssrn.com/abstract=3681541.
---------------------------------------------------------------------------

    Similar variation was found in the percentage of proxy fights won 
by management when supported by these proxy advisory firms. The authors 
found that these mixed findings were consistent with the overall 
corporate governance literature on proxy advisory services. In a review 
of relevant literature, Larcker, Tayan, and Copland (2015), observe 
that ``the empirical evidence shows that an against recommendation is 
associated with a reduction in the favorable vote count by 10 percent 
to 30 percent.'' \265\ Choi, Fisch, and Kahan (2010) estimate that the 
negative recommendations of proxy advisory firms only shifted investor 
votes by 6 to 10 percent after controlling

[[Page 73874]]

for observable factors.\266\ McCahery, Sauthner, and Starks (2015) find 
that ``55 percent of institutional investors agree that proxy advisory 
firms help them make more informed voting decisions,'' but concluded 
that institutional investors rely on the advice of proxy advisory firms 
as a complement to their decision-making, rather than a 
substitute.\267\
---------------------------------------------------------------------------

    \265\ David F. Larcker, Brian Tayan, and James R. Copland, ``The 
Big Thumb on the Scale: An Overview of the Proxy Access Advisory 
Industry,'' Harvard Law School Forum on Corporate Governance (June 
14, 2018), https://corpgov.law.harvard.edu/2018/06/14/the-big-thumb-on-the-scale-an-overview-of-the-proxy-advisory-industry/.
    \266\ Stephen Choi, Jill Fisch, and Marcel Kahan, ``The Power of 
Proxy Advisors: Myth or Reality?'' 59 Emory Law Journal 869, 882 
(2010), https://scholarlycommons.law.emory.edu/elj/vol59/iss4/2/.
    \267\ Joseph A. McCahery, Zacharias Sautner, and Laura T. 
Starks, ``Behind the Scenes: The Corporate Governance Preferences of 
Institutional Investors,'' 71 Journal of Finance, 2905, 2928 (2016). 
https://www.jstor.org/stable/44155408#metadata_info_tab_contents.
---------------------------------------------------------------------------

    As stated in the preamble, the Department believes that the 
solution to proxy-voting costs is for the fiduciary to be prudent in 
incurring expenses to make proxy decisions and, wherever possible, to 
rely on efficient structures, which may include the use of proxy 
advisory services. However, paragraph (d)(2)(iii) of the final rule 
states that a fiduciary may not adopt a practice of following the 
recommendations of a proxy advisory firm or other service provider 
without a determination that such firm or service provider's proxy 
voting guidelines are consistent with the fiduciary's obligations 
described in paragraphs (d)(2)(ii)(A) through (E) of this section. The 
Department recognizes some commenters' continued concerns about the 
role of proxy advisory firms, but this provision (in conjunction with 
the general monitoring provision in paragraph (d)(2)(ii)(E), discussed 
above) will protect plan participants and beneficiaries by ensuring 
adequate oversight of proxy advisory firms.
(d) Costs of Proxy Voting and Shareholder Engagement and Its Effect on 
Company Behavior
    The effects of proxy voting and shareholder engagement on company 
activity is the subject of a diverse body of literature. Much of the 
research on proxy voting and shareholder engagement focuses on the 
effects of proxy voting and shareholder engagement on a company's ESG 
performance, which could then affect a company's financial performance. 
The association between ESG and financial performance was discussed in 
detail in previous sections.
    Another body of research looks at the effectiveness of shareholder 
resolutions as a tool to incite change. For instance, K[ouml]lbel, 
Heeb, Paetzold, and Busch (2020) review five studies on shareholder 
resolutions and found that 18 to 60 percent of shareholder resolutions 
are successful in changing company behavior.\268\ The 18 percent 
finding by Dimson, Karakas, and Li (2015) comes from the oldest sample 
period (1999-2009) of the five papers, with more recent studies 
suggesting higher success rates.\269\ One of the studies reviewed went 
on to further demonstrate an increase in ESG ratings as a result of 
these shareholder resolutions.\270\
---------------------------------------------------------------------------

    \268\ Julian F. K[ouml]lbel, Florian Heeb, Falko Paetzold, and 
Timo Busch, ``Can Sustainable Investing Save the World? Reviewing 
the Mechanisms of Investor Impact,'' Organization & Environment, 
vol. 33, no. 4, 2020, pp. 554-574, https://doi.org/10.1177/1086026620919202.
    \269\ E. Dimson, O. Karakas, and X Li, ``Active Ownership,'' 
Review of Financial Studies, volume 28, issue 12, p. 3225-3268, 
2015.
    \270\ K[ouml]lbel, Heeb, Paetzold, and Busch, ``Can Sustainable 
Investing Save the World?'' 2020.
---------------------------------------------------------------------------

    Literature on the direct financial effects of proxy voting on stock 
returns is more limited. A literature summary by Clark, Feiner, and 
Viehs (2014) finds that most papers on proxy voting find inconclusive 
or statistically insignificant results on the relationship to stock 
returns. The authors find that the reviewed literature ``only provides 
limited evidence that proxy voting is an effective tool to promote 
proper ESG standards, or that it is helpful in creating superior 
financial performance at investee firms.'' \271\
---------------------------------------------------------------------------

    \271\ Clark, Feiner, and Viehs, ``From the Stockholder to the 
Stakeholder,'' 2014.
---------------------------------------------------------------------------

    Cu[ntilde]at, Gine, and Guadalupe (2012) find that companies with 
successful shareholder governance proposals yielded abnormal returns--
1.3 percent higher than firms with failed proposals on the day of the 
vote. Over the week of the vote, these abnormal returns accumulate to 
2.4 percent. This gain in shareholder value is more pronounced 
regarding anti-takeover provisions, like eliminating classified boards 
and poison pills. This effect is also stronger at firms with more 
concentrated ownership, more anti-takeover provisions in place, more 
research and development (R&D) expenditures, and more shareholder 
proposals in the past. The effect is also larger for proposals made by 
institutional shareholders rather than individuals. The authors further 
find that actually implementing these accepted proposals increases the 
shareholder value effect to 2.8 percent.\272\
---------------------------------------------------------------------------

    \272\ Cu[ntilde]at Vicente, Mireia Gine, and Maria Guadalupe, 
``The Vote Is Cast: The Effect of Corporate Governance on 
Shareholder Value,'' The Journal of Finance, vol. 67, no. 5, 2012, 
pp. 1943-1977, https://doi.org/10.1111/j.1540-6261.2012.01776.x.
---------------------------------------------------------------------------

    In summary, the literature provided leads the Department to believe 
that proxy voting and shareholder engagement is increasing in its 
frequency and scope. The effects of this activity are not uniformly 
agreed upon in the literature, however there is evidence of proxy 
voting and shareholder engagement leading to increased shareholder 
value and financial returns at firms. There is also evidence of proxy 
voting and shareholder engagement being able to increase a company's 
ESG performance, which may have financial performance benefits that 
were discussed previously. Proxy voting and shareholder engagement has 
a tangible time cost, which can be reduced through the use of efficient 
structures, including proxy voting guidelines, and proxy advisers/
managers that act on behalf of large aggregates of investors. Evidence 
regarding the influence of these proxy advisory firms is mixed, and 
varies from year to year, company to company, and topic to topic. 
Accordingly, the Department stresses fiduciaries' obligation to monitor 
the performance of proxy advisory firms to ensure that they are 
performing their work in a way that is consistent with the plan's best 
interest.
4. Cost Savings Relating to Paragraphs (d) and (e), Relative to the 
Current Regulation
    In the cost savings estimates below, the Department assumes an 
hourly labor cost of $129.74 for a plan fiduciary and $61.01 for a 
clerical worker.\273\
---------------------------------------------------------------------------

    \273\ The Department estimates labor costs by occupation. 
Estimates for total compensation are based on mean hourly wages by 
occupation from the 2021 Occupational Employment Statistics and 
estimates of wages and salaries as a percentage of total 
compensation by occupation from the December 2021 National 
Compensation Survey's Employee Cost for Employee Compensation. 
Estimates for overhead costs for services are imputed from the 2020 
Service Annual Survey. To estimate overhead cost on an occupational 
basis, ORA allocates total industry overhead cost to unique 
occupations using a matrix of detailed occupational employment for 
each NAICS industry. All values are in 2022 dollars. For more 
information in how the labor costs are estimated see: Labor Cost 
Inputs Used in the Employee Benefits Security Administration, Office 
of Policy and Research's Regulatory Impact Analyses and Paperwork 
Reduction Act Burden Calculation, Employee Benefits Security 
Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
---------------------------------------------------------------------------

    Paragraph (d) of the final rule eliminates the recordkeeping 
requirement in paragraph (e)(2)(ii)(E) of the current regulation which 
provides that, when deciding whether to exercise shareholder rights and 
when exercising shareholder rights, plan fiduciaries must maintain 
records on proxy voting activities and other exercises of shareholder 
rights. The change is

[[Page 73875]]

expected to produce a cost savings of $6.1 million per year relative to 
the current regulation.\274\ This cost savings was confirmed by one 
commenter.
---------------------------------------------------------------------------

    \274\ In the 2020 final rule published on December 16, it was 
estimated that a plan fiduciary and a clerical staff would expend, 
on average, 30 minutes each to fulfill the recordkeeping 
requirement. The burden in the 2020 rule was estimated as $6.05 
million. Updated to reflect updated estimates for affected plans and 
labor costs, the Department estimates the updated costs as: (63,670 
plans * 0.5 hours * $129.74 per hour for a plan fiduciary) + (63,670 
plans * 0.5 hours * $61.01 per hour for a clerical worker) = 
$6,072,526, or $6.1 million.
---------------------------------------------------------------------------

    The final rule amends the provision of the current regulation that 
addresses proxy voting policies, paragraph (e)(3)(i) of the current 
regulation, by removing the two ``safe harbor'' examples for proxy 
voting policies that would be permissible under the provisions of the 
current regulation. As discussed earlier in the preamble to this 
regulation, the Department believes that the two ``safe harbor'' 
examples would likely become widely adopted by plan fiduciaries if 
maintained. When adopting the current regulation, the Department 
estimated that it would take a legal professional two hours to evaluate 
and implement changes to proxy voting policies within the scope of the 
safe harbors. In the final rule, without the safe harbors, the 
Department estimates that it will take a legal professional 30 minutes 
to update policies and procedures. This final rule thus reduces the 
burden related to evaluating, updating, and implementing proxy voting 
policies and procedures and voting by $11.6 million in the first year 
relative to the current regulation.\275\
---------------------------------------------------------------------------

    \275\ In the 2020 final rule published on December 16, it was 
estimated that a legal professional would expend, on average, two 
hours to update policies and procedures. The burden in the 2020 rule 
was estimated as $17.2 million. Updated to reflect updated estimates 
for affected plans and labor costs, the Department estimates the 
updated costs for the original requirement as: 63,670 plans * 2 
hours * $129.74 per hour for a plan fiduciary = $16,521,092. As 
discussed in the Cost section of this analysis, the Department 
estimates that it will take a legal professional just thirty minutes 
to update policies and procedures for each of the estimated 63,670 
plans affected by the rule, resulting in a cost of $4,877,440. This 
results in a cost savings of $11,643,651, or $11.6 million. 85 FR 
81658.
---------------------------------------------------------------------------

    The total costs savings associated with the amendments to paragraph 
(d) are estimated to be approximately $17.7 million.

E. Costs

    The Department expects the amendments made by the final rule will 
change plan fiduciary investment behavior; however, the overall effect 
of amendments on investment behavior is largely uncertain. In the 
analysis below, the Department has carefully considered the costs 
associated with the amendments and quantified the costs expected to 
result from the final rule, with the acknowledgment that a precise 
quantification of all costs stemming from changes in behavior is not 
possible. Nevertheless, the Department expects the incremental costs of 
the final rule to be relatively small and the overall benefits to 
outweigh the costs. As shown in the analysis below, the known 
incremental costs of the proposal are expected to be minimal on a per-
plan basis.
    The analysis below is based on labor cost estimates of $153.21 for 
a legal professional.\276\
---------------------------------------------------------------------------

    \276\ The Department estimates labor costs by occupation. 
Estimates for total compensation are based on mean hourly wages by 
occupation from the 2021 Occupational Employment Statistics and 
estimates of wages and salaries as a percentage of total 
compensation by occupation from the December 2021 National 
Compensation Survey's Employee Cost for Employee Compensation. 
Estimates for overhead costs for services are imputed from the 2020 
Service Annual Survey. To estimate overhead cost on an occupational 
basis, ORA allocates total industry overhead cost to unique 
occupations using a matrix of detailed occupational employment for 
each NAICS industry. All values are in 2022 dollars. For more 
information in how the labor costs are estimated see: Labor Cost 
Inputs Used in the Employee Benefits Security Administration, Office 
of Policy and Research's Regulatory Impact Analyses and Paperwork 
Reduction Act Burden Calculation, Employee Benefits Security 
Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-june-2019.pdf.
---------------------------------------------------------------------------

1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
    Plans, plan fiduciaries, and their service providers will need to 
read the final rule and evaluate how it will impact their practices. To 
estimate the costs associated with reviewing the amended rule, the 
Department considers two sub-groups of plans: plans that consider ESG 
factors in their investment process and plans that hold corporate stock 
with voting rights.
    The Department estimates that approximately 149,300 plans will 
consider ESG factors in their investment practice and will be affected 
by the finalized amendments in paragraphs (b) and (c).\277\ For each 
plan, a legal professional will need to review paragraphs (b) and (c) 
of the final rule, evaluate how these provisions might affect their 
investment practices and assess whether the plan will need to make 
changes to investment practices. The Department estimates that this 
review will take a legal professional approximately four hours to 
complete, resulting in an aggregate cost burden of approximately $91.5 
million \278\ or a per-plan cost burden of approximately $613.\279\
---------------------------------------------------------------------------

    \277\ For more information on this estimate, refer to the 
discussion of affected entities in section IV.C.
    \278\ The burden is estimated as follows: 149,322 plans x 4 
hours = 597,288 hours. A labor rate of $153.21 is used for a legal 
professional. The cost is estimated as follows: 149,322 plans x 4 
hours x $153.21 = $91,510,494.
    \279\ The per-plan burden is estimated as follows: $91,510,494/
149,322 plans = $612.84, rounded to $613.
---------------------------------------------------------------------------

    The Department estimates that 63,670 plans hold corporate stock 
with voting rights and will be affected by the finalized amendments 
pertaining to proxy voting in paragraph (d). For each plan, a legal 
professional will need to review paragraph (d) of the amended rule and 
evaluate how it affects their proxy voting practices. The Department 
estimates that this review process will require a legal professional, 
on average, approximately four hours to complete, resulting in an 
aggregate cost burden of approximately $39.0 million \280\ or a per-
plan cost of approximately $613.\281\
---------------------------------------------------------------------------

    \280\ The burden is estimated as follows: 63,670 plans x 4 hours 
= 254,680 hours. A labor rate of $153.21 is used for a lawyer. The 
cost burden is estimated as follows: 63,670 plans x 4 hours x 
$153.21 = $39,019,523.
    \281\ The per-plan burden is estimated as follows: $39,019,523/
63,670 plans = $612.84, rounded to $613.
---------------------------------------------------------------------------

    The Department believes that most plans, in both subsets discussed 
above, will rely on a service provider to perform such a review and 
that each service provider will likely oversee multiple plans. The 
Department does not have data that would allow it to estimate the 
number of service providers acting in such a capacity for these plans. 
While the Department believes that this cost is likely an overestimate, 
given the lack of data, the Department believes it is reasonable.
2. Possible Changeover Costs
    The Department expects that some plans may change investments or 
investment processes in light of the clarifications in the final rule. 
For example, plans may decide to replace existing investments with ESG 
investments. This may involve some short-term costs. In the 
Department's view, this will be net beneficial because compliant 
acquisitions of ESG assets will be done with the aim of reducing the 
plan's ESG-related financial risk or improving the plan's investment 
performance. Thus, even if there are short-term costs associated with 
changed investment practices, the benefits to the plan of reduced ESG-
related financial risk are expected to exceed these costs over time. 
The Department lacks data to estimate the likely size of this impact. 
The Department solicited comments on this assumption in the NPRM but 
did not receive any comments.

[[Page 73876]]

3. Cost Associated With Changes in Investment or Investment Course of 
Action
    Paragraphs (b) and (c)(1) of the final rule address a fiduciary's 
duty of prudence and loyalty under ERISA with respect to consideration 
of an investment or investment course of action. Paragraph (c)(1) of 
the final rule provides that a fiduciary may not subordinate the 
interests of the participants and beneficiaries in their retirement 
income or financial benefits under the plan to other objectives, and 
may not sacrifice investment return or take on additional investment 
risk to promote benefits or goals unrelated to said interests of the 
participants and beneficiaries. Paragraph (b)(4) of the final rule, in 
relevant part, provides that a fiduciary's determination with respect 
to an investment or investment course of action must be based on 
factors that the fiduciary reasonably determines are relevant to a risk 
and return analysis, using appropriate investment horizons consistent 
with the plan's investment objectives and taking into account the 
funding policy of the plan established pursuant to section 402(b)(1) of 
ERISA. These provisions will require a fiduciary to perform an 
evaluation, including a prudent analysis of risk and return factors. 
These provisions provide direction on what to include in that 
evaluation.
    In the NPRM, the Department did not attribute a cost to these 
requirements, with the understanding that many plan fiduciaries already 
undertake such evaluations as part of their investment selection 
decision-making process, including documentation of their decisions, 
process, and reasoning. One commenter refuted this assumption, noting 
that the industry lacks consistent definitions on ESG topics and 
stating that evaluating ESG topics would be a manual process for plan 
sponsors, requiring time and resources. Conversely, another commenter 
noted that data collection costs imposed by the rule would likely be de 
minimis, as the investment community is collecting ESG data independent 
of the rulemaking process.
    The commenters have not persuaded the Department to change its 
views on this topic. Plan fiduciaries generally already undertake 
deliberative evaluations as part of their investment selection 
decision-making process and this final rule does not add burden to 
those deliberations; but rather, the final rule clarifies that the 
scope of those deliberations may include climate change and other ESG 
factors within the confines of paragraphs (b)(4) and (c)(1) of the 
final rule. The Department does not intend to increase fiduciaries' 
burden of care attendant to such consideration; therefore, no 
incremental costs are estimated for these requirements.
4. Cost Associated With Changes to the ``Tiebreaker'' Rule
    The final rule, at paragraph (c)(2), implements a version of the 
tiebreaker concept that is comparable to and commensurate with the 
formulation previously expressed in Interpretive Bulletin 2015-1 (and 
first explained in Interpretive Bulletin 94-1). The final rule's 
tiebreaker provision is relevant and operable only once a prudent 
fiduciary determines that competing alternative investments equally 
serve the financial interests of the plan. In these circumstances, the 
plan fiduciary may focus on the collateral benefits of an investment or 
investment course of action to decide the outcome. This version of the 
tiebreaker is more flexible than the regulation this rule replaces, 
which requires that the risk and reward of competing investments be 
indistinguishable before the tiebreaker can be utilized.
    While the provision implies a requirement for analysis and 
documentation, the Department expects that the analytics and 
documentation requirements of the tiebreaker provision are subsumed in 
the analytics and documentation requirements of the risk and return 
analysis required by paragraphs (c)(1) and (b)(4) of the final rule. 
The analysis of risk and return factors under paragraphs (c)(1) and 
(b)(4) of the final rule in the first instance will necessarily reveal 
any collateral benefits of an investment or investment course of 
action, which may then be used to break a tie pursuant to paragraph 
(c)(2) of the final rule. In this sense, paragraph (c)(2) of the final 
rule thus imposes no distinct process, and therefore no significant 
additional costs, apart from a plan's ordinary investment selection 
process. Based on this assumption, the Department attributes no costs 
to paragraph (c)(2) of the final rule.
5. Cost To Update Plan's Written Proxy Voting Policies
    Paragraph (d)(3)(i) of the final rule provides that plan 
fiduciaries may adopt proxy voting policies on when to vote a proxy 
ballot. Such a policy must be prudently designed to serve the plan's 
interests in providing benefits to participants and their beneficiaries 
and to defray reasonable expenses of administering the plan. In 
addition, plan fiduciaries must periodically review any such proxy 
voting policies under paragraph (d)(3)(ii).
    The Department estimates that 63,670 plans hold corporate stock 
with voting rights and will be affected by the finalized amendments 
pertaining to proxy voting in paragraph (d).\282\ For each plan, the 
Department estimates that, on average, it will take a legal 
professional thirty minutes to update policies and procedures, 
resulting in an aggregate incremental cost of $4.9 million,\283\ or a 
per-plan incremental cost of $77,\284\ in the first year relative to 
the current rule.
---------------------------------------------------------------------------

    \282\ For more information on this estimate, refer to the 
discussion of affected entities in section IV.C.
    \283\ The burden is estimated as follows: 63,670 plans x 0.5 
hour = 31,835 hours. A labor rate of $153.21 is used for a legal 
professional: (63,670 plans x 0.5 hour x $153.21 = $4,877,440).
    \284\ The per-plan burden is estimated as follows: $4,877,440/
63,670 plans = $76.61, rounded to $77.
---------------------------------------------------------------------------

    The amended paragraph (d)(3)(ii) will require plans to periodically 
review proxy voting policies. However, the Department believes that the 
final rule largely comports with current practice for ERISA 
fiduciaries, such that plan fiduciaries already periodically review 
proxy voting policies to meet their obligations under ERISA. The 
Department does not expect that plans will incur additional cost 
associated with the periodic review.
6. Summary
    The Department estimates that the total incremental costs 
associated with the final rule will be $135.4 million in the first year 
with no additional costs in subsequent years. The aggregate and per-
plan costs are summarized in Table 2.

[[Page 73877]]



                             Table 2--Costs for Plans To Comply With the Requirements
----------------------------------------------------------------------------------------------------------------
                                                          Aggregate cost                   Per-plan cost
                   Requirement                   ---------------------------------------------------------------
                                                      Year 1          Year 2          Year 1          Year 2
----------------------------------------------------------------------------------------------------------------
                            Plans considering ESG factors when selecting investments
----------------------------------------------------------------------------------------------------------------
Review of Plan Investment Practices.............     $91,510,494           $0.00         $612.84           $0.00
                                                 ---------------------------------------------------------------
    Total.......................................      91,510,494            0.00          612.84            0.00
----------------------------------------------------------------------------------------------------------------
                 Plans holding corporate stock, directly or through ERISA-covered intermediaries
----------------------------------------------------------------------------------------------------------------
Review of Proxy Voting Practices................      39,019,523            0.00          612.84            0.00
Update Proxy Voting Policies....................       4,877,440            0.00           76.61            0.00
                                                 ---------------------------------------------------------------
    Total.......................................      43,896,963            0.00          689.45            0.00
----------------------------------------------------------------------------------------------------------------
  Plans that both consider ESG factors when selecting investments and hold corporate stock, directly or through
                                          ERISA-covered intermediaries
----------------------------------------------------------------------------------------------------------------
    Total.......................................     135,407,458               0        1,302.29            0.00
----------------------------------------------------------------------------------------------------------------

    This cost estimate differs from the cost estimate in the NPRM in 
several ways. First, paragraph (c)(3) of the NPRM included a disclosure 
requirement when collateral benefits were used in a tiebreaker. The 
removal of this requirement in the final rule decreased the cost 
estimate. Additionally, in the NPRM, the Department estimated that 11 
percent of retirement plans would be affected by paragraph (c) of the 
proposal. In the final rule, in consideration of comments received on 
the NPRM, this estimate was increased to 20 percent of retirement 
plans. This change increased the cost estimate. Finally, this cost 
estimate reflects more recent data on the number of retirement plans 
and updated estimates of labor costs. The incorporation of updated data 
also increased the cost estimate.

F. Transfers

    The final rule will result in transfers. For instance, the final 
rule may facilitate changes in plan fiduciary behavior, resulting in 
transactions in which a party experiences increased returns while other 
parties experience decreased returns of equal magnitude, resulting in a 
transfer, due to either the selection of investments or the investment 
course of action.
    In particular, transfers could arise as a result of substantially 
greater confidence on the part of fiduciaries that they may consider 
ESG factors going forward. As discussed previously, the public record 
reflects that the current regulation has already had a chilling effect 
on appropriate use of relevant ESG factors in investment decisions. 
Although the current regulation acknowledges that ESG factors can in 
some instances be taken into account by a fiduciary, it also includes 
multiple statements that have been interpreted as discouraging their 
consideration. This conflicting guidance has disincentivized 
fiduciaries from considering relevant ESG factors in order to minimize 
potential legal liability under ERISA. Such a disincentive has a 
distortionary effect on the investment of ERISA plan assets well into 
the future by changing fiduciaries' investment decisions and preventing 
them from considering ESG factors that they would otherwise find 
economically advantageous. The Department expects the clear guidance in 
this final rule to eliminate this existing market distortion.
    While the effect the amendments will have on assets is discussed as 
a benefit in section IV.D, this will also impact the flow of revenue to 
investment entities. For example, if, because of the amendments, plan 
assets are moved from Fund A to Fund B, Fund A's asset managers would 
experience a decrease in revenue while Fund B's asset managers would 
experience an increase in revenue. As a result, there would be a 
transfer from non-ESG product providers to ESG product providers. 
Similarly, there could be a transfer from companies with lower ESG 
ratings to companies with higher ESG ratings. Although the Department 
is unable to quantify the transfers that might result, the Department 
expects the magnitude of transfers will likely exceed $100 million 
annually, given that roughly $12.0 trillion is currently invested in 
ERISA plan assets,\285\ and the lower bound estimate of plan assets 
invested using ESG factors in 2020 is 0.03 percent.\286\
---------------------------------------------------------------------------

    \285\ EBSA projected ERISA covered pension, welfare, and total 
assets based on the 2020 Form 5500 filings with the U.S. Department 
of Labor (DOL), reported SIMPLE assets from the Investment Company 
Institute (ICI) Report: The U.S. Retirement Market, Second Quarter 
2022, and the Federal Reserve Board's Financial Accounts of the 
United States Z1 September 9, 2022.
    \286\ 64th Annual Survey of Profit Sharing and 401(k) Plans, 
Plan Sponsor Council of America (2021).
---------------------------------------------------------------------------

    Similarly, transfers also could arise as a result of the proposed 
changes to the proxy voting provisions in paragraph (e) of the current 
regulation (relocated to paragraph (d) of the amended rule). For 
instance, the current regulation may discourage plans from voting 
proxies as a result of the no-vote statement in paragraph (e)(2)(ii) 
and the two safe harbors in paragraphs (e)(3)(i)(A) and (B) of the 
current regulation. The final rule's rescission of these provisions, 
however, will increase plan proxy votes and effectively transfer some 
voting power from other shareholders back to ERISA plans. A common 
proxy vote where such an outcome may occur would be a vote to select a 
member of the Board of Directors, resulting in a shift in power from a 
losing candidate to a winning candidate. A transfer might also occur 
related to a proxy vote for one company to acquire another company.

G. Uncertainty

    The Department's economic assessment of the final rule's effects is 
subject to uncertainty. Special areas of uncertainty are discussed 
below:
    A significant source of uncertainty comes from the lack of a 
widely-accepted standard or definition of what ESG is. This uncertainty 
was echoed by commenters. The Department received several comments 
concerned with the lack of a standard definition of ESG.

[[Page 73878]]

One commenter noted that there is no way to uniformly assess or weight 
the separate E, S, and G factors. Another commenter noted that because 
ESG frameworks in the U.S. have been designed by the private sector and 
are voluntary in nature, there is no industry-wide standard for how to 
disclose information or comply under these frameworks.
    In the affected-entities discussion of the regulatory impact 
analysis, the Department estimates that 20 percent of plans, both 
defined benefit (DB) and defined contribution (DC), consider or will 
begin considering ESG factors when selecting investments and, thus, 
will be affected by the final rule's amendments to paragraphs (b) and 
(c) of the current regulation. As discussed in the regulatory impact 
analysis, the Department referenced several sources and surveys for DB 
and DC plans to arrive at this estimate. However, the range of 
estimates from these resources confirms the degree of uncertainty of 
how many plan fiduciaries currently consider ESG factors when selecting 
investments. This is particularly true for DB plans. While there is 
some survey evidence on how many DB plans factor in ESG considerations, 
the surveys were based on small samples and yielded varying results.
    It is also difficult to estimate the degree to which the use of ESG 
factors by ERISA fiduciaries will expand in the future. The 
clarification provided by this final rule may encourage more plan 
fiduciaries to use ESG factors. Trends in other countries suggest that 
pressure for such expansion may continue to increase.\287\ Based on 
current trends, the Department believes that the use of ESG factors by 
ERISA plan fiduciaries will likely increase in the future, although it 
is uncertain when or by how much.
---------------------------------------------------------------------------

    \287\ See generally Government Accountability Office Report No. 
18-398, Retirement Plan Investing: Clearer Information on 
Consideration of Environmental, Social, and Governance Factors Would 
Be Helpful (May 2018), https://www.gao.gov/products/gao-18-398; 
Principles for Responsible Investment, Fiduciary Duty in the 21st 
Century, United Nations Environment Programme Finance Initiative 
(2019), https://www.unepfi.org/wordpress/wp-content/uploads/2019/10/Fiduciary-duty-21st-century-final-report.pdf.
---------------------------------------------------------------------------

    For purposes of this analysis, the Department has prepared low-, 
mid-, and high-cost scenarios for costs associated with paragraphs (b) 
and (c), varying by the estimated number of affected plans. As 
discussed in the cost discussion, the Department's estimate of 20 
percent of ERISA plans being affected by these provisions translated 
into approximately 149,300 affected plans and a cost of $91.5 million. 
If instead, the Department were to rely on the 5 percent estimate of 
401(k) and/or profit-sharing plans offering at least one ESG themed 
investment option from the Plan Sponsor Council of America \288\ and 
the 12 percent estimate of private pension plans that have adopted ESG 
investing from NEPC,\289\ this would result in an estimate of 
approximately 46,100 affected plans and a cost of $28.2 million.\290\ 
Further if the Department were to rely on the 36 percent estimate of 
large plans using ESG information to consider their investments 
provided by commenters to all plans, this would result in an estimate 
of approximately 268,800 affected plans and a cost of $164.7 
million.\291\
---------------------------------------------------------------------------

    \288\ 64th Annual Survey of Profit Sharing and 401(k) Plans, 
Plan Sponsor Council of America (2021).
    \289\ Smith and Regan, NEPC ESG Survey, 2018.
    \290\ The estimate of plans is calculated as: (5% x 621,509 
401(k) type plans) + (12% x 125,101 defined benefit and 
nonparticipant-directed defined contribution plans) = 46,087 plans, 
rounded to 46,100 plans. The cost estimate is calculated as: 46,087 
plans x 4 hours = 184,348 hours. A labor rate of $153.21 is used for 
a lawyer. The cost burden is estimated as follows: 46,087 plans x 4 
hours x $153.21 = $28,243,957. (Source Private Pension Plan 
Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee 
Benefits Security Administration (2022; forthcoming), Table D3.)
    \291\ The estimate of plans is calculated as: (36% x 746,610 
pension plans) = 268,779 plans, rounded to 268,800 plans. The cost 
estimate is calculated as: 268,779 plans x 4 hours = 1,075,116 
hours. A labor rate of $153.21 is used for a lawyer. The cost burden 
is estimated as follows: 268,779 plans x 4 hours x $153.21 = 
$164,718,522.
---------------------------------------------------------------------------

    Regarding paragraph (d) of the final rule, it is uncertain whether 
the amendments would create a demand for new or different services 
associated with proxy voting and if so, what alternate services or 
relationships with service providers might result and how overall plan 
expenses could be impacted. Similarly, it is unclear whether and to 
what extent paragraph (d) of the amended rule will cause plans to 
modify their securities holdings, for example, in favor of greater 
mutual fund holdings (to avoid management responsibilities with respect 
to holdings of individual companies).
    The Department has heard from stakeholders that the current 
regulation, and investor confusion about it, has already had a chilling 
effect on appropriate use of ESG factors in investment decisions. 
Additionally, the Department received a significant number of comments 
on the impacts the current regulation has had on the appropriate use of 
ESG factors in investment decisions. A larger discussion of the 
comments received is included in the discussion of the benefits above.

H. Alternatives

    In developing this final rule on the application of ERISA's 
fiduciary duties of prudence and loyalty to selecting investments and 
investment courses of action, the Department considered several 
regulatory approaches to the overarching rule and its various elements.
    Beyond the major alternatives discussed below, the Department 
considered many other specific alternatives. For example, the 
Department considered eliminating the tiebreaker test in response to 
commenters' requests to do so. The Department decided against this 
alternative because the tiebreaker test has been relied on by 
fiduciaries for many years in making decisions about plan investments 
and investment courses of action, is consistent with the fiduciary 
obligations set forth in Section 404 of ERISA, and complete removal of 
the provision could lead to disruptions in plan investment activity. In 
addition, the Department, in response to commenters' requests, 
considered amending the current regulation to explicitly provide 
participants' preferences with a status equal to risk and return 
factors under the final regulation, such that participants' preferences 
could be considered and factored into decisions alongside risk and 
return factors, and weighted as determined appropriate by the plan's 
fiduciary. The Department decided against this alternative for many 
reasons, but mainly because plan fiduciaries must focus on financial 
benefits and fiduciaries may not add imprudent investment options to 
menus based on participant preferences or requests because that would 
violate ERISA's duty of prudence. Many other relatively more granular 
alternatives that were considered and not accepted are discussed 
throughout section III of this preamble in connection with views of the 
commenters.
    In order to ensure a comprehensive review, the Department examined 
as an alternative leaving the current regulation in place without 
change. However, as explained in more detail earlier in this document, 
following informal outreach activities with a wide variety of 
stakeholders, including asset managers, labor organizations and other 
plan sponsors, consumer groups, service providers and investment 
advisers, and after considering the significant volume of public 
comment on the NPRM, the Department believes that uncertainty with 
respect to the current regulation has and likely will continue to deter 
fiduciaries from taking steps that other

[[Page 73879]]

marketplace investors might take to enhance investment value and 
performance, or improve investment portfolio resilience against the 
financial risks and impacts associated with climate change. This could 
hamper fiduciaries as they attempt to discharge their responsibilities 
prudently and solely in the interests of plan participants and 
beneficiaries. The Department therefore did not elect this alternative.
    The Department also considered rescinding the Financial Factors in 
Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting 
and Shareholder Rights final rules. This alternative would remove the 
entire current regulation from the Code of Federal Regulations, 
including provisions that reflect the original 1979 Investment Duties 
regulation. The original Investment Duties regulation has been relied 
on by fiduciaries for many years in making decisions about plan 
investments and investment courses of action, and complete removal of 
the provisions could lead to disruptions in plan investment activity. 
Accordingly, the Department rejected this alternative. As discussed in 
section IV.D.4, the Department quantified some costs of the current 
rule related to proxy voting totaled $17.7 million in the first year 
and $6.1 million in subsequent years for the current rule. Rescission 
of the current rule would save this quantified amount, but these 
savings would be offset by the aforementioned disruptions.
    As another alternative, the Department considered revising the 
current regulation by, in effect, reverting it to the original 1979 
Investment Duties regulation. This would reduce the potential of 
disrupting plan investment activity that would be caused by complete 
rescission, as described above. However, because the Department's prior 
non-regulatory guidance on ESG investing and proxy voting was removed 
from the Code of Federal Regulations by the Financial Factors in 
Selecting Plan Investments and Fiduciary Duties Regarding Proxy Voting 
and Shareholder Rights final rules, this alternative will leave plan 
fiduciaries without any guidance on the consideration of ESG issues 
when relevant to plan financial interests. Similar to the first 
alternative described above, this could inhibit fiduciaries from taking 
steps that other marketplace investors might take in enhancing 
investment value and performance, or from improving investment 
portfolio resilience against the potential financial risks and impacts 
associated with climate change. The Department therefore rejected this 
alternative. As discussed in section IV.D.2, the Department quantified 
some of the costs for the current rule related to the tiebreaker, which 
totaled approximately $506,000 annually.
    The Department also considered revising the current regulation by 
adopting changes similar to the fiduciary responsibilities as proposed 
by the European Commission.\292\ The European Commission (EC) is 
amending existing rules on fiduciary duties in delegated acts for asset 
management, insurance, reinsurance and investment sectors to encompass 
sustainability risks such as the impact of climate change and 
environmental degradation on the value of investments. Specifically, 
the EC has added the requirement that fiduciaries must proactively 
solicit client's sustainability preferences, in addition to existing 
requirements that a fiduciary obtain information about the client's 
investment knowledge and experience, ability to bear losses, and risk 
tolerance as part of the suitability assessment. The European Union's 
guidelines for the supervision of institutions for occupational 
retirement provisions (IORPs) require member states to ensure that 
IORPs consider ESG factors related to investment assets in their 
investment decisions, as part of their prudential standards. Where ESG 
factors are considered, an assessment must be made of new or emerging 
risks, including risks related to climate change, use of resources and 
the environment, social risks and risks related to the depreciation of 
assets due to regulatory changes.\293\ One estimate finds that 89 
percent of European pension funds take ESG risks into account as of 
2019.\294\
---------------------------------------------------------------------------

    \292\ Communication from the Commission to the European 
Parliament, the Council, the European Economic and Social Committee 
and the Committee of the Regions: EU Taxonomy, Corporate 
Sustainability Reporting, Sustainability Preferences and Fiduciary 
Duties: Directing finance towards the European Green Deal Brussels, 
21.4.2021 COM (2021) 188 final.
    \293\ ``It is essential that IORPs improve their risk management 
while taking into account the aim of having an equitable spread of 
risks and benefits between generations in occupational retirement 
provision, so that potential vulnerabilities in relation to the 
sustainability of pension schemes can be properly understood and 
discussed with the relevant competent authorities. IORPs should, as 
part of their risk management system, produce a risk assessment for 
their activities relating to pensions. That risk assessment should 
also be made available to the competent authorities and should, 
where relevant, include, inter alia, risks related to climate 
change, use of resources, the environment, social risks, and risks 
related to the depreciation of assets due to regulatory change 
(`stranded assets'). . . . Environmental, social and governance 
factors, as referred to in the United Nations-supported Principles 
for Responsible Investment, are important for the investment policy 
and risk management systems of IORPs. Member States should require 
IORPs to explicitly disclose where such factors are considered in 
investment decisions and how they form part of their risk management 
system. The relevance and materiality of environmental, social and 
governance factors to a scheme's investments and how such factors 
are taken into account should be part of the information provided by 
an IORP under this Directive.''
    \294\ ``ESG Becoming the New Normal for European Pensions'' 
(August 31, 2020), https://www.ai-cio.com/news/esg-becoming-new-normal-european-pensions/.
---------------------------------------------------------------------------

    Although this final rule clarifies that risk and return factors may 
include the economic effects of climate change and other ESG factors on 
the investment, the final rule does not require ERISA fiduciaries to 
solicit preferences regarding ESG factors nor are fiduciaries required 
to consider ESG factors when making all investment decisions. While 
aligning the U.S. to the European approach would have such benefits as 
harmonizing taxonomy for asset and investment managers across 
jurisdictions, the Department was concerned that incorporating such an 
approach would increase costs without a commensurate benefit, and could 
not be fully harmonized with ERISA's fiduciary provisions.
    Finally, in the NPRM, the Department proposed a requirement to 
inform plan participants of the collateral benefits that influenced the 
selection of the investment or investment course of action, when such 
investment or investment course of action constitutes a designated 
investment alternative under a participant-directed individual account 
plan, so participants could understand whether their preferences 
regarding the collateral purpose aligned with the fiduciary's for a 
given investment option. Upon further consideration, including the 
comments received on the NPRM, the Department has decided to remove the 
disclosure requirement from this final rule for all the reasons set 
forth in section III.B.2 of this preamble.

I. Conclusion

    In summary, a significant benefit of this final rule is to clarify 
the application of ERISA's fiduciary duties of prudence and loyalty to 
selecting investments and investment courses of action, exercising 
shareholder rights, such as proxy voting, and the use of written proxy 
voting policies and guidelines. These benefits, while difficult to 
quantify, are anticipated to outweigh the costs.
    The amendments to paragraphs (b) and (c) are designed to ensure 
that plans do not improvidently avoid considering relevant ESG factors 
when selecting investments or exercising shareholder

[[Page 73880]]

rights, as they might otherwise be inclined to do under the current 
regulation. The Department expects that acting on relevant ESG factors 
in these contexts, and in a manner consistent with the final rule, will 
redound to employee benefit plans, participants, and beneficiaries 
covered by ERISA. Further, by ensuring that plan fiduciaries will not 
give up investment returns or take on additional investment risk to 
promote unrelated goals, these amendments are expected to lead to 
increased investment returns over the long run.
    The final rule will also make certain that proxy voting activity by 
plans will be governed by the economic interests of the plan and its 
participants. The amendments require plan fiduciaries to make a 
reasoned judgment deciding whether to exercise shareholder rights and 
how to exercise such rights, while promoting the economic interest of 
the plan. This will promote management accountability to shareholders, 
including the affected shareholder plans.
    The total cost of the final rule is approximately $135.4 million in 
the first year with no additional costs in subsequent years. Over 10 
years, the costs associated with the amendments will total 
approximately $126.6 million, annualized to $18.0 million per year, 
applying a seven percent discount rate.\295\ In addition, the final 
rule is expected to result in cost savings. The total cost savings of 
the final rule is approximately $18.2 million in the first year with an 
annual cost savings of $6.6 million in subsequent years, relative to 
the current regulation. The estimates for cost and cost savings of the 
final rule are summarized in Table 3. Besides cost savings, the rule 
will have many other benefits that have not been quantified and are not 
shown in Table 3.
---------------------------------------------------------------------------

    \295\ The costs would be $131.5 million over 10-year period, 
annualized to $15.4 million per year, if a three percent discount 
rate were applied.

   Table 3--Quantified Costs and Cost Savings Associated With the Final
                                  Rule
------------------------------------------------------------------------
               Requirement                    Year 1          Year 2
------------------------------------------------------------------------
                             Aggregate Costs
------------------------------------------------------------------------
Review of Plan Investment Practices.....     $91,510,494              $0
Review of Proxy Voting Practices........      39,019,523               0
Update Proxy Voting Policies............       4,877,440               0
                                         -------------------------------
    Total...............................     135,407,458               0
                                         -------------------------------
                              Cost Savings
------------------------------------------------------------------------
Removal of the Special Collateral                506,029               0
 Benefit Documentation Requirement under
 the Tie-breaker Rule in the Current
 Rule...................................
Removal of the Special Recordkeeping           6,072,526       6,072,526
 Requirement for Proxy Voting in the
 Current Rule...........................
Removal of the Proxy Voting ``Safe            11,643,651               0
 Harbors'' in the Current Rule..........
                                         -------------------------------
    Total...............................      18,222,207       6,072,526
------------------------------------------------------------------------

V. Paperwork Reduction Act

    The current regulations contain two collections of information with 
OMB Control Number 1210-0162 and OMB Control Number 1210-0165. In the 
notice of proposed rulemaking, the Department had announced its intent 
to discontinue OMB Control Number 1210-0165 and revise OMB Control 
Number 1210-0162 to only include the proposed disclosure requirement 
contained in the proposed amendment. Paragraph (c)(3) of the NPRM 
included a requirement that if a plan fiduciary uses the tiebreaker to 
select a designated investment alternative for a participant-directed 
individual account plan based on collateral benefits other than 
investment returns, ``the plan fiduciary must ensure that the 
collateral-benefit characteristic of the fund, product, or model 
portfolio is prominently displayed in disclosure materials provided to 
participants and beneficiaries.'' This would have been a new disclosure 
requirement under ERISA. At this time, the Department has decided not 
to adopt the proposed disclosure requirement. As discussed in more 
detail earlier in the preamble, based on comments received, the 
Department has decided that a disclosure emphasizing matters collateral 
to the economics of an investment may not be in the best interests of 
plan participants. Plan fiduciaries will still have the ability to use 
collateral benefits to break a tie; they will not be required to make a 
special disclosure. The Department is aware that the SEC is conducting 
rulemaking on investment company names, addressing, among other things, 
``certain broad categories of investment company names that are likely 
to mislead investors about an investment company's investments and 
risks.'' \296\ The SEC also is conducting rulemaking on disclosures by 
mutual funds, other SEC-regulated investment companies, and SEC-
regulated investment advisers designed to provide consistent standards 
for ESG disclosures, allowing investors to make more informed 
decisions, including as they compare various ESG investments.\297\ The 
Department will monitor these rulemaking projects and may revisit the 
need for collateral benefit reporting or disclosure depending on the 
findings of that agency. The Department emphasizes that the decision 
against adopting a collateral benefit disclosure requirement in the 
final rule has no impact on a fiduciary's duty to prudently document 
the tiebreaking decisions in accordance with section 404 of ERISA.
---------------------------------------------------------------------------

    \296\ 87 FR 36594 (June 17, 2022).
    \297\ 87 FR 36654 (June 17, 2022).
---------------------------------------------------------------------------

    Therefore, upon publication of the final rule, the Department will 
request that OMB discontinue both information collection requests 
(ICRs) 1210-0162 and 1210-0165, eliminating all paperwork burden 
associated with the ICRs.

VI. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) \298\ imposes certain 
requirements with respect to Federal rules that are

[[Page 73881]]

subject to the notice and comment requirements of section 553(b) of the 
Administrative Procedure Act \299\ and that are likely to have a 
significant economic impact on a substantial number of small entities. 
Unless the head of an agency determines that a final rule is not likely 
to have a significant economic impact on a substantial number of small 
entities, section 604 of the RFA requires the agency to present a final 
regulatory flexibility analysis of the final rule.
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    \298\ 5 U.S.C. 601 et seq.
    \299\ 5 U.S.C. 553(b).
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    For purposes of analysis under the RFA, the Department considers a 
small entity to be an employee benefit plan with fewer than 100 
participants.\300\ The basis of this definition is found in section 
104(a)(2) of ERISA, which permits the Secretary of Labor to prescribe 
simplified annual reports for pension plans that cover fewer than 100 
participants. Under section 104(a)(3), the Secretary may also provide 
for exemptions or simplified annual reporting and disclosure for 
welfare benefit plans. Pursuant to the authority of section 104(a)(3), 
the Department has previously issued--at 29 CFR 2520.104-20, 2520.104-
21, 2520.104-41, 2520.104-46, and 2520.104b-10--certain simplified 
reporting provisions and limited exemptions from reporting and 
disclosure requirements for small plans. Such plans include unfunded or 
insured welfare plans covering fewer than 100 participants and 
satisfying certain other requirements. While some large employers may 
have small plans, in general small employers maintain small plans. 
Thus, EBSA believes that assessing the impact of these amendments on 
small plans is an appropriate substitute for evaluating the effect on 
small entities. The definition of small entity considered appropriate 
for this purpose differs, however, from a definition of small business 
that is based on size standards promulgated by the Small Business 
Administration (SBA) \301\ pursuant to the Small Business Act.\302\
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    \300\ The Department consulted with the Small Business 
Administration's Office of Advocacy before making this 
determination, as required by 5 U.S.C. 603(c) and 13 CFR 121.903(c). 
Memorandum received from the U.S. Small Business Administration, 
Office of Advocacy on July 10, 2020.
    \301\ 13 CFR 121.201.
    \302\ 15 U.S.C. 631 et seq.
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    The Department has determined that this final rule could have a 
significant impact on a substantial number of small entities. 
Therefore, the Department has prepared a Final Regulatory Flexibility 
Analysis that is presented below.

A. Need for and Objectives of the Rule

    In late 2020, the Department published two final rules (the current 
regulation) pertaining to the selection of plan investments and the 
exercise of shareholder rights to address concerns that some investment 
products may be marketed to ERISA fiduciaries on the basis of purported 
benefits and goals unrelated to financial performance. Responses to the 
current regulation, however, suggest that it created further 
uncertainty and may have the undesirable effect of discouraging 
fiduciaries' consideration of financially relevant ESG factors in 
investment decisions, even when contrary to the interest of 
participants and beneficiaries.
    The Department is concerned that uncertainty may deter plan 
fiduciaries, for small and large plans alike, from participating in 
investments or investment courses of action that enhance investment 
value and performance or improve investment portfolio resilience. The 
Department is particularly concerned that the current regulation 
created a perception that fiduciaries are at risk if they consider any 
ESG factors in the financial evaluation of plan investments and that 
they may need to have special justifications for even ordinary 
exercises of shareholder rights.
    The amendments in this document are intended to address 
uncertainties stemming from the current regulation and related preamble 
discussions and to increase fiduciaries' clarity about their 
obligations. The Department expects that the final rule will improve 
the current regulation and further promote retirement income security 
and retirement savings, while safeguarding the interests of plan 
participants and beneficiaries.

B. Comments

    The Department received more than 895 written comments and 21,469 
petitions (e.g., form letters) submitted during the open comment 
period. Comments received did not focus on the impacts to just small 
entities but focused on the impacts regardless of size. Comments are 
discussed by topic, and readers are directed to those respective 
sections for a summary of the significant comments and responses to 
those comments.
    The Office of Advocacy of the Small Business Administration did not 
file a comment on the proposed rule.

C. Affected Small Entities

    To estimate the costs associated with reviewing the final rule, the 
Department considers two sub-groups of plans: plans that consider ESG 
factors in their investment process and plans that hold corporate stock 
with voting rights. Due to the nature of the finalized amendments, 
these subsets are not mutually exclusive and some plans may be included 
in both subsets. The Department does not have the data necessary to 
estimate how many plans are included in both subsets, so the affected 
entities and related costs are calculated separately in this analysis.
1. Small Plans Affected by the Proposed Modifications of Paragraphs (b) 
and (c) of Sec.  2550.404a-1
    Plans, as well as plan participants and beneficiaries, whose 
fiduciaries consider or will begin considering ESG factors when 
selecting investments will be affected by the modifications of 
paragraphs (b) and (c). As discussed in the regulatory impact analysis, 
the Department estimates that approximately 20 percent of plans 
consider or will begin considering ESG factors when selecting 
investments. This estimate is based on administrative data and surveys 
on investment behavior, which did not address how the investment 
behavior of small plans might differ from plans overall. The Department 
acknowledges that this likely overestimates the number of small plans 
affected. For instance, one survey indicates that only 0.03 percent of 
total participant-directed DC plan assets are invested in ESG funds. In 
fact, it finds that among 401(k) and profit-sharing plans with fewer 
than 50 participants, none of the plans offered an ESG investment 
option.\303\
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    \303\ 64th Annual Survey of Profit Sharing and 401(k) Plans, 
Plan Sponsor Council of America (2021).
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    For the purpose of this analysis, the Department assumes that the 
proportions of plans who consider or will begin considering ESG factors 
when selecting investments is uniform across plan size. Accordingly, 
the Department estimates that 20 percent of small plans will be 
affected by the modifications of paragraphs (b) and (c). According to 
the 2020 Form 5500, there were approximately 652,935 plans with fewer 
than 100 participants,\304\ resulting in an estimate of approximately 
130,600 small plans that will be affected by the

[[Page 73882]]

modifications of paragraphs (b) and (c).\305\
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    \304\ DOL calculations reflecting plans with fewer than 100 
participants. (Source Private Pension Plan Bulletin: Abstract of 
2020 Form 5500 Annual Reports, Employee Benefits Security 
Administration (2022; forthcoming), Table B1.)
    \305\ Id. This estimate is calculated as: 20% x 652,935 pension 
plans = 130,587, rounded to 130,600.
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2. Subset of Plans Affected by Modifications of Paragraph (d) and (e) 
of Sec.  2550.404a-1
    Paragraphs (d) and (e) of the amended rule will affect small ERISA-
covered pension, health, and other welfare plans, and plan participants 
and beneficiaries, that hold shares of corporate stock, directly or 
through ERISA-covered intermediaries, such as common trusts, master 
trusts, pooled separate accounts, and 103-12 investment entities. While 
the majority of participants and assets are in large plans, most plans 
are small plans.
    There is limited data available about small plans' stock holdings. 
The primary source of information on assets held by pension plans is 
the Form 5500. Using the various asset schedules filed, only 3,900 
small plans can be identified as holding stock, either employer 
securities or common stock.\306\ The Department assumes that small 
plans are significantly less likely to hold common stock than larger 
plans.\307\
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    \306\ Based on DOL calculations based on 2020 Form 5500 data, 
only the 3,900 small plans that filed schedule H would report a 
separate line item for stock holdings. The small plans filing the 
Form 5500-SF (595,565) or file schedule I (52,737) do not report 
stock as a separate line item, therefore these plans cannot be 
identified as to whether they hold common stock.
    \307\ Many small plans have exposure to stocks only through 
mutual funds, and consequently will not be significantly affected by 
the finalized amendments to paragraphs (d) and (e).
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    For purposes of illustrating the number of small plans that could 
be affected, the Department assumes that five percent of small plans 
will be affected by the amendments to paragraphs (d) and (e). In 2020, 
there were approximately 652,500 small pension plans,\308\ resulting in 
an estimate of approximately 32,600 small plans that will be affected 
by the amended provisions.\309\ The Department requested comment on 
this assumption in the NPRM but did not receive any comments.
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    \308\ DOL calculations of plans with fewer than 100 participants 
find that in 2020, there were 652,935 plans with less than 100 
participants, rounded to 652,900. (Source Private Pension Plan 
Bulletin: Abstract of 2020 Form 5500 Annual Reports, Employee 
Benefits Security Administration (2022; forthcoming), Table B1.)
    \309\ This estimate is calculated as: 652,935 small plans x 5% = 
32,647, rounded to 32,600.
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    While paragraph (d) of this amended rule will directly affect 
ERISA-covered plans that possess the relevant shareholder rights, many 
plans hire asset managers to carry out fiduciary asset management 
functions, including proxy voting. The Department recognizes that 
service providers, including small service providers who act as asset 
managers, could also be impacted indirectly by this rule. The 
Department expects that service providers will pass incremental 
compliance costs onto plans.

D. Impact of the Rule

    As described in the preamble and the regulatory impact analysis, 
the amendments will impose costs on small and large plans
1. Cost of Reviewing the Final Rule and Reviewing Plan Practices
    Plans, plan fiduciaries, and their service providers will need to 
read the amended rule and evaluate how it will impact their practices. 
To estimate the costs associated with reviewing the amended rule, the 
Department considers two sub-groups of plans: plans that consider ESG 
factors in their investment process and plans that hold corporate stock 
with voting rights.
    The Department estimates that approximately 130,600 small plans 
consider ESG factors in their investment practice and will be affected 
by the finalized amendments in paragraphs (b) and (c). For each plan, a 
legal professional will need to review paragraphs (b) and (c) of the 
final rule, evaluate how these provisions might affect their investment 
practices and assess whether the plan will be needed to make changes to 
investment practices. The Department estimates that this review will 
take a legal professional approximately four hours to complete, 
resulting in a per-plan cost burden of approximately $612.84.\310\
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    \310\ The Department estimates that it will take a lawyer at 
each plan four hours to review the rule. A labor rate of $153.21 is 
used for a lawyer. The cost burden is estimated as follows: 4 hours 
x $153.21 = $612.86. Labor rates are based on DOL estimates for 
2022. For more information in how the labor costs are estimated, see 
Labor Cost Inputs Used in the Employee Benefits Security 
Administration, Office of Policy and Research's Regulatory Impact 
Analyses and Paperwork Reduction Act Burden Calculation, Employee 
Benefits Security Administration (June 2019), www.dol.gov/sites/dolgov/files/EBSA/laws-and-regulations/rules-and-regulations/technical-appendices/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calcu