The November Monthly Minute examines the new DOL final rule addressing fiduciary duties relating to ESG investing and shareholder rights, and a DOL proposed rule that would permit self-correction of late employee contributions.
New DOL Rule Addresses Fiduciary Duties of ESG Investments and Proxy Voting
On November 22, 2022, the DOL released a new final rule clarifying how ERISA's fiduciary duties of prudence and loyalty apply to selecting investments and exercising shareholder rights such as proxy voting. Periodically over the years, the DOL has considered how ERISA's fiduciary duties apply to plan investments that promote environmental, social, or governance ("ESG") goals. As reported in the November 2020 Monthly Minute, in 2020, the DOL published a final rule, "Financial Factors in Selecting Plan Investments," which adopted amendments to ERISA's "Investment Duties" regulation. The amendments generally required plan fiduciaries to select investments based solely on "pecuniary factors." In 2020, the DOL also published a related final rule, which adopted amendments that addressed plan fiduciaries' ERISA obligations when voting proxies and exercising other shareholder rights. The 2020 rules became effective in January 2021, yet were quickly followed by a period of non-enforcement as a result of the change from the Trump administration to the Biden administration.
The final rule announced this month retains the core principle that the duties of prudence and loyalty require ERISA plan fiduciaries to focus on risk-return factors and not subordinate the interests of participants and beneficiaries to objectives unrelated to the provision of benefits. The final rule also reiterates that when a plan's assets include shares of stock, the fiduciary duty to manage plan assets includes the management of shareholder rights related to those shares, such as the right to vote proxies. However, the final rule also reflects various notable changes:
- The regulatory text now clarifies that a fiduciary's duty of prudence 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 ESG considerations.
- Under the 2020 rule, an investment fund was prohibited from being used as a QDIA if its objectives, goals or principal investment strategies indicate that it uses non-pecuniary factors. Under the final rule, this stricter standard is removed and the standards applied to QDIAs are no different from those applied to other investments.
- The provisions requiring that competing investments be economically indistinguishable before fiduciaries could turn to collateral factors as tie-breakers are replaced with a standard that instead requires the fiduciary to prudently conclude that competing investments or investment courses of action equally serve the plan's financial interests over the appropriate time horizon, and in such cases, the fiduciary is not prohibited from making investment-related decisions based on collateral benefits (meaning, benefits other than investment returns).
- The special documentation requirement on the use of collateral factors is removed.
- The final rule adds a new provision clarifying that fiduciaries do not violate their duty of loyalty solely because they consider participants' non-financial preferences when constructing a menu of prudent investment options for participant-directed individual account plans.
With respect to governing the exercise of shareholder rights, the final rule retains the core principle that when a plan's assets include shares of stock, the fiduciary duty to manage plan assets includes the management of shareholder rights related to those shares, such as the right to vote proxies. The final rule also makes three noteworthy changes to the 2020 rules' shareholder rights provisions:
- The final rule eliminates the statement in the 2020 rules 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 removes the two "safe harbor" examples for proxy voting policies permissible under the 2020 rules. 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 if the plan's holding in a single issuer relative to the plan's total investment assets was below a quantitative threshold.
- The final rule also eliminates specific requirements in the 2020 rules on maintaining records on proxy voting activities and monitoring obligations when using investment managers or proxy voting firms.
The final rule will be effective 60 days after publication in the Federal Register, except for the effective date of certain proxy voting provisions.
KMK Comment: Under the new final rules, plan fiduciaries are given more leeway to consider ESG factors and participant preferences when making investment decisions. How much protection this gives to fiduciaries choosing an ESG fund and whether fiduciaries will ultimately choose this course of action remains to be seen. Plan fiduciaries may be wary of perceived pressure to weigh non-financial factors considering the fact that, based on past experience, DOL guidance in this area appears to be in a constant state of flux and some of the inherent difficulties in analyzing ESG funds. Plan fiduciaries will want to proceed with caution in considering ESG funds as an investment option.
DOL Proposes Self-Correction for Late Participant Contributions
Earlier this month, the DOL released proposed regulations expanding and streamlining the Voluntary Fiduciary Correction Program (VFCP). Most notably, the new VFCP revisions add a self-correction feature with respect to late 401(k) deposits and loan repayments. Under the current rules, large employers must contribute employee deferrals as soon as administratively possible (a safe harbor exists for employers of 100 or fewer employees allowing for a 7 business-day deposit period). Given the strict timing requirements, failures to timely transmit participant contributions are frequently subject to the VFCP and no self-correction mechanism exists – yet.
Relief under the newly proposed self-correction component for delinquent participant contributions and delinquent plan loan repayments is available to any plan regardless of size or amount of plan assets, but is limited to corrections where the amount of lost earnings is $1,000.00 or less. Late deposits corrected through the new program will qualify for excise tax relief. Conditions of the new self-correction program include:
- The delinquent participant contributions or loan repayments must have been remitted to the plan no more than 180 calendar days from the date of withholding or receipt, and the use of the DOL's online calculator to determine the amount of the loss payable to the plan is also required.
- The proposal includes an electronically filed notice requirement which replaces the VFCP paper application -- the required data elements in the notice include: the name and an email address for the self-corrector; the plan name; the plan sponsor's EIN and the plan number; the principal amount; the amount of lost earnings and the date paid to the plan; the loss date (date(s) of withholding or receipt); and the number of participants affected by the correction. The notice must be submitted via a new online VFCP web tool to be located on EBSA's website.
- Self-correctors also must provide a specific, completed checklist and required documentation to the plan administrator (this obligation applies even if the employer is the plan administrator) which is subject to retention requirements.
KMK Comment: The DOL expects the revamped self-correction feature will mean more voluntary corrections and more participant accounts receiving more timely correction amounts, and we tend to agree. Although the proposal is still subject to review and comment, it is expected to provide welcomed relief for occasional errors that can inadvertently occur due to payroll issues that frequently catch plan administrators off-guard considering the strict deferral timing requirements that otherwise apply.
The KMK Law Employee Benefits & Executive Compensation Group is available to assist with these and other issues.
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