THE END OF THE DOL FIDUCIARY RULE
On June 21, 2018, the Court of Appeals for the Fifth Circuit officially vacated the Department of Labor’s (DOL) 2016 fiduciary rule in its entirety, including the related prohibited transaction exemptions and the Best Interest Contract (BIC) exemption. The Court held that the DOL exceeded its rulemaking authority under ERISA in enacting the rule.
This brings to a close the legal battle over the fiduciary rule, as the deadline to seek the Supreme Court’s review lapsed in June 2018. Now, we return to the standard set by the DOL in 1975, using the five-part test to determine whether an individual is a fiduciary. Plan sponsors who previously relied on the BIC to avoid prohibited transactions may wait and see what service providers do to avoid them. The DOL issued Field Assistance Bulletin No. 2018-02 on May 7, 2018, in which it announced that, until after regulations or exemptions or other administrative guidance has been issued, the DOL will neither pursue prohibited transaction claims against investment advice fiduciaries who work “diligently and in good faith” to comply with the impartial conducts standards relating to transactions that would have been exempted in the BIC exemption, nor treat these fiduciaries as violating the applicable prohibited transaction rules. At this time, plan sponsors should be wary of one-time rollover recommendations by a fiduciary unless they meet the BIC standard.
THE DOL REMINDS ERISA FIDUCIARIES THAT ECONOMIC CONSIDERATIONS MUST COME BEFORE ENVIRONMENT, SOCIAL, AND GOVERNANCE FACTORS
In the DOL’s Interpretive Bulletin 2015-01, guidance encouraged plan sponsors to incorporate into their plans economically targeted investments (ETI), investments that are selected, in part, for the social and/or environmental benefits they provide in addition to the investment return. Now, a new Field Assistance Bulletin, No. 2018-01, reminds fiduciaries that economic considerations must take priority over any collateral environmental or social benefits. Specifically, “plan fiduciaries are not permitted to sacrifice investment return or take on additional investment risk as a means of using plan investments to promote collateral social policy goals.”
The guidance of IB 2015-01 stated that only when return expectations and risk profiles are equivalent is a fiduciary permitted to consider environmental, social, and governance (ESG) factors as a tie-breaker. However, it is accepted that ESG factors may have a direct relationship to the economic and financial value of an investment. Now, FAB 2018-01 cautions fiduciaries to “not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision.” The bulletin states that 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,” demonstrating a more reserved tone from the DOL than in the 2015 bulletin.
However, like many investors, plan sponsors are starting to recognize that ESG factors may, in fact, be indicators of a strong business model and sustainable practices, and serve as a legitimate factor in evaluating investments. The DOL has pulled back slightly on this idea with the new bulletin, and sponsors are cautioned, as fiduciaries, to focus first on financial performance.
We believe it is possible for investors to find impact or ESG-targeted investments that do not sacrifice performance nor add an additional layer of risk. The ESG trend is growing, and as participants demand investments that reflect their values, plan sponsors should consider all characteristics, not just ESG, to determine whether an investment can produce attractive future returns that remain in compliance with the DOL’s rules. We believe the DOL’s position remains in line with the previous bulletin and serves as a reminder that ESG characteristics alone are not a sufficient basis upon which to evaluate a potential investment: “ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits.”
IMPORTANT DISCLOSURES: These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable; Arnerich Massena cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.