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DOL Proposes Rule to Remove Barriers to ESG Funds in Retirement Plans

DOL Proposes Rule to Remove Barriers to ESG Funds in Retirement Plans

The U.S. Department of Labor (DOL) has proposed removing barriers put in place by the prior administration that would have limited plan fiduciaries’ ability to consider climate change and other environmental, social and governance (ESG) issues as risk factors affecting workers’ financial security when fiduciaries select retirement plan investments and exercise shareholder proxy voting rights.The proposed rule, Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, would apply to investments included in 401(k) and other defined contribution plans, as well as to defined benefit pension plans. The proposal, published in the Federal Register on Oct. 14, follows an executive order signed in May by President Joe Biden directing the federal government to treat climate change as a threat to workers’ retirement savings.In 2020, the administration of former President Donald Trump had issued a final rule, subsequently blocked by the Biden administration, that would have required sponsors of investment-based employee plans to strictly apply the fiduciary duties of prudence under the Employee Retirement Income Security Act (ERISA) when considering plan investments that promote nonfinancial objectives, such as reducing carbon emissions. A separate Trump administration final rule would have barred retirement plan fiduciaries from casting corporate-shareholder proxy votes in favor of social or political positions that don’t advance the financial interests of retirement plan participants.Duties of Prudence and LoyaltyUnder the Biden administration, the DOL takes the position that ESG factors, and climate change issues in particular, pose financial risks that plan sponsors should consider as prudent fiduciaries.According to a DOL fact sheet, the proposed rule “retains the core principle that the duties of prudence and loyalty require ERISA plan fiduciaries to focus on material 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,” a position similar to the prior guidance.The proposed rule, however, also “addresses the [DOL’s] concern that the 2020 [Trump administration] rules have created uncertainty and are having the undesirable effect of discouraging ERISA fiduciaries’ consideration of climate change and other ESG factors in investment decisions, even in cases when it is in the financial interest of plans to take such considerations into account.”Acting Assistant Secretary for the Employee Benefits Security Administration Ali Khawar said the new proposal “will bolster the resilience of workers’ retirement savings and pensions by removing the artificial impediments—and chilling effect on environmental, social and governance investments—caused by the prior administration’s rules.” He added, “A principal idea underlying the proposal is that climate change and other ESG factors can be financially material and when they are, considering them will inevitably lead to better long-term risk-adjusted returns, protecting the retirement savings of America’s workers.”ESG Default InvestmentsThe proposal also reverses the prior rule’s prohibition on using ESG funds as qualified default investment alternatives (QDIAs), which are types of mutual funds that plan sponsors can select as the default option in automatic enrollment 401(k)-type defined contribution plans.QDIAs can be target-date retirement funds, which …

Who Is Liable for Retirement Plan Mistakes?

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Who Is Liable for Retirement Plan Mistakes?

When a 401(k) or similar defined contribution plan fails to apply the correct definition of compensation in determining benefits, fails to calculate vesting service correctly, or doesn’t make distributions to participants who need to get required minimum distributions, who is responsible? Plan sponsors are often surprised to learn that they are.Why Your Recordkeeper Is Not ResponsiblePlan sponsors may find out that they are still responsible when their plans are selected for audit by the IRS or they are targeted in a lawsuit for miscalculating benefits. More frequently, the recordkeeper may find the mistake when reviewing operations and IRS procedures require that a costly correction be made.Because they rely on their vendors to operate their plans, plan sponsors may mistakenly think that their recordkeeper is the legal plan administrator responsible to fix these mistakes. To understand why administrative responsibility has not been legally delegated to their recordkeepers, plan sponsors need to review their service agreements.Typical Services Agreement LanguagePlan recordkeeping agreements contain disclaimers that the recordkeeper is not performing services as a fiduciary, which means that they are not assuming the legal responsibilities of a plan administrator as defined in the Employee Retirement Income Security Act (ERISA). Admittedly, vendors could and many should do a better job of explaining their limited legal role to plan sponsors. Some years ago, I wrote a post called “What Your Prototype Provider Doesn’t Tell You,” highlighting this problem, but unfortunately too little has changed.ERISA requires that every plan have a legal administrator and designates the plan sponsor as the default administrator when no other person has been appointed. This means that if the agreement doesn’t make the recordkeeper the fiduciary plan administrator, plan sponsors remain responsible for the recordkeeper’s mistakes found on audit or by a court, even if they just did what the recordkeeper told them to do or were unaware of the recordkeeper’s actions. Further, the costs of correcting mistakes are not allowed to be paid from plan assets, so this understanding of the recordkeeper’s real role may coincide with an obligation to pay substantial correction costs to keep the plan qualified. Some recordkeeping agreements do provide that the recordkeepers will indemnify the plan sponsor for errors caused by their gross negligence or willful misconduct, but that is a threshold not reached by most ordinary mistakes. Today the indemnification obligation is also often subject to a dollar cap, which may be a multiple of fees paid to the recordkeeper. While plan sponsors can try to negotiate more favorable indemnification provisions, they will always provide limited protection.There Are AlternativesThere are options available to busy company fiduciaries who want to make sure that their plans are run correctly. Just as they can pass fiduciary responsibility for day-to-day investments on to professional fiduciaries, plan sponsors can hire professional administrators to take over many of the legal responsibilities of plan administration. Professional administrators are referred to as 3(16) administrators after the section of ERISA that defines plan administrator and more busy company fiduciaries should consider hiring them. Professional administration …

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