Fiduciary Governance Blog

Deadline to Comply with DOL Investment Advice Exemption Fast Approaching

George Michael Gerstein • December 3, 2021 December 3, 2021 • Risk & Reward • Tags: DOL, ERISA, Fiduciary Rule

Financial services firms that interact with retirement investors, such as participants and fiduciaries of ERISA-covered plans, as well as individual retirement accounts (IRAs), should take this opportunity to consider the extent to which they provide recommendations (i.e., non-discretionary investment advice) to these investors, and, if so, whether reliance on an exemption from the prohibited transaction rules is necessary. This is relevant because U.S. Department of Labor (DOL) Prohibited Transaction Exemption (PTE) 2020-02, the newest and most notable exemption available to investment advice fiduciaries, is slated to go into full effect starting on Feb. 1, 2022 (the requirements specific to rollover advice become effective on July 1, 2022).

We suggest first determining if recommendations are being provided in the first place. Some communications are not investment advice, such as marketing and investment education. But these communications can morph into advice, as defined under ERISA, as they become more tailored to the investor and as specific products, services or accounts are identified for the investor. It is a fact-intensive inquiry, which is why one should, as a preliminary matter, ascertain the nature of communications with current and prospective investors.

If recommendations are being provided to retirement investors and fiduciaries, then an exemption strategy will be warranted to receive any compensation in connection with the advice. PTE 2020-02 was built for these types of arrangements, but it contains numerous conditions, most of which, as noted above, go into effect early next year. One important condition (among others) is a need for policies and procedures that are prudently designed to ensure compliance with the exemption’s “impartial conduct standards.”

Please feel free to reach out with any questions.

SEC Adopts Universal Proxy and Proposes to Rescind Certain 2020 Proxy Solicitation Rules

Sara Crovitz • November 23, 2021 November 23, 2021 • Risk & Reward

By: Sara P. Crovitz and Wesley Davis

Introduction
On Nov. 17, 2021, the Securities and Exchange Commission (SEC) adopted amendments to proxy voting rules (Final Rule) to require the use of a universal proxy card in contested director elections. The universal proxy card must include all registrant and dissident director nominees in non-exempt director elections, allowing shareholders to vote on each nominee rather than an entire slate of directors.¹ In a separate rulemaking, the SEC proposed amendments (Proposed Amendments) to proxy voting rules that generally would rescind certain 2020 rules governing advice provided by proxy voting advisors.²

KEY TAKEAWAYS

• The Final Rule does not apply to the director elections of investment companies or business development companies.

• The Final Rule is expected to make it easier for activist investors to win at least some board seats as the process to put dissident directors on the proxy card will be cheaper and more efficient.

• The Final Rule will become effective for any shareholder meeting held after Aug. 31, 2022.

• While the Proposed Amendments would rescind requirements that proxy voting advisors provide issuers an opportunity to comment on and provide their clients (e.g., investment advisers) with a mechanism by which the clients can reasonably be expected to become aware of any comments by public companies that are the subject of the advice, the largest proxy voting advisors have voluntarily provided similar opportunities and may continue to do so.³ This issue has become highly politicized and could be reversed again in a future administration.⁴

• The Proposed Amendments request comment on whether SEC guidance issued in conjunction with the 2020 Rules – which suggested how investment advisers should consider public company comments received through proxy voting advisor’s mechanisms – should also be reconsidered or rescinded.

Universal Proxy

General. For years, shareholders and their advocates have expressed concerns about being unable to choose a mix of dissident and registrant nominees when voting on contested director elections by proxy. To address the difference in voting opportunities between voting in person versus via proxy, new Rule 14a-19 under the Securities Exchange Act of 1934 (34 Act) includes a mandatory requirement to use a universal proxy card that includes the names of all director nominees from both the registrant and dissident(s) in a contested election. The universal proxy card will permit shareholders to vote for or against individual directors, rather than the current practice of having to choose between the registrant’s and dissident’s slates of directors.⁵
Minimum Solicitation Requirement. For dissident nominees to be listed on a universal proxy card, the dissident must indicate its intent to meet the minimum solicitation requirement when notifying a registrant of its nominees. The dissident must also solicit shareholders representing at least 67% of the voting power of shares entitled to vote in the election.⁶
Notice and Filing Requirements. The Final Rule adopts, as proposed, the requirement that a dissident provide the registrant with names of nominees for whom it intends to solicit proxies at least 60 calendar days before the anniversary of the previous year’s annual meeting date.⁷ Dissidents also must comply with advance notice requirements included in the registrant’s bylaws, which may be longer. Registrants will be required to notify dissidents of their nominees no later than 50 days before the anniversary of the previous year’s annual meeting date.⁸ Both a registrant and dissident’s proxy statement “must direct shareholders to the opposing side’s proxy statement for information about that participant’s nominees” rather than including such information in its proxy statement.⁹
Universal Proxy Presentation and Formatting Requirements. The Final Rule includes universal proxy card formatting and presentation requirements meant to avoid shareholder confusion and to “ensure that each side’s nominees are grouped together and clearly identified as such and presented in a fair and impartial manner.”¹⁰
Additional Amendments for All Director Elections. Additional amendments to the form of proxy and disclosure requirements apply to all director elections, not only those that are contested. Unlike the universal proxy voting requirements, these amendments also apply to registered investment companies and business development companies.¹¹ These amendments mandate that a form of proxy for the election of directors include an “against” voting option in lieu of a “withhold authority to vote” option where permitted by state law.¹² They also provide shareholders with the “opportunity to ‘abstain’ in a director election governed by a majority voting standard.”¹³

Proxy Solicitation Rules

General. The Proposed Amendments would rescind certain final rules regarding proxy voting advice under the 34 Act that the SEC adopted in the 2020 Rules. The Proposed Amendments were adopted by a vote of 3-2, with Republican Commissioners Peirce and Roisman dissenting. Comments on the Proposed Amendments will be due thirty days after their publication in the Federal Register.
Proposed Amendments to Rule 14a-2(b)(9). The 2020 Rules added conditions that proxy voting advisors must meet in order to take advantage of exemptions from certain solicitor information and filing requirements. The Proposed Rules would retain conflicts of interest disclosure requirements, and proxy voting advice would remain a solicitation subject to the federal proxy rules. Additional conditions (and related safe harbor and exclusions) would be deleted under the Proposed Amendments. In particular, proxy voting advisors no longer will be required to make their advice available to the public companies on which they are providing advice at or before the time that they provide such advice to their clients or to provide a mechanism by which their clients could reasonably be expected to become aware of any written statements by public companies regarding their proxy voting advice in a timely manner and before the relevant shareholder meeting.¹⁴
Proposed Amendment to Rule 14a-9. A proxy voting advisor’s proxy voting advice generally constitutes a solicitation, according to the SEC, and such advice is prohibited from “containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact.”¹⁵ Note (e) of Rule 14a-9 provides examples of material misstatements related to proxy voting advice. This note would be deleted under the Proposed Amendments, based on concerns that liability could extend to mere differences of opinion with public companies regarding proxy voting advisor’s advice. Such liability concerns could impair the independence of the advice that proxy voting advisors provide because it could lead to public companies threatening litigation against proxy voting advisors in order to influence the advice that they provide.¹⁶

¹ See Universal Proxy (https://www.sec.gov/rules/final/2021/34-93596.pdf) (adopted Nov. 17, 2021) (to be codified at 17 CFR 240) (Final Rule Release). The Final Rule was adopted substantially as proposed by a vote of 4-1, with Commissioner Peirce dissenting.

² See Proxy Voting Advice (https://www.sec.gov/rules/proposed/2021/34-93595.pdf) (proposed Nov. 17, 2021) (to be codified at 17 CFR 240) (Proposed Amendments Release); Exemptions from the Proxy Rules for Proxy Voting Advice (https://www.sec.gov/rules/final/2020/34-89372.pdf) (effective Nov. 2, 2020) (17 CFR 240) (2020 Rules Release).

³ Proxy voting advisors established a best practice principles group (BPPG), which has an oversight committee composed of non-affiliated industry experts and academics. The oversight committee’s 2021 report found that all six members of the BPPG including the two largest U.S. proxy voting advisors met the best practices principles regarding “(1) service quality, (2) conflicts-of-interest avoidance or management and (3) communications policy.” Proposed Amendments Release. at 14.

⁴ It is also possible that, if adopted, the Proposed Amendments could be subject to litigation. The National Association of Manufacturers already had filed suit against the SEC for announcing it would not enforce the 2020 Rules. See National Association of Manufacturers et al. v. SEC, No. 7:21-cv-183 (W.D. Tex.). The dissenting statements by Commissioners Roisman and Peirce highlight their procedural concerns regarding the rulemaking. Elad L. Roisman, Commissioner, U.S. Sec. & Exch. Comm’n, “Too Important to Regulate? Rolling Back Investor Protections on Proxy Voting Advice” (https://www.sec.gov/news/statement/roisman-proxy-advice-20211117) (Nov. 17, 2021); Hester M. Peirce, Commissioner, U.S. Sec. & Exch. Comm’n, “Dissenting Statement on Proxy Voting Advice Proposal” (https://www.sec.gov/news/statement/peirce-proxy-advice-20211117) (Nov. 17, 2021).

⁵ Final Rule Release at 8-9. Under current practice, shareholders are generally unable to vote for a mix of dissident and registrant nominees due to state and federal laws. The dissident and registrant generally send a proxy card listing only their respective nominees because consent is required to list an opposing party’s nominees on a proxy card, which is rarely provided. Additionally state law “provides that a later-dated proxy card invalidates an earlier dated proxy card,” which means that a shareholder “must choose between the dissident’s or registrant’s proxy card.”

⁶Id. at 27. The proposed rule would only have required a dissident to solicit shareholders representing at least a majority of shares. Commissioner Roisman stated that the revised minimum solicitation requirement “is a large reason that I am able to support the rule.” Elad L. Roisman, Commissioner, U.S. Sec. & Exch. Comm’n, “Statement on Universal Proxy Rules” (https://www.sec.gov/news/statement/roisman-universal-proxy-20211117) (Nov. 17, 2021).

⁷ Final Rule Release at 26-27.

⁸ Id. at 33.

⁹ Id. at 23-24.

¹⁰ Id. at 24.

¹¹ Id. at 56, fn. 146.

¹² Id. at 58.

¹³ Id.

¹⁴ Proposed Amendments Release at 9-10.

¹⁵ Id. at 25.

¹⁶ Id. at 27.

Information contained in this publication should not be construed as legal advice or opinion or as a substitute for the advice of counsel. The articles by these authors may have first appeared in other publications. The content provided is for educational and informational purposes for the use of clients and others who may be interested in the subject matter. We recommend that readers seek specific advice from counsel about particular matters of interest.

DOL Grants New Extension of Investment Advice Rulemaking

George Michael Gerstein • October 26, 2021 October 27, 2021 • Risk & Reward • Tags: DOL, Fiduciary Rule

Financial services firms—that were in a mad dash to comply with a new and important exemption for investment advice fiduciaries to ERISA plans and IRAs—can rest easy, at least for now. The U.S. Department of Labor (DOL) announced yesterday a new temporary enforcement policy with respect to Prohibited Transaction Exemption 2020-02 (PTE 2020-02).

PTE 2020-02 enables an “investment advice fiduciary” to provide rollover advice and advice on how to invest assets within a plan or IRA, and receive compensation for such advice, in a manner that avoids a non-exempt prohibited transaction. The exemption, adopted late last year, is part of a long saga over how the DOL identifies and regulates non-discretionary investment advice to plans and IRAs, and is colloquially known as “the Fiduciary Rule.”

Prior to this new temporary enforcement policy, all of PTE 2020-02’s conditions were set to go into effect this December, meaning, an investment advice fiduciary would have had to ensure that each condition was satisfied to avoid an impermissible self-dealing prohibited transaction. Yet, financial services firms expressed concern that they did not have enough time to do so. Fiduciaries that provide rollover advice, for example, are subject to detailed documentation requirements under PTE 2020-02. Obtaining, synthesizing, and documenting this information was no small feat, and the DOL ultimately agreed that more time was needed.

Under this new temporary enforcement policy:

For the period from Dec. 21, 2021 through Jan. 31, 2022, the DOL will not pursue prohibited transactions claims against investment advice fiduciaries who are working diligently and in good faith to comply with the Impartial Conduct Standards (as set forth in the exemption) for transactions that are exempted in PTE 2020-02, nor will the DOL treat such fiduciaries as violating the applicable prohibited transaction rules.
The DOL will not enforce the specific documentation and disclosure requirements for rollovers in PTE 2020-02 through June 30, 2022. All other requirements of the exemption, however, will be subject to full enforcement as of Feb. 1, 2022.

The DOL’s issuance of this temporary enforcement policy provides financial services firms needing breathing space to evaluate the applicability of PTE 2020-02 to their operations and to implement the exemption’s conditions, to the extent necessary.

New DOL Proposal May Be ERISA’s Zero-to-One ESG Moment

George Michael Gerstein • October 20, 2021 October 20, 2021 • Risk & Reward • Tags: DOL, ERISA, ESG, Proxy voting

Topline & Comment Period Deadline
A new U.S. Department of Labor (DOL) rule proposal would, if adopted, greatly accelerate ERISA fiduciaries’ need to evaluate climate-related financial risk and certain other environmental, social and governance (ESG) considerations during plan investment and proxy voting decision-making. The comment period for the proposal closes on December 13, 2021.¹

Who is Affected?
The proposal is directly relevant to all ERISA plan sponsors (both DB and DC), investment managers, and pooled investment funds that hold “plan assets.” Proxy advisory firms and product manufacturers are indirectly affected.

Why the DOL Proposed this Rule
The DOL has long wrestled with ESG, especially when ESG was historically associated with collateral benefits (i.e., non-investment performance reasons). Formalized guidance commenced during the Clinton Administration, with each subsequent administration taking different approaches. It was during the Obama Administration when the DOL first acknowledged that an ESG factor can be material to investment performance.

The Trump Administration reaffirmed the Obama Administration’s stance that an ESG factor can be material to investment performance, but its relevant rulemakings, the Financial Factors rule, and the 2020 proxy voting rule, expressed concern over the putative politicization of ESG investing and skepticism that certain types of ESG investing, particularly screens, was in a plan’s best interest. Many believed the Trump-era rules stigmatized, and, therefore, had a chilling effect on, ESG adoption by ERISA plans.

The DOL under the Biden Administration recognized, and agreed with, the concerns that the Financial Factors and proxy voting rules had a chilling effect on ESG adoption. The DOL, in drafting the proposal, sought to enable ERISA fiduciaries to “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.” Also, considering the Administration’s broader policy initiatives to address climate change risk, this new proposal fits into a larger tapestry the White House has weaved as part of its “whole-of-government” approach to climate change and other ESG issues.²

How the Proposal Goes Far Beyond Other DOL Approaches to ESG
As with the Financial Factors rule and Obama-era guidance, the proposal emphatically reaffirms that ESG factors can be material to an investment’s risk-return analysis, and in those situations, a fiduciary should consider them along with any other non-ESG material risks.³ In doing so, the DOL fleshed out various types of ESG risks, and, in considerable detail, the multi-dimensional aspects to an ESG factor. Specifically, the proposal describes the following ESG factors that might be material:

“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 risks⁴ of climate change and the positive or negative effect of Government regulations and policies to mitigate climate change;⁵
Governance factors, such as those involving board composition, executive compensation, and 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
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.”

We think this level of specificity by the DOL reveals an increasingly sophisticated and nuanced understanding of climate change risk. The proposal’s granularity on different ESG risks will likely enhance broader understanding of these risks by fiduciaries, thus aiding adoption.

Beyond that, we think the proposal’s express acknowledgment that government action (whether in policy or in rulemaking) may have a negative or positive material effect on plan investments could be transformational.⁶ Indeed, there will be winners – and there will be losers – from government policy and rulemakings aimed at a transition to a low-carbon economy (or for some other ESG-related reason), and ERISA fiduciaries would be expected to prepare a plan’s portfolio for these risks and opportunities.

The proposal contemplates a broad scope to government action as a potential material risk or opportunity consideration for ERISA fiduciaries. Consider the following:

The government action appears to include all government levels, both within the United States (federal and state) and abroad;
The government action need not be limited to actual regulation – a government policy, as reflected in the Biden Administration’s A Roadmap to Build a Climate-Resilient Economy, would likely be sufficient for the fiduciary’s consideration, if the policy initiative is likely to have a positive or negative effect on a particular industry, for example; and,
The government action can come from any government agency or body, such as the EPA or the Governor of California, for instance.

A government action that sets things into motion, which would trigger an ERISA fiduciary’s consideration under the proposal, will likely put fiduciaries on high alert and wanting to act quickly in response.

Yet another way in which the proposal could serve as ERISA’s zero-to-one ESG moment is that it appears to create a heavy presumption in favor of ESG adoption. Under the proposed text, a fiduciary must consider the projected return of the portfolio relative to the funding objectives of the plan, “which may often require an evaluation of the economic effects of climate change and other environmental, social, or governance factors on the particular investment….” (emphasis added).⁷ Though the rule separately lists various ESG factors that may be considered by the fiduciary if material to the risk-return analysis,⁸ the “which may often require” clause clearly reflects an intention by the DOL that various ESG factors are material, and, therefore, must be considered by a prudent ERISA fiduciary. Further lending credence to the view that the proposal goes beyond simply clarifying that ESG factors may be material, the DOL stated in the preamble, “the proposal makes clear that climate change and other ESG factors are often material and that in many instances fiduciaries [] should consider climate change and other ESG factors in the assessment of investment risks and returns.”⁹

A fourth reason this proposal is significant is the DOL’s acknowledgment that “all ESG is not equal, and when it is not material to the risk/return analysis, ESG still may be a legitimate collateral benefit for consideration….”¹⁰ Using ESG for these types “collateral benefits” is not new; in fact, it has been a means by which fiduciaries have incorporated ESG for decades.¹¹ But the proposal, relative to the Financial Factors rule, streamlines and broadens its usage. For example, the proposal would eliminate the special documentation requirement under the Financial Factors rule related to the use of collateral benefits. Moreover, the proposal expands the types of collateral benefits that may be considered.¹²

Notably, however, where a collateral benefit ESG factor is used in selecting a designated investment alternative for a participant-directed (e.g., 401(k)) plan lineup, the proposal would require that such reason/benefit “be prominently displayed in disclosure materials provided to participants and beneficiaries.”¹³ The DOL mentioned that this new disclosure could be added to the existing participant disclosures provided under 29 CFR Section 2550.404a-5.

How QDIAs are Affected
There was considerable controversy over the Financial Factors rule’s prohibition against an ERISA fiduciary selecting a “qualified default investment alternative” (QDIA) in a participant-directed plan lineup, if that fund, product or model portfolio’s investment objectives, goals or principal investment strategies referenced an ESG factor that was selected for collateral benefits. The stakes are high because there is a massive amount of plan assets invested in QDIAs. The proposal eliminates this prohibition. The proposal will likely accelerate the use of ESG funds, products and model portfolios as QDIAs.

How Pooled Investment Vehicles are Affected
The proposal retains the ability of a pooled investment fund that holds “plan assets” to require participating plans to accept the fund’s investment policy statement and/or proxy voting policy, to the extent consistent with ERISA, as a condition to subscribe into the fund. This is helpful insofar as fund managers would otherwise have had to ascertain, and avoid violating, each plan investor’s own investment policy statements and proxy voting policies.

How Brokerage Windows and Self-Directed Brokerage Accounts are Affected
As with the Financial Factors rule, the proposal does not extend to investment funds within brokerage windows and self-directed brokerage accounts. Some plan sponsors have enabled participants to access ESG funds through these arrangements, and that practice may persist.

How Proxy Voting and Other Shareholder Rights are Affected
ESG investing and the exercise of shareholder rights (including, but not limited to, proxy voting) often go together, which is likely why the DOL addressed them here at once. Consistent with the DOL’s longstanding position, the proposal reiterates that proxy voting and the exercise of other shareholder rights on behalf of ERISA plans is fiduciary conduct, and, therefore, is subject to the fiduciary duties set forth in ERISA. The current view of the DOL, as reflected in the proposal, is that exercising shareholder rights is important and should not be discouraged. Yet, the DOL was quick to reaffirm its historical 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 determines voting proxies may not be in the plan’s best interest (e.g., if there are significant costs or efforts associated with voting).”¹⁴

The proposal also eliminates the requirement in the 2020 proxy voting rule that there be special monitoring where the authority to exercise shareholder rights on behalf of the plan had been delegated to an investment manager or where a proxy advisory firm provides advisory services. The DOL believes that ERISA’s duties of prudence and loyalty already impose a monitoring obligation, and, therefore, no special monitoring obligation with respect to shareholder rights is warranted.

The 2020 rule provided two safe harbors for fiduciaries to satisfy ERISA’s fiduciary duties in determining whether to vote a proxy. Briefly, the two safe harbors were: (A) a policy to limit 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, and (B) a policy of refraining from 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 (or investment performance of assets under management in the case of an investment manager).

The DOL, in the preamble to the proposal, noted that, because the safe harbors are likely to be widely adopted, it is vital that they actually safeguard the interests of the plans. The DOL is currently not confident the two safe harbors from the 2020 rule are “necessary or helpful,” and, therefore, did not include them in the proposal. As noted below, however, the DOL solicits comments on whether the safe harbors should be retained.

The proposal eliminates a requirement from the 2020 rule that mandated fiduciaries to maintain records on proxy voting activities and the exercise of other shareholder rights.

The proposal retains a requirement that the fiduciary exercise prudence and diligence in the selection and monitoring of persons hired to provide research and analysis, recommendations regarding proxy votes, proxy voting administrative services, recordkeeping and other services related to shareholder rights. This is why the proposal indirectly affects proxy advisory firms.

Some Questions to Consider
The comment period closes on December 13, 2021. The DOL is interested in feedback and has solicited comments on the proposal, including:

Should a final rulemaking retain the specific examples of ESG risks that may be material (e.g., climate change, etc.)?
Is the proposal’s revised language around the tie-breaker test clear and appropriate? Should a final rule provide greater specificity on which collateral benefits may be considered?
Should a final rule retain the enhanced documentation requirement when a plan investment option is selected for collateral benefits?
Should the safe harbors in the 2020 proxy voting rule be retained?
Would the proposal cause plans to modify their holdings, such as in favor of mutual funds and away from individual companies, so as to avoid the proxy voting requirements set forth in the proposal?
Would the proposal affect how a fiduciary would manage the plan’s mutual fund shares in terms of exercising shareholder rights appurtenant to the mutual fund shares?
Are the proposal’s requirements regarding the selection and monitoring of proxy advisory firms and other service providers regarding the exercise of shareholder rights necessary and could they be read as creating special duties and requirements beyond those already existing under ERISA?
Should the DOL retain the specific requirement that a fiduciary may not adopt a practice of following the recommendations of a proxy advisory firm without a determination that such firm’s proxy voting guidelines are consistent with the fiduciary’s duties under ERISA? Do the proposal’s other provisions otherwise address concerns related to fiduciaries’ use of automatic voting mechanisms?

Final Thoughts
We believe there is more to this proposal than what may initially meet the eye. The DOL is clearly trying to nudge ERISA fiduciaries into considering ESG factors in their investment and proxy voting decision-making. Should the proposal be adopted as-is, it will likely serve as an accelerant to ESG adoption by ERISA plans and plan asset vehicles. Because these consequences would be profound, plan sponsors and other fiduciaries should carefully consider whether to provide feedback and comments to the DOL in response to the proposal.

____________________

¹ The proposed rule would amend the “Investment Duties” regulation set forth at 29 C.F.R. Section 2550.404a-1.

² See, e.g., A Roadmap to Build a Climate-Resilient Economy, https://www.whitehouse.gov/wp-content/uploads/2021/10/Climate-Finance-Report.pdf, Executive Order 13990, “Protecting Public Health and the Environment and Restoring Science to Tackle the Climate Crisis,” 86 Fed. Reg. 7037 (Jan. 25, 2021), and Executive Order 14030, “Executive Order on Climate-Related Financial Risk,” 86 Fed. Reg. 27967 (May 25, 2021).

³ Since 2015, the DOL has repeatedly asserted that ESG can be a material risk factor, and, in those situations, should be considered by an ERISA fiduciary as part of a prudent process. This holds true under the Obama, Trump and Biden Administrations. That the DOL, under both Democrats and Republicans, has acknowledged that ESG risks can be material to investment performance, strongly suggest this issue is officially off the table.

⁴ The preamble to the proposal notes, “[t]ransition 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.”

⁵ Per the DOL, the “imminent or proposed regulations…to reduce greenhouse gas emissions in the power sector, and other policies incentivizing a shift from carbon-intensive investments to low-carbon investments, [which] could significantly lower the value of carbon-intensive investments while raising the value of other investments.”

⁶ See George Michael Gerstein, Climate Change Defines the Fiduciary, Bloomberg Law, Oct. 2, 2017 (“The first major component of climate risk relates to forthcoming changes in policy and law at the international, national and local level.”); see also Mercer, Investing in a Time of Climate Change, 2015, https://www.mercer.com/content/dam/mercer/attachments/global/investments/mercer-climate-change-report-2015.pdf.

⁷ Proposed 29 C.F.R. Section 2550.404a-1(b)(2)(ii)(C).

⁸ Proposed 29 C.F.R. Section 2550.404a-1(b)(4).

⁹ 86 Fed. Reg. 57272, 57276 (Oct. 14, 2021).
¹⁰ Id. at 57279.

¹¹ The analytic framework for using collateral benefits has been called the “tie-breaker” test.

¹² Cf. 86 Fed. Reg. at 57280 (referencing “corporate ethos” and “esprit de corps of the workforce” as collateral benefits) with 85 Fed. Reg. 72846, 72862 (“responding to participant demand in order to increase retirement plan savings or investments in contribution creating jobs for current or future plan participants may be consistent with the interests of participants and beneficiaries in their retirement income or financial benefits under the plan, while selecting based on which investment would bring greater personal accolades to the chief executive officer of the sponsoring employer, or solely on the basis of a fiduciary’s personal policy preferences, would not.”).

¹³ The DOL noted in the preamble that, “[t]he 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.”

¹⁴ See also 86 Fed. Reg. at 57281 (“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 interest.”).

DOL Proposes New ESG & Proxy Voting Rule

Fiduciary Governance Blog • October 13, 2021 October 13, 2021 • Risk & Reward • Tags: DOL, ESG, Proxy voting

By: George Michael Gerstein and Wesley Davis

Plan sponsors and financial services firms that act as fiduciaries to ERISA plans and “plan asset” funds should take note of a new rule proposal that the U.S. Department of Labor (DOL) announced today. The proposed rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” would address ERISA fiduciaries’ duties with regard to considering climate change and other environmental, social and governance (ESG) factors when selecting investments and exercising shareholder rights.

This rule, if adopted, would have significant implications for financial services firms that act as ERISA fiduciaries. The comment period will run for 60 days after the rule’s publication in the Federal Register. We will be preparing a detailed analysis in the coming days.

Texas and Maine Approaches to Fossil Fuel Divestment a Cautionary Tale for Investment Managers

George Michael Gerstein • June 17, 2021 June 17, 2021 • Risk & Reward • Tags: ESG, Fiduciary Duties, Governmental Plans

State and local governmental plans, which are excluded from ERISA, are subject to idiosyncratic legal requirements, including specific investment restrictions. These plans are also not immune to the political winds blowing in that state. Nowhere is this more apparent than recent developments out of the States of Texas and Maine with respect to fossil fuel divestment. Investment managers of any governmental plan, especially those that take environmental, social and governance (ESG) factors into account, should pay close attention to these developments. Private equity and other fund managers, for the reasons stated below, should also take note.

Texas
On June 14, 2021, Texas Governor Greg Abbott signed into law SB 13. This new law, which goes into effect on September 1, 2021, generally prohibits state governmental entities, including the Employees Retirement System of Texas and the Teacher Retirement System of Texas, from directly or indirectly holding the securities of a publicly-traded financial services, banking or investment company that “boycotts” companies that (i) explore, produce, utilize, transport, sell or manufacture fossil fuel-based energy and (ii) do not “commit or pledge to meet environmental standards beyond applicable federal and state law….” The concept of “boycott” is not limited to divestment; rather, it picks up activity that is designed to inflict economic harm on the energy company. The exercise of certain shareholder rights could possibly amount to a “boycott” of a company.

The law also generally prohibits governmental entities from contracting with a service provider unless the contract provides a written verification from the service provider that it does not boycott energy companies and will not boycott energy companies during the term of the contract. This applies to contracts entered into on or after September 1, 2021.

Fiduciaries of these Texas governmental plans remain subject to countervailing fiduciary duties under Texas law, including the Texas Constitution. The new law crucially allows for breathing space between these core fiduciary duties and the state’s interest in protecting significant portions of its economy.

The law provides that these governmental entities are not required to divest from any holdings in “actively or passively managed investment funds or private equity funds.” However, the governmental entities are required to submit letters to the managers of these funds requesting that they remove from the portfolio financial companies that the state comptroller has designated as boycotting energy companies. The Texas governmental entities will alternatively request that the managers “create a similar actively or passively managed fund with indirect holdings devoid of listed financial companies.” Investment managers should be on the lookout for these letters starting this coming Fall.

Maine
Meanwhile, in Maine, the House of Representatives recently passed a bill that calls for the divestment of fossil fuel companies by the Maine Public Employees Retirement System (Maine PERS) and other permanent state funds by 2026. As with Texas, the law is sensitive to the overriding fiduciary duties that apply to the management of these assets. An official for Maine PERS recently testified that, “[p]ermanently striking broad portions of the financial market is incompatible with earning optimal returns for member retirements, will not change corporate behavior, and may not advance the social goals sought because investments are rarely one dimensional.”

Takeaways
Governmental plans invested in separate accounts or commingled funds managed by an investment manager have always posed risks to that manager, as these plans are subject to their own fiduciary duties and investment restrictions. Though the state laws applicable to governmental plans may contain ERISA-like language, we caution investment managers from relying on ERISA or DOL guidance as a failsafe way to manage governmental plan assets. As evidenced from the disparate approaches the States of Texas and Maine have taken, investment managers should pay close attention to the specific rules applicable to these plans to avoid running afoul of state law. With the calls for fossil fuel divestment growing louder in some quarters, and as other ESG issues come to the fore, careful due diligence on the part of investment managers is essential.

Please contact George Michael Gerstein to discuss these matters or other due diligence issues related to governmental plans.

Cybersecurity and Related Legal Risks Come Home to ERISA Plans

George Michael Gerstein • June 14, 2021 June 14, 2021 • Risk & Reward • Tags: DOL, ERISA, Fiduciary Duties

ERISA-covered plans have entered the digital world. As the amount of confidential information about plan participants that is stored in multiple information systems, and shared among plan service providers, increases, so, too, do the legal risks. The U.S. Department of Labor (DOL) has now made cybersecurity risk an enforcement priority; the courts have started to wrestle with whether participant data is a “plan asset.” Plan sponsors and service providers should brace themselves.

Just this past February, the U.S. Government Accountability Office (GAO) issued a report that highlighted the practice of, and risks related to, sharing personally identifiable information (e.g., a participant’s social security number, date of birth and username/password) (PII), and “plan asset data” (e.g., retirement account and bank account numbers) within the plan ecosystem. The plan sponsor’s own IT infrastructure may be vulnerable to attack or misuse. Where the plan sponsor outsources plan administrative responsibilities to a service provider, such as recordkeepers, third-party administrators and custodians, participant PII and plan asset data could be exploited if the service provider is hacked or lacks appropriate internal controls.

The report specifically noted that cybersecurity risk comes in many different flavors and from many different sources. The risk could, for example, be in the form of malware, ransomware, privilege abuse, data exfiltration and account takeover. The source of the risk could come from criminal syndicates, hackers and even an organization’s own employees.

Thus, the GAO report warned, “[t]he sharing and storing of this information can lead to significant cybersecurity risks for plan sponsors and their service providers, as well as plan participants.” Poor risk controls can lead to the leaking of usernames, passwords and social security numbers, which can lead to the unauthorized access of participant accounts, and, fatally, the illicit draining of a participant’s retirement savings. The misappropriation of participant PII or plan assets by virtue of a cybersecurity attack may not be expressly addressed in ERISA, but its effect on a participant may indeed result in “the great personal tragedy” Congress sought to prevent in enacting ERISA.¹

The GAO ultimately made two recommendations: (1) the DOL should formally state whether cybersecurity for ERISA-covered retirement plans is a plan fiduciary responsibility under ERISA; and (2) the DOL should develop and issue guidance that identifies minimum expectations for mitigating cybersecurity risks to plans and the relevant service providers.

A mere two months later, the DOL issued a series of cybersecurity tips and best practices for plan sponsors, service providers and participants. Specifically:

Tips for Hiring a Service Provider, to “[h]elp[] plan sponsors and fiduciaries prudently select a service provider with strong cybersecurity practices and monitor their activities, as ERISA requires.”
Cybersecurity Program Best Practices, to “[a]ssist[] plan fiduciaries and recordkeepers in their responsibilities to manage cybersecurity risks.”
Online Security Tips, to “[o]ffer[] plan participants and beneficiaries who check their retirement accounts online basic rules to reduce the risk of fraud and loss.”

Useful as the tips and practices may be, the big reveal is that the DOL indicated that ERISA’s duty of prudence encompasses “an obligation to ensure proper mitigation of cybersecurity risks.” This means that a responsible plan fiduciary, when determining whether to hire and retain a service provider, should consider the service provider’s cybersecurity risk controls, and should document such consideration as part of its overall evaluation of the service provider.

The upshot of the DOL’s April 2021 cybersecurity tips and best practices is that it puts employers on notice that both the DOL takes this seriously and that plaintiffs could attempt to use this new guidance as a basis for fiduciary duty breach claims. Moreover, service providers can expect detailed questions on cybersecurity in RFPs and RFIs. Plan sponsors will seek more transparency, whereas service providers may be reluctant to divulge too much on their cybersecurity defenses to guard against inadvertently offering up the keys to the castle. The balance of the two will become market practice.

The DOL is ramping up enforcement in this area. Plan sponsors should also gird for class-action lawsuits with allegations of breaches of ERISA’s duty of prudence when participant PII or plan asset data is misused. For these reasons, employers and plan service providers should carefully consider the DOL guidance.

A related string of litigation also poses a risk to plan sponsors and service providers. These suits argue that participant PII and plan asset data constitute “plan assets,” and that using such data for marketing purposes amounts to a breach of fiduciary duties. Some of these suits have targeted both the plan’s sponsor and recordkeeper. So far, the courts have rejected these claims.

In one case,² plaintiffs brought an action against the plan sponsor and recordkeeper alleging that participant data (e.g., names, contact info, investment history, etc.) constituted “plan assets,” and, therefore, the recordkeeper’s purported sharing of this information with affiliates to cross-sell non-plan retail financial products to participants amounted to violations of ERISA. In granting the recordkeeper’s motion to dismiss, the court ruled that “participant data does not meet the statutory definition of ‘plan assets’….”

In a similar case,³ plaintiffs brought suit against the plan administrator alleging, inter alia, breach of fiduciary duty over the plan’s recordkeeper access to participant information (e.g., investment choice, account size, etc.) and use of that data to market products to the participants. In granting the motion to dismiss, the court stated, “[p]laintiffs cite no case in which a court has held that such information is a plan asset for purposes of ERISA….[t]his Court does not intend to be the first.” Moreover, the court rejected the argument that “releasing confidential information or allowing someone to use confidential information constitutes a breach of fiduciary duty under ERISA.”

Cybersecurity is quickly becoming an important risk area for ERISA plan sponsors. Protection of participant PII and plan asset data against privilege abuse, account takeovers and other vulnerabilities to a participant’s information and account raises the specter for DOL enforcement action and litigation. Service providers should anticipate a greater focus on their cybersecurity measures by plan sponsors and expect that such measures could be an important basis to be hired and retained as a plan service provider. Both employers and plan service providers should also consider whether it is complying with other applicable privacy laws (to the extent such laws are not preempted by ERISA).

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¹ Nachman Corp. v. PBGC, 446 U.S. 359, 374, 100 S. Ct. 1723, 1733, 64 L. Ed. 2d 354, 366 (1980).
² Harmon v. Shell Oil Co., No. 3:20-cv-00021, 2021 BL 126207 (S.D. Tex. Mar. 30, 2021).
³ Divane v. Northwestern Univ., No. 16 C 8157, 2018 BL 186065 (N.D. Ill. May 25, 2018), aff’d, 953 F.3d 980 (7th Cir. 2020).

Significant ESG Movement on the ERISA Front

George Michael Gerstein • May 24, 2021 May 24, 2021 • Risk & Reward • Tags: DOL, ERISA, ESG

Legislation is afoot that would amend ERISA to expressly permit fiduciaries to account for environmental, social and governance (ESG) factors as part of their fiduciary duties. The proposed legislation, the Financial Factors in Selecting Retirement Plan Investments Act, was introduced by Senator Tina Smith (D-MN). It expressly permits, but does not compel, fiduciaries to “consider” ESG and similar factors when selecting investments or strategies on behalf of an ERISA-covered retirement plan. The legislation also permits fiduciaries to consider “collateral” factors “as tie-breakers when competing investments can reasonably be expected to serve the plan’s economic interest equally well with respect to expected return and risk over the appropriate time horizon.” Under either scenario, the fiduciary need not “maintain any greater documentation, substantiation, or other justification” when considering the ESG or similar factors. Notably, the bill provides that an investment selected based on ESG or similar factors (including such factors used as a tie-breaker) may be a permissible default investment option (a “qualified default investment alternative” (QDIA)) for a plan that uses a default investment option as part of its menu. Lastly, the US Department of Labor’s (DOL) 2020 Financial Factors rule would cease to have force or effect upon the enactment of the legislation.

Meanwhile, President Joe Biden just issued an Executive Order on Climate-Related Financial Risk, in which he directed the DOL to consider proposing by September 2021 a rule that would suspend, revise or rescind the Financial Factors and proxy voting rules promulgated under the Trump Administration. The Executive Order further directed the DOL to consider taking any other action under ERISA “to protect the life savings and pensions of United States workers and families from the threats of climate-related financial risk.”

Should the legislation pass, it could provide fiduciaries limited additional comfort that the incorporation of ESG factors in their investment decision-making complies with ERISA’s fiduciary duties. The trend is toward incorporating ESG factors into an investment process for their effect on investment performance, and existing guidance, including the Financial Factors rule, should already provide fiduciaries enough of a roadmap to do so in accordance with ERISA. The legislation also seeks to dial back the documentation requirements of the Financial Factors rule, which may indeed ease some of the angst over foot faults and the resulting liability exposure. Though the DOL removed all references to “ESG” in the final Financial Factors rule, some argued the rule’s aggressive proposal, coupled with the Trump Administration’s overall stance on climate change, was designed to curb ERISA fiduciaries’ appetite for ESG. Yet, carefully documenting important decisions is already a well-established requirement and technique used by fiduciaries to mitigate their fiduciary duty risk.

It is a big deal that, with a rescission of the Financial Factors rule, fiduciaries would seemingly no longer have to comb through a fund’s prospectus and marketing materials for references to non-pecuniary factors, nor would the fiduciary need to scrutinize a fund manager’s use of screens or ratings. These requirements obviously present legal risk to a fiduciary and, therefore, may deter some fiduciaries from considering ESG products. But they also may serve as useful guideposts for fiduciaries trying to avoid selecting a greenwashed fund. An unintended consequence of the legislation could be that stripping out specific actions a fiduciary must take to navigate the intricate ESG landscape perhaps deters more plan sponsors from adding ESG to their plans than if the guideposts (and associated legal risks) remained.

It is also a big deal that the proposed legislation would allow a fund, which incorporates ESG factors for non-investment performance reasons, to serve as QDIA. The Financial Factors rule outright prohibited such a result. This change will likely give some plan sponsors comfort in selecting an ESG-themed QDIA that does not base ESG decisions on risk and return criteria, for example. However, the zealous litigation routinely brought against defined contribution plan sponsors over the selection of investment options has largely resulted in playing it safe. Plan sponsors know they will be second-guessed. This change, therefore, is unlikely to dramatically increase the adoption of ESG by ERISA plans, which continue to lag other institutional investors on that score.

The Executive Order is worth watching. The DOL may opt to impose affirmative obligations on fiduciaries to mitigate climate change risk to the plan. The imposition of any such obligation will likely be litigated.

In sum, ESG is and will remain entirely relevant to ERISA fiduciaries. Under ERISA and existing guidance, fiduciaries may take ESG factors into account when investing plan assets or selecting investment options for a plan lineup. With ESG top of mind for the current Congress and White House, ERISA fiduciaries should continue to evaluate whether taking ESG into account is prudent under the circumstances.

Springtime DOL Updates

Fiduciary Governance Blog • May 5, 2021 May 5, 2021 • Risk & Reward • Tags: DOL, ERISA

By George Michael Gerstein and John “JJ” Dikmak Jr.

As we await even more fiduciary-related rules and guidance from the U.S. Department of Labor (DOL) over the coming months, we take stock of some lower-profile spring updates worth noting. We begin with the DOL’s recent cybersecurity guidance, the first of its kind, as cybersecurity becomes an increasingly important issue for plan sponsors and service providers. We conclude with some new DOL guidance related to locating missing plan participants.

Cybersecurity

On April 14, the DOL released a batch of guidance that attempts to clarify best practices for maintaining cybersecurity. The first of the guidance, aimed at plan sponsors and other fiduciaries, offers tips for hiring third-party service providers and ensuring they maintain strong cybersecurity practices. The second batch of guidance offers cybersecurity best practices for plan recordkeepers and plan fiduciaries. A final release offered tips for plan participants who access their account information online but will not be discussed here. These are the first cybersecurity guidance provided by the DOL.

The following tips offered by the DOL are designed to help fiduciaries meet their obligations under ERISA in prudently selecting and monitoring service providers:

Ask about the service provider’s information security standards, practices, policies, and audit results and compare them to industry standards.
Ask the service provider how it validates its practices and what levels of security standards it has met and implemented. Consider looking at contract provisions that confer rights to review audit results demonstrating compliance with the standards.
Evaluate the track record of the service provider, including litigation brought against the service provider.
Ask if the service provider has experienced security breaches and, if so, what happened, how the provider responded, and how it was resolved.
Inquire if the service provider has insurance that would cover losses caused by cybersecurity and identity theft breaches.
Include ongoing compliance with cybersecurity and information security standards as a part of the service provider’s contractual commitments. If possible, include terms that will enhance these protections, such as:

a. Require the service provider to obtain an annual audit from a third-party to evaluate the service provider’s compliance with information security policies and procedures.

b. Clearly stated provisions outlining the service provider’s obligations and restrictions on the use and sharing of information.

c. Require notification of any cybersecurity breaches.

d. Specific requirement to meet all federal, state and local laws, regulations, directives and requirements related to record retention, destruction, privacy, and security.

e. Required insurance to cover losses related to cybersecurity losses. This may include professional liability, errors and omissions liability, cyber liability, and/or privacy breach insurance.

In the second batch of guidance, the DOL offered best practices for plan recordkeepers and other service providers responsible for plan-related data. The list also includes the best practices for a plan fiduciary hiring one of these service providers. These best practices include:

Have a formal, well-documented cybersecurity program. DOL highlighted 18 specific areas an effective policy would cover, including data governance and classification, access controls and identity management, business continuity and disaster recovery, configuration management, asset management, and risk assessment.
Conduct prudent annual risk assessments. The scope, methodology, and frequency of assessments should be codified.
Have a reliable annual third-party audit of security controls.
Clearly define and assign information security roles and responsibilities. This includes clearly defining the roles of upper management, especially the Chief Information Security Officer (CISO).
Have strong access control procedures which cover both authentication and authorization.
Ensure that any assets or data stored in a cloud or managed by a third-party service provider are subject to appropriate security reviews and independent security assessments.
Perform cybersecurity awareness training at least annually.
Implement and manage a secure system development life cycle (SDLC) program.
Have an effective business resiliency program addressing business continuity, disaster recovery, and incident response.
Encrypt sensitive data, stored and in transit.
Implement strong technical controls in accordance with best security practices.
Appropriately respond to any past cybersecurity incidents. This would include notifying law enforcement, informing insurers, investigations, providing plan participants with information to assist in preventing or reducing their loss, honoring contractual terms, such as notification requirements, and fixing the problems which caused the breach.

Missing Participants

Earlier this year, the DOL provided a set of best practices for fiduciaries of defined benefit and defined contribution plans to locate missing participants and beneficiaries. Some “red flags” that a plan’s current approach may be insufficient for locating a missing or non-responsive participant include a large number of missing or non-responsive participants; missing, incomplete or inaccurate contact and other pertinent information (email, social security numbers, addresses, etc.), and the absence of adequate policies and procedures for handling returned mail marked “return to sender,” “wrong address” and the like.

The DOL’s list of best practices (copied below) are those that “have proven effective at minimizing and mitigating the problem of missing or non-responsive participants.” These practices are non-exhaustive, and some may be more appropriate for a particular plan than others. Ultimately, “[r]esponsible plan fiduciaries should consider what practices will yield the best results in a cost-effective manner for their plan’s particular participant population.”

1. Maintaining accurate census information for the plan’s participant population

Contacting participants, both current and retired, and beneficiaries on a periodic basis to confirm or update their contact information. Relevant contact information could include home and business addresses, telephone numbers (including cell phone numbers), social media contact information, and next of kin/emergency contact information. Well-run plans regularly reconfirm that the information in their possession is accurate.
Including contact information change requests in plan communications along with a reminder to advise the plan of any changes in contact information.
Flagging undeliverable mail/email and uncashed checks for follow-up.
Maintaining and monitoring an online platform for the plan that participants can use to update contact information for themselves and their spouses/beneficiaries, if any, and incorporating such updates into the plan’s census information.
Providing prompts for participants and beneficiaries to confirm contact information upon login to online platforms.
Regularly requesting updates to contact information for beneficiaries, if any.
Regularly auditing census information and correcting data errors.
In the case of a change in record keepers or a business merger or acquisition by the plan sponsor, addressing the transfer of appropriate plan information (including participant and beneficiary contact information) and relevant employment records (e.g., next of kin information and emergency contacts). [DOL] has found that in the context of an acquisition, merger, or divestiture, well-run plans make missing participant searches of plan, related plan (e.g., health plan) and employer records (e.g., payroll records) part of the collection and transfer of records.

2. Implementing effective communication strategies

Using plain language and offering non-English language assistance when and where appropriate.
Stating upfront and prominently what the communication is about – e.g., eligibility to start payment of pension benefits, a request for updated contact information, etc.
Encouraging contact through plan/plan sponsor websites and toll-free numbers.
Building steps into the employer and plan onboarding and enrollment processes for new employees, and exit processes for separating or retiring employees, to confirm or update contact information, confirm information needed to determine when benefits are due and to correctly calculate the amount of benefits owed, and advise employees of the importance of ensuring that the plan has accurate contact information at all times.
Communicating information about how the plan can help eligible employees consolidate accounts from prior employer plans or rollover IRAs.
Clearly marking envelopes and correspondence with the original plan or sponsor name for participants who separated before the plan or sponsor name changed, for example, during a corporate merger, and indicating that the communication relates to pension benefit rights.

3. Missing participant searches

Checking related plan and employer records for participant, beneficiary and next of kin/emergency contact information. While the plan may not possess current contact information, it is possible that the employer’s payroll records or the records maintained by another of the employer’s plans, such as a group health plan, may have more up-to-date information. If there are privacy concerns, the person engaged in the search can request that the employer or other plan fiduciary forward a letter from the plan to the missing participant or beneficiary.
Checking with designated plan beneficiaries (e.g., spouse, children) and the employee’s emergency contacts (in the employer’s records) for updated contact information; if there are privacy concerns, asking the designated beneficiary or emergency contact to forward a letter to the missing participant or beneficiary.
Using free online search engines, public record databases (such as those for licenses, mortgages and real estate taxes), obituaries, and social media to locate individuals.
Using a commercial locator service, a credit-reporting agency, or a proprietary internet search tool to locate individuals.
Attempting contact via United States Postal Service (USPS) certified mail, or private delivery service with similar tracking features if less expensive than USPS certified mail, to the last known mailing address.
Attempting contact via other available means such as email addresses, telephone and text numbers, and social media.
If participants are non-responsive over a period of time, using death searches (e.g., Social Security Death Index) as a check and, to the extent such search confirms a participant’s death, redirecting communications to beneficiaries.
Reaching out to the colleagues of missing participants by, for example, contacting employees who worked in the same office (e.g., a small employer with one or two locations) or by publishing a list of “missing” participants on the company’s intranet, in email notices to existing employees, or in communications with other retirees who are already receiving benefits. Similarly, for unionized employees, some have reached out to the union’s local offices and through union member communications to find missing retirees.
Registering missing participants on public and private pension registries with privacy and cybersecurity protections (e.g., National Registry of Unclaimed Retirement Benefits), and publicizing the registry through emails, newsletters, and other communications to existing employees, union members, and retirees.
Searching regularly using some or all of the above steps.

4. Documenting procedures and actions

Reducing the plan’s policies and procedures to writing to ensure they are clear and result in consistent practices.
Documenting key decisions and the steps and actions taken to implement the policies.
For plans that use third party record keepers to maintain plan records and handle participant communications, ensuring the record keeper is performing agreed-upon services, and working with the record keeper to identify and correct shortcomings in the plan’s recordkeeping and communication practices, including establishing procedures for obtaining relevant information held by the employer.

DOL Issues Guidance on 2020 Investment Advice Exemption

Fiduciary Governance Blog • April 14, 2021 April 14, 2021 • Risk & Reward • Tags: DOL, Fiduciary Rule

By George Michael Gerstein and John “JJ” Dikmak Jr.

Just yesterday, the U.S. Department of Labor (“DOL”) released a set of Frequently Asked Questions (“FAQs”) designed to clarify certain aspects of Prohibited Transaction Exemption 2020-02, Improving Investment Advice for Workers & Retirees (PTE 2020-02). The exemption enables investment advice fiduciaries to ERISA plans and IRAs to receive a wide range of compensation (e.g., commissions, 12b-1 fees, revenue sharing, etc.) as a result of the advice without running afoul of the applicable prohibited transaction rules. As described by the DOL, “[t]he exemption offers a compliance option to investment advisers, broker-dealers, banks, and insurance companies (financial institutions) and their employees, agents, and representatives (investment professionals) that is broader and more flexible than pre-existing prohibited transaction exemptions.” We summarize some of the key takeaways from the FAQs below:

PTE 2020-02 is in effect (February 16, 2021). There was some confusion over this due to a memorandum from Ronald Klain, Chief of Staff to the President, regarding a regulatory freeze. The (new) DOL, however, was pleased enough with PTE 2020-02, a Trump-era rulemaking, that it waved it through. The transition period for parties to devise mechanisms to comply with the provisions in the exemption remains in place until December 20, 2021.
The DOL hinted at further sub-regulatory guidance and/or returning to the fiduciary investment advice regulation. No promises were made or timetables offered.
The DOL reiterated that a “single, discrete instance of advice to roll over assets from an employee benefit plan to an IRA” would generally not give rise to investment advice under ERISA. But, such communication could constitute investment advice if it were part of an ongoing relationship or the beginning of an intended future ongoing relationship that an individual has with the investment advice provider.
The DOL reminded the industry that boilerplate, fine print disclaimers that investment advice is not being provided generally won’t cut it. This echoes sentiment the DOL expressed in 2020. However, “[w]ritten statements disclaiming a “mutual” understanding or forbidding reliance on the advice as “a primary basis for investment decisions” may be considered in determining whether a mutual understanding exists, but such statements will not be determinative.” Ultimately, whether there is a “mutual” understanding that investment advice is being provided is based on the totality of the facts and circumstances.
The DOL reiterated that PTE 2020-02 provides relief for rollover recommendations that result in a prohibited transaction, so long as the exemption’s conditions are satisfied.
Investment professionals and financial institutions can provide investment advice, despite having a financial interest in the transaction, as long as the advice meets the best interest standard. Under this standard, the advice must be based on the interests of the customer, rather than the competing financial interest of the investment professional or financial institution. Investment professionals may receive payments for their advice within this framework.
Prior to engaging in a transaction under the exemption, a financial institution must give the retirement investor a written description of its material conflicts of interest arising out of the services and any investment recommendation. The disclosure should allow a reasonable person to assess the scope and severity of the financial institution’s and investment professional’s conflicts of interest. The DOL cautioned that the disclosure should be more than simply having the retirement investor “check the box” to confirm that they know of the conflicts.
Financial institutions and their investment professionals need to consider and document their analysis of why a rollover recommendation is in a retirement investor’s best interest. For recommendations to roll over assets from an employee benefit plan to an IRA, the DOL listed the following “relevant” non-exhaustive factors to consider: (1) the alternatives to a rollover, including leaving the money in the investor’s employer’s plan, if permitted; (2) the fees and expenses associated with both the plan and the IRA; (3) whether the employer pays for some or all of the plan’s administrative expenses; and (4) the different levels of services and investments available under the plan and the IRA. The DOL also elaborated on what other factors would be part of a prudent analysis.
The DOL reminded financial institutions that they “must take special care in developing and monitoring compensation systems to ensure that their investment professionals satisfy the fundamental obligation to provide advice that is in the retirement investor’s best interest.” With carefully considered compensation structures, financial institutions can avoid structures that a reasonable person would view as creating incentives for investment professionals to place their interests ahead of the interest of the retirement investor. Thus, quotas, bonuses, prizes and performance standards are likely out. On the flip side, a financial institution could provide level compensation for recommendations to invest in assets that fall within reasonably defined investment categories (e.g., mutual funds), and provide heightened supervision as between investment categories (e.g., between mutual funds and fixed annuities), to the extent that it is not possible for the institution to eliminate conflicts of interest between these categories. The DOL also reminded financial institutions that the exemption requires they address and mitigate firm-wide conflicts.
Unlike the 2016 rulemaking, PTE 2020-02 does not impose contract or warranty requirements on the financial institutions or investment professionals responsible for compliance. Nor does the exemption expand an investors’ ability to enforce their rights in court or create any new legal claims beyond those in Title I of ERISA and the Code.

Financial institutions seeking additional information about their obligations under PTE 2020-02 may consider our initial analysis on PTE 2020-02 and its related rulemaking.