In my last post, Alternative Assets (1), I said that a surprise in the DOL’s proposed regulation on selecting investments was that it went beyond alternative assets and asset allocation investments, which were the focus of last August’s Executive Order, and instead applied to all investments in participant-directed plans—both traditional and alternative.
There were other surprises in the proposed regulation. For example, the proposal says:
(c) Prudent fiduciaries have maximum discretion to select investments to further the purposes of the plan. Section 404(a)(1)(B) of ERISA does not require or restrict any specific type of designated investment alternative, except insofar as designated investment alternative might be otherwise illegal. For example, there is no per se rule respecting investment in alternative assets generally or the inclusion of private market investments, ….
Comment: The concept of government neutrality on the types of investments for ERISA-governed retirement plans is not the surprise. The surprise is the wording of “maximum discretion”. I know what it means conversationally and I think I know the message the DOL is trying to convey, but as a lawyer, I’m not sure how it applies because it’s not defined in ERISA or in the proposed regulation. For example, does a fiduciary need to consider the needs and circumstances of the covered participants—such that fiduciary responsibility limits the application of the discretion? I would think so and, if so, it would be helpful to have guidance to that effect.
The discussion in the proposal’s preamble goes a little further, but doesn’t really answer the question of how fiduciaries should prudently exercise that discretion:
4.2. Fiduciaries Have Maximum Discretion to Select Investments to Further the Purposes of the Plan— Proposed Paragraph (c)
Paragraph (c) of the proposed regulation addresses the question of whether any designated investment alternative is per se prudent or imprudent under section 404(a)(1)(B) of ERISA. The text of section 404(a)(1)(B) of ERISA is plainly neutral to types or classes of designated investment alternatives that a fiduciary selects for the plan menu, so long as the fiduciary’s selection process adheres to section 404(a)(1)(B)’s articulated standard of care. Thus, plan fiduciaries have maximum discretion to select investments to further the purposes of the plan. Paragraph (c) of the proposed regulation adopts this foundational principle, providing, in relevant part, that section 404(a)(1)(B) of ERISA ‘‘does not require or restrict any specific type of designated investment alternative.’’ However, the investment discretion ERISA confers on plan fiduciaries is not a license to ignore other applicable laws. Paragraph (c) of the proposed regulation reflects this basic principle by clarifying that maximum discretion notwithstanding, a plan fiduciary is prohibited from selecting a designated investment alternative that is otherwise illegal. For example, as paragraph (c) of the proposed regulation clarifies, an investment in a foreign adversary which violates the Specially Designated Nationals and Blocked Persons List administered by the Office of Foreign Assets Control of the United States Department of the Treasury is not permitted. [Footnotes and citations omitted]
Comment: As with the proposed rule, the preamble uses the unfortunate (in my opinion) word “maximum”. I believe the Department’s intent is to, first, emphasize that ERISA is neutral in it’s approach to investments in retirement plans. But that doesn’t mean that there aren’t any rules. In effect, it means that investment decision-making is not up to the government, but instead is a private sector responsibility for plan fiduciaries (and subject to ERISA’s fiduciary standards). In that sense, if the fiduciaries make imprudent decisions in selecting the investment types, they could be subject to personal liability for fiduciary breach. It would be helpful to know the Department’s views on fiduciary responsibility for selecting investment types. For example, must fiduciaries consider the needs and circumstances of the workforce covered by the plan? Must fiduciaries consider the investment knowledge and experience of the covered workforce? As a best practice, that would be the case, but is it the law?
My view of the DOL’s second intent is that it wants to limit the ability of courts to review the decisions made by fiduciaries in selecting the types of investments chosen by fiduciaries. For example, if fiduciaries determine that hard-to-understand investments are appropriate for their plans, a “maximum discretion” standard would make it hard to challenge that decision. In that regard, it would be helpful for the DOL to provide additional guidance on (1) the limits on “maximum discretion” above and beyond illegal investments and (2) the factors that fiduciaries should evaluate when considering the types of investments that are prudent to offer to participants (for example, are they appropriate for the demographics of the covered workforce?).
The Department’s emphasis on investment neutrality is significant and, in my opinion, correct. However, it doesn’t mean that just because fiduciaries can theoretically do anything that it is prudent to do everything.
Concluding thoughts
The provisions discussed in this article and my first one are “big picture” guidance. My next article will be about the DOL’s position that setting the menu of investments is a fiduciary activity—which makes sense. And it may at least partially answer my questions in this article about limits on the ability of fiduciaries to select types of investments that are not appropriate for the covered workforce. Then, I will get into the weeds of the DOL’s expectations for the factors and processes for selecting any and all investments for participant-directed plans. That includes both alternative assets (such as private funds) and traditional investments (such as mutual funds).
