“Alternative Investments” in Retirement Plans
Recently, investors are showing an increasing appetite for risk. To this end, more investors are now moving away from the public markets into alternative investments such as private equity, corporate loans and real estate. This includes retirement plans where there is growing interest in “alternative investments.”
The Department of Labor takes a 180 Degree Turn on ESG Investing
- Proposed regulations published in December allow plan fiduciaries, when evaluating investments, to consider climate change and other environmental, social and governance (ESG) issues as risk factors affecting workers' financial security.
- At the very end of the Trump administration, the Department issued final regulations on ESG investing. Practically speaking, these regulations made it difficult for plan fiduciaries to add ESG options. Nonfinancial factors such as climate change and racial diversity could only be considered as a tie breaker. In March of 2021, the Biden aministration announced that it would walk back these rules.
- The Department has gone back and forth for many years on its position regarding ESG investing. Democrats endorse the concept while Republicans are more skeptical. The fact that the latest proposed regulations are such a radical departure from the Trump rules suggests that this back and forth will only continue.
- These proposed regulations seem go beyond just permitting consideration of ESG factors. Comments from administrative officials accompanying the publication of these regulations indicate that the current thinking of the Department is that ESG factors, and climate change issues in particular, pose financial risks that plan sponsors should consider as prudent fiduciaries in evaluating investments.
- Significantly, the proposed regulations would permit the use of ESG investments as the qualified default investment alternative (“QDIA”).
- Over 200 comments have been submitted regarding these proposed regulations. The majority are favorable. However, some comments express concern that these proposed regulations may be interpreted as not only permitting but requiring plan fiduciaries to consider ESG factors in making prudent investment decisions.
- The Securities and Exchange Commission has not issued any rules regarding ESG investments and comments from the Commissioner indicate there are no plans to do so.
- When voting proxies, the proposed regulations also make it clear that, in contrast to the Trump rules, plan fiduciaries may take into consideration climate change, environmental and social concerns.
- Two things to ponder. Promulgating a regulation that contains specific criteria for evaluating investments is unprecedented. While the Securities & Exchange Commission and other financial regulators have promulgated many rules over the years, there are none that establish specific criteria that must be applied to evaluate a particular investment. Also, one has to wonder how Department officials think they are helping plan fiduciaries with the never-ending back and forth on ESG investing.
Department of Labor Issues Cautionary Letter Clarifying It Does Not View Private Equity as Appropriate for Most Defined Contribution Plans
- During the Trump administration in 2020, the Department of Labor issued an information letter stating that alternative investments can be added to defined contribution plans without violating ERISA’s fiduciary standards.
- This letter did not endorse adding private equity directly to an investment lineup. Rather, the letter stated it may be appropriate for defined contribution plans to include private equity indirectly through a target date, target risk or a balanced fund.
- In December, the Department issued a follow-up letter clarifying the 2020 letter. This letter was issued because the Department is concerned that the original letter has been used as a marketing tool and has been interpreted as a broad endorsement of alternative investments in defined contribution plans.
- In this letter, the Department states that the original 2020 letter was directed only to large plan sponsors that have both a defined benefit and a defined contribution plan where the plan fiduciaries have experience evaluating private equity. The letter further states that the Department does not believe alternative investments are appropriate for the majority of defined contribution plans.
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This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation.