Under the Employee Retirement Income Security Act (ERISA), being a fiduciary is, in part, about duties of prudence and loyalty, making sure you are acting solely in the best interest of your participants, and avoiding any conflicts of interest.
ERISA doesn’t tell plan sponsors the precise way to design their defined contribution (DC) plans for their participants, nor does it tell fiduciaries what products to select, which is a good thing because it allows for innovation. Rather, fiduciaries must adhere to a strong standard of care, meaning they follow prudent expert standards, ensure they follow a prudent process, and document the rationale for their decisions.
Reasonable fiduciaries may come to different conclusions on what products are prudent and will lead to better outcomes for their participants. But, as long as they follow the steps above, I’ve always been led to believe they should be in good standing. In my experience working with large plan sponsors, many are feeling that even after taking these steps they are facing a great deal of scrutiny and second-guessing in the court of public opinion and the courts through class action lawsuits, leading them to a reluctance to innovate. Recent regulatory action could be viewed as giving mixed signals in this regard.
A look at recent regulatory actions
On a positive note, the recent Department of Labor (DOL) information letter on the inclusion of private equity in target date funds gives plan fiduciaries the opportunity to take a more innovative approach. The information letter was not a safe harbor, nor was it a new regulation; the DOL merely stated its view that the inclusion of private equity is not inherently improper. The letter did provide some special considerations a plan sponsor should evaluate given the unique nature of this asset class. Whether it’s private equity, other alternative strategies or any investment strategy, a fiduciary should be able to go through a process and rely on their own expertise and the expertise of their advisors to evaluate whether they believe a strategy will benefit their participants.
On the other hand, the recent DOL proposed regulation around Environmental, Social and Governance (ESG) investments feels like it’s more restrictive. ESG investing is of continued interest for investors in the US and around the globe. It’s an evolving area with varying views, differing definitions, and new research coming out all the time. At PGIM, managers within our autonomous businesses have a variety of views on ESG investing. Some in the industry generally may invest in an ESG strategy purely for social reasons; however, doing so for an ERISA plan would be impermissible. But many believe it’s important to consider ESG factors when investing because doing so may result in better long-term performance. Again, as an evolving area, reasonable people can come to different conclusions. Yet, while the DOL doesn’t forbid ESG investing, the proposed regulations and pronouncements around it seem to be skeptical that this approach has investment merits. The proposed regulation would make it critically important for fiduciaries to follow a prescribed set of standards in order to be able to justify ESG investments. The open question is whether plan sponsors who believe in ESG investing will take the necessary steps or will, instead, forgo such investments out of fear of perceived fiduciary risk.
The DC world is most in need of more innovation when it comes to providing lifetime income solutions for participants. Yet, we’ve seen little action to date from employers given the ongoing concern from plan sponsors that inclusion of such innovative solutions may bring additional scrutiny of their fiduciary duties. The SECURE Act, which passed in December, was very helpful in that it provided a new safe harbor, portability, and disclosure provisions which are expected to expand participant access to lifetime income offerings. Yet, it’s discouraging that in today’s environment, unless there is an explicit safe harbor, plan sponsors may often hesitate to take an innovative approach. Regulations will always trail innovations and thus progress will continue to be limited unless sponsors feel empowered to try new things.
Employer-based retirement plans, often called Pillar 2, will be an extremely meaningful piece of retirement savings and key to overall financial wellness for millions of working Americans. Plan sponsors and fiduciaries should continue to be held to high fiduciary standards of loyalty and prudence when implementing these plans. But, if we want them to continue to play this role and be responsive to the needs of their workforce, whether in terms of benefit or investment offerings, we need a statutory and regulatory system that encourages innovation and well-researched ideas to flourish, not one that constrains and dictates, or incurs unnecessary litigation risk. Otherwise, the government should just tell sponsors exactly what type of plan they should implement. But I don’t think we want to live in that world.
This material reflects the opinions of the author as of 7/24/2020 and has been provided for informational or educational purposes only. This material is not intended as investment advice and is not a recommendation about managing or investing your retirement savings. In providing this information, PGIM, Inc. and its affiliates are not acting as your fiduciary.