On April 4, the U.S. Department of Labor (DOL) released guidance and updated model notices for annual funding notices (AFNs) required under ERISA. This update comes just weeks before the April 30, 2025 deadline for many defined benefit plans and places plan sponsors in a time crunch. 

While the DOL acknowledges the late timing of this guidance, and that plan sponsors may have already prepared AFNs for the 2024 plan year, it has not granted any grace period or extension. Plan sponsors are expected to make a good faith effort to comply with the new requirements.

What plan sponsors need to do now:

To stay compliant with the latest DOL rules, plan sponsors should take the following steps:

1. Check with your service providers to ensure your AFN complies with the new model notice. Note: Use of the DOL’s model notice is not mandatory, but your AFN must include all required disclosures.
2. Send the updated 2024 AFNs to participants by the deadline:
   • April 30, 2025, for most plans
   • Sept. 15, 2025, for small plans (fewer than 100 participants)

Access the new guidance and model notices here:

• DOL Field Assistance Bulletin No. 2025-02
• Single-Employer Plan Model Notice

If you have any questions about the new DOL annual funding notice requirements or would like assistance reviewing your 2024 AFN, our employee benefits and ERISA compliance team is here to help.

Managing the complexities of employee benefit plans can raise questions you might hesitate to ask—whether they feel too basic or you’re unsure where to begin. In this series, “Employee benefit questions you didn’t want to ask (but should),” we tackle some of the most common questions about employee benefits to help you navigate the details with confidence. Whether it’s understanding plan documents, clarifying key terms or addressing compliance issues, we’re here to provide the answers you need.

Q: Are summary plan descriptions (SPDs) supposed to be easy to read?

A: Sort of.

An example might be helpful here. We can generally agree that furniture assembly instructions are typically designed to ensure that users can successfully assemble the furniture. However, some instructions are more user-friendly, while others are… not. While the first set of instructions is easier to understand, both sets are acceptable if they are written clearly enough for an average employee to assemble the furniture.

The same is true for an SPD. The official rule is that it must be “written in a manner calculated to be understood by the average plan participant.” It’s important to assess the education and comprehension level of your workforce and compare them to the complexity of your plan’s terms. Is your SPD written clearly enough to help your workforce understand the plan?

• Did you remove technical jargon that might be difficult to understand?
• Did you break long, complex sentences into shorter, more manageable ones?
• Did you provide plenty of examples to explain difficult topics?

In theory, if the SPD is written with these factors in mind, a typical participant should be able to understand it.

Before you start asking your employees if they understand the SPD, remember that the rule does not require every single participant to understand every single detail. It simply requires that the SPD be written in a way that helps a typical employee understand the plan.

For decades, the ESOP community has asked the Department of Labor (DOL) to provide regulations regarding “adequate consideration.” The desired regulations would provide needed guidance to trustees and other fiduciaries on how to ensure that ESOP transaction terms are fair to participants, and that the price paid for company stock does not exceed fair market value.

A brief history of DOL regulations on ESOPs

The DOL previously proposed adequate consideration regulations in 1988 but withdrew them after receiving comments that the proposed regulations would not be workable. Since then, particularly since a 2005 enforcement initiative, rather than proposing new regulations, the DOL has investigated newly formed ESOPs and taken legal action against many of them. Many of these cases have settled, and the DOL has pointed to the terms of these settlement agreements as reflecting the DOL’s view on how ESOP transactions should be conducted. 

Challenges faced by the ESOP community

This type of regulation by litigation has created administrative complexities for ESOP transactions. The ESOP community has largely worked through these challenges, but continues to want a more formal set of guidance for parties looking to form ESOPs. Congress responded to this concern when it passed SECURE 2.0 in 2022 and included a directive to the DOL to issue formal guidance on the matter. 

Recent developments and withdrawn proposals

The ESOP community was hopeful at the prospect of finally getting clear, fair, and reliable standards regarding adequate consideration. Instead, history repeated itself (or if it didn’t repeat, it rhymed). Although the DOL proposed regulations, they were quickly withdrawn due to an executive order from President Trump as the DOL had not published the proposed regulations in the Federal Register. 

However, withdrawing the proposed regulations is probably for the best since there were some unexpected surprises (to say the least) in the proposed regulations. This resulting break in the action gives all sides much needed time to catch their collective breath and come up with a new workable set of guidelines.

The future outlook for ESOP regulations + advice for business owners

In the meantime, the ESOP community will continue to follow the best practices that have developed from the DOL settlement agreements, court decisions, comparable tax regulations and standards from the valuation community over the past fifty years since ERISA’s enactment.

Business owners looking for an exit or succession planning strategy should talk with experienced counsel who can help them decide if an ESOP is the right fit, and if so, to guide them through a transaction.

Managing the complexities of employee benefit plans can raise questions you might hesitate to ask—whether they feel too basic or you’re unsure where to begin. In this series, “Employee benefit questions you didn’t want to ask (but should),” we tackle some of the most common questions about employee benefits to help you navigate the details with confidence. Whether it’s understanding plan documents, clarifying key terms or addressing compliance issues, we’re here to provide the answers you need.

Q: I asked my service provider for my plan document and they gave me something called a “summary plan description.” Is this my plan document?

A: No, that summary plan description is not your plan document. This happens a lot; go back to your service provider and tell them you want your plan document, not your SPD (what most HR people call the summary plan description). It may help to ask them for your adoption agreement and the matching basic plan document.

An SPD is a summary of the plan document. It’s supposed to be an easy to understand explanation of your retirement plan for your employees. Usually, an SPD is 10 to 30 pages long, which is a lot shorter than the 100 plus pages of most plan documents. Since you should have a copy of this document now, store it somewhere safe for your records. 

Managing the complexities of employee benefit plans can raise questions you might hesitate to ask—whether they feel too basic or you’re unsure where to begin. In this series, “Employee benefit questions you didn’t want to ask (but should),” we tackle some of the most common questions about employee benefits to help you navigate the details with confidence. Whether it’s understanding plan documents, clarifying key terms or addressing compliance issues, we’re here to provide the answers you need.

Q: What is a plan document? And do I need it?

A: A plan document is the official, legally binding document that contains all of a retirement plan’s rules. And, YES, you do need it and not just because the IRS and DOL say you do.  

A clear and well-structured plan document can act as a guide for plan operations. When is the new employee eligible to participate in the plan? Do we “match” employee contributions? When can employees take money from the plan? The plan document answers all of these questions and more. 

Even if your service provider handles most of the day-to-day operations of your plan, you should still have a copy of your plan document for your records. It may be a single document, or a combination of documents, such as an “adoption agreement,” plus a “basic plan document.” If you can’t find a copy of your plan document, ask your service provider for a copy and store it somewhere safe.

It has been a busy end of 2023 and first quarter of 2024 for the Internal Revenue Service and Department of Labor when it comes to implementing qualified plan regulatory guidance. You may have heard of some or more of these changes, many of which come from the SECURE Act and more recent SECURE 2.0. Although none of these items require plan document amendments this year, many administrative changes have become effective. ESOP plan sponsors should consult with their third-party administrators and legal counsel to make sure that their plans are being administered properly and to consider whether plan amendments are appropriate now to conform documents to administration. The key changes that may require action are summarized below.

Increased required minimum distribution age

Historically, participants were required to begin taking minimum distributions from qualified plans by April 1st of the calendar year after the calendar year in which the participant attained age 70 ½. Now, however, the required beginning date is April 1st of the calendar year after the year that the participant attains:

• Age 70 ½ if born before July 1, 1949
• Age 72 if born before Jan. 1, 1951
• Age 73 if born on or after Jan. 1, 1951

Further, in 2033, the required minimum distribution age is scheduled to increase to age 75. A draft technical correction bill would require those born in 1959 to be subject to RMD at age 73.

Forfeitures

Forfeitures represent amounts that did not vest, and so are not distributed to participants. The IRS recently issued proposed regulations that would require a plan to use forfeitures no later than 12 months after the end of the plan year in which they are incurred. A transition rule provides that any forfeiture incurred before Jan. 1, 2024, will be treated as if it were first incurred in the first plan year that begins on or after Jan. 1, 2024.

Plan sponsors need to consider the priority of uses for forfeitures. The preamble to the IRS regulations suggests that if the plan allows only a single use for forfeitures could create an operational failure if that single use does not use all forfeitures by the 12-month deadline. Additionally, recent litigation alleges that forfeitures should be used first to reduce plan expenses before reducing employer contributions. Although many commentators do not consider plan design regarding forfeitures to be a fiduciary function, the outcomes of these cases are yet to be determined.

Lost participants

The DOL will require employers to annually identify and report lost or missing participants who are entitled to a distribution. Much of the reportable information is what must already be reported on Form 8955-SSA. However, additional information regarding mandatory rollovers and purchases of deferred annuity contracts will also be required. The DOL has not yet released information yet on how to make these reports or when they will be due.
The reported information will be used to maintain a lost and found database for retirement benefits that participants will be able to search to determine if they have unclaimed retirement plan distributions. This reporting requirement does not relieve plan sponsors of having to locate missing participants. So plan sponsors will need to continue to make reasonable efforts to locate missing participants.

Long-term part-time employees (401(k) plans)

This item affects 401(k) plans, but we wanted to call attention to this item because most ESOP-sponsors also sponsor 401(k) plans. If you sponsor a 401(k) plan, remember that employees who have performed at least 500 hours of service for three consecutive years must be eligible to make elective deferrals. This three-year period is reduced to two years effective Jan. 1, 2025. Such an employee could receive a year of service for vesting by completing only 500 hours of service under this rule. That would represent a change in how vesting service typically is calculated.

Amendment deadlines

The changes described above represent significant changes. Amendments for these items generally will not be required in 2024. Deadlines for some items generally will be Dec. 31, 2025, and for others, Dec. 31, 2026. Because some of these changes are effective now, plan sponsors should consider whether to amend their plans now to conform the document to administration. We recommend that you work closely with your TPA and counsel to be sure your plans can be administered properly.

Effective Jan. 1, 2024, employers who sponsor 401(k) plans must allow employees who work at least 500 hours a year over a period of consecutive years (“long-term part-time” or “LTPT employees”) to be eligible to make deferrals into the plan. This change requires immediate action by plan sponsors to change the way they administer their plans — specifically, counting service hours and increasing eligibility for LTPT employees.

Plan sponsor considerations for long-term part-time employees

Our Employee Benefits team recommends that plan sponsors reach out to counsel and their plan administrators and recordkeepers to help ensure compliance. The main considerations for plan sponsors include the following:

1.  Plan administration changes are required now — but plan amendments can wait. Plan sponsors must begin to administer 401(k) plans in compliance with these new requirements starting with plan years beginning on or after Jan. 1, 2024. Written plan amendments are not due until the end of the 2025 plan year. In addition, while we expect the IRS to issue more guidance, it recently issued proposed regulations that provide guidance to plan sponsors on how to administer the requirements. The IRS has said that employers may rely on the proposed regulations to satisfy their compliance requirements until final regulations are published. The proposed regulations contain many nuances that are not always intuitive. 

2.  How to identify LTPT employees. LTPT employees are those who are at least age 21 and have completed at least 3 consecutive years of service in which they have worked at least 500 hours. Plan years that start before Jan. 1, 2021, are disregarded when determining who counts as an LTPT employee, which means that the first LTPT employees will be able to make elective deferrals starting with plan years that begin on and after Jan. 1, 2024. Effective for plan years that begin Jan. 1, 2025, the 500 hours of service requirement drops to 2 consecutive years.

Compliance note: Ideally, third party administrators worked with plan sponsors starting back in 2021 to track hours for employees and adjust their administrative systems. If not, plan sponsors may need to dig into historical payroll records back to Jan. 1, 2021 to make these important LTPT employee eligibility determinations. Plan sponsors should review their employee census data to make sure they are identifying LTPT employees and providing proper communications about elective deferrals to the employees, plan administrators, and payroll staff beginning Jan. 1, 2024. 

3.  Catch-up and Roth deferrals. Interestingly, there is not a requirement to offer LTPT employees the ability to make catch-up contributions or Roth elective deferrals. For the sake of administrative simplicity, plan sponsors choose to allow all eligible participants, including LTPT employees, to be able to make these type of contributions.

4.  No requirement to provide LTPT employees with employer contributions. Employers are permitted to make matching or employer contributions on behalf of LTPT employees, but they are not required to do so. The LTPT participation requirement relates only to elective deferrals.  Further, safe harbor plans are permitted to exclude LTPT employees from the right to receive safe harbor contributions and have the plan still maintain safe harbor status. Similarly, although LTPT employees are counted when calculating a plan’s top heavy ratio, a plan is permitted to exclude them from receiving top heavy minimum contributions.

By Jan. 1, 2024, plan sponsors should definitely determine their method of plan administration either to exclude LTPT employees from receiving these contributions or to include them.  Employers also should review their summary plan descriptions and other communication materials to participants to ensure they are consistent with their plan administration. 

5.  Special vesting rules for employer contributions allocated to LTPT employees. LTPT employees are always fully vested in their elective deferrals. If an employer chooses to provide employer contributions to LTPT employees as discussed above, special nuanced vesting service-crediting rules may apply. 

First, plan years before Jan. 1, 2021, can be disregarded for vesting purposes. Second, a year of service for LTPT employees for vesting purposes can be limited to years in which LTPT employees complete at least 500 hours of service. If an employee first becomes a participant in the plan as an LTPT employee, the regulations suggest that employee will forever earn a year of service for vesting after completing 500 hours of service in a plan year, even if the employee later qualifies for participation as a traditional full-time employee (e.g., by completing 1,000 hours of service). Such an employee would become a “former LTPT employee.” 

Consider the following scenario: Suppose a plan excludes LTPT employees from receiving employer contributions such that only participants who complete 1,000 hours of service are eligible to receive such contributions. If an LTPT employee later completes 1,000 hours of service and becomes eligible to receive allocations of employer contributions, can the plan credit years of service for vesting for those contributions only for years in which the employee completes 1,000 hours, or would it have to credit years with only 500 hours? Although not specifically addressed, it appears that the former LTPT employee would receive vesting credit for years in which at least 500 hours of service were performed. That means former LTPT employees could vest under a more generous schedule than those who were never LTPT employees.

6.  Exclusion of LTPT employees from nondiscrimination testing. Employers may exclude LTPT employees from all of their annual nondiscrimination testing requirements, including coverage testing, ADP and ACP testing, and top heavy testing. Employers who chose to exclude LTPT employees from nondiscrimination testing need to be mindful of the following:

• A plan sponsor must make a formal election to exclude LTPT employees from testing.
• Safe harbor plans that exclude LTPT employees from contributions must say so in the plan documents.
• The exclusion must be uniform.

7.  Elapsed time plans. Plans that do not count hours and instead use the elapsed time method generally are not subject to these rules. That is because these plans permit participation after completing a one-year period of service.

8.  403(b) Plans. The proposed regulations addressed only 401(k) plans, but the SECURE 2.0 Act extended LTPT eligibility to ERISA-covered 403(b) plans beginning with the 2025 plan year. We expect future guidance that closely resembles the 401(k) guidance.

Next steps

Employers are not required to amend their plans until the last day of the 2025 plan year, but they are required to operate their plans in compliance with these requirements starting with the 2024 plan year. Accordingly, employers should reach out to their plan administrators and work with legal counsel to review their plans and make sure they are prepared to satisfy these new requirements. 

Read IRS Notice of Proposed Rulemaking

ESOPs are increasingly a popular succession planning vehicle, and well they should be. When formed properly, an ESOP transaction preserves the legacy of the business that an owner helped create, while providing tax and financial benefits to the former business owner, the company and the employees.

Yet, as we have blogged in the past, the Department of Labor (DOL) remains concerned about private company employee stock ownership plan (ESOP) valuations in the formation of ESOPs. In particular, sellers are not immune from liability for Employee Retirement Income Security Act (ERISA) prohibited transaction and fiduciary breach claims when it can be shown that the ESOP paid a price that exceeded fair market value (“adequate consideration” in ERISA parlance).

On the other hand, selling business owners in an ESOP transaction can take advantage of many strategies to protect themselves from liability, particularly with respect to due diligence, valuation and corporate governance items. Many of those strategies continue to be relevant. Recently, there were two decisions that led us to want to highlight and update three particular lessons for sellers:

(1) the value of engaging an independent trustee,

(2) the importance of being engaged in the valuation process, and

(3) the ability to mitigate damages by forgiveness of debt.

These lessons not only help protect the selling business owners, but also help ensure the future success of the company — and the seller’s legacy — after the transaction.

Value of an independent trustee

One lesson is for the seller, long before the actual sale, to commit to hiring an independent trustee for the ESOP after the sale. One concern in the Vinoskey case, which provided

the case study in our prior blog, was that after the sale to the ESOP, corporate insiders comprised two of the three trustees. These individuals, who also included the seller, also represented a majority of the board of directors.

Although the company engaged an independent trustee to negotiate the transaction, both the trial court and appeals court concluded that the sellers never relinquished control of the company and thus had a fiduciary duty to participants even when they were negotiating the transaction. That type of holding would tie the hands of any seller because a seller would be restrained from negotiating the best possible purchase price. In contrast, in the Bowers case, the sellers agreed to hire an independent trustee after the transaction was completed. Because of that, the court held that the sellers were not fiduciaries, and thus they had more leeway to negotiate the best price they could receive.

These results are understandable. Independent trustees have more ESOP experience and present fewer conflicts of interest than insider trustees present. As a result, there has been a trend towards engaging independent trustees after a transaction is completed, and these cases should continue that trend. The independent trustee need not be the same trustee who negotiated the transaction, although that trustee typically will be the best one to serve because of the familiarity with the company.

Sellers should be engaged in negotiations

Sellers often defend themselves in ESOP valuation cases by claiming that they are not valuation experts, and thus they cannot be expected to know whether the ESOP paid more than fair market value for the company’s stock. After all, that’s why the trustee hires its own independent appraiser. Yet, the Vinoskey and Bowers decisions show that sellers still need to be engaged in the process.

The company in Vinoskey had received annual appraisals each year for its stock because it had been a minority ESOP-owned company prior to the transaction that became subject to the suit. Those appraisals (which were done by the same appraiser retained for the subject transaction) had ranged between $215-$285 per share over the preceding five years. The price that the ESOP trust paid per share upon assuming 100% of the shares was $406. Both the district court and appeals court explained that while the seller was not expected to be a valuation expert, the discrepancy from the prior appraisals should have prompted him to ask whether the higher valuation caused concern. As stated previously, the fact that the seller was a fiduciary made the courts less sympathetic to the argument that he was not a valuation expert.

In contrast, the sellers in Bowers were able to provide documentation and witnesses to support the valuation for the company. It also helped that the judge understood valuation principles. In particular, the judge noted that an informal indication of interest that represented a lowball offer was not representative of fair market value. The judge also criticized the DOL’s valuation witness for failure to follow various valuation best practices. The Bowers decision shows the importance of providing witnesses, experts and attorneys who fully understand ERISA principles and valuation principles and can fully educate the judge. In order to do that, it is helpful if the sellers are engaged in the process.

Mitigation of damages

Finally, we note a change in one of the lessons from our prior blog, which is good news — debt forgiveness after the transaction can in fact mitigate damages. In the Vinoskey case, the seller had forgiven a portion of the debt owed to him after the transaction and tried to argue that this debt reduction should mitigate damages. The district court rejected that argument, holding that the relevant question was whether the ESOP paid too much for the company stock on the date of the transaction. Whatever happened after the transaction was irrelevant. The appeals court rejected that holding, explaining that unmitigated damages plus the debt forgiveness would result in a windfall to participants.

This holding is good news because it shows that a company and seller can be proactive after the transaction, and courts should view that favorably.

Final thoughts

While sellers are not immune from liability, they are not expected to be valuation experts and are not expected to negotiate against themselves. Instead, sellers are expected to be engaged in the process and to understand that an ESOP is a regulated transaction. It is important to hire a team of professionals, including experienced legal counsel, to help navigate the various issues not only is a defensive strategy to protect from liability. Doing so also helps sellers make an ESOP a rewarding succession plan for themselves and the other stakeholders of the business.

But just how big of a win is it?

The U.S. Supreme Court recently issued a unanimous decision in Hughes v. Northwestern University, reversing and remanding a lower court ruling that had dismissed the case against a retirement plan sponsor. This decision reaffirms that the Employee Retirement Income Security Act’s (ERISA) fiduciary duty of prudence requires continuous monitoring of all investment options under a plan, especially when lower-cost share classes are available for funds.

There was hope the court would say that as long as there were prudent options in the plan, a duty to replace imprudent ones would be overridden. But, the court rejected that argument. While that holding provides a clear instruction to ERISA fiduciaries, what remains unanswered is the standard that plaintiffs must satisfy in their pleadings to survive a motion to dismiss. Some of the language in the court’s opinion suggests this standard could be a high one, resulting in this decision potentially being a Pyrrhic victory for plaintiffs.

Summary of ERISA fee litigation decision

Current and former employees of Northwestern University sued the university and its investment committee for breaching their ERISA fiduciary duty of prudence with respect to two 403(b) plans that allowed participants to direct the investment of their accounts. In particular, the plaintiffs alleged that the fiduciaries failed to monitor fees and expenses of investment options, resulting in funds with excessive fees that underperformed. They also asserted that the university offered too many investment options (over 400), which was confusing.

The District Court and Seventh Circuit dismissed the case as a matter of law. They explained that because prudent (low-cost) funds were available, the plaintiffs had the ability to select the investments they wanted. The ability to select prudent options eliminated any concerns about imprudent options. The Supreme Court, in an 8-0 decision, rejected that interpretation and remanded the case back to the Seventh Circuit. The court held that the Seventh Circuit erred by relying exclusively on participant choice. Being an ERISA fiduciary means there is a continuous duty to monitor investments and to remove imprudent ones. Accordingly, the court remanded the case so the lower courts could evaluate the specific claims presented by the plaintiffs.

Implications of unanimous decision

If the court affirmed the Seventh Circuit, that decision would have provided more breathing room for the plan fiduciaries as compared to current law. While that may appear to be a victory for plaintiffs in the future, such a victory could prove to be limited. Today’s opinion does not rule directly on the question that the plaintiffs had asked the high court to consider — whether a complaint can survive a motion to dismiss when it alleges that a defined contribution retirement plan paid or charged its participants fees that substantially exceed fees for alternative available investment products or services. Instead, the court chose to identify the lower court’s error in saying choice excuses the inclusion of imprudent investments.

The plaintiffs asserted that a complaint should survive a motion to dismiss by simply alleging that the plan paid or charged its participants fees that substantially exceed fees for alternative available investment products or services. The court’s opinion, however, has language that suggests such a standard should not apply. The opinion states: (1) the evaluation of a fiduciary’s decision is a context-specific inquiry; and (2) “the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.” The court did not need to include this language to reach its decision, so its inclusion could be interpreted as a signal that complaints that do not take into account such subtleties could be deficient.

Action items for plan fiduciaries

Until the pleading standard gets resolved, what should fiduciaries do? Essentially, they need to follow the best practices they should have been following all along. In particular, the decision reminds fiduciaries to be mindful of the following responsibilities:

1. Review and analyze each investment option. Having a large investment menu is not enough to protect fiduciaries. If anything, a large menu may capture poorly performing funds with high fees and thus may be counter-productive. The court made clear in its decision that a fiduciary has a duty to analyze whether the inclusion of each investment option is prudent.
2. Continuously monitor whether retaining investment options is prudent. In addition to selecting investment options prudently, the court’s decision stressed that fiduciaries also have an ongoing duty to monitor investments and remove imprudent ones. Fiduciaries periodically should review both performance and fees to determine whether retention of funds is prudent.
3. Document the decisions made to add, remove or retain funds. The court’s language about providing deference to reasonable judgements of fiduciaries means that fiduciaries should document the process and analysis behind investment lineup decisions. A well-documented record can show courts that fiduciaries acted prudently under any given set of circumstances.

The first two items can help reduce the risk of being sued. The third item can help fiduciaries receive deference from a court in the event of a lawsuit. Consulting with financial and legal counsel can help fiduciaries strengthen these defenses.

In what some commentators are describing as the latest volley in a game of regulatory ping-pong, the Department of Labor (DOL) published proposed regulations that would change the way an ERISA fiduciary should consider environmental, social and governance (ESG) issues and related proxy voting decisions with respect to plan investments (the proposed regulations). The proposed regulations would provide more flexibility than prior guidance and greater encouragement to fiduciaries to consider taking ESG factors into account for their investment decisions. They also would encourage fiduciaries to vote on more shareholder activist types of proxy proposals. Although this guidance is new, tried-and-true best practices such as documenting investment decisions and having (and following) an investment policy should remain best practices throughout this evolving guidance.

Historical background

As a starting point, it is important to remember that the ERISA fiduciary duties require fiduciaries to act prudently and diversify plan investments to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so. They also require fiduciaries to act solely in the interest of the plan’s participants and beneficiaries, and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable expenses of administering the plan. In the most general sense, when selecting investment options for defined contribution plans, ERISA fiduciaries should analyze the rates of return, fees and degrees of risk of various fund options.

The DOL occasionally has issued sub-regulatory guidance that has taken the general position that under the appropriate circumstances, ERISA fiduciaries can make investment decisions that reflect climate change and other ESG concerns. That particularly is the case as a tie-breaker among investments that otherwise had at least commensurate rates of return. The guidance also stated that ERISA fiduciary duties included the management of voting and other shareholder rights with respect to investments, and thus proxy voting is subject to ERISA’s duties of prudence and loyalty.

In November 2020, the DOL published regulations that increased the documentation requirements when selecting ESG funds and suggested that acting upon proxy resolutions related to ESG and other issues not directly concerned with economic issues would be inappropriate. In January 2021, the DOL issued a non-enforcement order for these regulations in order to examine whether the regulations were consistent with the Biden administration’s broader goals with respect to climate change, health and labor policies.

Proposed regulations—ESG guidance

With the proposed regulations, the DOL appears to be moving back in the direction of the prior guidance. The proposed regulations remove many of the documentation requirements related to selecting funds that use an ESG strategy. The proposed regulations also provide greater ability to use ESG funds as qualified default investment alternatives, although special disclosures may need to be made to participants. Interestingly, comments in the preamble suggest that in the final regulations, ESG factors may not only be permitted considerations, but required considerations (especially with respect to climate change). That will be something we will keep an eye on.

Proposed regulations—proxy voting guidance

Additionally, the proposed regulations remove restrictions on voting proxies that the prior final regulations impose. The proposed regulations restore fundamental principles that have been a consistent part of the DOL’s fiduciary guidance with respect to proxy voting. These principles state that proxy voting decisions must make the plan’s financial interest the primary concern. Fiduciaries also must evaluate both the facts that form the basis of a proxy vote and the persons who play a role in proxy voting. For example, the decision to follow recommendations of a proxy advisory form could be considered a fiduciary decision. Interestingly, the proposed regulations suggest that fiduciaries adopt proxy voting policies to provide guidelines designed to ensure that proxy voting decisions are consistent with fiduciary duties to the plan. The proposed regulations add that such proxy voting policies should be consistent with investment policy statements.

Conclusion and next steps

While the proposed regulations demonstrate a change in direction from last year’s regulations, they also demonstrate the importance of keeping the core fiduciary duties of prudence, loyalty and diversification in mind with respect to investment decisions. Fiduciaries should consider three best practices:

• When making core investment decisions, fiduciaries should act by following ERISA’s core fiduciary requirements of prudence, loyalty and diversification.
• Fiduciaries should document the analysis and conclusions with respect to the selection or removal of investment funds. That will always be a smart practice that withstands shifts in regulatory guidance. The proposed regulations suggest climate change and other ESG factors may be part of this analysis, but documenting decisions remains important.
• Fiduciaries should review their investment policy statements. Having—and following—an investment policy statement can demonstrate that plan investment decisions were made in a manner consistent with ERISA’s fiduciary duties. The proposed regulations suggest these policies should include a statement on proxy voting.

The DOL is requesting comments on the proposed regulations by Dec. 13, 2021. We will monitor how the guidance progresses to final regulations. In the meantime, fiduciaries should work with legal counsel to strengthen their fiduciary processes and determine how to apply the latest guidance in the proposed regulations.