In general, to satisfy the duty of prudence under ERISA section 404(a) when selecting a designated investment alternative, a plan fiduciary must use a prudent process. This process must consider the relevant facts and circumstances that, given the scope of such fiduciary’s investment responsibility or authority, the fiduciary knows or should know are relevant to the particular designated investment alternative. In the preamble to the proposed regulation, the DOL cites three key principles: (i) a need to affirm ERISA as a law grounded in process, (ii) that ERISA gives maximum discretion and flexibility to plan fiduciaries in selecting designated investment alternatives, and (iii) that when ERISA fiduciary decision-making follows a prudent process—such as the process reflected in the proposed regulation, "arbiters of disputes should defer to fiduciaries under a presumption of prudence.”

This proposed regulation is focused on the duty of prudence specifically, while not opining further on the duty of loyalty or other ERISA-related duties for plan fiduciaries selecting investments. The proposal further notes that section 404(a)(1)(B) of ERISA does not require or restrict any specific type of designated investment alternative, except insofar as a designated investment alternative might be otherwise illegal (for example, an investment in a foreign adversary that violates the Specially Designated Nationals and Blocked Persons List).

Safe Harbor Outlined

The proposal outlines six key safe harbor considerations that a plan fiduciary responsible for establishing and maintaining a plan investment menu of designated investment alternatives for a participant-directed individual account plan must “objectively, thoroughly, and analytically consider, and make determinations on, when selecting each such designated investment alternative for the plan investment menu.”

While acknowledging that each factor’s applicability to a specific designated investment alternative varies based on the particular facts and circumstances involved, the DOL recognizes that it is providing a non-exhaustive list of factors yet says that each of the six factors are “integral to the vast majority of designated investment alternatives participant-directed individual account plans provide.” In each of these, the proposed regulation says a plan fiduciary must “consider a reasonable number of similar alternatives" and determine that the criteria furthers the purposes of the plan. Those factors include:

• Performance: The fiduciary must appropriately consider a reasonable number of similar investment alternatives and determine that the risk-adjusted expected returns of the designated investment alternative, over an appropriate time horizon and net of anticipated fees and expenses, furthers the purposes of the plan by enabling participants and beneficiaries to maximize risk-adjusted return on investment, net of those fees and expenses.
  

• Fees: The fiduciary must consider a reasonable number of similar alternatives and determine that the fees and expenses of the designated investment alternative are appropriate, taking into account its risk-adjusted expected returns, and any other value the alternative brings to furthering the purposes of the plan. For this purpose, “value” includes any benefits, features or services other than risk-adjusted returns net of fees.
  

• Liquidity: The fiduciary must appropriately consider and determine that the designated investment alternative will have sufficient liquidity to meet the plan’s anticipated needs at both the plan and individual levels.
  

• Valuation: The fiduciary must appropriately consider and determine that the designated investment alternative has adopted adequate measures to ensure that the designated investment alternative is capable of being timely and accurately valued in accordance with the needs of the plan.
  

• Performance Benchmarks: The fiduciary must appropriately consider and determine that each designated investment alternative has a meaningful benchmark and compare the risk-adjusted expected returns, net of fees, of the designated investment alternative to the meaningful benchmark. The proposal defines “meaningful benchmark” for this purpose as “an investment, strategy, index, or other comparator that has similar mandates, strategies, objectives, and risks to the designated investment alternative.” The proposal clarifies that although there may be more than one meaningful benchmark for a designated investment alternative, no single benchmark is a meaningful benchmark for all designated investment alternatives. It also states that there is no presumption or preference against new or innovative designated investment alternative designs.
  

• Complexity: The fiduciary must appropriately consider the designated investment alternative’s complexity and determine that she has the skills, knowledge, experience and capacity to comprehend the designated investment alternative sufficiently to discharge her obligations under ERISA and the governing plan documents or whether she must seek assistance from a qualified investment advice fiduciary, investment manager or other individual in evaluating the designated investment alternative.
  

For each of these safe harbors, the proposed regulation contains detailed examples, analysis and conclusions that apply. Those include some of the concerns that have been raised regarding alternative investments (liquidity, valuation, complexity), notably private markets and retirement income.

Action Items for Plan Sponsors

For plan sponsors, consider the following action items:  

• Consult with your plan advisor or consultant as to the application of this proposed regulation to your plan’s investment options.
  

• Read and reaffirm that the safe harbor elements outlined in the proposed regulation are being applied consistently with current investment options, including your Investment Policy Statement.
  

• Consider how those factors might be applied to options beyond those on the current investment menu, notably expanded target date fund or managed account options, including private market investments and/or retirement income.
  

• Continue to monitor for a final regulation in the coming months to understand what changes may apply to your investment selection process.