Republican-Led States Sue to Block ESG Investment Rule, a Fight With Potential Far-Reaching Implications for the Anti-ESG Movement

The Department of Labor (DOL) on Dec. 1, 2022, finalized regulations titled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights” (the 2022 Rule)^[1] that provide greater flexibility to retirement‑plan fiduciaries to consider environmental, social and governance (ESG) factors when selecting investments and investment courses of action and exercising shareholder rights such as proxy voting. On Jan. 26, 2023, a 25‑state coalition sued the DOL in Texas over the 2022 Rule,^[2] and a second case was filed on Feb. 21, 2023, in the Eastern District of Wisconsin by two plan participants, assisted by the Wisconsin Institute for Law & Liberty.^[3] Both lawsuits include similar claims. The 2022 Rule replaces a 2020 DOL regulation that emphasized that plan fiduciaries must focus on “economic considerations that have a material effect on the risk and return of an investment” (the 2020 Rule). While the court challenges to the 2022 Rule are pending, on Feb. 28, Congress passed a resolution pursuant to the Congressional Review Act^[4] that would nullify the 2022 Rule, absent a presidential veto.

The 2022 Rule provides that a fiduciary’s analysis of investment risk and return “may include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action” and, in several respects, may ease the ability of plan fiduciaries to consider such factors. The rule is premised on the view that such risks can impact the long-term returns on managed investments.

In Utah v. Walsh, the plaintiffs assert that the 2022 Rule “undermines key protections for retirement savings of 152 million workers — approximately two-thirds of the U.S. adult population and totaling $12 trillion in assets — in the name of promoting environmental, social, and governance (‘ESG’) factors in investing, including the Biden Administration’s stated desire to address climate change.” Similarly, the plaintiffs in Braun v. Walsh assert that the 2022 Rule “puts the retirement savings of millions of Americans at substantial risk in service of a policy choice not found in ERISA or otherwise enacted by Congress.”

In addition to providing a venue for the courts to clarify the scope of the duties of fiduciaries under the Employee Retirement Income Security Act of 1974 (ERISA), these cases present an opportunity to address whether and to what extent ESG considerations relate to pecuniary interests and financial risk and return — a premise of the 2022 Rule and a key question raised by Republican-led states’ ongoing resistance to ESG‑based investing.

ERISA establishes the minimum standards governing private‑sector employee benefit plans and the fiduciaries who administer those plans. Sections 403 and 404 of ERISA require, in part, that plan fiduciaries act prudently and solely in plan participants’ and beneficiaries’ interests, and for the sole purposes of providing benefits to participants and beneficiaries and of defraying reasonable administrative expenses.^[5] Under DOL interpretive guidance, Section 404 of ERISA requires that plan fiduciaries put paramount focus on the plan’s financial returns and risks to beneficiaries.^[6]

The DOL has issued interpretive guidance several times over the years with respect to the ability of fiduciaries to consider ESG-type factors with respect to an ERISA plan’s investments. This guidance was in the form of subregulatory guidance until 2020, when the DOL issued the 2020 Rule, which then was replaced with the 2022 Rule.

In the complaint in Utah v. Walsh, the plaintiffs contend that the 2022 Rule permits fiduciaries to consider “ill-defined, subjective ESG concepts” and “abandons any attempt to define or advise what constitutes an ESG factor.” Furthermore, they contend that the 2022 Rule excessively loosens the “tiebreaker standard.” Under the 2020 Rule, a fiduciary only could consider noneconomic factors to break a tie among “economically indistinguishable” investments, provided that the fiduciary also complied with specific recordkeeping requirements. The 2022 Rule, in contrast, permits application of the tiebreaker rule if the competing investments “equally serve the financial interest of a plan over an appropriate time horizon” and eliminates the recordkeeping requirements with respect to tiebreaker situations. The complaint asserts that the new standard “allows fiduciaries substantial wiggle room” that “will transform the 2020 Investment Rule’s strict tiebreaker into something that occurs regularly, and thus authorize consideration of ‘collateral benefits’ — in direct contradiction to ERISA’s statutory commands.” The complaint argues that this violates ERISA’s requirement (as interpreted by the Supreme Court) that fiduciaries consider financial benefits only, and not nonpecuniary benefits.

In addition, with respect to voting of proxies for plan investments, the 2022 Rule deleted the statement that plan fiduciaries may not “promote non-pecuniary benefits or goals unrelated to those financial interests of the plan participants and beneficiaries,” although it retained the prohibition on “subordinat[ing] the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to any other objective.” The plaintiffs in Utah v. Walsh assert that this deletion also is contrary to ERISA.

The plaintiffs in Braun v. Walsh allege that the 2022 Rule violates ERISA by “encourag[ing] plan fiduciaries to make investment choices based on noneconomic factors that may not be in the sole interest of either participants or beneficiaries.” The complaint, in particular, highlights the ability to consider ESG factors when selecting a qualified default investment alternative (QDIA) and the elimination of the 2020 Investment Rule’s recordkeeping requirements as indications that the 2022 Rule encourages ESG-based investment decisions.^[7] In addition, the complaint asserts that the 2022 Rule “exceeds the statutory authority conferred on the Secretary and the [DOL]” and violates the Administrative Procedures Act.

The premise for both lawsuits — that ESG factors are nonpecuniary considerations — is consistent with the premises underlying other anti‑ESG efforts. For instance, as we have previously covered, many states have enacted or are considering laws requiring state funds to be invested based on “pecuniary factors” only. And those laws define “pecuniary factors” to exclude factors intended to further ESG-related interests. Thus, by presenting an opportunity to litigate — and the court to decide — whether ESG factors are pecuniary, this case could have wider implications for the anti‑ESG movement.

However, the cases could be decided on narrower grounds, since it is not clear that the 2022 Rule actually promotes ESG-based decision making. Clearly the 2022 Rule takes a more favorable view than the 2020 Rule, but it still retains significant language that fiduciary decisions must consider a risk return analysis and that a fiduciary “may not sacrifice investment return or take on additional investment risk to promote benefits or goals unrelated to the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan.”

The Utah v. Walsh case also raises the major questions doctrine, an emerging — and consequential — administrative‑law principle (a claim that was not raised in the Wisconsin complaint). As we have discussed in other Bulletins, the major questions doctrine is a statutory-interpretation concept based on separation-of-powers principles and legislative intent. The Supreme Court has stated that it applies in “extraordinary cases” when “the ‘history and the breadth of the authority that the agency has asserted,’ and the ‘economic and political significance’ of that assertion, provide a ‘reason to hesitate before concluding that Congress’ meant to confer such authority.”^[8] In such cases, “something more than a merely plausible textual basis for the agency action is necessary.”^[9] An “agency instead must point to ‘clear congressional authorization’ for the power it claims.”^[10]

The complaint in Utah v. Walsh argues that the DOL has asserted “broad authority in an area of substantial economic and political significance” by “commandeering the power of trillions of dollars in assets saved through ERISA to purs[u]e the current administration’s preferred climate objectives.” The complaint thus contends that, under the major questions doctrine, the DOL lacked the necessary clear congressional authority to promulgate the 2022 Rule. If successful, that argument could further expand the major questions doctrine — and further limit agency authority in other areas, such as the SEC’s authority to require climate‑related disclosures in financial statements,^[11] or the EPA’s authority to promulgate automobile emissions requirements that incentivize a shift toward electric vehicles.^[12]

The 2022 Rule and related litigation have received significant attention. Indeed, shortly after Utah v. Walsh was filed, the resolution seeking to nullify the 2022 Rule under the Congressional Review Act was introduced into Congress. While the resolution is likely to be vetoed by President Biden, the support for the resolution by all the Republicans in the House and Senate, as well as one House Democrat and two Senate Democrats, is an indication of the level of controversy surrounding the rule and ESG factors in investing generally. For all these reasons, the cases and the rule bear watching. We will continue to offer timely updates and insights about these important developments in the ongoing contest over ESG-focused investments. 

^[1] _{87 F.R. 73,826 (Dec. 1, 2022), https://www.federalregister.gov/documents/2022/12/01/2022-25783/prudence-and-loyalty-in-selecting-plan-investments-and-exercising-shareholder-rights.}

^[2] _{State of Utah, et al. v. Martin J. Walsh and the United States Department of Labor (here).}

^[3] _{Richard Braun and Frederick Luehrs III v. Martin J. Walsh (here).}

^[4] _{H.J. Res. 30. The Congressional Review Act allows Congress to overrule a regulation. See 5 U.S.C. §802.}

^[5] _{29 U.S.C. §§1103(c), 1104(a).}

^[6] _{See Interpretive Bulletin 2015–01, 80 FR 65135 (Oct. 26, 2015).}

^[7] _{A QDIA is the investment alternative in which participant accounts in a participant-directed account plan (such as a 401(k) plan) are invested if the participant has not selected an investment option. The 2020 Investment Rule prohibited plan fiduciaries from taking into account ESG factors when selecting a QDIA. The 2022 Rule eliminated this specific prohibition, although the plan fiduciary’s selection of a fund as a QDIA is subject to the full range of prudence and exclusive benefit duties.}

^[8] _{West Virginia v. Environmental Protection Agency, 597 U.S. ___ (2022) (slip op., at 19) (quoting FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 159–60 (2000)) (alterations adopted).}

^[9] _Id.

^[10] _Id.

^[11] _{See Supreme Court Rejects EPA’s ‘Clean Power Plan’ in Decision Raising Questions About the SEC’s Climate-Related Disclosure Rules (July 12, 2022), https://www.kramerlevin.com/en/perspectives-search/supreme-court-rejects-epas-clean-power-plan-in-decision-raising-questions-about-the-secs-climate-related-disclosure-rules-on.html.}

^[12] _{See Paxton Leads Coalition to Push Back Against New EPA Standards That Put American Energy and National Security at Risk (Nov. 28, 2022), https://www.texasattorneygeneral.gov/news/releases/paxton-leads-coalition-push-back-against-new-epa-standards-put-american-energy-and-national-security.}