Dueling Goals for New ESG 401(k) Rule to Vex Trump’s Regulators

The US Labor Department in replacing a Biden-era eco-friendly 401(k) rule is set to encounter pressure to balance the Trump administration’s interest in deterring ESG investments with plan sponsors’ needs for regulatory consistency and worker litigation safeguards.

The government told an appeals court that the DOL will put ESG rulemaking in its spring regulatory agenda to undo the Biden policy that permits plans to consider environmental, social, and corporate governance factors when selecting and monitoring investments.

Left unsaid in the status report filed Wednesday to the US Court of Appeals for the Fifth Circuit is what the DOL’s Employee Benefits Security Administration intends to leave in place of the defunct rule. But regulators are unlikely to pass up the opportunity to put their own mark on the ESG landscape, a former DOL official and several industry observers said.

Walking a fine line between the administration’s anti-ESG policy objectives and those of its corporate allies will be difficult. Wall Street has more firmly embraced ESG since Trump promulgated his own first version of the rulemaking in 2020 discouraging plans from environmentally friendly investments and do-good proxy voting.

The regulatory flip-flops on ESG in 401(k)s between that rule and Biden’s 2022 regulation have strained retirement plan compliance.

“If the department wants this new rule to stand in court, it’s going to have to find a way to balance the two rules,” said Catherine L. Reagan, an associate attorney at Trucker Huss APC in San Francisco. “The administration will pursue its own policy goals, but it can’t be seen as a complete 180-degree change.”

Tiebreaker Standards

Plan sponsors will likely seek clarity from the administration through the ESG rule’s replacement over the role of tie-breakers in investment management decisionmaking.

The Employee Retirement Income Security Act already requires plan fiduciaries to put financial considerations ahead of all else when choosing investments. But the Trump administration raised the notion of a “tie” between options in its 2020 rule, and slapped companies with strict reporting requirements to prove why they chose an ESG fund when breaking that deadlock between “indistinguishable” alternatives.

The president and his Republican allies have characterized ESG investing and its supporters as “woke” and decried investment managers who favor those strategies at the local, state, and federal levels.

Biden’s rule, on the other hand, lowered the standard for what constituted a tie to two investments that “equally serve the financial interests of the plan” and eliminated many of the requirements Trump’s critics said “chilled” the industry.

“It is unclear how often tiebreakers arise in practice,” said Marcia S. Wagner, founder and managing partner of the Wagner Law Group PC in Boston. “It is inefficient for plan fiduciaries to have to modify their operations whenever there is a change in administration.”

Absent federal agency deference the US Supreme Court cut back in its Loper Bright Enterprises v. Raimondo ruling last year, that back-and-forth degrades the agency’s credibility when it inevitably is left defending its rule in court, said Reagan.

The judiciary could even strip the administration of its power to promulgate a regulation on the issue altogether by invoking the major questions doctrine to demand a clear congressional directive before rulemaking, Wagner added.

Plan sponsors during both Trump and Biden administrations have remained hesitant to eagerly adopt ESG investment options because of political uncertainty, said David Levine, principal and executive committee chair at Groom Law Group Chartered in Washington.

“There’s an opportunity to add some clarity here,” Levine said. “The administration could define financial factors and outline process steps that are protective so plan sponsors aren’t left in the gray zone.”

Proxy Voting

In revamping the axed rule, Trump will also have the chance to address plan sponsor and asset manager concerns over fiduciary litigation threats.

Major US investment managers like BlackRock Inc. stand to lose business in the $9 trillion 401(k) market after a Texas federal judge found earlier this year that American Airlines Group Inc. violated its duty of loyalty to plan participants under ERISA by failing to monitor BlackRock’s ESG-themed proxy votes.

The lawsuit filed by a group of pilots invested in the company’s 401(k) plan came right out of the administration’s first-term playbook and a rule Biden froze that would have hit money managers with stiff penalties for voting on behalf of retirement investors outside their financial best interests—including promoting ESG.

US District Court for the Northern District of Texas Judge Reed O’Connor in his ruling “shocked much of the industry” by divorcing duties of loyalty from duties of prudence—fiduciary standards usually linked under ERISA, said Reagan.

Fiduciaries have usually relied on a well-documented prudent process to prove their loyalty to workers. Companies fear that, without being able to rely on prudence as a precursor to loyalty, the bar for litigation over third-party investment management contracts has been lowered.

Trump’s nominee to oversee EBSA, insurance executive Daniel Aronowitz, has himself been a critic of the agency’s focus on “political” issues such as ESG.

Eliminating Biden’s ESG rule would reinstate the first Trump administration’s proxy voting standards. Carving out protections for money managers could strike a bipartisan balance that avoids irritating financial service firms.

“There’s space for guidance there,” said former EBSA Assistant Secretary Lisa M. Gomez who served under former President Joe Biden. “The American Airlines case left a lot of plans wondering what their fiduciary responsibilities are with respect to proxy voting.”