Red States See Support in Appeal Challenging Pro-ESG 401(k) Rule

Republican states challenging the Labor Department’s ESG-friendly retirement investing rule in the Fifth Circuit received support from organizations and individuals arguing that political activism shouldn’t get in the way of workers’ retirement savings.

The US Court of Appeals for the Fifth Circuit this week received a handful of amicus briefs backing an effort by more than two dozen Republican state attorneys general to vacate a 2022 regulation giving retirement plan fiduciaries greater flexibility to consider “non-pecuniary” factors like environmental, social, and corporate governance goals as a tiebreaker when selecting investments. The states say this violates the Employee Retirement Income Security Act, which requires plan fiduciaries to act “solely” and “for the exclusive purpose” of providing financial benefits to plan participants.

Several briefs objected to the rule’s perceived elevation of partisan political goals over the financial interests of American workers. The rule puts “left-wing agenda ahead of the pecuniary interest of fund participants” and it benefits large money-management firms and “black-box” proxy-advisory firms, which counsel investors on how to vote at corporate shareholder meetings, at the expense of workers’ retirement savings, according to a brief filed by the National Center for Public Policy Research and the Manhattan Institute for Policy Research.

Tie-Breaker

The briefs also challenged a premise the DOL rule is built upon—namely, that two investments could be so similar as to warrant using ESG factors as a “tiebreaker.” There are so many factors to consider when weighing two investments that the “very concept of an exact tie is absurd,” Texas state Senator Bryan Hughes (R) told the appeals court in his brief.

Even worse, the rule creates an incentive for fiduciaries to declare ties in order to carry out their beliefs “using other people’s pension money,” professor Edward Zelinsky of Benjamin N. Cardozo School of Law said in his brief. ERISA includes a duty to diversify plan assets, and a fiduciary confronted with two truly equal investments shouldn’t use ESG factors to break the tie; rather, she should “buy some of each,” Zelinsky said.

Other groups said the rule is bad for small businesses because it makes it more difficult and time-consuming for them to monitor investment decisions made by hired advisers. The rule includes an “oversight cost that is not adequately measured,” according to a brief filed by the National Federation of Independent Business Small Business Legal Center Inc. and the Texas Public Policy Foundation.

These groups also objected to the rule’s “vague” language, which allows fiduciaries to deem investments equal when viewed over an “appropriate time horizon.” This provision is “ripe for abuse” because it gives fiduciaries free rein to make investment decisions based on “far-off future hypotheticals about climate disaster,” they said.

Court Battle

The rule in question, finalized by the Labor Department’s employee benefits arm last year, allows retirement plans to consider ESG factors when they are financially material to participants’ bottom lines. The state challengers characterize the rule as an attempt by regulators to steer private-sector investments into “woke” funds to the detriment of workers’ retirement savings.

Judge Matthew J. Kacsmaryk, a Trump appointee in the Northern District of Texas, upheld the rule in a September 2023 opinion. The judge, who has a history of undoing the Biden administration’s federal actions on issues ranging from birth control to LGBTQ+ bias, wrote that while he’s “not unsympathetic” to the states’ concerns about ESG investing trends, the Labor Department adequately explained why its 2022 rule was needed to clear up regulatory confusion.

The case is Utah v. Su, 5th Cir., No. 23-11097, amicus briefs 1/25/24.