A U.S. District Court ruled on Thursday against 26 states and other plaintiffs in their lawsuit challenging the legality of the Department of Labor’s final rule permitting retirement plan fiduciaries to use environmental, social and governance considerations in their decision making about investments.
The plaintiffs argued that ESG investing practices would limit the investments that oil and gas companies receive from the public markets, hurting those companies, the states that they operate in, and their employees. Additionally, ESG investing would result in lower returns for defined contribution plan participants, according to the complaint.
At the core of the plaintiffs’ argument was an allegation that, by expressly permitting ESG in fiduciary decision making, financial interests would be subordinate to politically or philosophically motivated interests.
On Thursday, Donald Trump-appointed Judge Matthew J. Kacsmaryk on ruled in Utah vs. Walsh that the proposal does not explicitly violate the Employee Retirement Income Security Act because ERISA does not forbid ESG investing or a tiebreaker test that includes non-economic factors. The rule, he noted, requires fiduciaries to act prudently and not subordinate financial interests when considering ESG.
If the rule does not expressly violate the statute, then plaintiffs must argue that it is arbitrary and capricious, a test they failed to back, Kacsmaryk wrote. He also explained plaintiffs failed that burden because the DOL argued that they were trying to address confusion and a “chilling effect” identified by commenters about an earlier rule from 2020 which made it unclear if ESG could be considered at all, and this is the “minimal level of analysis from which the agency’s reasoning may be discerned.”
To address this confusion, the DOL said that prudent risk and return considerations can include ESG factors, but they do not need to. However, a fiduciary cannot subordinate financial interests to non-financial interests; they must consider ESG only to the extent that it is a risk-return factor. The ruling noted that the DOL has considered ESG a financial factor since at least 2015, and that the 2020 rule that plaintiffs sought to restore acknowledged that not considering ESG factors in certain circumstances could actually be a breach of fiduciary duty.
The DOL also reworked the tiebreaker test for when a plan may consider non-financial factors when choosing between two investments. The 2020 rule said that the plan must be “unable to distinguish” between the choices, but the 2022 rule says they must “equally serve the financial interests of the plan.”
The latter test is understood to be less burdensome than the former, but Kacsmaryk wrote that the modification really “changes little” and there is “little meaningful daylight” between them.
The judge also ruled that ESG can be used in evaluating a qualified default investment alternative in an employer-sponsored retirement plan as long as that investment is otherwise prudent.
At the end of the ruling, the Kacsmaryk wrote that “while the Court is not unsympathetic to plaintiff’s concerns over ESG investing trends, it need not condone ESG investing generally or ultimately agree with the Rule to reach this conclusion.”
The DOL initially expressed skepticism of the venue, the Amarillo Division of the U.S. District Court for the Northern District of Texas, and requested a venue change, which was rejected.
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