National Conference on Public Employee Retirement Systems

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Department of Labor’s ESG Regulation Upheld

  • By: admin
  • On: 09/25/2023 16:22:23
  • In: News
  • Comments: 0

By: Tony Roda, Williams & Jensen

Last week, a well-known conservative jurist upheld the Department of Labor's Investment Duties Rule, commonly referred to as the ESG regulation.

On September 21, U.S. District Court Judge Matthew Kacsmaryk of the Northern District of Texas upheld the U.S. Department of Labor's (DOL) 2022 Investment Duties Rule (the rule or regulation). In so doing, Judge Kacsmaryk backed the Biden Administration's rule, which is often referred to as the ESG regulation.
The rule is being challenged by a group of 26 conservative state attorneys general and private plaintiffs, who allege that it is a violation of the Employee Retirement Income Security Act (ERISA), exceeds DOL's statutory authority, and is arbitrary and capricious. The federal district court in Texas disagreed on each claim.
The Texas ruling is notable because Judge Kacsmaryk is a well-known conservative jurist who, in April of this year, issued a stunning decision that the drug mifepristone should be withdrawn from use. That drug had been approved by the U.S. Food and Drug Administration 23 years ago. It was the first drug approved for medication abortion.
As the public plan community considers the recent court ruling and the underlying ESG regulation, it is important to note that it was promulgated under the authority of ERISA, which does not govern state and local governmental retirement plans. However, state and local officials, public pension boards, investment committees, and in-house and outside counsel often take DOL's regulatory pronouncements into consideration as they develop fiduciary standards and guidelines for investment-related decisions by plan fiduciaries.
The just-upheld regulation makes clear at the outset that a fiduciary shall discharge their duties “…for the exclusive purpose of providing benefits to participants and their beneficiaries…” Furthermore, the regulation states that, “A fiduciary may not subordinate the interests of the participants and beneficiaries…and may not sacrifice investment return or take on additional investment risk to promote benefits or goals unrelated to interests of the participants and beneficiaries in their retirement income or financial benefits under the plans.”
The final rule also moved away from the standard included in the Biden Administration's proposed regulation, which was “(t)he projected return of the portfolio relative to the funding objectives of the plan…may often require an evaluation of the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action.” (Emphasis added.) While the proposed standard was still discretionary because of the use of the word “may,” it would have taken us right to the brink of a regulatory requirement that in order to meet the fiduciary duty of prudence a fiduciary must consider ESG factors in all investment decisions.
Instead, the final regulation, in response to commenters who said the proposed language was a de facto mandate to analyze all investments through the ESG lens, replaced that standard with the following:
Fiduciary's determination…must be based on factors…relevant to a risk and return analysis; risk and return factors may include the economic effects of climate change and other ESG factors; whether any particular consideration is a risk-return factor depends on individual facts and circumstances.
A central issue before the court was whether the rule's allowance of ESG factors in a tiebreaker situation exceeded statutory authority. Judge Kacsmaryk cited U.S. Supreme Court precedent that where Congress hasn't directly spoken to a precise question at issue, courts must defer to a federal agency's interpretation of the law. When comparing Biden's 2022 tiebreaker rule to the Trump Administration rule of 2020, Judge Kacsmaryk stated:
“The 2022 Rule changes little in substance from the 2020 Rule and other rulemakings. Where the 2020 Rule explained that collateral factors may be considered when a fiduciary is “unable to distinguish” between two investment options on financial factors alone, the 2022 Rule allows the same when the two options “equally serve the financial interests of the plan…there is little meaningful daylight between “equally serve” and “unable to distinguish.”
Judge Kacsmaryk further stated that, “For nearly three decades, DOL has posited that ERISA's obligations do not forbid consideration of collateral or non-financial benefits in the selection of competing investments that serve the plan's economic interests equally.”
The plaintiffs are likely to appeal this decision to the U.S. Court of Appeals for the 5th Circuit, which is another conservative judicial forum. In addition, a separate lawsuit challenging the regulation and alleging similar legal arguments is pending in federal district court in Wisconsin.
Please know that NCPERS will keep its members up to date on future developments on this important topic.
Tony Roda is a partner at the Washington, D.C. law and lobbying firm Williams & Jensen, where he specializes in legislative, regulatory, and fiduciary matters affecting state and local pension plans. He represents the National Conference on Public Employee Retirement Systems and state-wide, county, and municipal pension plans in California, Colorado, Georgia, Kentucky, Ohio, Tennessee, and Texas. He has an undergraduate degree in government and politics from the University of Maryland, J.D. from the Catholic University of America, and LL.M (tax law) from the Georgetown University Law Center.


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