In another shot against ESG, half of all U.S. states are now suing the Department of Labor to protect Americans’ pension funds. Thursday, Texas and 24 other states sued to block a new rule from Biden’s Department of Labor that subjects Americans’ retirement funds to ESG investing.
The DOL issued the rule in November to reinterpret the duty that investment managers of retirement funds owe to their clients under the Employee Retirement Income Security Act, ERISA, which governs nearly all retirement plans for all non-government employees in the United States.
ERISA requires the investment managers to act “solely in the interest” and “for the exclusive purpose” of maximizing financial returns for their clients. As the lawsuit explains, “Courts have described ERISA’s fiduciary duties as ‘the highest known to the law.’”
But the DOL took aim at the law to comply with President Biden’s directive to address “the failure of financial institutions to appropriately and adequately account for and measure” “climate-related financial risk,” “disparate impacts on disadvantaged communities and communities of color,” and other risks commonly seen in ESG standards.
As the lawsuit explains, the Department’s rule “affirmatively embraces a broad view of the use of ESG and other non-economic factors by ERISA fiduciaries regarding plan assets and proxy voting.” It rolled back protections put in place by Trump’s DOL in 2020 and enacted three main changes that allow investment managers to consider “ESG factors.”
First, the 2022 Rule eliminates the objective pecuniary/nonpecuniary standard in the 2020 rule and instead formally incorporates ill-defined, subjective ESG concepts into the ERISA regulations. . . . .
The 2022 Rule also undermines a fiduciary’s prudence obligations. While fiduciaries had previously focused on risk and return estimates of financial benefits, under the revised 2022 Rule, a fiduciary’s analysis of an investment’s 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.”
Second, the 2022 Rule abandons the tiebreaker standard contained in the 2020 Investment Rule. While the 2020 Rule emphasized the importance of pecuniary factors, the revised 2022 Rule would declare a tie “if . . . competing investments, or competing investment courses of action, equally serve the financial interests of the plan.” Thus, the 2022 Rule removes the “economically indistinguishable” standard in the 2020 Rule, replacing it with a lower threshold that allows a fiduciary increased flexibility to choose an investment based on a collateral benefit so long the investments meet the vague standard of “equally serv[ing] the financial interest of a plan over an appropriate time horizon.”
Third, the 2022 Rule also removes from 29 C.F.R. § 2550.404a-1 important transparency protections that were added by the 2020 Investment Rule. While the 2020 rule required fiduciaries or investment managers to document that there had been a tie and how a particular collateral benefit or factor was consistent with the interest of the plan, its participants, and its beneficiaries, the 2022 Rule has no such requirement. Removing these recordkeeping and disclosure requirements also exacerbates the risk of plan fiduciaries unlawfully pursuing their own preferences and collateral ESG considerations.
Together, these rules radically reinterpret ERISA’s standard for fiduciary duty and allow investment managers to invest Americans’ retirement funds based on woke left-wing principles instead of maximizing an individual’s financial return.
As Louisiana State Treasurer John Schroder argued in a letter to BlackRock CEO Larry Fink, ESG investing is often at odds with the long-established understanding of fiduciary responsibility. Substituting financial goals for ideological aims, even defenders of its political ideology have argued that ESG is a fundamentally flawed approach.
And we have explained elsewhere how ESG investing divides and politicizes financial markets and the companies that adopt it. This imperils the retirement of over a hundred million Americans. As the lawsuit explains, ERISA covers over “152 million workers, approximately two-thirds of the United States adult population, and more than $12 trillion in plan assets, equivalent to more than half of the nation’s gross domestic product.”
The lawsuit claims that the rule violates both ERISA and Congress’ delegation of authority to the Department under the Administrative Procedure Act because it allows investment managers to invest for reasons other than the “exclusive purpose of . . . providing benefits to participants and their beneficiaries” and it is a major question outside the scope of the Department’s statutory grant of authority. It also claims that the rule is arbitrary and capricious because the Department did not adequately justify or explain the rule, consider alternative rules, or explain why it changed the 2020 rule.
To read the full lawsuit, click here.