Mere days before the Labor Department’s ESG regulation is set to go into effect, a coalition of 24 states has filed suit to stop it.
More specifically, the coalition, led by Texas Attorney General Paxton, says in a press release that the 2022 Rule “undermines key protections for retirement savings of 152 million workers—approximately two-thirds of the U.S. adult population and totaling $12 trillion in assets—in the name of promoting environmental, social, and governance (‘ESG’) factors in investing, including the Biden Administration’s stated desire to address climate change.”
The rule—Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights—takes effect Jan. 30, 2023. The suit claims that “the 2022 Rule oversteps the Department’s statutory authority under the Employment Retirement Income Security Act of 1974 (‘ERISA’), 29 U.S.C. § 1001 et seq., and is contrary to law”—and comments that “the 2022 Rule is also arbitrary and capricious.”
The states are seeking (Utah v. Walsh, N.D. Tex., No. 2:23-cv-00016, Complaint filed 1/26/23) a preliminary injunction, and “permanent relief in the form of a declaration that the ESG Rule violates the APA and ERISA and is arbitrary and capricious.” It states that the court “should hold unlawful and set aside the 2022 Investment Duties Rule, and DOL should be enjoined from implementing or enforcing the 2022 Rule in any manner.”
In addition to the 25 states[i], other plaintiffs include Liberty Energy, Inc. (a Delaware corporation and publicly traded energy company), Liberty Oilfield Services LLC (a Texas limited liability company, and subsidiary of Liberty)—that sponsors a defined contribution 401(k) plan for its employees, Western Energy Alliance (a 501(c)(6) nonprofit trade association that “represents 200 companies engaged in all aspects of environmentally responsible exploration and production of oil and natural gas across the West”), and James R. Copland, a participant in a retirement plan subject to ERISA.
The suit points out that Liberty Services, as a plan sponsor/fiduciary “…will be forced to expend additional time and resources monitoring and reviewing recommendations from its investment advisors, without the benefit of recordkeeping requirements or clearer fiduciary duty regulations, to ensure they are focusing explicitly on pecuniary considerations and not collateral ESG factors.” The suit continues to explain that “although ESG is specifically countenanced in the 2022 Rule, it remains undefined, as does the time period over which associated investments should be considered. This makes its value proposition difficult, if not impossible, to quantify.” They concluded that “considering ESG factors will greatly complicate and require Liberty Services to invest additional resources in the evaluation and selection of investments.”
The suit also notes that “Liberty, as a publicly traded company, will also likely be harmed by decreased interest from investors and access to investment capital. Liberty’s funding costs are determined, in large part, by its performance in public equity markets, and increased ability to consider ESG factors under ERISA will likely move investment away from oil and gas companies like Liberty to ESG-aligned funds.” They explain that “the Supreme Court has already recognized that potential loss of funding even indirectly as the result of government action is sufficient to establish standing. See Dep’t of Com. v. New York, 139 S. Ct. 2551, 2565–66 (2019).”
The suit continues by commenting that “…before the 2022 Rule, Liberty’s large institutional shareholders were prohibited from leveraging ERISA plan assets for nonpecuniary ESG purposes,” but states that “…the 2022 Rule would give those institutional shareholders increased latitude to invest using ESG considerations and vote plan assets in support of such proposals, inviting explicitly nonpecuniary activists to wage costly campaigns against Liberty and divert its focus from maximizing shareholder value to collateral considerations.” They express concern that the “dominance of ESG investment among institutional shareholders and proxy advisors” would result in an exercise of “their new discretion over ERISA plan assets in favor of ESG” which will, in turn, lead them to “…incur costs or suffer less access to capital because of changes implemented by the 2022 Rule.”
The suit further claims that “the 2022 Rule loosens protections against unlawful fiduciary activity, removes reporting requirements to ensure compliance, opens the door for plan fiduciaries to engage in unlawful plan administration, and changes requirements for proxy voting, so enjoining it will logically halt the harms it threatens, keeping the 2020 rules in place.”
As for the other parties, the suit notes that “Western Energy Alliance has standing for reasons similar to Liberty and Liberty Services. It sponsors a defined contribution 401(k) plan for its employees and hires an investment advisor to assist with management of that plan. Alliance members also maintain 401(k) and other retirement plans covered by ERISA for their employees and will be further harmed by the 2022 Rule when asset managers, large institutional investors, and other ERISA plan managers make investment decisions or pursue an agenda that discriminates against the oil and natural gas sector based on nonpecuniary factors and politicized ESG criteria.”
As for the plaintiff-participant, the argument here is basically an allegation that the 2022 rule provides less protection for participants. “The 2022 Rule loosens the restraints placed on fiduciaries by Sections 403 and 404, thereby allowing ERISA fiduciaries more discretion than ordinarily permitted, and surely more discretion than would have been the case under the 2020 rules,” they argue. In support, they claim that the 2022 Rule “also removes certain documentation, disclosure, and enhanced monitoring responsibilities for fiduciaries imposed by the 2020 rules. Those transparency requirements were designed to aid plan participants in monitoring and potentially holding accountable fiduciaries who deviated from their statutory obligations. Hence, the 2022 Rule increases the burden on Copland to monitor and hold accountable plan fiduciaries for breaches of conduct under ERISA Sections 403 and 404.”
As for the states, they assert that they:
- suffer a proprietary injury in the form of diminished tax revenue that will be caused by the 2022 Rule (and by this, they say it will “cause the Plaintiff States to lose specific tax revenue: tax revenue from retirement distributions to the extent they tax such revenue”); and
- have standing to challenge the 2022 Rule as parens patriae because the Rule will harm the economic well-being of their residents.
They note that “several of Plaintiff States have significant oil and gas deposits, and fossil fuel companies have a substantial presence in those states for the purpose of oil and gas exploration and extraction.” The suit states that “the 2022 Rule will result in reduced investment in the fossil fuel industry,” which will in turn “reduce the revenue that accrues to the Plaintiff States through oil and gas extraction on State lands, federal property in those States, or federal waters adjoining those States. Reduced investment in the fossil fuel industry will also decrease employment, adversely impact industries that support fossil fuel development, and decrease overall economic activity and tax revenue. Some impacts from reduced investment in the fossil fuel industry will be difficult or impossible to reverse, such that the harm is irreparable. Even if those impacts could be reduced to monetary harm, damages resulting from the 2022 Rule are presumably not recoverable as a result of the federal government’s sovereign immunity, such that those damages would be an irreparable harm.”
They also assert that they “warrant special solicitude in the standing analysis,” as they “are asserting ‘a procedural right under the APA to challenge agency action,’” and because “the 2022 Rule affects the Plaintiff States’ quasi-sovereign interest in the economic well-being of their residents.”
Ultimately, they argue that the “2022 Investment Duties Rule contravenes ERISA’s clear command that fiduciaries act with the sole motive of promoting the financial interests of plan participants and their beneficiaries,” because it:
- allows consideration “based on collateral benefits other than investment returns” whenever he “prudently concludes that competing investments . . . equally serve the financial interests of the plan over the appropriate time horizon,” and
- “deletes the prohibition on exercising proxy rights to ‘promote non-pecuniary benefits or goals unrelated to those financial interests of the plan participants and beneficiaries.’”
The suit also comments that “DOL justified the 2022 rule and revocation of the 2020 rules to cure a ‘chill’ or ‘confusion’ allegedly caused by the latter. DOL never identified who was confused, what the source of confusion was, or whether the alleged confusion caused a reduction in the financial returns for plan participants.”
Arbitrary and Capricious
The suit notes that while the preamble to the 2022 Rule claims it was not intended to “channel” investments into ESG investments or funds, but “to remove barriers to fiduciary’s consideration of all financially relevant factors.” But they comment that “financially relevant factors are pecuniary factors, and the 2020 rules already did that—allowed fiduciaries to consider all pecuniary factors when making investment decisions. Moreover, DOL’s assertion that the 2022 Rule was not intended to ‘channel’ money into ESG investments is undermined by the preamble’s emphasis on the increasing importance and anticipated growth of ESG investing.”
Consequently, the suit notes that “the 2022 Rule ‘cannot be adequately explained’ by DOL’s proffered justifications and ‘reveal[s] a significant mismatch between the decision the Secretary made and the rationale he provided’”—a disconnect the plaintiffs here say, “demonstrates that the 2022 rule is arbitrary and capricious.”
“In sum,” they conclude, “the 2022 Investment Duties Rule makes changes that authorize fiduciaries to consider and promote “nonpecuniary benefits” when making investment decisions. Such decisions include choosing investments, exercising proxies, and selecting options for participant-direct plans. The 2022 Rule makes such changes even though courts have explained—in Dudenhoeffer and elsewhere—that ERISA fiduciaries may only act with the motive of furthering the financial benefits of plan assets. Contrary to Congress’s clear intent, these changes make it easier for fiduciaries to act with mixed motives. They also make it harder for beneficiaries to police such conduct.”
[i] The states participating in the suit are Utah, Texas, Virginia, Louisiana, Alabama, Alaska, Arkansas, Florida, Georgia, Indiana, Idaho, Iowa, Kansas, Kentucky, Mississippi, Missouri, Montana, Nebraska, New Hampshire, North Dakota, Ohio, South Carolina, Tennessee, West Virginia, and Wyoming.
This is not, of course, the first attempt to set aside the ESG Rule. Just a month ago Senator Tom Cotton (R-AR) filed a remarkably short piece of legislation to block it. Shortly thereafter Rep. Andy Barr (R-KY) and Sen. Mike Braun (R-IN) introduced a Congressional Review Act (CRA) measure in the House and Senate, respectively, to nullify the Department of Labor’s recently finalized rule to greenlight environmental, social and governance (ESG) investing in federal pension plans.