DOL Defends ESG Rule Against 5th Circuit Appeal

The Department of Labor filed to the U.S. 5th Circuit Court of Appeals a defense of its rule governing “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” sometimes called the environmental, social and governance rule, as complying with the Employee Retirement Income Security Act.

The final rule permits fiduciaries under ERISA to consider ESG factors in their risk-return analysis when selecting retirement plan investments. It also permits fiduciaries to use collateral factors as a tiebreaker between two or more investments when both investments equally serve the interests of the plan and for fiduciaries to use qualified default investment alternatives that use consider nonfinancial factors, if it is a prudent investment. The department finalized the rule in September 2022.

In January 2023, the final rule was challenged in a Texas federal district court, which upheld the rule in September 2023. The plaintiffs in the initial litigation—26 Republican-led states, two corporations and a trade association in the fossil fuels industry, and two individuals—appealed in October in the case now known as Utah et al. v. Julie Su et al. The 5th Circuit hears appeals from federal cases in Louisiana, Mississippi and Texas.

The DOL argued its response to the appeal in much the same way that it did in district court: Fiduciaries are not permitted to subordinate the interest of the plan when considering ESG factors, and they may only consider nonfinancial factors to the extent that they are part of a prudent risk return analysis.

The DOL rejected the plaintiffs’ argument that the “rule improperly licenses fiduciaries to defy their statutory obligations by taking actions that are not in the financial interests of plan beneficiaries.” The DOL answered that “the rule does no such thing. To the contrary, a fiduciary engaging in such conduct would defy the clear text of the rule.”

Further, the DOL argued that the tiebreaker rule was the “best construction of ERISA.” Previously, fiduciaries could only use collateral benefits as a tiebreaker if the two choices were otherwise “indistinguishable,” a standard relaxed to “equally serve the interests of the plan.” The DOL’s filing notes investments need not be identical in order to equally serve the plan, and it is not always possible to choose both. Picking one or the other randomly, such as by a coin flip, is itself a collateral benefit, because it is nonfinancial and produces no marginal benefit to considering other nonfinancial factors.

The DOL added that, “if plaintiffs are correct that such ties are infrequent, that does not mean the tiebreaker standard is invalid; it just means the standard applies infrequently.”

The plaintiffs have not yet filed an answer, and oral arguments have yet to be scheduled.