‘Neutral’ ESG rule draws GOP fire in court and Congress

For a “neutral” regulation, the Labor Department’s ESG rule is attracting a lot of opposition on its rollout.

The DOL’s environmental, social and governance rule was years in the making as it volleyed from one side to the other, from the Trump administration to Biden’s. The final rule that went into effect Jan. 30 peeled off some of the provisions that opponents found objectionable, but they still objected, said Brad Campbell, an ERISA expert at Faegre Drinker.

The rule allows fiduciaries to consider ESG goals in their analysis with clients’ retirement funds but may not sacrifice investment returns or increase risk in pursuit of those goals.

“It's a pretty significant amount of neutrality, frankly, that goes into the final rule. Nonetheless, though, this is now a bigger political issue.”Brad Campbell, an ERISA expert at Faegre Drinker

“It's a pretty significant amount of neutrality, frankly, that goes into the final rule,” Campbell said during a recent Faegre webinar. “Nonetheless, though, this is now a bigger political issue.”

The politics are playing out in a few dozen red states, such as Texas, where attorneys general from 25 states filed a lawsuit to block the ESG rule just a few days before it went into effect.

The AGs claim that the rule removed protection for retirement plan participants, and that the DOL overstepped its authority under ERISA with an arbitrary and capricious regulation.

The argument is similar to one made by blue states in a suit opposing the Securities and Exchange Commission’s Regulation Best Interest rule, said Campbell, who was DOL’s assistant secretary for employee benefits during the George W. Bush administration.

ESG rule drew 'clear dividing lines'

“In that case, the Second Circuit told the blue states they didn't have standing. It was too tenuous a connection. We'll see what the courts say here,” Campbell said. “As far as the merits of the litigation go, this new litigation against the so-called ESG rule is probably not that strong a case purely as a legal matter. But politically, it did draw some clear dividing lines, and we should anticipate a lot more debate in the House of Representatives, especially on ESG-related issues.”

It didn’t take long for Republicans to take on the rule. On Feb. 1, every Senate Republican vowed to overturn the regulation in a joint resolution with the Republican-led House of Representatives. The announcement was more significant because of support from Democrat Joe Manchin of West Virginia in the closely divided body.

They plan to file a Congressional Review Act resolution, which allows Congress by simple majority to disapprove a federal agency’s rule within 60 legislative days of its effective date.
Sen. Mike Braun, R-Ind., said in the announcement that the regulation is jeopardizing retirement savings for a political agenda.

“In a time when Americans’ 401(k)s have already taken such a hit due to market downturns and record high inflation, the last thing we should do is encourage fiduciaries to make decisions with a lower rate of return for purely ideological reasons,” Braun said. “That’s why we are proud to stand up against this rule for the millions of Americans who depend on these funds for their retirement.”

ESG within prudent reason

The new rule puts ESG on par with other investment options, Campbell said in the webinar.
Fiduciaries can include ESG-related factors if they determine they are relevant. They can also have ESG factors present in a default investment alternative for automatic enrollment.
“There are no restrictions on using any of these types of investments for that,” Campbell said. “You continue to make your normal, prudent, thorough fiduciary process decision.”

The Biden administration had proposed a more far-reaching rule, he said, such as saying that prudence may often require the consideration of ESG factors.

Fred Reish, another Faegre Drinker retirement funds legal expert, said in the webinar that he agreed that the final rule found a spot in between the two positions.

The Biden administration had its “finger on the scale” in its proposed rule leaning toward requiring ESG considerations, Reish said, adding that the Trump-era proposal tilted the scale in the other direction. When the Trump-era DOL introduced its rule, then-Secretary Eugene Scalia said that retirement plans were not vehicles for social goals or policy objectives not in the financial interest of the plan. The final Biden administration rule also puts a heavier emphasis on plan performance.

“That's why it surprised me that a lawsuit has been filed because if you read the regulation, and you ignore the rhetoric, I don't know what they're complaining about,” Reish said. “It says you can't sacrifice return, you can't take greater risk to achieve these other purposes, whether they're ESG or not. You have to focus on the participants and the risk and return profile of the investment that I mean that seems pretty darn neutral to me.”

Steven A. Morelli is a contributing editor for InsuranceNewsNet. He has more than 25 years of experience as a reporter and editor for newspapers and magazines. He was also vice president of communications for an insurance agents’ association. Steve can be reached at [email protected].

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