ESG 401(k) Rule Case Sets Up Early Appellate Test Post-Chevron

One of the first tests of the post-Chevron legal landscape is set to hit the conservative-leaning Fifth Circuit on Tuesday as it hears a challenge to a major Biden climate change initiative aimed at encouraging sustainable investing in 401(k) plans.

Judge Matthew Kacsmaryk of the US District Court for the Northern District of Texas leaned heavily on the Chevron doctrine in his September decision that the US Labor Department acted within its authority in issuing the environmental, social, and corporate governance investing rule.

But that was before the US Supreme Court overturned Chevron in Loper Bright Enterprises v. Raimondo June 28, ending the requirement that judges defer to reasonable agency interpretations when the law is ambiguous or silent.

The coming showdown at the US Court of Appeals for the Fifth Circuit between the Biden administration and red state attorneys general suing over the ESG regulation could have a broad influence over how courts deal with these Administrative Procedure Act rules challenges post-Loper Bright. Federal district court judges have already begun to override Biden rulemaking in the days since the justices’ decision.

The Republican attorneys general in their appeal zeroed in on the ESG rule’s revision of a 30-year-old test known as the “tiebreaker standard,” claiming the update violates federal benefits law. The DOL standard allows retirement plan sponsors and other fiduciaries to select one investment over another based on “collateral benefits,” when two or more options are economically equivalent.

The states led by Utah in a letter filed just hours after Loper Bright said the decision means the tiebreaker standard and other parts of the ESG rule formulated by the DOL’s Employee Benefits Security Administration cannot stand under the APA, pointing to Kacsmaryk’s reliance on agency deference.

The DOL quickly struck back, arguing that its do-good investing rule does not need agency deference to be sustained, and that its latest Fifth Circuit brief did not rely on the Chevron doctrine at all.

‘Not Going Away’

Overturning the ESG regulation would impact the scope of investment selections available to retirement savers, as well as their ability to sue employers for breaches of their plan sponsor duties.

It also would be a major salvo in a political battle over the role of ESG factors in the investing world at large and on retirement plan menus specifically.

EBSA finalized the ESG regulation in 2022, two years after a Trump-era rule addressing the issue strictly limited retirement investment choices based on use of “non-pecuniary” factors.

Shortly after the Biden rule was enacted, the GOP attorneys general sued to block its enforcement, while their allies in Congress launched legislation aimed at eliminating it.

President Joe Biden used the first veto of his presidency to reject a Congressional Review Act measure that would have thwarted the rule, but the litigation remains.

The Fifth Circuit in particular has proved a popular venue for those suing over Biden administration rules.

But the DOL is holding its ground, arguing in its brief to the appeals court that its rulemaking is consistent with the Employee Retirement Income Security Act, as plan fiduciaries using ESG factors under its tiebreaker standard are still carrying out their fiduciary duty to act in investors’ best interests.

“I think it’s very noteworthy that Judge Kacsmaryk, who has a reputation for being one of the most conservative judges in the country, appropriately and correctly reached the conclusion that the Biden rule should not be vacated,” said Jason Levy, of counsel at Covington & Burling LLP. “I think that may be predictive, whether it’s a conservative panel or en banc in the Fifth Circuit, of how the Fifth Circuit may rule as well.”

Levy represented J. Mark Iwry, a former Treasury Department official, in his amicus brief supporting the DOL in the appeal.

Several amicus briefs filed in support of the red-state AGs on appeal said “political activism” shouldn’t factor into workers’ retirement savings under ERISA.

The argument that sustainability factors should be excluded from retirement accounts has gained steam even as the principles become more popular among some investment managers.

In another Northern District of Texas case that recently went to a bench trial, a pilot sued American Airlines Group Inc. alleging that its 401(k) plan is loaded with “leftist political agendas” because of the inclusion of funds from BlackRock Institutional Trust Company Inc. and other asset managers.

ERISA-type ESG cases are getting “more and more attention in the courts,” said Joanne Roskey, a member of Miller Chevalier Chartered’s employee benefits practice. “These issues are not going away, and I think clarification on the rule that’s going to be used to guide these decisions is going to be really important.”

Flow Law Firm PLLC represents the states along with the offices of the plaintiff attorneys general.

The case is Utah v. Su, 5th Cir., No. 23-11097, oral argument scheduled 7/9/24.