Biden ESG 401(k) Rule’s Survival in Court Pressures Trump to Act

A Texas federal court ruling that greenlit a Biden-era eco-friendly 401(k) investing rule puts pressure on the Trump administration to go back to the regulatory drawing board and defend its “anti-woke” policy.

The 2022 rule that permits retirement plans to consider environmental, social, and governance factors when selecting investments contradicts the effort President Donald Trump undertook during his first term to limit the proliferation of ESG funds in private-sector nest eggs.

Yet, US District Court for the Northern District of Texas Judge Matthew Kacsmaryk found little meaningful distinction between the Trump and Biden-era rules when he allowed the ESG regulation to stand on Friday.

It was the second win in a conservative-leaning court for the former administration’s rule and comes after several states have stood up to ESG money managers in their own public pensions. Rallied by GOP allies, the US Labor Department back under Trump’s control is now poised take a more radical approach on do-good retirement investing.

The Texas case, once considered the GOP’s best shot at undoing the Biden rule, quickly morphed into one piece of a broader partisan push to scrub ESG consideration among Wall Street asset managers, largely inspired by Trump. States such as Florida and Texas are defending laws that outright prohibit ESG factors and ban money managers that engage in climate-action causes. In his second term, Trump could follow their example, said Josh Lichtenstein, a Ropes & Gray LLP partner in New York.

“There’s been a lot of influence between the states and the federal government,” Lichtenstein said. “A lot of the state laws that were ultimately adopted after the Trump rules went further by focusing on things like proxy voting or memberships in net-zero organizations. I can imagine that a new rule from the Department of Labor might incorporate those approaches.”

Caught in the crossfire are hundreds of thousands of private-sector retirement plans and nearly $14 trillion in capital. Amid the regulatory ping-pong, Americans’ savings are held hostage by varying political interpretations of decades-old law.

“How this gets interpreted and how you’re able to make decisions will directly impact how and when investment managers select investments,” said Bradley Fay, a Seward & Kissel LLP partner who counsels employee benefit plan clients on investment plan assets.

Different Approach

Despite the pressure to act, there’s also reason to believe Trump may avoid the arduous notice-and-comment rulemaking process or even abandon its ESG policy altogether.

Kacsmaryk’s ruling struck a compromising tone, said Amy Gordon, a Winston & & Strawn LLP partner in Chicago. The administration could chalk that up to a win or take a leaf out of Biden’s book by using the subregulatory process to go after ESG considerations. Agencies like the DOL’s Employee Benefits Security Administration have thesubregulatory power to interpret law and make enforcement recommendations that don’t carry the legal weight like regulations do, but can affect actions the regulated community take.

Such was the case amid an uptick in 401(k) recordkeepers cozying up to cryptocurrency exchanges when EBSA under President Joe Biden issued a scathing compliance assistance notice in 2022 that verged on a ban of Bitcoin and other digital currencies in 401(k)s. The guidance survived a federal court challenge because it didn’t carry the weight of a “final agency action,” despite chilling uptake in crypto 401(k)s by putting plans on notice of a looming enforcement crackdown.

“If the Trump administration wanted to come out and say anything was a problematic investment, that’s a clear road map for doing it,” said Gordon.

The feuding Trump and Biden ESG rules were largely hypothetical when they were first introduced and challenged, since 401(k)s and other defined-contribution retirement plans had largely avoided wading into so-called “do-good” investing. Since then, American Airlines Group Inc. has lost a high-profile challenge to its 401(k) plan on the basis that its relationships with pro-ESG money managers subverted its duty of loyalty to participants and beneficiaries.

That’s a win for ESG detractors. It’s possible that EBSA under Trump could avoid resurfacing a rule or guidance to allow that process to play out in the courts, said Lichtenstein.

Meanwhile, Trump’s choice to lead EBSA is a insurance executive whose clients have faced scrutiny over legal challenges such as ESG considerations. By selecting ENCORE Fiduciary President Daniel Aronowitz for the chief benefits regulator spot, observers believe the administration is signaling an interest in tamping down private-sector litigation altogether. Aronowitz, in fact, has criticized the department’s focus on “political” issues such as ESG and fiduciary rulemaking.

“He’s felt like the DOL has focused too much of its energy on those kinds of issues,” said Lynn Dudley, senior vice president for global retirement and compensation policy at the American Benefits Council. “The ESG rule has distracted the industry in his view, and the agency needs to focus and get down to brass tacks to simplify things for retirement plans.”