Republicans at the state and federal levels are challenging a Biden administration rule (the "Rule") intended to walk back Trump-era regulations restricting the ability of retirement fund managers to consider climate change and other ESG factors in making investment decisions. The Rule, which went into effect in January 2023, aims to "clarify[] that fiduciaries may consider climate change and other environmental, social, and governance (ESG) factors when they make investment decisions and when they exercise shareholder rights, including voting on shareholder resolutions and board nominations."
Two separate lawsuits challenging the Rule are currently pending in the United States federal courts. Days after the Rule went into effect, a coalition of 24 Republican-controlled states, led by Texas Attorney General Ken Paxton, sued the Department of Labor in Texas district court, challenging the Rule. In a press release accompanying the complaint, Ken Paxton stated that "beyond being detrimental to the retirement accounts of hardworking Americans, the rule is fundamentally unlawful, as well as arbitrary and capricious. It violates both the Employee Retirement Income Security Act of 1974 ("ERISA"), which was created to protect retirement assets, and the Administrative Procedure Act." The Department of Labor has also departed from prior policy, as its 2020 rule required that financial factors take precedence over nonfinancial or nonpecuniary factors. The suit is pending before Judge Matthew Kacsmaryk, a Trump appointee who has overseen several high-profile cases, including most recently a challenge to the Food and Drug Administration's approval of a medication abortion pill called mifepristone.
A similar lawsuit brought by two participants in ERISA-regulated retirement plans was filed in Wisconsin federal court in February.
Because the lawsuits challenge the use of "ill-defined, subjective ESG concepts" instead of purely pecuniary factors permitted by the Rule, the outcome of these lawsuits could have wide implications to the ESG investment sector more generally. More specifically, however, retirement plan fiduciaries who intend to use the greater flexibility to consider ESG factors afforded by the Rule will need to be prepared to react to any successful challenges to the Rule, and the litigation that may follow.
Litigation is not the only challenge to the Rule, and congressional Republicans have made clear that they will take an aggressive stance against ESG investing. Representative Andy Barr of Kentucky stated that he and his team will "mark up a series of bills to counter the ESG movement." Congressional Republicans are working on new ESG legislation that would amend ERISA to mandate that retirement account managers consider only pecuniary factors when investing and explicitly rule out ESG factors. This new bill is a direct response to President Biden's recent veto blocking a bill that would overturn the Rule.
Given the multiple challenges to the Rule, it is likely to be some time before it is clear whether the Rule will continue in effect, and if so, whether it will be modified.
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