Both the US House of Representatives and the Senate passed a resolution to overturn the US Department of Labor’s so-called “ESG Rule” on February 28 and March 1, 2023, respectively. The ESG Rule has been a topic of debate as it sought to clarify the role that environmental, social, and governance (ESG) factors can play in fiduciary decision-making on behalf of retirement plans regulated by ERISA. This resolution is part of a larger effort to limit ESG investing at both federal and state levels.
The ESG Rule, released in final form in November 2022, provides ERISA-regulated fiduciaries greater flexibility and leeway to consider ESG factors and explicitly allows for the consideration of certain ESG factors that are financially relevant to an investment’s risk-return analysis.
The House and Senate voted to overturn the ESG Rule through the Congressional Review Act (CRA), which allows Congress to repeal a final rule issued by a federal agency within 60 legislative days of its going into effect via a simple majority in both chambers (the majority of the ESG Rule’s provisions went into effect on January 30, 2023).
The resolution passed the House with a party-line vote of 216–204, with only one Democrat crossing the aisle, and passed by a slim majority in the Senate, 50-46, with two Democrats crossing the aisle. President Joseph Biden has already declared he will use his veto power over the CRA resolution.
While this attempt to overturn the ESG Rule will likely be unsuccessful, it is not the only challenge the rule faces.
In the last month, multiple plaintiffs have filed two separate lawsuits seeking to block the DOL from enforcing the ESG Rule. Both lawsuits allege that the ESG Rule politicizes the retirement system by allowing consideration of ESG factors—which they allege may be tied to policy or ethically motivated goals—in fiduciary decision-making.
The first lawsuit, Utah v. Walsh, was filed in late January in the Northern District of Texas. The Utah plaintiffs, a coalition of attorneys general from 25 states, and three private plaintiffs allege that the ESG Rule oversteps DOL authority and is arbitrary and capricious under the Administrative Procedure Act. The second lawsuit, Braun v. Walsh, was filed in late February in Wisconsin district court. The two Braun plaintiffs, both of whom are participants in ERISA-regulated retirement plans, argue that the ESG Rule violates ERISA and exceeds the authority granted to the US secretary of labor by statute.
Additionally, since the start of the 2023 legislative session in mid-January, 26 states have proposed their own versions of ESG investing regulations, 23 of which seek to limit or restrict the consideration of ESG factors by state funds and/or their fiduciaries, in direct contrast to the ESG Rule. Eight states already enacted similarly restrictive bills in the prior legislative session.
These bills do not outright ban the consideration of ESG factors. Rather, they mandate that fiduciaries or companies may only consider those factors that are relevant for financial, rather than social or ethical, reasons. ERISA preempts these state laws from applying to private employer-sponsored retirement plans, but state regulations do serve as a harbinger of future federal ESG regulation if there were a shift in control of the Senate and the White House.
This regulatory dynamism underscores why it is important for fiduciaries to carefully ponder the role that ESG considerations play in their investment decisions. Neither the CRA resolution, nor the federal lawsuits, nor the state regulations would result in outright bans on the consideration of ESG factors in investing, writ large—their ultimate focus is on limiting the reasons why fiduciaries and companies may consider certain ESG factors.
Viewed through that lens, the ESG Rule and these challenges are not necessarily at direct odds with one another. Rather, these legislative and judicial challenges may clarify the lens through which fiduciaries and companies consider ESG, encouraging fiduciaries to document why the ESG factors they rely on are financially relevant to an investment’s risk and return characteristics.