ESG Regulation and Northwestern Litigation Updates

While we work to assess opportunities provided by the SECURE 2.0 Act of 2022 and await related governmental agency guidance, two additional developments merit additional discussion. Congress, President Biden, and the Federal courts have all had fiduciary items on their mind. Here’s an update on the so-called “ESG regulation” and the latest developments in the Hughes v. Northwestern University litigation. We hope you’ll tune into our upcoming Fiduciary 15 webinar that will take a deeper dive into these topics and register for the 15^th Annual Qualified Plan Fiduciary Summit on April 25.

The ”ESG Regulation”. In December of 2022, the Department of Labor (DOL) published a final regulation entitled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights”. Although not entirely accurate, many refer to the regulation as the “ESG rule”, in reference to questions about fiduciaries’ ability to consider “environmental, social, and governance” factors when evaluating and selecting plan investments. (If one were to ask various members of Congress or the Attorneys General for half of the states, the regulation may also be described as “woke” – particularly if the public official were running for office in the near future.) The regulation has been attacked through two different processes, one of which has concluded and the other still in process.

Congressional Challenge + Presidential Veto. Congress adopted a resolution to overturn the DOL regulation. The vote occurred largely on party lines, with a couple of Senate Democrats joining Republicans to pass the resolution in the Senate. President Biden subsequently used the first veto of his presidency to override Congress’s resolution.

Although the veto leaves the regulation in effect, this process is significant for a couple of reasons. First, Congress’s efforts – despite the inevitability of a veto – confirm that “ESG” remains a heavily politicized topic. Second, in the event the Republicans were to retake the White House and retain Congressional power in 2025, it appears likely that Congress would repeat the process, avoid any veto threat, and succeed in striking down the regulation.

Litigation Challenge. In addition, 25 states have joined with a handful of private companies to file a lawsuit aimed at striking down the DOL regulation. The lawsuit alleges that the regulation is outside of the DOL’s authority and undermines key protections for participants’ retirement savings.

On March 28, 2023, the DOL responded on two primary grounds: (1) the plaintiffs lack standing; and (2) the plaintiffs cannot meet the criteria for receiving a preliminary injunction that would stall application of the regulation. As this case continues to work its way through the courts, take note of the following comments from the DOL’s filing:

• As we wrote in a previous newsletter, the regulation does not require fiduciaries to take ESG factors into account.
• Instead, it swung the pendulum back to neutral, removing the “thumb on the scale” against consideration of ESG factors (from the Trump DOL regulation) and confirming that there should not be a thumb on the scale in favor of ESG factors (as the Biden DOL’s proposed regulation appeared to provide).
• Fiduciaries’ “exclusive purpose must be to secure financial benefits for plan participants and beneficiaries, and that this purpose may never be subordinated to unrelated goals.”
• “This lawsuit rests on a false premise that the Rule permits fiduciaries to pursue non-financial goals in violation of their statutory duties under ERISA. Not so.”

What Should Fiduciaries Do? As we have noted previously, much of the final regulation should not be controversial. It recites commonly accepted fiduciary principles relating to the two core responsibilities included in the regulation’s title: prudence and loyalty. The entire regulation references “ESG” only one time, and that reference is limited to the permissible consideration of the economic effects of ESG factors.

However, Congress, the Attorneys General for 25 states, and a number of private companies have given fiduciaries reason to pause. At this stage, fiduciaries are well-served to stick to the traditional fiduciary principles recited within the regulation:

1. A fiduciary’s determination with respect to an investment must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis.
2. Whether any particular consideration is a risk-return factor depends on the individual facts and circumstances.
3. The weight given to any factor by a fiduciary should appropriately reflect a reasonable assessment of its impact on risk-return.
4. A fiduciary may not subordinate participants and beneficiaries’ interests in retirement income or financial benefits under the plan to other objectives.
5. A fiduciary may not sacrifice investment return or take on additional investment risk to promote benefits or goals unrelated to the participants’ interests in retirement income or financial benefits under the plan.
6. A fiduciary may not, however, accept expected reduced returns or greater risks to secure additional benefits.

Join the Fiduciary 15 webinar as we discuss those six principles, as well as the two regulation provisions that serve as the basis for opponents’ challenges.

Hughes v. Northwestern Continues. Many may recall the Supreme Court’s Hughes v. Northwestern University opinion from January of 2022. The lower courts had granted the Northwestern fiduciaries’ motion to dismiss fiduciary breach claims brought against Northwestern plan fiduciaries. The Court remanded (sent back down) the case with instructions that the lower court better consider the Court’s prior fiduciary guidance and the appropriate standard for determining whether plaintiffs should survive a motion to dismiss.

On March 23, 2023, the U.S. Court of Appeals for the Seventh Circuit published an opinion that re-examined the plaintiffs’ allegations and applies the Supreme Court’s guidance. In short, it determined that two of the plaintiffs’ claims should indeed survive the motion to dismiss. Those claims relate to excessive recordkeeping fees and the failure to use institutional share class investment options. In doing so, the court clarified the applicable pleading standard as follows: a plaintiff must plausibly allege fiduciary decisions outside a range of reasonableness. In this month’s Fiduciary 15 webinar, we’ll expand on that standard and discuss the facts-and-circumstances basis for determining the applicable range.

Again, please be sure to register for this month’s Fiduciary 15. In addition, please visit the registration page for the 15^th Annual Qualified Plan Fiduciary Summit. The Summit agenda reflects that you’ll have the opportunity to hear from Fred Reish, the nation’s leading ERISA Attorney, as he provides additional commentary around SECURE 2.0.