DOL files motion/brief opposing preliminary injunction in ESG litigation

On February 21, 2023, plaintiffs in Utah v. Walsh (AKA the ESG lawsuit) filed a motion for a preliminary injunction of the Department of Labor’s ESG/proxy voting rule. On March 28, 2023, the Department of Labor filed its motion in opposition.

In this article, after providing background, we briefly discuss parts of this proceeding that may be relevant to the interpretation of DOL’s ESG rule or ongoing litigation in this case or that may come up in other ERISA litigation.

Background

There has been, since the 1990s, a tug of war between Administrations over the content of DOL guidance with respect to environmental, social, or governance (ESG) investing and plan fiduciaries’ obligations with respect to the exercise of shareholder rights (e.g., proxy voting) for plan-held securities. At the end of the Trump Administration (in 2020), DOL finalized amendments (the 2020 Rule) to its ERISA investment duties and proxy voting rules, tightening in some respects the rules with respect to ESG investing and to some extent “downplaying” fiduciaries’ obligations to exercise shareholder rights.

On taking office, President Biden issued an Executive Order instructing DOL to review the 2020 Rule. In October 2021, DOL proposed amendments to the 2020 Rule, in effect backpedaling on a number of its features, and then published final amendments to the 2020 Rule on December 1, 2022, (the 2022 Rule). (We are providing as a resource a brief summary of/takeaways from the changes made by the 2022 Rule to the 2020 Rule.)

On January 26, 2023, a group of plaintiffs including 25 states, an energy company, an oil and gas trade association, and a plan participant filed a complaint against DOL in United States District Court for Northern District of Texas (Amarillo Division), claiming that DOL, in adopting amendments to its ESG (environmental, social, and governance) investment/proxy voting regulation, (1) exceeded its authority under ERISA and the Administrative Procedure Act (APA) and (2) violated the APA’s arbitrary and capricious standard and is irreconcilable with the language of ERISA.

As we noted, on February 21, 2023, plaintiffs filed a motion for a preliminary injunction, and on March 28, 2023, DOL filed its motion in opposition.

Plaintiffs’ motion and DOL’s response

There are, generalizing, two “big questions” about plaintiffs’ motion for a preliminary injunction. First, do the plaintiffs have standing to bring it? And second, does their case meet the standards for a preliminary injunction?

Standing

As expected, in their response to plaintiffs’ motion, DOL makes a number of arguments against the standing of plaintiffs (particularly the State plaintiffs) to bring this lawsuit. Standing generally requires a showing of “(1) ‘an injury in fact,’ (2) ‘fairly traceable to the challenged conduct,’ (3) ‘that is likely to be redressed by a favorable judicial decision.’”

Standing here has, for plaintiffs, always seemed like something of a longshot. The States argue for standing based on lost tax revenues (because of reduced taxable distributions to participants) and injury to their citizens (because of bad fiduciary investment decisions). The energy company argues that it will have increased fiduciary monitoring costs and will lose access to capital. And the individual participant (also) argues that he will be injured by bad fiduciary investment decisions.

We flag the issue of standing because it seems to be one of the most likely reasons plaintiffs’ motion will be rejected.

Grounds for a preliminary injunction – likelihood of success on the merits

To get a preliminary injunction, a plaintiff must generally show “(1) ‘a substantial threat of irreparable injury,’ (2) ‘a substantial likelihood of success on the merits,’ (3) ‘that the threatened injury if the injunction is denied outweighs any harm that will result if the injunction is granted,’ and (4) ‘that the grant of an injunction will not disserve the public interest.’”

We focus on the second issue – “a substantial likelihood of success on the merits” – as the parties’ discussion of that issue goes to the substance of the legal validity DOL’s 2022 Rule.

Three issues raised by plaintiffs are of particular interest:

Tiebreakers and the exclusive purpose rule

Plaintiffs argue that, “[d]espite ERISA’s clear commands, the 2022 Rule expressly authorizes fiduciaries to act, or removes prohibitions on acting, for nonpecuniary purposes.” Plaintiffs argue that the 2022 Rule’s elimination of the pecuniary/non-pecuniary distinction “free[s] fiduciaries to pursue ‘collateral benefits’ and nonpecuniary objectives, contrary to ERISA.” Citing Fifth Third Bancorp v. Dudenhoeffer, they argue that “pecuniary benefits” are the only permitted plan investment objective, that DOL, in all its guidance (with the possible exception of the 2020 Rule), has “never grappled with Dudenhoeffer,” and that post-Dudenhoeffer, ERISA effectively prohibits a fiduciary from acting for nonpecuniary purposes.

Plaintiffs’ interpretation of ERISA’s requirements would negate DOL’s longstanding position, recapitulated in the 2022 Rule, that a fiduciary may act for more than one purpose, and that, e.g., in the case of “tiebreakers” a fiduciary may select an investment based on a “collateral” (i.e., nonpecuniary) benefit. Thus, in its motion in opposition, DOL argues that:

The [2022] Rule … recognizes what [ERISA] section 404’s text does not address: a situation in which a fiduciary is presented with two investment courses of action that are economically equivalent. In that circumstance, the fiduciary’s duty to act ‘for the exclusive purpose of providing benefits’ to plan participants does not provide the answer as to which of two equivalent investments to select; each is equally beneficial from an economic perspective. … Acknowledging this gap in the statute, DOL has, for nearly three decades and across five presidential administrations, including in the 2020 Rule, advised fiduciaries that ERISA does not prohibit looking to collateral benefits where competing investment alternatives are equally beneficial financially.

Plaintiffs are, in effect, arguing that Dudenhoeffer changed the law on ERISA’s exclusive purpose (duty of loyalty) standard. Many will see this position as radical – it will be interesting to see how the court handles this issue.

Adoption of the 2022 Rule was “arbitrary and capricious”

Plaintiffs make several arguments for why adoption of the 2022 Rule was “arbitrary and capricious” (and therefore violated the Administrative Procedure Act), including that DOL did not give adequate reasons for changing the 2020 Rule (arguing that “an agency must ’provide a more detailed justification than what would suffice for a new policy created on a blank slate . . . when, for example, its new policy rests upon factual findings that contradict those which underlay its prior policy’”), had prejudged its decision (before soliciting comments), and had not considered alternative, sub-regulatory solutions.

DOL, in reply, argues that it is generally not required to do anything other than what it did – propose a revision to the 2020 Rule, give reasons why it believed those revisions to be necessary, and respond to comments.

Nonpecuniary factors and proxy voting

A final target of plaintiffs’ lawsuit was DOL’s elimination of language in the 2020 Rule that prohibited fiduciaries from exercising shareholder rights to “promote non-pecuniary benefits or goals unrelated to those financial interests of the plan’s participants and beneficiaries.” This change, they argue, implicitly authorizes fiduciaries “to consider nonpecuniary factors in proxy voting and exercising shareholder rights,” in violation of ERISA’s exclusive purpose/fiduciary duty of loyalty rule.

In response, DOL argues that this language was eliminated because it was redundant with language in the regulation “unequivocally” stating that “in exercising shareholder rights, ‘plan fiduciaries must act solely in accordance with the economic interest of the plan and its participants and beneficiaries’ … [and that] [p]roxy voting policies must also be ‘designed to serve the plan’s interests in providing benefits.’”

In support of their position, plaintiffs again cite Dudenhoeffer. And in a sense, this issue is another version of the argument above with respect to “collateral benefits” and tiebreakers – does ERISA (post-Dudenhoeffer) prohibit nonpecuniary-motivated fiduciary actions, even where they have no negative financial effect?

A substantial threat of irreparable injury

We are not going to address the preliminary injunction requirement of ‘a substantial threat of irreparable injury’ in detail – it’s technical and more of a litigator’s issue. But we note that the injuries plaintiffs allege (see the above discussion of standing) are generally speculative and do not seem “urgent.” Moreover, as DOL notes, “Plaintiffs’ unexplained delay in seeking emergency injunctive relief – a full three months after the Rule was signed, and nearly a month after its effective date – alone counsels against finding irreparable harm.”

*     *     *

ESG has been a headline grabbing issue for some time, and (arguably) headlines are part of plaintiffs’ motivation. We would still bet that the court will reject this motion, probably on the issue of standing or the absence of a “threat of irreparable injury.”

We will continue to follow these issues.

This is a publication of O3 Plan Advisory Services. If you have any comments, or have questions about regulatory developments, please contact your relationship manager or Mike Barry at mbarry@octoberthree.com.    The information, analyses and opinions set out herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. Nothing herein constitutes or should be construed as a legal opinion or advice. You should consult your own attorney, accountant, financial or tax advisor or other planner or consultant with regard to your own situation or that of any entity which you represent or advise.   Information set out or referred to above has been obtained from sources believed to be reliable. However, neither O3 Plan Advisory Services nor any of its affiliates has verified the accuracy or completeness of any such information. All information is provided “as is” and O3 Plan Advisory Services and its affiliates expressly disclaim all express and implied warranties regarding the information. Neither O3 Plan Advisory Services nor any of its affiliates shall have any liability for any use of the information set out or referred to herein.