On February 14, 2025, the District Court in State of Utah v. Micone upheld the 2022 Biden-era fiduciary investment regulation, including the tiebreaker rule which allows fiduciaries to consider collateral benefits when and after investments are equally beneficial to participants. But if you believe that the ruling opens the floodgates for ESG investments in ERISA-sponsored plans, think again. Even though the Republican Attorneys General lost the battle, they won the war. No matter what the Biden Administration intended with the 2022 Rule, Judge Kacsmaryk’s decision makes clear that social investing in retirement plans will rarely, if ever, meet ERISA’s stringent fiduciary duty to act solely in the best financial interests of plan participants.
After the Supreme Court eliminated Chevron deference to agency regulations, we cautioned that many lawyers were over-reacting to its impact. See The Overreaction to the End of Chevron Deference – Encore Fiduciary We reasoned that the decision would not lead to the predicted avalanche of new regulatory lawsuits, because most consequential regulations are already challenged in court. We also predicted that it would not have a major impact on judicial review of agency regulations. The State of Utah holding that the Biden fiduciary investment rule with a tie-breaker provision does not violate ERISA, even after the end of Chevron deference, proves this point.
The more critical issue is how ESG and economically targeted investments in retirement plans will fare under the tie-breaker rule when applied in future decisions. Here again, any fear that fiduciaries will now have free reign to invest with improper ulterior ESG motives is misplaced. The reason is that the State of Utah opinion, while upholding the tie breaker rule, does not allow investments predicated on any ulterior motive. Anyone who wants to invest ERISA fiduciary assets with an ESG or economically targeted investment agenda will be disappointed. It is not allowed in most instances under a careful reading of the opinion and the 2022 fiduciary investment rule.
There is key nuance missing in the political war over ESG investing when applied to ERISA retirement plans, which is this: you are not permitted under ERISA to use fiduciary assets to achieve a social impact. That is an improper motive. You are, however, permitted — even required — to take into account all factors that affect the pecuniary interests of plan investments. That may include environmental or governance factors that will affect the long-term investment value in a proper risk-return investment analysis, such as when a company factory is polluting the environment. But you are not permitted to start an investment analysis with any improper motive to bring your political views or ulterior objectives into an investment decision in an ERISA plan. Simply put, you cannot change the world with fiduciary assets. That is not allowed, even when applying the tie-breaker rule. But ESG investing is not the same as a careful analysis of all possible risk-return factors that affect an investment. This critical nuance is lost in the politics of ESG as it relates to retirement plans.
The following is an analysis of three key issues from the State of Utah decision. These issues demonstrate that it will be extremely difficult to justify an ESG investment motive under the DOL’s investment rule and tie-breaker test.
KEY POINT #1: The tie-breaker test under State of Utah requires fiduciaries to act in the best financial interests of plan participants with no upfront social agenda or political motivation.
The Trump-era investment rule, titled Financial Factors in Selecting Plan Investments Rule (2020 Rule), forbade ERISA fiduciaries from considering nonpecuniary factors when making investment decisions. The 2020 Rule clarified that fiduciaries may only evaluate investments “based . . . on pecuniary factors.” The 2020 Rule made clear that fiduciaries must “act with a single-minded focus on the interests of beneficiaries” in accord with the duty of loyalty. It forbade subordination of financial benefit considerations to other objectives. Nevertheless, the 2020 Rule did not bar the consideration of nonpecuniary factors to break the tie between two “economically indistinguishable” investment alternatives. The 2020 Rule imposed documentation requirements when this occurred, reflecting the belief that a legitimate tie between ESG and neutral investments will be very rare. According to the Texas court, “confusion ensued” because fiduciaries supposedly no longer had clarity on whether nonfinancial factors could be considered “even when those factors are financially material.”
In 2022, the Department of labor promulgated a replacement rule entitled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights” (2022 Rule) that, among other things, allowed fiduciaries to consider collateral benefits when deciding between competing investment options that each equally serve the beneficiaries’ financial interests. The 2022 Rule clarified that risk and return factors “may include” – changed from the initial proposal of “may often require” – environmental, social, and governance (ESG) and related nonpecuniary factors depending on individual facts and circumstances. The 2022 Rule also modified the 2020 Rule’s standard for the tiebreaker provision to “equally serve the financial interest of the plan over an appropriate time horizon.” Finally, it eliminated the 2020 Rule’s documentation requirements surrounding the tie-breaker provision to not deter fiduciaries from finding a tie between two investment options.
The Republican State Attorney Generals sued to stop what they considered to be improper ESG investments allowed under the 2022 Rule. For the second time, after the remand from the Fifth Circuit to consider how the end of Chevron deference affects the Rule, the Northern District of Texas held that “[a] fiduciary has acted in full accord with his ERISA duty of loyalty when he chooses between investment options that all are valid options because they each maximize the beneficiaries’ financial benefits.” But the devil is in the details. While finding that the 2022 tie-breaker rule is valid under ERISA, the Court nevertheless explained how the tie-breaker works in practice, including dual guardrails that are extremely difficult to satisfy to justify an ESG investment.
To begin, the 2022 Rule permits fiduciaries to consider “collateral factors under tightly limited circumstances” – namely when a fiduciary must choose between two competing investment options that “equally serve the plan.” But the Court was clear that “[a] fiduciary must adhere to his duty of prudence when determining whether two competing investments truly equally serve the plan.” The court quoted from the regulation that the “tiebreaker provision installs double guardrails: both a strict ban on subordinating financial benefits and an insistence that any determination of a tie itself must be prudent.” (emphasis on “prudent” in DOL rule). From this background, the court held that the “2022 Rule’s tiebreaking provision does not violate ERISA’s text because it never permits fiduciaries to deviate from exclusively achieving financial benefits for the beneficiaries alone.”
The court used a driver analogy to illustrate the meaning of “exclusive purpose.” A driver duty-bound to choose the fastest route to his destination may choose the most scenic of two routes that each bring him to his destination at the same time. According to the court, “so too can a fiduciary choose a preferable investment option between two that will equally satisfy his duty of loyalty.” When the driver takes the most scenic of the two fastest, he does not act for a different purpose than taking the fastest route, because he chose the fastest route. But if he had chosen the two most scenic routes – and then selected the fastest of the two – he would have acted with an impermissible purpose. He could choose the most scenic of the two fast routes, but could not choose the fastest of scenic routes.
Just like the driver may not choose the fastest of the scenic routes, a fiduciary cannot choose the most lucrative of the other-factor options. “He would have no way of knowing he found the most financially advantageous plan if he began his search with impermissible factors. But he could consider them at the end once he reaches a tie because any chose is in accord with his duty.” The key point is that you cannot start your search with an ESG investment, and justify it after the fact. As we discuss below, this should doom the vast majority of all investments that contain a social agenda.
The following principles must be followed to meet the stringent duty to act in “exclusive financial benefit” of participants and beneficiaries:
- A fiduciary must act in the sole financial interest of plan participants:
- “A fiduciary violates ERISA’s duty of loyalty the second he acts for the interests of another or has any other purpose besides promoting financial benefits.”
- “Other considerations may be utilized if they do not alter or add to the interests the fiduciary represents or his purpose.”
- “Nothing in the tiebreaker provision of the 2022 Rule allows the fiduciary to act in a way contrary to the sole interests of the beneficiaries or for any purpose other than their financial benefit.”
- A fiduciary cannot begin the search with an impermissible social purpose: The tiebreaker permits consideration of collateral benefits only if the fiduciary has first determined that competing investments “equally serve the financial interests of the plan over the appropriate time horizon.” Stated differently, only after a “fiduciary prudently concludes that competing investments, or competing investment courses of action, equally serve the financial interest of the plan” can he then consider “collateral benefits” to choose.
- The rule does not permit mixed motives:
- The fiduciary cannot “be motivated by the purpose of advancing or expressing the trustee’s personal views concerning social or political issues or causes.”
- “[A] clear view of the common law reveals that it does not permit a fiduciary to act in two different capacities at once. A fiduciary, in the common law framework, may not act with conflicting interest because he ‘may favor the [other interest], whether consciously or unconsciously, over that of the beneficiaries.”
- An equal investment cannot sacrifice potential returns: The tie-breaker provision expressly bars fiduciaries from selecting investments with lesser returns in order to promote any collateral goal. “No form of so-called ‘social investing’ is consistent with the duty of loyalty if the investment activity entails sacrificing the interests of trust beneficiaries – for example, by accepting below-market returns – in favor of the interests of the persons supposedly benefitted by pursuing the particular social cause.” In sum, the permissible tie-breaker analysis requires fiduciaries to select financially prudent investments with no compromise in investment return.
Under these principles that require that plan fiduciaries act with an “eye single” to funding the retirements of plan participants and beneficiaries, investment decisions must be based solely on whether they enhance retirement savings, regardless of the fiduciary’s personal preferences. Even the tie-breaker rule makes it unlawful to sacrifice returns, or accept additional risk, through investments intended to promote a social or political end. As shown in the next section, very few social investments satisfy both parts of the tie-breaker test.
KEY POINT #2: If properly applied, it will be nearly impossible for any fiduciary to justify any ESG investments under the tie-breaker test, because it will be difficult to prove that (1) ESG investments are equal in performance and fees; and (2) and that the fiduciary did not start upfront with an improper collateral goal.
An ESG or social choice investment is nearly impossible to satisfy the tie-breaker test for two reasons. First, it will be difficult, if not impossible, for a fiduciary to demonstrate that an ESG investment has the same risk-return potential of a non-ESG investment. Second, the rule prohibits a fiduciary from justifying an ESG investment after the fact.
To begin, under the 2022 rule, a fiduciary may only “break a tie” using a collateral factor when the selected investment “has an expected rate of return at least commensurate to rates of return of available alternative investments with similar risks, and . . . otherwise compare with factors like diversification and the investment policy of the plan.” A fiduciary may not “accept expected reduced returns or greater risks to secure such additional benefits.” It is important to remember that both the 2020 and 2022 Rules provided that fiduciaries may consider collateral factors to break a tie, provided that other safeguards are met.
There is now plenty of evidence that ESG investments do not achieve comparable returns to neutral investments. The American Airlines ESG proxy decision started with the same premise, which was so obvious to the judge that he did not even bother to offer citations to prove his conclusion. Indeed, many studies have now demonstrated that ESG investment strategies, including when oil and gas or other types of investments are stripped out, do not match the returns of neutral investments. ESG investments typically compromise potential investment returns. In addition, the investment fees for most ESG funds are higher to compensate for the additional work in meeting collateral social goals. The investment return of an ESG investment must be higher to compensate for this additional investment fees, but this will be difficult to prove in an upfront risk-return analysis. This is a further hurdle to justify any ESG investment strategy, because equality of investment potential is difficult to prove as a threshold matter.
We are aware of no ESG investment available in the market that is equal to a neutral investment. Every ESG fund that we know about in the market is more expensive than a comparable neutral investment strategy, and there is no proof that the investment will perform better based on an ESG filter. Fiduciaries must act prudently to establish that the investment returns of multiple options are truly equal, and that is a steep uphill climb. Under this test, most ESG investments are dead on arrival.
Second, the 2022 Rule and the State of Utah decision both make clear that the tie-breaker test does not allow a fiduciary to start with the goal of choosing an investment with a social agenda. The end does not justify the means. You cannot start with the goal of justifying that an ESG investment somehow has the same risk-return prospect of a neutral investment. If the rule is properly applied, this should end most ESG investment strategies. If you cannot start with the goal of investing in an ESG investment, then it is not clear how you can credibly end up with two investments that are supposedly equal in a tie-breaker analysis. Any attempt to justify an ESG investment decision after the fact will be disingenuous.
Applying the driver analogy from the Court’s decision, fiduciaries need to show that they are still trying to achieve the fastest results – i.e., the best financial results with no additional risk – between an ESG and neutral investment. The court gave no example as to how a fiduciary can justify comparing an ESG investment to a neutral investment when they are rarely, if ever, equivalent from a holistic risk-return analysis. A fiduciary needs to show that the two investments are both the “fastest” route for plan participants.
This logic reveals the problem with the tie-breaker test in the first place. Both the 2020 Trump Rule and the 2022 Biden Rule had a tie-breaker provision. There were some differences, but they both had a tie-breaker test. Nevertheless, the attempt to justify an ESG investment as somehow equal to a neutral investment will almost always be a pretext for the goal or motive to push an ESG agenda in an investment selection. The tie-breaker will typically be an excuse to justify an investment decision that is not based solely on nonpecuniary factors and the best financial interests of plan participants. The 2020 Trump tie-breaker rule recognized that ties will be rare. That is because most purported ties will be suspect. In other words, is it a coincidence that your investment decision resulted in a purported tie between an ESG and some other investment? If you are not starting with an improper motive to add ESG investments to the plan, how then did the ESG investment even get into the final investment decision? The problem with the tie-breaker test is that many ESG strategies will be a pretext for an improper investment motive.
The difficulty in meeting the stringent tie-breaker test should be the end of any fiduciary consideration to add ESG investments in ERISA plans. It certainly opens any plan sponsor using ESG investments to fact-intensive litigation to justify how the investment met the stringent tie-breaker test.
We have previously documented that most retirement plans in America today do not offer ESG investments. Notwithstanding the prominence of the issue, we do not have an ESG problem in retirement plans. To this point, most prudent fiduciaries have avoided the risk, even if the reason was to avoid litigation.
Nevertheless, the place where social investing takes place most often is in multiemployer plans that invest in investments that attempt to create high-wage, quality union jobs. Long before we had ESG and social choice investments, we had decades of what we called “economically-targeted investments.” The classic examples are investments designed to use ERISA funds to create union jobs, like Ullico’s J for Jobs and the AFL-CIO Housing Investment Trust and Building Investment Trusts. Some union-related investments have expanded to infrastructure and other investments in which union labor is required. Many of these are long-standing, high-quality investments with significant track records of credible investment performance. But the question is whether these investments satisfy the tie-breaker test. Are they equal in investment return and risk to neutral investments without the social benefit of union work requirements? And how do you justify these investments if the analysis cannot start with a social motive, no matter how noble?
Again, the Department of Labor won the case confirming the validity of the 2022 Rule under ERISA, pending any appeal or repeal of the Rule. But the investment rule is more stringent than most would realize. The Court’s decision, as discussed above, demonstrates that most socially motivated investments cannot meet the fiduciary investment standards. Fans of ETI investments that attempt to create union jobs are the most at risk under the decision – not ESG proponents who mostly have been unable to convince retirement plan fiduciaries to adopt their investment strategies. In sum, we believe that ETI investments are at risk following the State of Utah decision.
KEY POINT #3: There is a difference between an improper ESG investment intent with the goal to change the world, and a prudent investment analysis that considers relevant environmental, social or governance factors that affect the long-term pecuniary prospects of an investment.
The American Retirement Association’s amicus brief in the State of Utah case is a must read for all plan fiduciaries to better understand the ESG investment debate as it relates to ERISA-sponsored plans. The brief explains that ERISA provides a “neutral framework,” and DOL guidance must maintain the same “regulatory neutrality.” ERISA does not attempt to prejudge or predict which funds are optimal. Instead, ERISA focuses on process. A fiduciary must consider “all factors impacting risk-return of a particular investment, including environmental, social, and governance factors that affect that financial analysis.” Congress, in enacting ERISA, did not attempt to dictate specific investment risks or return prospects that fiduciaries should consider, prioritize, or disregard. Instead, ERISA’s neutral framework requires fiduciaries to give “appropriate consideration” to all the facts and totality of the circumstances.
ERISA’s command to consider and manage risk involves a holistic risk-return analysis, which seeks to reasonably balance risk and expected reward. This means that ERISA requires fiduciaries to consider not only expected returns, but also the level of risk when analyzing investment options. A risk-return investment analysis under ERISA requires consideration of all factors relevant to a prudent investor.
To this point, the state attorneys general plaintiffs in State of Utah recognized that environmental, social and governance issues may present purely financial considerations that are proper components of the fiduciary’s primary analysis of the economic merits. And even the 2020 Rule expressly recognized “that there are instances where one or more environmental, social, or governance factors will present an economic business risk or opportunity that corporate officers, directors, and qualified investment professionals would appropriately treat as material economic considerations under generally accepted investment theories.” Notably, the 2022 Rule allows fiduciaries to weigh both positive opportunities and negative risks from environmental, social and governance factors. As an example, with the rise of consumer demand for electric vehicles, certain metal ore mining sectors saw extraordinary growth over the past several years. The Rule thus permits fiduciaries the flexibility to weigh the pros and cons of environmental, social and governance risk-return factors.
The 2022 Rule gave the express environmental example that “a company’s improper disposal of hazardous waste would likely implicate business risks and opportunities, litigation exposure, and regulatory obligations.” This appears to be borrowed from former Secretary of Labor Eugene Scalia’s example in a June 23, 2020 Wall Street Journal Op-Ed announcing the 2020 rule, which remains the most effective summary of how ERISA responds to the ESG investment movement. ARA’s amicus brief gave a governance example that fiduciaries may avoid investing in a company if its primary product will soon be regulated or litigated out of existence [with the specific example of the selling of an asbestos-related stock], or if a company faces executive compensation problems because it lacks an independent board [giving the example of avoiding Tesla stock after the $50B+ pay package to its CEO]. These examples demonstrate that environmental, social and governance factors can be relevant to risk-return considerations. Fiduciaries can, and must, consider these factors in performing the fiduciary process or a risk-return investment analysis
But there is a difference between using ESG factors in a risk-return investment analysis, and investing with a preordained social agenda. When the political drama over ESG calms down, this nuance will drive a more rational discussion of the topic. Plan sponsors need and deserve discretion to execute their fiduciary duties in investing plan assets. We must consistently strive to preserve fiduciary discretion, free from fear of abusive litigation or regulatory overreach, to meet fiduciary responsibilities. This discretion includes the flexibility and judgment to consider all factors that relate to a proper risk-return financial analysis of each plan investment. Against this, however, ERISA provides guardrails to prevent an improper social agenda in retirement plan investments. The State of Utah ruling found that the 2022 DOL fiduciary investment rule erects these same guardrails that will prevent ESG investing in retirement plans.
Final Thoughts
The State of Utah decision is not a victory for the ESG investor movement. Anti-ESG Republican AGs lost the case, but they won the war in principle. The State of Utah decision puts the final nail in the coffin of ESG investments in ERISA-sponsored plans, because it exposes how it is nearly impossible to justify an ESG motive under ERISA’s fiduciary principles. DOL may have intended the 2022 Rule to open the door to more ESG do-good investing in retirement plans, but that is not how Judge Kacsmaryk interpreted the rule.
We have consistently pointed out that the vast majority of ERISA fiduciaries never ventured into ESG investments, and the problem is not as widespread as the prominence of the issue would suggest. Nevertheless, the decision demonstrates that it is virtually impossible to meet the fiduciary duty of loyalty with any ESG investment designed with the ulterior motive to change the world. Simply put, ESG investing designed to achieve social change does not meet ERISA’s fiduciary standards, and State of Utah demonstrates the folly of even trying to justify an improper ESG motive in retirement plan investing.
Nevertheless, there is an important difference between ESG investing for the sake of social change, and prudently considering certain environmental or governance factors in performing a sound risk-return investment analysis. This is the key distinction that must guide prudent fiduciaries navigating the politics of ESG.
