Compliance October 27, 2023

26 State AGs Will Appeal ESG Rule Lawsuit Dismissal

After their initial challenge to the DOL’s ESG rule was dismissed, the states are appealing to the 5th Circuit Court of Appeals.

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A group of 26 state attorneys general have appealed to the 5th U.S. Circuit Court of Appeals the dismissal of their complaint challenging the legality of the Department of Labor’s final rule permitting environmental, social and governance factors to be used when selecting retirement plan investments.

The states’ lawsuit, Utah et al. v. Walsh, was dismissed on September 21 by the U.S. District Court for the District of Northern Texas because the Employee Retirement Income Security Act of 1974 does not specifically forbid ESG factors or a tiebreaker test that permits non-financial factors to be used in ERISA-covered investment decisions. Additionally, the DOL’s final rule states that fiduciaries must still act prudently and cannot subordinate financial factors to non-financial ones.

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The appeal notice did not spell out the legal argument for the appeal. The appeal was also signed by industry plaintiffs Liberty Energy Inc. and Liberty Oilfield Services LLC, two fossil fuel firms; and Western Energy Alliance, a fossil fuel lobby.

The original complaint argued that ESG investing is unlawful under ERISA because ESG factors are non-financial factors and would undermine retirement savings in order to advance political and ethical goals, especially in terms of environmental and climate concerns. The attorneys general argued it would hurt retirees’ savings in their respective states and would also harm investment in the fossil fuel industry, hurting tax revenues in those states.

Of the 16 judges on the 5th Circuit, which hears cases from Louisiana, Mississippi and Texas, 12 were appointed by Republican presidents. While it is considered on the conservative end of the appellate courts, U.S. District Judge Matthew J. Kacsmaryk, who dismissed the case, is also widely considered conservative because of his rulings on abortifacients and immigration policy.

In his dismissal order, he acknowledged that the suit should be dismissed, even though “the Court is not unsympathetic to [the] Plaintiffs’ concerns about ESG investing, [but] it need not condone ESG investing generally or ultimately agree with the [DOL] Rule to reach this conclusion.”

A separate lawsuit challenging the ESG rule in the U.S. District Court for the Eastern District of Wisconsin, Milwaukee Division, is still ongoing in Braun, Luehrs v. Walsh. Its plaintiffs make the same objections to the rule: that ESG investing will allow sponsors to select imprudent investment menu options for political reasons that will ultimately undermine investment returns in retirement plans.

The DOL’s rule, finalized in November 2022, does not require ESG factors to be used in investment selection. It permits them, but only to the extent that ESG issues are financial considerations and that the investment is otherwise prudent. Non-financial factors may only be considered as a tiebreaker between two options which both equally serve the interests of the plan.

The DOL rule also permits sponsors to include investment menu options that take participants’ non-financial interests and preferences into account, as long as those menu options are still prudent. This provision is intended to increase plan participation by allowing sponsors to provide participants with an incentive to use the plan that goes beyond economic returns. This provision has not been a focus of either lawsuit.
Benefits October 26, 2023

Despite Savings Shortfall for Public Sector Workers, Automatic Options Yet to Catch On

Research from the MissionSquare Research Institute shows that with defined benefit pensions not providing enough for full retirement, plan design could help participants save additional funds in defined contribution plans.   

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Adding automatic escalation could help state and local government defined contribution plan participants mitigate retirement savings shortfalls, according to a new report from the MissionSquare Research Institute.

While 17 DC plans in states and the District of Columbia have added automatic enrollment features over the past 15 years, few have used automatic escalation, the institute’s recently published report found.

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State and local government employees are more likely than counterparts in the private sector to continue to have access to a defined benefit plan, yet many still face retirement savings shortfalls.   

Despite the demonstrated need for additional savings, “few state and local governments have adopted automatic escalation, as government officials may be hesitant to move forward without explicit statutory authority,” MissionSquare stated in a press release accompanying the findings. “In the private sector, however, automatic enrollment is becoming a standard practice, with two-thirds of DC retirement plans incorporating automatic escalation.”

The SECURE 2.0 Act of 2022 requires all new 401(k) and 403(b) plans, beginning in 2025, to use automatic enrollment with a default rate of between 3% and 10% and automatic escalation of 1% per year up to a maximum of at least 10%, but no more than 15%.

Automatic enrollment and automatic escalation are design features applied to DC plans for the purpose of increasing participants’ retirement savings. In automatic enrollment, plan sponsors automatically enroll employees in a DC plan at a default contribution rate and in a default investment. Automatic escalation automatically raises participants’ contribution percentage at regular intervals, usually annually up to a predetermined maximum contribution level. Employees may opt out of both options.

At state and local governments, continuing resistance or indifference to adding auto-escalation persists, including the perception that the savings tools are overly paternalistic, financially burdensome for employees or unnecessary, the MissionSquare report stated.  

Yet National Institute on Retirement Security research, published last year, showed that pension plans alone often do not provide retirement income adequacy for state and local government employees. The researchers found that a public-sector worker with a pension, who also pays into Social Security and has access to a retiree medical plan, will need to save 4% to 6% of pay annually to fund an adequate retirement.

To reach optimal retirement readiness, relying exclusively on a defined benefit plan is insufficient, stated Deanna J. Santana, acting CEO and president of MissionSquare Retirement, in a statement that accompanied the research. The reasons may vary from a smaller defined benefit multiplier (the percentage of a vested and retired participant’s base pay they would receive in retirement for each year of service) and reduced employer contributions for retiree health care to a higher minimum retirement age and the reduction or elimination of cost-of-living adjustments by state and local governments, but the outcome is the same.

“Relying solely on their pension for financial security during retirement is no longer a viable option,” Sanatana said of public sector employees.

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