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.

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.