Continuing our series on this year’s retirement plan regulatory updates, we now shift our focus to the Department of Labor. If you missed our initial blog covering legislative changes, you can read it here.
The Department of Labor (DOL) update has traditionally focused on guidance and rule interpretations from the agency. In 2024, the DOL found itself on the defendant side of several lawsuits focusing on the legality of two new rules the fiduciary rule and the ESG rule.
Fiduciary Rule
In April, the DOL issued the Retirement Security Rule, the final version of its controversial fiduciary rule.
The rule states that a financial services provider serves as an ERISA fiduciary if:
- The provider makes an investment recommendation
- The recommendation is provided for a fee or other compensation, and
- The financial services provider holds itself out as a trusted advisor by:
- Stating that it is acting as an ERISA fiduciary, or
- Making the recommendation in a way that a reasonable investor would believe the recommendations are being made in the investor’s best interest
The rule expands fiduciary status to include rollovers to IRAs, annuity sales, and qualified retirement plan investment menu design. The most significant (and controversial) change was to expand fiduciary coverage to one-time advice, such as a recommendation to move assets from a retirement plan to an IRA. The rule also seeks to provide fiduciary coverage regardless of the recommended investment product to address the current system where different standards can apply.
The rule faced immediate opposition, as a group of insurance associations filed a lawsuit against the DOL seeking to have the rule overturned. It claims that sufficient regulation is currently in place to protect consumers, and the rule will dissuade investment advisors from providing much-needed advice. In addition, it says it is essentially the same as the previous fiduciary rule struck down by the Fifth Circuit in 2018.
The rule was scheduled to take effect in September 2024, but the federal judge in the case issued a nationwide preliminary injunction, barring the rule from taking effect until the case is decided. The judge indicated the injunction was warranted because plaintiffs have a strong likelihood of prevailing.
ESG Rule
In 2023, the DOL’s new rule regarding using Environmental, Social and Governance (ESG) factors in selecting retirement plan investments went into effect.
The rule allows fiduciaries to consider ESG factors when selecting investments, including selecting the plan's
default investments. Plan sponsors may also use ESG considerations when deciding between two similar investments and may consider participants’ nonfinancial preferences when selecting investments. While ESG factors can be taken into consideration, plan sponsors must still base decisions on a risk and reward analysis and demonstrate a prudent selection and monitoring process.
The rule clearly allows for but does not require, the consideration of ESG factors in developing a retirement plan fund lineup. While ESG consideration is permitted under the current rule, that could easily change under a different administration. As a result, we continue to recommend two things for plan sponsors who offer or are considering offering ESG-focused investments:
- While offering a suite of ESG-focused funds is common, we do not recommend utilizing a fund lineup that is exclusively ESG-focused.
- We also do not recommend the use of ESG-focused investment as the default option (QDIA).
The DOL’s ESG rule has been met with political resistance as 26 Republican State Attorney Generals filed a lawsuit challenging the legality of the rule. The suit claims the tiebreaker rule allows fiduciaries to wear two hats, allowing consideration of factors not in the best interests of plan participants. A lower court dismissed the case, ruling that ERISA does not specifically forbid ESG factors, the rule does not subordinate financial factors to ESG considerations, and the use of ESG factors is optional. The appellate court revived the case by remanding it back to the lower court based on the recent Supreme Court decision overturning what was known as the Chevron rule. That rule had required courts to defer to federal agencies' interpretation of legislation.
A second case targeting ESG considerations is Spence vs. American Airlines, Inc., 401(k). An American Airlines pilot filed a class action complaint, alleging millions in losses for poor performance and excessive fees linked to ESG strategies. American Airlines filed a motion to dismiss because the plan offered no ESG-focused investment options. The plaintiff amended the complaint to focus on the American Airlines retirement committee, alleging they applied corporate ESG policies in selecting BlackRock investments for the plan. The plaintiffs claim the BlackRock funds may not be labeled as ESG, but
BlackRock applies ESG principles in making all investment decisions. They claim the retirement committee applied American Airlines’ corporate ESG philosophy in selecting an investment company whose corporate ESG philosophy aligned with American Airlines and, therefore, was not made in the best interest of plan participants. A judge denied American
Airlines’ motion for summary judgment, sending the case to trial.
Supreme Court’s Chevron Ruling’s Impact on DOL Fiduciary and ESG Rules
On June 28, the Supreme Court ruled in the case of Loper Bright Enterprises v. Raimondo, which overturned the well-known precedent called the Chevron Doctrine.
The Chevron Doctrine came from a 1984 Supreme Court ruling that allowed federal courts to be deferential to a federal agency’s interpretation of ambiguous provisions within federal statutes. With the removal of the Chevron doctrine, now “courts may not defer to an agency interpretation of the law simply because the statute is ambiguous.”
This decision is expected to significantly reduce the authority of federal agencies while simultaneously expanding the federal judiciary's power. This will unquestionably impact agencies like the Internal Revenue Service (IRS) and DOL responsible for interpreting and enforcing retirement plan statutes.
This ruling is welcome news to plaintiff attorneys and will likely be used to challenge the two DOL rules related to retirement plans: the fiduciary rule and the ESG rule .
Courts will likely follow the Skidmore deference doctrine if there is no longer deference to Federal Agencies. Under Skidmore, “courts may - as they have from the start - seek aid from the interpretation of those responsible for implementing particular statutes."
Such interpretations ‘constitute a body of experience and informed judgment to which courts and litigants may properly resort for guidance consistent with the APA (Administrative Procedure Act).” This means the agency’s interpretation is “entitled to respect” only to the extent that those interpretations have the “power to persuade.”
The level of deference given to an agency under the Skidmore deference doctrine is decided by looking at numerous factors enumerated by the Supreme Court that “depend upon the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it the power to persuade if lacking the power to control.” While the overturn of the Chevron Doctrine may make it easier for courts to vacate agency rules, they should still consider agency interpretations of ambiguous provisions.
Going forward, lawmakers may need to anticipate potential ambiguities in statutes and reduce them when enacting laws. Federal agencies will also need to take more care in defining their reasoning when interpreting ambiguous provisions in anticipation of defending their interpretation when challenged in court.
Our next blog in our series featuring this year's Regulatory Update will focus on updates from the Internal Revenue Service.
You can download a copy of our complete 2024 Regulatory Update here.
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