ERISA attorney Joshua A. Lichtenstein warned “there is a real risk that this will be the first in a new series of class-action lawsuits to be brought against plan sponsors.”
Lichtenstein, a partner in Ropes & Gray, cited two concerns: “There is a risk of more politically motivated cases, but I think the greater risk is nonpolitical copycat cases that are seeking damages” that will lure the ERISA plaintiffs’ bar, he said.
In the case of Spence vs. American Airlines Inc. et al., U.S. District Court Judge Reed O’Connor, Fort Worth Texas, ruled on Jan. 10 that American and its fiduciaries violated ERISA’s duty of loyalty provision, which says fiduciaries must put participants’ interests above employer interests.
“The facts compellingly demonstrated that defendants breached their fiduciary duty by failing to loyally act solely in the retirement plans’ best financial interests by allowing their corporate interests, as well as BlackRock’s ESG interests, to influence management of the plan,” O’Connor wrote.
“Defendants knew BlackRock was pursuing ESG initiatives through delegated proxy voting authority and related activism,” the judge wrote. “At a minimum, a loyal fiduciary would have monitored the situation more closely and even questioned BlackRock’s non-pecuniary investment activities."
BlackRock isn’t a defendant.
“We always act independently and with a singular focus on what is in the best financial interests of our clients,” a BlackRock spokeswoman wrote in a Jan. 13 email. “Our only agenda is maximizing returns for our clients, consistent with their choices.”
American Airlines didn’t respond to requests for comment.
'Heavy on implications'
The judge’s decision is perplexing to some attorneys because Judge O’Connor said American Airlines' 401(k) plans followed proper procedures — ERISA’s duty of prudence — in managing the plan. He relied solely on the duty of loyalty provision.
“The ruling in this case seems heavy on implications, less so on actual facts regarding actions,” Adams said.
“I can't remember an ERISA case where the fiduciaries were held to have a prudent process where they didn't prevail at trial,” he added. “At a minimum, I think folks should at least wait to see what kind of injury (or) damages are quantified, if any.”
O’Connor didn’t criticize the American Airlines plans for offering ESG funds. The initial lawsuit claimed American Airlines' plans offered ESG funds, but they don't.
"It would have been impossible for plaintiff to find any such investment options in the plans' core investment lineup, where he has chosen to invest, because there are none," American Airlines attorneys wrote in August 2023 in an unsuccessful request to dismiss the complaint that was initially filed by a former pilot in June 2023.
The original complaint also cited 90 other investment managers that provide investments "that are not branded as ESG funds but are managed by investment companies who have voted for many of the most egregious examples of ESG policy mandates." The plaintiff apparently was referring to a self-directed brokerage account.
American countered, to no avail, that the plaintiff “has never opted for a brokerage account at all, much less navigated through the countless investment options accessible through it to find and invest in the ones he now challenges," the airline wrote.
The lawsuit offered no performance data or cost data to support these claims, which the plaintiff subsequently dropped in favor of focusing on American Airlines relationship with BlackRock.
Impact uncertain
The impact of O'Connor's ruling is uncertain because, as the first of its kind in a 401(k) setting, it is likely to be appealed. The judge wants information on alleged damages to participants' investments, asking whether the plaintiff must prove damages or the defendants disprove damages.
The judge also wants to know if he should issue an injunction relating to alleged losses — or no losses — and he asks what impact a 2021 BlackRock proxy vote against certain Exxon Mobil directors had on the American Airlines plans' investments.
“I find the court’s final request for briefs on whether it should issue an injunction even if no actual losses occurred to be troubling,” said Carol I. Buckmann founding partner of the law firm Cohen & Buckmann. “In my view the court is straining to find a basis for liability due to an underlying concern that these investments as a class are inappropriate.”
Deferring a ruling on damages is important, said Christina L. Hennecken, a partner in the Goodwin Procter law firm. “Showing loss to a retirement plan based on an investment manager’s proxy voting will be difficult,” she said. “It remains to be seen if this theory of liability will actually result in any monetary recovery and attract copycat litigation.”
The American Airlines case provokes different responses from ERISA attorneys who represent retirement plan sponsors.
Buckmann worried about the impact of defined contribution plan management. “I think this decision will have a chilling effect on ESG investment by employee benefit plans because it found liability despite evidence that American engaged in a prudent process,” she said.
However, other ERISA attorneys said the judge’s ruling suggests some flexibility for sponsors.
“While the court did not rule on the permissibility of ESG funds or ESG investment strategy per se, the opinion does contain a detailed discussion of the circumstances under which environmental, social and governance factors may permissibly inform investment strategy,” said Brantley Webb, a partner at the Mayer Brown law firm. “I do not think the opinion spells doom for ESG investment funds or strategies in the retirement plan context.”
Lichtenstein of Rope & Gray offered a similar analysis.
“I think the near-term effect will be more on the level of diligence and review that DC plans devote to ESG issues like proxy voting and stewardship,” he said. “I don’t think we will see changes in investments, assuming those investments were financially motivated, not ESG motivated, when they were made.”
ERISA attorney Stephen Rosenberg said sponsors — and their attorneys — should exercise caution.
“A knee-jerk reaction to one District Court opinion, particularly where it is so closely tied to very case-specific facts, would be an overreaction,” said Rosenberg, a partner at Wagner Law Group.
If plan executives panic and drop ESG funds, the plans could wind up being sued “if it led to losses in any manner” because plaintiffs could claim that divesting was an imprudent decision under ERISA, he said.
Sponsors should act just like they would for any other ERISA litigation. “Put administrative, evaluative and expert structures in place to analyze this issue regularly in a manner that a court would be willing to later bless as having been both prudent and loyal,” Rosenberg said.
Another strategy: “Turn over the entire question of ESG-linked investments and their use to an independent fiduciary (who can) pass on the propriety under all of the relevant circumstances,” he said.
Because O’Connor focused on what he viewed as company executives blurring their corporate and fiduciary roles — he wrote they didn’t maintain “the appropriate level of separation in their dual roles” — attorney Jodi H. Epstein said this is instructive for all sponsors.
“It is preferable not to have the person who is responsible for fiduciary oversight and due diligence of a vendor also be responsible for the business relationship with that same vendor,” said Epstein, a partner at Ivins, Phillips & Barker. “The judge made a leap, though, in concluding that any commentary by a fiduciary about BlackRock’s ESG positions must have clouded that person’s fiduciary actions.”
Still, the case illustrates why plan executive must make sure to follow their investment policy statements and that investment managers follow the investment management agreements with the sponsors, Epstein explained. “This case provides a timely reminder to plan fiduciaries to become familiar with the plan’s governing documents,” she said.
