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On February 26, 2024, defendants in Spence v. American Airlines filed a brief in support of a motion for summary judgment. Defendants’ motion comes just days after the court had handed down a decision denying defendants’ motion to dismiss. We continue to follow this case because it focuses on plan fiduciaries’ obligations, under ERISA’s fiduciary duties of prudence and loyalty, with respect to proxy voting – the “other” ESG (environmental, social, and governance) fiduciary issue (the first ESG issue being investment in ESG focused funds or companies).
In what follows we review defendants’ arguments in this case, mainly because they usefully raise the issues of proof and causation that vex challenges to the prudence (and loyalty) of certain proxy voting positions. To that end, we begin with a more abstract discussion of challenges to fiduciary proxy voting decisions, as a way of framing the specific arguments, and understanding what is going on, in Spence.
DOL guidance
Let’s begin with a brief review of the Department of Labor’s recent (2022) guidance on a plan fiduciary’s obligations with respect to proxy voting by the plan’s funds/fund managers.
While DOL did eliminate Trump DOL (2020) rules requiring “special” monitoring obligations with respect to investment managers and proxy voting firms and specific records requirements with respect to proxy voting/exercises of shareholder rights, it nevertheless reaffirmed the (general) duty of plan fiduciaries to monitor that activity: “The Department was concerned that the more specific provision relating to providers of certain proxy-related services could be read as creating special monitoring obligations above and beyond the statutory obligations of prudence and loyalty that generally apply to monitoring service providers. In this regard, the Department noted that it had previously indicated in Interpretive Bulletin 2016–01 that the general prudence and loyalty duties under ERISA section 404(a)(1) require a fiduciary to monitor decisions made and actions taken by an investment manager with regard to proxy voting decisions.” (Emphasis added.)
It is theoretically possible that a fund manager might have an imprudent proxy voting policy, with respect to which a plan fiduciary has an obligation to “do something.” But, with respect to a large index fund (like the BlackRock funds that are the focus of the plaintiff in Spence) and a widespread proxy voting policy (like BlackRock’s alleged policy favoring certain ESG initiatives), how is it possible to show imprudence?
How do you prove a proxy vote/proxy voting policy is imprudent?
At the core of the last 20-plus years of fiduciary litigation has been the issue of proof. That’s why nearly every complaint comes with (literally) pages of data on the fees (in fee cases) or performance (in performance cases) of allegedly “comparator” funds, with the idea that the challenged fund’s overpayment (of fees) or underperformance is “proof” that something has gone wrong in the process (the ultimate ERISA prudence issue) by which the fund was selected.
When the prudence challenge is with respect to, say, votes with respect to portfolio companies in an S&P 500 fund, the mechanism isn’t available. It’s all the same fund (the S&P 500). There is no comparator.
In this regard, consider the argument that some big public plans have made: That because they are such big investors, they are unable through asset allocation to affect performance – they can’t just sell the stocks they don’t like and buy the stocks they do like – because, whatever else they invest in, they have to invest in “US large cap,” e.g., the S&P 500. And therefore, they have to engage in shareholder activism to affect the performance of their portfolios.
In that context, how might a plaintiffs’ lawyer prove that a particular incident of shareholder activism was “imprudent?” You might, as the plaintiff apparently has done in Spence, point to the fact that, right after the proxy vote the value of the target company’s (in this case, Exxon’s) stock went down in value. In our discussion of Spence below, we review defendants’ arguments about why that sort of proof fails (at least in this case).
Other “proof” a plaintiff might put forward is likely to be less satisfying/persuasive, because it is less concrete. A plaintiff might (as in his complaint the plaintiff in Spence did) point to studies claiming to show that shareholder activism tends to hurt performance or to axiomatic criticism of activist shareholder objectives as “non-financial.”
Proving loss
In proxy voting cases, at least with respect to challenges related to large index funds (e.g., an S&P 500 index fund), the issue of proof-of-loss/loss causation – a necessary element of any ERISA fiduciary breach claim – is as problematic as proof of imprudence.
Is it realistic to think that in a large fund, a change in policy of one investor will affect the fund manager’s vote? And even if this one fund voted differently, if every other fund is voting for the (allegedly) imprudent choice (e.g., a climate activist director), is it realistic to think that that change (in vote of one manager) would affect the ultimate outcome? Finally, given the complexity of the issues confronting a large business, exactly how much – in dollars – would having a dissident director on the board affect corporate earnings?
This issue to a large extent circles back to the “proof of imprudence” issue and can be simplified to: If everyone is investing in this fund (or funds like it) and all these funds are voting the same way, this can’t be imprudent. As the defendant in Spence asserts, “In evaluating prudence under ERISA, courts regularly ‘look[] to the conduct of similarly situated fiduciaries to provide an objective standard.’”
With that framework, let’s now turn to the arguments defendants in Spence make in their brief in support of their motion for summary judgment. We begin with a brief review of the background to the case.
Background to the case
We discuss the facts of the case in our recent article on the court’s decision denying defendants’ motion to dismiss. Briefly: plaintiff Bryan P. Spence, a participant in the American Airlines, Inc. 401(k) Plan and the American Airlines, Inc. 401(k) Plan for Pilots (collectively, the “Plan”), individually and as a class representative, sued American Airlines Inc. and the Plan’s Employee Benefits Committee as Plan fiduciaries.
While plaintiff’s lawsuit originally challenged the fiduciaries selection of (allegedly) “imprudent ESG funds,” he subsequently dropped that claim “to streamline this case and focus on the primary issue” – the retention of managers who, in effect, exercise shareholder rights (e.g., vote proxies) to further ESG goals. In their brief, defendants argue that plaintiff has yet again changed the focus of his lawsuit, now arguing that Plan fiduciaries breached their duties of prudence and loyalty by not pressuring BlackRock to change its vote in favor of a dissident “climate activist” in a 2021 Exxon board of directors election. (The Plan held shares in Exxon as part of “approximately ten passively managed index funds each of which invests exclusively in a collective investment trust managed by BlackRock.”)
No proof that selected funds pursued an imprudent or disloyal proxy policy
According to defendants: “Plaintiff has simply failed to compile proof to substantiate the allegations the Court found sufficient to survive Defendants’ motion to dismiss. Defendants are accordingly entitled to summary judgment on all theories actually set forth in the Amended Complaint.”
To be clear, “the allegations the Court found sufficient to survive Defendants’ motion to dismiss” were that “certain managers like BlackRock pursue pervasive ESG agendas. That is, BlackRock’s ‘engagement strategy . . . covertly converts the Plan’s core index portfolios to ESG funds.’ As a result, BlackRock’s investments harm the Plan participants’ financial interests because BlackRock focuses on socio-political outcomes instead of exclusively on financial returns.”
How might a claim like this be proven? In his complaint (as we noted in our prior article), plaintiff cited studies and comments in general media. According to defendants, plaintiff has produced no data, no inadequate fiduciary/committee process, and no comments by plan fiduciaries in support of his assertion in his complaint that “BlackRock’s investments harm the Plan participants’ financial interests because BlackRock focuses on socio-political outcomes instead of exclusively on financial returns.”
Arguments with respect to the 2021 Exxon director vote
Instead plaintiff focuses on one proxy vote by BlackRock, in a 2021 Exxon director election:
Unable to prove the complaint’s allegations, Plaintiff has pivoted (through his expert’s report) to an unpleaded theory that Defendants should have maintained their investments in managers with misguided proxy votes and capitalized on the Plans’ continuing investment with one such manager – BlackRock Inc. – in order to change a single BlackRock proxy vote in a May 2021 election of Exxon board members. Plaintiff speculatively contends that, facing pressure from Defendants alone, BlackRock would have voted the shares it held for all BlackRock fund investors differently in that election.
As defendants describe it, plaintiff’s expert claims that “the Plans incurred losses as the result of BlackRock and other investors, including Vanguard, voting in May 2021 in favor of candidates for the Exxon board nominated by Engine No. 1, which [the expert] described as a ‘climate activist invest[ment] firm.’” That vote, according to plaintiff’s expert, caused the value of Exxon’s and other energy company’s stocks to “dip.”
Defendants attack this argument on several grounds:
The alleged “investor fear” created by BlackRock’s vote soon dissipated, and any short run decline in share value was offset by long run gains.
The Plan’s holdings “accounted for only 0.1% of BlackRock’s assets under management,” and there were significant holdings by public funds that “tend to be quite left-leaning” and would likely favor the director-nominees of the climate activist firm. In these circumstances it was unlikely that the Plan had sufficient leverage to affect BlackRock’s vote.
The Plan had used its leverage to significantly reduce fees. “Leverage is a finite resource, and, even assuming that the [fiduciary committee] could have persuaded BlackRock to follow [its] direction as to how to vote all of its proxies, Plaintiff and his expert offer no basis to conclude that the [fiduciary committee] could have done so while still garnering the same favorable financial terms for the [Plan].”
Other large investors in Exxon, including Vanguard (“an investment firm whose investment approach the Amended Complaint frames as being ‘[i]n stark contrast to the ESG agenda pursued by other investment managers’), had supported the “climate activist” directors.
“[N]o other large retirement plans or pension funds that had similarly delegated proxy voting authority conducted an ‘intervention’ [to change BlackRock’s vote] … [and] BlackRock’s support for the dissident directors was only reported in the media one day before the vote occurred.”
“BlackRock … articulated an economic rationale for its vote, explaining, among other things, that ‘unlike many of its peers,’ Exxon had done little to protect against a possible decline in demand for fossil fuels by diversifying into other energy technologies.” This rationale “was consistent with the proxy-voting policies (incorporated in the Plans’ IMAs [investment management agreements]) requiring BlackRock to vote proxies according to its analysis of the economic interests of investors.”
Proof of loss
As we noted at the top, a particularly difficult issue is how a plaintiff might show proof of loss in this sort of case. Consider: even if the Plan could have found an equivalent, alternative fund that did not “vote proxies in favor of ESG,” these are passive, index funds – they (in effect) take what the market returns. Unless fiduciaries could assemble enough non-ESG voting managers to out-vote the ESG voting managers, a minority non-ESG vote would not change the financial result.
Moreover, the performance of Exxon without “ESG directors” is purely hypothetical. It’s possible to spin theories about why it might have “done better,” but that alternative performance exists (at best) in a parallel universe – there is no “real life” comparator.
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The foregoing discussion of defendants’ arguments is necessarily one-sided – we do not have plaintiff’s side of this story. We’ve gone into them in detail primarily to give sponsors a flavor of the sorts of issues that have come up in a challenge to a major plan’s proxy voting policy – in this case, the delegation of voting to a fund manager, BlackRock, with what some believe is an explicit pro-ESG proxy voting bias.
It will be interesting to see if plaintiff can provide more proof, to counter defendants’ claim that “Plaintiff has not developed any evidence [in discovery] in support of [his] theory … that Defendants improperly offered funds with traditional strategies whose managers nevertheless pursue illicit ESG objectives through proxy voting.”
We will continue to follow this issue.