ESG-related lawsuits filed against plan sponsors

In this article we review cases recently filed against American Airlines and against three New York City pension funds, claiming that ESG investments/investment decisions violated duties of prudence and loyalty under ERISA (in the case of the American Airlines lawsuit) and under state and common law (in the case of the New York City pension funds lawsuit).

Background

Very briefly: At the end of the Trump Administration (in 2020), DOL finalized amendments to its ERISA investment duties and proxy voting rules, tightening in some respects the rules with respect to environmental, social, or governance (ESG) investing and to some extent “downplaying” fiduciaries’ obligations to exercise shareholder rights. On taking office, President Biden issued an Executive Order instructing DOL to review the 2020 Rule. In October 2021, DOL proposed amendments to the 2020 Rule, in effect backpedaling on a number of its features, and then published final amendments to the 2020 Rule on December 1, 2022. Some, on the Republican side of the ESG debate, were vocally critical of the changes to the rule made by the Biden DOL.

On January 26, 2023, a group of plaintiffs, including 25 states, filed a complaint (Utah v. Walsh) against DOL in United States District Court for Northern District of Texas (Amarillo Division), claiming that DOL, in adopting the 2022 amendments to its ESG investment/proxy voting regulation, (1) exceeded its authority under ERISA and the Administrative Procedure Act (APA) and (2) violated the APA’s arbitrary and capricious standard. Litigation in that case is ongoing.

Spence v. American Airlines

On June 2, 2023, in Spence v. American Airlines, a participant in the American Airlines 401(k) plan filed a complaint in the United States District Court for the Northern District of Texas (Fort Worth Division), against American Airlines, Inc., the American Airlines Employee Benefits Committee (the plan’s fiduciary committee), Fidelity Investments Institutional, and Financial Engines Advisors, LLC. The lawsuit claims that the inclusion in the American Airlines 401(k) plan as investment options of ESG funds, and funds that exercise shareholder rights based on ESG principles, violates ERISA’s fiduciary duties of prudence and loyalty.

The complaint is long on rhetoric, e.g., –

Defendants have breached their fiduciary duties in violation of ERISA by investing millions of dollars of American Airlines employees’ retirement savings with investment managers and investment funds that pursue leftist political agendas through environmental, social and governance (“ESG”) strategies, proxy voting, and shareholder activism ….

… but short on specifics.

Plaintiff claims that ESG funds generally underperform and have higher fees than non-ESG funds. And he lists the funds in the plan to which he objects. But he says nothing specific about those funds’ performance or fees and provides no comparisons with other funds’ performance and fees. It is unlikely that, in its current form, this complaint will survive a motion to dismiss. Plaintiff could, however, attempt to amend the complaint to provide sufficient specifics to survive such a motion.

Questions raised by the complaint

Nevertheless, the complaint raises several interesting questions:

What is the obligation of a sponsor fiduciary with respect to funds (including ESG funds) offered in a brokerage window? It appears that many of the funds complained of are part of the plan’s self-directed brokerage account (SDBA). The complaint attacks the plan’s SDBA (and brokerage windows generally), claiming that they are expensive, include higher-priced retail mutual funds, and include risky investments participants may not understand.

While most believe that investment options included in a properly constructed brokerage window are not generally subject to ERISA prudence standards, the Department of Labor has in the past expressed concern about brokerage windows. If this case ever gets to a decision on the merits, we might get some court guidance on whether sponsors have any obligations with respect to brokerage window investments, and if they do, just what those obligations are.

Where 401(k) plan participants are allowed to choose between investments, what is the standard for including ESG funds, where non-ESG funds are also available? As a threshold matter, we note that it’s unclear whether the plaintiff actually invested in any of the (alleged) ESG funds. As we have discussed, courts have generally denied standing to plaintiffs who have not invested in the funds their lawsuit attacks.

Moreover, even if a participant invested in an ESG fund, the Trump DOL stated, in its ESG regulation (just to emphasize, this was before the (Biden) DOL rewrote the Trump rule), that a DC plan that allows participants to choose investments from a “broad range of investment alternatives” may include as a designated investment alternative “an investment fund, product, or model portfolio” that “promotes, seeks, or supports one or more non-pecuniary goals,” so long as the fiduciary satisfies ERISA’s (general) fiduciary rules (including, among other things, that the investment was justifiable on pecuniary grounds alone) and certain disclosure and recordkeeping requirements were met. If (again) this case ever gets to a decision on the merits, it will be interesting to hear what the court thinks 401(k) plan fiduciaries’ obligations with respect to ESG funds are where a participant has the choice not to invest in them.

What fiduciary risks do ESG-based proxy voting policies present? The complaint does not just attack funds that explicitly claim to invest using ESG criteria, but also attacks funds that “are not branded or marketed as ESG funds” but “are managed by investment companies that pursue ESG policy agendas through proxy voting and shareholder activism.” ESG investing has received more attention than ESG shareholder activism, but in the end this may be the more important issue.

And finally, what deference will the courts give to DOL’s ESG regulation?

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As relief, the plaintiff is asking “[t]hat Defendants make good to the Plan all losses that the Plan incurred as a result of their breaches of fiduciary duties, and to restore the Plan to the position it would have been in but for this unlawful conduct,” and for injunctive relief.

Wong v. New York City Employees’ Retirement System, et al.

On May 11, 2023, in Wong v. New York City Employees’ Retirement System, Teachers’ Retirement System of The City of New York, and Board of Education Retirement System of the City of New York, a group of plaintiffs sued three New York City public employee retirement plans for voting, in May 2021 and at the urging of NYC’s Mayor de Blasio, “to divest their respective plans of all securities related to fossil fuel companies,” subsequently liquidating (according to plaintiffs) nearly $4 billion in holdings in fossil fuel companies. In related action, the three plans subsequently voted to double their investment in “climate change solutions.” Two other big New York City pension funds – the Police Pension Fund and the Fire Pension Fund – refused to implement such climate-related investment decisions.

The complaint was filed in the Supreme Court of the State of New York, County of New York. These are state government plans and not subject to ERISA. According to plaintiffs, however, the plan trustees are subject to duties of loyalty and prudence.

Plaintiffs, who are represented by (among others) former Secretary of Labor Eugene Scalia, argue that “Defendants’ decision to pursue an environmental agenda instead of safeguarding the retirement security of plan participants and beneficiaries has had, and will continue to have, a detrimental impact on the financial health of the Plans and their ability to pay the pension benefits they owe Plaintiffs and other municipal workers and retirees.”

In support of this claim, plaintiffs cite the above-market performance of energy sector securities since the divestment. E.g., “In 2022, the S&P 500 energy sector rose 58 percent, and was the only segment of the S&P 500 index that did not experience a loss for the year. As one market analyst put it, ‘[o]il and gas companies have . . . been the standout performer of 2022.’”

In support of their claim that defendants’ divestment/climate related investment actions violate state regulatory and common law fiduciary norms, plaintiffs cite (among other things) the (Biden) DOL’s 2022 ESG regulation:

[T]he duties of prudence and loyalty,” the U.S. Department of Labor said in issuing the rule, require “fiduciaries to focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives unrelated to the provision of benefits under the plan.

Plaintiffs are asking for money damages and that defendants make the plans whole for losses that were a consequence of their divestment action, a declaration that defendants’ actions violate “New York common law and New York’s regulatory standards for actuarily funded public retirement systems,” for appointment of a monitor and an independent fiduciary to review compliance with the court’s orders, and for injunctive and other equitable relief.

This is a very recent complaint – it will take a while to develop the issues it raises and to determine whether plaintiffs’ have any chance to succeed in their attempt to change New York City pension fund investment policy.

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To repeat, Wong is not an ERISA case. Moreover, divestment of an entire asset class (or sub-asset class) in a pension fund is clearly different from (and more problematic than) simply offering ESG investment funds, along with non-ESG funds, in a 401(k) plan. But a decision in Wong (if we get one) is likely to add to the discussion of what sorts of ESG investment policies will be tolerated by the courts.

Moreover, Wong, along with Spence, represent an emerging attack on ESG investment policy focusing on sponsors and sponsor fiduciaries (and not just, as in Utah v. Walsh, on DOL’s regulation).

We will continue to follow this issue.