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On June 20, 2024, in Spence v. American Airlines, United States District Court Northern District of Texas held for plaintiff, denying defendants’ motion for summary judgment. The court’s decision covers a number of issues of some urgency for plan sponsors, broadly involving their fiduciary obligations with respect to the voting of proxies by plan investment funds/managers, where those managers are (alleged to be) pursuing ESG (environmental, social, and governance) goals.
We note that after the court’s decision on this motion, the parties proceeded to a bench trial that concluded on June 27, 2024. When the judge renders his decision in that trial we will provide an update.
In this article we review the court’s decision denying defendants’ motion for summary judgment in some detail. We begin with a short review of summary judgment law.
Legal standard – motions for summary judgment
In this case, defendants American Airlines and plan’s fiduciary, the Employee Benefits Committee (EBC), asked the court to grant summary judgment in their favor. In considering a motion for summary judgment, “[a]ll of the evidence must be viewed in the light most favorable to the nonmovant” (in this case, the nonmovant is the plaintiff participant).
Where defendants, as here, “lose” a motion for summary judgment, it does not mean that plaintiff wins the case. It only means that plaintiff may proceed to a full trial of his lawsuit, which as we noted has taken place.
Plaintiff’s claims
Plaintiff’s lawsuit originally challenged the plan fiduciaries’ selection of (allegedly) “imprudent ESG funds.” But 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. Quoting the court:
The second – and remaining – theory of liability is that Defendants violated their fiduciary duty by mismanaging the Plan by including funds “that are managed by investment managers that pursue non-financial and nonpecuniary ESG policy goals through proxy voting and shareholder activism” on their investment portal (the “Challenged Manager Theory”). Specifically, Plaintiff contends that the Plan primarily contains funds administered by investment management firms like BlackRock Institutional Trust Company, Inc. (“BlackRock”). According to Plaintiff, 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 financial interests of Plan participants and beneficiaries because BlackRock focuses on socio-political outcomes rather than exclusively on financial returns.
Thus, this is a case about ESG-motivated proxy voting by fund managers, including managers of the plan’s “core index fund.” Plaintiff’s argument is that the selection, monitoring, and retention of that sort of fund/fund manager is imprudent – because such proxy voting policies, in effect, reduce shareholder value by advancing “non-financial and nonpecuniary” goals. And that it is disloyal, because advancing those goals is in the interest of American Airlines (which has a commitment to ESG policies) but not in the interest of the plan and its participants.
The court’s analysis
Defendants presented two threshold questions for the court to decide: First, whether plaintiff’s “new” theory of liability (the “Challenged Manager Theory” described above) had been properly pleaded. And, second, whether American Airlines was a fiduciary with respect to the alleged improper conduct (i.e., whether the EBC should be the sole defendant in the case). The court found for plaintiff on both of these issues.
Proceeding to the merits of plaintiff’s fiduciary breach claims …
According to the court, defendants in their motion for summary judgment devote only one paragraph to the duty of loyalty claim, focusing almost entirely on the issue of prudence. With regard to prudence, defendants argue that the plan fiduciaries (1) “maintained a robust, state-of-the-art process to administer the Plan” and (2) “properly relied on experts,” and (3) that “Plaintiff does not identify any alternative funds Defendants could have selected consistent with their fiduciary duties.”
The court found these arguments insufficient to grant defendants’ motion, finding that “the summary judgment record makes clear that a factfinder could find Defendants breached their duty of prudence by failing to monitor investment managers and failing to address the facts and circumstances of ESG proxy voting and shareholder activism present within the Plan.” In reviewing these arguments:
Reliance on experts – The court stated that hiring an expert (and following its advice) does not prove prudence and loyalty: “While Defendants’ choice of Aon as a reputable outside advisor may demonstrate sufficient investigation of the expert’s qualifications prior to engagement, this alone does not demonstrate that Defendants’ use of and reliance on Aon after engagement was appropriate. For instance, a reasonable fact finder could find that Defendants blindly followed Aon’s advice, hired them in an attempt to mask conflicts of interest, did not provide complete and accurate information to them, or otherwise failed to ensure that reliance on their advice was reasonably justified under the circumstances.”
Duty of loyalty
Defendants claimed that “Plaintiff has no evidence that [Defendants] selected and retained BlackRock funds for disloyal reasons.”
In finding for plaintiff on the duty of loyalty claim, the court stated that the “evidentiary combination” of “Defendants’ undeniable corporate commitment to ESG plus the endorsement of ESG goals by those responsible for overseeing the Plan … could convince a factfinder of disloyalty from the lack of separation between corporate goals and the fiduciary role.” (Emphasis added.) On that key issue – as the court put it, the “cross-pollination of corporate ESG goals with [the plan fiduciaries] role” – the court pointed to the fact that the Chair of the EBC “communicated with AA’s Director of Sustainability … to express support for BlackRock’s ESG objectives.”
In addition, the court pointed to evidence of BlackRock influence over American Airlines policy, noting that “AA’s Managing Director of Asset Management described the relationship [between BlackRock and American Airlines] in a particularly alarming manner, calling ‘this whole ESG thing circular’ because of AA’s ‘significant relationship[] at BlackRock,’ which owns a substantial amount of AA stock and fixed income debt at the same time it pursues ESG objectives as an investment manager with ‘$35 billion in assets’ under control.”
Loss causation
We won’t dive deep into defendants’ final “loss causation” argument. The question here goes back to the issue with respect to comparators noted above – how do you show that BlackRock’s pro-ESG proxy activities actually caused a loss to the plan? To do that, Plaintiff’s use an “event study” done by their expert, reviewing the performance of the plan’s energy stock holdings after, with BlackRock support, a slate of climate activist directors was elected to the ExxonMobil board of directors.
In this regard (quoting the court):
Heaton’s [plaintiff’s expert’s] report finds that BlackRock’s May 2021 ESG-oriented proxy vote at ExxonMobil hurt the Plan by devaluing its energy stocks. Heaton estimates losses of over $8.8 million following the ExxonMobil vote. The price drop also prevented the Plan from building additional value. Combined, Heaton estimates that the Plan lost approximately $15 million. And this is before consideration of any losses emanating from Heaton’s finding that ESG funds have an established record of underperformance.
The court found this sufficient evidence of loss from pro-ESG proxy policies to continue to a trial.
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Takeaways
It will be interesting to see how this case is ultimately decided, but the issues with the sponsor/defendants’ approach to proxy voting are worth considering. Some observations:
It is probably a good idea for sponsor fiduciaries to review the proxy voting policies of the plan’s portfolio fund/managers and determine whether they align with the plan’s investment policies.
If those funds/managers have “pro-ESG” policies, fiduciaries will want to articulate a reason why they believe that approach is prudent and document it (typically in committee minutes).
Where the fund/manager has contractual obligations, e.g., to comply with/certify compliance with the plan’s policies (e.g., the “contractual commitments from investment managers that proxy votes would be cast in the best long-term financial interests of the Plan” noted above), sponsor fiduciaries will want to consider how they will monitor compliance with those commitments.
Sponsors will want to consider how to keep an appropriate distance between plan fiduciary decision making and the employer’s own ESG initiatives. This can be problematic – typically plan committee members will also be regular company officials, sometimes with, in their company capacity, explicit ESG goals to meet. Sponsors will want to review this issue with counsel.
We will continue to follow this issue.