Decision Alert: Northern District of Texas Expands Fiduciary Liability To Cover Non-ESG Fund Managers’ ESG-Related Conduct
Case Name and Number: Spence v. American Airlines, Inc., et al., No. 4:23-cv-00552
Introduction
On February 21, 2024, Judge Reed O’Connor in the Northern District of Texas (the “Court”) denied a motion to dismiss an ERISA plaintiff’s (“Plaintiff”) complaint challenging American Airlines’ selection and retention of multiple investment funds in its retirement plan. Plaintiff alleged that the American Airlines defendants (“American Airlines” or “Defendants”) violated their fiduciary duties by knowingly offering non-ESG funds that are managed by investment managers who pursue “non-financial” ESG goals more broadly, such as through proxy voting. Plaintiff offered no allegations that such practices caused the specific investment funds offered by Defendants to underperform relative to peer funds. Shortly after the Court denied the Defendants’ motion to dismiss, Defendants moved for summary judgment. If adopted broadly, the court’s ruling could have far-reaching consequences for plan sponsors.
The Allegations
American Airlines offers a 401(k) plan to its employees with four tiers: target date funds, index funds, actively-managed funds, and a self-directed brokerage window. The first two tiers include funds which are either managed by BlackRock or invest in funds which are managed by BlackRock. Plaintiff does not allege that any fund in the first three tiers uses Environmental, Social, or Governance (“ESG”) factors in selecting investments. Instead, Plaintiff contends that certain investment managers of those funds engage in ancillary ESG-related activities like proxy voting in favor of carbon-neutral shareholder proposals. That alone, Plaintiff argues, makes it a breach of American Airlines’ duties of prudence and—when combined with American Airlines’ own corporate policy in favor of ESG efforts—loyalty to permit participants to invest in those managers’ funds. Plaintiff alleges that an investment manager’s broader pursuit of “ESG goals” is necessarily incompatible with maximizing financial benefits to investors, such that a prudent fiduciary would not have offered funds from such a manager. And, although Plaintiff also alleges generally that funds which select investments based on “ESG criteria” tend to underperform their peers and benchmarks, Plaintiff has not alleged that the specific funds in American Airlines’ plan underperformed their peers or benchmarks.
American Airlines’ Motion to Dismiss
The Court held that Plaintiff pleaded viable claims for breach of the duties of prudence and loyalty. On the duty of prudence, the Court concluded that Plaintiff stated a plausible claim that American Airlines acted imprudently by selecting and retaining funds managed by entities which engaged in ESG-related activities. The Court concluded that because ERISA is directed at fiduciary process, Plaintiff’s allegation that American Airlines had failed to consider investment manager ESG-related activity was enough to state a claim for breach of the duty of prudence.
The Court pointed to allegations that BlackRock’s vote for ESG-related measures at certain oil companies “caused” those companies’ stocks to drop as sufficient to establish that ESG conduct is something that American Airlines should have considered. As for American Airlines’ argument that Plaintiff had not shown underperformance of any funds in the plan relative to any benchmark, the Court concluded that the Fifth Circuit has not imposed a requirement that ERISA plaintiffs point to a “meaningful benchmark” when pleading a violation of the duty of prudence. Thus, this claim was adequately pleaded.
The Court also concluded that Plaintiff had adequately pled breach of the duty of loyalty. Here, Plaintiff alleged that American Airlines was motivated by its own non-pecuniary interest in promoting ESG initiatives, and that this motive caused it to select investment managers (and their funds) for reasons other than maximizing financial benefits for plan participants. To support that theory, Plaintiff claimed that American Airlines has a company-wide pro-ESG policy, as exemplified by actions it has taken in a non-fiduciary role (such as diversity initiatives in hiring). The Court rejected American Airlines’ argument that these actions were taken while wearing a “corporate hat” and thus irrelevant to its fiduciary conduct, explaining that “whether the company-wide ESG policy motivated Defendants’ choice to invest Plan funds with ESG-oriented investment managers is a fact question that is not appropriate to resolve at this stage.” As such, the Court found Plaintiff’s claim for breach of the duty of loyalty adequately pleaded as well.
While Defendants’ motion to dismiss was pending, the case proceeded to full fact and expert discovery. On February 26, Defendants moved for summary judgment. As grounds for its motion, Defendants argue that its procedures for selecting and monitoring investment managers are prudent, in line with comparable plans, and have resulted in benefits to plan participants in the form of lower fees. Defendants also argue that Plaintiff’s theory has shifted multiple times in the case, and that Plaintiff no longer pursues any pleaded theory.
Takeaways
The Court’s analysis in this opinion, if taken to its logical limits, could result in a massive increase in fiduciary liability. The Court’s duty of prudence analysis suggests that a plaintiff can sustain a breach claim merely by pointing to some activity of an investment manager not directly related to “maximizing” financial benefits, and that a plan sponsor erred by not considering that activity when selecting the manager’s funds. The Court did not find it dispositive that Plaintiff had not alleged any connection between the investment manager’s ESG activity and the performance of the specific funds retained by Defendants. While the opinion deals directly with the pursuit of ESG goals, the logic could extend beyond those programs. For example, some investment managers offer “faith-aligned” products, which are designed not to invest in corporations whose products conflict with certain religious beliefs. The opinion’s reasoning suggests it could be imprudent for the fiduciary of a plan covered by ERISA to offer such a product to plan participants.
Under the opinion, a plan sponsor’s investment selection and monitoring process could be imprudent if it does not ask about some activity of a fund manager which a plaintiff later claims resulted in lower investment returns. But plan fiduciaries cannot continuously ask about every ancillary action of an investment manager, leaving the door open to a future plaintiff (or plaintiffs’ lawyer) claiming that the one that just happened not to be asked about renders the entire process imprudent. Likewise, ERISA does not require plan sponsors, as part of the investment selection and monitoring process, to apply pressure to investment managers to conform all of their activities to the “exclusive pursuit of financial benefits.” Even if everyone agreed on what that means, plan sponsors have neither the bargaining power nor the 360-degree vantage point necessary for such an undertaking. Even attempting to do so would require plan fiduciaries to shift some of their focus from the actual investment funds in the plan to monitoring the ancillary day-to-day activities of the fund providers.
Similar issues abound with the opinion’s analysis of the duty of loyalty. If a corporation’s non-fiduciary goals and values can be used to portray its fiduciary decisions as disloyal, then a plaintiffs’ attorney can easily construct a narrative about a given plan sponsor valuing some non-pecuniary characteristic in a way that renders them disloyal. For example, a plan sponsor who donates to a local sports team might be accused of disloyalty for hiring an investment manager who sponsors the same team, on the theory that it was motivated more by the company’s desire to help the local squad win a championship than retiree benefits.
Fortunately, the opinion’s sweep is more limited than that suggests. The opinion itself recognizes that courts in other circuits—most notably the Eighth—require a “meaningful benchmark” before deeming a fund imprudent. In those circuits, plaintiffs who want to plead a breach of the duty of prudence will be required to allege evidence that other funds—whose managers did not engage in ESG-related “activism”—outperformed the challenged funds. General allegations that ESG funds underperform will not be enough. Those arguments, at least in most courts, remain important safeguards against far-fetched claims for violation of the duty of prudence, or derivative duty-of-loyalty claims such as the one pleaded here. Additionally, the Plaintiff abandoned his claim related to the ESG funds offered through the plan’s brokerage window. A ruling that plan sponsors must satisfy the same fiduciary requirements for investment options provided in a brokerage window compared with a plan’s regular investment options would have been a significant departure from Department of Labor guidance and practitioner understanding of brokerage windows.
Depending on how the Court rules on the motion for summary judgment, this case may, in practice, end up reiterating the different legal standard to clear a motion to dismiss compared to a motion for summary judgment. For example, the judge’s order on the motion to dismiss allowed the case to move forward, on that basis that risk-adjusted returns against comparable funds would be better resolved on a complete record. If American Airlines’ motion for summary judgment succeeds, this could indicate that future litigants should carefully consider which arguments are best suited for each stage of legal proceedings. Alternatively, it could suggest that raising an argument that is unsuccessful at the motion to dismiss stage could set up the argument to ultimately be successful at a later stage, such as a motion for summary judgment.
