Northern District of Texas Expands Fiduciary Exposure by Permitting ESG Proxy Voting Theory to Go to Trial
Case Name and Number: Spence v. American Airlines, Inc., et al., No. 4:23-cv-00552
Introduction
On June 20, 2024, Judge Reed O’Connor in the Northern District of Texas (the “court”) denied a motion for summary judgment filed by American Airlines and its retirement plan employee benefits committee (“American Airlines” or “Defendants”) in Spence v. American Airlines, Inc., et al. American Airlines had sought to put an end to a class action case in which the plaintiff is contending that the Defendants breached their fiduciary duties under the Employee Retirement Income Security Act (ERISA) by failing to monitor or take action to stop purported ESG “activism” by asset managers who provide investment funds in their 401(k) plan.
The court’s summary judgment decision is far-reaching, and its reasoning may result in an expansion of fiduciary liability for plan sponsors and their duty to monitor hired investment managers. Under the opinion’s broad sweep, at minimum, plan sponsors may need to dedicate additional resources to evaluating the proxy votes of the managers of the investment funds in their plans. Depending on the outcome at trial, plan sponsors also may be vulnerable to future challenges by plaintiffs for not seeking to prevent even short-term dips in stock prices, which plaintiffs may claim are traceable in some way to shareholder vote outcomes.
Background
American Airlines offers a 401(k) plan (the “plan”) to its employees with four different categories (“tiers”) of investment options: target date funds, passively managed index funds, actively managed funds, and a self-directed brokerage window. BlackRock Inc. serves as the investment manager for almost all of the funds in “Tier II” (the index funds), none of which are “ESG” funds. The plaintiff does not challenge the performance of any of these investment funds by claiming they underperformed a benchmark or an alternative fund, but instead claims that the investment managers of funds in the plan engage in ancillary ESG-related activities like proxy voting in favor of climate-focused shareholder proposals.1 By not monitoring or attempting to shut down those ESG-related proxy votes, the plaintiff argues, American Airlines breached its duties of prudence—and, when combined with American Airlines' own corporate policy in favor of ESG, loyalty—to participants who invest in those managers' funds.
One important assumption underlying both the plaintiff’s case and the court’s summary judgment opinion is that “pro-ESG” proxy vote outcomes necessarily harm investment returns. Thus, the plaintiff contends, prudent retirement plan fiduciaries would not offer funds from investment managers who support such shareholder proposals.
The court had previously denied Defendants’ motion to dismiss. Shortly thereafter, American Airlines moved for summary judgment, arguing that its process for selecting and monitoring investment managers is prudent, in line with comparable plans, and has resulted in financial benefits to plan participants. Specifically, American Airlines pointed to: (1) its use of a reputable outside consultant; (2) the plan’s well-performing index funds; and (3) contractual commitments it secured from the plan’s investment managers that they would “pursue investors’ financial interests when voting the [plan’s] proxies.”2
Summary Judgment Opinion
On June 20, 2024, the court issued its opinion denying American Airlines’ motion for summary judgment. The court accepted plaintiff’s premises that ESG “agendas” are incompatible with the financial interests of retirement plan participants and that, by voting for pro-ESG shareholder proposals, the plan’s investment managers “covertly convert[ed] the Plan’s core index portfolios to ESG funds.”3 With that in mind, the court found genuine issues of material fact concerning several claims, including: (1) whether American Airlines failed to sufficiently monitor the proxy voting of the plan’s investment managers; (2) whether, after learning about the ESG-related proxy voting by the plan’s investment managers, American Airlines took sufficient steps to persuade or force those investment managers to vote differently; and (3) whether the court should use “benchmarks and industry norms” to evaluate plaintiff’s claims, or whether it should fashion some other legal framework.
The court also reserved for trial the question whether American Airlines’ company-wide commitment to ESG caused its retirement plan fiduciaries to be disloyal to plan participants. The court pointed to one email sent by an American Airlines executive with responsibility for overseeing the plan, in which she “express[ed] support for BlackRock’s ESG objectives.”4 This “undeniable corporate commitment to ESG plus the endorsement of ESG goals by those responsible for overseeing the plan,” the court found, was “evidence … that Defendants allowed their corporate goals to influence their fiduciary obligations.”5
Finally, the court found that because BlackRock owns some 5% of American Airlines’ stock, and the two companies have other financial dealings, American Airlines may have been further deterred from “confront[ing] BlackRock about ESG proxy voting or other activism.”6
Trial
The case is moving at a fast pace, and the parties have begun a bench trial this week. At trial, the plaintiff will attempt to prove his prudence and loyalty claims. He is seeking millions of dollars in damages for a temporary dip in the price of Exxon stock (and contemporaneous dips in the prices of several other energy company stocks), which, he claims, resulted in losses to plan participants and was caused by American Airlines’ failure to switch BlackRock’s vote against several Exxon management-recommended directors.
Takeaways
1. Duty of Prudence
Through this case, plaintiff seeks to dramatically increase the responsibilities of plan fiduciaries with respect to proxy voting. Under his theory of ERISA liability, retirement plan fiduciaries would need to: (1) monitor all shareholder proposals and resulting proxy votes made by the managers of the investment funds offered in their plans; (2) determine which shareholder proposals are likely to impact stock price (including by causing a temporary decrease in price); and (3) lobby the plan’s investment managers to vote against those proposals that, in the plan sponsor’s judgment, are likely to have negative price impacts.
Defendants have pointed out many problems with the plaintiff’s theory, including that it is nearly impossible for plan sponsors to research and analyze the myriad shareholder proposals introduced at each company whose stock comprises holdings in their plan’s investment funds. As Defendants pointed out, for a plan like American Airlines’, this may include tens of thousands of shareholder proposals each year.7 Analyzing even a fraction of such shareholder proposals would consume a disproportionate amount of plan resources, raising the costs to administer the plan and proportionately reducing plan participant account balances.
But there is a more fundamental problem with the plaintiff’s theory. Even if plan sponsors could analyze the multitude of shareholder proposals each year, they cannot reliably predict the effects of shareholder vote outcomes on stock price. Stock prices are notoriously hard to predict. Price fluctuations do not—as plaintiff appears to assume—simply depend on whether a vote outcome is likely to increase or decrease corporate profits. Accurate prediction of short-term movements in stock price depends on an understanding of market expectations. In other words, if the market was already expecting a “bad” event at a company, the stock price may not move at all.
Trying to predict short-term event-based price impacts is a very different exercise than evaluating the expected returns of investment funds—something fiduciaries routinely do—where performance is measured based on benchmarks. In the case of proxy vote price impacts, the benchmark is missing. It would be the market’s expectations—but that is exceedingly hard to observe before the fact. Indeed, if American Airlines could accurately predict the price impacts of shareholder proposals, it would probably get out of the business of commercial aviation and into the business of investing.8
Ultimately, to win at trial, plaintiff must prove: (1) that the proxy vote on the 2021 Exxon shareholder proposal caused the dip in stock price; (2) that it was possible for American Airlines to predict that price impact in advance; and (3) that American Airlines could have taken action to change the outcome of BlackRock’s vote.
Whether the plaintiff ultimately wins damages or not, the court’s summary judgment opinion provides some guidance to plan sponsors navigating these issues. For example, the court relies heavily on what it describes as a “lack of evidence” that proxy voting was ever formally considered or discussed by plan fiduciaries before plaintiff’s lawsuit was filed.9 The court also noted that other state retirement plan fiduciaries took at least some action when they learned about ESG-related proxy voting.10
2. Loss
At summary judgment, American Airlines argued that the plaintiff had no evidence that there was any reduction in plan-participant balances at the time the complaint was filed in 2023; even if plaintiff was correct that there was a temporary dip in Exxon’s stock price back in 2021, the market had subsequently corrected itself. A proxy vote outcome may cause a temporary dip in stock price because it was out of sync with market expectations, but may lead to an overall net increase in stock price because it creates value for the company in the long term. Indeed, economists often study longer time periods precisely to strip out short-term price fluctuations. Similarly, in evaluating shareholder proposals, investors often focus on longer-term value. Rejecting these arguments, the court held that the plaintiff could carry his burden simply by pointing to a drop in investment returns “at a point in the life of the Plan.”11
On the surface, that holding is remarkable—it suggests that an ERISA plaintiff can demonstrate loss based on a temporary, minor drop in the value of an investment fund. In other words, plaintiffs will be able to avoid summary judgment unless the plan sponsor can show that the challenged investment fund went up in value throughout the entire relevant period. Curiously, the court holds—in a footnote—that the defenses to such loss theories which are available in securities class actions may not “be applicable in an ERISA breach-of-fiduciary duty context.”12 Read broadly, that holding would constitute a tremendous change in ERISA law, forcing plan sponsors to become guarantors that the funds placed on a plan lineup will never go down.
That said, there are reasons to doubt the court intended to sweep so broadly. First, the opinion assumes, but does not yet decide, whether the plaintiff’s expert’s analysis is admissible under the federal rules.”13 Defendants argue that plaintiff’s expert misapplied his methodology in ways that stacked the deck towards even finding a price dip (including by adopting a 50% threshold for statistical significance, instead of the usual 5%).14 Second, while most courts hold that temporary reductions in market value are insufficient to establish loss under ERISA, here, the court holds the opposite in part because it determined that there is evidence that the plan sponsor was acting disloyally.15 A court might not be willing to apply a similar model in cases where no improper motive is alleged.
3. Duty of Loyalty
The court made clear in its summary judgment opinion that corporate ESG commitments, published or otherwise, do not, alone, establish disloyalty. There must be evidence that the company “allowed their corporate goals to influence their fiduciary obligations.”16 However, the evidence the court found sufficient was a conversation endorsing “ESG objectives” between the company’s Director of Sustainability and a plan fiduciary. As part of its reasoning, the court assumed that ESG goals are incompatible with the financial interests of plan participants. This all imposes a very light standard for plaintiffs on summary judgment, and suggests that plan fiduciaries should be careful to separate their corporate and fiduciary roles at all times.
But it is the court’s ruling on BlackRock’s “influence” over American Airlines that may be the most significant aspect of its summary judgment decision. The court found that BlackRock’s 5% ownership stake in, and other financial relationships with, American Airlines could lead a reasonable fact finder to conclude that American Airlines had an “ulterior” motive to “further the interests of BlackRock.”17 BlackRock—like other large investment managers—owns shares of stock in many of the nation’s largest corporations. The court’s determination that this creates a “circular” relationship, and potential conflict of interest for retirement plan fiduciaries, is a conclusion that could be applied to other ERISA claims. For example, can a plan sponsor select investment funds from an investment manager who owns a substantial share of the company’s stock? Or would the fiduciary decision in that circumstance be clouded with a potential conflict of interest? If the fiduciary genuinely believes that the investment manager’s products are superior, is it obligated to pick a second-best option merely to avoid the appearance of a conflict of interest? The court’s opinion may open new litigation fronts in this respect.
Conclusion
Should the plaintiff win at trial, it could foretell a dramatic expansion in plan sponsor and fiduciary liability for running retirement plans. Not only would plan fiduciaries be responsible for selecting and monitoring prudent investments, they may also be obligated to (try to) micromanage the proxy votes of the plan’s investment managers. However, the court may not adopt such a sweeping approach. For example, it might hold that plan sponsors should simply have a process to monitor proxy voting by plan investment managers to issue spot votes that are out of line with the managers’ own proxy voting policies.
What should plan sponsors take away at this point? At this time, the Fifth Circuit has not weighed in and this is only one district court opinion without precedential impact. Nonetheless, plan sponsors could consider implementing a mechanism for evaluating their investment managers’ proxy voting process—particularly for plans that are administered in the Northern District of Texas. This could include reviewing the investment managers’ proxy voting policies and requiring manager certifications that they voted their proxies in accordance with policy. Plan fiduciaries should also take steps to distinguish between the actions they take in their fiduciary capacity on behalf of a plan, and those taken when acting in a corporate capacity on behalf of the business as a whole.
1 Publicly traded US companies hold annual meetings in which shareholders are eligible to vote on a slate of proposals. These votes are known as “proxy votes.” Investors who hold company stock directly may submit their own proxy votes; however, shares held indirectly through a mutual or other investment fund are typically voted by the fund manager.
2 Defendants’ Mot. for Summary Judgment, at 1.
3 Summary Judgment Op. at 3. Plaintiff has offered evidence that certain ESG-labeled funds underperformed, but he has not yet offered evidence that all ESG goals at the corporate level necessarily harm investment returns.
7 Defendants’ Proposed Findings of Fact and Conclusions of Law, at ¶ 106.
8 Further, as Defendants point out, even if a plan sponsor could accurately predict the immediate price impacts of particular shareholder proposals, it is unclear how they would then satisfy their fiduciary obligations. In its summary judgment opinion, the court notes that investment managers have scaled back “ESG activism after facing an onslaught of pressure from … Republican states.” Summary Judgment Op. at 38. Less clear is whether lobbying by a single (or even multiple) plan sponsors would cause investment managers to alter their proxy vote decisions.
10 Summary Judgment Op. at 26 n.111.
11 Summary Judgment Op. at 36.
12 Summary Judgment Op. at 36 n.142.
13 Summary Judgment Op. at 35 n.136.
14 Defendants’ Mot. to Exclude in part Expert Testimony of J.B. Heaton.
15 Summary Judgment Op. at 36-37.
