By Gerald L. Maatman, Jr., Brad A. Molotsky, and Jesse S. Stavis
Duane Morris Takeaways: On February 21, 2024, in Spence v. American Airlines, Inc., No. 4:23-CV-00552-O (N.D. Tex. Feb. 21, 2024), Judge Reed O’Connor of the U.S. District Court for the Northern District of Texas denied defendants’ motion to dismiss in a class action filed under the Employee Retirement Income Security Act of 1974 (ERISA). The ruling strikes the latest blow in the war between advocates and opponents of so-called environmental, social, and governance (ESG) investment. If the decision stands and if other courts adopt the rationale of the ruling, ERISA fiduciaries that invest in funds based on ESG factors are apt to face heightened risks and exposures.
Case Background
The primary purpose of the ERISA is to protect the beneficiaries of employee retirement plans. To achieve this goal, the law imposes demanding fiduciary duties on plan administrators, who are required to act with prudence and loyalty in selecting investment vehicles. In general, ERISA fiduciaries are expected to choose funds that will maximize profits for plan beneficiaries. However, in recent years, many investment funds have made concerted efforts to consider the social and environmental impacts of their decisions. This practice has proven controversial, as some plan beneficiaries have claimed that the focus on socially conscious investment has harmed their bottom line.
In Spence, the named plaintiff, an American Airlines pilot, is seeking to represent a class of approximately 100,000 participants in the company’s 401(k) plans. Spence argues that plan fiduciaries violated their duties of loyalty and prudence by investing in underperforming ESG funds, and by choosing funds that are managed by investment firms that pursue ESG goals through proxy voting and shareholder activism. According to plaintiff, firms like BlackRock had cast proxy votes that caused ExxonMobil and Chevron to adopt environmentally and socially conscious policies. Because these policies allegedly resulted in declining stock prices, the plaintiff asserts claims for breach of fiduciary duty to invest in funds managed by these individuals.
The airline and its employee benefits committee moved to dismiss. They contended that plaintiff lacked standing because he had not shown that he was personally impacted by any investment decisions. Defendants further argued that the plaintiff’s failure to provide meaningful comparisons between the airline’s plans and supposedly better-performing plans was fatal to his case. Finally, they urged the Court to reject plaintiff’s “Challenged Manager theory,” which suggests that investment in funds managed by individuals who have signaled their commitment to ESG is itself a breach of fiduciary duty. This theory, they argued, “is as wrong as it sounds.” Id. at 2.
The Court’s Ruling
In its ruling, the Court rejected all of the defendants’ arguments and denied the motion to dismiss. The Court held that the plaintiff had presented a plausible theory by arguing that ESG funds systematically underperform and that plan fiduciaries breached their duties by selecting these underperforming funds. According to the Court, “[f]ailure to consider [the alleged underperformance of ESG funds] gives rise to a plausible inference that defendants’ conduct was imprudent.” Id. at 12. The Court further held that plaintiff was not required to provide detailed benchmarks at the motion to dismiss stage.
Most significantly, the Court endorsed plaintiff’s Challenged Manager Theory. According to Judge O’Connor:
Plaintiff articulates a plausible story: Defendants’ public commitment to ESG initiatives motivated the disloyal decision to invest Plan assets with managers who pursue non-economic ESG objectives through select investments that underperform relative to non-ESG investments, all while failing to faithfully investigate the availability of other investment managers whose exclusive focus would maximize financial benefits for Plan participants.
Id. at 12-13. This focus on the identity of fund managers, rather than on specific actions taken by those managers, was an innovative theory, and one that the Court adopted in full.
Implications Of The Ruling
The implications of the Court’s ruling are striking. According to the Court, ERISA plans can breach their fiduciary duties not only by choosing the wrong funds, but also by doing business with fund managers who have signaled their commitment to ESG investment.
The decision in Spence is unlikely to be the last word in this space.