Two ESG-Related District Court Rulings
A pair of recent rulings in a Texas District Court offer contrasting perspectives on the legal implications of incorporating environmental, social, and governance (“ESG”) factors into retirement plan investing. Together, these decisions highlight the ongoing debate regarding the role of ESG factors in retirement plan investment strategies, potentially paving the way for further litigation on the matter. Companies and investors should closely monitor these developments, as they may signal the emergence of a clearer judicial framework surrounding ESG considerations in investment decisions. If upheld on appeal or adopted by other courts, these rulings could prompt a reevaluation of how investment decisions, particularly those involving ESG factors, are managed within benefit plans, potentially leading to widespread changes in fiduciary practices.
Overview of ESG Investing
ESG investing generally refers to the consideration of environmental, social, and governance factors when making investment decisions. These factors include issues like environmental sustainability, social justice, and corporate governance practices. As concerns about climate change, perceived inequality, and corporate accountability for diversity initiatives have grown over the past few years, ESG investing has gained significant traction among institutional investors, including pension funds and 401(k) plans.
The Spence v. American Airlines, Inc. Decision
On January 10, 2025, the U.S. District Court for the Northern District of Texas (the “Northern District of Texas”) issued its decision in Spence v. American Airlines, Inc., ruling that American Airlines (“American”) and its Employee Benefits Committee (“EBC”, together with American, the “Defendants”) breached their fiduciary duty of loyalty under the Employee Retirement Income Security Act of 1974 (“ERISA”). The Northern District of Texas determined that by including funds in the 401(k) plan managed by firms prioritizing ESG strategies, the Defendants failed to act solely in the financial interests of plan participants. This decision has ignited important discussions about the limits of socially conscious investing in retirement plans, particularly regarding how ESG considerations can be integrated into investment decisions without violating ERISA’s fiduciary duty requirements.
Background
Bryan Spence (“Spence”), a senior pilot for American, filed suit in June 2023 on behalf of participants in the American Airlines 401(k) Plan and the American Airlines 401(k) Plan for Pilots (collectively, the “Plan”). Spence alleged that the Defendants breached their fiduciary duties under ERISA by “mismanaging” the Plan when they engaged an investment manager (namely, BlackRock Institutional Trust Company, Inc. (“BlackRock”)) that favored nonpecuniary ESG policy goals through its proxy voting strategies and shareholder activism over the financial interests of Plan participants. Although Spence did not identify ESG strategies specific to the Plan’s BlackRock funds and assets managed by BlackRock, the lawsuit alleged that BlackRock and other investment firms “pursue a pervasive ESG agenda.” According to Spence, these actions compromised the Plan’s performance by prioritizing ESG strategies that were not aligned with the primary objective of maximizing returns for the Plan’s participants and beneficiaries.
Fiduciary Responsibilities Are Subject to the Exclusive Benefit Rule and the Prudence Standard
ERISA § 404(a)(1) requires fiduciary duties to be discharged in the sole interest of the plan’s participants and beneficiaries, making decisions that meet the exclusive benefit rule and the prudence standard. The exclusive benefit rule requires fiduciaries to place the interests of the plan’s participants and beneficiaries above those of the employer or any other party. The prudence standard requires fiduciaries to manage plan investments, including shareholder rights associated with investments such as voting proxies, with the care, skill, and diligence that a prudent person would exercise in similar circumstances.
The January 10th Decision in Spence
The Northern District of Texas’s ruling after a four-day, non-jury trial was that the Defendants breached their duty of loyalty under ERISA but did not breach their fiduciary duty of prudence. The court found that the exercise of Defendants’ fiduciary decision-making was influenced by their business relationships with BlackRock, and that the Defendants failed to consider how their plan consultants might be similarly influenced by their own relationships with BlackRock. The court held these lapses constituted a breach of the duty of loyalty to the Plan which allowed the Plan’s fiduciaries’ proxy voting, if not other investment decision-making, to include ESG strategies that were not aligned with the financial interests of Plan participants. The court cited evidence indicating the EBC members took into account BlackRock’s non-Plan relationships with American (specifically, that BlackRock was holding over 5% of American’s shares and $400,000,000 of American’s corporate debt) as well as BlackRock’s investment management relationship with the Plan in considering how to respond to BlackRock’s ESG positions; the EBC’s reliance on consulting firms with conflicting interests and relationships with American and the pilots’ union (which favored ESG initiatives) as well as with the Plan; and, finally, the EBC’s failure to take action (or possibly even notice) when BlackRock failed to periodically attest, as required by its investment management agreement, that BlackRock was adhering to its own proxy-voting guidelines requiring BlackRock to “vote proxies in the best long-term economic interests” of the managed Plan assets. The opinion described these conflicting interests as “Defendants turn[ing] a blind eye to BlackRock’s ESG activism.”
Despite the finding that these facts and circumstances showed a breach of loyalty, the court held that the Defendants’ investment decisions were prudent and consistent with prevailing industry practices.
The February 14th Decision in Utah v. Micone
The Biden Administration’s ESG rule (the “Rule”), issued by the U.S. Department of Labor, permits employee benefit plan fiduciaries to consider ESG factors when making investment decisions for their plans as long as the factors are relevant to a risk/return analysis and the plan’s financial interests are not “subordinate[d] . . . to other objectives.” The Rule, entitled “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” became effective in January 2023. The Rule states that if a fiduciary prudently determines that competing investment opportunities “equally serve the financial interest of the plan,” the fiduciary is not prohibited from selecting an investment based on “collateral benefits other than investment returns” and allows use of ESG factors as a “tiebreaker.” The preamble to the Rule reiterates the longevity of the “tiebreaker” rule, noting that “some version of the tiebreaker test has appeared in the [Department of Labor’s rules] since 1994.”
Shortly after the Rule was finalized, 26 attorneys general challenged it, arguing that it “undermines key protections for retirement savings of 152 million workers . . . in the name of promoting ESG factors in investing, including the Biden Administration’s desire to address climate change.” After the Supreme Court's decision last year to overturn the Chevron doctrine, which impacts how federal agencies interpret ambiguous Congressional statutes, the Fifth Circuit remanded this challenge to the Rule to the Northern District of Texas.
On remand, the Northern District of Texas upheld the Rule, acknowledging that retirement plan fiduciaries may prudently consider ESG factors when selecting investments but only after they have identified more than one financially prudent investment alternative that each “equally serve the plan’s financial interests.” The opinion emphasized that the “tiebreaker” standard in the Rule does not violate ERISA’s requirement that fiduciaries act “solely” in the interest of participants and beneficiaries and for the “exclusive” benefit of the plan’s financial interests, as long as the fiduciary reached the “tie-breaker” threshold by identifying “multiple, equal investment options” without deviating from a prudent analysis of the financial aspects of the “competing investment courses of action.” In its decision that the Rule did not violate the duty of loyalty requirement imposed on plan fiduciaries under ERISA, the court highlighted that the duty of loyalty pertains to how plan fiduciaries fulfill their obligations, rather than what factors they must take into account when doing so.[1]
Lessons Gleaned from These Opinions
The Spence decision establishes a relatively low threshold for what constitutes a breach of the fiduciary duty of loyalty under ERISA, raising concerns about the increased scrutiny plan sponsors may face when making investment decisions that incorporate ESG considerations. To mitigate the risk of disloyalty claims based on Spence, plan sponsors should closely monitor and review the shareholder activism strategies of their investment managers, particularly when proxy voting is involved. Where the plan has built-in assurances that an investment manager’s proxy votes protect the financial interests of participants and beneficiaries, care should be taken to monitor compliance with such assurances whether found in the investment management agreement, an investment policy statement, a fund prospectus, or proxy-voting guidelines, keeping in mind that the court found this ERISA violation regarding ESG considerations even though the plan did not hold specific ESG investments.
In contrast to the court’s attention to specific facts and circumstances in Spence, the Micone decision upholds as a general matter the tiebreaker test of the Rule under the Loper Bright standard of review. Although it is uncertain how the Labor Department under the Trump administration will address the Micone case and whether it will seek to amend or rescind the Rule (which currently remains in effect), it seems clear that plan fiduciaries should still review their plan investments and decision-making processes for inappropriate ESG-related activities due to the risk of private litigation of the type that arose in Spence.
Next Steps
- Determine how ESG considerations affect the employer, including whether the employer’s core business is affected by ESG considerations, whether it has taken public ESG positions, including required disclosures for publicly traded companies, and whether its corporate policies and governance include ESG factors.
- Look carefully at plan decisions and processes to determine whether ESG considerations have seeped into plan decision-making.
- If ESG issues are identified, determine whether an ESG-related issue was based on a purely financial basis. If so, decide how to document that and whether further attention is needed.
- If justified, consider hiring an independent fiduciary to review and address ESG issues, including whether to unwind problematic relationships to avoid conflicts of interest.
- Identify which of the plan’s service providers actively pursue ESG policies and positions and determine whether and how those policies and positions present risk to the plan and the plan fiduciaries.
- Determine whether the plan’s investment manager holds significant equity or debt positions in the employer.
- Consider whether to ask an independent fiduciary to vote proxies rather than the investment manager.
- Ask the service provider for its process to determine when a conflict of interest exists, and whether it thinks there is a conflict of interest in providing services to the plan. Document the response.
- Make an independent determination whether there is a conflict of interest and document your finding, taking corrective action if needed.
- Review investment management agreements to identify current requirements related to: ESG considerations; proxy voting; conflicts of interest; the employer’s monitoring requirements; and a manager’s reporting obligations. Determine whether and how the requirements are met. Document the findings.
- Does the plan have investments that reflect ESG considerations?
- Who has the duty to vote proxies?
- How does the plan monitor delegated proxy voting?
- If the investment manager monitors its own proxy voting, is the investment manager following its own guidelines?
- If the investment manager must follow its own guidelines, do the guidelines expressly require the investment manager to act solely in the plan’s financial interest?
- If the employer has ESG policies, positions or concerns, consider whether they have any consequence on how proxy voting has been delegated or how proxies are voted?
- Review consulting agreements for similar provisions and concerns related to ESG considerations and proxy voting.
- Ask your investment managers, fund managers, and other proxy-voting service providers to describe the process for making proxy decisions, including how ESG-related considerations are taken into account in voting proxies; whether and how advice from external proxy-voting advisors is vetted for ESG-bias; whether proxy-voting decisions have deviated from their own proxy-voting guidelines in the past five years and if so, how and why; and how they ensure proxy-voting decisions are solely for financial reasons.
- Review investment policy statements (“IPS”) to identify limitations on investments, including ESG considerations.
- Determine whether the IPS terms have been followed.
- Determine whether the IPS should be updated to include ESG limitations.
- Identify potential conflicts of interest arising from a service provider’s substantial relationships with the employer or significant customers.
- Do plan consultants, trustees, recordkeepers, investment managers, auditors, agents, etc., also have a business relationship with the employer?
- If so, does the business relationship with the employer affect services provided to the plan? Document your findings.
- Review past investment or plan committee records for evidence of conflicting loyalties reflected in the minutes, informal notes, and other records. If conflicting loyalties are found, address the conflict in a current meeting and reflect the results in committee records.
- Conduct fiduciary training for investment committee personnel, including but not limited to understanding:
- The prudence standard of care in fiduciary decision-making;
- How to act solely in the interest of participants and beneficiaries when making plan decisions (the duty of loyalty);
- How to separate fiduciary decision-making from a corporate or business decision-making role;
- ESG concerns and the potential for conflicts of interest in the fiduciary training;
- The role of each member of an investment committee and of the committee as a whole;
- How the exclusive benefit rule shapes investment decision-making, including the requirement to make investment decisions based on risk and return considerations;
- The different aspects of investment services, including asset allocation, selecting asset managers, delegating proxy-voting responsibilities and other shareholder rights and responsibilities, required disclosures, duty to monitor; cash sweep decisions, and similar concerns;
- How the duty to diversify investments affects the plan.
- Confirm the plan has strong policies and procedures that align with current industry practices and standards.
- If there is an investment committee, establish a committee charter outlining the duties and processes of the committee if a charter is not already in place.
- Whether operating as a committee or as individuals, set periodic meetings or schedule allocated review periods for an individual (generally, at least quarterly depending on the size and type of plan), and maintain robust records of meetings or reviews.
- Use a formal RFP with multiple firms to secure appropriate service providers.
- Identify internal resources who can lend expertise to the retirement plan decision-making process but be cautious in evaluating internal advice since it may be inherently weighted toward corporate concerns.
- If plan policies and procedures include reference to ESG considerations, confirm the reference adheres to applicable regulatory guidance.
For additional information about any of the above recommendations, or to discuss any questions that you may have, please contact a member of Maynard Nexsen’s Employee Benefits & Executive Compensation Practice Group.
[1] On February 21, 2025, the Trump administration issued a policy memo titled “America First Investment Policy” (the “Policy”), aimed at “protecting the savings of United States investors and channeling them into American growth and prosperity.” The Policy directs the U.S. Department of Labor to “publish updated fiduciary standards under ERISA for investments in public market securities of foreign adversary companies.” Notably, the Policy argues that “investment at all costs is not always in the national interest,” which could signal a potential shift in the way fiduciaries are directed to approach ESG considerations. This raises the question whether fiduciaries will need to consider national security concerns in their investment decisions, rather than focusing solely on financial factors, but that remains to be seen
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