Minding the Store: Unanticipated ESG Issues Affecting ERISA Fiduciary Supervision

A recent summary judgment decision from the U.S. District Court for the Northern District of Texas in an ERISA (Employee Retirement Income Security Act) class action challenging the alleged impact of environmental, social, and governance (“ESG”) policies on fiduciary decisions highlights the risks to plan fiduciaries of being caught up in litigation premised on political agendas and cultural division. On June 20, 2024, the Texas federal court denied a motion for summary judgment by American Airlines, the sponsor of a 401(k) plan, in a suit alleging that the plan’s fiduciaries breached their duties of prudence and loyalty by (i) allegedly failing to monitor and evaluate the ESG-related proxy voting practices of the managers of the plan’s investment options and by (ii) allegedly permitting the sponsor’s own ESG goals to influence fiduciary decisions.¹ Notably, the plan does not include any ESG-focused investment options, but that did not shield the plan or its fiduciaries from litigation. Following the denial of summary judgment, the parties tried the case during the last week of June. The court has yet to issue a decision, but when that decision comes, it may affect how plan sponsors and fiduciaries choose to structure their fiduciary processes, even when their plans do not offer or invest in ESG-focused investment options.

The Summary Judgment Decision

The facts underlying the litigation by the time it reached summary judgment are surprising. Contrary to press reports, many of which misunderstood the plaintiff’s shifting theories of liability, the summary judgment stage of the litigation did not involve a challenge to ESG-focused investment options (indeed, the plan did not include any, as the plaintiff eventually conceded), nor did it involve the availability of ESG-focused mutual funds via the plan’s brokerage window (although that was an earlier theory of liability that the plaintiff had abandoned by summary judgment). The plaintiff also did not argue that (i) ESG factors had influenced the investment managers’ investment buy-and-sell decisions, (ii) the investment options had higher fees or expenses than comparable options, or (iii) the investment performance was lower than comparable investment options. Rather, at the summary judgment stage, the plaintiff’s theory of liability focused on the fact that at least one of the investment managers of the plan’s passively-managed index investment options (and one of the world’s largest managers, including of retirement assets) had allegedly expressed support for ESG policies and had allegedly taken ESG factors into account in its proxy voting practices. 

In denying American Airlines’ motion for summary judgment, the court concluded that a reasonable fact finder at trial could find that the plan fiduciaries had breached their duty of prudence by failing to evaluate or monitor the ESG proxy voting practices of the plan’s investment managers. The court explained that it did not appear that ESG and proxy voting by the plan’s investment managers were ever discussed at plan committee meetings prior to the lawsuit being filed. Although the court acknowledged that 72,000 defined contribution plans use the manager in question to manage a portion of their investments, it held that this fact was insufficient, at least on summary judgment, to show that a fiduciary decision to use that manager was prudent. The court also concluded that a reasonable fact finder could find at trial that the plan fiduciaries breached their duty of loyalty by permitting corporate ESG goals to influence the plan committee’s fiduciary decisions. 

Following the decision, the parties tried the lawsuit before the court, without a jury, in the last week of June. The court has yet to issue its decision determining whether the plan fiduciaries breached their fiduciary duties and, if so, whether the plan and its participants suffered a resulting financial loss. Once issued, the losing party could appeal the decision to the U.S. Court of Appeals for the Fifth Circuit.

The Regulatory Landscape and Current Fiduciary Practices

A Department of Labor regulation under ERISA specifically addresses the consideration of ESG factors in selecting plan investments and exercising related duties, including voting proxies.² The regulation neither promotes nor inhibits the consideration of ESG factors. Rather, it takes a principles-based approach, focusing on whether plan fiduciaries act prudently and in the best interests of the plan in considering ESG factors. In a provision not addressed by the Texas federal court in its decision, the regulation states:

Risk and return factors may include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action. Whether any particular consideration is a risk-return factor depends on the individual facts and circumstances. The weight given to any factor by a fiduciary should appropriately reflect a reasonable assessment of its impact on risk-return.³

Thus, plan sponsors and other investment fiduciaries have leeway to determine whether and to what extent ESG factors are relevant in any given investment decision. Fiduciaries are not to be subject to heightened scrutiny merely for considering (or not considering) ESG factors.

The regulation’s principles-based approach to ESG factors extends to proxy voting. Investment managers have a duty to vote proxies, except where they are passed on to participants or where the managers determine that doing so is not in the plan’s interest, and managers must act prudently and in the plan’s best interests, including in considering ESG factors. Managers may maintain their own policies governing proxy voting activities on behalf of a plan. Managers must periodically review those policies to ensure they remain prudent and in the plan’s best interests.

Plan sponsors and other fiduciaries who appoint investment managers retain a general duty under ERISA to monitor those managers, including with respect to proxy voting. But the preamble to the regulation makes clear that this duty to monitor does not include “special obligations above and beyond the statutory obligations of prudence and loyalty that generally apply to monitoring the work of service providers.” Generally, the Department of Labor views “a fiduciary’s obligations with respect to monitoring a service provider [to] include measures to ascertain the service provider’s compliance with ERISA and the terms of the plan.”⁴ While the exact limits of this duty to monitor remain unclear in connection with proxy voting, it arguably includes reviewing a manager’s proxy voting policy and any changes thereto and reasonably assuring oneself that the manager has acted consistent with such policy but not re-examining or second-guessing specific proxy votes.

Key Takeaways

Many plan fiduciaries currently rely on policy disclosures and contractual representations by a plan’s investment managers regarding how they will vote proxies, and/or fiduciaries rely on consultants to evaluate proxy voting practices and may not otherwise devote significant time to proxy voting matters. The court’s summary judgment decision suggests that relying on such disclosures and representations, without additional diligence, may subject the plan fiduciaries to litigation risk. Moreover, the decision suggests that appointing investment managers that are widely used in other plans may not be a sufficient defense to allegations of this type. This is a single decision from a single court issued before trial, however. The outcome of the trial and any appeal will need to be taken into account in assessing litigation risks posed by the case.

The court’s summary judgment decision highlights the need for plan sponsors and other fiduciaries to ensure they act prudently and in the best interests of the plan in selecting and monitoring investments, including considering how ESG factors may play a role in such investments. Plan fiduciaries can mitigate such litigation risk by having and following robust policies and procedures with respect to initial due diligence of managers, including their proxy voting policies, and ongoing monitoring of their activities (even if the extent to which such monitoring must include actual proxy voting practices remains to be seen). But most of all, the decision highlights the ongoing litigation risk to plan fiduciaries of being caught up in ongoing political debate and cultural division with respect to certain investment practices.

^[1] Spence v. American Airlines, 2024 WL 3092453 (N.D. Texas June 20, 2024).
^[2] 29 C.F.R. 2550.404a-1.
^[3] Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, 87 Fed. Reg. 73822, 73833 (Dec. 1, 2022) (codified at 29 C.F.R. § 2550.404a-1).
^[4] Id. at 73842.

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