A pilot has sued American Airlines, Fidelity Investments, and others alleging that they violated ERISA by offering 401(k) plans that include environmental, social, and governance factors. If successful, it would open the door to a wave of litigation seeking to reclaim losses from ESG decisions.
Environmental, social, and governance, or ESG, is a type of investing where factors beyond strictly financial matters are considered. In concept, ESG is about giving investors the ability to choose how their money is used. If an individual is willing to take a lower rate of return to feel like they are making a positive impact, they can select a fund that matches their priorities.
The class action lawsuit revolves around a legal theory that ESG is a violation of fiduciary duty under the Employee Retirement Income Security Act. In ERISA, Congress delegated authority to the Department of Labor to regulate standards for pension plans, including 401(k)s. Under ERISA, the DOL manages what factors fund managers can consider when investing retirement savings. The primary factor has been, and continues to be, profit. However, the rise of ESG has caused confusion as to how it can be factored, it at all.
In 2020, the Trump Administration DOL issued a rule that said investments should be made based on “pecuniary factors” only. The rule was intended to be anti-ESG, however experts felt the rule caused more confusion as the pecuniary factors test was considered vague. In 2022, the Biden Administration DOL issued a new rule saying that investments can consider ESG as a tiebreaker. Only if two funds are projected to produce the same returns, then could the fund manager consider ESG. The new rule allows for the consideration of ESG factors if they are going to make the investment more profitable. How that is factored is yet to be determined. Congress tried to override the new rule, but Biden issued his first veto and reinstated it.
While the 2022 rule allows for some consideration of ESG, the lawsuit, Brian P. Spence v. American Airlines, is based on actions which occurred under the prior ERISA standards, which were murky at best.
Texas attorneys Heather Hacker and Andrew Stephens, of Hacker Stephens LLP, and Rex Sharp of Sharp Law LLP drafted the complaint. It alleges that ESG funds underperform on financial returns and, even though the plaintiff chose ESG funds, the fund managers still had a duty to maximize returns.
Further, the complaint alleges that, not only were the ESG funds a violation of the ERISA rule, but also that other fund options were in violation. Stating “defendants have also included in the Plan funds that are not branded as ESG funds, but are managed by investment companies who have voted for many of the most egregious examples of ESG policy mandates, on issues such as divesting in oil and gas stocks, banning plastics, requiring ‘netzero’ emissions, and imposing ‘diversity’ quotas in hiring.”
That argument gets at the core of how fund managers incorporate ESG into their decision-making process. Over the past few years, proponents have quickly shifted their views on ESG from something that can be considered in limited circumstances to a required part of fiduciary duty. That theory has yet to be tested in a U.S. court, but could be allowed under the 2022 rule.
Ultimately, the lawsuit may be about knowledge. The complaint opens with “many American workers don’t realize that their hard-earned money is being used against them. Firms whose job is to deliver investment returns are instead weaponizing retirement funds, public pensions and other investments in pursuit of nakedly ideological goals. It is perhaps the most severe breach of the fiduciary standard in American history.”
If successful, this litigation could upend the ESG debate in the U.S., and open the door for litigation which could force fund managers to reimburse for financial losses for ESG decisions.