Looks like an American Airlines participant-plaintiff who argued that plan fiduciaries didn’t act in participants’ best interests in including funds managed by firms that allegedly favored ESG interests will get his day in court.
Participant-plaintiff (and pilot) Bryan P. Spence filed suit in the U.S. District Court for the Northern District of Texas in June 2023 against Defendants American Airlines, Inc., American Airlines Employee Benefits Committee, Fidelity Investments Institutional, and Financial Engines Advisors, LLC (he subsequently dropped the latter two), alleging that they “breached their fiduciary duties in violation of ERISA by investing millions of dollars of American Airlines employees’ retirement savings with investment managers and investment funds that pursue leftist political agendas through environmental, social and governance (‘ESG’) strategies, proxy voting, and shareholder activism—activities which fail to satisfy these fiduciaries’ statutory duties to maximize financial benefits in the sole interest of the Plan participants.” The suit had also challenged “the unlawful decision to pursue unrelated policy goals over the financial health of the Plan.”
Since then, the two parties have gone back and forth—American Airlines filing a motion to dismiss, plaintiff Spence challenging that, and amending the suit, and the American Airlines defendants pushing back on those claims—arguing, among other things,[i] that the plaintiff hadn’t even been invested in those particular funds.
Primary Issue
Which brings us to the current status, where Judge Reed O’Connor of the U.S. District Court for the Northern District of Texas (Spence v. Am. Airlines, Inc., N.D. Tex., No. 4:23-cv-00552, 2/21/24) outlined two issues raised by participant-plaintiff Spence that constituted a breach of the duties of loyalty and prudence; first that by including the (allegedly underperforming) ESG funds in the plan the defendants failed to act in the best interests of participants—though Judge O’Connor noted that the plaintiff had since dropped this “Challenged Fund Theory to streamline this case and focus on the primary issue.”
As for that primary issue—the suit now alleges that “Defendants violated their fiduciary duty by knowingly including funds ‘that are managed by investment managers that pursue non-financial and nonpecuniary ESG policy goals through proxy voting and shareholder activism’ on their investment portal (the ‘Challenged Manager Theory’).” More specifically, Judge O’Connor noted that Spence’s argument was that the plan “primarily contains funds administered by investment management firms like BlackRock, Inc.,” and that those firms “pursue pervasive ESG agendas”—an “engagement strategy” that “. . . covertly converts the Plan’s core index portfolios to ESG funds”—which, in turn, harms participant financial interests “because BlackRock focuses on socio-political outcomes instead of exclusively on financial returns.”
A ‘Plausible Story’
Recalling that at the motion to dismiss stage, the courts are directed to essentially give the benefit of the doubt on factual matters to the party NOT moving to dismiss[ii] (here, the American Airlines defendants), Judge O’Connor concluded that the 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.” He further concluded that “failure to consider this information gives rise to a plausible inference that Defendants’ conduct was imprudent. Just as continuing to invest Plan assets with investment managers despite their ESG objectives likewise allows for the plausible inference that Defendants failed to “monitor investment and remove imprudent ones.”
“At this stage, Plaintiff need not plead the exact connection between the investment managers’ alleged ESG proxy voting and the financial harm Plaintiff suffered as a result,” Judge O’Connor wrote. “Instead, there need only be sufficient facts from which the Court can sufficiently infer a flawed process. Such an inference is possible here.”
More Than Required…
Judge O’Connor went on to explain that, “Even so, Plaintiff still pleads more than is required. For example, Plaintiff alleges that investment managers, such as BlackRock, cast proxy votes causing ExxonMobil and Chevron stocks to fall, thereby reducing Plan participants’ returns on those investments. BlackRock is a large shareholder in both of those companies and a major manager of the Plan. As Plaintiff points out, various sources have reported on the underperformance of ESG funds, including those managed by BlackRock. Combined, these allegations give rise to a plausible inference that Defendants should have known about these facts and circumstances. It is this failure to consider such information that gives rise to a plausible inference about Defendants’ flawed process.”
Acknowledging that the American Airlines defendants “repeatedly argue that Plaintiff does not ‘provide a sound basis for comparison—a meaningful benchmark’”—Judge O’Connor noted that “the Court determines that requiring a benchmark for measuring performance is not required at this stage given the inherent fact questions such a comparison involves. And, importantly, the Fifth Circuit has not imposed a performance-benchmark requirement” he noted, commenting that “the Court will defer evaluation of any comparators for future stages of this litigation. Contrary to Defendants’ characterization, the Court finds that Plaintiff has pointed to at least some benchmark for inferring the quality of the investment managers’ performance given the data provided on ESG funds’ ‘established record of underperformance.’”
He went on to comment that the plaintiff (at this stage of the proceedings) “need not marshal evidence of every ESG investment that has financially harmed Plaintiff and the other Plan participants at the pleading stage. Instead, Plaintiff has adequately alleged that Defendants breached their duty of prudence by selecting, including, and retaining investment managers who pursue ESG objectives rather than focusing exclusively on maximizing financial benefits. These specific actions—selecting, including, and retaining ESG-oriented investment managers—allow the Court to reasonably infer that Defendants’ process is flawed because it allowed Plan assets to be used to support ESG strategies.”[iii]
“These allegations do more than reach the mere conclusion that Defendants acted disloyally,” Judge O’Connor wrote. “Instead, Plaintiff’s allegations provide specific facts outlining a plausible theory for how Defendants breached their duty of loyalty by allowing their corporate goals to influence their fiduciary role.”
“In the Amended Complaint, 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. Taking these allegations as true, the Court finds that Plaintiff plausibly alleges at this stage that Defendants violated their duty of loyalty under ERISA by not acting with an “eye single to the interests of the participants and beneficiaries.”
He then concluded that, “Combined with the allegations that Defendants failed to monitor those responsible for Plan assets, the Court finds that Plaintiff has alleged sufficient facts supporting his allegations of breach of prudence at this stage. Therefore, Plaintiff’s breach of prudence and monitoring claims survive the Motion to Dismiss.”
What This Means
Whether or not one feels that the arguments presented are, in fact, “plausible” likely depends (at least to some extent) on how favorably one is predisposed toward ESG (or the notion that those concepts are already well-ensconced in most investment strategies).
That said, and to Judge O’Connor’s point, the deference accorded the position of the party not moving to dismiss is well-established precedent. Here, he seems to believe that the arguments presented go beyond a mere assertion of result, and lay out a credible explanation (dare we say “plausible”?) for motivations that might well not have been SOLELY in the best interests of participants. All of which he deemed more appropriate to resolve at trial.
Stay tuned.
[i] Defendants also argued that these allegations are insufficient to state a claim because Plaintiff provides no benchmark by which to compare performance. Defendants further contend that Plaintiff neither alleges any facts specifically showing how investment managers’ funds underperformed nor provides facts connecting the investment managers’ proxy votes for ESG measures to the alleged underperformance.
[ii] On a Rule 12(b)(6) motion to dismiss for failure to state a claim . . . the district court must accept the truth of plaintiff’s allegations or rely upon only those matters outside of the pleadings with respect to which there is no genuine issue of fact.”
[iii] Also noted were arguments by the plaintiff that the American Airlines defendants “did so as part of a company-wide commitment to ESG goals, knowing that investment managers—such as BlackRock—invest in and vote for ESG policies.” Judge O’Connor noted that the plaintiff contended that “this company-wide focus on ESG goals violated Defendants’ duty of loyalty.” The defendants argued that their company commitment to ESG initiatives was separate from their fiduciary role, but “Notwithstanding Defendants’ arguments, the Court finds that Plaintiff has alleged sufficient facts at this stage to establish a breach of the duty of loyalty,” explaining that the resolution of the dispute was not appropriate at this stage in the proceedings.
