Mixing politics and pensions in the private sector

While most headlines about regulating environmental, social, and governance (ESG) factors in investments have focused on public pensions and public finance, a recent federal ruling from Texas has thrown private-sector retirement plans into the discussion.

An American Airlines employee sued the company, contending it violated its fiduciary duties by hiring investment firms with “ESG objectives” to advise and manage AA’s employee 401(k) plan.

U.S. District Judge Reed O’Connor, whose court has become a favored forum for conservatives, ruled that while AA’s choice of BlackRock to manage part of its retirement program fulfilled the company’s duty of prudence, it didn’t fulfill its duty of loyalty to its beneficiaries. He said in his ruling that, in his view, BlackRock, the world’s largest asset manager, was tainted by “ESG activism.”

The judge asked the parties to file more briefs and is now deciding what financial penalties should follow.

The investments in question in American Airlines’ retirement program are index funds, none of which have ESG objectives. There was no evidence in the record that proved the funds under-performed their benchmarks, which some experts have stated should make the penalty portion of the legal case challenging. On top of that, O’Connor slipped past the conventional requirement that a fiduciary breach of prudence should precede any ruling on a duty of loyalty. He even admitted in the ruling that AA has acted prudently and that its actions were “consistent with and, in many aspects, exceeded the processed of other fiduciaries.”

BlackRock, which is not a party to the lawsuit, was mentioned frequently throughout the 70-page ruling, with Judge O’Connor listing examples of alleged issues with ESG that are largely out of date. That’s especially true of BlackRock’s high-profile retreat from climate-based groups and agreements. The firm’s support for ESG shareholder proposals has, over the last four years, decreased from 46% to just 4% after its own analysis found those proposals to be over-reaching, lacking economic merit, or unlikely to help promote long-term shareholder value.

O’Connor’s final ruling hasn’t been issued, but the State Financial Officers Foundation (SFOF) — a group of conservative state financial officials from across the country — has already urged federal agencies to incorporate it quickly into their regulations.

Many professionals in the retirement industry find the ruling confusing, and there is a general consensus that the potential impact on the role of ESG policies in investment management remains uncertain.

In Pensions and Investments, Nevin Adams, an attorney and former chief content officer for the American Retirement Association was quoted as saying, “I still find the conclusion — and the rationale — to be a bit of a head-scratcher,” adding: “This judge connected a lot of random dots to get to the implications he seems to be predicating the decision on.”

ERISA attorney Joshua A. Lichtenstein stated he thought there was “real risk that this will be the first” in a slew of new politically motivated cases, and even greater risk for “nonpolitical copycat cases… seeking damages that will lure the ERISA plaintiffs’ bar.”

American Airlines has not indicated whether it will appeal the ruling, but given the potential broad impact to private retirement plans, there will be a lot of attention given to the ruling and its associated fallout.