Texas Judge Lowers Bar for ESG Lawsuits Over Employer 401(k)s

A conservative Texas federal court’s decision to green-light a 401(k) lawsuit against American Airlines for its ties to environmentally friendly asset managers asserts a new, less-rigorous pleading standard that sets the stage for more private-sector ESG claims.

US District Court for the Northern District of Texas Judge Reed O’Connor denied the airline company’s motion to dismiss the proposed class action lawsuit on Feb. 21. The ruling shocked many in the workplace benefits industry who said they expected a swift end to what they call a frivolous environmental, social, and corporate governance claim.

O’Connor cited a “plausible story” a pilot has made that the airline’s public commitment to ESG initiatives fueled its decision to hire asset managers such as BlackRock that allegedly share those views. The pilot claims American violated its duties of prudence and loyalty as well as obligations to monitor under federal benefits law by offering funds managed by companies that pursue extra-financial policy goals to the detriment of investor returns.

The opinion promotes a novel, unproven legal theory with the potential to implicate major Wall Street asset managers that oversee trillions of US 401(k) and pension dollars nationwide. By lowering the bar for allowing the case to advance, the court has signaled its willingness to hear challenges against more corporate defendants—a retirement sector not yet mired in the same political controversy swirling around public-sector ESG investing.

“This case allows a speculative and contrived challenge to investments that are offered by investment managers that are supposedly woke and pursue non-economic ESG interests,” said Daniel Aronowitz, president of Encore Fiduciary, a Virginia-based fiduciary liability insurer. “This opens up every plan in America to a fiduciary breach challenge if you used BlackRock or pretty much every investment adviser in America.”

BlackRock, like other top 401(k) fund managers, has publicly committed to sustainable investment strategies and embraced ESG through a client-driven lens the firm says is backed by performance analytics and research. Asset manager activism on ESG has drawn the ire of Republican state politicians, many of whom have banded together recently to blacklist companies from public pensions that engage in what they’ve deemed “woke capitalism.”

‘No Benchmark’

Plaintiffs in the American Airlines case allege that employee savings suffered under company leadership and the influence of ESG, but they haven’t yet set clear benchmarks or market comparisons to support that claim.

That sets a dangerously low bar for politically motivated ESG cases to proceed, industry analysts said.

O’Connor ruled that plaintiffs “need not plead the exact connection between the investment managers’ alleged ESG proxy voting and the financial harm Plaintiff suffered as a result.”

BlackRock, Vanguard, and State Street, three of Exxon Mobil‘s biggest institutional investors, did side with a little-known shareholder activist fund in 2021 to install three new climate-friendly directors on the energy company’s board. The move resulted in a temporary dip in stock the American Airlines plan was invested in, which O’Connor said bolsters the plaintiff’s claim.

The fact that other top 401(k) fund managers voted in unison proves a market trend—not a standalone bad actor, Aronowitz said. Under O’Connor’s standard, every 401(k) plan in the country that offers BlackRock, Vanguard, or State Street funds could be forced to to reconcile their fiduciary responsibilities with a single proxy vote decision, he said.

Together, the three financial giants oversaw 47% of total US assets under management in 2022, according to Bloomberg analytics.

“It’s unfortunate, because even if American Airlines prevails here, it has to go through discovery; it’s going to have a big commitment of time and expense to make this go away,” said Carol Buckmann, a founding benefits partner at Cohen & Buckmann PC in New York. “There’s no specificity in that complaint. There’s no benchmark.”

The US Supreme Court set a higher pleading standard in the much anticipated Hughes v. Northwestern University case it remanded back to the US Court of Appeals for the Seventh Circuit in 2022. Justice Sonia Sotomayor’s brief opinion focused on a context-specific analysis that “gives due regard to the range of decisions plan sponsors can make,” Buckmann said.

“Other courts have said you need a meaningful benchmark for a case to proceed,” she said.

‘Politically Motivated’

Benefits lawyers reviewing the O’Connor decision fear it also sets a politically ominous tone for 401(k) plan sponsors eager to avoid legal fights.

Private-sector 401(k)s have all but flown under the radar amid the highly partisan public-sector ESG culture wars. Few corporate plans offer strictly socially conscious-themed funds and the last two presidential administrations have offered up competing theories for whether workers should be exposed to do-good investments at all.

American Airlines’ own pro-ESG corporate policy and its decision to promote diversity, equity, and inclusion is likely what thrust it into the legal limelight, said Candace Finn, a retirement plan analyst at Multnomah Group Inc., a benefits consulting firm.

“It seems American Airlines drew the short straw to be the first defendant in a 401(k) ESG case,” Finn said. “But if they hadn’t had an ESG policy, how would the judge have gotten from point A to point B? There would be no basis from which to suggest that they were motivated to select these fund managers.”

Neither American Airlines nor counsel for the plaintiff immediately responded to Bloomberg Law requests for comment.

The choice of the Northern District of Texas to bring the pilot’s suit will also likely help claims proceed that might not prevail in less conservative courts.

O’Connor is a George W. Bush appointee well-known for gutting much of the Affordable Care Act in 2015. In 2023, he blocked an Obamacare requirement for health plans to pay in full for certain preventive health-care services, including PrEP drugs for HIV.

The Fifth Circuit bench remains notorious for conservative rulings that have stripped back key Biden administration priorities.

“Clearly the filing of this case is politically motivated, and it’s unfortunate that politics gets mixed up in these cases,” said Buckmann.

The case is Spence v. Am. Airlines, Inc., N.D. Tex., No. 4:23-cv-00552, motion to dismiss denied 2/21/24.