New York Pension Case Poised to Decide Fate of ESG in 401(k)s

A state-court lawsuit challenging three New York City pension plans’ decision to divest from fossil fuel companies is poised to determine the fate of a broader, Republican-backed legal theory that ESG considerations don’t belong in workplace 401(k)s.

Workers’ rights group Americans for Fair Treatment filed the lawsuit in May, alleging that a 2021 decision by the public-sector pension plans to sell off more than $4 billion in oil and gas securities violated state laws governing fiduciary conduct.

A New York County judge is primed to rule at any moment on a fully briefed motion to dismiss the case.

The decision has the potential to unlock a wave of private-sector litigation under similarly constructed federal laws. Or it could hinder a novel GOP approach aimed at supporting the fossil fuel industry by protecting it from Wall Street’s environmental, social, and corporate governance trend.

“How the court comes out on this ultimately, regardless of how it weighs in at this early stage of a motion to dismiss, has some potential far-reaching effects on the various platforms on which this issue is being litigated and argued at the state regulatory level, the federal regulatory level, and in Congress,” said Amy D. Roy, a partner at Ropes & Gray LLP in Boston who specializes in securities litigation.

‘Nakedly Political’

The New York case pits public messaging over ESG policy against real-life decisions that pensions have made to invest or divest according to a social agenda or careful risk-return analyses.

Then-New York Mayor Bill de Blasio (D) pledged in 2018 that the city’s public pension funds would divest from major energy polluters, but didn’t cite any reasons for the move or ways that it would benefit plan participants or beneficiaries financially.

In 2021, the New York City Employees’ Retirement System, the Teachers’ Retirement System of the City of New York, and the New York City Board of Education Retirement System made good on the promise. The funds noted in the lawsuit that those assets lost 35% of their value after the funds divested of them, despite a 50% post-Covid stock resurgence.

But Americans for Fair Treatment and a handful of public-sector employees who have signed onto the lawsuit say city officials revealed their true intent early on.

“Relevant financial risk-return factors were completely ignored” in pursuit of a political agenda, said Elisabeth Messenger, the group’s CEO.

“AFFT’s mission is to protect the rights and interests of public employees,” Messenger said. “The decision of New York City officials to abuse these pension funds to advance a nakedly political agenda over the best interests of New York’s hardworking public employees is inexcusable.”

Biden Rule

State governments and Capitol Hill lobbyists are propping up the case as a test of the GOP effort to rid public coffers and workplace 401(k)s of do-good asset managers.

A US Labor Department rule (87 Fed. Reg. 73822) that allows private-sector pensions to consider ESG impacts when they’re materially relevant to a fiduciary’s prudent, risk-return analysis is inextricably linked to the litigation.

The Biden administration lit a fuse in both Congress and the courts earlier this year when the DOL’s Employee Benefits Security Administration adopted the regulation and defended it against a narrowly bipartisan Congressional Review Act measure to revoke it, which the president ultimately vetoed.

Since then, GOP attorneys general have challenged the department’s authority to regulate on the issue, and lawmakers have introduced bills that would prohibit regulators from enforcing it.

But political actors are missing the important nuances at play in a broader discussion over whether investment decisions should be based on investment merits or policy considerations, said Brad Campbell, a partner at Faegre Drinker Biddle & Reath LLP and former head of EBSA.

“There are times when you would say this environmental factor or this shareholder initiative is not relevant to the analysis of an investment, but I don’t think anyone with a straight face can say that environmental considerations are never relevant to an investment,” Campbell said.

The case is Wong v. New York City Emps’ Ret. Sys., N.Y. Sup. Ct., No. 652297/2023.