Texas Court Ruling Could Spark New ESG 401(k) Lawsuits

Highlights

• American Airlines must remove ESG elements from its 401(k) plan after a federal ruling found a breach of fiduciary duty.
• The court issued an injunction with stringent measures, including restrictions on asset managers and committee changes.
• The decision could influence future lawsuits as political and regulatory environments evolve on ESG investing.

A Texas federal judge has ordered American Airlines to remove ESG (Environmental, Social, and Governance) factors from its 401(k) retirement plan, following a lawsuit filed by a pilot.

The court found that the airline acted disloyally by giving preference to ESG goals when selecting investments for employees’ retirement savings. The judge decided against awarding monetary damages, as there was no proof that the retirement plan experienced financial losses because of these investment choices.

In his ruling, Judge Reed O’Connor directed American Airlines to make structural changes to its retirement plan.

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The airline must eliminate ESG-related considerations, stop using ESG-based proxy voting, and appoint independent members to its benefits committee who are not linked to large ESG-focused investment managers such as BlackRock.

He stated that American Airlines’ decision to hire BlackRock, whose proxy voting practices are ESG-oriented, breached the Employee Retirement Income Security Act (ERISA).

The decision sends a message to employers that courts may examine their retirement plan practices even without evidence of financial harm to employees.

Lawyers explained that the injunction includes practical measures that affect how companies work with major asset managers. It restricts American Airlines from using investment managers that hold 3% or more of the company’s shares or debt under certain conditions. This could complicate relationships between large companies and top asset managers.

Legal experts said this ruling may open the door to similar lawsuits against other employers, depending on changes in political and regulatory policies.

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The Trump administration plans to revise a Biden-era rule that allowed companies to consider eco-friendly factors as tiebreakers when selecting investments. If regulations shift, more lawsuits may follow, especially if lawyers see a possibility of financial damages or attorney fee awards.

However, legal specialists pointed out that proving financial harm in these cases is difficult. It requires evidence that the fund’s performance was worse than a suitable alternative, such as an S&P 500 index fund. Without this proof, plaintiffs may find such cases less attractive. One lawyer said proxy voting cases are unlikely to become major legal battles unless there are large sums involved.

Another complex aspect involves identifying what qualifies as an ESG fund. Investment products vary in their ESG criteria, and not all are clearly labelled. This creates difficulties for companies that must separate ESG as a social goal from ESG as a factor linked to investment performance, which the judge acknowledged as acceptable.

Legal experts described this dividing line as “fuzzy,” which may complicate compliance with the injunction.

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Some observers believe the ruling may not stand if appealed, as it second-guessed the company’s and BlackRock’s methods despite the absence of harm to employees’ savings.

Nevertheless, the decision adds compliance requirements for American Airlines and may influence how other companies structure their retirement plans.

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Source: Bloomberg Law