For plan fiduciaries, the Court’s decision should not be dismissed as merely another salvo in the debate over ESG investments in ERISA plans. Rather, in the immediate term, the decision may result in industry practice requiring greater diligence with respect to the monitoring of investment manager proxy voting practices. In addition, plan sponsors may conclude that it is prudent to review the corporate responsibilities of their staff members who serve as plan fiduciaries, as well as the business interests of their external fiduciaries, to ensure any potential conflicts of interest are understood, considered and mitigated. Finally, the Court questioned the benefits of ERISA’s objective, comparative fiduciary duty of prudence standard in the retirement plan industry, which industry it referred to as “incestuous” and whose biggest players, “in a cartel like manner,” can ensure they are not properly scrutinized. As a longer-term matter, it remains to be seen whether the Court’s words will result in any action by Congress.
Background
Bryan P. Spence, a pilot employed by American (the “Plaintiff”), filed a class action lawsuit against American and the EBC, the administrator and named ERISA fiduciary of each of the Plans, alleging that the Defendants breached their fiduciary duties under ERISA by mismanaging retirement plan investments in favor of ESG objectives, ultimately harming the financial interests of plan participants.
The Plaintiff alleged that the Defendants allowed BlackRock, the largest investment manager for the Plan, to pursue non-financial ESG policy goals through proxy voting and shareholder activism. BlackRock's ESG activism included supporting climate change-related proposals and other ESG initiatives that were not solely focused on financial returns.
The Court noted that Blackrock, in addition to managing USD11 billion of the Plans’ assets, was a 5% owner of American, as well as a holder of approximately USD400 million of American’s debt. The Court also noted that members of the EBC, as well as other American employees charged with monitoring Blackrock on behalf of the Plans, had additional relationships with Blackrock stemming from their corporate responsibilities.
Worth noting is that earlier in the proceedings, the Plaintiff dropped his claim that the investment funds established by Blackrock were designed for ESG goals, rather than pecuniary goals. Rather, his complaint is limited to Blackrock’s activism, including its proxy voting, and the impact of those activities on the stock prices of the Plans’ holdings.
The Court’s ruling and reasoning
Duty of loyalty
The Court examined the relationship between BlackRock and the Defendants and its potential to create a conflict of interest. Under ERISA, plan fiduciaries are required to act with prudence and loyalty. The duty of loyalty requires the fiduciary to act “solely in the interest of the participants and beneficiaries and . . . for the exclusive purpose of . . . providing benefits to participants and their beneficiaries.” In light of Blackrock’s investment in American, the Court felt the Defendants placed their corporate interests over their fiduciary obligations out of fear that failing to appease Blackrock could result in a proxy fight and/or the inability to obtain financing for essential loans.
To that end, the Court noted that the same individual who was responsible for the day-to-day fiduciary oversight of the Plans’ investment managers was simultaneously managing American’s corporate relationship with BlackRock, creating a misalignment of incentives. Despite being aware of BlackRock’s ESG-focused investing and proxy voting activities, the Defendants did not conduct any formal evaluation or assessment of the potential impact of these activities on the Plans, which suggested to the Court that the Defendants did not take proper precautions to keep corporate and fiduciary duties separate. The Court, therefore, found that the Defendants acted with an intent to benefit a party other than Plans’ participants and in a manner that was not wholly focused on the best financial benefit to the Plans.
Duty of prudence
Despite finding that the Defendants breached the duty of loyalty, the Court reached the opposite conclusion with respect to the duty of prudence. The Court applied an objective prudent person standard and considered whether the fiduciaries “employed the appropriate methods to investigate the merits of the investment and to structure the investment.” This focuses on the fiduciary’s conduct in making decisions and not on the results of the investment decisions. In this context, the Court measured the fiduciaries’ performance against contemporary industry practices and considered the monitoring process of other fiduciaries. The Court ultimately found that the Defendants’ practices did not fall short of industry standards. The Defendants maintained a robust process for monitoring, selecting, and retaining managers, which included quarterly meetings by the EBC and written and oral reporting from internal and external experts. Even with the reliance on external advisors to monitor the performance of investment managers, the Defendants acted according to prevailing practices and in a manner similar to other fiduciaries in the industry.
Notably, it is unusual for a court to determine that a fiduciary breached its duty of loyalty without having first determined that the duty of prudence has been breached. Typically, courts will first determine whether a fiduciary’s flawed process resulted in a breach of its duty of prudence before applying such determination to the court’s analysis of whether the fiduciary’s failures also led to, or were caused by, the fiduciary’s breach of its duty of loyalty to the plan and its participants.
Takeaways
- Heightened scrutiny on ESG investing: This decision highlights the shift away from the endorsement of ESG considerations during the early 2020s to the increasing backlash against these efforts more recently. Fiduciaries need to scrutinize ESG investing strategies to ensure that the strategies are aligned with the financial interests of plan participants and not influenced by non-monetary goals. Fiduciaries who are perceived to prioritize ESG objectives over financial returns should be prepared for greater litigation risk.
- Duty of loyalty: The Court emphasized the stringent requirements of the duty of loyalty under ERISA. The standard requires a fiduciary to always act solely for the plan and in the plan’s best interest. This excludes the ability to act in the public interest. Companies should remember to keep corporate and fiduciary hats separate and to maintain clear boundaries between these responsibilities.
- Independent oversight: Actively engaging with external advisors to provide independent oversight of investment managers may help mitigate legal risk, though fiduciaries should not blindly rely on external advisors. Fiduciaries should ensure that their advisors are thoroughly vetted and that their advice is critically evaluated.
- Corporate governance and proxy voting: Spence exemplifies the legal risks of failing to monitor and address investment managers’ proxy voting activities, especially when those activities are driven by ESG considerations. It remains to be seen whether there is any resulting change to industry standard practices for monitoring manager voting practices.