Should vegans stop buying vegetables at Walmart because the big box store also sells beef?
Is Amazon defrauding Orthodox Jews by selling smoked bacon to its non-kosher customers?
A Texas court ruling regarding the management of retirement accounts is raising similar — and critics say, similarly absurd — issues regarding retirement savings and socially-conscious investing.
Federal Judge Reed O’Connor ruled in Spence v. American Airlines that the airline breached its fiduciary duties under the Employee Retirement Income Security Act (ERISA) by choosing a retirement fund manager, BlackRock, whose company-wide portfolio includes some products that incorporate “ESG objectives.”
ESG stands for environmental, social, and governance, and generally scores companies on how their investments reflect these non-financial goals.
Some states have banned ESG investing for their retirement funds precisely because it prioritizes objectives other than the best returns for investors. In the Texas case, there is actually no evidence that the specific retirement accounts or investments offered by American Airlines have any ESG connection.
Instead, O’Connor said that because BlackRock offers other ESG investment products and has touted what CEO Larry Fink considers “sustainable” business practices, American Airlines was not doing its “fiduciary duty” toward retirees by working with the asset manager.
The initial 70-page ruling issued on Jan. 10 in the U.S. District Court for the Northern District of Texas said American Airlines and its chosen asset management must put plan participants’ interests above the employer’s interests.
“The facts compellingly demonstrated that defendants breached their fiduciary duty by failing to loyally act solely in the retirement plans’ best financial interests by allowing their corporate interests, as well as BlackRock’s ESG interests, to influence management of the plan,” O’Connor wrote. “Defendants knew BlackRock was pursuing ESG initiatives through delegated proxy voting authority and related activism. At a minimum, a loyal fiduciary would have monitored the situation more closely and even questioned BlackRock’s non-pecuniary investment activities.”
BlackRock, along with State Street and Vanguard, oversee more than $5.4 trillion in U.S. retirement assets, making them the largest group of investment managers in the country.
“They are the Walmart, Target, and Amazon of index funds,” according to Daniel Aronowitz, president of Encore Fiduciary, an insurer that underwrites retirement plans against fiduciary liability suits. Therefore, it’s hardly surprising they offer clients the choice to invest in ESG-minded funds, as well as traditional plans with no ESG goals or even a connection to ESG investments among their myriad number of products.
Nonetheless, the three have become the largest targets for activists using agenda-driven lawsuits to force investment strategies.
“These are plain vanilla operations for most people,” said Doug Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office. “What’s striking about this ruling is that it raises the possibility that every 401(k) in the country could face allegations of mismanagement just by using one of those companies to manage it.”
The American Airlines accounts were invested in index funds that did not have ESG objectives. Holz-Eakin noted that the funds did not underperform in the market, which will make it challenging for the class to claim it was damaged.
Meanwhile, BlackRock’s Fink has been making headlines for abandoning his embrace of ESG investing, replacing it with what he calls “energy pragmatism.”
All of which has left economists and attorneys asking, “What’s the problem?”
Nevin Adams, an attorney and former chief content officer for the American Retirement Association, told Pensions & Investments that it appeared the Texas judge “connected a lot of random dots to get to the implications he seems to be predicating the decision on.”
American Airlines has not indicated whether it will appeal the ruling. O’Connor has a history of having his rulings reversed by the Fifth Circuit Court of Appeals.
In 2017, O’Connor dismissed a prisoner’s claim alleging that prison guards had used excessive force on the basis that the prison’s internal review found no use of excessive force. The Fifth Circuit reversed, holding, “We have stated, on numerous occasions, that information from a [prison’s internal] report may not be used to resolve material disputed facts when the information conflicts with the plaintiff’s pleadings.”
In 2018, O’Connor attempted to invalidate portions of the Gun Control Act of 1968, which was reversed by the appeals court. In 2022, the Fifth Circuit again reversed an O’Connor ruling in which he excluded an association of black farmers from intervening as defendants.
“This ruling is the legal equivalent of junk science,” Alliance for Prosperity and a Secure Retirement President Tim Hill said of the American Airlines case. “It is full of inaccuracies and contradictory claims. It is only a matter of time before it is most likely reversed on appeal which will protect the retirement plans for millions of Americans.”
In a blog post on the American Action Forum, Holtz-Eakin wrote that “it seems a bit odd to conclude that [American Airlines] would fail its employees by investing in an index fund that meets the market return – no matter whose name is on it.”
“Regardless,” he added, “an incoherent but sweeping ruling that imposes litigation risk on every 401(k) plan is hardly to be applauded.”