Paying the (Fiduciary) Pipers

For years The Pipeline has been warning about that the policy of pension fiduciaries hopping aboard the ESG (environmental, social and governance) bandwagon. We argued it would subject them to litigation and loss for abandoning their legal responsibilities to prudently invest the funds to maximize financial returns for the beneficiaries.

 In a recent case in Texas, Brian P. Spence v. American Airlines, Inc., it appears our prophecy was correct. A federal judge just certified a class of 100,000 American Airlines pilots whose 401 (k) pension funds were managed by the airline and Fidelity Investments. The plaintiffs argue that the retirement-fund fiduciaries breached their legal responsibilities by pursuing ESG goals when they made investments with BlackRock, Inc. The managers control a plan worth $26 billion so the sum involved may well be substantial.

The class action lawsuit revolves around a legal theory that ESG is a violation of fiduciary duty under the Employee Retirement Income Security Act... The primary factor has been, and continues to be, profit. However, the rise of ESG has caused confusion as to how it can be factored, it at all.

In 2020, the Trump Administration DOL issued a rule that said investments should be made based on “pecuniary factors” only. The rule was intended to be anti-ESG, however experts felt the rule caused more confusion as the pecuniary factors test was considered vague. In 2022, the Biden Administration DOL issued a new rule saying that investments can consider ESG as a tiebreaker... Congress tried to override the new rule, but Biden issued his first veto and reinstated it.

Even under the Biden rule, however, it’s unlikely that the fiduciaries would escape consequences, as Judge Reed O’ Connor noted in an order.  The airline’s public commitment to ESG initiatives caused it to invest 401 (k) plan assets with ESG-focused managers while failing to properly investigate other managers that would focus exclusively in maximizing financial benefits for plan participants. The suit alleges that it was the fiduciaries’ bias towards BlackRock and other ESG-focused managers whose “engagement strategy . . . covertly converts the Plan's core index portfolios to ESG funds” that tilted the playing field, not a "tie-breaker." After all Black Rock’s returns hardly have been stellar.

BlackRock's Larry Fink: ideology before profit?

I expect a number of pension plan fiduciaries view this case with dread. The California Public Employees Retirement System (Calpers) which controls $44 billion in assets for two million state public employees, seems particularly vulnerable:

 The nation’s largest pension fund got a scathing performance review Monday when its new investment chief highlighted the retirement system’s underperforming returns and estimated it missed out on $11 billion in gains during a “lost decade” for private equity.

As the Wall Street Journal’s James Freeman reports, last year Calpers asked one of the most successful investment firms, Berkshire Hathaway, to provide “more disclosures on climate-related risks and opportunities” and withheld its votes to re-elect members of Berkshire’s audit and governance committees because it was unhappy with their climate risk disclosures.

One can certainly argue that Berkshire’s performance in recent years could have been better, but does anyone think Calpers officials have a better understanding of investment risk than Warren Buffett? Calpers’ disappointing decade is another reminder that taking care of retirees’ investments requires profits, not politics.

Litigation against ESG-loving fiduciaries is long overdue and it would appear they can no longer ignore their legal responsibilities without consequences.