Airline ESG Ruling Imperils Work of BlackRock, 401(k) Managers

A Texas federal judge has targeted “cartel-like” 401(k) investment managers in a ruling against American Airlines Group Inc. that could put nearly every plan in the country at risk of a fiduciary mismanagement lawsuit.

US District Court for the Northern District of Texas Judge Reed O’Connor said American Airlines broke federal benefits law by failing to rein in its investment manager BlackRock Inc. when it allegedly pursued a “green” shareholder activism agenda. Specific investments the workers had access to through BlackRock-managed index funds suffered as a consequence, O’Connor said.

BlackRock joined State Street Corp. and the Vanguard Group Inc. in a May 2021 proxy vote that installed three dissident directors on the ExxonMobil Corp. board of directors, a move that O’Connor said played a role in a short-lived decline in energy stock prices affecting American’s plan participants.

O’Connor’s Jan. 10 ruling lays out an unconventional road map for suing US companies that have hired those same Wall Street firms to manage funds their workers use to build nest eggs. Together, BlackRock, State Street, and Vanguard oversee more than $5.4 trillion in US retirement assets, according to Bloomberg market share analytics. And all three have, at times, embraced proxy voting standards and external investment strategies with an eye toward environmental, social, and corporate governance goals.

“They’re the Walmart, Target, and Amazon of index funds,” said Daniel Aronowitz, president of Encore Fiduciary, an insurer that underwrites retirement plans against fiduciary liability suits. “Everybody has the same risk. By that standard, plaintiffs could sue almost every single 401(k) in the country.”

The final outcome of the case against American Airlines hasn’t been determined, as the court deferred ruling on any losses or remedies and sought briefings from both parties on how damages could be calculated. Benefits attorneys said O’Connor’s final decision could unlock a new wave of ESG-themed 401(k) lawsuits—and motivate a higher-court appeal.

“There are those seminal cases in the retirement industry that we look back on as shaking things up, and changing how plans behave, said Josh Lichtenstein, a partner at Ropes & Gray LLP. “It’s possible that in the future, attorneys are asking their clients if they have American Airlines procedures in place to protect against this sort of thing. “

Prudence and Loyalty

The opinion found American Airlines was disloyal but not imprudent to its worker-investors. The airliner prudently comported to prevailing market standards in the way that it oversaw BlackRock, O’Connor concluded, but those standards form an “incestuous industry comprised of powerful repeat players who rig the standard of care to escape fiduciary liability,” that may be disloyal, he wrote.

Both prudence and loyalty are the measure of a fiduciary held to the strictest standards of care under the Employee Retirement Income Security Act, and it’s rare for a fiduciary to be guilty of violating one without the other, according to Lichtenstein.

But the court suggested that, in this case, American Airlines could have tried to influence BlackRock directly, even if they lacked the influence to make a difference, said Sterling Perkinson, a partner at Kilpatrick Townsend & Stockton LLP.

“It’s not clear what American Airlines could have done to satisfy the standard, other than divesting in the BlackRock funds,” Perkinson said. “On the other hand, because selecting those funds was ruled prudent, it may have been unwise to divest.”

Outside the ERISA context, large public pension managers like the Texas legislature have divested in money managers including BlackRock due to their shareholder activism. ESG has become a four-letter word on Capitol Hill, as Republican lawmakers investigate the role of “woke investing” on worker pensions.

Red state attorneys general sued the Biden administration’s Department of Labor for promulgating a rule that permitted retirement plans to consider ESG factors as long as they are financially relevant.

Anti-ESG sentiment has affected Wall Street firms. BlackRock has since 2021 amended its voting policies. On the same day O’Connor’s decision was released, BlackRock exited the Net-Zero Asset Managers Initiative, forcing the group to suspend activities.

“We always act independently and with a singular focus on what is in the best financial interests of our clients,” a BlackRock spokesperson told Bloomberg Law. “Our only agenda is maximizing returns for our clients, consistent with their choices.”

BlackRock is not a party to the lawsuit.

Lessons to Learn

O’Connor’s ruling has put the retirement industry on tenterhooks, waiting for a final outcome.

“Copy-cat cases would be motivated by the dollars-and-cents in this case,” said Lichtenstein. “It will determine the ramifications and the appeal.”

The court’s ruling relies heavily on BlackRock’s motive for pursuing ESG proxy votes and even American Airlines’ public statements supporting “green” pursuits. It’s difficult to assess motive, especially at the pleading stage of a case, which could make it less likely that a flood of plaintiffs’ firms will bring new suits following American Airlines, said Brantley Webb, a partner at Mayer Brown LLP.

But the case still offers important lessons for plan fiduciaries. O’Connor’s emphasis on proxy voting oversight could spur retirement plan committees to take a careful look at what sort of documentation they receive from money managers about how proxy votes are determined and whether third-party service agreements accurately reflect participant interests, said Perkinson.

Part of the “incestuous” relationship O’Connor railed against in his ruling had to do with the fact that one of the members of American Airlines’ fiduciary committee was also the corporate relationship manager between the airline and BlackRock.

“The court’s opinion here emphasizes that plan sponsors need to be mindful of the separate roles of those particular individuals and make sure that there’s adequate separation,” said Webb.

Whatever the practical lessons, O’Connor’s decision is “impossible to unwind” from the broader issue of ESG politics, said Lichtenstein.

“This decision is going to be less consequential if viewed just through a political lens, but, once damages have been assessed, it could motivate an entirely new class of plaintiffs.”