A Texas federal district court has decided that American Airlines breached its fiduciary duty of loyalty, but not its fiduciary duty of prudence, in allowing its $26 billion 401(k) plan to be influenced by environmental, social and governance (“ESG”) strategies unrelated to the best interests of participants. (Spence v. Am. Airlines, Inc., N.D. Tex., No. 4:23-cv-00552, 1/10/25.)
After a four-day, non-jury trial, the district court concluded in a 70-page decision that the airline’s activities, which included hiring BlackRock Inc. to manage billions of dollars in plan assets despite its “ESG-oriented investing and proxy voting activism,” violated ERISA’s directive to act loyally and in the best interests of plan participants. However, the district court’s post-trial opinion also held that the plan participants failed to prove a violation of ERISA’s prudence rule because the airline acted according to prevailing practices and in a manner similar to other fiduciaries in the industry.
This controversial “disloyal, not imprudent” decision draws a distinction that is not contained in ERISA since both prudence and loyalty are inextricable measures of a fiduciary’s statutory standard of care contained in ERISA section 404(a)(1)(A). The drafters of ERISA would consider a violation of the duty of loyalty to also be a breach of fiduciary duty and it is inconceivable to me as a participant in the ERISA drafting process that the drafters would conclude that a decision can be prudent and still violate the duty of loyalty.
Background
Participants in the American Airlines 401(k) Plan brought an action under ERISA in a Texas district court against American Airlines and the Company’s benefits committee. The suit alleged that the defendants breached their fiduciary duties in violation of ERISA by investing millions of dollars of plan assets with investment managers and investment funds that pursue “leftist political agendas” through ESG strategies, proxy voting, and shareholder activism, which fail to satisfy ERISA’s statutory duties to maximize financial benefits in the sole interest of plan participants. These were funds such as index and target date funds without a stated intent to pursue environmental, governance and social factors.
The suit also alleged that the defendants violated their fiduciary duty by knowingly including funds that are managed by investment managers that pursue non-financial and nonpecuniary ESG policy goals through proxy voting and shareholder activism on their investment portal. Specifically, the participants argued that the plan primarily contains funds administered by investment management firms like BlackRock, which “pursue pervasive ESG agendas” and an “engagement strategy” that covertly converts the Plan’s core index portfolios to ESG funds, which, in turn, harms participant financial interests because BlackRock focuses on socio-political outcomes instead of exclusively on financial returns.
Duty of Prudence
The court decided that the facts compellingly demonstrated that defendants breached their fiduciary duty by failing to loyally act solely in the plan’s best financial interests by allowing their corporate interests, as well as BlackRock’s ESG interests, to influence the management of the plan.
The court also concluded that the facts do not compel the same result for the duty of prudence since defendants acted according to prevailing industry governance practices. Specifically, the court devoted several pages of the 70-page opinion detailing not only American’s robust monitoring and documentation process, which the court noted even surpassed those typically employed by large plan fiduciaries, but the parties involved in the evaluation, review, and monitoring of the plan investments, as well as proxy voting.
However, the court pointed out that a prudent fiduciary adhering to its monitoring processes would have taken some action that defendants did not with respect to BlackRock. The court cautioned that perhaps this is due to BlackRock exercising an alarming degree of control and influence over the industry and “can effectively rig the process in a cartel-like manner to insulate against its removal.” The court was bound by Fifth Circuit law requiring judgment for defendants on the participant’s prudence claim which is rooted in the inherently comparative nature of the required analysis for the duty of prudence.
Duty of Loyalty
The court concluded that defendants acted disloyally by failing to keep American’s own corporate interests separate from their fiduciary responsibilities, resulting in an “impermissible cross-pollination of interests and influence on the management of the Plan” and that the most obvious manifestation of this was American’s relationship with BlackRock. As a result, defendants did not sufficiently monitor, evaluate, and address the potential impact of BlackRock’s nonpecuniary ESG investing. Together, the influences of these non-Plan interests constituted a breach of loyalty, allowing BlackRock to engage in ESG-oriented proxy voting and investment strategies using Plan assets.
Specifically, said the court, defendants knew that the Plan’s largest investment manager, BlackRock, was also one of American’s largest shareholders. Not only did BlackRock own 5% of the airline stock, but that it also financed approximately $400 million of American’s corporate debt at a time when American was experiencing financing difficulties.
In this regard, the court noted that given American’s corporate interests “bleeding over” into the fiduciary realm and BlackRock’s ownership stake in, and influence on, American, it is no surprise that defendants utterly failed to loyally investigate BlackRock’s ESG investment activities.
In addition, the court pointed out that BlackRock is also one of Aon’s largest shareholders – possibly the second largest – and given that Aon is responsible for monitoring and assessing BlackRock’s performance as an investment manager this relationship raises many additional questions including how many layers of conflicts exist in the Plan.
The court emphasized that a breach of loyalty claim depends on whether a fiduciary acted “solely in the interest” of plan participants and even if defendants acted in the same manner as other fiduciaries in the industry, such conformity is not enough to fend off a breach of loyalty challenge because the focus is on what the fiduciary considered when acting (or not acting), not what others did. In sum, said the court, the evidence makes clear that defendants “incestuous relationship” with BlackRock and its own corporate goals disloyally influenced the administration of the Plan.
Conclusion
Both prudence and loyalty are the essential measures of ERISA’s standard of care and it is inconceivable that a court could find a fiduciary guilty of violating one without the other particularly in a situation such as this where the court found that American’s robust monitoring, documentation and additional layers of review surpassed those typically employed by large plan fiduciaries.
It appears that the court’s incongruous decision stems from its determination that American has an “incestuous relationship” with BlackRock which is also one of the largest shareholders of Aon (the investment manager responsible for monitoring and assessing BlackRock’s performance) and that the court was struggling to find a basis for liability despite American’s prudent monitoring, analysis and documentation of the investment process. It remains to be seen if plaintiff can prove any damages.
Accordingly, I am hopeful that this decision will be viewed as an aberrant “one-off” and will not put plans at risk of liability in the absence of conflicts of interest that the court determined existed in this case.