For over two years, certain Republican officials at the state and federal levels have claimed that asset managers and pension officials breach their fiduciary duties by considering environmental, social and governance (ESG) factors in investing. This legal theory has been cited repeatedly in letters from legislators, state attorney general opinions, and investigative demands, but was teed up to be tested in court for the first time in a privately-funded suit filed against three New York City pension plans.
Sponsored by a conservative anti-union organization, Americans for Fair Treatment ("AFFT"), the case filed in New York State court last year challenged the decision by the trustees of the NYC pension plans to divest from most of their fossil fuel holdings. Lead counsel for the plaintiffs is the Trump administration's former Secretary of Labor, Eugene Scalia, who expressed opposition to ESG investing principles while in office and who headed the agency when it created a rule limiting the use of ESG in the management of private pensions governed by ERISA. The Trump-era rule was later replaced by a new rule from the Biden DOL.
The court's decision
On July 3, the New York trial court granted the pension plans' motion to dismiss the litigation. The court agreed with the city's argument that the plan participant plaintiffs have no legal standing to challenge the divestment decision, because the plans are "defined benefit" pensions.
While the city's pension obligations are funded in the first instance by the plans' investment portfolios, the retirees' benefits are ultimately backstopped by city taxpayers in the event the investments fall short. Therefore, the plaintiffs' pension benefits will by definition not be affected by the fossil fuel divestment decision or the outcome of the litigation, so the plaintiffs could show no alleged injury as is required to have standing to assert claims.
The court's reasoning is directly in line with a 2020 U.S. Supreme Court ruling, which reached the same conclusion in rejecting breach of fiduciary duty claims asserted by defined benefit plan participants under ERISA (the fiduciary duties at issue were very similar to those applicable under New York law). The plaintiffs here were unable to convince the state court that a different result should apply under New York law.
What was left undecided
The defense victory is on solid legal footing and was no doubt welcomed by NYC pension officials. While an appeal is likely, it would seem an uphill struggle for plaintiffs to overturn this decision, especially in light of the helpful Supreme Court precedent in the analogous ERISA setting.
However, because the case was decided on procedural standing grounds, the court was not required to address the underlying merits of the plaintiffs' claims. This means that the Republican anti-ESG fiduciary duty theory still remains untested in court.
We do not anticipate that the fiduciary theory is going away. For example, future plaintiffs who are participants in 401(k) or other "defined contribution" plans can be expected to argue that the New York court's reasoning does not apply to them, and that they have standing to challenge the use of ESG investing in their plans. These cases may have an easier time surviving similar challenges on standing since the Supreme Court precedent described above does not apply to defined contribution plans.
Even if the New York plaintiffs (or others in some future lawsuit) could establish legal standing, the fiduciary theory suffers from a basic flaw on the merits that should be revealed by eventual judicial review. The core allegation in AFFT's case comes straight from the anti-ESG playbook of Republican officials across the U.S. – that the city's decision to divest from fossil fuel companies was necessarily made in pursuit of a social and political agenda (addressing climate change) rather than to further the financial interests of plan participants.
The city's available response – mirroring the consistent refrain of the asset management industry – is that this is simply a false premise. As the plans made clear in public statements, the divestment decision was driven by consideration of financial risks posed to fossil fuel companies by climate change – risks acknowledged by the fossil fuel companies themselves – following lengthy analysis of the impact of these risks on portfolio returns. Pension plans considering divestment, like investors and asset managers incorporating climate risk more generally, still have this important defense available in the event of future litigation.
Recent developments in parallel settings suggest the core premise of the GOP fiduciary theory will be difficult to establish. For example, in litigation challenging the ESG rule from the Biden DOL, a judge in the Northern District of Texas held that the rule – which allows consideration of ESG-related factors in selecting plan investment options in some circumstances – is not inconsistent with ERISA's requirement that fiduciaries act for the exclusive purpose of providing financial benefits to participants. The judge pointed to consistent DOL statements over many years that ESG considerations do relate to financial returns.
On the other hand, another judge in the Northern District of Texas has refused to dismiss claims against American Airlines for breach of fiduciary duty under ERISA, in a case based on the supposed harm caused by consideration of ESG factors in proxy voting decisions by asset managers. These claims were recently the subject of a bench trial, and the court's forthcoming decision will bear careful attention.