For nearly two years, Republican officials and conservative commentators have proclaimed in various settings that consideration of environmental, social and governance (ESG) factors in investing is in breach of the fiduciary duties owed by asset managers and pension officials. While this legal theory has been cited in the issuance of state attorney general opinions and the launching of investigations, public officials have yet to bring any formal claims that would put the fiduciary duty theory to the test in court.
Instead, privately-funded litigation against three New York City pension plans has teed up the first direct judicial review of the anti-ESG fiduciary theory. Sponsored by a conservative anti-union organization, Americans for Fair Treatment (AFFT), the action filed this year in New York state court challenges the decision by the pension plans to divest from most of their fossil fuel holdings. The plans filed a motion to dismiss the claims, and the motion is now fully briefed by the parties and awaiting the decision of the court.
AFFT’s core argument
The core allegation in AFFT’s case comes straight from the anti-ESG playbook of GOP state officials – that the 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 plans’ retort – 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, following lengthy analysis of the impact of these risks on portfolio returns.
In their filings, AFFT’s lawyers seek to avoid this flaw in their claims by relying on a procedural shield: that the rules governing motions to dismiss require the court to assume the truth of the facts alleged by plaintiffs in the complaint at this initial stage of the case. In other words, the plaintiffs insist their complaint is entitled to the benefit of the doubt, based on the mere allegations that the plans’ trustees were motivated by social and political considerations rather than the cited financial analyses in deciding to divest – the evidence to the contrary notwithstanding.
The defendants have also argued that the plan participant plaintiffs have no legal standing to challenge the divestment decision, because the plans are “defined benefit” pensions.
The court’s forthcoming decision on this issue bears careful watching, as the first direct test of the oft-repeated GOP theory. Helpfully, recent developments in other cases involving parallel issues have suggested that this core premise of the larger anti-ESG crusade will be difficult to support when actually litigated.
In litigation challenging Missouri’s new anti-ESG rules, the state conceded that ESG considerations could be utilized to further financial goals, and thus the new rules would only be triggered if an adviser’s goals were solely nonfinancial.
Similarly, in litigation challenging the US Department of Labor’s ESG rule, the Northern District of Texas held that the DOL 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.
It is possible that the NYC pension case will be decided on grounds other than the merits of this central premise. The defendants have also argued that the plan participant plaintiffs have no legal standing to challenge the divestment decision, because the plans are “defined benefit” pensions. Because the plaintiffs’ pension benefits will by definition not be affected by the divestment decision or the outcome of the litigation, the plans argue that the plaintiffs can show no alleged injury as is required to have standing to assert claims.
Are more cases coming?
The NYC pension case involves the somewhat unusual setting of a stated policy of divestment. That said, it is not difficult to imagine how AFFT and other conservative activists could deploy the same model to launch litigations challenging the use of ESG investing more generally on the same fiduciary duty theory. Just as AFFT apparently solicited a handful of NYC plan participants to stand as plaintiffs, such organizations could presumably identify participants in any number of public and private retirement plans willing to play the same role.
After all, the private ERISA plaintiffs’ bar has launched a torrent of cases against corporate and university plans over the last several years, asserting fiduciary breaches based on supposedly imprudent selection of funds with high fees. There has been no shortage of plaintiff participants for these cases.
It would further appear that the anti-ESG interests behind the NYC suit are motivated and well-funded. Notably, the lead counsel in the New York action is Eugene Scalia, now a partner in a large international law firm, who previously served as the Secretary of Labor in the Trump administration.
In his government role, Scalia spearheaded the enactment of an earlier DOL rule that would have limited consideration of ESG factors in plan investments under ERISA. That rule was replaced by the Biden administration rule now being challenged in the Texas litigation. Scalia appears to have taken up the anti-ESG cause again upon his return to the private sector.
The possibility of additional cases challenging ESG investment practices generally on fiduciary duty grounds makes the NYC pension case and related developments all the more worthy of close attention.
Amy D Roy is a partner in Ropes & Gray’s securities litigation group, co-chair of the firm’s Associate Liaison Committee and a hiring partner for the Boston office. She also serves on the Board of Directors for Greater Boston Legal Services. Rob Skinner is a partner in the same group, where he represents investment advisers and other financial services firms in securities litigation and other complex business disputes.
