Federal district court judge Judge Reed C. O’Connor ruled on Friday that American Airlines violated its fiduciary obligation to employee retirement funds by investing in so-called ESG funds, rather than seeking the greatest possible returns for employees.
- The court has ordered the parties to brief on whether and to what extent employees incurred losses as a result of the investing decision
- And the court has deferred a decision on an injunction against American Airlines ESG investing for these funds
- These briefs are due January 31, 2025.
ESG investments are fairly standard and selecting a BlackRock fund hardly seems imprudent, but federal ERISA law is complicated and there’s zero theoretical question that ESG investing sacrifices returns (whether a given investment for a specific period of time gives up returns notwithstanding).
Pilot Bryan Spence argued he lost money by investing his 401(k) dollars into suboptimal funds that American had a fiduciary obligation not to include, while those selections supported the airline’s carbon and DEI goals.
- American Airlines has fiduciary obligations in selecting investment options for its employees
- It is the employees who choose what to invest in with their 401(k) dollars.
- This lawsuit is not about the market-based cash balance plan pilots can invest in where they do not make the investment selections.
Airlines make dubious claims about their environmental and sustainability efforts. Delta claimed to be carbon neutral in 2020 when they aren’t just an airline they own an oil refiner, and carbon credits they used for this turned out to be fraudulent.
The problem with this anti-deforestation project was that there was too little deforestation. That seems good? For the climate? But bad for the people hawking carbon credits. The idealistic Muench pointed out the problem, and the now-jaded Heuberger was like “meh still fine”:
ESG funds necessarily earn lower rates of return. Any good investment that an ESG fund makes, a non-ESG fund can also make. ESG funds can’t make the good investments which go against their principles.
So what’s an ESG fund good for? Driving progress on social causes with dollars. The usual mechanism by which this works (note: this is not just virtue signaling!) is by lowering the cost of capital for ‘good’ companies (more investment, more money available and competition to make those funds available) and by raising the cost of capital for ‘bad’ companies (with marginally fewer dollars available to them). However, and this really shouldn’t be controversial:
- Social investing isn’t a free lunch. If you exclude high return investments from your portfolio that are inconsistent with your guidelines, you will have lower returns. It’s easy to confuse environmental companies delivering good returns – and even the sector outperforming others – with environmental investing not incurring tradeoffs. Non-ESG funds can invest in ESG projects because they are likely to yield strong returns! The only investments that ESG funds can invest in and non-ESG funds won’t are the ones with lower expected returns.
- ESG investing leads to higher returns for non-ESG investors. That’s by definition, since it leaves profitable opportunities on the table for others rather than competing down those returns. It’s the mathematical flip side of raising the cost of capital for companies you deem bad actors! You should be fine with that, but recognize both that you’re giving up returns and helping raise the returns for other investors who don’t share your philosophy.
- How many ESG funds actually short non-ESG companies? Most ESG funds do their work badly. If they were serious about raising the cost of capital for non-ESG projects shorting would be a necessary component of the strategy, and possibly even more effective.
- It can be possible to do more for environmental and social causes by earning more and donating rather than by imposing strict constraints on business activities. Giving up returns gives up the ability to invest in those causes.
There’s enough of an industry practice, enough industry experts who promote these funds, and enough historically strong performance in some of them that the claim the plan is in violation of ERISA law seems problematic to me. But that’s more about the problems with ERISA law than with American Airlines stewardship in my view.
I believe it is admirable to invest with your principles, but you shouldn’t believe that you’re getting a free lunch by doing so. It’s admirable because it costs you something!
Of course ESG is headed somewhat out of fashion alongside DEI, as the winds may have tilted too far in one direction half a dozen years ago and now even Meta (Facebook) is walking away. This ruling is not surprising but I’m not sure it will be left as precedent either and surely will be appealed.
(HT: Paddle Your Own Kanoo)
Are these ESG funds part of the menu of included funds in a 401k plan, or are they part of a pension plan where the employee has no choice?
If the former, I don’t see an issue at all. It’s choice.
If the latter, it becomes more complicated. A number of ESG funds have done well because they invested in tech companies, which have done very well. If they beat the S&P 500, it’s hard to make an argument of loss.
As expected, it’s Judge O’Conner, Northern District of Texas. How predictable. A loyal partisan. And the federal courts in the US are now ultimately GOP-controlled. Likewise, ESG is DEI, and it’s all dead starting January 20, 2025, at noon. That’s undeniable at this point.
The real question is whether the outcome here is good. Of course, I think investing in renewable energy technologies is of strategic importance in our escalating global power struggle with the Chinese. Yet, those foreign adversaries are pleased to see us fight among ourselves over culture.
Jon F – If this were an individual plan then you’re correct. However employee plans have very strict rules about what can be offered. It’s not merely caveat emptour.
ESG is also a good examople of an ill-defined concept. Pick two scorers (companies that compute ESG scores for S&P500 member companies) and run a correlation on the ESG scores of each. It is around zero. The reason is that they rank different companies very differently. For example, one may rank Tesla high because its product is a green car while another ranks it low because it ranks its governance poor. This is so frequent that the Spearman Rank-Correlation coefficient for the two scorers on the S&P500 (or other broad index) is zero. I.e. no correlcation.
@Nun
There are lots of suboptimal choices in 401k plans. Indeed, one could make a argument that they should have almost nothing but low cost index funds.
Many 401k plans these days offer a Brokerage Link through which you can buy just about any stock or ETF. How can those all be verified by an administrator?
And some even offer company stock!
An over paid pilot that can complain about anything.. time to live in the real world and get their pay lowered so airfares can come down
It’s admirable to “invest in accordance with your principles,” but it’s immoral and illegal to invest other people’s money in your principles, particularly when acting in a fiduciary capacity.
Confusing case, Gary. I’m with @Jon F: “Are these ESG funds part of the menu of included funds in a 401k plan, or are they part of a plan where the employee has no choice?”. It sounds like Pilot Bryan Spence voluntarily invested some amount of his 401(k) dollars into a suboptimal ESG Fund, and is now blaming American for including the ESG fund along with other fund options. If this is the case, I don’t understand why American should make him whole. I’m generally agreed with what you’ve stated about ESG Funds in general, excepting the statement that ESG Funds “lower the cost of capital for ‘good’ companies through more investment and more money available”. It depends. ESG Funds that simply invest in the stocks of large mature companies do not lower the cost of capital for them: Those firms gain nothing from a very small increase in their stock price, nor would their credit rating move sufficiently for them to raise debt financing at lower costs of capital. It actually IS about trying to make the individual investor feel good.
@Tk
No. This is not the way. At all. The ‘ownership’ class does literally no actual work, and makes more money than everyone combined at the expense of everyone else. Workers deserve better. Pay ATC, TSA, pilots, flight attendants, ground crews, cleaning staff, gate agents, call center teams, and all people earning wages in this industry more. Plan for their career development, their retirements, and enrich their lives, too. When workers are actually well taken care of and invested in, you get better service. You get what you pay for, and ‘cheap’ isn’t good.
Every ESG fund is a scam. Pay more for less.
ESG investing is for dunderheads who should come out of mommy’s basement.
@1990: “When workers are actually well taken care of and invested in, you get better service. ”
What coconut tree did you fall out of?
Hey Gary,
The decision is not that AA “violated its fiduciary obligation to employee retirement funds by investing in so-called ESG funds”, as ESG funds weren’t even offered to plan participants. The actual claim is that allowing BlackRock as an investment manager at all was the breach, not the inclusion of any specific ESG-minded BlackRock funds, because BlackRock’s ability to manage any funds was tainted by its own ESG goals, for example in proxy fights.
FT puts the issue at hand much more plainly than other coverage:
“A US federal court has ruled that American Airlines has failed workers by picking BlackRock to manage part of its pension scheme, with a judge claiming the world’s largest asset manager was tainted by “ESG activism”… “This [case] is not about ESG funds at all,” said Josh Lichtenstein, a partner at law firm Ropes & Gray.”… The lawsuit, which was filed by a pilot in 2023, alleged that the carrier had breached its fiduciary duties to employees in its 401k plan by hiring investment managers “that pursue leftist political agendas through ESG strategies”… O’Connor seized on BlackRock’s relationship with American Airlines as the largest investment manager for its 401k plan. The savings scheme comprised passive index funds and active funds, but did not include any ESG-specific strategies. But he said BlackRock’s 2021 vote in favour of hedge fund Engine No. 1 in its proxy fight with energy giant ExxonMobil — among other votes — amounted to “ESG activism”.”
Under the theory of this decision, having any iShares index trackers would mean allowing “ESG” to violate the plan sponsor’s fiduciary duty, and the same logic surely applies to all the other large fund managers like Schwab, State Street, Vanguard, Fidelity etc. This obviously is a much more controversial claim, and frankly there’s a reason they found a Fort Worth based employer to test it.
@John
Given how many active funds underperform index funds, you can make a far better argument that the large majority of active funds are scams. But it’s interesting that you focus on ESG funds only (which are often ‘index’ funds too, and low cost)
@R T
Thanks for the clarification. That sounds beyond ridiculous. And if upheld, it would devastate the entire fund plan management industry.
Furthermore, anti ESG types should be careful what they wish for. If something like this were upheld, any manager could be sued for any unrelated vote it takes.
When I invested 457b funds (like 401k funds) into my available choices, I got ho hum returns at best. Once I went to the self directed brokerage, even though there were additional fees, I started making significantly more on my funds and investing became fun instead of a chore. As long as there was a mix of available choices, I don’t see what the problem was. Maybe a need for a dark web company (sarcasm.)
@L3
Thank you. This is why I’m here. For the name-calling. Coconuts! Good one! I got the reference.
So, if I understand correctly, your position is: screw labor; profits over people; climate is a hoax.
10-4. No need to worry, sir. Your team won. We’re all about to live that reality. I think most people are not going to enjoy it much. There’s a better way.
@R T: “The savings scheme comprised passive index funds and active funds, but did not include any ESG-specific strategies.”
Blackrock has not broadened its customers’ choices by offering ESG and non-ESG funds. It has announced a blanket ban on certain firms in pursuit of a corporate-wide ESG objective. A case in point would be oil-related stocks. The plaintiff’s case has considerable weight given this bias. The only exceptions are broad index funds which obviously cannot be ESG as the concepts are mutually contradictory.
If AA had offered the plaintiff funds from e.g. Vivek Ramaswamy’s Thrive Capital (anti-woke funds) he would have been able to diversify and capture the premium from disfavored non-ESG funds.
@L3
That is a plain and simple lie.
AA’s plan includes a brokerage link (I checked). That means a participant can buy any stocks and ETF. The pilot can load up on Exxon Mobil if he wants. I doubt he could prove any harm even if the broker link did not exist, but its existence makes it impossible.
This decision is beyond absurd. Besides, consider the ramifications — I’ll now sue because Ramaswamy’s funds are not including the companies I approve of.