First 401(k) lawsuit over ESG targets American Airlines' $26 billion plan

American Airlines was sued late last week over its 401(k), in what appears to be the first litigation focused on the use of ESG factors by investments in a defined-contribution plan.

The suit, which is seeking class status, was filed in federal court in Texas on behalf of American Airlines pilot Bryan Spence. In addition to the airline, Fidelity Investments Institutional and Financial Engines are named as defendants.

The case comes as environmental, social and governance considerations have become a political target in the U.S., and its outcome could influence more such lawsuits, as copycat litigation against 401(k) sponsors and service providers has become common.

In the complaint filed last Friday, the plaintiff alleges that the defendant companies, along with the American Airlines benefits committee, breached their duties of loyalty and prudence under the Employee Retirement Income Security Act. The airline and the committee are also accused of breaching their duty to monitor fiduciaries to the plan, which at the end of 2021 represented about $26.5 billion in assets.

The 43-page complaint raises numerous allegations about ESG generally, and the plaintiff names dozens of mutual fund options within the plan.

“Defendants have breached their fiduciary duties in violation of Erisa by investing millions of dollars of American Airlines employees’ retirement savings with investment managers and investment funds that pursue leftist political agendas through environmental, social and governance ESG strategies, proxy voting and shareholder activism — activities which fail to satisfy these fiduciaries’ statutory duties to maximize financial benefits in the sole interest of the plan participants,” the complaint read. “The unlawful decision to pursue unrelated policy goals over the financial health of the plan is not only flatly inconsistent with defendants’ fiduciary responsibilities, it jeopardizes the retirement security of hundreds of thousands of American Airlines employees.”

The law firms that filed the suit — Hacker Stephens and Sharp Law — claim that investments using ESG factors in their decision-making process have underperformed the broader market over the past five years by more than 250 basis points annually.

However, the complaint does not include comparisons of returns versus benchmarks for the funds on the plan menu that it singles out for using ESG criteria. Often ERISA class actions over plan investments cite the performance or fee shortcomings of the funds on a plan’s menu.

American Airlines and Fidelity didn't respond to requests for comment about the lawsuit. Edelman Financial Engines stated that it “is aware of the matter and intends to defend itself” but doesn't comment on the details of ongoing litigation.

Although the case is likely the first involving claims related to ESG in a 401(k) plan, it's not the first related to sustainability and retirement plans generally. Last month, plaintiffs represented by former Labor Secretary Eugene Scalia brought a proposed class action against three New York City pension funds over divestments from fossil fuels. Scalia, now in private practice as a partner at law firm Gibson Dunn, led the DOL’s rulemaking during the Trump administration that limited the use of ESG factors in retirement plans.

The DOL has since changed its stance on ESG, with a rule taking effect earlier this year that allowed plan sponsors to consider such criteria when selecting plan investments, including for the default funds participants use.

Generally, companies defend against legal attacks around performance and fees of a plan’s investment options by showing that plan fiduciaries had a documented, prudent process for selecting funds. Not having the strongest possible performance or lowest fees is not enough to show that plan sponsors and other entities violated Erisa.

"This lawsuit — and others like it that are sure to follow — will be closely watched, but I think they will be extremely difficult for plaintiffs to win given the ever-evolving nature of the DOL’s rules on ESG investing and the fact-intensive nature of the claims," Greg Ash, partner at Spencer Fane, said in an email.

"The standard for a 'prudent' investment under Erisa is contextual by its very nature, requiring actions to be prudent 'under the circumstance then prevailing,'" Ash said, noting that he had not studied the lawsuit in detail. "Those circumstances — and thus whether a decision is prudent — can change over time (as political winds shift), and can vary based on the makeup of an employer’s workforce.  I suspect that courts will require plaintiffs to prove that an investment fund decision was egregiously inappropriate before finding fault against fiduciaries."

Further, fund managers that consider ESG factors usually make the case that such data are necessary to make fully informed decisions about risk and opportunity, presenting the criteria as financially material in nature.

But the complaint accuses the plan sponsor and other defendants of putting social motivations ahead of investment performance.

“These imprudent investment choices were not the result of mere negligence or oversight,” the complaint read. “To the contrary, defendants selected the ESG funds and included them as investment options with knowledge of their nonfinancial investment objectives, higher costs of owning ESG funds, poor financial performance of ESG funds and ESG fund shareholder activism to achieve social policy changes rather than maximize the risk adjusted financial returns.”

The lawyers representing the plaintiff and proposed class are Rex Sharp and Andrew Stephens. Sharp, according to his firm’s site, has led other class actions and has “substantial experience advising clients in the oil and gas, beef and trucking industries.”