Takeaways from the Texas District Court’s decision on ESG investing in 401(k) plans

In this memo, Ropes & Gray summarizes the facts associated with the recent decision by the District Court for the Northern District of Texas that a company breached its fiduciary duty of loyalty under ERISA due to the ESG-related influence of its investment manager notwithstanding the absence of ESG-focused funds in the company’s 401(k) plan. Here are the “Key Takeaways” from the memo:

1. ESG was Scrutinized even with no ESG Funds – As described above, this lawsuit did not deal with any ESG-focused, impact or similar funds. The broader net of ESG activity at issue here was based solely on the proxy activities of standard funds. In response to this decision, plan sponsors may wish to conduct greater diligence and monitoring of investment managers’ use of ESG and other collateral considerations in conducting business that impacts retirement plans. Plan sponsors and fiduciaries should also remain cognizant of the risk that virtually any service provider or investment manager retained by a plan could potentially form the basis for a similar lawsuit (although not all such suits may be successful).
2. Scrutiny of Delegated Proxy Voting? – The lawsuit focused on the Investment Manager’s public statements, proxy voting activities and other instances of shareholder engagement to promote ESG objectives. This ruling (especially if its reasoning is upheld on appeal and adopted by other courts) may suggest that for ERISA plan fiduciaries that delegate proxy voting authority to their managers under the terms of their IMAs, there will be additional focus going forward on their monitoring and scrutiny of the voting activities of their managers. This could entail more robust due diligence of managers’ voting records as well as greater reliance on reporting and regular certifications/attestations that managers are complying with applicable proxy voting guidelines. Delegation of proxy voting authority is a widespread practice in the retirement industry, and it remains to be seen whether this decision will lead to enhanced monitoring of proxy voting and/or increased pressure to use pass-through voting in order to mitigate potential litigation risks for plan sponsors and plan fiduciaries going forward.
3. Prudence is Process: Lessons for Surviving a Claim Alleging Breach of the Duty of Prudence – As the ruling notes, the defendants were focused on investment performance, and they had a robust process and protocols in place for doing so, which were in line with (if not exceeded) the prevailing practices of large plan fiduciaries at the time. The EBC convened regularly, they maintained detailed records and documentation of their meetings, utilized a well-regarded consultant (who was selected following a formal request for proposal process, in which the merits of Aon’s advisory services were vetted and compared to those of other investment advisory firms), and relied on various internal experts to advise them on how to evaluate the Plan’s investment options and managers. While these practices may be routine for large plan sponsors, they still provide a useful example of what measures plan fiduciaries can take to demonstrate adherence to their duties under ERISA.
4. The 2022 ESG Rule Remains in Effect (for Now) – Even though the decision clearly demonstrates Judge O’Connor’s hostility toward allegedly pro-ESG initiatives and his skepticism regarding the role of ESG in investment decision-making, it does not invalidate the 2022 ESG Rule that the Biden administration adopted. That said, the rule remains subject to ongoing litigation in the same district by the attorneys general of 26 states seeking to invalidate it. Moreover, with the upcoming change in administration, the Trump-led DOL may choose to stop defending the 2022 ESG Rule, and it may also be sympathetic to the theories offered in this case as to why ESG investing and ESG shareholder engagement do not square with ERISA fiduciary duties.