In other words, it was not a question of whether investing in ESG funds was the right decision financially for plan participants, but whether the EBC’s loyalty strayed from participants to other matters.
Usually when we discuss fiduciary duties of financial advisors, it is in the context of potential legislation or rulemaking to extend duties to additional players in the investment area. However, two news stories may show a rising public concern. Most often when discussing fiduciary duties, the topic at hand involves the research and appropriateness of decision making. There may be a new player in the fiduciary duty sandbox, and it involves ESG. Issues of loyalty and trust in investment advice are always worth following.
Recently, the decision in the Spence v. American Airlines, Inc. case caught attention from financial advisors related it its ruling on ESG issues. ESG refers to environmental, social and governance factors, part of a socially responsible investing trend. There are many concerns with ESG investing, including performance as well as so called “greenwashing” a practice of deeming a fund to involve ESG on flimsy premises. ESG was once a darling of many institutional investors.[1] This new ruling could be a strike against ESG. But not so fast, say attorneys. ““While the news headlines suggest that the case is about ESG investing, none of the funds on the Plan menu were actually ESG funds. The ruling is solely focused on the Investment Manager’s proxy voting practices and alleged pro-ESG shareholder engagement.”[2]
But questions around the definition of ESG began to bedevil the trend, leading to proposed rules from both the SEC and DOL. The SEC’s proposed rules (which could take some time to become final) relies on the Names Rule to require that a funds with a stated intention in their name (like a climate fund, or a green fund) must have 80% of their assets in investments that align with the name. The DOL’s rule would allow plan fiduciaries to consider ESG. The rule removed parts of a previous recommendation against recommending ESG-focused investing enacted by President Trump’s administration. The previous rule said plan fiduciaries should focus on pecuniary factors alone.[3] These rules faced quick push back in Congress and the courts, including a veto from President Biden on legislation rebuking the DOL’s rule. Now states are separating around how to treat ESG, with some restricting the investment options and others explicitly allowing it.
The Court’s ruling in Spence provides an interesting angle for those who opposed the DOL’s rule. In Spence, class action plaintiffs sought relief under the ERISA for breach of fiduciary duty. In an unusual twist, the federal court ruled that American Airlines’ Employee Benefit’s Committee violated the duty of loyalty, not prudence. In other words, it was not a question of whether investing in ESG funds was the right decision financially for plan participants, but whether the EBC’s loyalty strayed from participants to other matters. The plaintiffs claimed that the plan’s investment manager “harmed the financial interests of plan participants and their beneficiaries due to [the manager] pursuing socio-political outcomes rather than exclusively chasing financial returns.”[4]
Under general legal principles, a fiduciary owes a high duty of care to the beneficiary. That duty of care usually requires that the fiduciary inform themself or themselves of all material and available information prior to making a decision, and to make prudent decisions based on that information. Fiduciaries also owe their beneficiaries a duty of loyalty. That duty requires that a fiduciary avoid conflicts of interest and not use their position of confidence to further their own interests. Fiduciaries must also act in good faith, maintain confidentiality, and communicate with complete candor by disclosing information.[5]
Most often, the duty of loyalty is raised when a fiduciary is faced with a conflict of interest. A conflict of interest would arise if a fiduciary diverted an opportunity that should have gone to the beneficiary. Issues around the duty of loyalty can also arise if the fiduciary uses its work to win contracts or obtain other goods. This is considered "self-dealing." A plan advisor who chooses their own firm to function as a plan administrator, without reviewing other vendors, might be engaging in self-dealing, for example.
In the Spence case, the court found that when the plan manager chose ESG funds, its interest was not exclusively to benefit the plan participants. While this may have those opposing the DOL’s ESG rule cheering, there are complicating factors to the case. The plan manager was also a large shareholder. It had specific aims towards ESG in its own plans. The court held that ERISA requires a fiduciary to act to the exclusive benefit of its beneficiaries. Here, the plan manager did not.
Financial advisors may want to keep an eye on these developments not only because of the gathering storm around ESG, but also because of a potential backlash against fiduciaries. With new conservatorship issues in the public eye over celebrities such as Wendy Williams, clients may be concerned about issues around loyalty.
[1] https://www.bcgbenefits.com/blog/socially-responsible-investing
[3] https://www.bcgbenefits.com/blog/new-dol-esg-rule
[5] https://www.bcgbenefits.com/blog/fiduciary-services-rules-321-338-and-316
These articles are prepared for general purposes and are not intended to provide advice or encourage specific behavior. Before taking any action, Advisors and Plan Sponsors should consult with their compliance, finance and legal teams.
Before leaping into the unknown, we recommend a thorough examination of your plan. Because we are experts in the field, we know the marketplace and know what your existing vendor is capable of offering. Through this examination, we can help you optimize the service you receive.
get xpress proposal
