• In the past year, environmental, social, and governance (“ESG”) practices have faced heightened scrutiny in the United States from state attorneys general, state and federal legislators, other government officials, and private parties.
• There has been a sudden increase in governmental inquiries and both public and private litigation critical of ESG-related decisions.
• Corporate boards and members of the financial industry, as well as their attorneys and other advisors, should consider preparing for potential involvement in the growing ESG scrutiny.

The consideration of ESG factors as part of investment or corporate decision-making processes is at an important crossroads in the United States. Until recently, the ESG discussion has primarily taken place outside the courtroom. In the past year, however, private litigants, “red state” attorneys general, and other government officials in the United States have increasingly scrutinized the ESG-related decisions of corporate boards, investment managers, pension fiduciaries, and funds—including through litigation filings in state and federal courts. Meanwhile, some investors, “blue state” officials, foreign governments, and regulators continue to advocate for including ESG factors in business and investment decisions.

As the proper scope of incorporating ESG into business and investment decisions continues to be debated, and the current political environment remains unsettled, the risk of litigation and state inquiries is likely to continue, if not expand. In this environment of competing demands from different regulators and investors, corporate boards and investment managers will face increasingly difficult choices regarding their consideration of ESG factors, and should consider preparing to respond if their organization draws scrutiny over its ESG practices.

Current State Inquiries and Litigation

Since 2022, the financial industry has received numerous formal inquiries from state officials into their ESG practices. Meanwhile, private litigants have filed complaints in state and federal courts challenging the ESG-related decisions made by companies and investment funds. A recurring theme in these matters is that ESG practices allegedly run counter to the duties of fiduciaries to maximize the profit-taking goals of investors. To provide a sharper picture of the current environment, we summarize the key assertions in these actions below.

Letters from State Attorneys General and State Treasurers to Financial Industry

Attorneys general and state treasurers from over 20 “red states” have sent various letters criticizing ESG factors and their use in investment or proxy decisions to leading participants in the financial industry, including ratings agencies, asset managers, and proxy advisors, among other firms and groups. The letters broadly cite federal and state legal regimes, and in some cases contractual duties, that the state officials claim potentially are being breached by financial organizations, insurers, managers, and boards when they advance climate change mitigation or other ESG goals.

These state officials have questioned the use of ESG factors on several fronts. A central theme of the state letters is whether ESG practices—including proxy voting in line with ESG considerations—represent a conflict of interest and a breach of fiduciary duties. Other letters have questioned whether there are antitrust concerns arising from financial entities’ commitments to develop investment practices addressing climate change and the de-carbonization goals of the Paris Agreement.

To date, the state officials have requested information—and in some cases sent civil investigative demands (CIDs) or subpoenas—on the mechanics of calculating ESG factors, whether the implementation of such factors were coordinated within the financial sector, and whether the financial industry is specifically aligning with particular groups or policy positions, among other details. While none of the letters formally threaten litigation or investigation, statements by various attorneys general have suggested the possibility of future formal action related to the use of ESG factors in investment decisions and financial activity. Some states have also adopted blacklists in certain circumstances.

Utah, et al. v. Su

Twenty-five states and certain oilfield exploration interests filed a lawsuit against the U.S. Department of Labor (the “Department”) in the Northern District of Texas challenging the Department’s rule finalized in December 2022 concerning the management of retirement investment accounts (the “Rule”). According to plaintiffs, the Rule subverts fiduciary duties required by the Employee Retirement Income Security Act (ERISA) and exceeds the authority granted to the Department by Congress.

The complaint specifically alleges that a series of recent changes included in the Rule undermine protections for investors and conflict with ERISA. Plaintiffs point primarily to provisions that would allow plan administrators to consider ESG factors in investment decisions rather than managing plan assets for the “exclusive purpose” of providing benefits to participants and their beneficiaries. Plaintiffs also allege that the Rule is procedurally invalid under the Administrative Procedure Act.

Plaintiffs, who include the same state attorneys general investigating ESG practices within the financial industry, seek declaratory relief deeming the Rule arbitrary and capricious or otherwise unlawful and to enjoin the Department from implementing, applying, or taking any action under the Rule. If the Rule were vacated, ERISA standards could revert to a Trump-era rule potentially providing additional grounds for litigation challenging the use of ESG factors in retirement plans.

Spence v. American Airlines, Inc. et al.

The named plaintiff for a putative class of current and former American Airlines pilots filed a lawsuit in the Northern District of Texas on June 2, 2023, against American Airlines, its Employee Benefits Committee, its retirement plan administrator, and its financial advisors for alleged breaches of fiduciary duty under ERISA relating to the consideration of ESG principles in the management of the class plaintiffs’ 401(k) plan. According to the complaint, the selection and inclusion of investment options that pursue ESG policy goals via investment strategies, proxy voting, and shareholder activism is inconsistent with the defendants’ fiduciary duties under ERISA.

The complaint further alleges that including ESG funds in the American Airlines 401(k) plan necessarily breaches fiduciary duties because, purportedly based on selected third-party analyses and reports, ESG funds are more expensive, do not perform as well as their peers, and engage in shareholder activism in the pursuit of goals beyond the maximization of financial benefits. In short, plaintiff contends that “[a]n ERISA plan manager is not acting solely in the interests of [beneficiaries] . . . if it uses an ESG investment strategy or offers a selection of funds to self-directed individual accounts that utilize an ESG strategy.”

The complaint asserts two causes of action, namely (1) breach of ERISA’s duty of loyalty and prudence in violation of 29 U.S.C. §§ 1104(a)(1)(A)-(B); and, (2) breach of ERISA’s duty to monitor fiduciaries in violation of 29 U.S.C. § 1105(a), which is alleged only against American Airlines and its Employee Benefits Committee. The putative class, who would be represented in part by a former Texas Assistant Solicitor General, seeks a declaration that defendants breached their fiduciary duties under ERISA, an injunction that would permanently enjoin the defendants from such fiduciary breaches, and monetary relief to restore the 401(k) plan to the position it would have been in had it not offered ESG funds.

Wong et al. v. New York City Employees’ Retirement System et al.

Plaintiffs benefitting from New York City’s Qualified Pension Plans (the “Plans”) sued their respective pension administrators for breaches of fiduciary duty relating to the Plans’ decision to divest from fossil fuel investments in an effort to combat climate change. The complaint, filed in New York Supreme Court on May 11, 2023, describes the Plans’ January 25, 2021, decision to divest from all holdings related to fossil fuel companies as an “utter abandonment of fiduciary responsibilities” that runs afoul of common law protections and New York’s regulatory standards for public retirement systems. The Plans, which control approximately $150 billion in assets, allegedly divested approximately $4 billion in fossil fuel related securities.

Plaintiffs claim that the alleged “blunderbuss divestments” represented the administrators’ “zealous pursuit of a policy agenda” over their mandate to maximize returns for pension participants. Plaintiffs further claim that divestment has caused the Plans to miss out on the energy sector’s growth since mid-2021. The complaint further notes how the alleged missed growth owing to the divestment has contributed to the growing fiscal gap in New York’s pension system and will require additional investment from the City’s general fund.

Plaintiffs bring three causes of action: (1) breach of common law fiduciary duties of loyalty and care; (2) violation of New York insurance regulations that impose similar duties of loyalty and care; and (3) declaratory relief that the Plans’ divestment constitutes a breach of fiduciary duties owed to plaintiffs. Plaintiffs also seek an injunction that would require the Plans to rescind their divestment policy and make decisions going forward “exclusively on relevant risk-return factors,” but Plaintiffs do not seek monetary damages.

Simeone v. The Walt Disney Company

A stockholder of The Walt Disney Company filed an action pursuant to 8 Del. C. § 220 in the Delaware Court of Chancery to inspect corporate books and records relating to the Company’s decision to express public opposition to Florida’s parental rights legislation, referred to by some as the “Don’t Say Gay” bill. The stockholder claims that he wants to investigate wrongdoing, mismanagement, and possible breaches of fiduciary duty related to the company’s public opposition to the bill. The stockholder alleges that this opposition led Florida Governor Ron DeSantis and the Florida legislature to revoke the company’s special tax district (i.e., the Reedy Creek Improvement District).

The stockholder seeks to inspect both board-level documents, including director independence questionnaires and meeting minutes, and correspondence between the company’s directors concerning the legislation and other political stances.

The case was tried on March 15, 2023. In its pre-trial briefing, the company argued, among other things, that the stockholder was prosecuting the case on behalf of a political advocacy organization and that the identified proper purpose was improperly “lawyer-driven.” The stockholder, meanwhile, argued that the company’s “choosing to take a formal political stance opposing a law not regulating its business either ignored a known risk to the Company’s valuable real estate asset or else placed some other personal interests ahead of . . . fiduciary obligations to Disney and its stockholders.”

A decision in Simeone is anticipated in June 2023.

Weighing Strategies in the Current Environment

In addition to the above matters, there is good reason to believe that within the United States there will be increased legal and political scrutiny of ESG practices over the coming year. Besides the litigation and state official inquiries noted above, several “red state” legislatures have enacted legislation to limit or prohibit the consideration of ESG factors by investment advisors. Some state treasurers similarly have sought information regarding ESG-influenced decisions made by investment managers. At the same time, “blue states” have taken the opposite approach and are acting to bolster ESG practices through, for example, proposed legislation promoting the consideration of ESG factors and public statements claiming that some ESG factors are material financial considerations. The action on both sides coincides with politicians in the United States making pro- and anti-ESG stances a political battleground ahead of the 2024 election cycle.

Caught in the midst of this brewing storm, corporate boards and members of the financial industry doing business or investing in the United States may rightly feel beset from all sides. For example, if a board of directors or investment advisor ignores the views of ESG critics—whether state attorneys general or certain investors—then they may find themselves caught up in costly litigation, investigations, or enforcement proceedings. Conversely, if that same board and advisor accedes to the demands of the ESG critics, they may find themselves at odds with other investors or other regulators leading to litigation, investigations, or enforcement proceedings. In light of these challenges, corporate boards, investment managers, and other members of the financial industry should continue to engage with their various stakeholders, consider the growing legal and reputational risks, and consider developing, with the aid of counsel and other advisors, potential strategies for responding to any state inquiry or possible litigation related to the organization’s ESG practices.