We’ve had a number of questions from clients about adding environmental, social and governance (ESG) investments in their retirement plan. To date, the law and guidance about using ESG has been a grey area. ESG has also been a political football, which means guidance issued during one administration becomes invalid when a new one takes over.
Meanwhile, the legal community has started to test the waters in suits against plans that have ESG investments, highlighting potential issues with fees, forfeitures, and other details. In early January 2025, we received one of the first decisions from the courts about whether including ESG investments in a plan is prudent.
Ruling: ESG can’t be basis for investment decisions
A suit filed in 2023 claims American Airlines violated the federal Employee Retirement Income Security Act (ERISA) by making investment decisions related to ESG instead of basing them purely on financial interests. U.S. District Judge Reed O’Connor ruled against American, saying that the company had breached its legal duty to its 401(k) participants.
The suit claimed violations of the company’s “duty of loyalty” and “duty of prudence” to plan participants, but O’Connor ruled against American Airlines only on the duty of loyalty question, noting that the company followed industry standards.
The court found that the retirement committee allowed its own corporate interest in ESG and that of the target date manager to influence plan management. And that American Airlines did not act in the best interests of their participants by taking the companies ESG beliefs into account.
And here’s the political football element: A rule that allowed plans to consider ESG, but only as a tiebreaker for options that otherwise were comparable, had been adopted by the Biden administration in 2023. That rule reversed one put in place during Trump’s first term prohibiting any nonfinancial factors to be considered. Now that we’re in a second Trump administration, reversing the reversal wouldn’t be a surprise.
Even though American Airline’s 401(k) plan assets were not invested directly in ESG funds, the basis for selection of these funds included financial and nonfinancial (ESG) goals.
Takeaways from the American Airlines decision
This is the first ruling of its kind, but it won’t be the last. As the courts and lawmakers go back and forth on issues related to investment approaches that include ESG funds, the matter is unlikely to become clear anytime soon. For now, I think take aways from this lawsuit include these important points:
- When looking for investment options in a retirement plan, don’t prioritize corporate ideologies over what’s in the best interest for your participants.
- Vet investment managers to understand what they use for selection of the underlying holdings and understand how they vote proxies. For example, are they using the proxies to promote their ideologies?
- Make sure to let the numbers drive the decision-making process. Be careful when you are using nonfinancial metrics in making decisions about the funds. Organizational stability, manager tenure, and other details are commonly used today.
- Document, document, document your decision- making process. If you do get pushback about your choices, you’ll be better able to defend yourself if you can show the financial considerations that drove your process. Be careful in documenting your decisions. Here are a couple of examples that could potentially get a plan sponsor in trouble if these were what was documented in the minutes:
a. “We are afraid of being sued, so we are only going to pick low cost index funds.”
b. “Our corporate initiative is to promote (fill in the blank), so we are going to select funds that support our corporate initiatives.”
c. “We are going to choose funds that are managed by our recordkeeper, because it lowers the administration costs the company has to pay.”
No matter where you stand on ESG in terms of corporate policy, this ruling underscores the importance of pushing it aside when it comes to fiduciary management. Your goal for plan investments is to best serve the financial interests of your participants. Because this issue will almost certainly remain in the spotlight for a while, my best advice is to avoid it: Take all precautions to leave ESG out of the investment equation to keep your company and your participants in the safest position.
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