While Los Angeles Burns, Judge Says It's Illegal for Investors to Consider Climate Risk

Strong out-of-season wildfires ripped through the Los Angeles area over the past week, killing at least 25 people, destroying an estimated 12,000 structures, and forcing thousands to evacuate and leave their homes and belongings behind. Still only partially contained, the Eaton and Palisades fires are already the most destructive in Southern California’s history, according to the state's Department of Forestry and Fire Protection, CNN reports.

Experts say the environmental tinderbox fueling the devastating blaze is caused by climate change. The last time Los Angeles had significant rainfall — 0.13 of an inch — was in May of last year, and the past 25 years have been the driest on record in the American West, The Los Angeles Times reports. 

“A year from now, peer-reviewed studies will confirm that the conditions leading to these wildfires were intensified by human-driven climate change," Jeffrey B. Simon, the climate attorney behind a recently filed lawsuit against big oil companies over climate impacts, said in a press statement this week. "The heating of the Earth’s surface, the drying of soil, and these uncontrollable fires are not acts of nature — they are the direct result of fossil fuel burning.”

Experts say climate change will come at a massive financial cost: Vanguard estimates that unchecked temperature rise could slash global GDP by 10 percent by 2050, outpacing the estimated costs associated with reducing emissions to net zero. But even as the wreckage of the California fires unfolds before our eyes, a very different string of worrying litigation aims to block private companies from measuring and managing climate risk.

On Friday afternoon, a Texas judge issued his decision in a class-action lawsuit filed by current and former employees of American Airlines, ruling the company violated its fiduciary duty to 401(k) plan holders by allowing the asset manager BlackRock to support investor proposals related to climate change. The case may sound isolated or hyper-specific, but the judge's ruling is so broad that one expert said it could theoretically apply to nearly "every 401(k) plan in the country." 

Spence v. American Airlines: A broad opinion with dizzying implications 

At issue in the case brought by pilot Bryan Spence is whether American Airlines violated its fiduciary duty to employees who participate in its 401(k) plan. The company's plan is administered by BlackRock, the world's largest asset manager, which has engaged with companies in its portfolio to manage climate risk.

The decision ultimately focused on three things: BlackRock voted on investor proposals linked to climate change; BlackRock, which owns thousands of stocks and manages over $11 trillion in assets, owns shares in American Airlines; and American Airlines has set goals to reduce greenhouse gas emissions. Together, this adds up to a conflict of interest that prevented American Airlines from intervening when BlackRock used plan resources to vote on climate-related investor proposals, U.S. District Judge Reed O'Connor said.

If you're thinking this scenario — a large asset manager that assesses climate risk administering a 401(k) plan for a company that also assesses climate risk — could apply to others beyond BlackRock and American, you'd be right. 

"Part of what makes the opinion so hard to grapple with is that the implications of it are almost hard to believe," said Luke Morgan, a staff attorney at the shareholder advocacy organization As You Sow. "With this opinion, you could change the parties’ names, and it probably applies to just about every 401(k) plan in the country."

The Employee Retirement Income Security Act of 1974 (ERISA) outlines the fiduciary duties associated with 401(k)s, as well as pensions and healthcare plans offered by employers. Fiduciaries are held to a duty of loyalty, meaning they must act solely in the interest of plan participants, and a duty of prudence, meaning they must responsibly and diligently manage the plan's assets. 

O'Connor found American Airlines violated the fiduciary duty of loyalty, but did not violate the fiduciary duty of prudence. That's because, to put it simply, the company wasn't doing anything differently than anyone else. "If you are doing what the market is doing, as a general rule, you're not going to be found to violate the duty of prudence," Morgan said.

In other words: Even while acknowledging American's activities are consistent with other employers, O'Connor still found them to be illegal. The district judge is an appointee of former President George W. Bush who Reuters noted is "known for frequently ruling in favor of conservative litigants challenging laws and regulations governing guns, LGBTQ rights and healthcare."

The broad scope of his opinion seems "designed to curb any assessment of climate impact or climate risk," said Danielle Fugere, president and chief counsel of As You Sow. "[The opinion determines] just because American Airlines has adopted climate change principles and BlackRock has too, therefore one can conclude they are colluding in some way or they have conflicts of interest. That's such an enormous leap. It makes no sense in today's market where climate change is a risk, investors and companies have to address those risks, and if they don't, they will be impacted financially and negatively." 

What happens next?

Morgan and Fugere don't believe the decision will hold up under appeal, but it will be at least a few months before we know for sure. While the lawsuit found American liable, it did not determine what — if any — financial relief will be provided to plan participants. O'Connor previously rejected American's attempts to dismiss the lawsuit because Spence could not demonstrate the 401(k) plan had underperformed. Following the decision, he asked for additional briefings to determine if financial loss occurred, but based on the evidence, that seems unlikely.

The judge's opinion largely hinges on BlackRock's vote to replace board members at ExxonMobil in 2021. While O'Connor chalks this up to nothing more than climate activism, the vote came shortly after Exxon was dropped from the Down Jones Index following years of financial underperformance, and the oil giant's stock price has improved since the board shakeup. "The judge acknowledged that because he based his findings almost entirely on this Exxon vote, and because Exxon's stock has gone up significantly, it may be the case that 'no actual loss has occurred,'" Morgan said. He expects O'Connor to decide on damages toward the end of February, at which point American could decide to appeal. 

Until then, employers and financial providers are left in limbo, and some are understandably anxious about what the decision could mean for them. "The conclusions are so overly broad that anybody looking at it might say, 'Well, I can't address climate change,'" Fugere said. "But in fact, we believe that fiduciary duty requires that companies, investors, investor representatives and asset managers consider climate risk because it is so costly."

In his decision, O'Connor asserts the threat of climate change is "unproven" and "nebulous." But global investors and insurers disagree, and they should be the ones to decide how to best manage assets for the clients that hire them, Fugere said. "Investors need to be able to make investment decisions, and every investor will make decisions differently," she said. "You cannot have a court or politicians tell investors what to consider and how to do their jobs, and that is where we are right now."

The latest in a string of lawsuits that aim to chill measurement of climate risk

At the start of the year, the sustainability space buzzed with news of large financial companies leaving the Net Zero Asset Managers initiative, a voluntary coalition of banks and investors aiming to support the global transition to net-zero greenhouse gas emissions by 2050. The group announced on Monday it is "suspending activities" following a string of exits from financial firms including Morgan Stanley, Citigroup, Bank of America, Goldman Sachs, Wells Fargo and BlackRock. 

But coverage of the exits often misses crucial context: another lawsuit filed by 10 conservative states against the asset managers BlackRock, Vanguard and State Street the day before the U.S. Thanksgiving holiday. The states say the financial companies illegally colluded to increase energy prices and manipulate the market away from coal. Though the firms continue to invest in fossil fuels, the suit specifically names their membership in groups like the Net Zero Asset Managers initiative and Climate Action 100+, a similar investor-led coalition, as evidence of illegal collusion and antitrust violations. 

If simply joining a voluntary coalition that supports reducing emissions — or, in the case of American, having an emissions reduction plan at all — could put companies at risk of costly litigation and antitrust allegations, it becomes more understandable why some would prefer to distance themselves. Even so, the broad scope of the Spence v. American Airlines decision may soon compel more companies and investors to directly defend their ability to measure climate risk as essential to safeguarding their financial futures. 

"These are very concerning, but I at some point am hopeful that companies will actually begin to stand up for their rights to make their own decisions, and investors are doing that as well," Fugere said. "They don't think these decisions should be dictated by politicians or judges that want to put their opinions in place of facts." 

Though Fugere sees companies "being more cautious in what they say publicly," they continue to make their decisions based on financially material factors, including impacts tied to the world's changing climate, and she doesn't expect that to change between now and a potential appeal in the American case. 

"Business is not going to simply throw up its hands and ignore climate change, because that would be devastating to companies and certainly would be devastating to the competitiveness of the U.S. if its companies ignored climate risk," Fugere said. "Companies should be worried at this point if this decision becomes the norm. But what we have seen is that, for the most part, even conservative Republican judges want to apply the law and they want to do their job, which is to actually make findings of fact and application of law."