Anti-ESG claim faces first legal test in New York

By Lesley Clark | 11/29/2023 06:42 AM EST

A lawsuit before the New York Supreme Court “could open up a floodgate of litigation” over consideration of climate change in investing, said one lawyer.

Bill de Blasio speaks into a microphone while pointing his right finger.

As New York City mayor, Bill de Blasio promoted fossil fuel divestment from pension funds. Charlie Neibergall/AP

A New York court may be the first to consider a legal claim leveled by critics of investment managers who account for climate risk.

In their lawsuit before the New York Supreme Court, four New York City employees and the conservative nonprofit Americans for Fair Treatment contend that a decision by former Mayor Bill de Blasio to rid public pension funds of billions of dollars in fossil fuel investments put their retirement at risk.

The case — and the theory that asset managers breached their fiduciary duties by including climate-related risks when assessing the financial liability of energy companies — “could open up a floodgate of litigation,” said Robert Skinner, a partner at Ropes & Gray.


“Energy companies themselves freely admit that technological and regulatory changes to address climate change may hurt their share price in the long run,” said Skinner, who is not involved in the New York lawsuit. “Asset managers can hardly ignore those facts.”

Republicans across the United States have cited environmental, social and governance (ESG) investing as a threat to the energy industry. A federal lawsuit against a Labor Department rule that allowed investment managers to consider ESG factors in decisions regarding retirement funds failed earlier this year.

But the New York lawsuit — if successful — could unlock a new legal claim for critics of ESG investing.

The case charges that de Blasio, a Democrat, vowed in 2018 that New York City’s pension funds would divest from fossil fuel companies — but did not “discuss, cite, or refer in any way” to any financial studies that suggested the move would benefit the participants in the pension plan.

The decision “to pursue an environmental agenda instead of safeguarding the retirement security of plan participants and beneficiaries has had, and will continue to have, a detrimental impact on the financial health of the plans,” the lawsuit says.

The lawsuit argues that the three public pension funds that pulled money out of the oil and gas industry in 2021 “breached their fiduciary duties and abused their control” by divesting holdings in what the complaint calls a “misguided and ineffectual gesture to address climate change.”

The pension funds — the New York City Employees’ Retirement System, the Teachers’ Retirement System of the City of New York and the New York City Board of Education Retirement System — have urged that the lawsuit be dismissed.

They noted that after the decision to stop investing in fossil fuels, the energy stocks lost more than 35 percent of their value, while the broader stock market increased in value by more than 50 percent. And they say that public pension funds routinely decide how to structure their portfolios.

“Their legal theory is premised on the radical, absurd notion that courts may force public pension funds to invest in a particular industry if it performs well enough,” said attorneys for the pension funds.

The funds noted that Texas divested from companies that produce pornography in 2006, and Tennessee sold stock in a marijuana company in 2019.

“Those decisions, and countless other discretionary decisions that public pension funds make daily, do not end up in court because courts are not the right place to challenge them,” the pension funds said.

‘Politically motivated’

Americans for Fair Treatment, a right-to-work group that provides assistance to public sector workers who want to leave a union, says the pension plans breached their obligations to retirees by using the plans to advance a political agenda.

“We take this issue very seriously; pensions are a promise, and governments owe it to their employees to keep their commitment,” Elisabeth Messenger, the group’s CEO, said in May when it filed the lawsuit.

She added that municipal employees “who keep our government running effectively deserve properly managed retirement systems, free from politically motivated intervention.”

The challengers — who include a subway train operator, a public school teacher, a school secretary and an elementary school occupational therapist — noted in the lawsuit that some pension plan managers expressed hesitation at the time, with the trustees of the police and firefighters’ pension fund “raising immediate concerns that divestment was not consistent with their fiduciary duties.”

The president of one union also urged that efforts to address climate change “should not be funded on the backs of our members,” the lawsuit notes.

The pension plans argue that the challengers have no injuries to bring a case because they are entitled to a fixed payment every month, regardless of the plan’s performance.

“Fossil-fuel companies are free to bet that their industry will continue to make money even in the face of expanding regulation, ever-rising temperatures, and the increasingly intense global impacts of climate change,” the pension plans contend. “But public pension funds are not required to bankroll that bet. And that is a decision appropriately left to the funds, their trustees, and the financial experts who advise the funds’ investment decisions — not the courts.”

The lead counsel for the lawsuit is Trump-era Labor Secretary Eugene Scalia, now a partner at Gibson, Dunn & Crutcher.

As head of the Labor Department, Scalia adopted an anti-ESG rule that targeted efforts by the financial sector to provide clients with socially conscious options. He said at the time that the rule would ensure that investment managers “are focused on the financial interests of plan participants and beneficiaries, rather than on other, non-pecuniary goals or policy objectives.”

The Biden administration rolled back the Trump regulation, giving retirement plan managers the green light to account for ESG issues.

Federal lawsuit

The Biden administration’s rollback withstood a challenge from 25 Republican-led states that sued Labor in February, arguing that the rule would result in “reduced investment in the fossil fuel industry,” which would reduce state revenues.

The lawsuit was one of several fronts Republicans have waged against ESG investing, with Texas Attorney General Ken Paxton charging that the rule would place “the radical left’s climate and social agenda above sound financial investment principles.”

Judge Matthew Kacsmaryk of the U.S. District Court for the Northern District of Texas, however, rejected Paxton’s challenge in September, writing that the Biden rollback was not “arbitrary and capricious” under the Administrative Procedure Act, nor did it run afoul of the federal law that sets standards for retirement plans.

Though both the federal and New York cases target environmental investing, Skinner of Ropes & Gray noted the litigation over the Labor regulation involved a question of whether the department had the authority to adopt the rule. The federal case did not involve the question of fiduciary duty.

Still, Skinner said the Northern District of Texas’ decision could support the New York City pension funds’ case.

He noted that Kacsmaryk, a Trump appointee, acknowledged that ESG investing considerations can be raised in pursuit of financial returns — as opposed to solely a social agenda.

In his decision, Kacsmaryk wrote that the Labor Department since at least 2015 had “posited that ESG factors ‘may have a direct relationship to the economic value of the plan’s investment.’”