Fund managers could see ‘anti-ESG’ litigation risk flare without new guidance

In the US, where there is increasing polarisation of the political system, there has been a backlash by the right against what they consider to be the “left-leaning ESG agenda” of president Joe Biden and the Democrats.  

A recent example of this is the claim being pursued by Wayne Wong and four others, including a train operator, a teacher, and non-profit organisation ‘Americans for Fair Treatment’, against the trustees of three New York City retirement systems.

The complaint, which was filed on 11 May 2023, alleges that the funds’ 2021 plans to divest all investments in fossil fuel related assets – around $4 billion – has caused ongoing material harm to the financial wellbeing of the plans and, in doing so, constitutes a breach of the trustees’ fiduciary duties to the scheme’s beneficiaries. Such duties, the plaintiffs allege, include an “undivided loyalty to act in the interests of fund participants”.

The plaintiffs argue that the trustees were motivated by a political agenda, rather than to maximise returns for their beneficiaries. In making their complaint, the plaintiffs point to two other New York pension funds that rejected similar plans for fossil fuel divestment on the basis that a pension fund is not for making political statements.

On 7 August, the funds applied to the New York court seeking dismissal of the claim against them on the basis that the plaintiffs face no harm and that there are appropriate avenues outside the courts for “displeased but uninjured” members to challenge the funds’ investment decisions. A decision on the motion to dismiss is awaited.

Whilst we have not yet seen any such anti-ESG lawsuits being pursued here in England and Wales, great parallels can be drawn against historical claims that required the courts to deal with the question of how to balance fiduciary duties against prominent social and political issues of the day.

For example, in the 1985 case of Cowan v Scargill, five trustees of the Mineworks’ Pension Scheme appointed by the National Coal Board, pursued proceedings against the other five trustees of the scheme, who were appointees of the National Union of Mineworkers. The union trustees had objected to plans to increase investment in oil and gas, and overseas – ie assets competing with coal. The court was asked to consider whether the union trustees were in breach of their fiduciary duties by rejecting the proposal. Sir Robert Megarry VC held that a trustee’s overriding duty is to act in the best interests of the beneficiaries and should not take into account social or ethical considerations when making investments.

Financial institutions continue to grapple with the issue of how to reconcile ESG considerations with fiduciary duties today. 

Despite societal expectations and regulation around ESG only increasing, formal guidance around the scope of fiduciary duties is lacking. There is clear demand for this to change. 

According to Principles for Responsible Investment (PRI), an international network of financial institutions supported by the UN, fiduciary duty “requires investors to incorporate all value drivers, including environmental, social, and governance (ESG) factors, in investment decision making”. In an article posted in 2020, the PRI wrote that an investor’s failure to incorporate ESG issues constitutes a failure to comply with their fiduciary duties and is “increasingly likely to be subject to legal challenge”.

This sentiment has support among policymakers and financial institutions. For example, Scottish Widows’ March 2023 report, “Nature and Biodiversity: The pensions imperative”, stated that “when it comes to biodiversity loss, it is clear that investors should ensure consideration of this systemic risk”. The UK government indicated in its green finance strategy report, “Mobilising Green Investment”, also released in March this year, that clarity for trustees on their fiduciary duties in the context of the net zero transition will be provided in late 2023. 

Given the differences between the political, legal and regulatory ESG landscape in the US and in England and Wales, it seems unlikely that anti-ESG lawsuits will have quite the same impact in this jurisdiction. Nonetheless, fund managers and investors will be keenly awaiting the government guidance in this area and will be hopeful that it brings the clarity that is needed. The recent case of Wong and others is an example of the potential consequences that financial institutions could face if this lack of clarity continues.

Co-written by Beth Pendock of Pinsent Masons.