There are more than 800 federal judges in the United States. None of them create as much work for their colleagues as Reed O’Connor, a federal judge who serves in the northern district of Texas. For nearly two decades, O’Connor has delivered one ideologically driven ruling after another. No matter how many times those decisions are overturned by the appellate courts and the Supreme Court itself, he persists.
In his latest haphazard ruling, O’Connor held last week that American Airlines violated its legal obligations to employees by allowing BlackRock, the company’s 401(k) manager, to consider “environmental, societal, and governance” factors when making investment decisions and casting proxy votes. If upheld on appeal, the ruling threatens to upend the entire retirement plan industry by opening 401(k) managers to litigation and penalties for using ESG factors as part of their investment strategies—something that nearly every manager has done in recent years.
At issue in the case is whether the airline violated its legal obligations to employees by investing their 401(k) plans with BlackRock, one of the nation’s three largest investment managers, while the investment firm pursued environmentally and socially conscious goals. The class-action plaintiffs claimed that the airline financially harmed its 401(k) participants by not sufficiently scrutinizing BlackRock’s ESG principles when investing and casting proxy votes in shareholder meetings.
BlackRock currently manages more than $10 trillion in retirement funds. Like nearly all such managers, it adopted a series of ESG policies over the last decade. Those policies led it to use its proxy voting powers on behalf of shareholders to encourage companies to adopt more socially and environmentally conscious policies. In perhaps the most famous episode, it sided with a group of activist investors in a 2021 proxy vote to put three members on ExxonMobil’s board who would push for investments in renewable energy.
The plaintiffs claimed that this approach violated the Employee Retirement Income Security Act of 1974, also known as ERISA. The law sets basic standards for pensions and employee benefit and retirement plans offered by employers. Those employers have a fiduciary requirement to administer their plans on behalf of their employees to minimize risk, avoid conflicts of interest, and so on. Two of these obligations are known as the “duty of prudence” and the “duty of loyalty.”
In the plaintiff’s telling, considering ESG issues when making investment decisions violates these duties because they inherently reduce the fund’s performance. “[American Airlines and its subsidiaries] have violated ERISA by selecting and retaining ESG funds that pursue nonfinancial or nonpecuniary objectives like ESG social policy objectives, rather than investment funds that have the exclusive purpose of maximizing financial returns for investors,” they argued in their complaint.
American Airlines rejected that assertion and noted that it followed industry standards when offering investment products to employees via BlackRock and reviewing the managers’ actions, which it deemed to be prudent. It also denied that it acted disloyally to its employees by using BlackRock, even though it (and most other investment managers) is a shareholder in American Airlines itself, based on existing precedent. The airline further warned that adopting the plaintiffs’ approach could itself be illegal.
“Acceptance of Plaintiff’s theory would compel ERISA fiduciaries to ignore actual investment performance and instead screen out investment options ‘based on non-pecuniary factors’ (i.e., the manager’s proxy voting record when the rationale for such votes is speculative at best), potentially harming participants by depriving them of access to some of the best performing, most popular, and highest rated funds in the market,” the company wrote. “Ironically, this is the exact practice that Plaintiff insists is forbidden by ERISA.”
O’Connor ultimately accepted the plaintiffs’ assumption that ESG principles inherently reduced shareholder returns and sided with them. But he struggled to separate out ESG investing, which he found to be unlawful, with investment managers such as BlackRock considering environmental and social factors when deciding how to invest funds, which he found to be acceptable.
“If the reason for investing in the company is because these social expenditures are viewed as reasonably reducing, for example, the material risk of government expropriation of the oil fields or mitigating against other types of impactful labor strife, this is not ESG investing because the focus is fundamentally fixed on maximizing a financial benefit,” O’Connor wrote as part of a hypothetical scenario.
“But if the reason is due to the belief that the company has a responsibility to improve the society in which it operates notwithstanding the lack of or reduced economic benefit to the company,” the judge continued, “such a non-pecuniary consideration would qualify investments based on these social expenditures as a form of ESG investing.”
Even accepting some of O’Connor’s assumptions, his reasoning would require litigants and judges to engage in some casual telepathy to determine a fund manager’s motives. Suppose, for example, BlackRock said that it would draw down its investments in oil and gas companies because of the risk that future climate-minded regulations would impact profits. Is that an unreasonable assumption? Or could it be attacked as a pretext to adopt ESG principles by other means?
O’Connor complicated matters by only giving the plaintiffs half of what they wanted. While he ruled that American Airlines had violated its duty of loyalty by not spurning or challenging BlackRock for its ESG initiatives, he rejected the plaintiffs’ assertion that the company had violated the duty of prudence along the way. O’Connor complained that the airline had not acted imprudently when supervising employees’ retirement plans, namely by “selecting and retaining investment managers, overseeing proxy voting, and not intervening in the Exxon proxy vote.”
He held that the plaintiffs had offered no evidence that the airline had gone against the industry’s best practices by continuing to rely on BlackRock, noting that no one else had removed the firm after the ExxonMobil vote, either. And while the plaintiffs pointed to the Texas legislature’s recent divestiture from BlackRock over its ESG policies, O’Connor admitted that the lawmakers’ moves, while “based on their sound view of the public interest,” weren’t bound by ERISA’s requirement to follow prevailing industry standards.
The split ruling leads to a paradoxical result: In its telling, American Airlines violated ERISA by not challenging BlackRock’s ESG efforts in general and the ExxonMobil vote in particular, but would have also violated ERISA if it had imprudently dropped the management firm after the ExxonMobil vote. O’Connor tried to square the circle by describing the retirement plan industry as “oligopolist” and “cartel-like,” and claiming that “industry norms are not enough to safeguard against breaches of loyalty,” but the paradox remained.
This mishmash of a ruling is par for the course with O’Connor. The judge became famous in the 2010s for habitually ruling that the Affordable Care Act was unconstitutional. In 2018, he ruled that the entire law was unconstitutional because a Republican-led Congress had zeroed out the individual mandate’s penalty. The decision was widely condemned as lawless, even by some of the ACA’s critics. In 2021, the Supreme Court nixed the lawsuit on standing grounds in a 7–2 ruling, with even Justice Clarence Thomas voting to uphold the ACA. More recently, O’Connor butchered the Indian Child Welfare Act through a series of profound misreadings of Indian law and precedent, again leading to a 7–2 reversal by the justices.
O’Connor is also widely seen as an extremely friendly judge to conservative legal interests. Right-wing plaintiffs routinely file lawsuits in his division in hopes of getting them assigned to him. Elon Musk, the far-right CEO of X, updated the company’s terms of service last fall to require that any user lawsuit brought against X be filed in O’Connor’s division in Texas, even though the company is headquartered in California. It is unsurprising that the plaintiffs chose his court to file an anti-ESG lawsuit in, or that he might be interested in enforcing right-wing policy goals.
Last December, for example, O’Connor threw out a proposed plea deal between the Justice Department and Boeing over its 737 MAX crashes because of a provision that would have required a federal monitor to be selected “in keeping with the [Justice] Department’s commitment to diversity and inclusion.” The judge claimed that “the parties’ DEI efforts only serve to undermine this confidence in the government and Boeing’s ethics and anti-fraud efforts.”
The Supreme Court is already hearing two cases this term derived from O’Connor’s trial-court rulings. In one of them, Garland v. VanDerStok, the justices appeared poised to uphold a ghost-gun regulation that the judge had previously struck down. And the court agreed last week to review the lower court rulings in Becerra v. Braidwood Management Inc. In that case, O’Connor struck down an ACA mandate that required companies to provide coverage for preventative-care services, siding with a group of Texas employers who wanted to deny coverage for anti-HIV medications for their workers on religious grounds.
If neither the Fifth Circuit Court of Appeals nor the high court reverses O’Connor in the American Airlines case, it could potentially reshape how the 401(k) management industry considers risks when making investments in general, as well as severely damage ESG efforts in particular. More litigation will follow, as well as potential financial hits to major American companies themselves—O’Connor has yet to rule on the penalty for American Airlines in this case. It is usually hard to predict whether the Supreme Court will take up a particular case at this stage in the proceedings. With O’Connor, however, we can assume that the court’s intervention is more likely than not.
