United States: Fiduciary Duty And ESG Engagement

US institutional investors are governed by legal standards like those contained in the Employee Retirement and Income Security Act (ERISA) and similar laws that are relevant to their engagement with companies. However, these statutory fiduciary duties are also supplemented by a body of case law that governs trustees generally. The US Supreme Court has confirmed that Congress's intent was to incorporate trust law into ERISA when it was enacted. "Rather than explicitly enumerating all of the powers and duties of trustees and other fiduciaries, Congress invoked the common law of trusts to define the general scope of their authority and responsibility." Central States v. Central Transport, 472 US 559 (1985)

The law of trusts contains several well-established concepts that are particularly relevant for today's fiduciaries as they seek to engage with issuers:

  • Duty of Impartiality: The duty of loyalty includes an obligation to identify and fairly balance conflicting interests of different beneficiary groups, including those of younger and older generations.9 This makes short-term earnings, long-term wealth creation and risk exposures over both time frames equally important for long-term investors. The US Supreme Court confirmed that the duty of impartiality applies to ERISA: "The common law of trusts recognizes the need to preserve assets to satisfy future, as well as present, claims and require a trustee to take impartial account of the interests of all beneficiaries." Varity v. Howe, 516 US 489 (1996)
  • Standards of Prudence Evolve: Understanding of fiduciary duty has been relatively stable for a generation. However, fiduciary principles are dynamic concepts that evolve over time in response to advances in knowledge and changes in circumstances. For example, a generation ago, pension fiduciaries were generally precluded from trading in stock because it was seen as an imprudent investment.10 Today, with the unprecedented growth of institutional investor assets and their collective economic impact, and the greater appreciation of shortcomings in prevailing investment theories that became evident during the recent financial crisis, understanding of fiduciary principles is once again in flux.11 "Trust investment law should reflect and accommodate current knowledge and concepts. It should avoid repeating the mistake of freezing its rules against future learning and development." Restatement of Trusts (Third) §227, Introduction (1992)

These trust law principles present a challenge for 21st century fiduciaries. Investment practices that foster intergenerational transfers of risk and wealth raise duty of impartiality concerns for long-term investors. Changes in understanding of systemic risk, and related investment management practices among global peers, demonstrate an ongoing evolution in the prudence standards against which the conduct of fiduciaries is judged. "As a long-term investor, CalPERS must consider risk factors, for example climate change and natural resource availability, that emerge slowly over long time periods, but could have a material impact on company or portfolio returns." Investment Belief 9-B of the California Public Employees' Retirement System (2013)

After a year-long study of fiduciary duty in the UK, a country with which the US shares the common law of trusts, the Law Commission concluded, "There is general agreement that wider investment factors may be considered, but concern that pension trustees may continue to receive risk-averse legal advice on the issue. We hope we can finally remove any misconceptions on this issue: there is no impediment to trustees taking account of environmental, social or governance factors where they are, or may be, financially material." UK Law Commission, Fiduciary Duties of Investment Intermediaries, §6.28, 6.29 (June 2014)

Indeed, the duties of loyalty and impartiality require that "conduct in administering a trust cannot be influenced by a trustee's personal favoritism...nor is it permissible for a trustee to ignore the interests of some beneficiaries merely as a result of oversight or neglect." Restatement of Trusts (Third) §79, Comment (b) (1992)

Most trustees are tasked with balancing risk and return across generations in an impartial manner that reflects evolving standards of care. Those who proactively integrate consideration of the material, long-term effects of environmental, social and governance factors into their investment and risk management process will be in the best position to demonstrate future compliance with fiduciary obligations. "As a fiduciary that invests on behalf of its clients, we have a responsibility—and exercise our right—to monitor and engage with the boards and management of our portfolio companies on matters concerning shareholders' long-term interests and the good of the market as a whole." Leadership in Responsible Investing, TIAA-CREF (2013 Report)

Primary Legal Duties For ERISA Fiduciaries Include:

1.The duty of loyalty, which requires the discharge of responsibilities:

a.solely in the interest of fund beneficiaries and

b.for the exclusive purpose of providing benefits

2. The duty of prudence, which expects adherence to the standard of care, skill, prudence and diligence that a prudent expert would exercise at a comparable entity under similar circumstances12


9 www.reinhartlaw.com/Publications/Documents/art111020%20RIIS.pdf

10 www.law.harvard.edu/programs/olin_center/papers/pdf/Schanzenbach_Sitkoff_580.pdf

11 www.cfapubs.org/doi/pdf/10.2469/faj.v70.n3.1

12 www.law.cornell.edu/uscode/text/29/1104

Previously published in 21st Century Engagement

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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