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Responsible Investment Forum with Steve Schueth

The conventional definition of fiduciary duty has often excluded socially responsible investing -- until now. By Steve Schueth

Long-term investment returns are driven primarily by the performance of innovative, well-managed companies that are themselves dependent on the health of ecological systems and human societies. Institutional investors such as pension funds and university endowments are controlled by investment fiduciaries -- elected or appointed officials who supervise those who have direct control of the organization's investment assets.

The conventional definition of fiduciary duty has often excluded socially responsible investing -- until now. On the face of it, a fiduciary's primary duty is "to maximize returns," but the courts do not necessarily agree. All investments carry some risk of loss beyond the control of the investment manager, so a purely return-based standard is unreasonable. Since 1830, the courts have relied on some version of the "prudent man rule" which says that investment fiduciaries should govern affairs according to the prevailing standard of "how men of prudence, discretion, and intelligence manage their own affairs." As risks and markets have changed over the years, and as new investment strategies and more sophisticated research techniques have been developed, the common understanding of how a "prudent man" might act is evolving.




Another SRI Myth Busted

One of the world's largest law firms, London-based Freshfield Bruckhaus Deringer, has issued a detailed report that is redefining fiduciary duty. It's big news in the staid world of pension funds: Trustees have a fiduciary duty to consider environmental, social, and governance (ESG) issues in their investment decision-making.

"The links between ESG factors and financial performance are increasingly being recognized. On that basis, integrating ESG considerations into an investment analysis is clearly permissible and is arguably required in all jurisdictions," the report said.

A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment (PDF) was written by Freshfields partner Paul Watchman and published by the United Nations Environmental Program Finance Initiative. The UNEP had asked Freshfields to determine whether the integration of ESG issues into investment policy is "voluntarily permitted, legally required or hampered by law and regulation," in seven major jurisdictions -- the U.S., the U.K., Germany, France, Italy, Spain, and Japan. Freshfields also looked at Australia and Canada.

"The surveyed countries represent two distinct legal traditions: the Anglo-American common law system and the Roman-French civil law system,” Noted Peter Kinder of KLD Research & Analytics. “Nonetheless, Freshfields found all permitted consideration of ESG issues."

In most jurisdictions, the laws provide wide discretion on the part of fiduciaries to consider ESG factors in management of investment portfolios for the beneficiaries of pension funds and foundation endowments. "A number of the perceived limitations on investment decision-making are illusory," said Watchman.

Jim Hawley, co-director with Andrew Williams of the Center for the Study of Fiduciary Capitalism at St. Mary's College of California and co-author with Prof. Williams of The Rise of Fiduciary Capitalism, speaks in superlatives about the report's importance.

"The report is extraordinarily significant for a number of reasons. First, it essentially flip-flops the conventional wisdom on fiduciary duty, completely turning it on its head," Prof. Hawley said. "Second, the fact this report was prepared by Freshfields -- the third largest law firm in the world, well known as a corporate fiduciary firm -- carries huge clout."

According to University of Illinois College of Law Professor Cynthia Williams, "the Freshfields analysis confirms something many people, myself included, have been saying: not only it is permissible to consider ESG factors, but fiduciary duty requires that they be considered where there is the potential for material, financial impact from those factors.”

UNEP Executive Director Klaus Topfer commented, "As the world's largest pension schemes...and foundations adjust, this will set in train a new dynamic along the investment chain. When these large institutional investors move on ESG issues, the broader market will listen and react."

While the report represents a coup for fiduciaries who already rejected conventional wisdom, it remains to be seen how the broader community of fiduciaries will receive the report.

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Steven J. Schueth is president of First Affirmative Financial Network, LLC. An independent investment advisory firm registered with the SEC. First Affirmative provides asset management and consulting services to socially conscious individual and institutional investors nationwide. He is a former director and president of the Social Investment Forum.

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