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October 01, 2004
Fiduciary Duty, Undivided Loyalty, and Socially Responsible Investment Performance
    by William Baue

Does the principle of undivided loyalty preclude fiduciaries from practicing SRI, or will competitive SRI financial performance shift the definition of fiduciary Duty? Part one of a two-part article.

In July 2004, the American Enterprise Institute (AEI) convened a conference entitled "Socially Responsible" Investing and Pension Funds: Welcome Reform or Fiduciary Nightmare?. The quotation marks around SRI indicate a degree of cynicism for this form of investing on the part of AEI, a conservative public policy think tank. Interestingly, the panel on SRI and pension fund issues generated general agreement from either side of the SRI divide.

Peter Kinder, founding president of the SRI research firm KLD Research & Analytics, unsurprisingly argues that trustees will increasingly take up SRI, due to a fundamental shift in the concept of fiduciary duty. Charles Rounds, a Suffolk University Law School professor who counts himself amongst "those of us who look upon social investing with a jaundiced eye," surprisingly agrees that pension fund uptake of SRI will increase--though he laments this development.

Beneath this begrudging agreement, however, brews a controversy over the history and interpretation of fiduciary duty when it comes to social and environmental considerations.

Prof. Rounds bases his argument on an elemental charge of fiduciaries to act "solely in the interest of the beneficiary," which is characterized in legal vernacular as "undivided loyalty."

"Social investing is a precarious investment philosophy that cannot help but reflect the personal, financial, social, and/or political predilections of the investor," writes Prof. Rounds in the paper he prepared for the conference. "Human nature being what it is, trustees will always be tempted to practice social investing in derogation of their fiduciary duty of undivided loyalty."

Prof. Rounds argues that such nonfinancial considerations necessarily divide fiduciaries' loyalty to the financial interests of their beneficiaries. The financial performance of SRI (which he assumes will "sacrifice returns," though he allows for the possibility of SRI neutral or even outperformance) is "legally irrelevant" according to Prof. Rounds, as the loyalty line has already been crossed. He invokes the image of trustees advancing goals not just from the left side of the political divide but also from the right to support his call for trustees' decision-making to be driven by pure, undivided loyalty to beneficiaries' financial best interests.

However, Prof. Rounds admits that federal and state law does not provide recourse against public pension or charitable fund trustees that practice what he characterizes as "abusive social investing," hence his belief in the "inevitable" rise of SRI.

The prevailing argument against this position from the SRI community debunks the notion that social and environmental issues are disconnected from financial issues, in which case taking the former into consideration would not divide fiduciaries' loyalty.

For example, Steve Viederman, founding director of the Initiative for Fiduciary Responsibility (IFR), describes "New Directions in Fiduciary Responsibility" in a January 2004 Journal of Practical Estate Planning article by this title.

"Fiduciary responsibility for the 21st century must require consideration of the social, environmental, political, and cultural effects of investments, both positive and negative, over the short and long term as a fundamental part of the investment process," Mr. Viederman writes. "This is a financial issue--one that identifies risks and opportunities not captured by conventional financial analysis."

Matthew Kiernan, CEO of SRI research firm Innovest Strategic Value Advisors, argues against the "seriously mistaken assumptions" of SRI underperformance. In a book chapter entitled "Sustainable Governance: the 'Sustainability' and Corporate Governance Agendas Converge," he cites empirical evidence of SRI outperformance from QED International, WestLB Panmure, UBS Warburg, and Bank Sarasin.

"Indeed, the fiduciary/governance equation is now effectively being turned on its head: given the demonstrable impacts of sustainability performance on companies' risk/return profiles, fiduciaries are increasingly viewed as derelict in their responsibilities if they do not take them into account," Dr. Kiernan writes.

While it is difficult to imagine beneficiaries challenging trustees for increasing returns with SRI, it is unclear from a legal perspective whether Prof. Rounds' interpretation of undivided loyalty would preclude consideration of the financial impact of social and environmental issues.

Interestingly, Mr. Kinder takes a distinctly different tack from his fellow SRI proponents. Instead of asserting social and environmental issues as financially relevant (though he does consider them so), he asserts them as relevant to undivided fiduciary duty in their own right. His supporting evidence? Proxy voting, which encompasses both fiduciary duty and social and environmental issues, exposing the structural bridge uniting these two realms that Prof. Rounds would keep divided.

Part two of this article discusses how mandatory mutual fund proxy voting disclosure may shift the definition of fiduciary duty.


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