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