October 05, 2004
Disclosure: How SEC Proxy Voting Rules May Shift the Definition of Fiduciary Duty
by William Baue
Will mandatory disclosure of mutual fund proxy voting records drive change in the general
definition of fiduciary duty, or will the principle of undivided loyalty prevent this development?
Part two of a two-part article.
Part one of
this article discusses Suffolk University Law Professor Charles Rounds' opinion that the principle
of a fiduciary's "undivided loyalty" precludes pension fund trustees from considering social and
environmental issues. It also surveys the opinion most commonly voiced from the socially
responsible investment (SRI) community that social and environmental issues impact financial
performance, and hence the definition of fiduciary duty must expand to encompass these issues.
Part two of this article explores the different tack Peter Kinder takes in arguing that
the definition of fiduciary duty is changing to encompass social and environmental issues.
In his paper Mr. Kinder,
the founding president of the SRI research firm KLD
Research & Analytics, bases his argument on a definitional aspect of fiduciary duty, the
"prudent investor rule," which arose from an 1831 Massachusetts Supreme Court case. This rule
calls for "men of prudence, discretion, and intelligence" to invest with regard to "the permanent
disposition of their funds, considering the probable income, as well as the probable safety of the
capital to be invested." Mr. Kinder notes that a 1994 restatement of this rule omits both a
negative reference to speculative investing as well as the admonition to manage investments for the
long term--a foundational aspect of SRI.
However, instead of focusing on the financial
implications of social and environmental issues, Mr. Kinder discusses how a shift in mutual fund
fiduciary duty may change the landscape for pension fund fiduciary duty. He posits that the
January 2003 Securities and Exchange Commission (SEC) rules requiring mutual fund administrators to disclose their
proxy voting guidelines and records created "a new concept of fiduciary duty."
put, the SEC's redefinition of fiduciary duties as to equities will become the general rule"
despite the fact that "pension schemes are not subject to SEC jurisdiction," according to Mr.
"Trust lawyers, a notably conservative lot, will default to the most
stringent statement of fiduciary duty," Mr. Kinder explains in his presentation paper. "Its
simplicity will also appeal to them, as will its incorporation of important features of the . . .
'prudent investor rule.'"
More importantly, constituents' expectations will drive
cross-pollination of this new definition of fiduciary duty, according to Mr. Kinder: if the funds
in their retirement plans must disclose, why shouldn't their pension plans?, he asks. Of course it
remains to be seen whether this prediction comes true.
Focusing on proxy voting shines a
spotlight on an aspect of fiduciary duty that by definition encompasses social and environmental
considerations. According to Prof. Rounds, fiduciaries who consider nonfinancial social and
environmental issues necessarily divide their loyalty (because such issues are impossible to
separate from personal predilections, according to Prof. Rounds). If this is indeed the case, then
trustees contravene their fiduciary duty every time pension funds vote on social and environmental
shareowner resolutions, a very common occurrence.
Besides exposing this internal
contradiction in Prof. Rounds' argument, Mr. Kinder has appended additional discussion to his paper
since presenting it at the conference. In this appendix, Mr. Kinder chides Prof. Rounds for
failing to cite legal cases that support SRI in his 2004 treatise Loring A Trustee's
Handbook, which Prof. Rounds cites 13 times in his AEI paper (which similarly does not address
cases supporting SRI).
"If social investing has any place in the law of trusts, it is
incumbent upon the courts and the legislatures to create objective standards, i.e., to
define away this exception to the trustee's duty of undivided loyalty in a way that establishes
reasonable limits on a trustee's right to promote with the trust estate his own personal,
political, and social goals, or the personal, political, and social goals of third parties," Prof.
Rounds writes in his treatise.
Such standards do, in fact, exist, Mr. Kinder points out,
citing the 1998 Department of Labor (DOL)
advisory opinion allowing plans under the Employment Retirement Income Security Act (ERISA) to hold SRI
funds, among other legal cases and opinions. Prof. Rounds' treatise does not cite these cases.
Perhaps the most visible legal precedent supporting SRI is the 1989 Board of Trustees
v. Mayor of Baltimore City case, which upheld the right of the city council to require limited
divestment from companies doing business in apartheid South Africa.
"[W]e do not believe
that a trustee necessarily violates the duty of loyalty by considering the social consequences of
investment decisions," the court wrote in its decision.
The fact that Prof. Rounds acts as
if this case (and others supporting SRI) does not exist is not insignificant, as lawyers form their
opinions based on precedents cited in such treatises, and trustees in turn base their notions of
fiduciary duty on extant legal opinion. The proper evolution of fiduciary duty standards depends
upon the accurate reporting of related case law.