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November 03, 2005
Fiduciary Duty Redefined to Allow (and Sometimes Require) Environmental, Social and Governance Considerations
    by William Baue

A report commissioned by UNEP FI and prepared by Freshfields attorneys dispels the persistent myth that laws prevent fiduciaries from considering environmental, social, and governance issues.

The longstanding conventional wisdom that fiduciary duty precludes environmental, social, or governance (ESG) considerations in institutional investment decisions was overturned by a report released at the United Nations Environment Programme Finance Initiative (UNEP FI) Global Roundtable last week. The report, entitled A legal framework for the integration of environmental, social and governance issues into institutional investment, was conducted pro bono by Freshfields Bruckhaus Deringer, a London-based global law firm.

"A number of the perceived limitations on investment decision-making are illusory," said Paul Watchman, a Freshfields partner and lead author of the report. "Far from preventing the integration of ESG considerations, the law clearly permits and, in certain circumstances, requires that this be done."

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 told "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."

The UNEP FI Asset Management Working Group (AMWG), a group of 13 asset managers including ABN AMRO, BNP Paribas, Calvert Group, Citigroup, Groupama, Insight, Nikko, and Sanpaolo IMI, commissioned the150 page report to answer a specific set of questions. Namely, are ESG considerations "voluntarily permitted, legally required, or hampered by law and regulations" by public and private pension funds primarily and insurance company reserves and mutual funds secondarily. The report analyzes this question in a number of regions, including those bound by "common law" (US, UK, Australia, and Canada) where case law allows for a degree of flexibility of interpretation, as well as those bound by "civil law" (France, Germany, Italy, Spain, and Japan) where rules are "frozen in codes and often rigid doctrine."

"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," University of Illinois College of Law Professor Cynthia Williams told "Thus, the impacts of climate change and how to mitigate them would be something that trustees and other fiduciaries really must consider, since the physical risks from climate change, and the regulatory and legal risks, portend serious financial impacts in addition to social impacts, health, welfare, and other impacts."

While the conventional wisdom has long been disputed by some fiduciary duty experts, support for them from the legal profession has been spotty. One of the few instances of support was a November 2000 paper by Baker & McKenzie, one of the largest US law firms, commissioned by the California County Employee Retirement System, which opined that state law allows fiduciaries to consider ESG issues if they maximize returns.

The Freshfields report takes a much bolder stance while also advancing a more nuanced approach to profit maximization.

"[T]here is no duty to 'maximize' the return of individual investments, but instead a duty to implement an overall investment strategy that is rational and appropriate to the fund," states the report.

"It's not clear to me what the implication of the Freshfields report is regarding maximizing individual returns, as its stance has a number of possible implications--it may be that maximizing a particular firm or sector, you're minimizing another firm or sector," said Prof. Hawley. "The report never fleshes this out, so it will be interesting to see if Freshfields or others pursue this point."

"Also, the report raises the question of 'interest,' in that fiduciary obligation must be in the interests of beneficiaries, but does that mean immediate financial interests, or broader, longer-term interests?" asked Prof. Hawley. "If what you do now is very likely to create a world 30 years from now that's far more polluted, is that in beneficiaries' best interest or not?"

The report leaves this question unanswered, noting only that there are different interpretations of the term "interest," both legally and in different jurisdictions--in some cases, the term is totally ambiguous, according to the report.

While the report represents a coup for fiduciaries who already rejected conventional wisdom, such as the California Public Employees Retirement System (CalPERS) and TIAA-CREF, it remains to be seen how the broader community of fiduciaries will receive the report.

"I think what fiduciaries need to do is take a close hard look at what their practices are and recognize at the very least that there are varying expert opinions on what their obligations are," said Prof. Hawley. "When fiduciary lawyers say 'you can't do anything around ESG issues,' fiduciaries can cite the Freshfields opinion and say, 'wait a minute, now we're also being told it's a breach not to do due diligence on ESG issues.'"

"We need to at least open this conversation up, and I think that's what's going to happen," he added "We'll see a range of action--as well as inaction."


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