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Department Of Labor, Fiduciary Duty And The Future Of Environmental, Social & Corporate Governance

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Let’s talk about the U.S. Department of Labor’s (DOL) new proposed rules for public comment on proxy voting—and shareholder engagement—under the provisions of the Employee Retirement Security Act of 1974 (ERISA). It is, after all, a fitting topic in honor of Labor Day. 

The proposed rules are controversial because of their potential to impact the ways in which investment managers, trustees or plan managers (fiduciaries) deal with proxy voting matters, especially on investment decisions related to environmental, social and governance (ESG) factors. They are meant to clarify when ERISA fiduciaries need to vote, and provide that “fiduciaries must not vote in circumstances where plan assets would be expended on shareholder engagement … that [does] not have an economic impact on the plan….” 

Some commentators are upset with these new developments, arguing that the proposed rules are “unnecessary and represents a confused understanding of ESG and its role in mainstream investment analysis.” Especially since only a few weeks ago, the DOL also proposed new rules to limit ESG investing.

As usual, there’s not much agreement among academics, policy-makers and advocacy groups about how the money of hard-working laborers and retirees should be managed and invested. 

Let’s try to unpack this. 

What is a fiduciary? 

Typically, a fiduciary cautiously and prudently takes care of money—or other assets—for another person or a group of people. Fiduciary duty is imposed upon people or organizations in a position of trust. 

With regards to ERISA fiduciaries, who manage other people’s money, fiduciary duty ensures that they act solely in the interests of their investors (or beneficiaries) when making an investment decision, voting shares, engaging or otherwise exercising shareholder control rights. 

According to my amazing mentor, Professor Michal Frenkel, investors (or beneficiaries) depend on the fiduciaries because they “cannot acquire the knowledge and expertise necessary for all the services that all fiduciaries can, and do, offer.” In return, they reward fiduciaries for their services.

Under current US law, fiduciaries must act in a way that benefits their investors (or beneficiaries) financially, otherwise they are in a breach of their fiduciary duty. 

So, what’s the problem?

There is a lack of legal and economic clarity on whether incorporating ESG factors when making investment decisions or voting shares, for example, is allowed. 

There is tension due to the concern that a fiduciary’s use of ESG factors in the decision process, can be motivated by the fiduciary’s own sense of ethics or by a desire to obtain collateral benefits for third parties, and not for the benefit of the plan, which is a violate of her fiduciary duty. 

Traditionally, in common-law countries—including US, Canada, UK, Israel, Australia and South Africa—certain limits are placed on the discretion and decision-making powers of fiduciaries, in order to protect retail investors. 

However, around the world, there is a global movement towards “incorporating ESG standards into regulatory conceptions of fiduciary duty.”

Until recently, institutional investors in the U.S. were reluctant to embrace this new movement, reasoning that their fiduciary duty was limited to the maximization of shareholder values irrespective of environmental or social impacts, or broader governance issues. 

But things change and institutional investors are now under pressure to balance their traditional fiduciary duties in making investment decisions with taking ESG factors into account.

These days, perhaps due to social pressure by millennial—or perhaps due to growing evidence that ESG issues have financial implication— the tides have shifted.

ESG integration is increasingly perceived as part of their fiduciary duty. Many institutional investors have already started incorporating analysis of ESG issues into their investment analysis and decision-making processes. 

Some prominent U.S. scholars also maintain that prudent investors should consider ESG factors when making investment decision or voting shares. 

More on ESG 

But, investment in ESG also depends on the political climate. Depending on the election results and the type of administration, the treatment of these sort of investment decision and boundaries of fiduciary duty can vary. If you are interested in finding out more about this, click on this link for a blog by my friend Professor Ann Lipton

If you are interested in finding out more about the literature on the importance and value of proxy voting, check out the following pieces, by my friends (I have several). 

Professors Yaron Nili and Kobi Kastiel outline in their new paper, Competing for Votes, that “competition over shareholder votes generates ex ante incentives for management to perform better, to disclose information to shareholders in advance, and to engage with large institutional investors.”

Second, Professor David Yermack makes the astute observation that “Activist institutions frequently state that their goal is not to improve the value of individual investment positions, but rather to create positive externalities by signaling optimal governance practices market-wide, potentially improving the value of the institutions’ other diversified investments.”

Again, I’m emphasizing that many institutional investors are already incorporating analysis of ESG issues into their investment analysis. The following is the latest development on this is from Jim Hamilton’s blog:

  • “The North American Securities Administrators Association (NASAA) has asked the Department of Labor to delay adopting its proposed fiduciary rulemaking until the agency can evaluate the effectiveness of the SEC’s Regulation Best Interest (Reg BI).” 

One thing is clear: fiduciaries will have to think hard about the boundaries of their fiduciary duties and about how to invest the funds that they control. Fiduciaries must act in a way that is reliable, honest, truthful, and without a conflict of interest.

It is hard to predict the future, but with regards to voting, it is plausible that ERISA fiduciaries may abstain more often than not on certain votes regarding ESG. It is also plausible that the matter will be brought to the attention of the Supreme Court.

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