Between a Rock and a Hard Place: Fiduciary Duty and Investment Concerns

October 27, 2022

It seems as though Environmental, Social and Governance investing is on the forefront of everyone’s mind these days. News stories on the topic abound, with politicians of every stripe propounding their positions. A recent opinion piece in one national newspaper pronounced that trustees who engaged in Environmental, Social and Governance investing were clearly violating their fiduciary duty, while an op-ed in a competing news outlet claimed that those who ignored Environmental, Social and Governance investing were most certainly in violation of their fiduciary duty. What is a prudent fiduciary supposed to do in these polarized times?

Language Matters—Define the Terms

Critical to the analysis of fiduciary duty and Environmental, Social and Governance investing is an understanding of exactly what Environmental, Social and Governance investing actually means. One of the greatest difficulties in this area is a lack of clarity over Environmental, Social and Governance investing terminology, as Environmental, Social and Governance investing is not clearly defined and can mean different things to different investors. As set forth by State Street Global Advisors, different Environmental, Social and Governance investing strategies include: “exclusionary screening” (excluding certain companies, sectors or countries from the universe of possible investments); “positive screening” (affirmatively tilting the portfolio toward certain companies based on Environmental, Social and Governance investing metrics—note that the appropriateness of the metrics themselves has been hotly debated); “impact investing” (targeting a measurable positive social or governance impact, usually project specific); “active ownership” (engaging with companies on a variety of issues to initiate changes in company policies, practices and behaviors), and “ESG integration” (consideration of factors in order to achieve higher returns and/or mitigate risk). As these strategies differ widely, analyzing the application of fiduciary duty in each of these strategies may likewise be different.

Back to Basics

The fundamental starting point for any prudent pension system fiduciary facing a difficult situation is to return to the fundamental elements that underlie fiduciary duty. Fiduciary duties have been called “the highest known to the law.” Key to beginning an analysis is the exclusive benefit rule, which provides that investments shall be for the exclusive benefit of the participants and beneficiaries of the system and therefore fiduciaries must act solely in the interests of the members and beneficiaries of the system. This common law rule is codified in the enabling legislation that governs most public pension plans. Moreover, the Internal Revenue Code (“IRC”) provides that no part of the corpus or income of the pension trust may be used for or diverted to purposes other than for the exclusive benefit of the employees or their beneficiaries. This is critically important since public pension plans must remain “qualified plans” in order to entitle their members and beneficiaries to tax exemptions.

Closely related to the exclusive benefit rule and central to every statement of fiduciary duty is the fiduciary duty of loyalty, which provides that trustees must act solely in the interest of members and beneficiaries without regard to the interest of any other person. The trustee owes a duty to the beneficiary to administer the trust solely in the interest of the beneficiary and may not be guided by the interests of any other parties or person. The duty of loyalty is strictly construed in law and the U.S. Supreme Court has stated that the duty to trust beneficiaries must overcome any loyalty to the interests of the party that appointed the trustee. This is sometimes called the “one hat rule,” requiring that while trustees may also have a “day job”—as an elected official, an employee of an employer who pays into the system, or an officer of a union whose members belong to the system, for example—when making decisions as a trustee of the retirement system they may only wear their fiduciary trustee “hat.” This means that trustees of public retirement systems are not fiduciaries for appointing authorities, employers who pay into the systems, employees, unions, constituents, taxpayers, the public—or anyone other than the members and beneficiaries.

One Size Does Not Fit All—And May Not Fit Forever

Public pension plans come in a variety of sizes and shapes and each plan is different. Funding levels, for example, may vary dramatically, as may pension obligations. When setting the strategic asset allocation for the pension plan, which is often referred to as one of the most important functions of a trustee, trustees consider the plan’s funding levels and pension obligations and the plan’s risk tolerance and diversification of the investment portfolio. When making investment decisions, the fiduciary duties of prudence and care require consideration of the prevailing circumstances—meaning that investment action that is prudent for one investor may not be prudent for another.

Moreover, since fiduciaries must consider the prevailing circumstances, what is prudent at one time may not be prudent at a later time. This means that fiduciary duty is dynamic—i.e., while the fundamental fiduciary duties are based on legal principles that do not change, the application of those principles cannot be static, since fiduciaries must take into consideration current circumstances.


Applying this analysis, we see that not every type of Environmental, Social and Governance investing may be appropriate in every case. Prudent fiduciaries must keep the interest of the plan participants and beneficiaries paramount, and may not permit the use of the corpus or income of the pension trust in violation of the exclusive benefit rule, thereby risking disqualification under the IRC. They may not sacrifice investment returns and take on additional risk to promote interests unrelated to the portfolio’s objectives.

But prudent fiduciaries cannot ignore Environmental, Social and Governance investing factors that influence the performance of investments and are material to long-term returns and levels of risk. It cannot be impermissible for trustees to consider the state of the world in applying fundamental fiduciary principles to fulfill their obligations to members and beneficiaries, since they are seeking to preserve the assets for future generations of members and beneficiaries. Indeed, that is what trustees do when exercising their fiduciary responsibilities: they gather facts about prevailing circumstances and potential investment vehicles to make well informed decisions. Decisions made in 2022 are not the same as those that might have been made in 1972. The world has changed, and circumstances are different. Factors affecting the long-term considerations that public pension trustees must weigh are different. If responsible, informed decision making were static, there would be little need for trustees or the rules guiding their decision making. Fiduciaries must gather facts, analyze and assess those facts, and make decisions based on all relevant facts. It is impossible to invest prudently, loyally, and carefully without considering the impact of factors—including environmental, social, governance, cultural, economic, and political factors—that influence the performance of investments and are material to long-term risk and return. It’s a classic approach that has served pension funds and their beneficiaries well for a very long time—and should serve them for a very long time to come.