There’s much to be welcomed in the Law Commission’s recently-published consultation paper on investors’ fiduciary duties. It confirms that fiduciary investors’ duty to protect beneficiaries’ financial interests is not a matter of mechanically maximising performance on a quarterly basis, but a question of subjective judgement in which a broad range of factors are relevant. It suggests that fiduciaries may legitimately oppose company activity which creates harmful externalities for their portfolios as a whole – such as exploration for unconventional fossil fuels – even if it is profitable for the company concerned. And it states that fiduciaries can have regard to purely non-financial factors, such as beneficiaries’ quality of life or their ethical views, as long as they do not compromise the primary objective of securing a pension. But as the responsible investment community begins to digest the paper and debate its substance, it’s important not to lose sight of the reason this review was commissioned in the first place. The Kay Review recommended that a review was needed to “address uncertainties and misunderstandings on the part of trustees and their advisors”. Accordingly, the Law Commission was asked to look not just at the law as it stands, but at the law “as applied in practice”. The questions ‘what does the law say?’ and ‘what should the law say?’ will understandably be the focus of much attention and debate in the coming months. But just as important – and less fully dealt with in the consultation paper – are the questions ‘what dopeople think the law says?’ and ‘should the law be clarified?’ Worryingly, the Law Commission appears to have concluded that the problem it was tasked to solve does not exist. It suggests that fiduciary duties are not perceived as a key barrier to the consideration of wider factors, pointing the finger instead at accounting standards. On this basis, the paper asks the rather leading question, “Do consultees agree that the main pressures towards short-termism are not caused by the duty to invest in beneficiaries’ best interests?” Of course, no reasonable person could give an answer other than ‘yes’ to this question. But this answer misses the point. Firstly, neither John Kay nor ShareAction have ever claimed that fiduciary duty is the ‘main’ culprit when it comes to short-termism: we have merely concluded that a legal principle which should be part of the solution is too often part of the problem. Secondly, it would be strange indeed to put this problem down to ‘the duty to invest in beneficiaries’ best interests’ – on the contrary, this principle is the beating heart of fiduciary obligation which ShareAction’s 2011 report argued we must ‘rediscover’. The problem arises with the interpretation of the term ‘best interests’, which we concluded had become corrupted and misunderstood to the point where it was frequently invoked to justify behaviours which could actually harm beneficiaries’ interests. With a few minor exceptions, it is the prevailing interpretation of fiduciary duty, not the law itself, which we take issue
with. Anyone who works in responsible investment will surely know what we mean by this. From the large pension fund whose lawyers suggested their policy of voting all shares held might be unlawful because the benefit to the fund could not be monetised, to the trustee of a small fund who told me that thinking about stewardship was “very difficult, because we have a duty to maximise returns” – fiduciary duty comes up time and time again as a roadblock to more engaged and enlightened share ownership. I’m aware of at least one fund that sacked a fund manager for seeing the dotcom bubble coming and refusing to invest in overvalued tech stocks because his fund was under-performing and they feared it would be a breach of their fiduciary duties not to act. The notion of a ‘duty to maximise returns’ too easily morphs into the maxim that ‘if it can’t be monetised, it doesn’t count’ – even if ‘it’ might have enormous implications for beneficiaries’ pension pots or the economy and society in which they will spend them. The individual pension savers who ShareAction supports know this problem only too well. Fiduciary duty is routinely invoked to fob off members who raise legitimate and intelligent questions about their fund’s management of environmental and social risks. From tar sands in 2010 to the carbon bubble in 2013, every analysis we conduct of funds’ responses to member emails finds fiduciary duty given as a reason for inaction by some funds. In our soon-to-be-published analysis of responses to recent emails on climate change, 25% of funds referenced fiduciary duty – half as a reason to acton climate change, the other half as a reason to ignore it. There could scarcely be a better illustration of the confusion that continues to reign on this issue. And when it comes to purely ethical investment, the waters are even muddier. Savers who raise ethical concerns are routinely told that the fund is legally prohibited from taking ethics into account – a claim which is at odds with the Law Commission’s own conclusions on this issue.
So what is the solution? ShareAction has long argued that only legislative clarification will finally lay this issue to rest and end the prevailing ‘lowest common denominator’ approach to fiduciary duties. In our experience (and according to the evidence received by the Kay Review), this problem cannot simply be blamed on ill-informed trustees, but stems directly from the legal advice trustees receive. And if we want to change the legal advice, we must clarify the law. Although lawyers will take note of the Law Commission’s conclusions, they do not in and of themselves carry formal legal status. For that reason, we will continue to argue for statutory clarification along the lines advocated in our 2012 report ‘The Enlightened Shareholder’. This would confirm that trustees may have regard to a range of factors – such as ESG considerations, systemic risks, their beneficiaries’ quality of life and their beneficiaries’ ethical views – provided that this does not compromise beneficiaries’ financial interests. (For pension fund trustees, this could be achieved by amending the investment regulations.) It would be permissive, rather than prescriptive: this is not about attempting to reform the pensions
industry by regulatory fiat. It is about removing a perceived roadblock for those who want to take a more enlightened approach, and a convenient smokescreen for those who do not. The Law Commission’s consultation paper is cautious about such measures, arguing that judge-made law is inherently more flexible than statute, and that “it is worth preserving this flexibility, even if the result is some uncertainty”. This may be the case in theory, but in practice the current situation offers neither flexibility nor certainty. Concerns that the law is ambiguous result in cautious legal advice and a perception that it is ‘safer’ to adhere rigidly to received wisdom, almost regardless of outcomes for beneficiaries. Permissive clarification would enhance, not restrict, the flexibility open to trustees, whilst ensuring they remained focussed firmly on their beneficiaries’ interests. Nor would this inhibit the future evolution of the law. There is a reason why the case of Cowan v Scargill casts such a long shadow: it is because there havebeen virtually no other cases on point before or since. The most recent was that of Martin v City of Edinburgh District Council in 1988. In the 25 years since that case, I can count at least five Pensions Acts (in 1993, 1995, 2004, 2008 and 2011), with another on the way, not to mention countless updates to regulations. The idea that the common law is more flexible and adaptable than legislation in this area simply does not stand up to serious scrutiny. This area of law is stagnating, failing to keep pace with evolving best practice and emerging risks to pension savers’ interests. The present review offers a golden opportunity to finally lay to rest a tired debate that has held back responsible and sustainable investment for decades. For the sake of millions of pension savers whose future depends on the pensions system’s ability to face up to complex challenges like climate change, we cannot afford to continue rehearsing these debates. We owe it to them to ensure that the opportunity is not lost.
Tomorrow: the Law Commission has its say