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On May 18, 2015, the U.S. Supreme Court held that trustees have a fiduciary duty, emanating from trust law, to timely and continually monitor fund investments and to remove imprudent ones. The duty to monitor, the unanimous court held, is present in addition to their duty to exercise prudence in the initial selection of investments. Further, the court found that breaches of fiduciary duty may occur when investment fees are not properly considered. See Tibble v. Edison International
The simple language of this case provides a powerful opening for responsible investment advocates. To take just one concrete example, the effects of climate change on investments and on society was not an issue when many holdings were purchased. Today it is. Thus, trustees must consider what effect climate change has on their investments now, not what effect it had at some time in the past when fund investments were initially purchased. A failure to do so may constitute a breach of fiduciary duty.
In the case, the claimants argued that the trustees of the Edison International defined contribution pension plan “acted imprudently by offering six higher priced retail-class mutual funds as plan investments when materially identical lower priced institutional-class mutual funds were available.” The lower court dismissed this claim, applying ERISA’s six-year statute of limitations from the date the investments were initially offered in the plan. By finding this duty to monitor, however, the U.S. Supreme Court held that ERISA’s six-year statute started running whenever a failure to monitor occurred. ERISA, the Employee Retirement Income Security Act of 1974, covers trustees of private pension and benefit plans and is the template used by many public plans when considering their duties, making it is the most important law in the U.S. which speaks to fiduciary duty.
This short unanimous opinion should have wide reaching ramifications for trustees and for responsible investment in the United States, as fundamentally the question of what is a breach of fiduciary duty lies withthe judiciary not with opinions of fiduciary lawyers or well-meaning advocates. So, if supporters of responsible investment can carry the day on the importance of investors’ consideration of ESG factors, the failure of trustees to regularly monitor for these risks may constitute a breach of their fiduciary duty. For promoters of responsible investment, there are three important issues that emanate from the unanimous opinion.
First, the court affirms that trust law is the touchstone for analysis when trustee duties are considered. The court wrote that: “In determining the contours of an ERISA fiduciary’s duty, courts often must look to the law of trusts.” While this may seem like just so much legal gymnastics, the language of the opinion validates the responsible investment approach to fiduciary duty that emanates from trust law. See: “The Time Has Come for a Sustainable Theory of Fiduciary Duty in Investment,” Hofstra Labor and Employment Law Journal, Vol. 29, 115 – 139 (Winter 2011-2). Given the paucity of legal decisions interpreting ERISA duties as they might apply to responsible investment, the court’s reaffirmation of trust law is a boon. For many trustees and responsible investment advocates, pronouncements by fiduciary lawyers or their opinion of what the U.S. Department of Labor “might” do in interpreting ERISA have closed avenues. These lawyers, often called ‘Doctor No’s’ for constantly stopping trustees from considering ESG factors, seemed to draw their judgments like Mayan priests of old from some secret stash of knowledge, unavailable to commoners. With the affirmation that trust law is paramount, the hundreds of decisions of American courts on the meaning of fiduciary duty in trusts become relevant. The court itself cited several old cases, one which was issued in 1891. This will democratize the discussion in the boardroom. Second, the decision puts the onus back on trustees for investment decisions. Trustees who believe they can be “sleeping governors,” to use an Australian phrase, may be sadly mistaken in the future. Buoyed by the investment consulting industry and
previous lower court decisions which protect trustee decisions whenever they were vetted by a professional, trustees are often hesitant to follow their own common sense on questions such as climate risk or labor standards. The recent trend to outsource investment decisions has only made the situation worse. But now fiduciary duty must be seen as a personal duty for each trustee that cannot be delegated away.
Third, the court reaffirmed the axiom that “fees matter.” In the land of Wizard of Oz inhabited by many alternative investments and Internal Rate of Return calculators, trustees often choose higher cost investment options for reasons which smack of institutional corruption or worse. This decision will fuel the current plaintiff’s legal bar in the US which is sure to file more cases against trustees who do not choose low cost investment options for their funds, whatever the reason may be. Consultants and other service providers are sure to be properly drawn into the ensuing litigation.
Tibble has the possibility of being a game changer. Of course, as with all U.S. Supreme Court decisions, lawyers disagree as to meaning and divining future impact is difficult. But there are winners and losers, to be sure. The defined contribution industry is gnashing its teeth as to how Tibble will affect its business. Advocates of greater trustee board process and documentation are cheered, as are those who seek greater transparency. Lawyers who work for fund boards should be concerned as they mayfind themselves sued for malpractice if they do not advise their trustees to monitor investments, no matter the opinion of fund consultants or investment managers. For RI readers, complex ramifications lurk in the responsible investment arena as well. Many PRI signatories, for example, do not consider high fees an ESG issue. But now providers who peddle products with high fees and low returns may suffer, even if they market their offerings as ESG compliant. And, the burgeoning ESG ancillary service provider industry may find Tibble creates significant headwinds for the sale of pricey analysis. Further, for Tibble to be useful to the responsible investment community, advocates for responsible investment must prevail in the agora of financial ideas. For, if responsible investment is not a “special” argument, of much greater magnitude than the fads of smart beta, risk parity and the like, it probably does not need to be considered for trustees in periodic investment reviews. If it is truly a matter of compulsory consideration, however, a lack of attention to it can subject a trustee to legal liability.
For all the potential fall-out, there can be no question that the U.S. Supreme Court has ruled that trustees who are “asleep at the switch” when they consider their investments in the United States, do so at their own personal risk. For all those who believe that investing must be done in a responsible manner, with attention to what you own and what effect your investments have on society, this is an important and positive development.