Article

Reconciling Fiduciary Duty and Social Conscience

The Law and Economics of ESG Investing by a Trustee

Trustees of pensions, charities, and personal trusts invest tens of trillions of dollars of other people’s money subject to a sacred trust known in the law as fiduciary duty. Recently, these trustees have come under increasing pressure to use environmental, social, and governance (ESG) factors in making investment decisions. ESG investing is common among investors of all stripes, but many trustees have resisted its use on the grounds that doing so may violate the fiduciary duty of loyalty. Under the “sole interest rule” of trust fiduciary law, a trustee must consider only the interests of the beneficiary. Accordingly, a trustee’s use of ESG factors, if motivated by the trustee’s own sense of ethics or to obtain collateral benefits for third parties, violates the duty of loyalty. On the other hand, some academics and investment professionals have argued that ESG investing can provide superior risk-adjusted returns. On this basis, some have even argued that ESG investing is required by the fiduciary duty of prudence. Against this backdrop of uncertainty, this Article examines the law and economics of ESG investing by a trustee. We differentiate “collateral benefits” ESG from “risk-return” ESG, and we provide a balanced assessment of the theory and evidence about the possibility of persistent, enhanced returns from risk-return ESG.

We show that ESG investing is permissible under American trust fiduciary law if two conditions are satisfied: (1) the trustee reasonably concludes that ESG investing will benefit the beneficiary directly by improving risk-adjusted return; and (2) the trustee’s exclusive motive for ESG investing is to obtain this direct benefit. In light of the current theory and evidence on ESG investing, we accept that these conditions could be satisfied under the right circumstances, but we reject the claim that the duty of prudence either does or should require trustees to use ESG factors. We also consider how the duty of loyalty should apply to ESG investing by a trustee if such investing is authorized by the terms of a trust or the beneficiaries, or is consistent with a charity’s purpose, clarifying with an analogy to whether a distribution would be permissible under similar circumstances. We conclude that applying the sole interest rule (as tempered by authorization and charitable purpose) to ESG investing is normatively sound.

* Max M. Schanzenbach is the Seigle Family Professor of Law, Northwestern University. Robert H. Sitkoff is the John L. Gray Professor of Law, Harvard University.

The authors thank Cliff Asness, Lucian Bebchuk, Tom Brennan, John Campbell, Einer Elhauge, Melanie Fein, Allen Ferrell, Ronald Gilson, Jeffrey Gordon, Oliver Hart, J.B. Heaton, Howell Jackson, Kim Kamin, Louis Kaplow, John Langbein, Alex Lee, Eugene Maloney, James Marion, Dylan Minor, John Morley, Dana Muir, Donald Myers, Mark Ramseyer, Michael Richman, Edward Rock, Mark Roe, Steve Shavell, Holger Spamann, Kathy Spier, Matthew Stephenson; and workshop participants at Bank of America, Bessemer Trust, Greenwich Roundtable, Northwestern, Harvard, the 2019 Delaware Trust Conference, the Symposium on ESG Investing and Stewardship: Risk-Return, Conscience, and Fiduciary Duty (2019), the Ninth Annual Employee Benefits & Social Insurance Conference at Boston College (2019), the 2018 Trust and Wealth Executive Seminar sponsored by the Trust Management Association, the 2018 ESG and Investors conference at NYU, and the 2018 Fiduciary Law Workshop at Washington University for helpful comments and suggestions; and Alex King, Jeannette Leopold, James Mulhern, Joseph Ruckert, Erin Thomas, and Catherine Wiener for superb research assistance.

This Article draws on the authors’ work in a consulting engagement with Federated Investors, Inc. In accordance with Harvard Law School policy, Sitkoff discloses certain outside activities, one or more of which may relate to the subject matter of this paper, at https://perma.cc/FDB4-B937.