The John M. Olin Center

Paper Abstract

971. Max M. Schanzenbach & Robert H. Sitkoff, Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee, 03/2020; published in Stanford Law Review, Vol. 72 (2020).

Abstract: 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. Under the “sole interest rule” of trust fiduciary law, however, 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, we examine the law and economics of ESG investing by a trustee. We differentiate “collateral benefits” ESG from “risk-return” ESG. We show that ESG investing is permissible under 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 conclude that applying the sole interest rule (as tempered by beneficiary or settlor authorization as well as by the capaciousness of charitable purposes) to ESG investing is normatively sound.

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