[UPDATE: My colleague Prof. Stephen Bainbridge, who is a corporate law scholar, has more on the subject here; much worth reading.]
Excerpt from Notice 22-05 of the Kentucky Attorney General’s Office, issued a week ago:
Syllabus: “Stakeholder Capitalism” and “Environmental, Social and Governance” Investment Practices, Which Introduce Mixed Motivations into Investment Decisions, Are Inconsistent with Kentucky Law Governing Corporate Fiduciary Duties Investment Management to Kentucky Public Retirement Plans….
Some investment management companies are increasingly using money from public and state employee pension plans, i.e. other people’s money, to advance their own political agendas and force the social change. State Treasurer Allison Ball asks if these asset management practices comply with Kentucky law. For the reasons below, the Bureau is of the opinion that they are not….
For years, … the Commonwealth’s public pension schemes have hovered at seriously underfunded levels. According to the Kentucky Public Pension Authority’s latest annual report, the public pension plan for most state employees is about 17% funded…. And while public pension plans administered by the Kentucky Public Pension Authority have shown improved funding year-over-year, there are concerns that this trajectory could be threatened by extreme approaches to investment management, especially those that put ancillary interest before returns on investment. for the benefit of public pensioners and state employees.
One such approach is “stakeholder capitalism”. According to its advocates,[s]Shareholder capitalism is an expansion of corporate management loyalty beyond shareholders to include the workforce, supply chain, customers, communities, corporations and the environment. interests of their clients, civil servants and agents of the State.
To achieve this version of “capitalism”, investment management firms adopt “environmental, social and governance” or “ESG” investment practices. ESG investing is an “umbrella term that refers to an investment strategy that emphasizes a company’s governance structure or the environmental or social impacts of the company’s products or practices”.
American economist Milton Friedman once criticized an earlier version of this trend that one group of shareholders sought to convince another group of shareholders that corporations should have a “social conscience”. As he explained, “it’s really about certain shareholders trying to get other shareholders (or customers or employees) to contribute against their will to ‘social’ causes promoted by activists. To the extent that they succeed, they again tax and spend the proceeds.” Friedman found this problematic because “the great virtue of competitive private enterprise” is that it “forces people to be responsible for their own actions and makes it difficult for them to “exploit” other people for selfish or selfless ends. They can do good, but only at their own expense.”
Today, in a perhaps even more pernicious version of the trend, the debate is no longer left to shareholders. In fact, there is little or no debate. Investment managers in some corporate suites now use the assets they manage, i.e. other people’s money, to enforce their favored partisan sensibilities and seek desired societal and political change.
Asset management companies have publicly committed to coordinating joint actions for ESG purposes, such as reducing climate change. For example, the Glasgow Alliance for Net Zero (“GFANZ”) Steering Committee states: “The systemic change needed to alter the planet’s climate trajectory can only happen if the entire financial system makes ambitious commitments and translates these commitments into short-term actions. That’s why we formed [GFANZ]to bring together more than 450 leading financial firms united by a commitment to accelerate the decarbonization of the global economy. explicitly concedes a mixed motive, stating that its signatory investors believe that taking action “is consistent with their fiduciary duty essential to achieve the objectives of the Paris AgreementAs another suggestion of a political motive, some investment management firms have pledged both to defend government-imposed climate change mandates, and use their fiduciary role to prevent portfolio companies from arguing against such mandates.
Whether these ancillary purposes are beneficial to the corporation has nothing to do with the duty of fiduciaries. Trustees must have a single focus in the investment returns of their beneficiaries.
And it affects Kentuckians. An investment management firm, which at one point managed about $1.5 billion on behalf of the Kentucky Public Pension Authority, has made a “company-wide commitment to integrating ESG information into [its] investment process” to affect “the whole of [its] investment divisions and investment teams. “Other investment management firms that invest billions of dollars in Kentucky pension funds have publicly made similar commitments to ESG investing practices. Some suggest that politically biased investment strategies have costs real and worsening outcomes for retirees.These harms are significant because companies that employ ESG investment strategies are tasked as fiduciaries to manage funds in the best interest of pension recipients like teachers, firefighters and many other civil servants who have ordered their lives around promises made and who depend on public pensions to finance their retirements….
State and federal laws have long recognized the fiduciary duties of those who handle other people’s money. The Employee Retirement Income Security Act (“ERISA”), for example, requires a trustee to “carry out such person’s obligations under the plan solely for the benefit of the members and beneficiaries, for the purpose of exclusively to provide benefits to participants and their beneficiaries and in defraying the reasonable expenses of administering the plan, and with the care, skill, prudence and diligence in the circumstances then prevailing that a prudent person acting in a similar capacity and familiarity with these matters would use in the conduct of an enterprise of the same character and with the same objectives.”
Kentucky law provides similarly stringent obligations for trustees. KRS 61.650 provides that a “trustee, officer, employee, employee of the Kentucky Public Pensions Authority, or other trustee shall perform his or her duties with respect to the pension system… [s]olely in the interest of members and beneficiaries [and for] the exclusive the purpose of providing benefits to members and beneficiaries and paying reasonable system administration costs[.]“This language draws from traditional trust principles requiring a single purpose on the part of fiduciaries which has been summarized as follows:”[a]acting with mixed motives triggers an irrebuttable presumption of fault, period.”
Like ERISA, state law also requires these trustees to perform their duties.”[w]with the care, skill and prudence, in the circumstances then prevailing, which a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an activity of like character and purpose.” The duty Prudence Requires More Than Assuming Under Kentucky law, fiduciary duty is not simply a gift wrap that a fiduciary can use to disguise a set of personal motives.
Along with these fiduciary duties, the trustees of the Kentucky Public Pension Authority, for example, have adopted an investment policy which expressly provides that in “cases where the investment committee has determined that it is desirable to employ services of an external investment manager, “these “Investment Managers … agree to serve as trustees of the Schemes.” Moreover, the trustees expressly stated that “[c]Consistent with the exercise of their fiduciary responsibilities, the Trustees will not routinely exclude any investment in any business, industry, country or geographic area except as required by law.” …
Whereas asset owners may pursue a social objective or “sacrifice part of the performance of their investments to achieve an ESG objective”, investment managers responsible for making financial investments for Kentucky’s public retirement systems must be determined in their motivation and actions and decisions must be “[s]Solely in the interest of affiliates and beneficiaries [and for] for the exclusive purpose of providing benefits to affiliates and beneficiaries. To do otherwise risks violating clearly established statutory and contractual fiduciary obligations and threatens the stability of already fragile pension systems.
In sum, politics has no place in Kentucky’s public pensions. Accordingly, the Bureau is of the view that “stakeholder capitalism” and “environmental, social and governance” investment practices that introduce mixed motivations into investment decisions are inconsistent with Kentucky law governing fiduciary obligations owed by investment management companies to Kentucky public pension plans. .