Investment is a core duty of pension trustees. The importance to the economy of the funds they control is recognised by everyone from government to the European Commission. As long-term investors, pension schemes are seen as particularly suited to investment in infrastructure and similar projects that might be regarded as socially useful. And the potential for damage to the reputation of charities, companies and even political parties as a result of the investment policy of their pension trustees remains considerable. So it is worth looking in detail at what is meant by ‘socially responsible investment’ and some of the practical issues that arise for trustees and investment managers. This article, the first in a series that we will publish on the issue, deals with the current legal framework.
Pension trusts by their nature are designed to provide financial benefits. Accordingly, pension trustees must when they invest focus primarily on the long-term financial aspects of any investment. They are not required to focus only on short-term value, and may well consider environmental or ethical issues relevant to the preservation of long-term value. Pension trustees must use their own judgement, having taken advice, and not act on the direction of members, the employer or any third party, unless member choice is part of the scheme design. In the context of a balance of cost final salary scheme, they must have regard to the impact of their decisions on the employer that ultimately bears the cost, as well as scheme members, and must consult the employer on investment policy. In such schemes, reckless conservatism – or acting in accordance with members’ wishes or lobby groups – could lead to a breach of the trustees’ duties just as much as complying blindly with the employer’s wishes. Acting on members’ direction in a defined contribution context designed to promote member choice is, conversely, unlikely to breach the trustees’ fiduciary responsibilities. Trustees must first have considered the suitability of the investment choices available to members (in particular the nature of any default fund) and given sufficient information designed to enable members to make an informed choice. Subject to these considerations, the deeds and rules of most occupational money purchase schemes under which members have a choice are likely to exonerate trustees from the consequences of members’ choices.
The leading case is Cowan v Scargill  1 Ch 270. Five union-appointed trustees were held to be in breach of their fiduciary duties when they refused to agree an investment strategy unless it excluded overseas investment and prohibited investment in industries that directly competed with the coal industry. The Court decided that the trustees were primarily motivated by their wish to support union policy, rather than acting in beneficiaries’ interests. There was not in any event a sufficient link between the investment restrictions proposed and the benefit to pensioners or any wider social benefits.
Trustees should not normally fetter their investment discretion. The principles are set out in the following often-quoted passage from the judgment of Sir Robert Megarry VC:
“… the starting point is the duty of trustees to exercise their powers in the best interests of the present and future beneficiaries of the trust, holding the scales impartially between different classes of beneficiaries. This duty of trustees towards their beneficiaries is paramount. They must of course obey the law; but subject to that, they must put the interests of their beneficiaries first. When the purpose of the trust is to provide financial benefits of the beneficiaries, as is usually the case, the best interests of the beneficiaries are normally their best financial interests… in the case of a power of investment, as in the present case, that power must be exercised so as to yield the best return for the beneficiaries, judged in relation to the risks of the investments in question; and the prospects of the yield of income and capital appreciation both have to be considered in judging a return from the investment.
Trustees may have strongly held social or political views… they may object to any form of investment in companies concerned with alcohol, tobacco, armaments or many other things. In the conduct of their own affairs of course they are free to abstain from making any such investment. Yet under a trust, if investments of this type would be more beneficial to the beneficiaries than other investments, the trustees must not refrain from making the investments by reason of the views they may hold…
… I should say that I am not asserting that the benefit of the beneficiaries which a trustee must make his paramount concern inevitably and certainly means their financial benefit, even if the only object of the trust is to provide financial benefits. Thus if the only actual or potential beneficiaries of a trust are all adults with very strict views on moral and social matters, condemning all forms of alcohol, tobacco and popular entertainment, as well as armaments, I can well understand that it might not be for the ‘benefit’ of such beneficiaries to know that they are obtaining rather larger financial returns under the trust by reason of the investments in those activities than they would have received if the trustees had invested the trust funds in other investments. The beneficiaries might well consider that it was far better to receive less than to receive more money from what they consider to be evil and tainted sources… But I would emphasise that such cases are likely to be very rare, and in any case I think that under a trust for the provision of financial benefits… the paramount duty of the trustees is to provide the greatest financial benefits for the present and future beneficiaries.”
The case has become controversial, with some citing its authority for the proposition that it is unlawful for pension fund trustees to do anything but seek to maximise profits for their beneficiaries. Others see it as a narrow case turning on its own facts and find fiduciary duty, in any event, as an evolving concept.
In Martin v City of Edinburgh  SCRL 90, the question before the Scottish Court was whether trustees were acting properly in divesting their holdings in South Africa at the time of apartheid. The decision – that they were not – turned on the lack of any investment advice. However, the Court made it clear that trustees were not required simply to rubber stamp the decisions of investment advisers – the exercise of discretion meant just that. Accordingly, while pre-existing policy requirements (such as dictated by union or political party) could not be substituted for independent judgement, it was neither reasonable nor practicable for trustees exercising independent judgement to divest themselves of all moral or other preferences or principles, providing they were acting in members’ best interests.
The principles that emerge from these cases are generally accepted – at least up to a point. Pension trustees are acting in breach of their fiduciary duties if they blindly follow a particular predetermined policy that has a social or political context, unless they have considered on advice the impact of those policies on members and have concluded that they are in members’ best interests. Since the purpose of the pension trust is to provide a financial benefit, the financial aspects of any investment are the primary consideration, albeit that environmental or other issues that could have an impact on the value of the investment are relevant factors for the trustees to consider in their investment policy. So it would be relevant in any decision to invest in BP, for example, to consider the safety culture and environmental impact of BP’s operations and the knock-on effect to the company’s reputation. The economic consequences of those issues to the company have been vividly illustrated by the US oil spill.
A report from Freshfields for the Asset Management Working Group of the UNEP Finance Initiative in October 2005 took a broadly similar view of UK law, analysing Cowan v Scargill as a case that restates the accepted principle that trustees exercising fiduciary powers must do so for the purpose for which they were granted. “Where that purpose is to achieve a financial return, as in the case of the typical pension or mutual fund, securing a financial return must be the primary motivation behind investment decisions in respect of the fund…” The report went on: “There may be one other respect in which Cowan v Scargill offers useful guidance: it confirms that the fiduciary powers must be exercised in the interest of beneficiaries; as such, the interests of beneficiaries beyond financial return should be considered in arriving at investment decisions in certain circumstances.”