The Volokh Conspiracy
Mostly law professors | Sometimes contrarian | Often libertarian | Always independent
[UPDATE: My colleague Prof. Stephen Bainbridge, who is a corporate law scholar, has more on the subject here; much worth reading.]
From opinion 22-05 by the Kentucky Attorney General's office, handed down a week ago:
Syllabus: "Stakeholder capitalism" and "environmental, social, and governance" investment practices, which introduce mixed motivations to investment decisions, are inconsistent with Kentucky law governing fiduciary duties owed by investment management firms to Kentucky's public pension plans….
There is an increasing trend among some investment management firms to use money in public and state employee pension plans—that is, other people's money—to push their own political agendas and force social change. State Treasurer Allison Ball asks whether those asset management practices are consistent with Kentucky law. For the reasons below, it is the opinion of this Office that they are not….
For years, … the Commonwealth's public pension plans have hovered at severely underfunded levels. According to the Kentucky Public Pension Authority's most recent annual report, the public pension plan for most state employees is roughly 17% funded…. And while the public pension plans administered by the Kentucky Public Pension Authority have shown year-over-year improvement in funding, there is a concern that this trajectory may be threatened by extreme approaches to investment management—particularly those that put ancillary interests before investment returns for the benefit of public pensioners and state employees.
One such approach is "stakeholder capitalism." According to its advocates, "[s]takeholder capitalism is an expansion of corporate management fealty beyond shareholders to include the workforce, supply chain, customers, communities, societies, and the environment." What this means in reality is that investment management firms who embrace stakeholder capitalism propose prioritizing activist goals over the interests of their public and state employee clients.
To achieve this version of "capitalism," investment management firms are adopting "environmental, social, and governance"—or "ESG"—investment practices. ESG investing is an "umbrella term that refers to an investment strategy that emphasizes a firm's governance structure or the environmental or social impacts of the firm's products or practices."
American economist Milton Friedman once criticized an earlier version of this trend whereby one set of stockholders sought to convince another set of stockholders that business should have a "social conscience." As he explained, "what is in effect involved is some stockholders trying to get other stockholders (or customers or employees) to contribute against their will to "social' causes favored by activists. Insofar as they succeed, they are again imposing taxes and spending the proceeds." Friedman found this problematic because "the great virtue of private competitive enterprise" is that it "forces people to be responsible for their own actions and makes it difficult for them to 'exploit' other people for either selfish or unselfish purposes. They can do good—but only at their own expense."
Today, in perhaps an even more pernicious version of the trend, the debate is no longer left to stockholders. In fact, there is little-to-no debate. Investment managers in some corporate suites now use the assets they manage—that is, other people's money—to enforce their preferred partisan sensibilities and to seek their desired societal and political changes.
Investment management firms have publicly committed to coordinating joint action for ESG purposes, such as reducing climate change. For example, the Steering Committee for the Glasgow Alliance for Net Zero ("GFANZ") states: "The systemic change needed to alter the planet's climate trajectory can only happen if the entire financial system makes ambitious commitments and operationalises those commitments with near-term action. That is why we formed [GFANZ], to bring together over 450 leading financial enterprises united by a commitment to accelerate the decarbonisation of the global economy." Similarly, Climate Action 100 "aims to ensure the world's largest corporate greenhouse gas emitters take necessary action on climate change." Climate Action 100 explicitly concedes a mixed motive, stating that its investor signatories believe that taking action "is consistent with their fiduciary duty and essential to achieve the goals of the Paris Agreement." As further suggestion of a political motive, some investment management firms have committed to both advocate for government-imposed climate change mandates, and use their fiduciary role to prevent portfolio companies from advocating against such mandates.
Whether these ancillary purposes are societally beneficial is beside the point when speaking of the duty of fiduciaries. Fiduciaries must have a single-minded purpose in the returns on their beneficiaries' investments.
And this affects Kentuckians. One investment management firm, at one time directing roughly $1.5 billion on behalf of the Kentucky Public Pension Authority, has made a "firmwide commitment to integrate ESG information into [its] investment processes" to affect "all of [its] investment divisions and investments teams." Other investment management firms that direct billions of dollars in Kentucky pension fund investments have publicly made similar commitments to ESG investment practices. There is some suggestion that politically biased investment strategies have real costs and worsen outcomes for pensioners. These harms are significant because companies employing ESG investment strategies are entrusted as fiduciaries to manage the funds in the best interests of pension beneficiaries like teachers, firefighters, and many other public servants who have ordered their lives around promises made and who depend on public pensions to finance their retirements….
State and federal law have long recognized fiduciary duties for those who manage other people's money. The Employee Retirement Income Security Act ("ERISA"), for example, demands that a fiduciary "discharge that person's duties with respect to the plan solely in the interests of the participants and beneficiaries, for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan, and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims."
Kentucky law provides similarly demanding duties for fiduciaries. KRS 61.650 provides that a "trustee, officer, employee, employee of the Kentucky Public Pensions Authority, or other fiduciary shall discharge duties with respect to the retirement system … [s]olely in the interest of the members and beneficiaries [and for] the exclusive purpose of providing benefits to members and beneficiaries and paying reasonable expenses of administering the system[.]"This language draws from traditional trust principles requiring a single-minded purpose by fiduciaries that has been summarized as follows: "[a]cting with mixed motives triggers an irrebuttable presumption of wrongdoing, full stop."
Like ERISA, state law also demands that such fiduciaries discharge their duties "[w]ith the care, skill, and caution under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with those matters would use in the conduct of an activity of like character and purpose." The duty of prudence requires more than assuming sweeping government mandates that coincide with an investment manager's policy preferences. Under Kentucky law, fiduciary duty is not merely gift wrapping that a fiduciary may use to conceal a package of personal motivations.
Along with these fiduciary duties, the trustees of the Kentucky Public Pension Authority, for example, have adopted an investment policy that expressly provides that, in "instances where the Investment Committee has determined it is desirable to employ the services of an external Investment Manager," those "Investment Managers … agree to serve as a fiduciary to the Systems." Moreover, the trustees have expressly stated that, "[c]onsistent with carrying out their fiduciary responsibilities, the Trustees will not systematically exclude any investments in companies, industries, countries, or geographic areas unless required to do so by statute." …
While asset owners may pursue a social purpose or "sacrifice some performance on their investments to achieve an ESG goal," investment managers entrusted to make financial investments for Kentucky's public pension systems must be single-minded in their motivation and actions and their decisions must be "[s]olely in the interest of the members and beneficiaries [and for] the exclusive purpose of providing benefits to members and beneficiaries." To do otherwise risks breaching clearly established statutory and contractual fiduciary duties and threatens the stability of already fragile pension systems.
In sum, politics has no place in Kentucky's public pensions. Therefore, it is the opinion of this Office that "stakeholder capitalism" and "environmental, social, and governance" investment practices that introduce mixed motivations to investment decisions are inconsistent with Kentucky law governing fiduciary duties owed by investment management firms to Kentucky's public pension plans.