ESG is Dead – Long Live ESG

Serving as a pension investment fiduciary has become considerably more difficult in the past few months due to market gyrations, inflation and potential recession. More surprising has been discovering that pension funds and their investment managers are now a piñata in the “culture wars” with whacks coming from all sides.

We explore what this means for pension fiduciaries and offer six suggestions for managing trust fund assets through these challenges. This is a time that requires working closely with fiduciary counsel and investment advisers to ensure pension plans can fulfill the full range of their pension fiduciary obligations. Pension fiduciaries should develop a fact-based understanding of the situation, clarify their investment beliefs and policies, update stakeholder communication plans, and explicitly focus on balancing investment strategies to impartially deliver promised benefits both now and in the future.

Fiduciaries Are Caught Between a Rock and a Hard Place

Pension fiduciaries are finding themselves in a Catch-22 situation, as they have recently been pulled into the broader national debate regarding environmental, social, and governance (“ESG”) investing. Assuming, for the sake of this discussion that the term “ESG investing” is even a defined thing (some would argue that it is not), ESG investing has, in any event, become a ubiquitous concept used by investment professionals as a shorthand reference. Nevertheless, it remains an ambiguous concept that encompasses several different investment and analytical strategies that are evolving at a rapid pace. ESG investing means different things to different people. This ambiguity has generated heated debate about the application of fiduciary duties to ESG, often without differentiation between vastly different ESG approaches

On one side, some states are passing anti-ESG legislation. State treasurers have started firing investment managers for allegedly boycotting fossil fuel companies. Attorneys general from 19 states have accused investment firms of breaching both fiduciary duties and anti-trust laws by joining with other investors to allegedly impose a “woke” policy agenda. Former Vice President Pence asserted that “ESG is a pernicious strategy because it allows the left to accomplish what it could never hope to achieve at the ballot box or through competition in the free market.” A group of US Senators even sent a letter to 51 large US law firms, warning of coming Congressional hearings and advising that lawyers have “a duty to fully inform clients of the risks they incur by participating in climate cartels and other ill-advised ESG schemes.”

On the other side, the heat on pension fiduciaries to address material ESG risks is increasing. New York City’s Comptroller recently filed shareholder resolutions at Bank of America, Goldman Sachs, JPMorgan Chase and Royal Bank of Canada asking them to cap financing of carbon emissions. The Comptroller said, “These banks say they have net zero commitments, but if they don't have absolute emissions targets, they don't really have a net zero plan.” An open letter from 14 state treasurers accused their counterparts on the anti-ESG side of the debate of imposing an “ideological screen on an investment manager’s ability to perform” which “increases potential risks” and “in the case of state and public pension funds, these losses will be borne by the taxpayers and that means all of us.”

On the Federal level, the Department of Labor recently issued new private pension fund rules which confirm that ESG factors may be financially material and can be used by plan fiduciaries in making investment selections and proxy voting decisions. Pension investment fiduciaries are finding themselves caught between these increasingly contradictory narratives of what their roles require. As demands and threats from both sides continue to increase, fiduciaries should focus on their mandate and the practical application of their fiduciary duties.

The Fiduciary Duty Context

Uninformed observers and those with ancillary policy goals often make assertions about pension fiduciary duties based upon a limited or unnuanced understanding of the concepts involved. However, pension managers and trustees must operate with a full understanding of the legal principles which govern their conduct. Blindly applying sweeping and/or conclusionary notions of what prudence requires and what it means to manage assets solely in the interests of plan beneficiaries runs the risk of violating legal duties. We highlight several fundamental aspects of fiduciary duty that have largely been missing from the debate and are essential for a fully informed understanding of investor fiduciary obligations. Prudence Is Process Oriented and Forward Looking The duty of prudence is often described in a conclusory manner (i.e., “this” or “that” is prudent or imprudent). However, prudence is a processoriented and forward-looking concept. In fact, the Oxford Languages dictionary definition of prudence is “acting with care and thought for the future.” It requires investigation of relevant facts and application of logical analysis to reach well-informed conclusions. Fiduciaries cannot merely jump to conclusions without using a robust decision-making process that considers all fiduciary duty principles. Peer practices serve as a reference point for prudent fiduciaries. However, variances in plan design, size, demographics, investment strategy, funding levels, plan sponsor financial stability, state constitutional and statutory provisions, or other characteristics can result in plan fiduciaries independently following similar prudent processes but reaching different conclusions. In other words, prudence in not a “one size fits all” concept – even, for example, when it comes to climate change risk exposures and related investment opportunities. Different pension plan characteristics can introduce variances that generate different conclusions. A prudent process requires analysis of relevant facts and circumstances in the context of the unique characteristics of each plan. Prudence Is Dynamic Prudence is often viewed as a static concept. However, while prudence has been part of trust law for centuries, its application evolves as conditions change and investment industry knowledge grows. For example, during the last half of the 20th century, application of the duty of prudence evolved away from what used to be a common