Ethical Investing

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Ethical Investing Fiduciary Responsibilities
Ken Hartviksen Associate Professor Faculty of
Business Administration Lakehead University
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Agenda

• Fiduciary Responsibility
• Primer on Socially Responsible Investing
• Is SRI in conflict with Fiduciary Responsibility?

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Duties of Corporate Directors

• Section X of CBCA
• Duty of care of directors and officers122. (1)
  Every director and officer of a corporation in
  exercising their powers and discharging their
  duties shall(a) act honestly and in good faith
  with a view to the best interests of the
  corporation and(b) exercise the care, diligence
  and skill that a reasonably prudent person would
  exercise in comparable circumstances.

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What is a Fiduciary?

• The duties imposed upon a person or organization
  that exercises some discretionary power in the
  interests of another person in circumstances that
  give rise to a relationship of trust and
  confidence.

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A Fiduciary

• Is a person or an institution that manages money
  and/or business affairs for another person or
  institution.
• Key is discretionary control
• A fiduciary is created through the nature of the
  relationship
• It is a legal state that should not be taken
  lightly highest legal standard of duty of care,
  skill and diligence.

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Fiduciary Law

• Common law precedent
• An evolving field

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Duties of Fiduciary

• PRUDENT PERSON DUTY
• Due Care, Skill and Diligence that a normal
  person would in the management of their own
  affairs
• DUTY OF LOYALTY
• Act in accordance with the purpose for which
  investment powers are granted

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Fiduciaries versus Agents

• Principal-agent (contractual) relationships
• Assumes relatively equal power
• Assumes ability of principal to contract with
  monitor assess the performance of the agent
• Fiduciary relationships
• Assumes relatively unequal power or knowledge
  critical to management of the relationship
• Assumes inability of beneficiary to contract
  with monitor assess the performance of the
  agent (there is inherent vulnerability of the
  beneficiary)

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When Does a Fiduciary Relationship Exist?

1. Named fiduciary in the pension complex (ie.
   Pension board)
2. When a position of trust comes into being.

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Myths Dispelled about Fiduciary Duty

• Fiduciaries do not need to be clairvoyant.
• However, they need to use good judgment and make
  long-term decisions for other people in a manner
  consistent with how reasonable people manage
  their own money.
• Good returns are not a defense against
  imprudence.
• Prudence is process.
• Each portfolios component must be judged on the
  extent to which it contributes to overall
  portfolio characteristics
• Fiduciary law expects application of Modern
  Portfolio Theory (MPT) rather than legal lists.

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A Study in Contrast

• Canadian versus U.S. Fiduciary Standards (Pension
  legislation)

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Harvard College v. Amory Case(1830) The
Genesis of the Prudent Man Rule

• The issue whether a trustee could invest in the
  stock of manufacturing and insurance
  corporations.
• In the early 1800s, English courts limited
  trustees to investing in government securities.
• In this case that practice was rejected.
• Implications fiduciaries do not need to be
  clairvoyant. They do, however, need to use good
  judgment and make long-term decisions for other
  people in a manner consistent with how reasonable
  people manage their own money.

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Spitzer v. Bank of New York(1973) Affirmation
of Modern Portfolio Theory (MPT)

• Facts
• M. James Spitzer, the guardian of a trust,
  alleged imprudence on the part of the bank in the
  administration of the trust.
• He disputed four security issues that resulted in
  a total loss of 238,000 over four years,
  however, the aggregate portfolio showed a gain of
  1.7 over the same period.
• Outcome
• Court of appeals dismissed the banks contention
  that the positive return was a defense against
  imprudence.
• Each portfolio component must be judged on the
  extent to which it contributes to overall
  portfolio characteristics.
• Hindsight is an inappropriate perspective from
  which to judge the prudence of an investment
  decision.

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ERISA Prudent Expert StandardEmployee
Retirement Income Security Act (1974)

• Established a national, uniform set of
  requirements for fiduciary conduct with pension
  funds.
• A pension fiduciary shall discharge his duties
  with the care, skill, prudence and diligence
  under the circumstances then prevailing that a
  prudent man 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.

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Fiduciary Duties

• Care (four elements)
• Prudent expert
• Diversification rule
• Documents rule
• Indicia of ownership rule
• Loyalty (two elements)
• Sole interest of the beneficiary rule
• Prohibited transactions

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Due Diligence

• Such a measure of prudence, activity or
  assiduity, as properly exercised by a reasonable
  and prudent person under the particular
  circumstances not measured by any absolute
  standard, but depending on the relative facts of
  the case.

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Conclusions

• Fiduciary Prudence is all about process
• Disciplined portfolio management
• Documented
• Logically defensible after-the-fact based on the
  circumstances at the time of the decision
• Transparent

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Question

• In Canada, does fiduciary duties preclude or
  permit consideration of socially responsible
  investment considerations?
• Lets Try to Answer this Question in our next
  phase of this Workshop

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A Primer on Ethical Investing
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Semantics

• Ethical investing
• Social investing
• Sustainable investing
• Responsible investing (RI)
• Socially responsible investing (SRI)
• Principles of responsible investing (PRI)
• Environment, Social Justice, Governance (ESG)
  Issues

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SRI Chronology1758 Quaker Philadelphia Yearly
Meeting

• Prohibited members from participating in the
  slave trade buying or selling humans.

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SRI Chronology1700s John Wesleys Sermon 50
The Use of Money

• Basic tenets of social investing outlined
• Do not harm your neighbour through your business
  practices
• Avoid industries like tanning and chemical
  production that can harm workers.

"The love of money," we know, "is the root of all
evil" but not the thing itself. The fault does
not lie in the money, but in them that use it. It
may be used ill and what may not? But it may
likewise be used well
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SRI ChronologyModern SRI Movement 1960s

• Civil Rights Movement together with protests
  against war (specifically Vietnam)
• Sit ins on campuses
• Marches / protests

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SRI ChronologyModern SRI Movement 1970s

• Consumer Boycotts
• Nestle ( baby formula) July, 1977
• Dow Chemical (manufacturer of Napalm)

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SRI ChronologyModern SRI Movement 1980s

• Consumer Boycotts
• Union Carbide (Bhopal India)
• Investment Embargos (disinvestment)
• Apartheid Regime in South Africa

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SRI ChronologyModern SRI Movement 1990s

• Corporate Behaviour
• Environmental Disaster Exxon Valdez in March
  1989
• Bailout of LTCM Long Term Capital Management
  (taxpayers bailing out billionaires)

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SRI ChronologyModern SRI Movement Early 2000s

• Corporate Behaviour
• Enron fraud and bankruptcy
• Tyco Scandal
• Issues
• Collusion to defraud between auditors and public
  corporations
• Use of corporate assets for personal use
• Misaligned incentives (executive compensation,
  sales commissions, interest rate policy, tax
  policy)

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SRI ChronologyModern SRI Movement Later 2000s

• Business Behaviour
• Madoff Earl Jones Weizhen Tang Ponzi Schemes
  Revealed
• Issues
• Collusion to defraud between auditors and public
  corporations
• Use of corporate assets for personal use
• Misaligned incentives (executive compensation,
  sales commissions, interest rate policy, tax
  policy)

Greed
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SRI ChronologyA connection to boomers of the
1940 1960s generation
Women's Rights
Labour Movement
Civil Rights

1. 1960s Protests as students
2. 1970s - Boycotts as consumers and parents
3. 1980s - Ethical investing as investors
4. 1990s - Environmental Change concerns
5. Early 2000s - Governance Issues
6. 2008 present economic justice (growing gap
   between rich and poor and declining middleclass)

Occupy Wall Street
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Examples Current Ethical Issues
Canadian Production and Export of Asbestos
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Examples Current Ethical Issues
Monsanto genetically modifying organisms and
patenting genes - controlling access to crops
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Examples Current Ethical Issues
Nestle Chocolate from the Ivory Coast and Ghana
using Child Slaves in the supply chain.
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Examples Current Ethical IssuesCanadian Mining
Company Practices in Other Countries
Claims concerning Canadian mining companies
violating human rights and indigenous rights in
other countries among other resource extraction
issues..
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Examples Current Ethical IssuesMining and
Export of Crysotile Asbestos in Quebec
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Examples Current Ethical Issues
Supply chain issues with NIKE in lesser developed
countries using child labour.
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Principles of Responsible Investing Initiative
United Nations

• 2005 initiative of the United Nations
  Secretary-General, in coordination with the
  United Nations Environment Program Finance
  Initiative and the UN Global Compact
• invited a group of the worlds largest
  institutional investors to join a process in
  developing the principles

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Principles of Responsible Investing Initiative

• PRI is based on the notion that ESG issues, such
  as climate change and human rights, can affect
  the performance of investment portfolios and
  should therefore be considered alongside more
  traditional financial factors if investors are to
  properly fulfill their fiduciary duty.
• The six principles provide a global framework for
  mainstream investors to consider these ESG
  issues. The PRI Initiative has also been created
  alongside the Principles to help put the
  framework into practice.
• Over 650 investment institutions, and 200 service
  providers have signed up to the Principles, with
  an increased sign up arising from the global
  financial crisis of 2008-2009, according to a
  report in the Financial Times.
• The Principles are voluntary and aspirational
  and they do not have minimum entry requirements
  or absolute performance standards for responsible
  investment. However, signatories have an
  obligation to report on the extent to which they
  implement the Principles. In 2009, five
  signatories were delisted for not fulfilling this
  obligation.

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Principles of Responsible Investing Initiative

• Over 650 investment institutions, and 200 service
  providers have signed up to the Principles, with
  an increased sign up arising from the global
  financial crisis of 2008-2009.
• The Principles are voluntary and aspirational
  and they do not have minimum entry requirements
  or absolute performance standards for responsible
  investment.
• Signatories have an obligation to report on the
  extent to which they implement the Principles.
• In 2009, five signatories were delisted for not
  fulfilling this obligation.

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The Principles

• As institutional investors, we have a duty to act
  in the best long-term interests of our
  beneficiaries. In this fiduciary role, we believe
  that environmental, social, and corporate
  governance (ESG) issues can affect the
  performance of investment portfolios (to varying
  degrees across companies, sectors, regions, asset
  classes and through time).
• We also recognize that applying these Principles
  may better align investors with broader
  objectives of society. Therefore, where
  consistent with our fiduciary responsibilities,
  we commit to the following

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The Principles

• 1. We will incorporate ESG issues into
  investment analysis and decision-making
  processes.
• 2. We will be active owners and incorporate ESG
  issues into our ownership policies and practices.
• 3. We will seek appropriate disclosure on ESG
  issues by the entities in which we invest.
• 4. We will promote acceptance and implementation
  of the Principles within the investment industry.
• 5. We will work together to enhance our
  effectiveness in implementing the Principles.
• 6. We will each report on our activities and
  progress towards implementing the Principles.

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SRI

• Also known as sustainable, socially conscious, or
  ethical investing
• Is an investment strategy which seeks to maximize
  both financial return and social good

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What is Socially Responsible Investment (SRI)

• Socially responsible investment (SRI) is the
  inclusion of social, environmental and governance
  (ESG) considerations into the management and
  selection of investments.
• (As defined by the Social Investment
  Organization of Canada)

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What is Socially Responsible?

• Generally SRI favours corporate practices that
  promote
• Environmental stewardship (ie. FSC Canada)
• Consumer protection
• Human rights and diversity
• Avoiding businesses involved in
• Alcohol, tobacco, gambling, weapons, and/or the
  military
• Investing in economic activities that make a
  positive contribution to important values
• Micro finance, private capital, etc.

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The Concept of SRI

• Two broad conceptual paths
• Values-based approach to investment, selecting
  and managing investment according to
  pre-determined views of the ethical consequences
  of investment choices.
• Fiduciary view, based on the belief and evidence
  that the incorporation of environmental, social
  and governance issues into the investment process
  will help to mitigate risk and enhance return.

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Core SRI Strategies

1. Screening based on exclusionary or inclusionary
   criteria
2. Impact investing (venture capital based)

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Broad SRI Strategies

1. Integration of environmental, social and
   governance (ESG) factors into stock portfolio
   analysis and management.
2. ESG corporate engagement and proxy voting.
3. Sustainable venture capital

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Statistics

• According to the Social Investment Organization
  of Canada1
• SRI holds steady at about 1/5 of assets under
  management (AUM) in Canada in 2010.
• Assets managed by pension funds under responsible
  investment policies are at 453.4 billion, or 85
  of the total.

1Canadian Socially Responsible Investment
Review, 2010 Social Responsibility
Organization, May, 2011. Page 7.
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The Wall Street Rule(The Discipline of the
Market)

• If you dont like a stock sell it (rather than
  getting involved in proxy challenges of
  management)

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CPPIB and ESG

• CPPIB recognizes with more than 130 billion in
  AUM it cannot effectively pursue disinvestment
  strategies and still invest their funds.1

1See Report on Responsible Investing, 2011
Canada Pension Plan Investment Board. June 30,
2011.
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Return to our Question

• In Canada, does fiduciary duties preclude or
  permit consideration of socially responsible
  investment considerations?
• As in most countries, there is very little
  jurisprudence to guide Canadian fiduciaries. Not
  surprisingly, legislative and regulatory
  frameworks in Canada do not either require or
  expressly sanction the consideration of ethical
  concerns with one exception. Manitobas
  legislation governing trustees expressly allows
  them to consider non-financial criteria in the
  investment decision making process, with the
  prudence context set by broader trust law.1

1Best Practices in Responsible Investment for
Canadian Pension Funds Mercer,November, 2009.
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Further to our Question

• In Canada, does fiduciary duties preclude or
  permit consideration of socially responsible
  investment considerations?
• Fiduciary duty has generally been interpreted to
  mean that trustees must make investment decisions
  based exclusively on maximizing the financial
  returns of beneficiaries. However, possible
  benefits from a beneficiaries perspective, may
  arguably extend beyond immediate financial
  returns. If beneficiaries share a moral
  objection to a particular form of investment, it
  could be considered to their benefit if the trust
  avoided that investment, possibly even at the
  cost of lower financial returns.2

2Best Practices in Responsible Investment for
Canadian Pension Funds Mercer,November, 2009.
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Finally to Answer our Question

• In Canada, does fiduciary duties preclude or
  permit consideration of socially responsible
  investment considerations?
• There is no reason why an investment strategy
  should not include investments with positive ESG
  characteristics as long as the decisions are
  motivated by the interests of the funds
  beneficiaries and not the personal views of the
  decision-maker.3

3Best Practices in Responsible Investment for
Canadian Pension Funds Mercer,November, 2009.
Page 10 11.
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Other Questions?

• How do other pension plans take ESG factors into
  account?
• Are the managed investment products out there
  that have a socially-responsible mandate?
• Other?

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Questions -- Discussion
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Useful Resources

• Best Practices in Responsible Investment for
  Canadian Pension Funds, Commissioned by the
  Social Investment Organization with funding from
  Environment Canada, Mercer, November, 2009.
• Canadian Socially Responsible Investment Review
  2010, Social Investment Organization. May, 2011.
• Canada Pension Plan Investment Board Policy on
  Responsible Investing - http//www.cppib.ca/files/
  PDF/Responsible_Investing_Policy_August2010.pdf
• Canada Pension Plan Investment Board Report on
  Responsible Investing, 2011
• http//www.cppib.ca/files/PDF/CPPIB_RI_Report.PDF