Schemes that screen out companies on ethical grounds risk breaching their legal fiduciary duty to steward members' assets, argues DLA Piper's Tamara Calvert in the latest Informed Comment.
I am not suggesting for a moment that trustees should go out looking for opportunities to invest in these companies, or indeed the many cash-for-gold, logbook loan providers or pawn shops that are springing up along our high streets.
Defining ethical investment
It is surely no accident that the government has not even attempted to define 'ethical'. It means different things to different people.
Alcohol, nuclear power, tobacco or payday loan companies will give rise to strong feelings in some people and complete apathy in others.
Trustees have to put aside their own views when investing scheme assets and should not use pension scheme investments to make a moral or ethical statement.
The Pensions Regulator says trustees must not let their ethical or political convictions get in the way of achieving the best returns.
But they should not rule them out, any more than they should rule out any other investment on purely ethical, moral or political grounds.
To do so could result in a breach of trustees’ obligations to beneficiaries.
A moral obligation
Case law dating back to the 19th century tells us trustees have a duty to “take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide”.
It could perhaps be considered ironic that a moral obligation to provide for someone could involve “immoral” investment, but ultimately this obligation generally means getting the best financial return for beneficiaries.
Trustees risk breaching that duty if they rule out specified investments solely on ethical grounds.
In a 1984 case involving Arthur Scargill, the courts held that it was inconsistent with the investment duties of the Mineworkers’ Pension Scheme trustees to have a blanket restriction on investing in overseas companies or companies competing with coal.
That was despite it being a hard and fast rule of the National Union of Mineworkers, whose members formed a significant part of the trustee board.
The court reiterated that trustees should invest with the beneficiaries’ best financial interests in mind.
The courts have even gone so far as to say that this duty might include acting “dishonourably” – though not illegally – as in the example of a 1950 case about a trustee’s duty to gazump.
Members’ interests above all
The power to invest in the best interests of beneficiaries is now enshrined in legislation, and in the case of any conflict of interest the investments have to be made in the sole interests of beneficiaries. This is a clear steer to trustees that members’ interests override any ethical consideration.
There is also a requirement to have regard to the suitability and diversity of scheme investments. Limiting investment on ethical grounds is hardly likely to help on the diversification front.
Practicalities of screening
Trustees have to include in their statement of investment principles the extent, if any, to which social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments.
Trustees should not allow ethical, moral or political considerations to cloud one of their key decisions
This is not a duty to take account of these factors, but a requirement to disclose their policy if they choose to do so.
Finally, a note on practicality. For trustees investing in pooled vehicles it will not always be possible to monitor the underlying investments, so it might be impractical to screen investments on ethical grounds.
If trustees can achieve the same or better returns through investments that don’t offend their ethical principles then fine, although even a small reduction in return could expose trustees to criticism.
Similarly, if the scheme’s rules themselves restrict investments then trustees are required to abide by those restrictions – although as the Archbishop of Canterbury discovered, even the Church Commissioners’ restricted investment powers do not prevent investment in payday loan companies.
The considerations might also be different for trustees of defined contribution schemes. In a defined benefit scheme, the trustees alone are responsible for the selection of investments and for ensuring the best outcome for beneficiaries.
In a DC arrangement, trustees might very well decide to offer an ethical fund within its range on the basis that the member takes the risk of choosing ethical investment.
The duty of the trustee is to act in the interests of the beneficiaries. Trustees should not allow ethical, moral or political considerations to cloud one of their key decisions: where to invest the scheme’s assets in a way that gives the best chance of being able to pay members’ benefits.
Tamara Calvert is a partner at law firm DLA Piper
