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May 21, 2004

Baker & McKenzie Paper Concludes Social Investing Consistent with Fiduciary Duty
    by William Baue

The opinion of a major US corporate law firm sets the bar for the fiduciary case for SRI.

SocialFunds.com -- In November 2000, three lawyers from Baker & McKenzie, one of the largest law firms in the US, presented a paper to the board of the California County Employee Retirement System on the fiduciary duty to address social and environmental issues. They concluded that social and environmental considerations fall within the purview of fiduciary responsibility of board members, so long as they follow their legal mandate to maximize returns concomitantly.

"If the social investment's rate of return is similar to the return on a similar type of investment that does not possess the social objective sought, then it appears that public employee retirement system boards can make the social investment," state authors Virginia Gibson, Bonnie Levitt, and Karine Cargo in the paper. "Similarly, if the return on an investment is likely to be impaired, then the decision to divest can be made even if consideration is given to non-economic social factors."

The paper carries significant implications, in part because it comes not from the chorus of voices predisposed to supporting socially responsible investing (SRI), but rather from an impartial independent source.

"The paper is important because it comes from a reputable US law firm, and it acknowledges the ability of fiduciaries to address social and environmental issues," said Gil Yaron, director of law and policy for the Shareholder Association for Research and Education (SHARE), a Vancouver-based nonprofit advisor of Canadian pension funds.

Mr. Yaron is currently writing a series of papers for a project coordinated through a union and university research alliance examining to what extent and how Canadian pension funds can engage in SRI. The papers, which will be published over the next year, will cite the Baker & McKenzie paper as an example of state-specific legal opinion in the US.

The paper was also cited in a 2002 report by the Oakland-based Rose Foundation for Communities and the Environment entitled The Environmental Fiduciary: The Case for Incorporating Environmental Factors into Investment Management Policies. The Rose Report uses the Baker & McKenzie paper as a point of departure, extending the responsibility beyond the optional realm.

"In fact, as a matter of preventative law, a fiduciary would be better positioned to defend a legal challenge to an investment or investment management decision if he or she incorporated relevant environmental information into the investment decision . . . " state Tim Little, Susannah Blake Goodman, and Jonas Kron in the Rose report. "A failure to consider and act on environmentally related information is not prudent in the financial sense of the word and should not be considered prudent in the legal sense of the word."

The B&M paper goes into more detail about the so-called Avon letters, a series of opinions from the Department of Labor (DOL) establishing the legality of pension funds actively voting proxies, holding SRI funds, and conducting shareowner action.

The paper also cites an example when Texas Governor George W. Bush signed a 1997 law limiting state retirement fund investment in companies that produce songs with lyrics that promote violence and criminal behavior or degrade women.

"This legislation targeted a social objective with no consideration for the return on investment, perhaps because the standards of fiduciary duties differ from the California Constitution and its enabling legislation," state the authors.

Matthew Kiernan, the founder and CEO of sustainability research firm Innovest Strategic Value Advisors who has also cited the B&M paper in his writings, knows of no instance where the legal or pension fund community has advanced further on the B&M opinion.

"As a great believer in the awesome power of intellectual and organizational inertia, I'm sorely tempted to hypothesize it's because the current ideological and organizational infrastructure built around the status quo (ie, pension fund trustees, investment staff, outside money managers, and pension fund consultants) has too much invested in the way things are to be motivated to change," Dr. Kiernan told SocialFunds.com.

Mr. Yaron voices a similar, but more tempered, opinion.

"In the last couple of years, there has been a chill in addressing environmental and social issues following market declines, as pension funds focus on bottom line issues," Mr. Yaron told SocialFunds.com. "Educating the pension community and interpreting the law articulately regarding social and environmental issues is a slow process--nothing moves quickly in the world of pensions."

"I would make the argument that the fiduciary duty of loyalty and prudence obligates trustees to at least take into consideration social and environmental issues," Mr. Yaron added. "Studies are inconclusive whether there are long-term financial benefits or liabilities associated with corporate environmental and social policies and practices, but clearly they can impact returns in one way or another, so prudence and loyalty dictates that they be considered from a financial and risk-based perspective.

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