Co-Authored by Perry Goldschein, a corporate sustainability consultant, and former environmental and regulatory lawyer, with 15 years of experience helping organizations create value through sustainability.
It's not often that fiduciary duty makes the news. But when the Department of Labor (DOL) -- which oversees pensions and retirement accounts -- recently announced rules that will require financial advisors to act in their clients' best interests, it was front page news. Even HBO comedian John Oliver got into the act, with a significant segment about the new rules on his program.
Prior to the new rules, which will not go into effect for at least a year, advisors have been held to a much lower standard, requiring only that they select "suitable" investments. Suitable investments selected for retirement accounts were deemed legal even if they carried exorbitant fees or were invested in assets that might create systemic risks for young investors likely to bear the brunt of such risks.
The DOL's new rules will hold retirement advisors to a much higher standard -- fiduciary duty. A fiduciary duty is the strictest duty of care recognized by the US legal system. As we'll discuss in this article, this seemingly simple rule change has profound ramifications for sustainable investing.
Under the new rules, brokers and advisors must put their clients' interests ahead of their own interests, which have often included recommending investments with higher fees instead of comparable investments with low fees; and investments in such dying industries as coal. Some readers may be surprised that this rule had not been in place. Probably less surprising: The DOL faced bitter opposition from the financial services and insurance industries for six years. The SEC, which governs non-retirement-based investing (the logic being that retirement funds are related to labor), does not require advisors to exercise fiduciary duty.
One of the overlooked ramifications of these new rules is the sea change for sustainable investing that could result, and how advisors -- and, by extension, investors -- view sustainable investments. Fiduciary duty requires both the duty of prudence -- to advise in a way that would best serve a so-called prudent investor -- but also a duty of impartiality. Impartiality requires that a fiduciary be impartial to all her beneficiaries.
While the duty of impartiality has not been given as much attention as other fiduciary duties (duty of care, duty of loyalty, etc.), it may well lead to significant changes among the investment community. As pension and retirement advisors increasingly represent Millennials, many of whom may not retire for nearly 50 years, failure to consider sustainability in their investment advice may constitute a failure to be impartial.
What is Duty of Impartiality?
The relevant law governing the duty of loyalty requires that fiduciaries must seek to impartially balance the interests of different fund participant groups, such as different generations of current participants, and not unreasonably favor one group of participants over the other, according to Keith L. Johnson, who heads the Institutional Investor Legal Services team at Reinhart Boerner Van Deuren, a law firm which represents pension funds and institutional investors on fiduciary, investment, securities litigation and corporate governance program matters.
In Varity v. Howe, 516 U.S. 489 (1996), the United States Supreme Court explained that the Employee Retirement Income Security Act (ERISA) applies the common law duty of impartiality principles. In its opinion the Court wrote: "The common law of trusts recognizes the need to preserve assets to satisfy future, as well as present, claims and requires a trustee to take impartial account of the interests of all beneficiaries..."
In practice, the duty of impartiality means that advisors to pensions or retirement funds representing many age groups must provide impartial advice, not favoring or discriminating against any groups, such as current retirees receiving benefits, older workers approaching retirement age, and -- increasingly important -- Millennials who may not retire for 50 or more years. As Millennials increasingly enter the workforce and invest in their retirement, to say nothing of the trillions they will begin to inherit from their Boomer parents, what is in their best interest may be far different than what may be in a Boomer's best interest. No longer can brokers simply ignore the impact on the largest generation in history -- at a whopping 80 million individuals born in the United States between 1980-2000, Millennials comprise the largest generation in history, approximately 20 million larger than the Boomer generation.
"Fiduciary duty is a flexible concept that evolves over time as both facts and circumstances which affect investment decisions change," notes Johnson. "Investment theory and our understanding of the role that sustainability plays in promoting long-term investment success have changed substantially over the past decade. That, in turn, has influenced investors to incorporate material sustainability factors into their investment decisions."
Millennials Have Different Investment Perspectives, Goals
With their formative years around the turn of the millennium (hence their name), the Millennials came of age during a period of rapid technological disruption and globalization. Research suggests they view investing and money differently than their parents or grandparents. The collapse of the financial markets during the Great Recession have led them to be the "least trusting of any generation," according to Pew Research Center, which published "Millennials in Adulthood."
Based on their age, their investment horizon should be long-term. But it's not. As this generation begins to think about which, if any, financial institutions to trust with their money, they're gun-shy. According to UBS's research, the average investor aged 21 to 36 has 52 percent of their savings in cash, compared to 23 percent for other age groups. Millennials, who came of age during the Great Recession, are "the most conservative generation since the Great Depression" with regard to savings habits.
Millennials' Values: Fairness, Equality, Climate Justice
Much has been written about Millennials' concern for fairness, social justice, and concerns about risks posed by climate change. Millennials report dissatisfaction with current institutional and economic status quo. It's no wonder that they've flocked in record numbers to Bernie Sanders' campaign rallies.
Just as Millennials have grown up in financial disruption, they've also experienced the reality of threats posed by climate change. They witnessed Katrina and Superstorm Sandy. Their science classes likely studied climate change in detail. According to a biannual poll by the Harvard Public Opinion Project, more than 75% of Millennials surveyed believe climate change is a proven fact.
As Millennials begin to shift their cash into major asset classes, financial advisors will need to advise them appropriately, based on their unique reality. Not their grandparents' or parents' reality. Failure to consider long-term environmental, social and governance (ESG) factors integration in investment decisions could be a failure of the common understanding of fiduciary duty. And for institutional investment managers who oversee funds serving multiple generations, failure to consider Millennials' particular interest might breach their duty to be impartial.
Is ExxonMobil an Appropriate Investment for Millennials' Retirement Funds?
Advisors will no doubt struggle with the duty of impartiality when balancing the needs of Millennial investors and those of Gen Xers and Boomers. Take investing in fossil fuel companies such as ExxonMobil, for example. Given Millennials' conservative stance on investments and their overwhelming belief that global warming is a fact, not a theory, might advisors be in breach of their fiduciary duty by investing millennials retirement assets in ExxonMobil?
Sure, its already high dividend was recently raised to .75/quarter, offering investors an annual yield of 3.39 percent. This may well serve a current retiree, or an employee who may retire imminently. But is ExxonMobil an appropriate investment for Millennials? The oil major has funded climate deniers. It fought shareholders who wanted to see the company's business plan to address climate change risks. Perhaps most worrisome, from an investor standpoint, are the risks posed by stranded assets, according to reports by Carbon Tracker Initiative. Roughly 26% of Exxon's CapEx over next ten years is not consistent with a 2 degree Celsius Scenario (2DS), the global increase temperature amount consistent with limiting concentration of greenhouse gases in the atmosphere to 450 parts per million of CO2. Will this cost Exxon's long-term investors dearly?
Millennials' Investment Choices Potentially Transformational
If Millennials' financial investments align with their concerns and their worldview, it could dramatically alter the financial landscape. And should Millennials opt en masse to "sustainably" invest, shifting their considerable existing -- and prospective -- financial wealth to assets that address their values, the financial landscape could be far different. It will no longer be business as usual. "Soon, as Millennials become an increasingly large share of the adult population and gather more and more wealth, the generation's size and unity of belief will cause seismic shifts in the nation's financial sector, shaking it to its very foundations . . . . " according to a Brookings research report.
Advisors will likely grapple with understanding fiduciary duty in this generation's context. Failure to consider long-term ESG integration in retirement investment decisions will soon actually be a failure of fiduciary duty to Millennials, and will become even more so over time.